6-The Financial Crises in Russia and East Asia-How Bank Can Help

8/13/2019 6-The Financial Crises in Russia and East Asia-How Bank Can Help

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THE FINANCIAL CRISES IN RUSSIA AND EAST ASIA:

HOW THE WORLD BANK CAN HELP.

- O VERVIEW OF A SIAN FINANCIAL CRISIS

On July 2, 1997, the Government of Thailand abandoned its efforts to maintain a fixed-

exchange rate the !aht had been "egged to a bas#et of currencies dominated by the $%&% dollar

and allo'ed the !aht to float% This !aht (uic#ly de"reciated, falling 1)* on the first day

alone% The colla"se of the Thai !aht 'as follo'ed by s"eculative attac#s on other countries+

currencies including the ndonesian .u"iah, the /alaysia .ingitt, the 0hili""ine 0eso, and the

orean on3 and to a further round of forced devaluations% The colla"se of fixed exchange

rates 'as accom"anied by a series of more general financial sector crises in several of these

countries% 4lthough the "recise details vary, the immediate cause a""ears to be a mismatch

bet'een assets and liabilities in the cor"orate and ban#ing sectors in both currency and term

length3 and a shar" decline in asset values% These immediate "roblems 'ere exacerbated by

general financial sector 'ea#ness due to inade(uate su"ervision and ram"ant insider lending%

n many 'ays the crises in 4sia 'ere some'hat different than "reviously observed

exchange rate crises% 5orsetti, 0esenti and .oubini 199)3 note that several of the usual

indicators of a "ending financial crisis slo' gro'th, large fiscal deficits, high rates of inflation

and lo' savings and investment rates 'ere not observed in these countries "rior to the crises%

This led several observers to suggest that the crises 'ere the result of self-fulfilling "ro"hecies

i%e%, the belief that the currency might be devalued led to s"eculative attac#s on the currency

'hich then forced the governments to devalue the currency even though fundamentals remained

strong3% 6o'ever, many observers suggested, both before and more often3 after the crisis

occurred, that there 'ere visible "roblems 'ith macroeconomic stability% The most noted

'ea#nesses 'ere i3 large, and "otentially unsustainable, current account deficits8 ii3 ra"id

a""reciation of currencies 'hich 'ere "egged to the dollar8 and iii3 a slo'do'n in gro'th due

to sectoral 'ea#ness es"ecially in semi-conductors3 and stagnation in Ja"an% The large current


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account deficits made the countries vulnerable to shifts in investor confidence or to a slo'do'n

in economic gro'th 'hile the ra"id a""reciation of the $%&% dollar led the currencies to become

overvalued% hen Thailand had floated its currency, this increased "ressure on other countries

to do the same to maintain com"etitiveness in ex"ort mar#ets%

The current account deficits 'ere not the result of dis-saving by the government i%e%,

fiscal deficits3, but 'ere caused by large inflo's of "rivate investment% !an#s and enter"rises in

these countries 'ould borro' abroad in foreign currencies and then use these funds to invest at

home% This led to ra"id stoc# mar#et and real estate "rice increases i%e%, asset bubbles+3 and to

ill-"lanned investment in "ro:ects 'ith lo' real rates of returns% The "roblem 'as intensified by

moral ha;ard due to im"licit or ex"licit government guarantees and by "oor su"ervision and

regulation of the ban#ing sector% 1 4s a result, 'hen the exchange rate fell, ban#s found

themselves 'ith large "ortfolios of non-"erforming loans and that the currency mismatch

bet'een assets and liabilities meant that they 'ere unable to service foreign currency loans% t

must, of course, be recogni;ed different factors "layed different roles in each individual crisis%

4s 5a"rio 199)3 notes, excessive leveraging of cor"orate debt a""ears to have been the main

"roblem in orea, 'hile in ndonesia, foreign exchange mismatches seem to have been a greater

"roblem in the cor"orate sector 'hich indirectly led to ban#ing sector "roblems3%

The ban# crises, es"ecially the crisis in Thailand, 'ere "redictable% /odels of ban#ingcrises e%g%,


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arge current account deficits that left the countries vulnerable to changes in investor

confidence and macroeconomic conditions i%e%, slo'er gro'th3%

Over-valued exchange rates that 'ere often "egged to the $%&% dollar 'hich 'as, at that time,

a""reciating (uite ra"idly%

.a"id and unsustainable increases in asset "rices, es"ecially stoc# mar#et and real estate

"rices%

4 currency mismatch bet'een assets and liabilities that left ban#s and enter"rises vulnerable

to exchange rate devaluations%

nade(uate ban# regulation and su"ervision%

m"licit and ex"licit government guarantees that made high-ris# "ro:ects including "ro:ects

'hich relied u"on continued a""reciation in real estate "rices3 attractive to investors%

III - L ESSONS LEARNED FROM A SIAN CRISIS

n Fast 4sia, in addition to su""orting the nternational /onetary Cunds "rograms, the

!an# "rovided &tructural 4d:ustment oans to "ro" u" and reca"itiali;e select ban#s by

su""orting bond issues% n addition, the orld !an# set u" credit lines to hel" finance im"orts%

IV - O VERVIEW OF ROOT CAUSES OF R USSIAN FINANCIAL CRISIS

The recent financial crisis in .ussia has many of the sym"toms of a classic crisis e%g%,

large fiscal deficits, macroeconomic instability, and lo' savings3, but is very different from the

crises in 4sia% Cor exam"le, although "oor data (uality ma#es it hard to dra' strong

conclusions, .ussia+s current account a""ears to have been in sur"lus through the end of 1997%

n addition, foreign investment 'as "rimarily directed to'ards the government sector rather than

into ris#y "rivate sector ventures or overvalued real estate% Oxford 4nalytic !riefs Hovember

1I, 19973 re"orted that non-residents might have been holding as much as B>* of outstanding

government "a"er at the end of 1997% 4s a result, the government+s 4ugust 17 th decision to

sus"end re"ayment of foreign debt and the subse(uent decision to com"ulsorily convert short


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term Treasury bills and federal loan bonds to ruble-denominated government securities 'ill

undermine foreign investment% t 'ill also have a significant effect on .ussia+s ability to

continue to fund deficits by issuing government debt even if this decision is reversed in the

future3% This might also aggravate ban#ing sector instability since the la' does not distinguish

bet'een resident and non-resident investors%

4n additional difference bet'een 4sia and .ussia is that ban# lending to the "rivate

sector remains miniscule in .ussia less than 7* of G* in real terms in 1997, this is not li#ely to be a ma:or "roblem given the small

amount of current lending%

t seems "lausible that the main "roblem is .ussia is sim"ly large fiscal and

macroeconomic imbalances%


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The ban#ing sector does faces some "roblems that are similar to the "roblems in Fast

4sia% /ost notably, regulation and su"ervision of the sector is "oor% n addition, the close ties

that the ban#s maintain 'ith industrial grou"s means that insider lending remains a significant

"roblem% These "roblems are magnified by corru"tion the F!.< ran#ed .ussia along 'ith

a;a#hstan, $#raine, 4;erbai:an, and $;be#istan3 as the most corru"t country in the 'orld

and the com"licated structure of the ban#ing sector% 4t the beginning of 199), there 'ere 1@7?

ban#s in .ussia although this is a shar" decrease form the I>>> ban#s that 'ere active at the end

of 199B3% Caced 'ith the tas# of su"ervising so many ban#s, the 5entral !an# has identified

those ban#s that are of greatest im"ortance and concentrates its resources on these ban#s%

4nother "roblem is that it is very difficult to actually li(uidate insolvent ban#s and, therefore an

effective la' on ban# li(uidation is urgently needed%

V - B ULLET POINTS OUTLINING KEY ROOT CAUSES

n contrast to Fast 4sia, .ussia has a modest current account sur"lus and there has not been

excessive foreign investment in ris#y "rivate sector "ro:ects% The main "roblems

macroeconomic uncertainty, "olitical instability and excessive fiscal deficits that ma#e the

commitment to maintain the exchange rate at current levels non-credible a""ear to be

driven by "roblems in the "ublic sector, not in the "rivate sector as in Fast 4sia%

4lthough "roblems in the ban#ing sector has some similarities to "roblems in Fast 4sia

"roblems in .ussia are far more acute% 0roblems related to "oor regulation and su"ervision

are exaggerated by the com"licated structure of the sector and by endemic corru"tion%

VII - I MPLICATIONS FOR THE ECA REGION (CAN THIS CRISIS REEMERGE ELSEWHERE ?)

Given the large numbers of ban# crises in the region and continued "roblems 'ith

regulation and su"ervision, the re-occurrence of "roblems in at least some of the countries in theregion seems inevitable% The ban#ing sectors of many countries are small and underca"itali;ed,

accounting standards are 'ea# and collateral la's, registries and ban#ru"tcy legislation have

develo"ed slo'ly and have not been im"lemented forcefully% 4lthough some countries e%g%

6ungary, 0oland3 have underta#en broad measures to ma#e their ban#ing systems more sound%


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the dis"arity bet'een those countries that have ta#en serious action to'ards reforming their

financial sector versus those that have yet to ta#e action is 'idening%

n contrast to .ussia, most transition countries in Furo"e and 5entral 4sia are running

huge current account deficits see Cigure3 over half are running current account deficits greaterthan ?* of G* of G


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countries and in more than half of the 5 & countries &ee Cigure3% nstitutional and structural

"roblems aggravate these difficulties in many transition economies% 0oor tax collection, often

rooted in "oor design and administration, "lague many economies and have consistently

undermined the tax bases% &"ecific "roblems include the 'ides"read use of barter and "ayments

in-#ind, the continuing accumulation of inter-enter"rise arrears, and the develo"ment of large

informal sectors that evade and avoid taxation% These dual "roblems leave many countries,

es"ecially in the C&$, extremely vulnerable to future crises

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HELP .

&tructural ad:ustment loans are not li#ely to be an effective solution to .ussia+s current

crisis% The most urgent "roblem is solving the continuing fiscal imbalance% Technical assistance

to im"rove tax legislation, com"liance, and collection is a clear first ste"% n the ban#ing sector,


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significant "rogress needs to be made in rationali;ing the number of ban#s, ending insider

lending, and im"roving su"ervision and legislation, before the orld !an# can effectively lend

money to reca"itali;e insolvent ban#s% &te"s that the !an# might ta#e include "roviding

technical assistance to hel" the government draft effective ban# li(uidation legislation and to set

u" an effective monitoring system% Curther, the !an# might also "rovide technical assistance to

hel" im"rove the "erformance of the resolution agency%

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6-The Financial Crises in Russia and East Asia-How Bank Can Help