The IMF and Recent Capital
Account Crises: Indonesia, Korea,
BrazilIndependent Evaluation Office,IMF

GDP growth (%)
1997

1998

1999

Indonesia

4.7-13.1

0.8

Korea

5.0-6.7

10.9

Brazil

3.3

0.1

0.81

Exchange Rate Against the U.S. Dollar(Percentage change from the date of program approval)-50%

Korean won

0%

50%

Brazilian real
100%

150%

200%

Indonesian rupiah

250%

300%

350%

400%
-24 -16-8

t=08

16

24

32

40

48

56

64

72

80

8896

104 112 120 128 136 144 152 160(weeks)Indonesia• Record of strong growth, but also “cronyism” andweak banks• July-August 1997: Crawling peg bands widened,
then abandoned• November 1997: IMF stand-by arrangement,$10 bn (plus $8 bn from other sources)• Bank closures mishandled. Central bank createsliquidity. Political crisis.
• January 1998: Detailed structural program
signed, but never formally approved2

Indonesia (cont.)• March 1998: President reelected. New economicteam• April 1998: Revised program with tightermonetary controls• May-June 1998: Political crisis worsens.
President resigns.
• August 1998: Financing replaced by $6.3 bn
Enhanced Fund Facility. Slow and unevenstabilization and reform.
• Overall: Severe collapse in growth and rise inpoverty.

The IMF and Indonesia• In pre-crisis surveillance, identified banking
sector vulnerabilities, but underestimatedseverity and macroeconomic impact• Political “ownership” of the program andresistance of vested interests underestimated• Poor implementation of bank restructuring
strategy• Excessive structural conditionality

3Rep of Korea• Record of strong growth and macroeconomic stability.
• Economy dominated by large conglomerates, directedinvestment.
• Extensive short-term foreign-currency borrowing bybanks.
• Unprecedented wave of bankruptcies of chaebol in earlymid 1997.
• End-October 1997: Speculative attacks on Hong Kong
and Taiwan. Investors take a second look at Korea.
• Capital outflows and a run on the currency by midNovember 1997. BOK deposits hard-currency reservesin banks’ overseas branches. Rollovers fall.

Korea (cont.)• Early December 1997: IMF stand by arrangement: $21
billion from the IMF, $14 billion from other sources, c.$20
billion “second line of defense”• After a few days, the won goes into free fall and reserves
disappear.
• Kim Dae-Jung elected president, announces his support
for radical reform measures.
• Christmas eve: major creditor banks announce
coordinated rollover, willing to negotiate maturity
extension.
• The government begins energetically implementing thereform package and cleaning up the banking system.
• 1998: V-shaped recovery.

4

The IMF and Korea• Surveillance missed the relevance of unevenfinancial liberalization• Gaps in data: reserves, private debt
• Uncertain status of the “second line of defense”• Crisis coordination role – but with a delay?
• Initial fiscal tightening unnecessary, but quicklyreversed• Financial sector restructuring ultimately
achieved impressive results

Brazil• 1994: The Real Plan brings disinflation, large fiscal
deficits, overvalued exchange rate.
• August-September 1998: Capital outflows after
Russia/LTCM.
• December 1998: IMF financing of $18 bn (plus $24 bn
from other sources) to support the crawling peg.
Pressure on real continues.
• January 1999: Currency floated.
• March 1999: Revised IMF program, based on inflation
targeting. Voluntary rollovers of interbank lines and tradecredit.
• Inflation is lower than expected; positive growth.

5The IMF and Brazil• Key vulnerabilities were identified, butdownplayed• Had little impact on policies pursued byauthorities• Too concerned about contagion?
• Transition to inflation-targeting managed
wellSome similarities• Change in market sentiment causes
reversal in capital flows• “Exceptional” IMF access, supplemented
by other sources• Initial programs did not restore confidence,but subsequent responses more
successful6Some differences• Indonesia and Korea had balanced fiscal
accounts and a history of low inflation;
Brazil did not.
• Indonesia and Korea were “twin crises”;
Brazil was not.
• Political commitment was strong in Korea
and Brazil (after initial uncertainty), weakin Indonesia.

Pre-crisis surveillance• Good on macro vulnerabilities.
• Not as good on extent of/implications of:– Financial sector balance sheets– Corporate balance sheets– Governance issues• Information provision by authorities• Impact on policies generally limited• Confidential advisor role?

7Program design: Macro framework• Projections were too optimistic in
Indonesia and Korea; too pessimistic in
Brazil.
• In all three cases, this led to mistakes infiscal policy.
• Projections missed currency depreciation,balance sheet effects,
implications for privateinvestment.

Program design: fiscal policy• Indonesia and Korea: Mild tightening
initially, soon relaxed.
• Brazil: Strong tightening, but not sufficient
to stabilize debt/GDP ratio.

8Program design: Monetarypolicy• In all three countries, initially tight.
• In Indonesia, money supply expandsrapidly.
• In Korea, gradual easing – too gradual?
• In Brazil, more rapid easing.
• Possible conclusion: high interest rates
were necessary for stabilizing exchangerate, but not sufficient.

Program design: Financing andPrivate Sector Involvement (PSI)• Korea: Ambiguity over “second line ofdefense” was damaging.
• PSI important for Korea and (to a lesserextent) Brazil. IMF played a role incoordination, information provision.
• Credible program needed foreffective voluntary PSI.

9

Program design: Bank closure andrestructuring• Important in Indonesia, Korea; not Brazil• Need a comprehensive and wellcommunicated strategy• Partial vs blanket guarantee?

Program design: Structuralconditionality• Indonesia and Korea: Extensiveconditionality• The financial ones were probably
necessary, the non-financial ones not• Quantity vs quality• Brazil: Fewer conditions, mainly fiscal

10

Program design: Communications
strategy• Need to explain the logic and strategy ofthe program to the public and the markets.
• All three cases: Didn’t do so.

IMF internal governance• Lack of candidness. Judgments becameless sharp as they went up to Executive
Board level.
• Coordination across departments.
• Role of major shareholders.
• Coordination with World Bank, otherMDBs.

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Recommendation 1. Surveillanceshould take a stress-testing
approach.
• Staff reports itemize the major potential
shocks the economy could face
• Explore real and financial consequences• Discuss response plans with authorities• Can reveal:– Information gaps
– Balance sheet mismatches– Political constraints on policy making

Recommendation 2: Improve
impact of surveillance, throughgreater candidness, transparency.
• Escalated signaling• Second opinions from outsiders• Presumption of publication of Article IVstaff reports, country-related working
papers• Institutional incentives for candid staff
assessments

12

Recommendation 3.
Comprehensive review of program
design• More attention to impact of balance sheetinteractions• Allow for flexible response• Review use of quantitative performance
criteria• Avoid imposition of reforms that are notcritical to crisis resolution• Communications strategy

Recommendation 4: Financing
should be sufficient and credible• Terms for parallel official financing shouldbe clear• Terms for involvement of other institutions
should be specified at the outset

13

Recommendation 5: The IMF
should be proactive as a crisis
coordinator• Management should be frank with board
and shareholders about probability ofsuccess• No political interference in technicaljudgments of staff• Identify circumstances where PSI could beuseful, through such means as dialogue
with the private sector

Recommendation 6: Better
promotion and utilization of staff
expertise• Key areas: Country-level expertise, political
economy, crisis management• Ensure that resources are maintained and readyto respond to crises• Review role of resident representatives• Protect those who raise uncomfortable issues• Develop critical mass of staff with country
experience14