The Asian crisis provides several valuable lessons on how existing models of surveillance/monitoring can fail to signal an impending crisis or to induce pre-emptive responses. These are discussed in this section (some of them are drawn from the analysis of recent research in chapter IV, and others from actual experience in the crisis period).

First, surveillance can fail because countries do not disclose adequate information. Transparency refers to the process by which information about existing conditions, decisions and actions is made accessible, visible and understandable to all stakeholders. In the context of the Asian crisis, improved transparency might have helped prevent the build-up of financial and economic mismatches, and prompted swifter policy response and limited contagion; hence, the renewed call after the outbreak of the crisis to improve the quality of information concerning traditional and new key macroeconomic variables, as well as the financial reporting of banks, financial institutions and corporate entities.

The quality of information made available to monitoring agencies has an important bearing on the quality of surveillance. In an early warning system, more specifically, the timeliness and accuracy of information are very important. Often daily, weekly or monthly series are being proposed to provide the necessary lead-time for policy responses. Accuracy, on the other hand, is important for formulating the appropriate policy response. Unless these information problems are addressed, surveillance and early warning systems will be severely hampered.

Transparency helps to instil market discipline, which in turn makes the economic and financial systems more resilient to shocks. The implicit assumption appears to be that the markets and international monitoring bodies, when they have access to accurate and timely information, will perceive the deterioration of the financial and economic conditions of a country more easily. This is expected to trigger a gradual response by the markets, such as an increasing borrowing premium or a downgrading of credit ratings, thereby avoiding panics and creditor rush behaviour. In addition, the evils of crony capitalism, where long-term links between banks and corporations lead to overlending and investments in excessively risky areas, can be reduced when there is sufficient information about the true financial position of banks and corporate borrowers.

Transparency helps markets function better. A sudden loss of confidence in both financial firms and enterprises which prompts creditors to exit rapidly is due, in large part, to a lack of transparency on the part of firms as well as national authorities. In periods of financial stress, a lack of transparency tends to reinforce rather than dispel the rumours that form the basis of the unwillingness of creditors to deal with indebted parties. Thus, the provision of timely information can help mitigate the spectre of contagion effects and stabilize expectations and market sentiments.

Because developing countries are more vulnerable to bouts of financial instability and contagion than developed economies, their making available good quality data in a timely manner is a concrete way to fill in the gap in existing international mechanisms.

Second, early warning may not operate because political pressure prevents a warning from being heeded. For example, in some instances IMF has advocated an adjustment of exchange rates, but the policy advice was ignored because of the perceived political importance of maintaining the peg.² In such cases, while surveillance was able to pick up an unsustainable policy, it was not successful in eliciting the necessary policy response to avert an impending crisis. This drives home the point that warnings through surveillance carry no guarantee of action; a political obstacle can lead to policy inertia until a crisis is actually triggered. On some occasions, by the time authorities turn to IMF for financial support and technical assistance, the situation is already too difficult for effective policy advice to matter. The loss of confidence is accentuated and the crisis deepened.

Heedful of political constraints, recent discussions on surveillance have emphasized regional peer pressure as one way of encouraging the adoption of appropriate policies.³ For this modality to be effective, a frank exchange of views among the members of a (regional) consultative body is imperative. Although such an exchange may not necessarily mean that a member will adopt the policies proposed by the others, it does allow the spillover considerations and the burden of dealing with them to be discussed openly. In order to motivate policy makers to adopt the needed policy response, taking into consideration the political cost of doing so, it is also necessary to have a significant sense of ownership of the process.

A third possible reason for the failure of surveillance is that there are differences in the interpretation of the signals. When an indicator emits a signal, this may be viewed as issuing a warning by some but not by others, depending on the underlying hypotheses concerning the anticipated effects. For example, the rapidly rising level of short-term debt in several Asian countries before the crisis was evident and clearly signalled. However, this was not seen as a warning of an impending problem by the government authorities as they felt that the private sector, which had mainly incurred the debt, would be able to deal with the problem. However, the market interpreted the signal differently.

Fourth, it is possible that the model underlying the surveillance mechanism was not fully relevant, so that the indicators being monitored did not give adequate warning of potential problems or of their severity. Thus, the situation was not diagnosed correctly and important points of vulnerability were not noticed. Indeed, one criticism levelled at IMF during the Asian crisis is that its bilateral surveillance mechanism was not focusing on the problems of financial sectors, banks and debtors, that proved to be at the core of the loss of confidence in the region. Bilateral surveillance, at least during the pre-crisis period, tended to concentrate on macroeconomic policies, and paid little attention to issues such as the volatility of capital inflows, the consequences of financial liberalization, maturity mismatches, build-up of fragility in the financial system and other capital account issues. Thus, it is alleged that there was an important gap in IMF surveillance in terms of not giving importance early enough to structural issues such as corporate governance, supervision and regulation.

It is increasingly recognized that the crises of the late 1990s were very different from the traditional balance-of-payments problems facing developing countries which usually arose from developments in the current account (such as terms-of-trade shocks). Rather, the Asian crisis emanated from the capital account, which calls for somewhat different responses in both crisis prevention and its resolution.⁴ The crisis has shown the importance of including structural issues and capital account indicators in monitoring and resolving crises. Thus, partly in order to fill the aforementioned gap, IMF has tended over time to broaden its surveillance to cover all the policies that affect trade, capital movements, external adjustment and the effective functioning of the financial system. The areas covered now include structural policies (for example, market policy, privatization, industrial policy and competition policy), the financial sector (for example, capital account issues, banking supervision, deposit insurance and other financial sector regulations), and a number of other issues (for example, the environment and military spending). ⁵ Further, IMF, as well as BIS and other relevant organizations, is starting to collect more information on the structure of external debt (both maturity and ownership), the availability of reserves and the contingent liabilities of governments as part of its template on reserves.

A fifth reason why surveillance can fail is that, even when diligent monitoring can pick up incoming shocks that may destabilize an economy and can issue warnings, it is often too late to do anything about it. For instance, the crisis in Thailand could have been taken as a harbinger of shocks or a warning for the other countries in the region. However, despite the warning, the weak financial systems in the other countries could not bear the reassessment of markets.⁶ The result was contagion. Thus, under these circumstances, even if policy makers in Indonesia and the Republic of Korea had been able to anticipate, through surveillance, that their economies were highly vulnerable following the initial disturbance in Thailand in July 1997, their ability to respond effectively was probably constrained by weaknesses in their financial sectors that had persisted for years. In contrast, though not insulated from the regional turmoil, Singapore's robust financial sector absorbed the shocks without the severe interruptions in financial flows that hit the most affected economies. ⁷

Sixth, surveillance, particularly at the national level, may not function well because the authorities may be unsure of what the actual problem really is. This incapacity to diagnose a problem can come from the lack of technical resources for effective surveillance. International financial institutions and the private sector, on the other hand, spend large amounts on analysts and expensive databases in order to produce high-quality monitoring outputs. In this regard, there is considerable scope for international cooperation between countries and international financial institutions. Certainly, technical assistance to enhance the capacity of national authorities to perform good surveillance work is a step in filling this gap.

Lastly, contagion was largely unanticipated by existing surveillance mechanisms such as IMF partly because of the lack of a regional perspective in these mechanisms. It is useful to recall that IMF traditionally performs surveillance at two levels, bilateral and multilateral. Concentrating on domestic macroeconomic development (as is done in bilateral surveillance) would tend to ignore regional linkages or channels for the transmission of disturbances. Inasmuch as contagion effects have become more pronounced as a result of globalization and deeper economic interdependencies, insufficient focus on the regional spillover dimensions of crises would tend to diminish the effectiveness of a purely nationally based surveillance mechanism. On the other hand, multilateral surveillance can be too broad and could easily miss regional dynamics, especially those that affect countries which are not systemically important.

In order to address this problem, there is a suggestion⁸ that IMF should bring international and regional considerations and experience to bear when giving advice about domestic policies as a part of Article IV consultations. This suggestion is motivated by the fact that the impact of developments in the international environment is becoming more powerful owing to increasing private capital flows and the greater openness of countries. In fact, one of the intentions behind the IMF presentations to the now twice-a-year meetings of the Manila Framework members is to respond to the need for taking into account international developments at the regional level.

The gap in the form of a lack of a regional perspective is very closely tied up with the phenomenon of contagion, which tends to have strong regional characteristics. Because of contagion and the increasingly swift escalation of crises, there is an observed need to have a regional or subregional surveillance and monitoring system as a complement to domestic and global ones. It has been generally recognized that countries which suffer from currency and/or financial crises have similar structural weaknesses, such as currency and maturity mismatches, financial sector weaknesses and weakness in general supervision. Furthermore, the spillover of policy responses often has more severe effects on countries that belong to the same subregion, owing to their substantial financial, investment and trade linkages. The existing mechanisms focus too much on the effects of policies of major industrial countries (which tend to have a global orientation), or on the country level, and so do not sufficiently cover regional concerns until after the fact.

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Footnotes:

² See, for example, J. Crow, R. Arriazu and N. Thygesen, "External evaluation of surveillance report", in External Evaluation of IMF Surveillance (Washington DC, IMF, 1999), available at <http://www.imf.org/external/pubs/ft/exev/surv/index/htm> (26 January 2000).

³See, for example, the executive summaries of the ADB Institute-sponsored workshops on regional surveillance in Asia: Responding to Crisis (Tokyo, ADB Institute, 1998), pp. 79-102.

⁴See discussions in the Report of the Commonwealth Expert Group on Protecting Countries Against Destabilizing Effects of Volatile Capital Flows (Commonwealth Secretariat, September 1998); and R. Moreno, G. Pasadilla and E. Remolona, "Asia's financial crisis: lessons and policy responses", in Asia: Responding to Crisis (Tokyo, ADB Institute, 1998).

⁵ Crow, Arriazu and Thygesen, "External valuation of surveillance report..."

⁶ There are a number of views on the timing and severity of the financial crisis in Asia. One view is that economies were inherently sound but a sudden change in market expectations triggered a panic and put a halt to funds flow. Another explanation is that the recent crisis stems directly from policies that encouraged imprudent lending or excessive risk-taking, making the economies vulnerable to shocks. As a result, the financial systems became very fragile over time. In principle, the build-up of vulnerabilities would not have happened had prudential regulation been working effectively. While prudential systems cannot prevent banks from failing, a strong regulatory system can provide a cushion to systemically risky banking practices and mismanagement. Asia liberalized its financial systems to a large extent, but did not put in place the requisite supervisory and regulatory institutions. As a consequence, these systems were not able to stem imprudent lending behaviour on the part of banks and over-investment in dubious areas on the part of corporate borrowers. The financial systems of the affected economies were very vulnerable, simply accidents waiting to happen. But for a while, rapid economic growth rates masked the weaknesses in the financial systems.

⁷ G. Manzano and R. Moreno, "Supporting regional consultations: the roles of research, policy analysis and surveillance", in Asia: Responding to Crisis (Tokyo, ADB Institute, 1998).

⁸ Crow, Arriazu and Thygesen, "External valuation of surveillance report..."