A DECADE ago, the Asian crisis began to unfold across the region. The crisis was unprecedented in its nature and virulence, and few countries escaped unscathed.
Ten years later, Asia has made great progress in strengthening its economic foundations and is once again the most dynamic region in the world. The International Monetary Fund (IMF), too, has undertaken major reforms, retooling itself to better help its membership benefit from increasing economic and financial globalisation.
The defining characteristic of the Asian crisis was a sudden reversal of investor sentiment and cross-border capital flows. The roots of the crisis, however, were in financial and corporate sector weaknesses not fully apparent at the time. Other important ingredients were pegged exchange rates that encouraged excessive unhedged foreign borrowing, inadequate reserves and lack of transparency - not least about the true level of usable reserves. In most cases, traditional macroeconomic imbalances were not evident beforehand, and did not play a major role.
As private creditors stampeded for the exits, the international community - working through the IMF - provided substantial funding. At the same time, governments in the region adjusted policies, increasingly taking strong and appropriate actions. Also, crucial steps were taken to involve the private sector in providing financing. After some initial adjustments, confidence began to recover and capital to return. Output then recovered quite rapidly, though not before substantial economic and social damage had been done.
A central lesson from the crisis - supported by recent research - is that to reap the considerable potential gains that financial globalisation offers, and limit attendant risks, macroeconomic frameworks and financial sectors must be robust. This requires meeting certain standards on institutional quality, governance and transparency - preconditions not adequately met in Asia prior to the crisis.
Asia has taken this lesson to heart. Over the past decade, while continuing to embrace globalisation, countries in the region have strengthened their policy and institutional frameworks to an impressive extent. These reforms have been aimed especially at reducing vulnerabilities to volatile capital movements. Macroeconomic frameworks have been strengthened in several important respects.
The most visible change is the build-up of foreign exchange reserves as a defence against future market volatility. While this is a positive development, too large a reserve buffer can be costly to maintain, can create difficulties for monetary control and ultimately can come at the expense of an unbalanced and unsustainable pattern of growth.
Many countries have adopted more flexible exchange rate systems to better absorb external shocks, including sudden shifts in investor sentiment. Flexible exchange rates also allow greater monetary independence. However, the move towards flexibility has not been uniform.
In particular, the limited exchange rate flexibility in China makes it more difficult for other countries to allow their exchange rates to strengthen under appreciation pressures, lest competitiveness is lost in a unilateral move. This is reflected in certain cases in continued accumulation of reserves to very substantial levels.
The transparency of government policies and the overall availability of information has improved significantly. Asian governments - aided in many cases by IMF-led transparency initiatives - now routinely publish economic data, including an external debt and reserves. With many of the region's central banks now using inflation-targeting frameworks, statements about monetary policy developments are also published regularly.
Asian countries also have launched important reforms of financial sectors and corporate governance. As a result, there has been a marked reduction in non-performing loans, and corporate debt-equity ratios have been reduced across the board.
The lessons of the crisis have also spurred regional initiatives aimed at increasing financial integration and resilience. The crisis perhaps has created a stronger sense of regional identity. One result is that information exchange and policy dialogue have been stepped up since the crisis through various fora, including Asean and Asean+3.
Under the Asean+3 framework, a system of bilateral swap arrangements known as the Chiang Mai Initiative was set up to enable individual governments to draw upon their neighbours' resources in case of a sudden outflow of capital or other volatility. Recently, a plan was announced to turn this mechanism into a reserve pooling arrangement. The IMF supports these initiatives as useful complements to its own financing. To broaden and deepen regional capital markets, efforts are underway to promote local bond markets. Government efforts in this area - including under the Asian Bond Market Initiative and the two Asian Bond Funds - are facilitating a bottom-up process of market integration.
These country and regional initiatives have enhanced the strength and resilience of Asia's financial sectors. Over the past year emerging Asia has handled two moderate bouts of global financial market turbulence. Of course, the region remains to be tested by a major disturbance to global markets.
The IMF also has changed in response to the Asian crisis. First, we have given new emphasis to analysis and policy advice related to financial sectors, integrating them with our macroeconomic analysis. The goal is better to identify vulnerabilities and the appropriate policy responses. Second, we now do more multilateral and regional analysis to complement our country work to better define common trends, and actual and potential spillovers. Third, we are assessing whether our financing tools for crisis prevention can be improved. Fourth, we have a better understanding of the importance of country ownership essential to give prominence to a government's own priorities in programme design. And we have streamlined the conditions attached to our lending to cover only issues critical to macroeconomic stability and growth.
Finally, the IMF is moving ahead with governance reform to ensure the structure of decision making better reflects global economic realities. An important step was taken at last year's annual meeting in Singapore when the Fund's governors agreed to a two-year reform programme that began with quota increases for four countries, including China and Korea. The second stage of this reform programme is to involve further increases in quotas for the Fund's more dynamic members, while bolstering the voice of low-income countries. These reforms will be completed no later than September 2008.
Looking forward, Asia is well-placed to become an even greater force in the world economy. To fulfil this promise, new policy challenges will need to be overcome. These include rebalancing growth towards greater reliance on domestic demand, coping with volatile capital flows and changing regional and global production patterns and addressing problems arising from ageing societies and growing inequality. The IMF, for its part, will continue to work closely with countries in the region to help them meet these challenges.
The writer is director of the Asia and Pacific Department of the International Monetary Fund.
