THE ASIAN (GLOBAL?) FINANCIAL CRISIS, THE IMF, AND JAPAN: ECONOMIC ISSUES

CRS Report for Congress
The Asian (Global?) Financial Crisis, the IMF,
and Japan: Economic Issues
Updated September 3, 1998
Dick K. Nanto
Specialist in Industry and Trade
Economics Division

Congressional Research Service ˜ The Library of Congress

A^BSTRACT
This report focuses on several economic aspects of the Asian (global?) financial crisis, the
International Monetary Fund (IMF), and Japan. It briefly examines the origins, effects, and
policy options with respect to the Asian financial crisis, provides information on the size of
and actual disbursements under the IMF support packages to Thailand, Indonesia, and South
Korea, and discusses issues related to the IMF such as IMF resources, moral hazard,
contagion, conditionality, prevention, and transparency. It also examines effects on the U.S.
economy in terms of economic growth, the trade deficit, U.S. exports to Asia, and on specific
sectors of the economy. Finally, it discusses Japan’s economic weakness and how that
weakness relates to the Asian financial crisis. This report will be updated periodically as
economic conditions change. Other CRS products on this topic include CRS Report 97-1021,
The 1997-98 Asian Financial Crisis, CRS Report 98-238, The Asian Financial Crisis:
Chronology, Press Releases, Exchange Rates, and Stock Market Indices, and CRS Report

98-74, Asian Financial Crisis: An Analysis of U.S. Foreign Policy Interests and Options.

Information and legislation on funding for the International Monetary Fund can be found in
CRS Report 98-56, The International Monetary Fund’s (IMF) Proposed Quota Increase:
Issues for Congress, CRS Issue Brief 97038, The International Monetary Fund’s “New
Arrangements to Borrow” (NAB), and CRS Report 98-123, Supplemental Appropriations
and Rescissions for FY1998.

The Asian (Global?) Financial Crisis, the IMF,
and Japan: Economic Issues
Summary
The Asian financial crisis involves four basic problems or issues: (1) the role,
operations, and replenishment of funds of the International Monetary Fund, (2) a
shortage of foreign exchange in Thailand, Indonesia, South Korea and other Asian
countries that has caused the value of currencies and equities to fall dramatically, (3)
inadequately developed financial sectors and mechanisms for allocating capital in the
troubled Asian economies, and (4) effects of the crisis on both the United States and
the world. In 1998, the crisis that had been confined primarily to Asia appeared to be
spreading to the world. The crisis was taking global dimensions.
The Asian financial crisis was initiated by two rounds of currency depreciation
that have been occurring since early summer 1997. The first round was a precipitous
drop in the value of the Thai baht, Malaysian ringgit, Philippine peso, and Indonesian
rupiah. As these currencies stabilized temporarily, the second round began with
downward pressures hitting the Taiwan dollar, South Korean won, Brazilian real,
Singaporean dollar, and Hong Kong dollar. Governments have countered the
weakness in their currencies by selling foreign exchange reserves and raising interest
rates, which, in turn, have slowed economic growth and have made interest-bearing
securities more attractive than equities. The currency crises also has revealed severe
problems in the banking and financial sectors of the troubled Asian economies.
The International Monetary Fund has arranged support packages for Thailand
($17.2 billion), Indonesia ($42.3 billion), and South Korea ($58.2 billion). The
packages include an initial infusion of funds with conditions that must be met for
additional loans to be made available. The actual funds disbursed to date include only
those from the IMF, World Bank, and Asian Development Bank. The United States
has offered a line of credit from its Exchange Stabilization Fund for Indonesia and
South Korea. Under separate initiatives, the U.S. Export-Import Bank and U.S.
Department of Agriculture have allocated trade credits and loan guarantees to finance
U.S. exports to the troubled Asian countries.
The U.S. Congress is considering the Asian financial crisis within three broad
legislative contexts. The first is in the financing and scope of the activities of the IMF.
This includes legislation to provide the IMF with a $17.9 billion increase in its quotas
or capital subscriptions and New Arrangements to Borrow. Questions are being
asked, however, about the need for the additional funding, whether the IMF creates
a moral hazard, and whether the IMF should attach different conditions to its support
packages. The second legislative context is in the impact of the crisis on the U.S.
economy and American financial institutions. Forecasters foresee a decline in U.S.
economic growth of about 0.5 percentage point and an increase in the U.S. trade
deficit of about $65 billion because of the crisis. The third context is the efforts of
other countries, particularly Japan, in resolving the problem. Although Japan has
pledged credits under the IMF support packages, its economy is in recession and it
has not been performing its role as an engine of growth and absorber of exports from
its neighbors in Asia. Rather, Japan’s trade surplus is rising, particularly with the
United States.

Contents
Introduction ................................................... 1
Legislative Context..........................................1
An Outline of the Crisis...........................................2
IMF Support Packages...........................................7
The Role and Operations of the IMF................................10
IMF Resources............................................12
Moral Hazard.............................................14
Contagion ................................................ 17
Conditionality ............................................. 17
Transparency .............................................. 21
Prevention ................................................ 21
Effects on the U.S. Economy......................................21
Economic Growth..........................................22
U.S. Merchandise Trade Deficit................................24
U.S. Exports to Asia........................................26
Microeconomic Effects......................................27
Japan’s Economic Weakness......................................28
Conclusion ................................................... 33

The Asian (Global?) Financial Crisis, the IMF,
and Japan: Economic Issues
Introduction
The Asian financial crisis involves five basic problems or issues: (1) the role,
operations, and replenishment of funds of the International Monetary Fund (IMF), (2)
a shortage of foreign exchange in Thailand, Indonesia, South Korea and other
countries that has caused the value of currencies and equities to fall dramatically, (3)
inadequately developed financial sectors and mechanisms for allocating capital in the
troubled Asian economies, (4) Japan’s role in the financial crisis, and contagion effects
of the crisis on the United States and other countries of the world, particularly Russia
and Latin America. The Asian financial crisis may be spreading to the rest of the
world.
The focus of this report is on the economic issues related to the Asian financial
crisis. Russia also is undergoing a similar crisis and has received support from the
IMF. The Russian problem is addressed separately in CRS report 98-578. This
report provides a short description of the crisis in Asia, a summary of the IMF support
packages for Thailand, Indonesia, and South Korea, a discussion of the role of the
IMF and some of the legislative issues involved, the effects on the U.S. economy, and
a discussion of Japan’s role in the crisis. This report will be updated periodically. A
more detailed discussion of the origins of the crisis, the IMF support packages, and
implications for U.S. foreign policy can be found in CRS Reports 97-1021, The 1997-
98 Asian Financial Crisis; 98-238, The Asian Financial Crisis: Chronology, Press
Releases, Exchange Rates, and Stock Market Indices, and 98-74, Asian Financial
Crisis: An Analysis of U.S. Foreign Policy Interests and Options. Information on the
International Monetary Fund and legislation can be found in CRS Report 98-56, The
International Monetary Fund’s (IMF) Proposed Quota Increase: Issues for
Congress, and CRS Issue Brief 97038, The International Monetary Fund’s “New
Arrangements to Borrow” (NAB).
Legislative Context
The U.S. Congress is considering the Asian financial crisis within three broad
legislative contexts. The first is in the financing and scope of the activities of the IMF
and other international financial institutions. Attempts to resolve the problems have
been led by the International Monetary Fund (IMF) with cooperation from the World
Bank, Asian Development Bank, and several nations. In the 105 Congress,^th
legislation is being considered to provide and additional $17.9 billion in capital and
a credit line for the IMF. This includes $3.5 billion in New Arrangements to Borrow
and a $14.4 billion increase in the U.S. subscription to the IMF quotas or capital base.
The legislation includes new conditions for the IMF to impose on borrowers, requires

greater transparency by the IMF, new reporting requirements, and other provisions
that deal with IMF operations.
The second legislative context occurs in the impact of the Asian financial crisis
on the U.S. economy. Financial markets are interlinked. What happens in Asian
financial markets often affects U.S. markets — both financial and real. Not only has
the value of Asian equities on their stock markets affected U.S. investors, but the
financial problems in Asia are expected to increase the U.S. trade deficit by about $65
billion in 1998, reduce U.S. economic growth by about 0.5 percentage point, and
affect values on U.S. equity markets.
The third legislative context is in actions other nations, particularly Japan and the
Asian nations with currency problems, are taking to cope with the crisis. For Japan,
the question is whether its fiscal policies, restructuring, and measures to resolve its
problem with nonperforming bank loans are sufficient to bring its economy out of
recession, absorb more of the exports from the troubled Asian economies, and
strengthen the value of the yen. As for Thailand, Indonesia, and South Korea — the
three countries that have received IMF assistance — Indonesia is facing the most
difficulty with its currency down about 70% and economic and political conditions
unstable. Although the IMF and Indonesia came to a new understanding on economic
and financial policies and Indonesia’s President has changed, important questions
remain to be addressed before economic conditions in this fourth most populous
country in the world return to normal. Thailand and South Korea are undergoing
major structural changes and recovery is not expected to begin until after 1999.
An Outline of the Crisis
An outline of the Asian Financial Crisis, its major effects on the United States,
and some policy issues are presented in Figure 1. In essence, beginning in the
summer of 1997, a combination of excessive short-term and questionable bank
borrowing in the troubled Asian countries, lax oversight and regulation of financial
institutions, overheated property markets, and a structural relationship in which their
currencies were tied to an appreciating dollar (which led to rising trade deficits)
generated doubts among investors and lenders that Thailand and other Asian
governments could maintain their pegged exchange rates. This induced capital flight,
speculation that currency depreciation would occur, and a growing reluctance by
international lenders to roll over short-term loans. As speculators attacked exchange
rates and central banks depleted their foreign exchange reserves attempting to defend
them, currencies weakened further. Monetary authorities responded by raising
interest rates to try to keep capital from leaving their respective countries. This
caused values on equity markets to decline and even more investors to flee local stock
markets. Within a half year, about $700 billion was lost in Asian equity markets, and
many once-pegged exchange rates dropped considerably.
The falling currency values and rising interest rates hit local Asian businesses
hard. Not only were the size of their international loan repayments growing with each
drop in their exchange rates, but supplies of trade credit and loans to fund daily

Figure 1. Policy Options and Outline of the 1997-98 Asian Financial Crisis
as It Occurred in Thailand, Indonesia, and South Korea
and Affected the United States
THE CRISIS IN ASIAPOLICYEFFECTS
OPTIONSON THE U.S.
^{Excessive Short-term &}^{Stricter Bank}
^{Questionable Bank}^{Supervision in Asia}^{U.S. Bank Loan}
^{Borrowing & Lending}^{Less Asian Government}^{Quality Declines}
^{Appreciating Currencies Tied}^{Support of industries}
^{to the U.S. Dollar}^{More Market Data}
^{More Transparency}
^{Capital Flight &}^{Funds Flow}^{Into the U.S.}^{Lenders Extend}
^{Refusal by International}^{Loan Terms}
^{Banks to Roll Over}^{Get Government}
^{Asian Loans}^Guarantees
^{U.S. Interest Rates}
^Ease
^{Asian Currencies Weaken}^{Dollar Strengthens}^{More Exchange Rate}
^{Stock Market Rises}^Flexibility
^{Central Banks Sell}^Monetary
^{Foreign Exchange}^Authorities^{More U.S. Imports}^{More Efforts by Japan}
^{& Buy Own}^{Raise Interest}^{Fewer U.S. Exports}^{& Others to Provide}
^Currency^Rates^{U.S. Trade Deficit Rises}^{Assistance & Absorb}
^{Growth in U.S. Interest-}^Imports
^{Rate Sensitive}
^{Stock Markets Fall}^{Sectors (e.g. Housing)}
^{Foreign Exchange}^{Operating Costs for}^{Alter IMF Fiscal &}
^{Reserves Fall}^{Businesses Rise}^{Monetary Conditions}
^{Placed on Borrowers}
^{Lower U.S.}
^{IMF & Others}^{Economic Growth Slows}^{Business Profits Fall}^Economic^{Growth Rate}^{Replenish IMF}^{Quota &}
^{Lend Support}^{More Loans Turn Sour}^and^{Arrangements to}
^Lower^Borrow
^Profits^{Provide Trade Credits}
^{IMF Resources}^{Imports Decline}
^{Are Taxed}^{Exports Rise}^{Use IMF Conditions}
^{to Further U.S.}^Commodity
^Interests^{Prices Fall,}
^{Farmers, Oil}
^Producers,^{Crisis Spreads}
^{Trade Balance}^{etc. Hurt,}^{to Russia, Latin}
^Improves^{U.S. Stock}^{Re-impose Capital}^America
^Markets^{Controls, Re-peg}^{Exchange Rates}
^{Source: Congressional Research Service}^Jittery
operations shrunk considerably. Asian businesses began facing default — not only on
their international loans — but on domestic ones also. Despite the fact that certain
Asian exports had become significantly more price competitive in foreign markets
(because of the depreciation in exchange rates), Asian exporters faced difficulty
acquiring the finance capital to manufacture the goods for export. For the economies
as a whole, economic growth was slowing, business profits falling, and more and

more loans were turning sour. First Thailand, then Indonesia and South Korea were
compelled to turn to the International Monetary Fund for emergency financial
assistance. The Philippines had an existing credit line in place, and Malaysia took
resolute action to avoid having to resort to IMF support. The IMF coordinated
support packages to the three nations that included initial infusions of loans to ease
the liquidity crises and lines of credit that could be activated later. In return, the IMF
placed conditions of the countries for specific reforms that were designed to keep the
problems from recurring.
Figure 2. Exchange Values of the Japanese Yen, Thai Baht, Indonesian
Rupiah, and South Korean Won Relative to the U.S. Dollar
July 1997-August 1998
¹²⁰
^{IMF Package}^{Japanese Yen}
¹⁰⁰^{for S. Korea}
^{Thai Baht}
⁸⁰
⁶⁰^{IMF Package}^{for Thailand}
^{S. Korean}^Indonesian
⁴⁰^Won^{IMF Package}^{for Indonesia}^Rupiah
²⁰
^2nd^3rd
^{IMF & Indonesia Sign 2nd & 3rd Agreements}
⁰
¹⁸¹⁵¹⁹¹⁷²¹¹⁹¹⁶²⁰²⁰¹⁷¹⁵¹⁹¹⁷²¹
^{Jul 4}^{Aug 1}^{Sept 5}^{Oct 3}^{Nov 7}^{Dec 5}^{Jan 2}^{Feb 6}^{Mar 6}^{Apr 3}^{May 1}^{Jun 5}^{Jul 3}^{Aug 8}
¹⁹⁹⁷¹⁹⁹⁸
^{Source: PACIFIC Exchange Rate Service}
Figure 2 shows the value of the Japanese yen, Thai baht, Indonesian rupiah, and
South Korean won relative to the U.S. dollar. The currency depreciation that began
in Thailand soon became contagious and affected other currencies as well. Some
(such as the Hong Kong dollar and Chinese renminbi) proved quite resilient to this
“Asian flu,” but others likewise fell. Each has stabilized recently — albeit at
considerably lower levels relative to their exchange values at the beginning of July
1997. The exchange value of the Japanese yen, which was not an issue at the
beginning of the crisis, has continued to erode. If its value declines much more, it
could trigger further declines in other Asian currencies — perhaps even the Chinese
renminbi and Hong Kong dollar .
Figure 3 shows the total percentage change (appreciation or depreciation) in the
value of selected currencies relative to the U.S. dollar from July 1, 1997 to September

2, 1998. These currencies can be grouped into those with stable currencies (France,

China, the United Kingdom, Germany, Argentina, and Hong Kong), those with a
sizable depreciation of about 10% (Brazil, Poland, Canada, and Chile), those
experiencing substantial currency depreciation with declines of 15 to 25% (Venezuela,
Japan, Singapore, Mexico, Taiwan, and Australia), those countries in crisis with
depreciation of 25 to 50% (Thailand, South Korea, Malaysia, and the Philippines),
and those with a financial disaster on their hands with depreciation of more than 50%
(Russia and Indonesia). The exchange values of the currencies of the three Asian
nations that have received IMF assistance have fallen as follows: Thailand 28.3%,
South Korea 33.9%, and Indonesia 77.5%. As of early September 1998, the Russian
ruble was yet to stabilize. The currency crisis had reignited and had spread to Russia
and was threatening Latin America.
Figure 3. Total Changes in the Exchange Value of Selected
Currencies Relative to the Dollar,
July 2, 1997 to September 2, 1998
^Depreciation^Appreciation
^0.8^France
^0.2^China^Stable
^0.2^U.K.
^0.2^Germany
⁰^Argentina
^-0.1^{Hong Kong}
^-8.5^Brazil
^-8.8^Poland^Sizable
^-10.4^Canada^Depreciation
^-12.1^Chile
^-16.4^Venezuela
^-16.9^Japan
^-17.7^Singapore^Substantial
^-20^Mexico^Depreciation
^-20^Taiwan
^-22.5^Australia
^-28.3^Thailand
^-33.9^{S. Korea}^{In Crisis}
^-33.4^Malaysia
^-39^Philippines
^-55.9^Russia^Disaster
^-77.5^Indonesia
⁰²⁰^-20^-40^-60^-80^-100
^{Data Source: PACIFIC Exchange Rate Service}
As currency values have fallen, monetary authorities have attempted to defend
their exchange rates by raising interest rates and taking other austerity measures.
These higher interest rates in combination with lower economic growth and the threat
of further currency depreciation have caused investors to withdraw funds from the
troubled countries and invest them in less risky markets, such as those in the United
States. This has caused stock values on the Asian markets to fall. As capital flowed
into the United States, moreover, values on U.S. markets have risen, and U.S. interest
rates have fallen.

Figure 4. Stock Market Indexes for the United States, Japan, Thailand,
South Korea, and Indonesia, July 1, 1997 to August 20, 1998
¹⁴⁰
^{IMF Thai}^Indonesian^{U.S. Dow Jones}
^Package^Package
¹²⁰
^Japan
¹⁰⁰^Tokyo
⁸⁰
⁶⁰
⁴⁰^Indonesia^Jakarta^{South Korea}
^S.Korean^{Hong Kong}^Seoul^{Attack on Hong}
^Package^{Hang Seng}^{Kong Dollar}
²⁰
^{Jul 4}^{Jul 18}^{Aug 1}^{Oct 10}^{Oct 24}^{Nov 7}^{Dec 5}^{Jan 2}^{Jan 16}^{Jan 30}^{Apr 10}^{Apr 24}^{May 8}^{Jun 5}^{Jun 19}^{Jul 3}^{Jul 17}^{Jul 31}
^{Aug 15}^{Aug 29}^{Sep 12}^{Sep 26}^{Nov 21}^{Dec 19}^{Feb 13}^{Feb 27}^{Mar 13}^{Mar 27}^{May 22}^{Aug 14}^{Aug 28}
¹⁹⁹⁷¹⁹⁹⁸
^{Source: Trendlines,}^F^{inancial Times}^.^{Seoul Composite, Jakarta Composite,}
^{Tokyo Nikkei 225, Hong Kong Hang Seng, & Dow Jones Industrial Indices}
Figure 4 shows indexes of stock values denominated in local currencies for the
United States, Japan, Hong Kong, South Korea, and Indonesia. The linkages that had
developed among world equity markets was demonstrated dramatically in late
October 1997 when the Hong Kong monetary authority had to defend its fixed
exchange rate. The resultant high interest rates caused values on the Hong Kong
stock exchange to fall which triggered a similar decline in values in South Korea and
even in the United States. Turmoil continued through 1997, but in early 1998,
markets had stabilized and appeared to be recovering. The U.S. Dow Jones average
climbed to record highs. As spring turned to summer, however, a rising U.S. trade
deficit in combination with lower corporate profits and a more pessimistic outlook for
Asian economies began to be reflected in stock prices. During July and August, all
five of the indexes have declined. The Russia Trading Index of stock values (not
shown) had fallen even more dramatically. At the end of August 1998, it was 84%
below its level in July 1997.
One structural change that is causing world stock markets to become more
interlinked has been the rise of mutual funds. When mutual fund managers incur
losses in one market (Hong Kong, for example), they may sell stock on another
market (New York?) in order to realize profits there and make up for the losses. The
popularization of no-load mutual funds (no entry fees) in combination with Internet
trading also implies that investors can move in and out of funds more quickly and
inexpensively. Investor withdrawals because of a stock decline in one market,
therefore, can start a chain reaction as fund managers are forced to liquidate stocks
in other markets in order to meet the cash requirements of investors leaving the funds.

IMF Support Packages
As the Asian financial crisis hit Thailand, Indonesia, and South Korea, each
approached the International Monetary Fund, World Bank, Asian Development Bank
and certain countries for help. The IMF coordinated the response with support
packages that were designed to restore investor confidence — both international and
local — in the economies of the recipient nations. The packages constituted a three-
pronged approach to the problems: (1) immediate efforts to restore liquidity in
currency markets by providing loans, introducing more flexibility to exchange rates,
a tightening of monetary policy (raising interest rates), efforts to reopen lines of
external financing, and maintenance of sound fiscal policies; (2) structural reforms
aimed at strengthening financial sectors which included closing unviable financial
institutions, recapitalizing some institutions, improving supervision and regulation,
and allowing for more foreign participation in domestic financial systems; and (3)
addressing governance issues underlying the crisis which included improving the
efficiency of markets, breaking the “crony capitalism” links between business and
government, liberalizing capital markets, and providing for more transparency (in
disclosing data on external reserves and liabilities). The financial commitments are¹
summarized in Table 1.
Table 1. IMF Financial Support Packages
(Amounts in U.S.$Billion)
ThailandIndonesiaSouth Korea
Date Initially ApprovedAugust 20November 5December 4
(1997)
Total Pledged$17.2 $42.3$58.2
First-Line Lending
IMF $4.0 $11.2$20.9
World Bank, Asian $2.7 10.0$14.0
Development Bank
Secondary Lines of Credit
U.S. None $3.0 $5.0
Japan $4.0 $5.0 $10.0
Others $6.5 $13.1 $10.3
Source: World Bank, Asian Development Bank Press and News Releases, Wall Street
Journal. International Monetary Fund. The IMF’s Response to the Asian Crisis. April

1998. On Internet at <http://www.imf.org/External/np/exr/facts/ asia.htm>.

International Monetary Fund. The IMF’s Response to the Asian Crisis. July 27, 1998. On¹
Internet at <http://www.imf.org/External/np/exr/facts/asia.HTM>.

The total amounts of the packages are approximate because the IMF lends funds
denominated in special drawing rights (SDRs), and because pledged amounts have
changed as circumstances have changed. The support package for Thailand was
$17.2 billion. For Indonesia the total package reached $42.3 billion, and the package²
for South Korea was even higher at $58.2 billion.
The program begins with loans from the IMF, World Bank, and Asian
Development Bank — the first-line lenders. The rest of the support package consists
of secondary lending that is to be activated only under emergency conditions. As part
of these secondary lines of credit, the United States pledged $3 billion for Indonesia
and $5 billion for South Korea from its Exchange Stabilization Fund (ESF). No
funds have yet been disbursed for the two Asian nations from the ESF. The U.S.
Treasury lends money from the ESF at appropriate interest rates and with what it
considers to be proper safeguards to limit the risk to American taxpayers. This fund
of approximately $30 billion has been self-financing after the initial appropriation of
$2 billion in 1934 and has been used to provide loans to many Latin American, Asian,
African, and European countries experiencing currency difficulties. This includes $12
billion loaned to Mexico in 1995 at the time of the Peso crisis. Loans from the ESF
do not require congressional approval. (In the 105 Congress, several bills have been^th
introduced that would impose restrictions on the amount of ESF loans under certain
conditions, require money to be transferred from the ESF to another fund, or require
reports by the Administration on the ESF.)³
After the IMF commits funds to a support package, it begins with an initial loan
installment (tranche) of hard currency to the borrowing nation. The loan is
conditioned upon certain actions or commitments by the borrowing country.
Subsequent amounts are made available (usually quarterly) only if certain performance
criteria are met and satisfactory program reviews are completed. The funds borrowed
by the recipient country usually go into the central bank’s foreign exchange reserves.
These reserves are used to supply foreign exchange to sellers of the domestic currency
— both domestic and international. Since the funds from the IMF go into the
recipient nation’s foreign exchange reserves which then may be supplied to foreign
exchange markets, they cannot be tracked to determine who actually receives the
money. In some cases, the IMF funds may be used merely to increase the level of
foreign exchange reserves, since the IMF usually requires a certain level of foreign
exchange reserves to be maintained by a country as a condition of its loan.
The World Bank and Asian Development Bank operate more on a project basis.
They are development banks. They lend their funds directly to the recipient nation for
specific projects at an interest rate and repayment schedule they determine. Projects
may be for institution building such as modernization of the banking sectors in the

The $17.1 billion IMF support package for Russian announced on July 13, 1998, included²
$11.6 billion in new loans from the IMF, $4.0 billion from the World Bank, and $1.5 billion
from Japan.
For background on the Exchange Stabilization Fund, see: CRS Report 98-583, The³
Exchange Stabilization Fund of the U.S. Treasury Department: Purpose, History, and
Legislative Activity, by Arlene Wilson.

troubled Asian countries. Table 2 shows total commitments and actual disbursements
of funds by the IMF and the two development banks.
Table 2. Actual Disbursements of Loans as Part of the
IMF-led Asian Financial Support Packages
(As of August 30, 1998, Amounts in U.S.$Billion)
ThailandIndonesiaSouth Korea
Total Pledged$17.1 $36.6$58.2
IMF Disbursements(8/20/97)$1.6(11/5/97)$3.040(12/4/97)$5.56
(Date and Amount)(12/8/97)$0.81(5/4/98)$0.989(12/18/97)$3.5
(3/5/97)$0.27 (7/15/98)$1.000 (12/30/97)$2.0
(6/10/98)$0.135 (8/25/98)$1.000 (1/8/98)$2.0
(2/17/98)$2.0
(5/29/98)$2.0
Total: $2.8Total: $5.989Total: $17.06
World Bank(9/11/98)$0.015(7/97)$0.0425(12/23/97)$3.0
Disbursements (12/23/97)$0.350 (11/19/97)$.0345 (3/27/98)$2.0
(2/26/98)$0.015 (12/4/97)$0.0200
(7/9/98)$0.300 (3/4/98)$0.0205
(7/9/98)$0.400 (4/1/98)$0.3607
(6/2/98)$0.2250
(7/2/98)$1.0000
(7/14/98)$0.0447
(7/29/98)$0.0215
Total: $1.080Total: $1.769Total: $5.0
Asian Development(12/22/97)$.300(12/19/97)$3.015
Bank Disbursements(3/12/98)$.300
Ongoing projects
in 1997$0.269
(3/26/98)$1.000Total: $3.015
Total: $1.869
Total Disbursements$5.749$7.758$25.075
Source: World Bank, Asian Development Bank Press and News Releases, Wall Street
Journal. International Monetary Fund. The IMF’s Response to the Asian Crisis. April

1998. On Internet at <http://www.imf.org/external/np/exr/facts/asia.htm>.

The financial crisis also has impaired the ability of these countries to obtain
normal trade finance, such as letters of credit. This problem was addressed at a
meeting of the financial leaders of the Group of Seven Industrialized Nations (G-7)
on February 21, 1998, in which the leaders decided that the eighteen export credit
agencies from eleven industrialized countries would work to provide trade financing
support to the troubled Asian economies. The U.S. Export-Import Bank stated that
it could commit up to $3 billion in additional short-term financing in support of
American products sold to South Korea, Thailand, and Indonesia. In January 1998,

the Bank also decided to expand the short-term insurance capacity for commercial
banks in South Korea. ⁴
Since East Asia accounts for 40% of total U.S. agricultural exports, the U.S.
Department of Agriculture has been increasing its support for U.S. sales there. It has
allocated/authorized export credit guarantees (under the Commodity Credit
Corporation’s GSM-102 and 103 programs) for fiscal year 1998 of $100 million for
Malaysia, $300 million for Thailand, $410 million for Indonesia, $102 million for the
Philippines, $90 million for other Southeast Asia, and another $1.5 billion for South
Korea. ⁵
On March 16, 1998, the Asian Development Bank (ADB) approved participation
in a $1 billion export financing facility for Thailand. The facility is to provide liquidity
for Thai exporters whose operations have been hampered by lack of credit and
consists of two loans to the Export-Import Bank of Thailand. The first loan consists
of $50 million from the ADB. The second is a syndicated loan (partially guaranteed
by the ADB) of $950 million fully underwritten and arranged by ten leading
international banks.⁶
The Role and Operations of the IMF
Among the international institutions, the focus of the IMF is on maintaining a
stable, accessible, and transparent system of buying and selling of currencies in order
that payments and other currency flows can take place among countries smoothly and
without delay. It is a cooperative monetary institution of 182 members that
specializes in the system of buying and selling of currencies and in assisting, when
necessary, its member countries to develop the financial infrastructure that supports
those flows. It serves as a lender of last resort for its members, much like a central
bank does for nations. In emergencies, it lends hard currencies to members facing
severe financial difficulties but only on condition that they undertake economic
reforms that address the causes of their troubles. The IMF has authority to require
its members to disclose information on monetary and fiscal policies and to avoid, as
far as possible, putting restrictions on transactions in foreign exchange or on making
payments to other members. It also reviews world economic and financial trends and

U.S. Export-Import Bank. Ex-Im Bank Working in Support of 18 Country Export Credit⁴
Agency Trade Finance Initiative to Stabilize Asian Markets. Press Release. February 23,

1998. Available on Internet at <http://www.exim.gov>.

U.S. Department of Agriculture. Foreign Agricultural Service. $400 Million More in Credit⁵
Guarantees For Republic of Korea. News Release. April 20, 1998. $1 Billion in Credit
Guarantees Available for Southeast Asia, FAS Release PR 0004-98. January 5, 1998. On
Internet at <www.fas.usda.gov>.
Asian Development Bank. ADB Approves $1 Billion Export Financing Facility for Thailand.⁶
News Release No. 22/98, 26 March 1998. On Internet at <www.asiandevbank.
org/news98/nr022-98.htm>. The ten banks are: ABN-AMRO Bank N.V.; The Bank of
Nova Scotia Asia Limited; the Bank of Tokyo-Mitsubishi Limited; Banque Nationale de
Paris, Singapore Branch; Barclays Capital; Citicorp Investment Bank (Singapore) Limited;
The Development Bank of Singapore Limited; DKB Asia Limited; The Industrial Bank of
Japan Limited; and Sakura Finance Asia Limited.

may warn countries of what it sees as their emerging financial problems. It collects
data and analysis and promotes modernization and liberalization of national financial
sectors. The IMF claims to have learned from the Mexican Peso crisis in 1995 and
has instituted emergency procedures that has enabled it to respond more quickly to
the crises in Asia.
The mission of the IMF differs from that of other international economic
institutions. The IMF is not a development bank, such as the World Bank (IBRD),
Asian Development Bank (ADB), and other regional development banks that focus
primarily on lending to poorer nations for specific development projects. It also
differs from the Bank for International Settlements (BIS) which is an international
bank that is owned and controlled by central banks. BIS provides specialized central
banking services, promotes cooperation among central banks, and fosters financial
stability among the major industrial countries. The IMF also has a different mission
from the World Trade Organization (WTO) which deals primarily with trade in goods
and services.
In place of the IMF, nations (such as the United States, members of the
European Union, or Japan) with support from BIS, might have been able to
coordinate the financial support packages as the “Asian flu” spread, but individual
nations are subject to the constraints of domestic politics and diplomacy. The United
States, for example, did not participate in the initial financial support package for
Thailand. After the extent of the crisis and the economic and security threats to the
United States became more apparent, the U.S. government joined in promising
financial resources in the Indonesian and South Korean packages, but the IMF
negotiators and specialists (along with U.S. Treasury officials) played the chief role
in determining the needs, conditions, and reforms necessary in the borrowing
countries. By relying on the IMF, the United States has been able to influence the
outcome of the negotiations without committing large financial resources to provide
support for the borrowing nations. The United States has been able to exercise power
at relatively low cost. U.S. backup loan commitments under the IMF support
packages are yet to be activated. (Of course, U.S. influence in the IMF also carries⁷
the potential for the United States to be blamed for any failures of the IMF or for the
economic hardship that arises in nations that have borrowed from the IMF.
As the crisis developed, Japan attempted to establish a $100 billion emergency
fund for Asia. It, however, was rebuffed by other nations, particularly the United
States, but also by its Asian neighbors who were wary of Japan’s intentions. There
also were questions about how the fund would operate and its relation to the IMF.
The policy questions with regard to the IMF span a broad gamut from whether
it should exist at all to what its level of funding should be and how it should operate
in order to accomplish the goals of international financial stability and growth in world
trade and investment. In the 105 Congress, H.R.3090 (Paul) would require the^th
withdrawal of the United States from the International Monetary Fund.

See: Davis, Bob. With GOP Support for the IMF Weakening, Danger Is the Slow Erosion⁷
of U.S. Leadership Globally. The Wall Street Journal, April 27, 1998. P. A24.

The Asian financial crisis has raised several questions pertaining to IMF
operations. The first is whether such crises have increased in scale and whether IMF
resources are sufficient to cope with them. The second is whether the Fund’s
willingness to lend in a crisis contributes to moral hazard (a tendency for a potential
recipient country or investors to behave recklessly knowing that the IMF may bail
them out in an emergency). The third is whether the contagion of financial crises can
be stopped effectively. The fourth is conditionality — whether the changes in
economic policy and performance targets that the IMF requires of the recipient
countries are appropriate and effective. The fifth is transparency — whether the IMF
releases sufficient information to the public, including investors, to allow for accurate
assessment and accountability — especially with respect to IMF program design and
provisions imposed as a condition for borrowing. The sixth is prevention — whether
the IMF has sufficient leverage over non-borrowing member countries to prevent
financial crises from occurring.⁸
IMF Resources
With respect to the available IMF resources and scale of financial crises, it is
clear that recent liberalization of capital markets and advances in telecommunications
have increased the scale of financial crises. The size of the support packages for
South Korea and Indonesia have been unprecedented. The question is whether the
IMF has sufficient resources to handle more financial crises, particularly if they occur
simultaneously. A related issue is whether the IMF should be denied any additional⁹
funding as a way to express disapproval of its handling of the financial crisis.
As for IMF resources, the ratio of the IMF’s uncommitted and adjusted liquid
resources to its liquid liabilities — its so-called liquidity ratio — had fallen from

120.5% at the end of April 1997 to 47.8% at the end of December 1997. Further¹⁰

deterioration has occurred in 1998. This implies that the IMF has half or less than the
amount of liquid resources it needs to meet its liquid liabilities. An April 1998 article
in the Wall Street Journal estimated that after making the loans to deal with the Asian
crisis, the IMF would have another $13 billion or so in capital plus a $24 billion credit
line to deal with other emergencies. Considering the $20.9 billion in IMF support¹¹
for South Korea alone plus a new commitment of $11.2 billion for Russia, the IMF
is left with arguably inadequate resources to deal effectively with a possible spread of
the financial crisis or other emergencies. In funding the support for Russia, the IMF
activated its general arrangements to borrow.¹²

See also: CRS Report 98-56, The International Monetary Fund’s (IMF) Proposed Quota⁸
Increase: Issues for Congress, by Patricia A. Wertman.
For a detailed discussion of IMF resources, see: CRS Issue Brief 97038, The International⁹
Monetary Fund’s Proposed Quota Increase and “New Arrangements to Borrow (NAB), by
Patricia A. Wertman.
Ibid., p. 9.¹⁰
Davis, Bob. With GOP Support for the IMF Weakening, Danger Is the Slow Erosion of¹¹
U.S. Leadership Globally. The Wall Street Journal, April 27, 1998. P. A24.
International Monetary Fund. IMF Approves Augmentation of Russia Extended¹²
(continued...)

In the United States, the primary legislative issue related to the IMF and the
Asian financial crisis revolves around a total of $17.9 billion from the United States
for an increase in the IMF’s capital base and in a further line of credit. The IMF has
asked for a $14.4 billion increase in its quota (capital base) and for a $3.5 billion
increase in a line of credit (New Arrangements to Borrow) to be used in emergencies.
The IMF quotas provide the financial resources from which the IMF extends loans to
financially troubled member nations. In addition to determining the size of the IMF's
capital and members’ contributions, quotas also determine a member country's voting
power and, in part, its access to IMF loans, and share in allocations of Special
Drawing Rights (SDRs, the international reserve asset created by the IMF).
On September 21, 1997, the Interim Committee of the IMF announced an
agreement to increase overall IMF quotas by 45%. This proposal was finalized in late
December 1997 and adopted by the IMF on February 6, 1998. Total IMF quotas
would increase from about SDR 146 billion (about $197 billion, as of April 9, 1998)
to SDR 212 billion ($287 billion).
The U.S. portion of the IMF quota would increase by 40%, from SDR 26.5
billion ($36 billion) to SDR 37.1 billion ($50 billion), an increase of about $14.4
billion. At the same time, the U.S. share of the total IMF quota would drop from
18.1% to 17.5% which would still be sufficient to enable it to veto major IMF
decisions (which require an 85% majority vote). The voting power of members is
determined by their quota shares.
In addition to the request for approval of U.S. participation in the quota increase,
Congress is considering a request for an increase in its credit line to the IMF of $3.5
billion called "New Arrangements to Borrow" (NAB). The NAB are an arrangement
of medium-term credit lines that the IMF may borrow against to supplement its
resources in the event of a financial crisis that requires additional liquid resources.
Commitments to the NAB from 25 participant nations total about $46 billion of which
the U.S. share would be $9.0 billion (counting the additional $3.5 billion). In the

105 Congress, H.R.1171 (Kasich) would declare the sense of Congress that the^th

United States should not participate in the NAB.
If the United States does not fund its share of the quota increase or the NAB, its
18.1% of the voting shares means that, in effect, the 85% majority vote would not be
achieved and either funding increase would be disapproved at the IMF level. Other
countries also would likely not provide their shares of the funding.
On March 26, 1998, the Senate passed S. Amendment 2100 to S.1768 (105^th
Congress), the Supplemental Appropriations Bill. This would have provided for both
the $3.5 billion for the NAB and $14.4 billion for the IMF quota increase (with certain
conditions). On March 31, the Senate passed H.R. 3579 with the language of S.
1768, as amended. The Conference committee, however, did not include the IMF
funding in the final bill. On September 2, 1998, the Senate passed S.2334

(...continued)¹²
Arrangement and Credit under CCFF; Activates GAB. Press Release No. 98/31, July 20,

1998.

(McConnell), the Foreign Operations FY99 Appropriations bill, which includes IMF
funding. The House is considering other legislation (H.R. 3580, Livingston
[Supplemental Appropriations Bill] as well as H.R. 1293 [Kennedy], H.R. 3114
[Leach] and H.R.3287 [Frank]) that would provide funding for the IMF.
Under current budgetary treatment, U.S. quota subscriptions to the IMF are
considered to be an exchange of assets. Both the quota increase and NAB must be
authorized and appropriated (because of congressional concern at the time this
budgetary rule was made over the rising fiscal deficit and off-budget spending), but
neither would result in a net budgetary outlay nor have any effect on the Federal
budget deficit or surplus. IMF funding also would increase the budget’s discretionary
spending limits in order not to preclude other spending.¹³
One question with respect to the IMF resources is whether it should be required
to borrow on international capital markets rather than rely on quota subscriptions and
lines of credit from member nations. The World Bank and Inter-American
Development Bank both sell bonds on international markets in order to raise funds for
their operations. In this respect, H.Con.Res 207 (Saxton, 105 Congress) expresses^th
the sense of the Congress that the IMF should raise funds in private financial markets
through the sale of bonds or notes, rather than from member countries, in order to
reduce the risk of loss to U.S. taxpayers.
Moral Hazard
Moral hazard refers to the tendency for something that is designed to alleviate
the ill effects of risky decisions to encourage more risky decisions to be made. In the
international financial context, it refers to the tendency for borrowers and lenders to
behave less prudently knowing that the IMF or their respective governments may bail
them out if the loans turn sour. Even supporters of the IMF recognize that the very
existence of the IMF may encourage countries to borrow excessively on international
markets and for lenders to act imprudently..
The IMF, points out, however, that governments in trouble usually are too slow
in approaching the Fund for help because of the conditions the IMF places on such
support. Even some countries with severe currency difficulties, such as Malaysia in

1997, will do almost anything to avoid having to swallow the “bitter IMF medicine.”

According to the IMF, the real moral hazard is not with governments (particularly
quasi-governmental banks) engaging in unsound borrowing and lending but that,
because IMF support is available, the private sector may be too willing to borrow and
lend. Private sector financial institutions know that a country in trouble will go to the
Fund rather than default on international loans. ¹⁴

More details on U.S. budgetary treatment of the IMF may be found in: CRS Report 96-¹³

279, U.S. Budgetary Treatment of the International Monetary Fund, by Patricia A.

Wertman.
Boorman, Jack. The Changing Emphasis of the Fund, Implications for Stabilization and¹⁴
Growth Policies. Paper presented at the IMF Seminar, Asia and the IMF. September 19,

1997. Hong Kong.

Others, moreover, assert that the IMF is perpetuating the moral hazard that lies
at the heart of the problem for troubled economies like South Korea. By providing
support for countries in financial trouble, the IMF may be allowing their governments
to use other resources to prop up companies that essentially are insolvent. Some
governments have not allowed certain favored corporations to fail because of political
or other connections. In the words of one commentator, “Capitalism without
bankruptcy is like Christianity without hell. There is no systematic means of
controlling sinful excesses.” This type of moral hazard certainly existed in the¹⁵
troubled Asian countries. Banks may continue to lend to corporations in difficulty on
the prospect that they will receive government assistance. In other cases, the
government, itself, may channel funds to troubled companies from private or quasi-
governmental financial institutions. The Bank of Thailand, for example, revealed that
it had spent or otherwise committed about $25.5 billion between mid-1996 and March
1998 to prop up troubled Thai financial institutions — most of which it later shut
down. It claimed that it had been acting "on orders" given by two successive finance
ministers. In South Korea, when the Hanbo steel venture collapsed in 1997 with¹⁶
$5.8 billion in debts, it was found that government officials has exerted pressure on
banks to provide loans to Hanbo in return for illegal political contributions.
One solution to the problem of moral hazard is to ensure that imprudent lenders
or investors in the recipient countries do not escape real losses. This has been
happening to a large extent. International banks, for example, face large potential and
real losses from their operations in Asia. For example, in 1997, the Asian turmoil
reduced Citicorp’s pretax earnings by about $250 million. The Bank of America¹⁷
reported that as of December 31, 1997, it had assets of $24.0 billion in Asia (up from
$20.4 billion in December 1996), but net income from Asia had dropped from $224
million in 1996 to -$218 million in 1997. During the fourth quarter of 1997, J.P.¹⁸
Morgan designated as nonperforming approximately $587 million of its total $5.4
billion in loans, swaps, and debt investment securities in Indonesia, Thailand, and
South Korea. The bank reported charge-offs of $24 million during the quarter —
mostly related to Asia, and considered about 60% of its total allowance for credit
losses of $1.081 billion to be related to exposures in the three troubled Asian¹⁹
countries. As for investors in equity markets, they also have incurred major losses.
In January 1998, U.S. Federal Reserve Chairman Alan Greenspan stated that U.S.
investors in Asian stock markets (excluding those in Japan) had lost an estimated $30
billion. ²⁰

South China Morning Post, January 8, 1998. P. 3.¹⁵
Bangkok Discloses Lending to Banks. Wall Street Journal, March 5, 1998. P. A18.¹⁶
Citicorp. Fourth Quarter Report. January 20, 1998. P. 1.¹⁷
Bank of America. BankAmerica Fourth Quarter 1997 Earnings. January 21, 1998. P. 15.¹⁸
J.P. Morgan. Fourth Quarter and 1997 Full Year Results. January 1998. P. 4. Available¹⁹
on Internet at <http://what.inet.jpmorgan.com/Corp...information/4qtr97earns/
summ.html>.
U.S. Federal Reserve Board. Testimony of Chairman Alan Greenspan before the Committee²⁰
on Banking and Financial Services, U.S. House of Representatives, January 30, 1998.
(continued...)

As for the domestic moral hazard and perceived lack of bankruptcy in some
countries, this too has changed as the crisis swept through certain economies of Asia
and the IMF imposed conditions aimed at strengthening financial sectors. In Korea,
for example, the operations of 14 of 30 merchant banks have been suspended. The
remaining merchant banks also are being monitored closely. In Indonesia, 16
insolvent banks have been closed, and weak but viable banks have been required to
submit rehabilitation plans. In Thailand, 56 of 91 finance companies are being
liquidated.
One question is whether the IMF loans are used to bail out international banks,
including American banks, that have made loans to the troubled Asian economies that
in retrospect seem imprudent. There is little doubt that banks which have loans
outstanding in Asia have much to gain by a return to stability in financial markets
there. To the extent that the IMF support packages have contributed to that stability
and to the extent that the infusion of dollars by the IMF has enabled borrowers to
purchase foreign exchange needed to make loan repayments, the losses by U.S. banks
and other creditors have been stemmed.
The IMF insists, moreover, that its assistance has been provided to support
programs that are designed to deal with economy wide, structural imbalances and not²¹
to protect commercial banks and private investors from financial losses. A more
stable exchange rate may contribute to a recovery on stock markets or better business
conditions, but there is no IMF “bailout” of specific investors. Since IMF loans are
used primarily to augment foreign exchange reserves of the borrowing nations, they
become intermingled with existing reserves. Foreign exchange from the IMF is
usually sold through local foreign exchange dealers for local currencies. The IMF
does not loan directly to private companies.
As for bailouts of manufacturing or other nonfinancial corporations, the IMF
claims that there are no provisions in the IMF-supported programs for public-sector
guarantees, subsidies, or support for them. Shareholders and creditors bear losses,
although individual governments may devise separate policies for dealing with such
cases. Any company in need of foreign exchange, however, usually is better off when
foreign exchange markets are stabilized.
As for financial corporations, the IMF recognizes that governments often
guarantee accounts of certain categories of depositors (deposit insurance).
Governments also can provide liquidity support to undercapitalized, but solvent,
financial institutions. According to the IMF, however, such support normally requires

(...continued)²⁰
Available on the Internet at <http://www.bog.frb.fed.us/boarddocs/testimony/

19980130.htm>.

International Monetary Fund. IMF Bail Outs: Truth and Fiction. January 1998. Available²¹
on the Internet at: <http://www.imf.org/external/np/exr/facts/bailout.htm>.

that institutions be capable of actually being recapitalized and restructured to restore
them to health.²²
Contagion
With respect to contagion, the track record of the IMF in stopping the spread
of the financial crisis has not been reassuring. The size of the global capital flows
underlying the crisis along with the extent of structural problems uncovered in the
economies of the troubled nations seem to reach beyond the ability of the IMF handle
completely. The total of $26 billion in IMF loans to Thailand, Indonesia, and South
Korea is small when compared with the total foreign exchange needs of these nations
and the billions of dollars that flow through foreign exchange markets each day.
For the first year of the Asian financial crisis, the problems seemed to have been
confined largely to Asia. During the summer of 1998, however, Russia had to
devalue its ruble even further, Japan’s yen and its economy continued to weaken,
China intimated that it might devalue its currency, values had dropped on stock
markets worldwide, and economic forecasts were becoming more an more
pessimistic. According to Standard & Poor’s DRI, the major reason for the more
pessimistic outlook was that Asian exports were doing more poorly than had been
anticipated. They also indicated that the Japanese yen could depreciate even further,
a devaluation of the Chinese renminbi was “almost a certainty,” the insolvency
problems of corporations and financial institutions throughout the Asian region appear
to be much more ominous than previously imagined, anti-Chinese turmoil in Indonesia
was driving away capital, the collapse of regional tourism had undermined service-
sector growth in nearly every country in the region, and the severe decline in the
international prices of primary commodities had severely reduced incomes in the
agricultural and mining sectors of many Southeast Asian nations. ²³
The fall in the price of crude petroleum, copper, and other commodities also was
undermining the export income of Russia, Mexico, Venezuela, Chile, and other
commodity exporting countries. The drop in values on stock markets in late August
along with speculative attacks on the currencies of nations such as Russia, Venezuela,
and Mexico have added to the uncertainty in world markets. A risk still exists not
only for the financial crisis to worsen in Asia but for it to spread to other countries of
the world. The Asian financial crisis may become global.
Conditionality
IMF conditionality refers to the “strings attached” to its lending. Opinions on
conditionality are diverse and can be intense. Although the IMF provides support to
the very countries who also are its owners and managers, the support comes with
powerful strings attached. Not only is the financial assistance extended in the form
of loans that carry a rate of interest and must be repaid, but the loans are disbursed
in installments with each disbursement dependent on the borrower meeting the

Ibid.²²
Standard & Poor’s DRI. International Financial Bulletin, August 1998. P. 3.²³

performance criteria and receiving favorable reviews by IMF officials. In the United
States, much of the controversy associated with the legislation to provide additional
funding for the IMF centers on the conditions that the IMF may or may not impose
upon the recipient nations.
According to IMF policy, IMF conditionality is to be applied only in areas that
relate to the recipient country’s macroeconomic performance. The IMF Articles state
that performance criteria “will normally be confined to (i) macroeconomic variables,
and (ii) those necessary to implement specific provisions of the [IMF’s] Articles....”
Performance criteria may relate to other variables only in exceptional cases when they
are essential for the effectiveness of the member’s program because of their²⁴
macroeconomic impact.
In practice, most microeconomic policies can be interpreted to have some
macroeconomic effect. In the Indonesian support package, for example, the IMF
conditions required that the country restructure certain banks, dismantle a quasi-
governmental monopoly on all commodities (except rice), cut fuel subsidies, increase
electricity rates, increase the transparency of public policy and budget-making
processes, and speed up privatization and reform of state enterprises. The IMF,²⁵
however, did not require action on human rights or security policy, two controversial
areas less closely linked to Indonesia’s macroeconomy.
In the South Korean support package, the IMF required numerous
macroeconomic and financial conditions, and it also required the Korean government
to undertake several microeconomic or structural measures. These included reducing
trade-related subsidies, increasing the ceiling for foreign investment in listed Korean
firms, liberalizing other capital account transactions, and easing labor dismissal²⁶
restrictions under mergers and acquisitions and corporate restructuring.
The controversy over IMF conditionality extends in two directions. The first is
whether the monetary and fiscal policies required by the IMF are too stringent and
slow economic growth too much in the recipient countries. The World Bank, in
particular, reportedly fears that the slowdown in economic growth in the troubled
Asian economies will only worsen their economic problems. As non-Asian²⁷
economies, such as Russia, Mexico, and Venezuela, have been buffeted by currency
and stock market weakness, the critics of the stringent IMF conditions have become

International Monetary Fund. Guidelines on Conditionality. Decision No. 6056-(79/38),²⁴
March 2, 1979. In Selected Decisions and Selected Documents of the International^nd
Monetary Fund, 22 Issue. Washington, D.C., 1997. P. 118.
International Monetary Fund. IMF Approves Stand-by Credit for Indonesia. Press Release²⁵
No. 97/50, November 5, 1997.
International Monetary Fund. IMF Approves SDR 15.5 Billion Stand-By Credit for South²⁶
Korea.
Davis, Bob and David Wessel. World Bank, IMF at Odds over Asian Austerity. Wall²⁷
Street Journal, January 8, 1998. P. A5, A6. See also: Pearlstein, Steven. Tiff in the
Economists’ Temple. Washington Post, April 5, 1998.

more vocal. Some claim that the IMF has actually made conditions worse. The IMF
has been sensitive to these criticisms and has eased the requirements for Thailand and
Korea. One measure of whether the IMF conditions are too onerous is the²⁸
performance of Malaysia. Malaysia has avoided an IMF support package but has
been subject to the same market pressures as its neighbors, Thailand, Indonesia, and
South Korea. As shown in Figure 5, however, Malaysia’s economic performance,
however, has not been too different from that of Thailand and South Korea, both of
which are under IMF austerity programs.
Figure 5. Currency and Stock Market Declines (Since JulyAnother IMF
1997), Estimated Growth Rates for 1998, and Primecondition that is
Interest Rates (August 1998) for Malaysia,opposed by some in
Indonesia, Thailand, and S. Korea the United States is
requiring tax
¹⁰⁰increases by
⁷⁰borrowing countries.
⁵⁰This is intended to
¹²¹⁶¹²reduce fiscal deficitsand to promote
^-2.7^-12.2^-6.5^-7⁰currency stability.
^-33^-28^-34^-50Others claim
^-55^-64^-48that the IMF should
^-77^-73focus on its
^-100traditional task of
^Malaysia^Indonesia^Thailand^{S. Korea}
helping countries
^{Currency Depreciation}^{Stock Market}cope with temporary
^{1998 Growth Rate}^{Interest Rate}shortages in foreign
^{Source: Congressional Research Service}exchange and with
sustained trade
deficits rather than imposing major structural and institutional reforms at all. They²⁹
assert that the IMF does not have the expertise or resources to intervene to such an
extent in the economies of borrowing nations.
The second direction of controversy relating to IMF conditionality is whether the
United States should use its voice and vote in the IMF to press for certain conditions
to be imposed or to drop certain conditions from IMF programs. Currently, there are
about 30 voice-and-vote requirements in U.S. statutes that direct the U.S. Executive
Director of the IMF to promote certain desired changes. Typical of these is the³⁰

International Monetary Fund. IMF Executive Board Completes Second Review of²⁸
Thailand's Economic Program. News Brief No. 98/5, March 4, 1998. P. H1. Seoul, IMF
Agree to Lower Rates to Curb Insolvencies, Create Jobs. Wall Street Journal Interactive
Edition, April 27, 1998. On Internet at <http://interactive.wsj.com>.
Feldstein, Martin. Refocusing the IMF. Foreign Affairs, March/April 1998. P. 20.²⁹
Montes, Manual. Global Lessons of the Economic Crisis in Asia. Asia Pacific Issues, No.

35, March 1998.

CRS Report 98-391. The IMF and “Voice and Vote” Amendments: A Compilation, by³⁰
(continued...)

Frank-Sanders amendment (U.S.C. 22 § 262p-4p). Among its provisions, this law
requires the U.S. Executive Directors of the International Financial Institutions to use
their voice and vote to urge their respective institution to adopt policies to encourage
borrowing countries to guarantee internationally recognized worker rights and to
include such rights as an integral part of the institution’s policy dialogue with each
borrowing country.
In the 105 Congress, S.2334 (McConnell), the Foreign Operations FY99^th
Appropriations bill, includes provisions that would require G-7 countries to support
a requirement that borrowing countries liberalize restrictions on trade consistent with
trade agreements and also would require borrowers to eliminate government directed
lending on non-commercial terms, remove discriminatory treatment between foreign
and domestic creditors in its debt resolution proceedings, adopt modern bankruptcy
laws, and for the IMF to increase the transparency of its operations. The bill also
would establish an International Financial Institution Advisory Commission to
examine consolidating the IMF, World Bank, and World Trade Organization; require
the Administration to provide certain reports to Congress and certify that no IMF
resources have resulted in support to the semiconductor, steel, automobile, or textile
and apparel industries. H.R. 3580 (Livingston, Emergency Supplemental
Appropriations) and H.R. 3114 (Leach, 105 Congress) also include similar and^th
additional provisions.
One question that has been raised concerning IMF conditionality is whether it
can require trade liberalization that goes beyond that which is necessary under World
Trade Organization agreements. In this respect, the IMF’s “Guidelines/ Framework
for Fund Staff Collaboration with The New World Trade Organization” (adopted by
the IMF in 1995) states that policy measures and program conditionality should be
consistent with the member’s agreements under the auspices of the WTO. The
Guidelines also state that IMF policy advice, however, often encompasses features
that require reforms that may go beyond a member’s undertakings in the WTO. For
example, trade barriers or subsidies may be reduced under an IMF-supported program
below the levels required under the relevant WTO agreements, but they cannot be
raised above the WTO-required levels. The Guidelines further state that IMF-
supported programs should avoid directly linking the use of IMF resources to the
performance of obligations under the WTO-administered agreements.³¹
Transparency
Critics of the IMF claim that the institution does not release sufficient data to the
public — particularly to investors who have financial interests in the success or failure
of the IMF support packages and who need more information to devise effective

(...continued)³⁰
Patricia A. Wertman and Pamela Hairston.
International Monetary Fund. Guidelines/ Framework for Fund Staff Collaboration with³¹
The New World Trade Organization, Decision No. 10968-(95/43), April 21, 1995. In^nd
Selected Decisions and Selected Documents of the International Monetary Fund, 22 Issue.
Washington, D.C., 1997. P. 468-69.

strategies to cope with the crises. A problem in the current environment of³²
insufficient information and data is that certain information from the IMF could
precipitate a crisis if investors reacted en masse. The IMF, therefore, has released
certain detailed information only with the concurrence of the pertinent country.
Recently, the IMF has tried to disclose more information that it did previously. Its
press releases and speeches by IMF officials now contain more data and analysis.
Other documents have been made public with permission. For example, the
Supplemental Memorandum of Economic and Financial Policies agreed to between
the IMF and Indonesia on April 10, 1998, was released by the IMF only with the
permission of the government of Indonesia. The bills in the 105 Congress that would^th
provide additional funding for the IMF include provisions on transparency.
Prevention
With respect to prevention, the IMF has little leverage over member countries
who are not borrowers. Political parties facing re-election, moreover, may inflate the
domestic economy or may be reluctant to take harsh measures for fear of losing the
election. For example, prior to the financial crisis in Thailand, even though the IMF
claims to have warned the country that it was headed for trouble, Thai leaders faced
great difficulty in mustering the political support to restructure the 58 financial
institutions that eventually became insolvent. Also, before their currency crises, both
Mexico and South Korea held presidential elections. IMF is now reportedly exploring
a system in which it would issue increasingly severe warnings to nations whose
economic policies are seen as “seriously off course.” The Fund would issue warnings
as private communications with member nations but would consider making them
public in certain circumstances.³³
Effects on the U.S. Economy
The Asian financial crisis affects the U.S. economy both in a macroeconomic and
microeconomic sense. On the macroeconomic level, it is affecting the U.S. growth
rate, interest rates, balance of trade, and related variables. On a microeconomic level,
it is affecting specific industries, each in a different way depending on their
relationship to the troubled Asian economies.
A danger exists that the Asian financial turmoil may turn into a worldwide crisis.
In August 1998, Russia and certain countries of Latin America were experiencing
currency weakness and a drop in values on their stock markets similar to that
experienced in Asian countries. In many respects, Russia appears to be in a situation
worse than that of Asian nations because its fundamental economic structure is
weaker. The current recession (depression in some countries) in Asia could evolve
into a world recession that would affect the United States directly.

See, for example, Sachs, Jeffrey. Power Unto Itself. Financial Times, December 11, 1997.³²
P. 11.
Blustein, Paul. IMF Seeks to Be More Forceful in Approach to Crisis. Washington Post,³³
April 18, 1998. P. D1.

The mechanism by which the Asian financial crisis affects the U.S.
macroeconomy is through trade, capital flows, and investor confidence. The
depreciation in the values of the Asian currencies (except for the Hong Kong dollar
and Chinese RMB) combined with a slowing of growth and financial difficulties of
banks and manufacturing corporations in these countries is expected to increase the
U.S. trade deficit by about $65 billion. In the Asian countries, the immediate effect
of the change in the value of their currencies and outflows of capital is to reduce their
trade deficits, and, in some cases, to generate a trade surplus. Much of this increased
trade surplus for Asia appears to be coming at the expense of the United States.
The second macroeconomic mechanism by which the Asian financial crisis affects
the U.S. economy is through capital flows. As the contagion began and Asian banks
and corporations began to face severe financial difficulties, a concern arose in the
United States that Asian holders of American financial assets, particularly U.S.
Treasury securities, might be forced to dispose of them in order to generate much
needed cash or that foreign central banks might sell them as part of their intervention³⁴
to support their respective currencies. This has occurred to some extent. It seems,
however, that a “flight to quality” has more than offset this activity. Both American
and foreign investors withdrew liquid capital (by selling securities and not rolling over
loans) from the troubled Asian countries and moved the funds into safer markets like
those in the United States. The appreciating U.S. dollar also has made U.S.
investments more attractive. This influx of capital has eased the upward pressure on
U.S. interest rates and has had a positive effect on U.S. economic growth. The
capital flows, however, have caused some volatility on U.S. stock markets.
Economic Growth
The Asian financial crisis has slowed down U.S. economic growth directly and
indirectly through its negative effects on world economic growth. In April 1998, the
IMF reduced its projections for world output growth for the year to just over 3%
which is down from 3.5% it projected in December 1997 and 4.25% it projected three
months earlier in October 1997. This lower world growth is being caused by
downward revisions in the outlook in the three economies most affected by the crisis
— Indonesia, South Korea, and Thailand — and also more pessimistic outlooks for
Malaysia, the Philippines, and Japan.³⁵
Other forecasts parallel those in the IMF outlook. Table 3 shows forecasts for
several countries for 1998 and 1999. These forecasts were made before the Russian
crisis in August 1998, and, therefore, are probably on the optimistic side for most
countries. The worst economic performance is expected in the troubled Asian
economies with Indonesia, Thailand, South Korea, Hong Kong, and Japan in
recession with negative growth rates in 1998. The outlook for each of these

Much of the foreign central bank reserves of foreign exchange is kept in the form of U.S.³⁴
Treasury securities under the custody of the U.S. Federal Reserve. When the Bank of Japan,
for example, intervenes to support the yen, it may sell some of its Treasury securities for
dollars and use those dollars to buy yen.
International Monetary Fund. March 1998 World Economic Outlook. P. 1. On Internet³⁵
at <http://www.imf.org>.

economies has worsened during 1998. The rest of Asia seems to be weathering the
storm with Hong Kong and Singapore expected to grow by 2 to 3% and Taiwan and
China to log growth rates more than twice as high. Economic recovery in Europe is
expected to continue.
Table 3. Outlook for Economic Growth (Change in
Real GDP) in Selected Countries
1998 and 1999
(In Percent)
Country 1998 1999 Country 1998 1999
Indonesia -15.0 -0.6. Taiwan 4.4 4.7
Thailand -8.0 -1.0 China 6.3 6.4
S. Korea-7.0-1.0United States3.42.3
Japan -1.1 1.1 Germany 2.7 2.7
Philippines03.3United Kingdom2.21.9
Hong Kong-1.51.6Mexico4.84.4
Singapore 1.1 2.9 Russia -3.0 -6.0
Sources: Forecasts for Indonesia, Thailand, South Korea, and Philippines are from
Goldman Sachs. Those for Russia are from Standard & Poor’s DRI. Other forecasts
from Blue Chip Economic Indicators, August 10, 1998.
Figure 6. Growth in U.S. Real Gross Domestic ProductAs for the United
1990-99 (forecast)States, American
forecasters project
⁵that U.S. economic
^Actual^Forecastgrowth will slow
^3.5^3.8^3.4⁴slightly from 3.8% in
^2.7^2.4³1997 to about 3.4% in

^2.3²^2.3
²
^1.3
¹
⁰
^-1^-1
^-2
¹⁹⁹⁰⁹¹⁹²⁹³⁹⁴⁹⁵⁹⁶⁹⁷⁹⁸⁹⁹
^{Sources: Blue Chip Economic Indicators, U.S. Dept. of Commerce}

1998. (See Figure 6.) As 1998 has progressed, this forecast had risen from 2.5%³⁶

in January to 3.1% in May. In April 1998, the Organisation for Economic
Cooperation and Development projected U.S. economic growth to be 2.7% in 1998
and 2.1% in 1999. ³⁷
The slowdown in U.S. economic growth is being caused primarily by two
factors: the Asian financial crisis and tightness in U.S. labor markets. A comparison
of forecasts for U.S. economic growth made in August 1998 with those made before
July 1997, however, reveals one unexpected result. The forecasts for economic
growth made after the crisis erupted are higher than those published in July 1997
before the onset of the troubles. The main reason for this seems to be that in mid-
1997 forecasters were wary of the Federal Reserve Board’s concern over the run-up
in the U.S. stock market and tightening labor markets and thought it probable that the
Federal Reserve would raise U.S. interest rates. These concerns were eased by the
correction in the U.S. stock market in October 1997 and by the financial turmoil in
Asia. After the market volatility in August-September 1998, the Federal Reserve is
even less likely to raise interest rates soon. The rising U.S. trade deficit, therefore,
is being offset by the easing of upward pressures on U.S. interest rates and higher than
expected activity in interest-sensitive sectors, such as housing.
U.S. Merchandise Trade Deficit
Forecasters expect the 1998 U.S. merchandise trade deficit to increase
significantly because of the drop in the value of currencies in Asia, net capital inflows,
and the slowdown in growth in those economies. The capital inflows into the United
States and outflows from the troubled Asian economies imply that the respective
current accounts must move in the opposite direction. For the United States, a rise
in the surplus in the capital account implies an offsetting rise in the deficit in the U.S.
current account — most of which is trade in goods and services.³⁸

Blue Chip Economic Indicators. August 10, 1998. P. 2.³⁶
Organisation for Economic Cooperation and Development. OECD Economic Outlook 63,³⁷
Preliminary Edition. April 8, 1998. On Internet at <http://www.oecd.org>.
Trade in goods and services plus income from foreign investments and unilateral transfers.³⁸

Figure 7. U.S. Merchandise Trade and Current AccountAs shown
Balances, 1990-1999 (forecast)in Figure 7,
Standard &
⁰Poor’s Data
^-4Resources, Inc.
^-51^-50^{Current Acct. Balance}(DRI) expects
^-74^-100the U.S.
^-92^-86^-96merc handis e
^-124^-115^-135^-109^-133^-150trade deficit
^-155^-166(bal ance-of -
^-174^-191^-200^{Merchandise Trade}payments basis)
^-198^Balance
to increase by
^-235^-250about $65
^-262^-265billion from
^-300^Actual^Forecast$198.9 billion
^-307
^-350in 1997 to $265
¹⁹⁹⁰⁹¹⁹²⁹³⁹⁴⁹⁵⁹⁶⁹⁷⁹⁸⁹⁹billion in 1998
and further to
^{Sources: Actual data from U.S. Dept. of Commerce. Forecasts are from Standard}$307 billion in
^{& Poor's Data Resources Inc.}^{Review of the U.S. Economy}^{. Akugust 1998. p. 94.}1999. DRI also
expects the
U.S. deficit on current account to rise by about $80 billion from$155 billion in 1997³⁹
to $235 billion in 1998 and further to $262 billion in 1999.
Figure 8. U.S. Merchandise Trade Balances As shown in
with Selected Asian Countries, 1996-97Figure 8, the
United States has
²⁰been experiencing
⁴^4.1^1.9^4.8a deficit in its
⁰merchandise trade
^-4.1^-4.3^-2^-3.6^-5.2^-4.6^-3^-2.3with the Asian
^-11.4^-12.2^-20countries that
1996have experiencedcurrency
^-39.5^-401997problems —
^-47.6^-49.7except for South
^-55.6^-60Korea. With the
exception of
^Japan^China^Taiwanthose for
^Thailand^Indonesia^Philippines^Singapore^{S. Korea}^{Hong Kong}Singapore and
Hong Kong, the
deficits increased
^{Source: U.S. Department of Commerce}in 1997. The
surplus with
South Korea is expected to change to a deficit in 1998. The largest trade deficits,
however, still are with Japan and China. While the Japanese yen has been weakening,
Japan has not yet encountered a currency crisis, although that country faces severe

Standard & Poor’s DRI. Review of the U.S. Economy, August 1998. P. 94.³⁹

financial difficulties and a stagnant economy made worse by the financial crisis in
neighboring countries. China has been holding the value of its currency stable.
What effect does intervention by the IMF and others to stabilize currency
markets have on U.S. industries that compete with imports from Asia? On one hand,
the intervention helps Asian companies, such as Samsung or Hyundai in Korea, meet
their needs for foreign exchange and provides a more stable operating environment
for them. This makes them more competitive relative to their U.S. counterparts. On
the other hand, a currency that depreciates lowers the price for Asian exports relative
to products made in America. IMF intervention to stabilize Asian markets and curb
excessive currency depreciation, therefore, helps U.S. companies competing with
imports from Asia by keeping import prices from falling even further.
U.S. Exports to Asia
Figure 9. U.S. Merchandise Exports by Month to the AsianU.S. export
Eight: Indonesia, Japan, South Korea, Malaysia, Philippines,industries depend on
Singapore, Taiwan, and ThailandAsia for more than a
July 1996-June 1998quarter of their
foreign markets.
²⁰The economic
^{Asian Financial}performance of the
^Crisiscountries in Asia
¹⁵along with their ex-
change rates are a
¹⁰major determinantof how much they
buy from American
⁵ex-porters. The rise
in the U.S. deficit in
trade with Asia, so
⁰far, is being caused
^Jul^Sep^Nov^Jan^Mar^May^Jul^Sep^Nov^Jan^Mar^Maymore by a drop in
¹⁹⁹⁶¹⁹⁹⁷¹⁹⁹⁸
U.S. exports there
than by a rise in U.S.
imports from those
countries. Asian exporters’ production has been constrained by a lack of foreign
exchange to import raw materials and components and other disruptions to their
operations. As conditions stabilize, however, production for export is expected to
rise. Figure 9 shows total U.S. exports of merchandise by month to eight of the
Asian nations affected by the crisis (Indonesia, Japan, South Korea, Malaysia, the
Philippines, Singapore, Taiwan, and Thailand). The fall-off in U.S. exports since the
onset of the Asian financial crisis is apparent.

Figure 10. U.S. Merchandise Exports by Month to theFor the three
Asian Three: Thailand, Indonesia, and South Korearecipients of IMF
July 1996-June 1998support packages
(Thailand,
⁵Indonesia, and
South Korea), the
⁴^{Asian Financial}^Crisisdrop in U.S. exports
associated with the
³Asian financial crisisis even more
²^Koreaconspicuous.Figure 10 shows
U.S. merchandise
¹exports to these
^Thailand
three countries from
⁰^IndonesiaJuly 1996 to June
^Jul^Sep^Nov^Jan^Mar^May^Jul^Sep^Nov^Jan^Mar^May1998. As the
¹⁹⁹⁶¹⁹⁹⁷¹⁹⁹⁸
financial crisis
affected the ability
of these countries to
import, U.S. exports to Korea fell by 49% from $2,326 million in July 1997 to
$1,196 million in June 1998. Likewise, U.S. exports to Indonesia declined by 52%
from $346 million to $166 million, and U.S. exports to Thailand dropped by 33%
from $534 million to $360 million over the same eleven-month period.
Microeconomic Effects
On a microeconomic level, the Asian financial crisis affects those industries most
closely linked to the economies in question. The following provides a rough outline
of the major U.S. sectors that may be affected.
!U.S. creditors and investors in Asia — U.S. banks, pension funds, and
investors stand to lose on their pre-crisis exposures, but “bottom fishers” may
gain as Asian equity markets recover and currencies strengthen.
!U.S. exporters to Asia — U.S. providers of major export items, such as heavy
equipment, aircraft, manufacturing machinery, computers, and agricultural
commodities (particularly soybeans, corn, lumber, and tobacco) are seeing
Asian demand for their products decline. U.S. producers of commodities used
in manufacturing processes in Asia also are experiencing soft prices (e.g.
petroleum, chemicals, cotton, copper, and rubber).
!U.S. businesses that compete with imports from Asia — U.S.
manufacturers of automobiles, apparel, consumer electronics, steel, and other
products that compete with imports from Asia are likely to see increased
competition and downward pressures on prices. Exporters from Korea,
however, report that they are experiencing difficulty obtaining foreign
exchange to finance imports needed in their production processes. This, in
turn, constrains their exports. U.S. labor engaged in manufacturing competing
products tend to be hurt by Asian exchange depreciation.

!U.S. businesses related to interest rates — mortgage bankers, refinancing
companies, builders, and other businesses that benefit from lower rates of
interest are seeing greater activity.
!U.S. businesses the sell imports from Asia — distributors and retailers of
products from the troubled Asian economies are likely to have increased
activity. These include discount retailers and Korean automobile dealers.
!U.S. multinational corporations seeking market access in Asia — U.S.
companies, particularly in the financial sector, that have encountered barriers
to entry or restrictions on their activities in Indonesia, Thailand, and South
Korea are likely to benefit from the market opening required by the IMF
support packages. They also may be able to buy existing firms that need
restructuring and recapitalization at attractive prices.
!U.S. multinational corporations with manufacturing subsidiaries in Asia
— Most U.S. companies with direct investments in the region will probably
weather the storm, although some investments have been thrown into question.
Since about 60% of the output from U.S. manufacturing subsidiaries in Asia
is sold in the region, local sales are likely to stagnate until economic growth
resumes. Some excess capacity may emerge. For a manufacturing subsidiary
in a country with a depreciated local currency, its cost of imported components
has risen, but the price of the finished export to the U.S. and other hard
currency markets has fallen.
!U.S. subsidiaries of companies from troubled Asian nations — Companies
from South Korea, in particular, with subsidiaries in the United States are
being forced either to cut back operations or, in some cases, to sell their
American subsidiary companies. Some Japanese banks also are selling certain
subsidiaries in the United States (e.g. Sumitomo Bank’s sale of 85% of the
Sumitomo Bank of California to Zions Bank).
!U.S. industries that use components from Asia — U.S. manufacturers that
use parts and other inputs from Asian countries whose currencies have
depreciated (e.g. computer assemblers) are experiencing lower costs of
production.
An overall indicator of the effect of the Asian financial crisis on U.S. businesses
is the outlook for corporate profits. The increased competition from imports
combined with rising wage costs in the United States is expected to reduce the growth
in U.S. corporate profits in 1998 to about 1.6% (before adjusting for inflation) which⁴⁰
is a significant decline from the 9.4% in 1997 or the 13.2% in 1996. Lower profit
growth by corporations tends to have a negative effect on their stock prices.
Japan’s Economic Weakness
The Asian financial crisis also calls into question the actions by other nations to
resolve the situation, particularly Japan. Japan plays a key role in the financial turmoil
because it is the second largest economy in the world, its currency plays a large role
in Asian trade, and its banks and businesses are major players in the economies of
Asia. The problem with Japan is four-fold. First, the Japanese yen is weakening
relative to the dollar. The weak yen was a primary cause of the overvaluation of the

Blue Chip Economic Indicators, August 10, 1998.⁴⁰

Asian currencies (which had been tied to the dollar) that led to the drop in their
values. Second, Japan’s economy, with the exception of 1996, has been virtually in
recession since 1991. This weak domestic economic activity has depressed the
market for other exports from other Asian countries. Third, Japan’s financial sector,
particularly its banks, face a massive problem with nonperforming loans that the
government and financial institutions have been slow to resolve. This banking
problem not only has depressed economic growth in Japan, but Japanese bank lending
in Asia also is being curtailed. And fourth, it was the Japanese model of strong
central government intervention in allocating capital through bank loans that led many
of the other Asian nations into what has been called “crony capitalism” or the
allocation of loans based more on personal or other relationships rather than on sound
market principles. In these ways, Japan has been as much a contributor to the
economic problems in Asia as a solution to them.
The Asian financial crisis could hardly have hit Japan at a worse time. Japanese
banks that have been struggling for a half decade with an overhang of nonperforming
loans at home now face the prospect of many of their foreign loans also turning sour.
At the end of 1996, Japanese banks reported total loans outstanding to Indonesia at
$22.0 billion, to South Korea $24.3 billion, Thailand $37.5 billion, Malaysia $8.2
billion, the Philippines $1.6 billion, and to Taiwan $2.7 billion. In addition, Japanese
banks had loans of $87.5 billion in Hong Kong and $58.8 billion in Singapore — both
offshore banking centers (which often re-loan the funds to borrowers in other nations)
for a total lending exposure in these eight economies of Asia of $242.6 billion or

62.3% of the total international lending of Japanese banks. Japanese banks have⁴¹

more exposure to the troubled Asian economies than those of any other nation.
Japan has pledged significant amounts as part of the IMF support packages ($4
billion to Thailand ($2.68 billion disbursed), $5 billion to Indonesia ($1 billion
disbursed), and $10 billion to South Korea. Most of the funds disbursed by Japan are
from its Export-Import Bank to finance trade with these countries or through its
foreign aid program (which likely would have occurred anyway). The Bank of Japan
also has intervened in foreign exchange markets to support certain Asian currencies.
The Japanese support is partly under a program agreed upon by the finance ministers
of the Group of Seven (G-7) industrialized nations on February 20, 1998 in which
Japan’s Export-Import Insurance Division of the Ministry of International Trade and
Industry (MITI) is to underwrite $1 billion of trade insurance for each Thailand and
Indonesia. Japan’s Export-Import Bank also provided about 300 billion yen ($2.3
billion) in loans during Japan’s fiscal year 1997 (ending March 30, 1998) and another
$1 billion this fiscal year in order to promote trade between Japan and the region.
The problem with Japan has been its basic economic policy stance. Until
recently, the underlying strategy of the Japanese economic policymakers seems to has
been to: (1) increase the surplus in its trade accounts by allowing the yen to weaken,
(2) encourage capital outflows, (2) place higher priority on reducing the budget deficit
(tight fiscal policy) than stimulating economic growth, (3) pursue a monetary policy
that appears to be loose but actually is restrictive in some respects, and (4) take only

Bank for International Settlements. The Maturity, Sectoral and Nationality Distribution of⁴¹
International Bank Lending. Second Half 1996. Basle, Switzerland, July 1997. P. 19-20.

incremental measures (although sizable) to resolve the problem of nonperforming
loans.
Japan’s economy is not performing the role as an engine of growth for Asia.
Rather the country, itself, is facing recession and has exhibited weak demand for
imports from the troubled Asian economies. Over the past year, the only growing
sector in the Japanese economy has been net exports. Just when other Asian
economies need help, Japan has been relying on its exports, including those to its⁴²
neighbors in Asia, to generate growth at home. In February 1998, Japan’s surplus
on total merchandise trade jumped by 68% from ¥875 billion a year earlier to ¥1,471
billion (about $11 billion). While these surpluses have been declining since the onset⁴³
of the Asian financial crisis, they are shrinking, not because imports from these
countries are increasing, but because Japanese exports there are decreasing. Trade
data for January 1998, show that compared with a year earlier, Japanese exports to
South Korea declined by 41.8%, to Indonesia by 18.3%, and to Thailand by 34.4%.
In the same month, Japanese imports from South Korea did increase slightly, but
those from Thailand dropped 5%, and those from Indonesia were down 16%.
Some of this decline in Japan’s imports from Thailand and Indonesia can be
attributed to the economic turmoil there. Companies in those countries may have had
difficulty obtaining trade credits to purchase raw materials or to finance exports. The
decline, however, also could be caused by stagnation in the Japanese economy that
is depressing imports and a tendency by Japanese firms with subsidiaries in Southeast
Asia to favor home production over imports when markets are slack. Exporters in the
troubled economies also may bypass the Japanese market in favor of that of the
United States and Europe because they perceive Japanese markets to be less open.
According to Singaporean trade statistics, for example, Singapore’s exports to Japan
in December 1997 fell by 7.1% compared with that a year earlier, while exports to the
United States rose by 19.8% and to the European Union by 19.7%. At a March 7,
1998, meeting of the Asia Pacific Economic Cooperation (APEC) forum, government
and business leaders called on Japan to promote market-opening measures to help
alleviate the economic and financial crisis in the region. ⁴⁴

See, for example, Landers, Peter. Gaiatsu Galore. Far Eastern Economic Review,⁴²
Interactive Edition, March 5, 1998. On Internet at <www.feer.com>.
Japan. Ministry of Finance.⁴³
APEC Officials Urge Japan To Open Market Further. Nikkei Net News, March 9, 1998.⁴⁴
On Internet at <http://www.nikkei.co.jp>.

Figure 11. Monthly Changes in Japan’s Yen-Dollar Exchange Rate
and Foreign Exchange Reserves (Percent)
(X = Intervention to weaken a weakening yen,
O = Intervention to weaken a strengthening yen,
z = Intervention to strengthen a weakening yen.)
¹⁰
Yen-dollar Exchange Rate
Weaker Yen
⁵
X X X X X X XX X
⁰
O O
^-5ForeignStronger YenO
Exchange
ReservesO
^-10
¹²³⁴⁵⁶⁷⁸⁹¹⁰¹¹¹²¹²³⁴⁵⁶⁷⁸⁹¹⁰¹¹¹²¹²³⁴⁵⁶
¹⁹⁹⁶¹⁹⁹⁷¹⁹⁹⁸
^{Source: Data from International Monetary Fund, Japan Ministry of Finance}
Data on holdings of foreign exchange reserves by Japan, moreover, indicate that
Japan has been following a deliberate weak-yen policy despite the Asian financial
crisis. Figure 11, shows monthly percentage changes in Japan’s official foreign
exchange reserves (including holdings of gold) along with changes in Japan’s yen-
dollar exchange rate. The accumulation or disposal of foreign exchange reserves is
functionally equivalent to intervention in foreign exchange markets. If Japan’s central
bank is accumulating foreign exchange, it is refraining from converting dollars, marks,
pounds, and other foreign currencies into yen. This weakens the value of the yen and
strengthens the value of foreign currencies, particularly the dollar. (As the volume of
Japan’s foreign trade increases, its need for foreign currency reserves also may rise,
but the level of Japan’s currency reserves seems out of line with those of other major
trading nations. Germany’s reserves [including gold] are about $80 billion, the United
Kingdom’s about $40 billion, and the U.S. government’s about $70 billion.)
If Japan’s policy is to stabilize its exchange rate, changes in its holdings of
foreign exchange and in the level of its exchange rate should move in opposite
directions. When the yen is weakening, Japan should be selling foreign exchange
(buying yen), and vice versa. If, however, Japan is accumulating foreign exchange at
the same time that its currency is weakening, it is pursuing a “weak yen” policy. It
is intervening in the market to further weaken the yen. In Figure 11, such policy
episodes predominated during 1996 and 1997. They are indicated by an X in the

figure. When Japan is accumulating foreign exchange at a time the yen is
strengthening, it also is pursuing a policy of weakening the yen. These episodes are
indicated with an O and add to the episodes in which Japan pursued a “cheap yen”
policy. The times when Japan was selling dollars to strengthen its yen, which is the
policy the United States has encouraged Japan to take, are indicated by a z. These
episodes occurred primarily after the onset of the Asian financial crisis (from mid-
1997) and primarily after the value of the yen had dropped to levels that threatened
to further destabilize world markets. Even during the Asian crisis, however, Japan
has, at times, reported net increases in foreign exchange reserves. After intervening
in foreign exchange markets by selling off $1.1 billion in June 1998, the Bank of Japan
added $1.6 billion in July to raise its foreign exchange reserves to $207.5 billion.⁴⁵
Japanese monetary policy also faces a dilemma. Some economists point out that
interest rates have fallen so low (the Bank of Japan’s discount rate is 0.5%) that they
no longer provide any stimulus. Even with cheap loans, businesses report that they⁴⁶
face a “credit crunch” because banks are not anxious to lend. One cause of this
reported reluctance in the midst of an easy money policy is that Japanese banks are
now required to meet international banking standards for their capital-asset ratios.
Since banks count part of their unrealized gains on holdings of corporate equities as
capital, the decline in values on Japanese stock markets has reduced their capital and
forced them to decrease their assets (loans) to keep their ratios from falling below the
required level. One suggestion is for Japan to reflate its economy by expanding its
money supply and continue to allow its currency to depreciate. In June 1998,⁴⁷
Japan’s money supply (M+CD’s) was up only about 3.5% from the year previous.²
Given the need for economic stimulus, this increase seems fairly conservative.
The United States and other industrialized nations have been encouraging Japan
to stimulate its economy by cutting taxes, increasing spending, and taking other
measures. On April 9, Prime Minister Hashimoto announced a long anticipated
economic stimulus package that included a ¥10 trillion yen (about 2% of GDP or $75
billion) increase in government spending and tax cuts. It was the largest stimulus
package in Japanese history, but was greeted with little enthusiasm by investors on
Japan’s stock exchange. It includes a ¥4 trillion tax cut that had been advocated by
U.S. officials. When Japan’s new Prime Minister Keizo Obuchi took office on July
31, 1998, he promised to temporarily freeze the fiscal austerity law with its limits on
the budget deficit, to implement an additional ¥10 trillion supplementary budget, and⁴⁸
carry out ¥6 trillion in permanent income tax cuts. Obuchi’s promised policy
changes, however, are yet to be implemented.

Japan’s Exchange Reserves Climbed to $207.5 Billion in July. The Daily Japan Digest,⁴⁵
August 6, 1998. P. 2.
Meltzer, Allan. Time for Japan to Print Money. On the Issues, American Enterprise⁴⁶
Institute for Public Policy Research, August 1998.
Ibid.⁴⁷
Obuchi Urges Party Support in Tackling Economy. Kyodo News Service newswire article.⁴⁸
August 6, 1998.

In March 1998, U.S. Treasury Secretary Rubin said that one of the keys to Asian
recovery is Japan. As the Group of Seven industrialized nations’ finance ministers had
stated in London, a return of domestic, demand-led growth and confidence in Japan,
through pursuit of appropriate policies, could contribute greatly to recovery in Japan's
Asian neighbors, and Japan's failure to accomplish these objectives is a major
impediment to Asia's recovery. ⁴⁹
In August 1998, the IMF announced the results of its annual assessment of
Japan’s economy. The IMF Executive Directors noted that the performance of the
Japanese economy had been much weaker than anticipated. The recent economic
downturn as well as the related weakness of the yen were especially worrisome since
they had exacerbated economic difficulties elsewhere in Asia and adding to instability
in financial markets. They expected growth to be low in 1999 and the downside risks
to be considerable. The Directors stressed the need for Japan to take swift and
decisive measures to reverse the deteriorating economic situation and place the
economy back on a path of sustained domestic demand-led growth. In their view,
Japan’s overall response so far has fallen short of the timely, comprehensive, and
forceful program that is required. ⁵⁰
In the 105 Congress, H.R. 3580 (Livingston) expresses the sense of the^th
Congress “that Japan should assume a greater regional leadership role, coinciding
with its goal of promoting strong domestic demand-led growth and avoiding a
significant increase in its external surplus with the United States and the countries of
the Asia-Pacific region.”
Conclusion
The Asian financial crisis has put the brakes on the rapid economic growth in
many of the so-called “Asian Tiger” economies and threatens to spread further to
other regions of the world. After a period of relative stability and some recovery in
the first half of 1998, conditions have worsened. The strengthened U.S. dollar is
making imports cheaper for Americans and U.S. exports more expensive for Asian
and other buyers. Debate continues around the increase in funding and role of the
IMF in the financial crisis. In the 105 Congress, the Senate has passed (with^th
conditions) the Clinton Administration’s request for the $17.9 billion increase in the
IMF’s capital base and borrowing arrangements. This is the major legislative issue
now being considered by Congress with respect to the Asian financial turmoil that is
becoming global in scope. Regardless of the outcome of the IMF funding legislation,
the increased scrutiny and experience of the IMF resulting from the Asian financial
crisis already is inducing changes that are making the IMF more transparent, able to
respond more quickly to currency and financial crises, and have moved the IMF

U.S. Secretary of the Treasury Rubin. Secretary Robert E. Rubin Remarks Before the⁴⁹
Institute of International Bankers. March 2, 1998. On Internet at <http://www.treas.gov/
press/releases/pr2266.htm>.
International Monetary Fund. IMF Concludes Article IV Consultation with Japan.. Public⁵⁰
Information Notice No. 98/60, August 13, 1998. On Internet at < http://www.imf.
org/external/np/sec/pn/1998/PN9860.HTM>.

toward more involvement in the microeconomic aspects of a borrowing country’s
economy.