The "seven pillars" of IMF wisdom - or just blind faith?

by Martin Khor

KUALA LUMPUR: Participants at an ASEAN conference on finance here were engaged in an interesting debate on the causes of and solutions to the current financial crisis, the role of the markets and the state, and the need for liberalization versus regulation of the financial sector.

On one side there was the IMF Managing Director, Michel Camdessus, who on 2 December, defended the role of the markets and promoted the intensification of capital market liberalization as part of his "seven pillars of wisdom" for the region's future policies.

On the other side was the Malaysian Prime Minister, who on 1 December, renewed his call for international regulation of currency speculators whose activities he said were the main cause of the crisis, and several participants from the region who questioned the view that markets are always right and governments always wrong.

The conference on ASEAN Financial Initiatives, organized by the ASEAN Business Forum, also saw some of the region's business leaders and analysts questioning the wisdom of rapid liberalization and the freedom and power enjoyed by financial speculators.

Camdessus began his speech by noting that there was indeed a serious problem. With crises breaking out simultaneously in Moscow, Brazil and Seoul, "this is a time when I am having no sleep."

He then struck an upbeat note, stating that the world was changing, possibly for the best. He did not agree with suggestions that this is the end of Asia's high growth, reiterating that East Asia's success in the past quarter century had been "outstanding, superlative, though not a miracle."

This had been due to good policies, including fostering high savings and investment, trade openness and quick responses to market signals. The region's fundamentals (strong fiscal position, dynamic private sector, and high competitiveness) have been and are still favourable.

"To the prophets of gloom and doom, I reply that with lucidity of diagnosis, adjustment now and sound future policies, Asia will be able to re-establish high growth in a more sustainable way."

How could such a crisis overtake South-East Asia after its outstanding performance? Camdessus said "we have not yet the full response to this mystery, but we know the key elements."

Key elements

He blamed the Thai crisis on high real exchange rates, large current account deficits, unhedged private sector foreign borrowing, weak banking system, and a "denial syndrome" by the authorities that delayed the needed policy changes.

More vexing, he said, was why the Thai crisis spread to so many other countries. He said the Thai developments prompted "market participants" to take a much closer and anxious view of the risk in other countries. "After being over-complacent they became over-anxious, and this is part of human nature," he added. "Markets looked at weaknesses which they earlier saw as minor, and became less forgiving."

The main flaws were lack of transparency of governments and central banks in disclosing their liabilities, the state of health of the financial sector, and unsatisfactory, and at times, "incestuous" relation between banks, industries and governments.

The imposition of controls on market activities reinforced the view that governments were addressing only symptoms, and caused investors to flee to safer havens, and thus there is an uphill battle to regain confidence.

Camdessus said the contagion effect was also due to the "denial syndrome", that "it couldn't happen to us." For example, questions arose about the role of hedge funds. At the request of some governments, he added, the IMF has been looking at how hedge funds work and how they contributed to the problem.

"It would be a mistake to blame hedge funds or other market participants as central agents in the turbulence," he concluded. "Market movements are only symptoms of problems."

He conceded however, that there were "many things" that could be done to promote more orderly working of the markets, including Central Bank action, steps to discourage bad behaviour among market participants, and to avoid "one-way betting." He said the IMF would soon come up with comprehensive suggestions.

The "seven pillars" of Camdessus

To avoid recurrence of the crisis, Camdessus proposed key principles for the globalized world of the 21st century. Governments must start from what is obvious, that "they are now much more vulnerable to crises than their own economic fundamentals would suggest."

Camdessus put forward principles which he dubbed "seven pillars of the new wisdom."

These include maintaining appropriate exchange rates and exchange rate regimes; appropriate interest rate policy; "second generation reforms" involving increased competition and transparency; developing regional surveillance and a "club spirit" to put peer pressure on neighbouring countries; continuing to be "market friendly" and treating markets in a responsible way by respecting their signals even when you don't like these signals; open and transparent policies; and further capital liberalization.

On the last point, Camdessus said there was a unanimous decision on this at the IMF/World Bank meeting in Hong Kong. "If this crisis has demonstrated something, it is not that freedom of movement of capital is bad but that it's urgent to have the necessary rules to provide orderly capital account movements."

He added that the IMF had been invited to adjust its Articles of Agreement to make capital account liberalization one of its mandates, and the IMF was now working on this change in the Articles. He stressed that full liberalization of capital movements in an orderly way is positive.

During question time, an Indonesian participant remarked that there were other people who explained the crisis differently from Camdessus' approach. These other explanations included that many affected Asian countries are not yet ready for the free market and thus could not compete in the global market. They were now predicting a doomsday situation.

People had a right to be suspicious and say "we are not ready for a free market," Camdessus responded, noting that even in France there were such feelings. But these were "reactions of fears and regressive feelings all of us have in our hearts.... When we are in the midst of crisis we fear invisible hands strangling you, and you're tempted to say you are not ready, and you need protection."

The solution, Camdessus said, was to "exorcise this devil" by "sitting together among peers and confess our temptation and see how we can resist it together." He said he was not pressing to go immediately for full liberalization and dismantling of governments, but liberalization could be done with wisdom and ambition.

A Malaysian participant commented that Camdessus had asked countries to re-examine and change their policies, however painful this might be. However, the IMF Managing Director had not applied the same principle to the market players and the IMF itself.

He added that with the current crisis it was obvious that financial speculation had not been regulated, and also that financial liberalization had taken place too fast, before the authorities had the opportunity to understand how liberalization works, or to put the regulatory and human resources infrastructure in place.

Since the IMF had been the main agency advocating liberalization, he urged Camdessus to now re-assess the IMF's theory and policies in light of the present crisis, instead of pushing for full capital account liberalization now.

Camdessus said the question involved the need to find a balance between regulation and freedom, and to do this the analysis had to be right.

"That's why I was happy to study hedge funds in order to have clarity on it. This study will say that you must carefully use heavily-loaded words like speculation and speculators. Speculation is often only good management and prudent use of our savings."

He added when governments have the wrong policy on interest rates they should not complain about speculators. "What is needed is not to curb your market but not to expose your policy to speculation."

Camdessus said the balance between regulation and freedom is needed, "but don't forget the benefits of freedom." He said that protection for industries under the infant industry argument had prevented countries from progressing fast enough.

In a subsequent session, commenting on the "seven pillars" of Camdessus, a Philippine participant remarked that "the IMF's seventh pillar is about freeing the capital markets even more."

"...This is just blind faith that markets are good and governments are bad," the participant said. "In reality there is a lot of imperfections in the market and we need more regulations. Don't allow the market players to protect their niche. We must get a better handle over the capital flows. Just as political mistakes can undermine the economy, economic activities can also undermine politics. We need a way to defend against speculation."

Dr Munir Majid, Chairman of the Malaysian Securities Commission, (the chief regulator of the country's stock market), said the Malaysian Prime Minister, Dr Mahathir Mohamad's criticisms about currency traders were valid, but there was a lot of vested interests and power involved in protecting the currency trade from regulation. "There is obvious resistance to change."

Majid said it was ironic that the principles of the need to strengthen prudential standards, and rules to ensure adequate protection for capital against risk, were not applied to investment and hedge funds.

"There is a systemic threat to the world financial system from the unregulated activities of these funds, yet there is resistance to regulation. This situation cannot be sustained."

He suggested that prudential standards (like what the Bank of International Settlements, BIS, applies to banks) and disclosure requirements be applied to investment and hedge funds. (Third World Economics No.175, 16-31 December 1997)

Martin Khor is the Director of Third World Network.