By Moore, Terbeek, Thym


Recent events in the global financial marketplace have underscored how inter-linked the world’s economies really are.  As information technology and media coverage have become ubiquitous, it is impossible for any country’s economy to “hide” from economic and political scrutiny.  These economic interdependencies heighten the need for impartial, objective mediators to watch the world’s financial decision-makers.


But what role should these organizations play?  Should they merely record and report the world’s economic transactions, or should they play a more direct role in regulating and assisting these forms of exchange?  Should these institutions promote free exchange or should they step in and help countries in need?  The answers to these questions are quite complicated and, not surprisingly, opinions of the world’s economic leaders regarding these issues differ significantly.  



The need for organizations like the International Monetary Fund (IMF) and the World Bank became evident during the Great Depression that rocked the world’s economies in the 1930s.  The Depression was devastating to all forms of economic life; banks failed by the thousands, factories stood idle, ships waited indefinitely in their harbors for cargoes that never arrived, and millions of people searched for jobs that did not exist.  This devastation also manifested itself in the world of international finance and monetary exchange.  Many nations’ value of money was questioned as the gold standard was abandoned.  Exchange became almost impossible between countries that remained on the gold standard and those that did not.  Nations hoarded gold and freely-exchangeable currencies, further restricting the amount of monetary transactions between countries which eliminated jobs and lowered living standards.  Other governments, desperate for foreign buyers of their goods and services, sold money below its real value to cheapen the apparent costs of their domestic products.  In turn, this strategy was copied by other trading partners and the relation between money and goods became quite confusing.  Similarly, the exchange rates between countries were questioned broadly.  Under these conditions, the world economy continued to suffer and the prices of goods plummeted by 48% and the value of international trade dropped by 63%.


In order to establish world economic and financial order as a result of the Depression, delegates of 44 nations founded the IMF and the World Bank during the Bretton Woods Conference in July 1944.  The delegates of the conference consciously established a division of labor between the organizations and granted them separate charters.  However, these organizations share many common elements and are quite often confused by the general public.  For example, both are owned and directed by their member nations (virtually all countries are members) and both institutions focus on economic issues and attempt to strengthen and grow the economies of their member nations.


Despite these similarities, the organizations perform very distinct tasks.  The IMF is a cooperative organization that attempts to maintain an orderly system of payments and receipts between nations; in essence promoting fluid exchange mechanisms to promote free trade.  The World Bank focuses primarily on helping to develop countries’ economies.  Each institution “has a different purpose, a distinct structure, receives its funding from different sources, assists different categories of members, and strives to achieve distinct goals through methods particular to itself.”[2]  Below, each of these institutions is explained in greater detail.


The International Monetary Fund


The international community established the IMF as a reaction to the unresolved financial issues that initiated and prolonged the Great Depression of the 1930s.  These issues included sudden, volatile and unpredictable variations in exchange rates between national currencies and a widespread disinclination among governments to allow their currencies to be exchanged for foreign currencies.  “Set up as a voluntary and cooperative institution, the IMF attracts to its membership nations that are prepared, in a spirit of enlightened self interest, to relinquish some measure of national sovereignty by abjuring practices injurious to the economic well-being of their fellow member nations.” [3] 


This goal is accomplished by a set of institutional rules.  These rules, signed by all members, include a code of conduct that requires all members to allow their currency to be exchanged for foreign currencies freely and without restriction, to keep the IMF informed of changes they contemplate in financial and monetary policies that will affect fellow members’ economies, and, to the extent possible, to modify these policies on the advice of the IMF to accommodate the needs of the entire membership.


To help nations follow these rules, the IMF administers a fund of money that member banks can borrow from when they are in trouble.  However, this is not the IMF’s primary purpose.  The IMF is an overseer of its member’s monetary and exchange rate policies and a keeper of the code of conduct.  The IMF receives frequent reports from its members concerning their policies and prospects.  It debates, comments on, and communicates its findings and opinions to its entire membership so that all members have full disclosure on the relevant issues and can understand how these issues may affect their economies.


Size and Structure

The IMF is relatively small, housing only 2,300 staff members.  Its professional staff is comprised of mostly economists and financial experts and its headquarters are located in Washington D.C.


Sources and Uses of Funding

While the IMF is not a bank (like the World Bank), it does administer a large sum of money that is presently valued at over $215 billion.  These revenues are derived from member fees paid in by the 182 member nations.  These fees are determined in a proportionate manner to economic size and strength.  The IMF acts like a credit union at times.  Members are able to access resources equal to their total contributions in times of need.


All member nations have the right to financial assistance from the IMF.  This assistance typically comes in the form of balance of payment relief.  In order to maintain an orderly and efficient international monetary system, the IMF requires all members to fulfill their financial obligations to the other participants.  If a member country cannot fulfill its obligations because of a shortage of foreign exchange, this country may borrow from this pool in order to complete its pending transaction.


Money received in these transactions must be repaid within three to five years, and no longer than ten years.  Interest rates are slightly lower than market rates, but are still meaningful enough to require timely retirement.  Through the use of these IMF funds, member countries are theoretically able to buy time to fix their economic policies and to restore growth without having to undertake drastic actions that could be harmful to other members’ economies.



The IMF operates in three main ways.  First, the institution urges its members to promote and respect currency exchanges without restrictions.  Currently, there are about 115 member nations that have agreed to full convertibility.  Second, the IMF oversees the economic policies that influence its members’ balance of payments in the presently legalized flexible exchange rate environment.  The goal of this monitoring is to detect early warning signs of any exchange rate or balance of payment problems.  Third, the IMF continues to provide short and middle term financial assistance to member nations that run into temporary balance of payment difficulties.  The IMF believes its role in these cases is not to subsidize further deficits, rather it is to help a country transition to living within its own means.


When a country is in trouble, it can turn to the IMF for consultative and financial assistance.  Working together, the country and the IMF attempt to isolate the root causes of the balance of payments problem.  Once the causes are identified, the country and the IMF will collaborate to design a program aimed at restoring the country’s financial matters. 


However, reorganizing the nation’s economy to implement these reforms is disruptive and not without cost.  Therefore, the IMF will lend money to subsidize policy reforms during hard periods of transition.  To ensure the money is invested properly, the IMF works closely with the country and provides technical assistance and further consultative advice as necessary. 


Finally, the IMF also helps by providing technical assistance in organizing central banks, establishing and refining tax systems, and setting up agencies to gather, analyze and publish economic statistics.  The IMF is also authorized to issue special money, called the special drawing right (SDR), in order to provide its members with additional liquidity.  The SDR can be retained by members as part of their monetary reserves or be used in place of national currencies in transactions with other members.



Each member nation is required to contribute funds according to its economic size and strength.  In proportion to their the funding requirements, nations are awarded votes which determine the overall policy of the institution.  All members receive votes.  However, the voting results often follow a block pattern that is typical in geopolitical contexts.  The table on the following page analyzes which countries and blocks of countries have the largest voting power.


Table 1: Voting Power


Voting (%)

United States


All of Europe


European Union




Latin America


Rest of World



While the largest block of votes resides with the Rest of World countries, they are geographically, politically, economically and religiously diverse.  We expect small sub-groups could bind together and vote as a block, however we do not expect them to garner much momentum or support form the other nations.  Europe is the most interesting group of countries.  As of January 1, 1999, the European Monetary Union is now official (the currencies have all been permanently pegged to the Euro).  This united economic block has a coordinated monetary policy now.  Therefore, it is not a stretch to believe this group may vote as a block on IMF issues.  If this happens, the EU will have the most power and votes.  If they can gain support from other countries, similar to the U.S. in the past, then they can emerge as a new driver of policy initiatives.  All member nations will have to consider this when interacting with the IMF in the future.


The World Bank


The World Bank’s formal name is The International Bank for Reconstruction and Development (IBRD).  The World Bank is primarily responsible for financing economic development.  Its central purpose is to “promote economic and social progress in developing countries by helping to raise productivity so that people may live a better and fuller life.”[4]


The World Bank made its first loans to war ravaged Western Europe just following WWII to help finance these economies’ reconstruction.  As these nations were recovering, the World Bank turned its primary attention to helping the world’s poorer nations.  Since the 1940s, the World Bank has loaned more than $330 billion to these developing countries.


Size and Structure

The World Bank’s structure is much more complex than the IMF’s structure.  The World Bank consists of two organizations, the International Bank for Reconstruction and Development and the International Development Association (IDA).  Also, the International Finance Corporation, which raises funds for private enterprises in developing countries, the International Center for Settlement of Investment Disputes and the Multilateral Guarantee Agency are associated with, but separate, from the World Bank. 


The World Bank has over 7,000 employees in over 40 offices around the world, although 95% of the staff is in Washington D.C.  The Bank has a very diverse employee base, ranging from economists to lawyers, to statisticians, to experts in telecommunications, water treatment and health care.


Sources and Uses of Funding

The World Bank serves as an investment bank, brokering between investors and recipients, borrowing from one and lending to the other.  The 180 member governments own equity stakes in the Bank and its current valuation is over $175 billion.  The Bank obtains most of the funds that it lends to its member nations by borrowing through the issuance of AAA bonds that are guaranteed by the member governments.  The proceeds of these bond sales are lent in turn to developing countries at affordable rates of interest to help finance projects and policy reform programs that are deemed necessary.  The IDA is financed mostly by grants from member countries.  


The World Bank lends only to creditworthy governments of developing nations.  The poorer the country, the more favorable the conditions under which it can borrow from the Bank.  These loans carry an interest rate slightly above the market rate at which the Bank itself borrows and must be repaid within 12-15 years.  The IDA focuses on very poor developing countries whose per capita GNP is below $1,305.  These loans are interest free and have a maturity of 35 or 40 years.



The World Bank exists “to encourage poor countries to develop by providing them with technical assistance and funding for projects and policies that will realize the countries’ economic potential.  The Bank views development as a long-term, integrative endeavor.”[5]


The Bank focuses most of its efforts on funding projects that can directly benefit the poorest people in a developing country.  The direct involvement in economic activity is being promoted through lending for agriculture and rural development, small-scale enterprises, and urban development.  The Bank is helping the poor to be more productive and to gain access to such necessities as safe water and waste-disposal facilities, health care, family-planning assistance, nutrition, education and housing.   The World Bank provides most of its assistance to developing countries by supporting specific projects.


Every project financed by the Bank is designed in close collaboration with national governments and local agencies, and often in cooperation with other multilateral assistance organizations.  In fact, about half of all Bank-assisted projects also receive cofinancing from official sources, such as governments, multi-lateral financial institutions, export-credit agencies that directly finance the procurement of goods and services, and private sources such as commercial banks.


While making these loans, the Bank does not compete with other financing sources.  It will only assist projects where capital is not available from other sources on reasonable terms.  The goal of the Bank is to help these developing countries graduate from needing special assistance.  At this point, these countries would be able to raise funds for undertaking key projects from conventional sources of capital.  Over the life of the IBRD and IDA, 34 poor countries have borrowed money from the IDA.  More than 24 have made enough progress for them to no longer need IDA money, leaving more resources for many new members who have recently joined.  Similarly, over 20 countries that borrowed from the IBRD.


The Bank also helps developing countries with macroeconomic analyses and strategy.  As the Bank studies its member nations in order to effectively disburse loans, it learns which sectors are best and worst off.  It can then help these countries by designing policies to invigorate these nascent sectors.




The Asian crisis differs from previous crises in many respects.  Unlike the typical situation in which the IMF’s assistance is requested, “this crisis did not result mainly from the monetization of fiscal imbalances and only in Thailand were there substantial external current account imbalances.”[6]  As a broad generalization, the crises in East Asian countries were the result of interaction among shortcomings in the global system, flawed national financial systems, and deficient corporate and public governance.  As global financial markets developed, especially in the early 1990s, capital was attracted to East Asia in large part because of exceptional record of growth and macroeconomic management.  However, serious weaknesses that had been concealed in part by the magnitude of the flows, and in part by the inadequacy of risk assessment by foreign creditors and weak supervisory practices in some creditor countries, eventually came to light with the onset of the crises.  The crisis was not overnight in the making.  Its approach had been overshadowed and concealed by the economic boom in the area.  Weaknesses in governance in the corporate, financial and government sectors, which made these Asian economies increasingly vulnerable to changes in market sentiment, a deteriorating external situation and contagion all contributed to the crisis.


The combination of these long-term trends led to the most critical weakness – the immediate cause of the crisis – the accumulation of very large amounts of short-term debt.  In the years prior to the crisis, “large capital inflows contributed to a variety of problems including overinvestment, inflated domestic asset prices and deteriorating loan quality.  These weaknesses in return reflected more fundamental problems, including weak domestic bank supervision and regulation, a history of interference and the lack of sound commercial standards in the allocation of credit and pervasive explicit or implicit government guarantees.”[7]  Short-term capital inflows were also drawn in by the perceived implied guarantee represented by the exchange rate regimes that were viewed as de facto pegs.


Adding to these inherent problems in East Asia, the method by which capital flows were liberalized contributed to weakness in the financial sector.  Through this liberalization, banks and corporations gained unprecedented ready access to large amounts of short-term external borrowing that was not adequately monitored by authorities.  At the same time, longer-term capital inflows were liberalized more gradually and deliberately.  The consequence of sudden, rapid liberalization of short-term capital inflows and the slower, more deliberate liberalization of long-term capital inflows made countries in East Asia highly vulnerable to sudden shifts in investor sentiment.


“The domestic vulnerabilities came to a head as growth slowed in 1996, largely as a result of adverse terms-of-trade shocks, a loss of competitiveness associated with currency pegs that were maintained in the face of sharp dollar/yen appreciation, declining export demand and growing over-capacity in certain sectors.”[8]  In Thailand, the first crisis to “blow up,” the developments were reflected in a widening current account deficit (see Table 2).  Added to that, Thailand already had a relatively large fiscal imbalance going into 1996.  The policy responses in early 1997 were not adequate.  The slowdown in Thailand’s economy, in turn, was reflected in sharp declines in equity and property prices, which aggravated financial sector weaknesses and acted as a further brake on growth.  Finally, the crisis began in the financial sector because of excessive maturity mismatches in balance sheets.  Much has been written about what happened in Thailand, Indonesia and Korea.  A brief summary of events leading to the crisis and policies implemented for each country follows.



Pressures on Thailand’s currency, the baht, which had been evident already in late 1996, increased dramatically during the first half of 1997.  Primary contributors to this built up pressure were an unsustainable current account deficit, significant appreciation of the real effective exchange rate, rising foreign debt (in particular short-term), a deteriorating fiscal balance, and increasing difficulties in the financial sector.  Reserve money growth accelerated sharply as the Bank of Thailand provided liquidity support for ailing financial institutions.  “Most of the policy responses to the pressures in the exchange market focussed on spot and forward intervention, introduction of controls on some capital account transactions and limited measures to halt the weakening of the fiscal situation.”[9]  On July 2, 1997, following more and more speculative attacks on its currency, Thailand’s Central Bank decided to float its exchange rate.  However, the policy changes introduced with the floatation of the baht were inadequate.  Market confidence failed to return and the baht depreciated by 20 percent against the U.S. dollar during.  On August 20, 1997, the IMF’s Executive Board approved financial support for Thailand of up to SDR 2.9 billion or about $4 billion, equivalent to approximately 505 percent of Thailand’s quota, over a 34 month period (see Table 5).  Additional financing in the amount of $2.7 billion was pledged by the World Bank and the Asian Development Bank while Japan and other interested countries pledged another $10.5 billion.  “The underlying adjustment program was aimed at restoring confidence, bringing about an orderly reduction in the current account deficit, reconstituting foreign exchange reserves and limiting the rise in inflation to the one-off effects of the depreciation.”[10]  Growth was expected to slow down dramatically, but still remain positive.  Key elements of the initial economic reform package included restructuring of the financial sector (focusing on the identification and closure of insolvent financial institutions; included 56 finance companies); fiscal measurers equivalent to about three percent of GDP to correct the public sector deficit to a surplus of one percent of GDP in 1997/1998[11] and contribute to shrinking the current account deficit; and control the domestic credit, with indicative ranges for interest rates. 


In subsequent months, the baht continued to depreciate as roll-over of short-term debt declined and the crisis in Asia spread.  Despite the fact that macroeconomic policies were on track and nominal interest rates were raised, market confidence further declined because of delays in the implementation of financial sector reform, political instability and poor communications of the key aspects of the program.  In light of a larger than expected depreciation in the baht and a sharper than anticipated slowdown in the economy, the bailout program was strengthened at the first quarterly review on December 8, 1997.  The indicative range for interest rates was raised and a specific timetable for financial sector restructuring was announced.  In early February 1998, the baht started to strengthen as improvements in the policy setting revived market confidence.  At each subsequent quarterly review (March 4, 1998; June 10, 1998; September 11, 1998), the program was again revised.  Real GDP growth projections were continuously revised downward, reaching a projected decline of 4-5 percent in 1998 as of June 10 and a decline of 6-8 percent as of September 11.  From February to May, the baht strengthened markedly (almost 35 percent vs. the U.S. dollar from the low in January), but the economy fell into a deeper than expected recession.  In order to stimulate growth (or more appropriately, curb the real GDP contraction), further adjustments were made to allow for an increase in the fiscal deficit target for fiscal-year 1997/98.  The fiscal deficit target for 1997/98 was raised from two percent to three percent of GDP.


Interest rates started to slowly decrease in late March of 1998.  Additional measures to strengthen the social safety net were planned and the program for financial sector and corporate restructuring was further specified.  By the fourth quarter review completed September 11, 1998, foreign exchange market conditions were relatively stable, allowing room for further lowering of interest rates.  The following table provides a snapshot of select economic indicators for Thailand.

Table 2: Selected Economic Indicators for Thailand






percent change

Real GDP Growth



    -7 to –8


Consumer Prices (period avg.)




  2.5 to 3.0

percent of GDP; a minus signifies a deficit

Central government balance(3)





Current account balance





(billions U.S. dollars)

External debt





Source:  Thai authorities and IMF staff estimates

(1)     Estimate

(2)     Program

(3)     Fiscal year, which runs from October 1 to September 30



In July 1997, soon after the floating of the Thai baht, pressure on the Indonesian rupiah intensified.  While the key macroeconomic indicators in Indonesia were stronger than in Thailand (the current account deficit had been modest, export growth had been reasonably well maintained, and the fiscal balance had remained in surplus), Indonesia’s short-term private sector external debt had been rising rapidly.  Increased evidence of weakness in the financial sector raised doubts about the government’s ability to defend the currency peg.


On July 11, 1997, Indonesia widened the exchange rate intervention band.  On August 14, 1997, the rupiah was floated.  The exchange rate depreciated sharply and despite a temporary small recovery, the rupiah fell further against the U.S. dollar.  By early October, the cumulative depreciation of over 30 percent since early July became the largest in the region.  On November 5, 1997, the IMF’s Executive Board approved a three-year stand-by arrangement with Indonesia totaling $10 billion, equivalent to approximately 490 percent of the country’s quota (see Table 5).  Key objectives of the IMF program included restoring market confidence; bringing about an orderly adjustment in the current account; limiting the unavoidable decline in output growth; and containing the inflationary impact of exchange rate depreciation.  After an initial brief strengthening of the rupiah, the exchange rate fell again during December 1997 and January 1998.  Poor implementation of proposed structural changes signaled a lack of commitment to the program.  Coupled with political uncertainty due to the President’s health problems and the upcoming presidential election, capital outflows increased and reserves declined sharply.


A revised strengthened program was announced on January 15, 1998 in an attempt to stop and reverse the decline in the rupiah, but market reaction was skeptical.  Despite the revised rescue program by the IMF, implementation of the structural reforms continued to lag again and the macroeconomic program quickly ran off track.  The economic downturn deepened and inflation accelerated sharply.  Indonesia’s economy was on the verge of a vicious circle of currency depreciation and hyperinflation.  The first review of the IMF programs was completed on May 4, 1998, after the new government headed by re-elected President Soeharto was formed, and resulted in several modifications to the original program.  “In order to stabilize the exchange rate, reduce inflation and limit the decline in output (and eventually restore growth), the revised program included: tight monetary policy with drastically higher interest rates and strict control over the central bank’s net domestic assets; expanded far-reaching structural reforms, including privatization and dismantling of monopolies and prices controls, to improve efficiency, transparency and governance in the corporate sector; adjusted fiscal framework that took into account the less favorable outlook for growth; and a revised plan for the restructuring of the banking system.”[12]  Unfortunately, the program was once again steered off course, this time by civil unrest which culminated with the resignation of President Soeharto on May 21, 1998.  “While food prices sky-rocketed, production, exports and domestic supply channels were disrupted and banking activities came to a virtual standstill.”[13]  The rupiah hit an all time low against the U.S. dollar in mid June 1998, with a cumulative depreciation of approximately 85 percent since June 1997. 


On June 4, 1998, a critical agreement with private creditors was reached which covered the restructuring of interbank debt falling due before the end of March 1999.  The government also established a framework for the voluntary restructuring of corporate debt involving a government exchange guarantee scheme.  By the time of the IMF’s second program review in July 1998, output for fiscal year 1998/99[14] was expected to decline by 10-15 percent and inflation was projected to average 60 percent.  On August 25, 1998, the IMF’s Executive Board replaced the previously agreed upon stand-by agreement with an extended arrangement with access to the same capital amounts of the original agreement.  Additionally, the World Bank and Asian Development Bank pledged $2 billion and bilateral sources close to $1 billion of additional financing sources (see Table 5).


Since then, macroeconomic policies have been generally speaking on track and policies regarding financial and corporate sector restructuring have been further strengthened.  The last major hurdle seems to have been overcome on September 23, 1998, with an agreement on the rescheduling or refinancing of Indonesia’s principal payments on official debt and export credit for the period from August 6, 1998 to March 31, 2000, totaling $4.1 billion.  In recent months, the rupiah has appreciated significantly, allowing interest rates to be lowered.  Inflation has decreased to reach 80 percent at year-end.  Some of the key economic indicators for Indonesia are summarized in the table below:


Table 3: Selected Economic Indicators for Indonesia(1)






percent change

Real GDP Growth




-2.0 to 1.0

Consumer Prices (period avg.)





percent of GDP; a minus signifies a deficit

Central government balance





Current account balance




1.5 to 2.0

(billions U.S. dollars)

External debt





Source:  Indonesian authorities and IMF staff estimates

(1)     Fiscal year, which runs from April 1 to March 31

(2)     Program



Through the beginning of the crisis in Thailand and Indonesia, Korea appeared relatively unaffected.  Its exchange rate remained generally stable through October 1997.  However, high amounts of short-term debt and only moderate levels of international reserves made the economy very vulnerable to a shift in market sentiment.  Concerns about the soundness of financial institutions and chaebol had increased significantly after several large corporate bankruptcies earlier in the year.  Korean banks started to experience difficulties in rolling over their short-term foreign liabilities.  As a response, the Bank of Korea shifted foreign reserves to the banks’ offshore branches and the government announced a guarantee of foreign borrowing by Korean banks.  As external financing conditions deteriorated in late October, the won fell sharply while exchange reserves declined rapidly.  Monetary policy was initially tightened, but concerns about the effect of high interest rates on the highly leveraged corporate sector lead to a loosing of monetary policy again.  By December 1997, the won had depreciated by over 20 percent against the U.S. dollar.


As a response to Korea’s financial crisis, the IMF approved on December 4, 1997 a three-year stand-by arrangement totaling $21 billion, equivalent to approximately 1,940 percent of the country’s quota (see Table 5).  The World Bank and Asian Development Bank and other interested countries pledged another $14 billion and $22 billion, respectively.  Similar to the programs announced in Thailand and Indonesia, however, positive impacts of the announced program were short-lived and the won continued to fall.  Adding to the existing uncertainty, the leading candidates for the December 18 presidential election all hesitated in publicly endorsing the program.  With the won in a free fall and a sever credit crunch, a temporary agreement was reached on December 24, 1997 with private bank creditor to maintain exposure and discussions on voluntary rescheduling of short-term debt were initiated.  During the first two weeks of January 1988, roll-over rates increased, the current account had moved into surplus and general signs of stabilization emerged.  However, due to the large depreciation in the exchange rate, inflation increased above projections and economic activity decreased more than expected.  On January 28, 1998, Korea reached an agreement with private bank creditor on a voluntary rescheduling of short-term debt covering a total of $22 billion.


During the next few months, the IMF rescue program remained on track and market confidence increased as the new government stated its commitment to the bailout program.  Economic growth projections were further revised downward, yet by July, Korea had made substantial progress in overcoming its external crisis.  By the end of August, output was projected to decline by 5 percent in 1998, but inflation had decreased significantly and was expected to average 8.5 percent during the year.  Fiscal deficit targets were raised to four percent of GDP to stimulate growth through additional expenditures, especially social programs and the won remained broadly stable and appreciated against the U.S. dollar.  Table 4 below summarized some of Korea’s key economic indicators.


Table 4: Selected Economic Indicators for Korea







Percent change

Real GDP Growth





Consumer Prices (period avg.)





Percent of GDP; a minus signifies a deficit

Central government balance





Current account balance





(billions U.S. dollars)

External debt





Source:  Korean authorities and IMF staff estimates

(1)     Estimate

(2)     Program

Criticism / Misunderstandings of the IMF Programs in Asia

In the popular press, the IMF has been widely criticized for its role in the Asian crisis.  Below, we summarize two often-cited criticisms, or misunderstandings as the IMF refers to them, and give a brief rebuttal from the IMF.  A third criticism, that the IMF bails out reckless investors and thus creates a moral hazard, is addressed in further detail in the third section of our paper.

(i)                   The IMF failed to predict the financial crisis in Asia; this proves that the surveillance methods used by the IMF don’t work.  The IMF admits that it underestimated the severity of the financial crisis that followed the events in Thailand.  However, the IMF is quick to point out that it did anticipate the events in Thailand.  The IMF stressed the unsustainability of the country’s policies and pressed for urgent action during the 18 months leading up to the floating of the baht.  This, however, shows a basic shortcoming of the IMF.  The IMF can only advise, not force governments to take any steps.

(ii)                 IMF programs are structured wrong.  The programs include high interest rates that are inappropriate and overlook the private sector debt problems that were at the heart of the crisis.  The IMF argues that while an increase in interest rates has been part of the countries’ economic programs, the centerpiece revolved around far-reaching structural reforms.  Also, past experience shows that the temporary raising of interest rates makes the currency more attractive to hold and avoids a depreciation-inflation spiral effect.  Regarding the private sector debt problem, the IMF is only empowered to deal with sovereign governments, not directly with private sector agents.  The IMF’s policy consisted of restoring confidence through policy packages and official financing to induce private creditors to roll over their claims voluntarily, but any other action is beyond the scope of the IMF.


Early Results and Outlook

To a large extent, the full scope of the Asian crisis is still unfolding and further setbacks cannot be ruled out.  The magnitude of recessions in the affected Asian countries has far exceeded all initial estimates.  The further weakening of Japan’s economy has had a particularly large, negative impact on demand in the region and on international financial market sentiment in general.  However, many of the still existing risks can be mitigated as long as the affected economies continue to implement the stabilization and reform policies specified by IMF programs and financial support is maintained.  Table 5 below summarizes the financial commitments and disbursements made by the international community through January 1999.

Table 5: Commitments of the International Community and Disbursement of the IMF in Response to the Asian Crises

(billions U.S. dollars)



IMF Disbursements   As of 1/17/99






























Source: IMF

(1)     World Bank and Asian Development Bank

(2)     Includes augmentations since July 1998

(3)     Disbursements does not reflect Supplemental Reserve Facility repayments of $2.8 billion made by Korea in December 1998


While the road to recovery has been more troublesome than anticipated, there has also been notable progress in Thailand, Indonesia and Korea in the implementation of corrective policies and the stabilization of exchange rates:[15]

n       Exchange rates have strengthened significantly from their lows reached in the first part of 1998.  While the Indonesian rupiah still remains severely depreciated, it too has recovered;

n       Interest rates in Thailand and Korea have returned to pre-crisis levels as currency pressures have eased;

n       Significant progress has been made in macroeconomic stabilization and structural reforms are beginning to be implemented;

n       Current account deficits have been reversed to surpluses for all three countries;

n       Reserves have strengthened substantially in Korea and Thailand, and Korea made repurchases to the IMF under the Supplemental Reserve Facility, indicating the progress made in the country’s emergence from its foreign exchange crisis; and

n       Equity prices increased significantly from their lows in Korea and Thailand, yet they are still far below past highs.


Figure 1:
Thai Equity Market Index

Weekly, January 3, 1997 – March 5, 1999

Source: Bloomberg

Figure 2:
South Korean Equity Market Index

Weekly, January 3, 1997 – March 5, 1999

Source: Bloomberg


While Thailand’s and South Korea’s equity markets increased over 70 percent and 80 percent, respectively, from their lows at the beginning of September, Indonesia’s equity market index only increased less (see Figure 3 below).


Figure 3:

Indonesian Equity Market Index

Weekly, January 3, 1997 – March 5, 1999

Source: Bloomberg

It is remarkable to note that while the percentage increases and decreases in the above figures differ, the directional trends are remarkably similar over time, indicating the strong interdependence and linkage between the three Asian economies.  For example, all three graphs show market lows around the beginning of September 1998 and the following recoveries exhibit extremely similar trends and spikes.


Lessons Learned

The Asian crisis has reconfirmed the importance of a sound macroeconomic policy framework and the dangers of unsustainably large current account deficits.  Some details of the Asian crises are still in the process of unfolding.  In a continuous effort to improve its operations and effectiveness, the IMF has already started to analyze the events leading up to the crisis and how it responded.  The IMF strives to learn from the crises “how to strengthen the architecture of the international financial system to lessen the frequency and severity of future disturbances.”[16]  So far, the IMF has identified six distinct areas where changes are already on the way:[17]

(i)                   More effective surveillance over countries’ economic policies and practices.  The IMF will continue to establish new and improve existing data standards to guide members in releasing reliable and timely data to the public and require fuller disclosure of all relevant economic and financial data;

(ii)                 Financial sector reform, including better prudential regulation and supervision.  The IMF is working closely with the Basle Committee on Banking Supervision and the World Bank to develop and communicate a set of “best practices” in the banking area;

(iii)                Ensuring that the integration of international financial markets is orderly and properly sequenced.  This should maximize the benefits from and minimize the risks of international capital movements;

(iv)               Promoting regional surveillance;

(v)                 Worldwide effort to promote good governance and fight against corruption.  On April 16, 1998, the Interim Committee of the Board of Governors of the IMF adopted the “Code of Good Practices on Fiscal Transparency – Declaration on Principles,” which serve as a guide for members on how to enhance the accountability and credibility of fiscal policy; and

(vi)               More effective structures for orderly debt workouts.  This includes better bankruptcy laws at the national level and better ways at the international level of association private sector creditors and investors with official efforts to help resolve sovereign and private debt problems. 

These efforts must be supported by adequate financial resources for the IMF.  Furthermore, continued cooperation of bilateral and multilateral funding sources will be critical for the future success of IMF policies.


One problem, however, that the IMF continually faces is its dependence on the cooperation from the local governments that are affected by crises.  The best programs in the world are of little use when they are not implemented forcefully and at the right time.  As mentioned earlier, the IMF can only advise, not force governments to take steps.  The six initiatives mentioned above are all improvements and steps in the right direction, but without the proper commitment of local governments, even the best IMF programs will not be able to rescue economies fallen on hard times.




The stated purpose of the IMF is to facilitate flows of capital between countries and promote economic stability. Increasingly, however, the IMF has played the role of lender of last resort to countries in need of capital injections in times of financial crisis.  This has raised concerns about the incentives that this provides to the governments, corporations, and financial intermediaries acting in these countries, for they are not lacking in blame for the existence of the crisis in the first place.  Are governments less prudent in their fiscal policy than they would be if they were not backed up by the IMF safety net?  Do large companies and their investors assume that the companies are “too big to fail” so will, at worst, be bailed out by their home country governments or by the IMF if a fiscal crisis emerges?   These issues illustrate the “moral hazard” that results from the safety net provided by the existence (or supposed existence) of a lender of last resort.


Definition of Moral Hazard

A situation of moral hazard exists when an actor does not bear all of the risks of his actions.  He has incentive to take risky actions if he will receive all of the benefits of a positive result but will only share part of the downside caused by a negative result.  For example, insurance companies deal with this when they insure property.  The property owner does not take the same level of care with the property that he would if he were not insured.  To correct for this problem, it must be in the insured party’s interest to take actions that the insurer would prefer. 


Moral Hazard in the World Economy

The moral hazard exists in a variety of ways in the world economy.  Corsetti, Pesenti, and Roubini, in their September 1998 paper, divide the moral hazard problem into three types: corporate, financial, and international. [18]


Corporate-level Moral Hazard

The corporate-level moral hazard problem occurs when companies are encouraged to make uneconomic investments (that is, investments that return less than the cost of capital) because of subsidies or bailouts that are expected from the government if the project is unsuccessful.   The companies are not bearing all (or perhaps any) of the risk of the projects, so they are not prudent in their risk taking.  In Asia, for example, in order to encourage high economic growth public money was used to finance private sector projects.  Sometimes the projects were directly controlled by the government, sometimes the projects received subsidies, and sometimes the companies in charge of the projects received credits.  As Corsetti, Pesenti, and Roubini state:


“With financial and industrial policy enmeshed within a widespread business sector network of personal and political favorites and with governments that appeared willing to intervene in favor of troubled firms, markets operated under the impression that the return on investment was somewhat insured against adverse shocks.”[19]


This was true despite the actual low levels of profitability of the projects.  In Korea, for example, 20 of the 30 largest consortiums had a 1996 return on invested capital that was less than the cost of capital.  Some of these firms were effectively bankrupt by 1997.  Clearly the market for capital was not operating efficiently.


Financial-level Moral Hazard

Moral hazard also exists within the financial sector.  Financial institutions are the intermediaries who channel capital between lenders and borrowers.   When they are not prudent in their risk taking, capital is allocated to firms who are investing it in marginally or totally unattractive projects.  This is similar to what happened in the above example of government money flowing to uneconomic projects.  Financial institutions act in this way when they are not (or at least, they believe they are not) bearing all of the risks of the loans that they are making.  This would occur if they expect the recipients of the loans to be supported by public funds if a crisis emerges.  They then make loans based on uneconomic factors, such as relationships they have with borrowers or pressure that they are feeling from the government.  Further, since they are not very worried about the performance of the loans, they inadequately supervise them and hold inadequate reserves to support them.  The financial system gets weaker and weaker as more and more unprofitable investments are made.  In the end, if the government can not actually bail out all of the providers of capital, a crisis occurs.  This is part of what happened in Asia.  Asian banks borrowed heavily from abroad and lent heavily at home.  They believed that their home governments would always support the companies to whom they were lending.  When crisis hit, however, even the government did not have the money to offset all of the liabilities incurred by companies.


International-level Moral Hazard

There is also moral hazard at the international level.    This refers to the lending by foreign banks to local banks under the assumption that the loans will be effectively guaranteed by either the local banks’ government or the IMF.  Such banks may assume that short-term cross-border liabilities would be the first to be protected in times of crisis.  In Asia, however, this was not the case.  Indeed, the levels of short-term, cross border liabilities were far too high to be covered by the governments.  By the end of 1996, short-term liabilities represented more than 50% of total liabilities in Asia, and the ratio of short-term liabilities to total foreign reserves was greater than 100% in Korea, Indonesia, and Thailand.  The currency crisis made the situation even worse.  The IMF had to intervene to cover these liabilities, and many others.    There had simply been no incentive for international financial intermediaries to be prudent in their risk taking.   In fact, as the situation worsened, they may have actually taken on more risk since the likelihood of an IMF bailout seemed even greater.


Together, these three types of moral hazard have presented and will continue to present obstacles to maintaining world financial stability.  For as long as the incentives of capital providers are not affected by the riskiness of the projects that they are undertaking, capital will continue to flow to projects that are not economically justified.  The moral hazard problem results in the funding of projects that would not be funded in efficient capital markets in which economic actors behave rationally.


Minimizing the Moral Hazard Problem

There are several ways in which the IMF can minimize the moral hazard problem, as Stanley Fischer of the IMF explained in a recent paper.[20]   First, the IMF can make funds available only to the extent that they are guaranteed by sufficient collateral.  Such collateral must have value in “normal times,” i.e., not times of financial crisis.  This would limit risky investments, as such investments might not qualify as acceptable collateral.  Second, the IMF can impose costs on borrowers who need funds.  The IMF can make loans at penalty rates.  Loans are then available if needed, but at rates that are reasonably unattractive.  This limits risk taking because the potential borrower knows that cheap borrowing will not be available in times of crisis.   The IMF can also allow some insolvent institutions to fail – the ultimate penalty.  Third, the IMF can lend to the market not the individual institution (i.e. lend to Indonesia to boost reserves and improve liquidity, but do not bail out specific financial institutions).    The market will then decide which institutions will survive, and it will presumable choose the most competitive and solvent.  Note that this policy has its drawbacks because in times of financial panic, market forces may not be effective and such policy will just increase confusion.   Fourth, the IMF can be somewhat ambiguous about its exact lending rates and policies.  Potential borrowers will be aware that the IMF may be prepared to bail them out in times of crisis, but they will not be certain of it.  They will be less willing to take risks if there is no guarantee that the IMF will protect them. 


In addition to IMF actions, there are actions at the country level that can minimize the moral hazard problem.   For example, regulations that limit banks’ lending can be imposed.  There can be limits on the size of deposits covered by insurance, as there are in the U.S.  Additionally, the private sector can provide emergency credit lines under strict terms.  This would provide a partial safety net and thus promote stability, without guaranteeing that risky investments would be insured against disaster.


Should the IMF Continue to Operate?  Should its Role Change?

There has been voluminous debate recently about what the IMF’s role should be and whether it should exist at all.   The IMF has sought to implement some of the above policies.  For example, emergency credit comes attached with reform requirements and somewhat higher borrowing rates.  But perhaps the IMF is not the appropriate party to be outlining and enforcing reforms.  Should the IMF play this role?


Why the IMF Should be the Lender of Last Resort

There are strong arguments in support of the world’s need for a lender of last resort, and in support of the IMF playing that role.  Capital mobility is beneficial for the world economy, but such mobility will only exist if the risk of major financial crises is sufficiently low.  International capital flows and the economic performances of countries are extremely volatile.  Crises are contagious.  The lender of last resort can help to minimize volatility and contain crises.


There are several compelling reasons why the IMF should continue to be, essentially, the world’s lender of last resort.  The most compelling is that the IMF is in a better position than anyone else to play this role.  It has a broader reach than any individual country.  It has access to human resources and financial capital from almost every country.    Further, while large countries (US, UK, Japan) dominate the voting within the IMF, numerous countries have a voice in making IMF policy.   A second reason is that if the IMF does not play this role, it is unlikely that anyone will.  Individual countries and private lenders will not always are sufficient access to capital when crises arise.  They might also be swayed by politics to favor some countries more than others.  The IMF (ideally anyway) would act with the proper function of the entire world economic system in mind, rather than individual country interests.  The U.S. took the lead in the Mexico bailout tin 1994/95, but there is no guarantee that the US will always find it in its interests to play such a role.  A third reason is that when the IMF steps in, such action sends a very visible signal to the world that economic reform is underway.  The IMF at least gets some reform underway in places that may have been in need of reform for years.  This helps restore credibility among companies and financial institutions in times of crisis.  A fourth reason is that with the IMF as lender, borrowers need negotiate with only one large lender, rather than with a variety of leaders with diverse interests.  In times of crisis, such simplification is crucial. 


Why the IMF Should Not be the Lender of Last Resort

There are, of course, two sides to every debate.  Perhaps the IMF should not be the world’s lender of last resort.  There are several reasons for this.  First, the IMF may simply be bailing out financial institutions who made incredibly risky loans in the first place.  Such institutions should be allowed to fail.  They would have kept the benefits of risky projects for themselves, so they should incur the costs.  Second, there is no apparent limit to the amount of funds that the IMF will continue to demand in the name of mitigating financial panic.  Why should the IMF have an automatic call on the capital of countries who are prudently managing their own economies?  Third, it is not clear that IMF bailouts are beneficial at all.  Countries who have received IMF funds are generally in serious need of economic reform (e.g., exterminating corruption, encouraging private sector competition, etc.).  Throwing capital at their problems is not enough, and IMF-imposed reform measures do not seem to be working.   Witness the ongoing turmoil in Indonesia and other parts of Asia.  Further, IMF bailouts actually enable countries to delay reform.   The inflow of IMF funds lessens the need for banks to deal with problem loans, governments to adjust spending, and unprofitable, mismanaged firms to change hands. 


With such arguments in mind, some policy makers have argued that the IMF should be replaced by the market in solving world financial crises.    Governments and institutions should be forced to work with private leaders in times of crisis. They must present reform plans in order to receive funds.  If their reform plans are not viable, they should be allowed to fail.  They should not simply be allotted funds.  Failed enterprises should confront bankruptcy, with assets transferred to managers who can manage them more effectively than those who created crisis.    Reforms would have to be implemented before the receipt of funding.  No longer would funding be freely available to anyone in need.


Conclusions About the IMF’s Role

The IMF tries to remedy existing problems, not create crises.  Therefore, the best way in which to limit the role of the IMF in the world economy is to address the policies that result in the crises in the first place.  It is up to local governments in each country to implement regulatory actions that limit the risk taking of financial institutions in their country.  These governments will have incentive to do this if their access to international capital from other countries is tied to their maintenance of responsible fiscal policy.  For example, the architects of the European Union have been working towards something along these lines by requiring member countries to stay within certain budget deficit limits.  More measures like this will go a long way in promoting financial stability, and will require minimal IMF activity.


The fact remains, however, that there must be some last resort provider of capital to assist countries in times of severe financial distress.  For the reasons listed above, it does make sense for the IMF – an institution governed by a broad spectrum of countries – to act in this role.   No individual country or small number of countries can along be the world’s lender of last resort.  The IMF should focus on being a capital provider, however, not a policy dictator.  The IMF should infuse capital but should not jump in to determine fiscal policy.


The moral hazard problem will never disappear.  It can, however, be minimized.  The penalties attached to emergency funding must be severe.  The amount of IMF funding must not be unlimited. There must not be a guarantee that the IMF will always bail out countries and institutions when they need funds. 





“Annual Report of the Executive Board for the Financial Year Ended April 30, 1998,” International Monetary Fund, Washington, D.C.

Camdessus, Michel, “The IMF and its Critics,” The Washington Post, November 10, 1998.

Camdessus, Michel, “Economic and Financial Situation in Asia: Latest Developments”, Background paper for Asia-Europe Finance Ministers Meeting, Frankfurt, Germany, January 16, 1999.

Corsetti, Pesenti, and Roubini, “What Caused the Asian Currency and Financial Crisis?  Part I:  A

Macroeconomic Overview,” Second draft, September 1998.

Fischer, Stanley, “On the Need for an International Lender of Last Resort,” January 3, 1999.  Paper

presented at lunch for the American Economic Association and the American Finance

Association.  New York.

Fischer, Stanley, “The Asian Crisis and the Changing Role of the IMF,” Finance & Development, Volume 35, Number 2, June 1998.

International Monetary Fund, “International Capital Markets: Developments, Prospects, and Key Policy Issues,” World Economic and Financial Surveys, Washington, D.C., 1996.

International Monetary Fund, “World Economic Outlook, December 1997: A Survey by the Staff of the International Monetary Fund, World Economic and Financial Surveys, Washington, D.C., 1997.

Lane, Timothy et al, “IMF-Supported Programs in Indonesia, Korea and Thailand”, A Preliminary Assessment, January 1999.

Lindsey, Lawrence, “The Benefits of Bankruptcy,” January 1998, Enterprise Institute for Public

Policy Research.

“Memorandum on Economic Policies of the Royal Thai Government,” Bangkok, February 24, 1998.

Neiss, Hubert, “In Defense of the IMF’s Emergency Role in East Asia”  International Herald Tribune,

October 9, 1998.

“Overview of World Bank Activities,”

Schlafly, Phyllis.  “Congress Should Just Say No to IMF Funding,” Eagle Forum, January 7, 1998.

Summers, Lawrence. Text of speech to Senate Foreign Relations Subcommittee on International

Economic Policy and Export/Trade Promotion.  RR-2916.  January 27, 1999.


[1] The introduction borrows heavily from the IMF and World Bank websites

[2] “The IMF and World Bank: How Do They Differ,”

[3] Ibid

[4] Ibid

[5] “Overview of World Bank Activities,”

[6] Lane, Timothy et al, “IMF-Supported Programs in Indonesia, Korea and Thailand,” A Preliminary Assessment, January 1999

[7] Camdessus, Michel, “Economic and Financial Situation in Asia: Latest Developments,” Background paper for Asia-Europe Finance Ministers Meeting, Frankfurt, Germany, January 16, 1999

[8] Ibid

[9] “The IMF’s Response to the Asian Crisis”, External Relations Department of the International Monetary Fund in collaboration with the relevant regional and policy departments, Washington, D.C., January 17, 1999

[10] Fischer, Stanley, “The Asian Crisis and the Changing Role of the IMF,” Finance & Development, Volume 35, Number 2, June 1998

[11] Fiscal year begins in October

[12] “The IMF’s Response to the Asian Crisis”, External Relations Department of the International Monetary Fund in collaboration with the relevant regional and policy departments, Washington, D.C., January 17, 1999

[13] Ibid

[14] Fiscal year begins in April

[15] Borrows heavily from IMF website and December 1998 IMF World Economic Outlook

[16] “The IMF’s Response to the Asian Crisis”, External Relations Department of the International Monetary Fund in collaboration with the relevant regional and policy departments, Washington, D.C., January 17, 1999

[17] Ibid

[18]Corsetti, Pesenti, and Roubini, “What Caused the Asian Currency and Financial Crisis?  Part I:  A Macroeconomic Overview,”  September 1998

[19] Ibid

[20] Fischer, Stanley, “On the Need for an International Lender of Last Resort.”  January 3, 1999, New York.  Paper presented at lunch for the American Economic Association and the American Finance Association