|CAPITAL FLOWS IN CRISIS AND THE
INTERNATIONAL FINANCIAL INFRASTRUCTURE: AN INDONESIAN
J. Soedradjad Djiwandono (*)
SOME NOTES ON THE INTERNATIONAL FINANCIAL ARCHITECTURE
The awareness of the need to strengthen international financial system has been going on for sometime now. As I recall, it started with an acknowledgement by pundits and authorities on the close link between the soundness of financial sector and macroeconomic management, which has been manifested in different studies and communiqu or declaration of multilateral gathering. But, the Asian crisis seems to be the driving force of the world to be more focus on what to do about it. Now we have reports from studies by working groups formed by 22 Finance Ministers and Central Bank Governors as well as report of the Managing Director to the Interim Committee, and a hose of papers discussing the issues or advancing proposals to address the problems.
In general the proposals for strengthening the architecture of the international financial system compose of the following areas:
Let me touch on these issues in
sequence based from my assessment on the Indonesian
experience. When one makes an assessment form a distance,
in terms of physical or time, one could see things
clearer, and tends to be more ready to accept or agree to
some proposals or concepts. Of course one has the benefit
of hindsight for discussing about something of the past.
And it is not too difficult to agree on something in the
future about something normative.
On the role of internationally accepted standards, the Interim Committee of the Fund reported that progress had been made in formulating codes of good practice for public and private sector entities to be adopted as benchmarks on which countries could be compared. 'Transparency in the financial sector is a golden rule' Mr. Camdessus said. I think everyone accepts this. Both efforts of multilateral institutions as well as individual countries to increase transparency have been widely accepted now. This is encouraging. My only note is that we also have to prepare the public that increasing disclosure would also imply a possibility of an increase in market nervousness, especially if the problems of disclosures are not properly treated. We have been observing that market nervousness could lead to a panicky as a manifestation of the 'herd instinct'.
The private sector involvement in resolving and preventing crises is, I think, becoming very important, at least from the perspective of the Asian experience. I think, there has been some kind of consensus that in the most effected countries the private sector external debts have been one of the major problems causing the crisis. However, what has been the private sector's role in each case has not been very clear. Mr. Camdessus in one of his speeches on the subject acknowledged that this is, in fact, one of the most complex issues of the new agenda for international financial architecture. The Indonesian experience shows how difficult is to come up with a workable scheme to solve the private sector debts' problems. In the beginning, partly because of the IMF position on the issues, the government policy was absence except stating that the government is not going to bail out the private sector that faced problems of default. Only after a long winding process that some formula of the government involvement in addressing the private sector debts problems in the end resulted. But, the problem is far from being clearly identified, let alone solved.
There is one observation that I would like to make here. I have to admit that some views on the problems of private sector debts in the Asian crisis are sometimes confusing. The argument on moral hazard to explain the large exposures of investors in these countries has not been very convincing. If indeed, these investors were pouring money to these countries, assuming that the host countries' governments - and the Fund - would be bailing the debtors out in the event of default, then, if it turned out that there is no bail out, who is to blame? The fact is that their assumption is just not right in the first place. In the case of Indonesia, there has never been any implicit, let alone explicit, guarantee by the government. The reverse expectation is on the deposit guarantee. Some critics argue that the failing of bank closures in Indonesia was because there was no deposit guarantee. I think the private sector involvement in resolving current debt problems as well as finding formula for preventing future crises is very important. The fact that these issues have been recognized is an encouraging development. There is still a long way to go, but a preliminary step has been in the right direction.
Issues on strengthening financial sector have been discussed earlier, and more results have been achieved here. We have to admit that the Fund has been instrumental in creating international awareness about the importance of bank soundness in monetary policy and macro-economic management in general. Beginning with studies on cases of banking crisis in the early nineties, and continued in mid nineties, monetary authorities all over the world were reminded about the issues. The fact that we still have Asian crisis with unsound banking problems at the center of it may only tell us that timeliness is so important. Had these problems were identified sooner and properly addressed, we might not have to experience Asian crises at all.
It had been the Indonesian experience that the unsound banking sector had been constraining the implementation of monetary policies, the working of payment system as well as a strict adherence to prudential measures. It still has to be seen whether a sound banking sector could withstand contagion effects and crises. However, it is almost sure that an economy could withstand currency shock not to become a crisis. It has been well documented that in the past two decades more than two third of IMF member countries, developed as well as developing countries have been experiencing some sort of banking distress or crisis. The Asian crisis has also been dominated by problems of unsound banking sector. These development should be enough to convince monetary authorities and market players all over the world to get really focus in doing everything necessary to have sound banking system as part of economic fundamentals of each national economy.
The issue of liberalization of capital account has been receiving so much attention, in the beginning on how to speed up the process, culminated in the Interim Committee declaration of 1997 in Hongkong to proceed with the mechanism for IMF member countries. However, since the Asian crisis led people to see that short-term capital flows had been prominent in causing the contagion, then there have been more discussions on whether it should not be reconsidered. In the last Interim Committee Communiqu it was phrased in more realistic way, i.e. "The opening of the capital account must be carried out in orderly, gradual and well sequenced manner, keeping its pace in line with the strengthening of countries' ability to sustain its consequences".5 Of course, discussion on the issues is still on, especially since Malaysia introduced capital control recently. My only note with this issue is that once a country chooses a path of liberalization, it is almost impossible to reverse. This is true in capital account liberalization, which in the case of Indonesia was done in the seventies. It is also true in the case of banking sector liberalization. In both cases there are requirements to be made, whether in conjunction with or prior to the liberalization. If you did not do that you will be in trouble. But, how would you do to correct, i.e. to retract the sequence when it was already done? Banking sector liberalization as a means to establish a sound banking sector should be done also in orderly manner. It has to be supported with sound financial infrastructure, including strict regulation and supervision plus good governance. But, if you had not been doing all these adequately, you will be in trouble. The problem is how could we correct this.
Capital flows have been very important for developing countries. Inflows of capital to developing countries in different forms have been instrumental for the host countries to achieve significant economic growth, both through their roles in filling the gap of investment expenditures and domestic savings, as well as facilitating the development of the banking and capital market. However, capital flows also pose new challenges for monetary authorities as well as the market players of the developing countries. There has been a consensus that capital flows, in particular short term's private capital flows, have played a prominent role in causing or exarcebating Asian crisis. Addressing properly issues on capital flows, for the policy makers and market players is very crucial in the world efforts to overcome the crisis and establish a sound international financial infrastructure.
In a global finance, when national markets, small and big, developing and developed, are integrated, all parties have to make effort to enable the system works for the benefits of all. The proposed financial architecture that has been widely discussed is an effort aimed at facilitating that globalized finance. I think, all the ingredients are there for all parties to make their best effort to adopt.
Based from my assessment on what have been unfolding in Indonesia, the followings are some notes relevant for the proposal on international financial architecture:
Finally, I have to get
back to my theme that, right now the major problem is not
about the international financial architecture, at least
for those countries suffering from the crisis. The first
priority is still on how to end the crisis. This is, of
course, a topic on its own. For Indonesia, this means
that, aside from the food problems, the issues are
outside economics and finance. The main problem lies in
the capability of the national leadership to establish
and maintain political and social stability to facilitate
the national efforts for ending the crisis. And, as the
Indonesian case showed us, it means dealing with problems
of national leadership, politic as well as social
problems. Without any resolve in these very pressing
problems, it is difficult to address issues on
international financial architecture.
(*) Professor of Economics, the University of Indonesia and a Visiting Scholar at the Harvard Institute for International Development (HIID).
Communiqu of the Interim Committee of the Board of
Governors of the International Monetary Fund, October