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Keywords:

  • E65;
  • F34;
  • G28

Lee and Rhee (2012) provide a very informative account of the Korean experiences through the 1997 and 2008 crises, stressing the policy responses and lessons, particularly the differences between the policy prescription during the East Asian financial crisis and the recent global financial crisis. In my comments I will discuss three main issues.

The first issue is about the extent of short-term foreign debt in Korea prior to the global financial crisis. East Asian economies learned the painful lessons about the danger of short-term foreign debt from the 1997 crisis. Thailand, Indonesia, and Korea all had more short-term foreign debt than reserves prior to that crisis, and all three became insolvent in the sense of not having enough foreign reserves to meet their foreign currency obligations. They had to seek International Monetary Fund (IMF) assistance and went through stringent and painful conditionality. Since that time, most countries have been carefully monitoring the amount of short-term foreign debt. For Thailand and Indonesia, the ratio of short-term debt to total reserves had been kept well below 50% in the years prior to the global financial crisis. However, as indicated in the paper, the ratio of short-term debt to total reserves in Korea reached almost 80% in the third quarter of 2008. If foreign holdings of stocks and bonds, which could in theory be quickly liquidated and the proceeds converted to foreign currencies, are taken into account, Korean reserves were inadequate to cover all its potential short-term foreign currency liabilities (short-term debt plus foreign holdings of stocks and bonds).

Lee and Rhee explain that some components of the short-term debt were covered by future foreign currency receipts, particularly for shipbuilding contracts, and a large part of the short-term debt was incurred by the branches of foreign banks in Korea, who should not have faced liquidity problems. However, neither of these explanations address the problem that if reserves cannot cover all the potential short-term foreign currency liabilities, then the situation may develop into a rush to exit in order to avoid facing the possible unavailability of foreign currencies and also a substantial depreciation of the local currency, which was basically what happened back in 1997/1998. Of course, in 2008, the US dollar liquidity crunch came from outside Korea, but having large short-term debt in relation to reserves runs the risk of some form of foreign currency liquidity problems, whether originating from the inside or outside. The authorities should have been muchmore cautious, and I am sure that from now on Korea will make sure that reserves can easily cover all potential short-term foreign currency liabilities of the country.

The second issue has to do with the Chiang Mai Initiative (CMI) that ASEAN+3 countries (Association of Southeast Asian Nations plus China, Japan, and Korea) worked hard to establish after the 1997 crisis. While the Chiang Mai Initiative Mulilateralization (CMIM) was not yet set up in 2008, the CMI was in place, and Korea had bilateral swap agreements through the CMI of US$23.5 billion equivalent with Japan, China, Indonesia, Malaysia, the Philippines, and Thailand. Lee and Rhee point to the facts that if more than 20% of the swap amounts was used, the country would have to be under IMF supervision, and that the CMI was an ex post crisis resolution facility rather than a crisis prevention one. The IMF link was a major constraint for the CMI (and the current CMIM). Given the harsh and controversial nature of IMF conditionality back in 1997/1998, there is still a stigma attached to the IMF even at this time, and there could be a severe political backlash if an East Asian government takes its country into another IMF program (even with much milder or almost no conditionality). Changes to the IMF link are clearly needed if CMIM is to be useful in the future, and work is also underway to add a crisis prevention mechanism to CMIM.1

Finally, Lee and Rhee point to many differences in the policy stances to resolve the crisis between those imposed on East Asian economies back in 1997/1998 and the ones used to deal with the 2008 crisis in the West. One can argue that the Western economies and the IMF have learned from earlier crises, particularly the East Asian financial crisis. Arguments back in 1997/1998 that many bailout measures, proposed by the crisis affected countries, would lead to “moral hazard” have been almost totally downplayed in the 2008 crisis, and many bailout measures with severer moral hazard implications have been implemented. On the other hand, one may also suspect unequal treatment of financial institutions in the West compared to those in the crisis-hit countries in East Asia, and indeed some may view the conditionality imposed in 1997/1998 as being to bail out the Western banks that imprudently lent to East Asia before the crisis. Both these views probably have some element of truth. The only way to know for certain is if East Asia faced another financial crisis requiring IMF assistance. However, the best is not to have to know this, that is, to make sure that East Asia does not get into another financial crisis. Given the lessons that have been learned through the two crises, this should be achievable.

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