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G-24 Discussion Paper Series

UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT

UNITED NATIONS

CENTER FORINTERNATIONALDEVELOPMENTHARVARD UNIVERSITY

Reform of the International FinancialSystem and Institutions in Light

of the Asian Financial Crisis

Yung Chul Park and Yunjong Wang

No. 12, July 2001

G-24 Discussion Paper Series

Research papers for the Intergovernmental Group of Twenty-Fouron International Monetary Affairs

UNITED NATIONSNew York and Geneva, July 2001

CENTER FOR INTERNATIONAL DEVELOPMENTHARVARD UNIVERSITY

UNITED NATIONS CONFERENCE ONTRADE AND DEVELOPMENT

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iiiReform of the International Financial System and Institutions in Light of the Asian Financial Crisis

PREFACE

The G-24 Discussion Paper Series is a collection of research papers preparedunder the UNCTAD Project of Technical Support to the Intergovernmental Group ofTwenty-Four on International Monetary Affairs (G-24). The G-24 was established in1971 with a view to increasing the analytical capacity and the negotiating strength of thedeveloping countries in discussions and negotiations in the international financialinstitutions. The G-24 is the only formal developing-country grouping within the IMFand the World Bank. Its meetings are open to all developing countries.

The G-24 Project, which is administered by UNCTAD’s Macroeconomic andDevelopment Policies Branch, aims at enhancing the understanding of policy makers indeveloping countries of the complex issues in the international monetary and financialsystem, and at raising awareness outside developing countries of the need to introduce adevelopment dimension into the discussion of international financial and institutionalreform.

The research carried out under the project is coordinated by Professor Dani Rodrik,John F. Kennedy School of Government, Harvard University. The research papers arediscussed among experts and policy makers at the meetings of the G-24 Technical Group,and provide inputs to the meetings of the G-24 Ministers and Deputies in their preparationsfor negotiations and discussions in the framework of the IMF’s International Monetaryand Financial Committee (formerly Interim Committee) and the Joint IMF/IBRDDevelopment Committee, as well as in other forums. Previously, the research papers forthe G-24 were published by UNCTAD in the collection International Monetary andFinancial Issues for the 1990s. Between 1992 and 1999 more than 80 papers werepublished in 11 volumes of this collection, covering a wide range of monetary and financialissues of major interest to developing countries. Since the beginning of 2000 the studiesare published jointly by UNCTAD and the Center for International Development atHarvard University in the G-24 Discussion Paper Series.

The Project of Technical Support to the G-24 receives generous financial supportfrom the International Development Research Centre of Canada and the Governments ofDenmark and the Netherlands, as well as contributions from the countries participatingin the meetings of the G-24.

REFORM OF THE INTERNATIONAL FINANCIALSYSTEM AND INSTITUTIONS IN LIGHT OF THE

ASIAN FINANCIAL CRISIS

Yung Chul Park

Professor, Department of Economics, Korea University, Seoul

and Yunjong Wang

Director and Research FellowDepartment of International Macroeconomics and FinanceKorea Institute for International Economic Policy, Seoul

G-24 Discussion Paper No. 12

July 2001

viiReform of the International Financial System and Institutions in Light of the Asian Financial Crisis

Abstract

When East Asian countries came under speculative attacks in 1997, some of them

were not able to defend themselves, and subsequently had to seek the financial

assistance of IMF and accept its stabilization programmes. These crisis-hit countries

were criticized for not having restructured their financial, corporate, and public

sectors along the lines suggested by the Washington consensus. This failure was singled

out as the main cause of the crisis and, understandably, these crisis-hit countries

were subject to heavy doses of structural reforms. The East Asian crisis became

contagious, even threatening the stability of major international financial centres.

The severity and contagiousness of the East Asian crisis underscored the importance

of, and renewed interest in, reforming the international financial system. Numerous

proposals have been put forward. The G-7-led reform, however, has concentrated its

efforts on reforming the financial and corporate sectors of developing economies,

while by and large ignoring the problems of the supply side of international finance.

As was the case in the Mexican crisis of 1994/95, the appetite for radical reform

of the international financial system has receded considerably in the wake of global

recovery. The ongoing debate on the future direction of the international financial

reform in fact suggests that most of the problems that beset the international financial

system are likely to remain unchanged. This pessimistic outlook arouses deep concern

in developing countries lest they remain vulnerable to future financial crises, even if

they faithfully carry out the kinds of reform recommended by IMF and the World

Bank. Given this reality, developing countries may have to develop a defence

mechanism of their own by instituting a system of capital control and adopting an

exchange rate system that lies somewhere between the two corner solutions.

ixReform of the International Financial System and Institutions in Light of the Asian Financial Crisis

Table of contents

Page

Preface ............................................................................................................................................ iii

Abstract ........................................................................................................................................... vii

I. Introduction .............................................................................................................................. 1

II. Reform of international financial institutions ....................................................................... 2

A. Role of international lender of last resort ............................................................................ 2B. Conditionalities versus pre-qualification ............................................................................. 4C. Governance of IMF .............................................................................................................. 5

III. International standards and codes ......................................................................................... 6

A. Standardization versus regulatory competition.................................................................... 6B. Too many one-size-fits-all standards ................................................................................... 7C. Legitimacy ........................................................................................................................... 7D. Sovereignty and global governance ..................................................................................... 8

IV. Bailing in the private sector .................................................................................................... 9

V. Exchange rate regimes and capital controls ........................................................................ 11

VI. Regional financial arrangements .......................................................................................... 13

A. Arguments against regional financial arrangements .......................................................... 13B. Rationales for regional financial arrangements ................................................................. 14C. Challenges and tasks .......................................................................................................... 15

VII. Concluding remarks .............................................................................................................. 16

Notes ........................................................................................................................................... 17

References ........................................................................................................................................... 18

1Reform of the International Financial System and Institutions in Light of the Asian Financial Crisis

I. Introduction

Following the collapse of the Thai baht on2 July 1997, the financial markets in other East Asiancountries suffered similar and disastrous conse-quences up until mid-1998. The simultaneousfinancial meltdown in the East Asian countries hasled to the widespread use of terms such as the Asian“flu”, with the implication that this was a real caseof contagion, where one country’s crisis spread toother vulnerable countries. Many academic research-ers and pundits have argued that the domino effectsamong the East Asian currencies were mainly attrib-utable to deep-seated regional structural weakness.Blame has been heaped on “the Asian way”.1 Oneunpleasant term that has been coined to label thisstructural weakness is “Asian cronyism”. The moralhazard problems existing in both the corporate andfinancial sectors are discussed in a more gentle tonein Krugman (1998a, 1998b), Fischer (1999) andCorsetti et al. (1998).

Contrary to the popular opinion in most credi-tor countries, however, the economic crisis in EastAsia was not an “East Asian” one. The conditionsthat precipitated the crisis were by no means uniqueto the region. They had their roots in the liberaliza-tion of the financial sector prior to establishing anefficient framework of regulation and supervision,excessive borrowing and lending by private agents,and the inability and unwillingness of key players –including governments – to accurately assess risks.The resulting collapse of domestic financial and cur-rency markets is a phenomenon already observed inthe 1990s in Europe, Latin America, and then in EastAsia. Furthermore, the continued spillover effects ofthe East Asian crisis hit the Russian Federation andreached Latin America.

The speed of recovery in East Asia since mid-1999 has been impressive. It is quite possible thatEast Asia will remain crisis-free for the next severalyears. Despite the optimistic outlook for East Asianrecovery, there is also widespread concern that the

REFORM OF THE INTERNATIONAL FINANCIALSYSTEM AND INSTITUTIONS IN LIGHT OF THE

ASIAN FINANCIAL CRISIS*

Yung Chul Park and Yunjong Wang

* We should like to thank to Dani Rodrik, Charles Wyplosz and the participants of the G-24 Technical Group Meeting , Geneva,14–15 September 2000, for their valuable comments and suggestions.

2 G-24 Discussion Paper Series, No. 12

economic upswing under way in the crisis-hit coun-tries does not necessarily mean that the region is outof the danger zone. In the eyes of many East Asians,few of the structural deficiencies of the internationalfinancial system that also contributed to the crisishave been sufficiently rectified. Along with consist-ent and lasting structural reforms in East Asia,creating a new international financial architectureshould be more balanced; it should address the prob-lem of market failures that beset international capitalmarkets and that often trigger financial panic and herdbehaviour. Even if the most ambitious architecturalreform would not forestall a future financial crisis, anew international financial architecture should tem-per the depth and scope of subsequent disruptions inthe aftermath of the inevitable next financial crisis.

Since the East Asian financial crisis of 1997/98, numerous proposals for reforming the interna-tional financial system have been put forward.2 Fromthe viewpoint of the East Asian countries, relativelylittle has been accomplished vis-à-vis reducing thedegree of instability in the international financialsystem and improving its capacity to manage criseswhen they occur. Thus, additional reforms are neededboth to prevent such crises in the future and to re-spond more effectively to the painful disruptions thatwill inevitably occur. However, as in the Mexicancrisis of 1994/95, the appetite for radical reform ofthe international financial system has receded con-siderably in the wake of global recovery. Signallingthis new perception at their meeting in Cologne inJune 1999, the G-7 Finance Ministers explicitly ruledout the creation of any new institutions and made itclear that their aim would be to work with the exist-ing system, strengthening it when necessary (Groupof Seven, 1999).

There is nothing wrong with incremental changeas long as it yields positive outcomes. However, thereality is that the already slow progress would notsafeguard financial stability in the emerging marketeconomies (EMEs). As long as the structural prob-lems on the supply side of capital are not addressed,the East Asian countries will remain as vulnerableto future crises as they were before. Would the inter-national community need another global crisis or twobefore reaching the political consensus that seemsalmost impossible at this juncture?

In what follows, we shall examine various ar-chitectural reform issues in the light of the East Asianfinancial crisis. Because the international financialarchitecture covers such a broad area, this paper fo-cuses on a few selected issues. Section II discusses

the reform of international financial institutions(IFIs); section III examines the current process ofsetting and enforcing international standards; sectionIV deals with bailing in the private sector; section Vexamines the issue of exchange rate regimes andcapital controls; and, finally, section VI considers analternative safeguarding scheme – the so called “re-gional financial arrangements” – to supplement andcomplement the existing global financial architec-ture.

II. Reform of international financialinstitutions

A. Role of international lender of last resort

The debate on the need for an internationallender of last resort (ILLR) dates back to the incep-tion of the Bretton Woods system. Keynes putforward the plan to establish an International Clear-ing Union, which would issue new internationalmoney to be called bancor, and provide automaticfinancing of current-account deficits. The issue sur-faced again in the 1970s, when the dollar crisis ofAugust 1971 constituted a threat to the BrettonWoods parity system. With the collapse of the rule-based international financial order between 1971 and1973, most industrialized countries moved towardsfloating. Furthermore, the international activity ofcommercial banks increased dramatically with theadvent of the euro-currency markets, and the needfor recycling the sizeable surpluses of OPEC coun-tries complicated the international monetary order(De Bonis et al., 1999).

The issue of an ILLR may be simplified intotwo questions. The first is whether there is a needfor an ILLR. If so, the second question is what insti-tutions, or group of institutions, should assume theresponsibility. According to Kindleberger (1973,1989), the international dimension of crises makes acase for such a global institution. When a crisis isunfolding, countries may face limited access to capi-tal markets, even though they are implementingappropriate policy corrections.3

As for the second question, the role of an ILLRhad been informally performed by either the centralbanks or major financial centre institutions beforethe creation of the Bretton Woods institutions in 1945.The institutional setting that was shaped at BrettonWoods fell short of providing a full-fledged ILLR.


Instead, IMF was created as a quasi-lender of lastresort or, as Fischer (1999) puts it, a crisis manager-lender in order to provide to its member countriesthe financial assistance needed to correct their ex-ternal imbalances. However, the principles governingIMF’s lending activities could hardly be reconciledwith the classic Bagehot rules of (i) lending freelyto solvent borrowers, (ii) against good collateral, and(iii) at a penalty rate.4

The current discussion on the reform of the in-ternational financial system effectively rules out thepossibility of creating a world central bank. Eichen-green (1999a), for instance, dismisses the idea of aglobal central bank as quixotic. This leads to thequestion of whether and how the existing BrettonWoods institutions should be restructured to serveas a lender of last resort. On this question, there ap-pears to be at least four competing approaches.

The first approach, which reflects the view ofKindleberger’s detractors, proposes that even the lim-ited role of IMF as a quasi-lender of last resort shouldbe further circumscribed because it has become thesource of moral hazard in the global financial sys-tem, and financial markets are intrinsically stable andefficient, as well to deal with crisis contagion. Al-though there is no empirical support for the moralhazard problem associated with IMF (Bergsten,2000a), the Republican-led majority of the Congres-sionally appointed International Financial InstitutionsAdvisory Commission (IFIC) (known as the “MeltzerCommission”) calls for drastically shrinking both thescope of IMF intervention and the role of the WorldBank in development finance. The majority reportadvocates turning most development finance overcompletely to private capital markets, except in thepoorest countries, and restricting IMF lending tocountries that pre-qualify according to strict free-market criteria.

As opposed to the idea of drastically reducingthe role of IMF, it is possible to create a global crisislending mechanism by strengthening IMF as a quasi-lender of last resort and at the same time comple-menting it with the liquidity support of the G-7 coun-tries. This is the second approach.

In the current international context, it is not clearwhether IMF, or IMF and the World Bank combinedtogether, could even assume the role of a quasi-lenderof last resort. The experiences with managing theMexican and Asian crises in fact show that IMF sim-ply does not have enough resources to lend insufficient volume to end a financial panic, let alone

prevent it, without brining in the liquidity support ofthe G-7 countries. In view of the critical role playedby some of these countries in managing the crises inMexico and the Republic of Korea, IMF together withthe G-7 countries could develop an institutional lend-ing arrangement that adheres to the Bagehot rules incrisis lending and substitutes for the role of an ILLR.To be viable, such an arrangement would require (i) asubstantial increase in the amount of resources to bedeployable at short notice by the Fund, and (ii) insti-tutionalization of a second line of defence primarilysupported by the G-7 countries. This is the secondpossible approach for the reform of the role of theBretton Woods institutions as an ILLR.

Major steps have been taken in recent years toincrease the amount of resources EMEs and otherdeveloping countries (DCs) could draw from IMFfor their provision of liquidity. Notwithstanding theseefforts, which have led to a series of quota increases,the size of IMF financial resources today, as a pro-portion of the total GDP of its member countries, isonly one third of what it was at its inception in 1945.

Another problem concerning IMF facilities isthat they cannot be disbursed in a speedy manner tocountries suffering from a liquidity shortage. Real-izing this limitation, IMF and the World Bank haveintroduced new facilities intended to increase theamount of resources to be deployed at short notice;these include: the Emergency Financing Mechanism,introduced after the Mexican crisis; SupplementalReserve Facility (SRF), established in 1997; theContingent Credit Lines (CCL), introduced in April1999 by IMF; and the supply of guarantees by theWorld Bank. However, serious questions still remainas to whether these facilities could be activated intime to guard against a speculative attack.

While IMF together with the second line ofdefence supported by the G-7 could be a viable ar-rangement, it may not be readily acceptable to manyEMEs and DCs, as it may justify a system of globalfinancial governance controlled by the G-7 countries.

A third approach to reforming IMF as a quasi-lender of last resort emphasizes the need for createregionally based monetary funds to complement therole of IMF (Rose, 1998, Bergsten, 2000b). As willbe shown in section VI, the idea of establishing aregional monetary fund in Asia has been stronglyopposed by both IMF and the United States treasuryon the ground that regional funds could weaken therole of IMF and also aggravate the moral hazard prob-lem.


The fourth view is directed to a limited reformand a larger global role for both IMF and the WorldBank. A minority report of the Meltzer Commission,written by C. Fred Bergsten and signed by severalDemocrats, calls for more limited reform and a largerglobal role for both institutions. At the recent meet-ings of the IMF International Monetary and FinancialCommittee (IMFC) and of the Finance Ministers andCentral Bank Governors of the G-7 countries, virtu-ally all of the radical proposals of the MeltzerCommission majority were rejected. They reaffirmedthe central role of IMF as a quasi-lender of last re-sort, acknowledging the potential risk of moral hazardbut placing it in a decidedly secondary position.

While in broad agreement on the role of IMF,the G-7 Finance Ministers, who convened on 8 July2000 in Fukuoka (Japan), recommended two pricingchanges in the management of IMF facilities, oneof which is to increase the interest charges on allnon-concessional facilities, with the rates set on agraduated basis, depending on the duration of theoutstanding obligation. The new pricing structureis intended to establish more consistent incentivesacross facilities, encourage access to private capital,deter inappropriate large-scale access to and discour-age prolonged use of IMF resources (Group of Seven,2000).5

A second element of the pricing change of IMFfacilities involves reducing the rate of charge andthe commitment fee on CCL resources. The CCL wasestablished in order to protect innocent victims fromthe perils of speculative contagion. These “goodguys” would have pre-qualified for CCL access onthe basis of well-defined and transparent standardsof sound economic and financial policies. By mak-ing the CCL easier and more attractive to use, anycurrency contagion would quickly come face-to-facewith a large liquidity backstop. However, there stillremains the real issue of the mechanism to select afew “good guys” from among the many EMEs.6

B. Conditionalities versus pre-qualification

IMF’s clear mission is to promote the financialstability and macroeconomic prosperity of its mem-ber countries. In dealing with the recent financialcrises, however, IMF has included in its condition-ality a large number of reforms in many sectors,including the corporate and public ones and the la-bour market. In the aftermath of the East Asian crisis,the IMF structural policy conditionality has become

the target of intense criticism. In a recent paper,Goldstein (2000) describes a number of criticismslevelled against the IMF conditionality. One concernis that the IMF structural policy conditionality is of-ten viewed by DCs as so costly and intrusive as todiscourage seeking Fund assistance during crises. Asecond criticism is that in a crisis structural reformswill serve to frighten private investors about the se-riousness of the problem, which will make it moredifficult to restore market confidence. A third is thatthe Fund’s conditionality is biased against DCs. TheFund often asks DCs for structural reforms that itwould not ask of developed countries. The abovethree concerns are well worth noting, but they aresecondary and do not address the fundamental prob-lems of the IMF conditionality. One such problem isthat when IMF strays from its core competence andexpertise in macroeconomic and economic policiesinto longer-term structural reforms, the Fund maynot be able to manage efficiently financial crises.7

Feldstein (1998) was the first to criticize IMFfor moving beyond its traditional macroeconomicadjustment role by including in its programme anumber of structural elements. However, Fischer(1999) in his reply to Feldstein (1998) asserts thatthe basic approach of IMF to these crises has beenfar better than if the structural elements had beenignored or the Fund had not been involved. Eichen-green (2000a) also supports the Fund’s view that IMFcannot realistically be legislated out of the structural-reform business and, if there is one lesson to belearned from the Asian crisis, it is that structuralweaknesses in prudential regulation, bankruptcy andinsolvency procedures, and corporate governance cangreatly aggravate macroeconomic instabilities. TheFund may have to continue to address these matters,but if it does, it should be more sensitive to the so-cial, cultural and historical circumstances of itsmember countries.

The Meltzer Commission, on the other hand,was extremely critical of the existing approach tothe Fund’s conditionality. The majority on theMeltzer Commission concluded that “detailed Fundconditionality has burdened IMF programmes in re-cent years and made such programmes unwieldy,highly conflicting, time consuming to negotiate, andoften ineffectual”. It recommended permitting theFund to lend only to those countries that pre-qualifyfor assistance by building impeccably strong bank-ing systems. However, rigid rules for IMF lendingare patently unrealistic. Lending only to the coun-tries pre-qualifying for assistance would mean thatthe international community would be indifferent


to the fate of countries that do not meet the pre-qualification requirements, or to the instability thatmight be generated by systemic risks in the globalfinancial markets. For these reasons, the Fund’sconditionality cannot easily be replaced by the pre-qualifications proposed by the Meltzer Commission.However, conditionalities attached to the Fund’s pro-grammes should not go beyond its core competenceto help crisis-affected countries gain renewed accessto international capital markets. At the same time,they should be more carefully tailored to the verydifferent economic conditions of EMEs and providesufficient liquidity with promptitude and appropri-ate policy advice.

As far as financial and corporate restructuringis concerned, reform suggestions could be more ef-fective if they were designed on a consultative basis,because structural reforms are long-term develop-ment issues that cannot be achieved in a short spanof time.

The second critical problem of the IMF condi-tionality is that multiplication of reform measuresand the reliance on structural benchmarks and pro-gramme reviews have made it difficult for Fundborrowers to comply with the conditionality. Theyhave also increased the uncertainty faced by borrow-ers in a crisis situation. In East Asian crisis-strickencountries receiving IMF assistance, short-term policygoals were not necessarily consistent with medium-term structural reform objectives. Restructuring andreform would be imperative not only to minimizingthe likelihood of an occurrence of the crisis but alsoto building a strong and sound foundation for therecovery of sustainable growth. However, a widearray of reform packages would entail institutionalreforms, and adaptation would take time. Structuralreform businesses are medium- or long-run develop-ment issues that cannot be easily achieved in a shortspan of time. If pursued aggressively without dueconsideration of implementation constraints, struc-tural reforms could delay economic recovery, or endup being a perfunctory gesture (Park, 2000).

C. Governance of IMF

The G-7 Finance Ministers acknowledged thatfor IMF to maintain its legitimacy, credibility andeffectiveness as a global institution in the interna-tional financial system, it is essential that IMF’sdecision-making structure and operation remain ac-countable. This announcement may be seen as a

welcome sign of progress and shows that IMF is nowexamining the formula for calculating country quo-tas, which should reflect changes in the worldeconomy.

The structure of IMF is similar to that of a creditunion. Thus, IMF should be a universal institutionworking in partnership with all its members, basedon their shared interests. However, unlike a typicalcredit union, there is a clear demarcation betweennet depositors (lenders) and net borrowers. Indus-trial countries constitute the majority of lenders,whereas EMEs and DCs make up practically all IMFborrowers.8 A few rich industrial countries controlthe decision-making process as well as the opera-tions of Fund. Given this dominance, one couldlegitimately raise the concern that IMF may be “tooresponsive to its principal shareholders, which arehigh income, international creditor countries whoseinterests do not necessarily coincide with those ofthe global society as a whole” (de Gregorio et al.,1999).

In order to redress the imbalance between in-dustrial countries and EMEs in managing IMF, EMEsand DCs should be given the opportunity and be pre-pared to contribute more resources for the operationof the Fund. Commensurate with their enlarged con-tributions, EMEs and DCs should be accorded greaterrepresentation both on the board of directors and inthe Fund’s management. Many EMEs are more will-ing and able to share the burden of financing variousIMF credit facilities than ever before. This issue ofrepresentation will become more contentious in thefuture, if IMF is given a central role in the surveil-lance and enforcement of various standards.

One should, of course, recognize that IMF isan international institution providing for the publicgood by contributing to international financial sta-bility. Crisis management and prevention do haveexternalities, and are not only the responsibility ofEMEs and DCs but also of the advanced countries.Looking into the future, IMF will mostly be lendingto EMEs and DCs in emergencies, and will serve astheir crisis manager (Fischer, 1999). IMF will sel-dom lend to the G-7 countries, even when in crisis.It is only natural and logical for EMEs and DCsto have a stronger voice in managing the organiza-tion that is primarily serving as their crisis lender-manager.

Industrial countries are likely to object to theidea of giving EMEs and DCs a larger representa-tion in running IMF. They may argue that without


the dominant participation of the industrial countries,IMF may suffer from leadership problems, deterio-ration in the quality of staff output, and laxity in theenforcement of standards and loan conditions. If theIMF decision-making process is not politically neu-tral – and for this reason the EMEs and DCs cannotexpect more active participation in the IMF decision-making process – then the G-7 and IMF shouldconsider amending the IMF Articles of Agreementto strengthen the independence of the ExecutiveBoard and give the Fund financial independence(de Gregorio et al., 1999).

The rule requiring an 85 per cent super major-ity for important changes in IMF policy should alsobe amended. In an age when European and Asiangovernments complain that the Fund too often al-lows itself to be used as an instrument of US foreignpolicy, giving the United States effective veto powerundermines the legitimacy of the institution world-wide (Eichengreen, 2000a). Reform of the procedurefor appointing the Managing Director is imperative,so that there may be a more open process and candi-dates considered on their merits. The ExecutiveBoard should be more independent, for essentiallythe same reasons that it is desirable for the board ofa national central bank to be independent of the gov-ernment.

III. International standards and codes

Recent financial crises have underscored theidea that domestic financial institutions should besupervised and adequately regulated, as structuraldeficiencies – such as laxity in risk management,poor governance, inadequate loan classification andloose loan-loss provisioning – could invite crises andserious contagion. As a basic national financial in-frastructure, a growing number of proponents suggestestablishing a set of international standards and en-couraging countries to adopt them. Harmonizationof standards is also expected to help to achieve do-mestic financial stability (Eichengreen, 1999a).

The development and adoption of commonstandards is likely to reduce transaction costs in theprocess of financial integration, and therefore to fos-ter international trade and investment, as well as toincrease transparency and reduce moral hazard. Mini-mum standards are needed to reduce uncertaintyconcerning the substance of law in different juris-dictions (Pistor, 2000).

While the establishment and enforcement ofinternational standards is an important step towardsbuilding a legal architecture for global markets, har-monization has met serious challenges on theoreticalas well as political grounds. This section discussessome of these challenges.

A. Standardization versus regulatorycompetition

In a recent paper, Pistor (2000) argues that theexistence of a fairly well developed, well function-ing domestic legal infrastructure is a preconditionfor the success of the reforms related to standardiza-tion. When, as in most DCs, this infrastructure doesnot exist, reforms in accounting standards, securi-ties legislation, insurance legislation and corporategovernance in an EME could become artificial andsuperficial. Harmonization of standards and codesis often believed to accelerate the process of legalconvergence, which is in turn expected to reducetransaction costs for transnational investors and im-prove the quality of legal institutions in the hostcountries. In contrast to this conventional view, Pistorargues that standardization could impede the devel-opment of effective legal systems in EMEs for anumber of reasons.

Standardized rules and codes can be fitted intodomestic legal systems and enforced only if they arecompatible with other bodies of law that already ex-ist in the standard receiving legal system. In theabsence of complementarity between the new rulesand pre-existing legal institutions, standardizationmay distort rather than improve the domestic legalenvironment. This is because, given the differencesin different legal cultures, the standardization proc-ess may make it necessary to develop syntheticconcepts to bridge the differences or agree to thelowest common denominator. Neither result is satis-factory for domestic law makers and economicagents, as harmonization will result in sub-optimalrules and prevent flexible adaptation to better rulesand to changing circumstances.

Ultimately, the success of the proposed stand-ards and codes will depend on the existence of localconstituencies with a strong interest in and under-standing of new rules. Success will also requiredomestic agents willing to comply with the new rules.Without voluntary compliance, enforcing new stand-ards will not be effective. For these reasons, Pistor(2000) argues that regulatory competition is prefer-


able to harmonization, because the former could pro-duce laws whose relevance would be understooddomestically, and would also teach regulators that inthe long run they would be better off by protectinginvestors and developing an effective legal system.

B. Too many one-size-fits-all standards

From the perspectives of EMEs and develop-ing economies, there already exist too many standardsand codes to be observed. The Financial StabilityForum (FSF) has now highlighted 12 key codes andstandards that are crucial, and identified an additional64 standards relevant to sound financial systems. Ofthese, 12 deserve priority implementation and an-other 43 standards are complementary to the keycodes (FSF, 2000).9 All countries cannot be expectedto meet the same standards, since they are not atthe same level of development. In particular, theone-size-fits-all approach is likely to ignore the in-stitutional constraints of EMEs and DCs.10 Ifenforcement of common standards does not permit adegree of variance and flexibility at the individualcountry level, standardization efforts could result inill-judged or unhelpful harmonization, and henceimpose enormous adjustment costs on EMEs andDCs (Rodrik, 1999). With regard to the IFI condi-tionality, some of the standards could act as the wedgewhereby a broader set of policy and institutional pref-erences – in favour of an open capital account,deregulated labour markets, arms-length finance, andAnglo-Saxon-style corporate governance – would beimparted among the recipient countries (Rodrik,2000).

For the poorest DCs, the budgetary cost of im-plementing the myriad codes and standards could beenormous.11 Data collection and processing, as wellas strengthening the regulatory and supervisory stand-ards, would require technical assistance, equipment,training and computerization. Without their fundingby external grants, the cash-strapped DCs would havelittle choice but to squeeze the budget for the mostsocially vulnerable groups (Soludo and Rao, 1999).Indeed, the implementation costs of building the nec-essary legal and institutional infrastructure wherethose standards and codes could work out effectivelywould be a formidable burden to taxpayers in EMEsand DCs. In realization of these difficulties, the G-7Finance Ministers agreed to work together with theIFIs, FSF and international regulatory and supervi-sory bodies to provide technical assistance andtraining to EMEs and DCs.

In order to reduce adjustment costs to manage-able proportions, transitional arrangements may haveto be made for EMEs and DCs to prepare for theimplementation of international standards, as in tradenegotiations. For example, the Trade-Related Intel-lectual Property Rights (TRIP) agreement12 – whichis the most comprehensive set of international stand-ards on intellectual property rights (IPRs) – givesdifferent countries different transition periods, inaddition to a one-year transition period after the en-try into force of the WTO agreement. Developingcountries and economies in transition are entitled toan additional four-year period, except for obligationspertaining to national and MFN treatment. But DCsare also entitled to an additional five-year period forproduct patents in fields of technology that are notprotected at the time the agreement is applied. Theleast-developed countries are entitled to a 10-yearperiod from the date of application of the TRIP pro-visions – that is, 11 years after entry into force of theWTO agreement – to enable them to comply withthe obligations of the agreement. They are also al-lowed to request an extension of this transition period.

C. Legitimacy

In most of the forums or agencies drawing upstandards, the EMEs and DCs are not included or, atbest, are under-represented. Despite the lack of ex-pertise among EMEs and DCs, if the G-7 countriesreally want to introduce a set of international stand-ards, they should follow a more legitimate processof negotiation (e.g. like the Uruguay Round, 1986–1993). This may be particularly necessary if theinterest of the advanced countries, on the one hand,and that of EMEs and DCs, on the other, diverge.The G-7 countries could take the initiative in start-ing a negotiation process among IMF memberstowards introducing international standards ratherthan tacitly consenting to a set of ready-made ones,because standard-setting should not be biased to-wards a particular model of an industrial country.Even major industrial countries cannot agree on spe-cific standards for banking, corporate governance,disclosure and accounting, because understandablythey insist on standards serving their own interests.

Such negotiations may not take many years, asthe Uruguay Round did, but they would have to gothrough an arduous and protracted process of set-tling the differences between the industrial countriesand the EMEs and DCs. Such a negotiation processwould be costly, but unless IMF member countries


come to an agreement on internationally agreed com-mon standards, one cannot ensure the compliance ofEME and DC firms, banks and governments. In or-der to reduce the number of participants and makethe negotiations more manageable, one possibility isto limit participation in the initial stages to thoseEMEs and DCs with relatively resilient financial re-gimes. Not truly multilateral but sensibly plurilateralagreements on international standards would invitemore participation from EMEs and DCs. Withoutsuch a process, it is quite possible that there wouldemerge only two sets of competing standards, sup-ported by the United States and the European Unionrespectively. Neither set of standards would, in thatcase, reflect the needs or wishes of the EMEs andDCs.

D. Sovereignty and global governance

The establishment and enforcement of commonstandards could also raise the question of sovereigntyin managing financial systems and conducting mon-etary and fiscal policy in EMEs. Even if the G-7,EMEs and DCs could come to an agreement on a setof international standards, there still remains thequestion of enforcement. As noted earlier, enforce-ment will typically be difficult unless some stringentand observable parameters are devised and subjectedto international surveillance. A relevant example isprovided by minimum bank capital requirements,along the lines set out by the Basel Committee in1988. Such requirements have been introduced bymost DCs, but only nominally enforced.13 For exam-ple, before the crisis all the East Asian banksgenerally met the 8 per cent BIS ratio.14 Awarenessof these problems has generated an intense debateon how to provide an effective surveillance mecha-nism. A concerted effort in this direction is the jointIMF-World Bank’s Financial System Stability As-sessments Programme, aimed at evaluating the healthand vulnerabilities of member countries’ financialsystems.15 The programme also includes assessmentof compliance with the BCBS Core Principles.

The Financial Stability Forum has recently elic-ited three key factors for fostering the implementationof standards (FSF, 2000). The first is the promotionof country ownership of implementing standardsto make it rather sovereign while the internationalcommunity can only encourage it through otherchannels. The second is the provision of incentivesfor the observance of standards; market incentives(e.g. different credit ratings, borrowing spreads, as-

set allocations, etc.) and official incentives (e.g. fi-nancial and technical assistance, market access, etc.)should be considered. The third is the mobilizationof scarce (human and financial) resources by enhanc-ing international cooperation.16

Regarding implementation and enforcement,opinions are divided on whether the process shouldbe voluntary or compulsory. For example, IMF isdebating on whether implementation of certain stand-ards should be part of the criteria for access to theCCL. The G-7 Finance Ministers consider whethera foreign bank’s home country is adhering to inter-national standards when evaluating whether theforeign bank should be allowed entry to their mar-ket. The G-7 recommended the IOSCO and theBasel-sponsored working groups to make member-ship in their bodies contingent on progress in theimplementation of standards. That is, the dominantview appears to support compulsory compliance.

If IMF and other IFIs are given authority to en-force compliance with the common standards, thesurveillance mechanism implies that those countrieswhich fail to observe the agreed standards can bepenalized in terms of incentives. However, manyEMEs and DCs will find it difficult to accept theseincentive-based proposals, because such schemesraise the issue of fairness and national sovereignty.If the incentive system is determined and adminis-tered by both IFIs and the regulatory authorities ofindustrial countries, in reality this means that indus-trial countries can dictate the access of EMEs andDCs to world capital markets and IMF credit facili-ties. Also, one cannot discount the possibility ofindustrial countries using the incentive scheme topursue their own interests. Any direct enforcementby IFIs will therefore impair sovereignty and dimin-ish legitimacy.17

Universal adoption of common standards onaccounting, disclosure and banking, for example, islikely to promote deeper financial integration at theglobal level. From the perspectives of EMEs, deeperintegration could mean considerable erosion in theirpolicy autonomy, and hence the necessity to coordi-nate their macroeconomic and other policies withthose of developed countries. Although the advocatesof common standards claim that the universal accept-ance of common standards would help to stabilizeinternational financial market and reduce the fre-quency of financial crises, there is no evidence tosupport such an argument. On the contrary, as Pistor(2000) notes, harmonization may produce perverseresults.


An important conclusion to be drawn from thepreceding analysis is that a country or group of de-veloping countries asking other countries to acceptand authorize IFIs to enforce compliance with com-mon standards and codes is in fact attempting toprovide quasi-governance of international finance,since IFIs are developing a de facto global legal ar-chitecture for financial markets through legalharmonization. Therefore, EMEs may justifiably askwhether a group of countries promoting universalstandards is also prepared to produce public goodssuch as the services of a lender of last resort. Thisquestion arises because there is no guarantee thatthose EMEs which faithfully comply with the com-mon standards will become less vulnerable tofinancial crises. If a financial crisis breaks out andspreads to other countries, those innocent victimssuffering from crisis contagion may expect the groupof countries providing quasi-governance to assistthem with unconditional liquidity support. This isthe reason why harmonization, to be acceptable,should also be accompanied by the provision of anumber of public goods, such as the services of anILLR and regulatory authorities.

IV. Bailing in the private sector

From the creditor and investor side, experienceover the past few years has reminded us that theytend to underestimate risks as they seek for higheryields. In other words, international lenders have asmuch responsibility for the crisis as emerging mar-ket borrowers; for every questionable borrower thereis a questionable lender.

Efforts to achieve greater private-sector burdensharing are motivated by the perception that officialassistance to crisis countries creates a source of moralhazard on the part of private-sector creditors. If pri-vate-sector creditors are bailed out through officialassistance without bearing any cost of the crisis, theirhabitual poor lending and reckless investment deci-sions will not be rectified. In addition, because theFund is almost always reimbursed, many critics pointout that official assistance merely allows privatecreditors to be repaid at the expense of the taxpayersof the crisis country (Eichengreen, 2000a). On bothefficiency and equity grounds, bailing in the privatesector – private-sector involvement (PSI) – has be-come a core part of architectural reform.

Historically, however, this issue is not new. Thelegal doctrine of sovereign immunity would appear

to exempt the property of foreign governments fromthe jurisdiction of domestic courts. Over the years,the practical application of the doctrine has increas-ingly given creditors leverage to retaliate againstdefaulting sovereigns. Creditors’ legal rights of di-rect punishment could make it difficult for a countryin default to gain access to new international loans.Restricted sovereign immunity certainly has meritin the sense that it would address debtors’ moral haz-ard (Dooley, 2000; Friedman, 2000). Nevertheless,the Latin American debt crisis of the 1980s endedup with the Brady Plan; it allowed debt forgivenessof about 35 per cent for bank claims on much of theregion (Cline, 1995). After the Mexican crisis, the1996 G-10 report – the so-called “Rey Report” – alsorecommended various proposals for bailing in theprivate sector. Furthermore, this issue resurfaced af-ter the Asian financial crisis and other subsequentemerging market crises.

However, since the keen conflict of interestsbetween creditors and debtors is pitting them againsteach other, very conspicuous divergences persist inthis area. The most unsettled aspect of the PSI issueconcerns the question of whether the nature of PSIshould be based on predetermined rules or should behandled on a case-by-case basis. Some want thoserules to be very hard and tight, while others want toleave a degree of flexibility. The June 1999 the G-7report proposed a compromise approach for the PSIframework – a “case-by-case approach with princi-ples and tools”. G-7 consensus contends that sincethe cases for private-sector involvement will be suf-ficiently different, no general set of principles willbe adequate to cover every case; there will have tobe case-by-case variations.

Although G-7 allegation contains some truth,constructive ambiguity could become a source ofconfusion and arbitrary decision. Bergsten (2000a),among the critics, contends that clear rules, tailoredto different types of crises, need to be developed forPSI in order to replace the ad hoc approach now be-ing pursued to bail in the private creditors. Underthe broadly defined PSI framework laid out in the1999 Cologne Summit, the G-7 put forward “opera-tional guidelines” for PSI at IMF/WB meeting inApril 2000. They distinguished two different cases.First, private-sector involvement could be ensuredprimarily through reliance on IMF’s traditional cata-lytic role: if the member’s financing requirementsare modest; or if the member has good prospects ofrapidly regaining market access on appropriate terms,even in cases in which the financing requirementsare at large. Second, more concerted forms of PSI


might be required: if the financing requirement isgreat and the member has poor prospects of regain-ing market access in the near future; or if the memberhas an unsustainable medium term debt burden.

These operational guidelines could be valid. Asnoted in Eichengreen (2000b), however, the cases ofEcuador, Pakistan, Romania and Ukraine have beendisappointing. IMF’s efforts to condition official as-sistance on PSI – specifically, on the willingness ofinvestors to roll over maturing debts, inject newmoney, or restructure existing debts – have been lessthan successful. Requiring countries on the verge ofa sudden standstill – being denied access to interna-tional capital markets – to first raise new money as aprecondition for IMF assistance is certainly unreal-istic, given the palpable reluctance of investors whohave lost confidence in a country in crisis. In thisregard, Eichengreen (2000b) contends that ex postmeasures would complicate the resolution processand aggravate economic conditions, since an effec-tive bargaining table between international creditorsand the crisis country would not be conceivable inmost cases.

Despite the disappointing performance of therecent IMF experiments with small poor crisis coun-tries, the official sector will need to insist onappropriate debt restructuring with private creditorsas a condition for IMF financial assistance. To makeoperational guidelines more workable, IMF couldplay a role as a crisis lender and manager. AlthoughIMF avoids micromanaging the terms of debt restruc-turing, IMF could provide bridging loans while thenegotiations are in progress, provided it is convincedthat the crisis country is negotiating with its credi-tors in good faith. Or if voluntary negotiations areproblematic, IMF could endeavor to bring the in-volved players to the negotiation table. However, asEichengreen (1999b) points out, for various reasonsthis moral suasion would hardly be successful. Then,what is required for a workable voluntary approach?

First, IMF’s analytical capacity would be a mostimportant ingredient for diagnosing the nature of thecrisis. Once the creditors’ grab race has started, ifIMF judges that the nature of the crisis is closer toilliquidity rather than insolvency, IMF may be ex-pected to play a role as mediator in arranging aneffective bargaining table. This proactive role of IMFwould relieve the market participants’ panickingbehaviours. However, it would be technically diffi-cult to distinguish an illiquidity crisis versusinsolvency crisis when a crisis abruptly erupts. Itwould take time for creditors and the debtor country

to reach a correct diagnosis on the nature of the cri-sis.

When the government of the Republic of Ko-rea decided to turn to IMF, it expected the Fund’srescue package, agreed on 3 December 1997, to suf-fice to stop capital outflows. On the contrary, theforeign creditors accelerated their retrieval of short-term credits. As the liquidity situation furtherworsened, the Korean government, in close consul-tation with the G-7 countries, urgently initiatednegotiations with foreign creditors to reach a tempo-rary standstill arrangement. After a series of intensivenegotiations, the government and 13 representativesof the foreign creditor banks reached on 28 January1998 a consensus on maturity extension principles.As the case of the Republic of Korea vividly shows,foreign creditor banks were not assured of its under-lying creditworthiness, even with IMF officialassistance. IMF’s catalytic role in bringing the pri-vate creditors back to normal would be supportedonly when IMF could successfully assure the credi-tors of the member’s good prospects for regainingmarket access in the near future, even in cases wherefinancing requirements were large.

Second, more reliable workout-type solutionscould be required when the nature of the crisis israther closer to insolvency, as in the cases of Ecua-dor, Pakistan and Ukraine. As almost unanimouslyproposed by the international community, it wouldbe worthwhile to amend bond contracts to includesharing clauses, majority voting clauses, and mini-mum legal threshold clauses. If those provisions wereincorporated into international sovereign bond con-tracts, IMF would not need to immediately provideofficial assistance to a country in crisis. A fair bur-den sharing could be voluntarily settled throughsuccessful debt restructuring facilitated by those pro-visions. However, little concrete progress has beenmade to date.

There are various reasons for this lack ofprogress. First, on the side of the creditor, this is re-lated to the issue of international standards in thearea of sovereign bond contracts. The United Statesis reluctant to follow the market standard governedby UK law, since the US Trust Indenture Act of 1939would need to be modified. Historical path depend-ence hinders a common standard to be universallyadopted. Second, on the side of the debtor, Ameri-can-style international bonds have been the mostprevalent bonds issued by EMEs and DCs until re-cently. Most EMEs and DCs worry that such bondsmight raise the cost of borrowing. Although recent


empirical work by Eichengreen and Mody (2000)suggest that such anxiety does not seem be well-founded,18 countries with poorer credit ratings wouldface more difficulties in financing developmentprojects when collective action clauses (CACs) areincorporated into their sovereign bond contracts.Third, the use of debt exchange offers obviates theneed for CACs, as in the case of Pakistan, whererestructured bonds all included CACs. Indeed, asshown in all recent cases of bond restructuring (Ec-uador, Pakistan, the Russian Federation and Ukraine),debt exchanges are the norm, and CACs are notneeded or used when available (Roubini, 2000).

V. Exchange rate regimes andcapital controls

In the wake of the Asian currency crisis, anumber of relatively fixed-rate countries were forcedto abandon their pegs. Many economists and policymakers argued that these regional currencies wereovervalued on the eve of the crisis, although the lackof an operational definition of overvaluation is stilltroubling. However, pre-crisis Asia was not on a rigiddollar peg, as most countries in fact adjusted theirrates from time to time. Statistically, there is no cor-relation between pre-crisis rigidity, or overvaluationof the domestic currency, and the severity of subse-quent currency attacks (Ohno, 1999).

The soft-peg exchange rates of East Asian cur-rencies have been blamed for the generation of crises.As a result, the so-called “corner solutions” – greaterflexibility or credible institutional assurance, like acurrency board system – are gaining wider support.However, the international community shouldsquarely recognize an important source of systemicvulnerability: the G-7 currency gyrations in recentyears have far exceeded any conceivable shifts ineconomic fundamentals. In particular, the sharpswings in the yen-dollar rate contributed greatly tothe outbreak of the Asian crisis. Every 10 per centdecline of the yen vis-à-vis the US dollar takes US$20 billion off the trade balances of the rest of Asia(Bergsten, 1999). Every time the yen appreciatesagainst the dollar, the economic growth of non-Japa-nese Asia picks up, as happened between 1986 and1988, and again between 1991 and 1995. The reverseis also true when economic growth decelerated andthe asset-price bubble burst on the back of a weakeryen in 1989/90 and again in 1996/98 (Kwan, 2000).The soft-peg currencies were extremely vulnerableto volatile fluctuations of the yen-dollar rate. The

procyclical aspect of capital flows in and out of EastAsia is closely related to the instability of the yen-dollar rate.19

The international community has encouragedEMEs and DCs to adopt appropriate exchange rateregimes, but it has been voiceless in reducing thesystemic risks generated by G-7 currency gyrations.The flexible exchange rates of the G-7 currenciesquite often tend to overshoot wildly and generateequally disruptive misalignments.20 For the G-7 thegoal of currency reform can best be pursued by main-taining substantial flexibility but modifying themethod by which it is managed. For the past decade,interventions have always come long after largemisalignments have set in and severe economic dam-age has resulted (Bergsten, 1999).

The G-7 and IMF generally agree that no sin-gle exchange rate regime is appropriate for allcountries or in all circumstances. In any case, stabil-ity depends on the exchange rate regime being backedby consistent macroeconomic policies and supportedby robust financial systems. As is also well recog-nized, countries cannot simultaneously maintain anindependent monetary policy based on domestic ob-jectives, open capital markets and an exchange ratepeg.

As long as EMEs and DCs maintain open capi-tal accounts, only two options – flexible exchangerate regimes or those having very hard pegs (e.g. theadoption of a common currency or of a currencyboard) – may be suitable in the light of the “impossi-ble trinity” hypothesis.21 However, the adjustmentprocess of a flexible exchange rate regime with freecapital mobility could easily generate a cycle of boomand bust in EMEs and DCs. In many East Asian coun-tries, for instance, foreign portfolio investors havebecome dominant players in determining the direc-tion of asset price movements, since these countriesfurther opened their capital markets during the crisisperiod. Suppose that the ongoing recovery in EastAsia attracts large capital inflows in the region. Theselarge inflows could rekindle asset price bubbles andspeculation. When a currency appreciates as a resultof capital inflows, market forces can create expecta-tions that will induce even greater capital inflows,further pushing for greater appreciation in the nomi-nal exchange rate, together with a larger trade deficit.

Furman and Stiglitz (1998) provide a very plau-sible story by which, given the circumstances of theEast Asian economies, a floating exchange rate wouldhave exacerbated the problems. With irrational ex-


pectations, investors may extrapolate the exchangerate appreciation, so that investing in, say, Thailandlooks an even better deal, with huge real estate re-turns plus an appreciating currency. The increase inthe exchange rate discourages exports, and thus al-lows internal macroeconomic balance to be achievedat a lower interest rate than otherwise. But suddenlyone day the real estate bubble bursts. In the process,capital flows reverse, and the exchange rate plum-mets.

This thought experiment put forward by Furmanand Stiglitz (1998) makes clear that flexible exchangerate regimes would not necessarily have insulatedthe East Asian economies against the ravages broughton by a sudden change in expectations in a worldwith no restrictions on capital flows. As also notedin IMF (2000), large exchange rate fluctuations insmall- or medium-sized open economies may havesignificant economic costs. While it is important forexchange rates to be allowed to adjust in response tomarket pressures, it may also be appropriate to usedomestic monetary policy, or intervention, to limitfluctuations to the extent they affect inflation andinflationary expectation. Thus, IMF acknowledgesthat EMEs and DCs can manage exchange rate fluc-tuations through an alternative nominal anchor, suchas inflation targeting. However, it is still uncertainwhether this nominal anchor could effectively relievethe exchange rate misalignment caused by the con-stant pressure of capital flows. Sterilized interventioncould more effectively forestall the emergence ofsuch misalignments.

A common currency, or currency board regime,could be an alternative exchange rate arrangementto replace a flexible exchange rate regime, whilemaintaining capital mobility. Most EMEs in East Asiawould not find it practical or politically acceptableto move in this direction. A common currency couldbe considered, in the very long term, as a regionalmonetary arrangement. Even with political consen-sus, the huge menu of preconditions for a regionalcurrency bloc will take up a great deal of time.22

If the EMEs and DCs are going to stay withflexible exchange rate regimes, they must considerthe introduction of capital controls over short-runcapital movements to ease the burden of adjustmentthrough exchange rate fluctuations. In this respect,IMF, while advocating the overall liberalization ofcapital account transactions, points to the need toimplement measures to influence the volume andcomposition of capital flows. Such measures couldinclude taxes on short-term foreign borrowing and

prudential limits on offshore borrowing (Council onForeign Relations, 1999, Furman and Stiglitz, 1998).

While there remain differences of view on themerits of capital controls, the mainstream view isthat capital controls cannot substitute for sound mac-roeconomic policies, although they may provide abreathing space for corrective action. However, theflexible exchange rate regime alone may not be ableto reduce massive, especially short-term, capital in-flows. Thus, there may be a need for EMEs to managesuch inflows, while continuing to strengthen theirfinancial systems. As it is generally agreed that theChilean scheme on capital controls was successfulin lengthening the average maturity of the country’sexternal debt, EMEs and DCs could provide them-selves with the power to implement unremuneratedreserve requirements (URR) and minimum holdingperiods (MHP) on capital inflows. This Chileanscheme is widely supported by various economistson prudential grounds.23

Despite justifiable reasons for adopting capitalcontrols, the legal controls on capital flows are notalways effective because economic agents attemptto evade the controls by over-invoicing imports, un-der-invoicing exports, and mislabelling the nature ofcapital flows (Edwards, 1999a, b ). With respect tothe economic performance of capital controls,Edwards (1999b) disputes that desired goals of capi-tal controls have only been achieved. According tohis empirical results, Chile’s capital controls did ap-pear to increase the maturity of its foreign debtsignificantly. However, even in 1996 more than 40 percent of Chile’s debt to banks in the BIS “reportingarea” had a residual maturity (not contractual matu-rity) of less than one year, and the total volume ofaggregate capital flows into Chile during the 1990sdid not decline. The controls on capital inflows hadno significant effect on Chile’s real exchange rate,and only a very small effect on interest rates. Chile’scapital controls policy helped to reduce stock mar-ket instability, but the controls were unable to isolateChile from the very large financial shocks stemmingfrom East Asia in 1997–1999.

There is another potential difficulty with theChilean type of capital controls – the adverse selec-tion problem. Some foreign investors, includingcommercial and investment banks, do not focus ex-clusively on speculation for short-term earnings.Indeed, many international lenders often move intoemerging markets in search of long-term investmentopportunities and establish long-term relationshipswith local financial institutions. Yet, uniform reserve


requirements on all types of capital inflows penalizenot only short-term speculators but also those inves-tors who help to strengthen and stabilize emergingfinancial markets. If the reserve requirements areprohibitive enough to alter the composition of debtprofiles, these desirable investors might avoid EMEsand DCs with capital controls. In this regard, theChilean scheme cannot be a purely unilateral movetaken by an individual EME or DC. Most EMEs andDCs facing volatile capital movements are still veryreluctant to adopt this scheme because it might pro-vide unclear or incorrect signals to the internationalfinancial markets.

While the Chilean scheme of capital controls isa unilateral approach taken by an individual coun-try, Tobin taxes would be a global approach todiscourage short-term speculation in currencies. Inother words, Tobin taxes should be universally im-plemented by all countries simultaneously for thepolicy to be effective. However, that would makethem technically and politically unfeasible.

A large, but undiversified financial system ishighly exposed to systemic crises. An economy withan equally deep but more diversified financial sec-tor, where equity and bond markets are also welldeveloped, would be resilient to contagious shocks.Thus, a number of structural policy actions shouldbe geared to strengthen the financial sector. A par-tial list would include the development of capitalmarkets, effective corporate governance, prudentialsupervision and regulation, and a cautious policy offinancial liberalization. In particular, the developmentof capital markets is essential to the emergence oflong-term debt instruments.

Too often, financial liberalization – both inter-nally and externally – has been synonymous withthe accelerated development of short-term instru-ments. Domestic financial liberalization, with itsremoval of limits on bank interest rates, credit ex-pansion and required reserves, has often resulted inthe fast acceleration of bank credit and converselyof money aggregates. External liberalization, in turn,has prompted a large upswing in short-term inter-bank funding from more developed to developingeconomies (Chang and Majnoni, 2000). The lessonthat market freedom requires regulatory vigilance hasbeen driven home recently by the experience in EastAsia. In the Republic of Korea and Thailand, as inso many other DCs, financial liberalization and capi-tal account opening led to financial crisis preciselybecause of inadequate prudential regulation and su-pervision (Furman and Stiglitz, 1998; Rodrik, 2000).

VI. Regional financial arrangements

A. Arguments against regional financialarrangements

After the crisis touched off in July 1997, crea-tion of a regional monetary fund in East Asia wasproposed by Japan and received a positive responsefrom a number of East Asian countries. The idea,however, was strongly opposed for a number of rea-sons by the United States, the European countriesand, of course, IMF. Eichengreen (1999b) and oth-ers dismiss the contention that an East Asian regionalfund may have a comparative advantage in diagnos-ing regional economic problems and prescribingappropriate solutions on the basis that it will increasecompetition in the market for ideas. A more seriousargument is that East Asians are not ready for, orcapable of, creating and managing an effective re-gional monetary fund. According to Eichengreen(1999b), in contrast to Europe, for example, East Asialacks the tradition of integrationist thinking and theweb of interlocking agreements that encourage mon-etary and financial cooperation in Europe.

For over a half century, European countries haveworked very hard to develop a wider web of politi-cal and diplomatic agreements which encourage themto cooperate on monetary and financial matters. Cer-tainly, such a web does not exist in East Asia. As forEast Asia’s limited capacity, Eichengreen (1999b)has a point. If the European experience is any guide,East Asia may take many years to develop an effec-tive cooperative arrangement for finance. However,East Asia may be on the brink of an historical evolu-tion, as Europe was half a century ago (Bergsten,2000b). Having suffered such a painful and costlyfinancial crisis, the East Asian countries are preparedto set aside their differences and to work together todevelop a region-wide self-defence mechanism to theextent it could help to protect themselves from fu-ture crises. After three years of crisis management,East Asia has developed a large pool of skilled andexperienced people capable of managing regionalfinancial cooperation among the countries in EastAsia. Furthermore, the type of arrangements currentlybeing discussed in the region do not necessarily re-quire integrationist thinking or a web of interlockingagreements, as in Europe.

Furthermore, East Asians may not be preparedto negotiate an international treaty which includesprovisions for sanctions and fines for countries thatdo not adjust their domestic policies accordingly. This


unwillingness would make it difficult for the regionalfund to impose politically unpopular policies on themember countries and, hence, may pose a seriousproblem of moral hazard.

However, moral hazard is not a problem thatwill beset only regional arrangements. IMF is notimmune to this problem, and the task force report ofthe Council on Foreign Relations (1999) advises “theFund to adhere consistently to normal lending limitsto redress the moral hazard problem”. The reasonswhy East Asian financial arrangements would suffermore from the moral hazard problem than IMF, orany other regional institutions, have not been madeclear. As Sakakibara (2000) puts it, if those coun-tries unaffected by the East Asian crisis do not haveany political incentive to contribute their own money,they should say so instead of using the moral hazardargument as an excuse for opposing regional arrange-ments in East Asia.

Another controversial argument against regionalfinancial arrangements is that there may be no needfor regional funds and other arrangements in a glo-bal economy where much of the trade in goods andservices is increasingly conducted in cyber space.The ongoing revolution in information and com-munications technology will accelerate both globali-zation and virtualization. What the world economyneeds, therefore, is a new system of global govern-ance, which may include a global central bank andglobal regulatory authorities. As for the financialmarkets and financial services industries, the scopeof governance should be raised to the global level soas to realize scale economies and to accommodatethe market forces driving financial globalization. Thatis, public goods, such as the services of a lender oflast resort and regulatory institutions, could be bet-ter provided at a global level.

While in theory, the creation of a system of glo-bal governance may sound reasonable, in reality it ispolitically unacceptable and must be dismissed asquixotic (Eichengreen, 1999b). As a second best al-ternative to a worldwide governance system, theadoption of global standards and codes of conducton banking, corporate governance, management ofmonetary and fiscal policies, and many others, hasbeen proposed by EMEs and DCs and also enforcedby IMF. Doubts have been raised as to the effective-ness of international standards, and the legitimacyof imposing them on EMEs and DCs has been ques-tioned.

B. Rationales for regional financialarrangements

Any argument for regional arrangements mustbegin by answering the most fundamental questionof whether regional groupings, whatever forms theymay take, are conducive to, or likely to interfere withmultilateral free trade and the orderly globalizationof financial markets. Despite many misgivings aboutthe role of regional economic arrangements that havegrown in number in recent years, the experiences ofthe past decade suggest that they have been a com-plement and supplement to multilateral trade andfinancial liberalization. That is, they have been build-ing blocs rather than stumbling blocs for a moreintegrated world economy. There is no evidence sug-gesting that an East Asian financial arrangementwould be oriented towards a withdrawal from theglobal economy and, hence, would erect barriers toglobal financial integration.

As Lawrence (1996) points out, the forces driv-ing the current wave of regionalism may differfundamentally from those driving earlier moves to-wards regionalization in this century, and the currentinitiatives represent efforts to facilitate participationby their members in the world economy rather thantheir withdrawal from it. Developing countries aremotivated to join regional groupings as their partici-pation could facilitate implementation of a strategyto liberalize and open their economies. Since mostof the East Asian EMEs are pursuing export cum for-eign investment-led policies, they will gain very littleby forming a regional arrangement that is designedto thwart globalization.

There have been several developments that haveencouraged the formation of a regional financial ar-rangement in East Asia. As already pointed out, onedevelopment has been the slow progress of the re-form of the international financial system. Theurgency of reform in the G-7 countries has recededconsiderably with the rapid recovery of East Asia.The slow progress has been further complicated bythe perception that a new architecture, as it is de-signed, may not be effective in sustaining globalfinancial stability. Nor would it safeguard financialstability in EMEs and DCs. As long as the structuralproblems on the supply side of capital are not ad-dressed, the East Asian countries will remain asvulnerable to future crises as they were before.Instead of waiting until the G-7 creates a new archi-tecture, whose effectiveness is at best questionable,it would be in the interest of East Asian economies


to work together to create their own system of de-fence (Park and Wang, 2000). For these reasons, therehas been increasing support in East Asia for devel-oping a regional defence mechanism in the form offinancial cooperative arrangements. This supporthas culminated in the Chiang Mai initiative ofASEAN+3 to create currency swap arrangementsamong 13 countries. The agreement is widely per-ceived as a major step towards strengthening financialcooperation among the East Asian countries.

Many EMEs and DCs, in particular those whichhave experienced a financial crisis, are taking meas-ures to build up their foreign currency reserves abovethe level that has been regarded as adequate in termsof their import requirements. For instance, the Re-public of Korea is currently building a level ofreserves (US$ 91.43 billion as of the end of August2000) equivalent to 20 per cent of its GDP, largelybecause of the increased volume of its capital ac-count transactions. By any measure, this level isexcessive, costly, and represents a clear case of re-source misallocation. To reduce the amount of reserveholdings, at least some EMEs and DCs could enterinto an arrangement for precautionary lines of creditwith private financial institutions. They could alsorely on IMF as a quasi-lender of last resort, whichcould provide an additional issuance of SDRs.

There are other schemes for reducing the hold-ings of foreign currency reserves. For example, agroup of countries, not necessarily from the sameregion, might decide to pool a certain percentage oftheir reserves to create new credit facilities for them-selves. An individual country belonging to thearrangement would not have to hold as large reservesas it otherwise would if it could borrow from thecredit facility. The group of 13 East Asian countries(ASEAN+3) has command over a large amount offoreign currency reserves, estimated to be more thanUS$ 800 billion. Depending on how these reservesare pooled together and managed, a mere 10 per centof the total amount would be sufficient to provide afirst and second line of defence against any specula-tive attack. If the East Asian countries had been ableto cooperate to use part of their reserves to supplyshort-term liquidity to Thailand, East Asia could havebeen spared the misery of recession and social dislo-cation.

There is also the argument that regional finan-cial management could be structured and managedto be complementary to the role of IMF. For exam-ple, an East Asian regional fund could provideadditional resources to IMF, while joining forces to

work on matters related to the prevention and man-agement of financial crises. An East Asian monetaryfund could also support the work of IMF by moni-toring economic developments in the region andtaking part in IMF’s global surveillance activities.The East Asian monetary fund could also be designedinitially as a regional lender of last resort, while IMFassumes the role of prescribing macroeconomicpolicies to the member countries of the East Asianmonetary fund.

Finally, East Asians must begin to examine thepossibilities and desirability of cooperation and co-ordination in exchange rate policies, creation of aregional currency unit, and eventually an East Asiancommon currency. An East Asian monetary fundcould serve as a forum for such an examination, al-though these monetary options are not viable at thisstage.

C. Challenges and tasks

Three years have passed since the crisis. Asiareturned to positive growth in 1999, much faster thanhad been expected. Some economists would like tocall this recovery a tenuous one, hinting that a dou-ble dip could be expected unless fundamentallyimportant structural problems are successfullyaddressed. It is certainly true that we cannot over-emphasize the importance of restructuring theeconomy into one possessing strong economic fun-damentals. However, it is also important to preparefor regional financial arrangements that could greatlycontribute to the stability of the financial system inthe region, unless the architectural deficiencies of theglobal financial system are satisfactorily rectified.

There has been an emerging consensus in EastAsia that East Asians must join forces to establishregional financial arrangements which will help themfend off speculative attacks and, in so doing, stabi-lize the East Asian financial markets (Park and Wang,2000; Wang, 2000). However, it is still at an earlystage and it is not yet quite clear whether they willbe able to successfully negotiate the creation of sucharrangements, given the various interests of differ-ent countries with respect to regional financialcooperation. Details of the swap arrangement mecha-nism among the ASEAN+3 countries will have to beworked out, and it is still too early to tell whetherASEAN will be able to design a scheme acceptablenot only to ASEAN member states but also to China,Japan and the Republic of Korea.


Now that China is about to join the WTO, Chi-nese policy makers realize that they may have toliberalize and open their financial markets and fi-nancial services industries sooner than expected.They also realize that, as the country with the largestmarket, China must contribute to, and cooperate with,other countries in order to sustain financial stabilityin East Asia. However, China will find it very diffi-cult to support any regional arrangements dominatedby Japan.

In promoting regional cooperation in East Asia,Japan has a very important role to play as the secondlargest economy in the world and as a member of theG-7. While Japan and the other East Asian countriescannot, and should not, ignore the wishes of theUnited States and the European Union, the East Asiancountries must decide whether a regional coopera-tive mechanism would help to restore the dynamismand vitality the region was accustomed to before thecrisis. In recent months, Japan has become, onceagain, more active in advocating the creation of EastAsian monetary and financial arrangements, at leastinformally. In order to attract wider support fromother East Asian countries, Japan must tell them whatits national interests are and what it is prepared to doto support the establishment of East Asian financialarrangements. Japan must find ways in which it couldcollaborate with China to resolve regional economicissues.

East Asia has a long way to go before formaliz-ing, and putting into effect, the Chiang Mai initiativeand launching other types of cooperative mecha-nisms. In this regard, Japan should be able to provideleadership in papering over the differences amongEast Asian countries that are likely to emerge in thenegotiation process. In addition, most of all, Japanshould be prepared to provide a large share of theresources needed to facilitate regional financial co-operation without dominating the other countries.

Finally, but most importantly, Asian regionalinitiative should contribute to the stability of theinternational financial system, as the Asian Devel-opment Bank has done for global development fi-nance for over 30 years. A first requirement forachieving cooperative evolution with the rest of theworld is for East Asians and outsiders to consult ac-tively and candidly, perhaps with the United Statesin APEC and with Europe in ASEM (the Asia-Europe Meetings). East Asians need to tell the inter-national community clearly what they are motivatedto do, how they are developing a plan of action, andhow they believe it will fit in with global systems.

Outsiders should also carefully listen to and supportthem, if possible, in an outward-looking direction(Bergsten, 2000b).

VII. Concluding remarks

Unlike trade in other commodities and services,trade in financial intermediary services is dominatedby industrial countries: practically all DCs are netimporters, whereas most of the developed countriesare net exporters of financial services. At the sametime, most of the developing countries are recipientsof foreign direct and portfolio investment suppliedby advanced economies. The rules and regulationsgoverning trade in financial services and capital ac-count transactions are not well established. IMF,which serves as a quasi-lender of last resort, is oftenviewed as the handmaiden of the US Treasury. Be-cause of these features of international finance, tradein financial services and assets is often perceived tobe one-sided and unfair to DCs.

Since the early 1990s, developed countries ledby the United States have exerted pressure on DCsto adopt market-oriented reforms. Although they werenot prepared in the absence of an efficient system offinancial regulation and supervision, they neverthe-less proceeded with financial market opening.

When East Asian countries came under specu-lative attacks in 1997, some of them were not able todefend themselves, and subsequently had to seek IMFfinancial assistance and accept its stabilization pro-grammes. These crisis-hit countries were criticizedfor not having restructured their financial, corporate,and public sectors along the lines suggested by theWashington consensus. This failure was singled outas the main cause of the crisis and, understandably,these crisis-hit economies were subject to heavydoses of structural reforms. The East Asian crisisbecame contagious, even threatening the stability ofmajor international financial centres. The severityand contagiousness of the crisis underscored theimportance of, and renewed interest in, reformingthe international financial system. The G-7-led re-form, however, has concentrated its efforts on thefinancial and corporate sectors of developing econo-mies, while by and large ignoring the problems ofthe supply side of international finance.

With the recovery of East Asia and the reced-ing fear of contagion, the G-7 and IFIs have not been


able to gather as much support as needed for the re-form. The ongoing debate on the future direction ofthe international financial reform in fact suggests thatmost of the problems that beset the international fi-nancial system are likely to remain unchanged. Thispessimistic outlook arouses deep concern in devel-oping countries lest they remain vulnerable to futurefinancial crises, even if faithfully carrying out thereforms recommended by IMF and the World Bank.Given this reality, DCs may have to develop a defencemechanism of their own by instituting a system ofcapital control and adopting an exchange rate systemthat lies somewhere between the two corner solutions.

Notes

1 Socio-political-legal explanations have dominated thejournalistic explanations of the Asian crisis, and perhapsthese are most readily understandable to the general pub-lic. The calls against “korupsi, kolusi and nopotismi”(KKN) in the midst of political changes and the politicalmovements in East Asia which the crisis has spawned findresonance in this explanation. See Montes and Popov(1999) for further discussion.

2 Two previous crises in the first half of the 1990s did notprovide a wake-up call to the international financial com-munity. The ERM crisis of 1992 was primarily a currencycrisis, and the industrial countries affected did not experi-ence a financial crisis with a disruptive impact on the realeconomy. The Mexican crisis of 1994/95 was a full-fledgedcurrency and financial crisis, which signalled the need foran architectural reform of the international financial sys-tem. However, the warning was muted as the crisis wasmanaged well, and Mexico made a quick recovery. TheEast Asian crisis of 1997/98 was the real watershed in thisrespect; the international financial system was seen to haveseriously malfunctioned (Ahluwalia, 2000: 1).

3 Many conservative economists, including Schwartz(1986), Meltzer (1986), and recently Bordo et al. (1996),have challenged Kindleberger’s interpretation of the in-ter-war experience on which he partially bases his argu-ment and also his argument for intrinsic instability in theworld financial market without an ILLR. They reject thenotion that markets are intrinsically unstable and need tobe stabilized by an ILLR. They argue that an ILLR wouldcreate a greater problem, rather than a solution.

4 Bagehot (1886) set out his proposals first in The Econo-mist, of which he was editor in the middle decades of thenineteenth century.

5 The increase in interest rates has some problems, how-ever. If the SRF penalty rate were to be extended to allnon-concessional IMF lending, it could worsen the un-derlying external position of the borrowing country ratherthan improve it. When countries finally decide to ask theFund for emergency loans, they are already in dire cir-cumstances, where the private sources of international fi-nancing have almost dried up. For the SRF, the penaltyrate is reasonable, but the initial rate of charge on othernon-concessional IMF loans that is as high as the SRFrate may not be justifiable, because the decision to go to

the Fund is likely to be less price-elastic. Furthermore,whatever the economic merits, the decision to appeal toIMF is politically costly from the viewpoint of the incum-bent government, since domestic political opponents maytake advantage of the relatively powerless authorities. Inmost cases, the crisis-affected countries tend to requestIMF loans late in their survival game. In this regard, a“conditionality-equivalent” interest rate is high enough todeter, at least, the moral hazard of the incumbent govern-ment (Goldstein, 2000). An additional interest premiumcum conditionality would be excessive and, in most cases,make it more difficult for borrowers to service their exter-nal debts.

6 A selection process for pre-qualified countries has a trade-off between eligibility and extra burden for complying withpre-qualification standards. Moreover, as long as coun-tries applying for the CCL could be interpreted as coun-tries in trouble, not many countries are likely to apply forthe CCL, even if the rate of charge and the commitmentfee on CCL resources are significantly reduced to belowthat on the SRF. A post-activation review conducted byIMF could in theory reassure the market that the economicsituation for a pre-qualified country requesting activationof the CCL is not directly related to its own policy mis-takes but to developments largely beyond its control. How-ever, the question still remains as to whether the marketwill accept IMF’s assessment. For these reasons, eligibleapplicants for the CCL are likely to be limited, and hencea larger group of innocent victims of speculative conta-gion would be excluded. IMF should therefore be morecautious in exercising its leverage in admitting eligiblecandidates by imposing high standards based on its dis-cretionary policy preference. If this were not the case inpractice, many potentially eligible EMEs and DCs wouldfind no incentive to pre-qualify.

7 See Council on Foreign Relations (1999) and Park (2000)for a discussion of this problem in the context of the EastAsian crisis.

8 The collapse of the par value system in 1973, combinedwith the growth of international capital markets, made IMFirrelevant as a source of finance for industrial countries.No major industrial country borrowed from IMF after1976, and its financing role therefore has focused only onDCs, eventually also adding countries in transition(Ahluwalia, 1999).

9 The FSF Compendium of Standards provides one-stop ref-erences for 43 economic and financial standards relevantto sound financial systems. These standards are no lessimportant than complementary to the 12 key standards,dealing with particular functional areas. The FSF also re-fers to additional standards not included in its Compen-dium; the proposed inclusion of these new standards wouldraise the total number in the Compendium from the cur-rent 43 to 64.

10 Andrew Crockett of the Bank for International Settlements(BIS) appreciates the complexity of implementing stand-ards: “It would be unreasonable to expect an emerging ordeveloping country with a rudimentary financial sector tocomply with standards that an advanced financial centerhas reached only after decades of development. Sensitiv-ity will be required to balance the desire to move quicklyto best practice, with the need to recognize practical con-straints” (Archarya, 2000).

11 Finger and Schuler (1999) show that the cost of imple-menting just some tiny aspects of the WTO commitmentswas significant for many DCs. For example, poor and heav-ily aid-dependent economies, such as the United Repub-


lic of Tanzania, had to spend some US$ 10 million onmodernizing their customs operations; Madagascar spentUS$ 11 million to implement sanitary and phytosanitarystandards; Algeria spent US$ 112 million on Locust con-trol; and the Russian Federation spent US$ 150 millionon improving the disease control component of food-processing facilities. These are only the minimum aspectsof the spending required to comply with global standards.Imagine, then, what the total spending would mean forthe budgets of poor countries (Soludo and Rao, 1999).

12 Despite WIPO efforts to promote international comity to-wards IPR protection, countries had achieved little har-mony by the mid-1980s. In most cases, WIPO conven-tions simply required that their signatories follow nationaltreatment, and they lacked minimum standards either forlevels of protection or for the coverage of subject matter.The prevailing perception of the industrial countries wasalso that the WIPO lacked effective powers to disciplinesignatories for non-compliance. These regulatory and in-stitutional shortcomings prompted a bloc of US-led in-dustrial countries to push for the inclusion of IPRs inmultilateral trade negotiations in the early 1980s (PrimoBraga, 1996).

13 The capital adequacy standard has made long-term loansmore expensive, as banks are required to hold higher capi-tal for these loans. This particular feature may have wors-ened the situation during the 1990s by stimulating short-term lending to DCs (Rodrik, 1999).

14 In the Republic of Korea banks had no difficulty in satis-fying the BIS ratios. At the end of 1997, immediately af-ter the crisis, the BIS ratio on average remained at 8.67per cent. Moreover, five non-viable banks that were closedin June of 1998 were reported to have BIS ratios of 7.4 to9.6 per cent at the end of 1997. The reported BIS ratiosdid not accurately reflect the true state of the financialsoundness of banks for various reasons. Inadequate loanloss provisions, partial recognition of stock revaluationlosses, and loose loan classification standards and account-ing rules led to a discrepancy between official figures andthe actual state of the health of banks.

15 IMF is also working, together with the World Bank andothers, on producing reports on the observance of stand-ards and codes; there were about 20 countries in the pilotproject as of April 2000.

16 The paper also suggests a five-stage strategy for fosteringthe implementation of standards: (i) identifying andforging international consensus on key standards;(ii) prioritizing standards for implementation, taking ac-count of country circumstances; (iii) designing and install-ing an action plan to implement standards; (iv) assessingprogress in the observance of standards on an ongoingbasis; and (v) disseminating information on progress inthe observance of standards.

17 Acharya (2000) also asserts that IMF’s role should be lim-ited to the dissemination of information; it should not extendto incorporating standards as part of Fund conditionality.

18 Eichengreen and Mody (2000) suggest that spreads onbonds with CACs are lower for good-credit countries andhigher for poor-credit countries. In this regard, they con-clude that the credit market would function better by dif-ferentiating sovereign credit risks and the benefits of re-ducing debt-restructuring costs outweigh the risk of stra-tegic default.

19 Kwan (2000) and Ueda (1998) assert that one of the keydeterminants of the boom-bust cycle in East Asia was thesharp appreciation of the yen against the dollar betweenthe mid-1980s and mid-1990s, and its subsequent depre-

ciation. They also find that real investment and specula-tive financial capital within and in East Asia respondedtoo much to the yen-dollar movements. In a similar vein,Ogawa et al. (1999) propose a regional basket currencyarrangement to mitigate an adverse impact of the yen-dollar exchange rate fluctuations on the trade balance.

20 Floating exchange rates have repeatedly led to the emer-gence of large misalignments. The US dollar went frombeing chronically overvalued in the mid-1980s to under-valued in early 1995 to again overvalued. The yen hasbeen a large part of the obverse side of that roller-coaster,with the euro’s current undervaluation another part of theobverse. For instance, the US dollar rose by 80 per centagainst the yen and 40 per cent against the deutsche markfrom early 1996 to mid-1998 and late 1997, respectively.See Williamson (1999) for further elaboration on exchangerate misalignments.

21 If capital mobility is perfect, a fixed exchange rate and anindependent monetary policy are not consistent with oneanother. However, if a country is to give up free capitalmobility by imposing capital controls, as in the case ofChina, and more recently Malaysia since September 1998,both a fixed exchange rate regime and an independentmonetary policy can be compatible.

22 Bayoumi et al. (1999) assert that the essential precondi-tions for a durable regional arrangement in ASEAN coun-tries are political rather than economic, and by almost anymeasure Asia comes less close than Europe to meetingsuch political criteria. However, if China, Japan and theRepublic of Korea, as well as new members of ASEAN,are considered as a potential members of the regional cur-rency bloc, even the economic criteria pointed to by thetheory of an optimum currency area (OCA) would not besatisfactorily fulfilled.

23 See Bhagwati (1998), Cooper (1998), Eichengreen(1999a, b), Sachs and Woo (1999), and Stiglitz (2000).

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G-24 Discussion Paper Series*

Research papers for the Intergovernmental Group of Twenty-Four on International Monetary Affairs

No. 1 March 2000 Arvind PANAGARIYA The Millennium Round and Developing Countries: Ne-gotiating Strategies and Areas of Benefits

No. 2 May 2000 T. Ademola OYEJIDE Interests and Options of Developing and Least-developed Countries in a New Round of MultilateralTrade Negotiations

No. 3 May 2000 Andrew CORNFORD The Basle Committee’s Proposals for Revised CapitalStandards: Rationale, Design and Possible Incidence

No. 4 June 2000 Katharina PISTOR The Standardization of Law and Its Effect on Develop-ing Economies

No. 5 June 2000 Andrés VELASCO Exchange-rate Policies for Developing Countries: WhatHave We Learned? What Do We Still Not Know?

No. 6 August 2000 Devesh KAPUR and Governance-related Conditionalities of the InternationalRichard WEBB Financial Institutions

No. 7 December 2000 Andrew CORNFORD Commentary on the Financial Stability Forum’s Reportof the Working Group on Capital Flows

No. 8 January 2001 Ilan GOLDFAJN and Can Flexible Exchange Rates Still “Work” in FinanciallyGino OLIVARES Open Economies?

No. 9 February 2001 Gordon H. HANSON Should Countries Promote Foreign Direct Investment?

No. 10 March 2001 JOMO K.S. Growth After the Asian Crisis: What Remains of theEast Asian Model?

No. 11 April 2001 Aziz Ali MOHAMMED The Future Role of the International Monetary Fund

* G-24 Discussion Paper Series are available on the website at: http://www.unctad.org/en/pub/pubframe.htm. Copies ofG-24 Discussion Paper Series may be obtained from c/o Editorial Assistant, Macroeconomic and Development Policies Branch,Division on Globalization and Development Strategies, United Nations Conference on Trade and Development (UNCTAD), Palaisdes Nations, CH-1211 Geneva 10, Switzerland; Tel. (+41-22) 907.5733; Fax (+41-22) 907.0274; E-mail: [email protected]

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