“New debt crisis”

15 September 1998

Investors’ growing aversion to risk is leading to a general withdrawal of finance from many Southern countries. The Economist has announced a “new debt crisis” as countries struggle to find new money to pay off their liabilities. The threat to the global economy is thought to be greater than any time since the 1930s. Concerns are growing that the contagion may now spread to Latin America (particularly Brazil, Venezuela, and Mexico), Eastern Europe, and other parts of Asia.

“when per capita income (measured in US dollars) sinks tenfold as it did in Indonesia, and Western economies benefit from rock-bottom commodity prices, low inflation and interest rates, it ought to result in a serious re-examination of business practices (of lending institutions), economic policies (international trade and capital market liberalisation) and the sequencing of economic reforms pursued by the International Monetary Fund at the behest of its major shareholders. The IMF should roll back some of its absurdly stringent conditions imposed on borrowing governments [and] abandon its insistence on capital market liberalisation in the borrowing countries.”

V. Anantha-Nageswaren, Credit Suisse Private Banking, letter to the Financial Times, 17 September 1998

Fears of contagion are made worse by the failure of the IMF‘s medicine to revive its Asian patients; GDP is expected to fall by 15% in Indonesia, 8% in Thailand and 7% in Korea this year. An overhang of unpayable foreign debt, and domestic credit problems, are inhibiting recovery. The recession in Asia is causing large social problems across the region, and political stability is uncertain in many countries.

The IMF has held precautionary talks with Latin American governments The Brazilian government has already raised interest rates twice to try to stem the outflow of private finance; Argentina has arranged a financial package with the IMF, World Bank, Inter-American Development Bank and local private sector banks to ensure the country has access to funds should it be unable to borrow from usual commercial sources; and Ecuador and Columbia both devalued their currency in September as a result of balance of payment pressures caused by the financial crisis.

If Japan eventually devalues its currency, as expected, this will put pressure on other countries. Devaluation could then spread globally as each country tries to restore its competitiveness, triggering a recession. The FT remarked that

“the contagion effect is now well established. Countries that rely on foreign capital – and on selling commodities such as oil and low-value manufactured goods, for which prices have collapsed globally – have found the props being pulled from under their currencies.”

Immediate attention is being given to possible US government action, for example an interest rate cut to weaken the dollar, reduce debt servicing costs and raise demand for commodities. More long-term discussions are needed about the roles of the Fund, the Bank and the G8, and how to assess the risks of global financial flows in a more balanced way.

A World Bank report, The Road to Recovery is due out soon on E. Asia. It will not, however, include much analysis of the WB and IMF‘s roles.