AT a time when the US credit squeeze and the resultant recession is threatening to spread to the rest of the word, the East Asian nations have made a timely move to pre-empt any recurrence of the kind of financial crisis that badly mauled their economies eleven years ago.

On May 6, China, Japan, South Korea and the 10 members of the Association of Southeast Asian Nations (Asean) decided to expand their network of bilateral currency swaps into a virtual Asian Monetary Fund in an effort to ensure that 1997 does not happen again. In the past, the United States and the IMF had opposed the creation of any Asian counterpart, saying it would duplicate functions and create a ‘moral hazard’.

However, Ifzal Ali, chief economist of the ADB, dismissing the notion of ‘moral hazard’, said the Asian countries were ‘quite responsible’ states and knew what they were doing and what was right for them.

“If they create an Asian Monetary Fund, it is going to be their money and if it is their money, they are going to use it quite prudently.” He said they would “prefer less influence from the IMF because, in 1997, they feel the advice they got from the IMF was not correct and led to a lot of suffering.”

Initially, China, Japan and South Korea, the three giant economies, will contribute 80 per cent of the $80 billion foreign exchange reserves pool while the 10 members of the Asean will make up the rest. The finance officials of ‘Asean+3’ who met in the sidelines of the Asian Development Bank (ADB) annual conference in Istanbul last week, appeared enthusiastic and upbeat over their momentous decision.

Although none of the officials would call it an Asian Monetary Fund, most of them agreed that, though a step towards ‘multilateralisation’ at this stage, it would eventually lead to that.

What the East Asian states cannot forget is the unfriendly, rather hostile, role of the International Monetary Fund (IMF) in 1997 in trying to pull them out from the deadly meltdown that had set in. Instead of bailing them out under its $95 billion loan package, what the IMF did was to bail out their western lenders.

And the crisis-hit states were, to add salt to their wounds, subjected to a bitter medicine and forced to cut spending, raise interest rates, carry out structural reforms and sell state-owned industries. Joseph Stiglitz, the Noble laureate economist, who was chief economist of the World Bank when the crisis erupted, later observed that the IMF itself had at that time “become a part of the problem rather than part of the solution.” It is because of this attitude that the East Asians lost trust in the IMF.

The crisis, one may recall, began when the Thai baht collapsed on July 2, 1997 by about 25 per cent after having traded at around 25 to a dollar for ten years. Currency speculation spread and hit Indonesia, South Korea, the Philippines and then Malaysia. In a little more than a year, what had started as an exchange rate disaster became a global financial crisis, also causing a crash of Russia’s ruble and Brazil’s real.

The crisis took most observers by surprise as not long ago even the IMF had forecast strong growth for East Asia. For the past three decades, it had been a stable region, had grown faster and done better at reducing poverty. That is why some of the region’s states came to be known as “Asian tigers”.

In Stiglitz’s view, “the single most important factor leading to the crisis was the full capital account liberalisation” imposed on the countries. The IMF and the US Treasury had argued that liberalisation would help the region grow faster while East Asian countries needed no additional capital, given their high savings rate. So, the capital inflow posed huge risks and little reward.

And the later events confirmed these fears when the sudden change in investor sentiment reversed this huge inflow into huge outflow. It was not an accident that the two countries which escaped the crisis were India and China. The reason was that both of them had resisted capital market liberalisation.

When the crisis broke out, the IMF was the first to criticise economic policies of the affected countries and said it happened because their institutions were “rotten”. A major reason why it had developed animosity towards the ‘miracle economies’ was that they had become success stories and even came nearer to the West’s level of industrial advancement without following the mantra of the Washington Consensus. In the end, only Malaysia was brave enough to defy the IMF and risk its wrath by trying to keep interest rates low and put brakes on rapid flow of speculative money out of the country. Hence, its downturn was shorter.

One may recall that the ten members of Asean –– Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam — had launched an initiative in Chiang Mai, Thailand, in May 2000, in the wake of the 1997 Asian financial crisis, which also involved Japan, South Korea and China, for the purposes of making available emergency foreign currency loans to the member nations in case another currency crisis raises its head.

This initiative now covers some 16 bilateral agreements totalling almost $40 billion. While the original initiative involved only bilateral swaps, the countries concerned have now agreed to expand these into multilateral exchanges involving three or four countries, hence the need for a new crisis fund or an IMF of their own. Crisis-hit countries would soon also be able to draw down as much as 20 per cent of the money under the bilateral swap arrangements without having to go to the IMF.

Can a 1997-type crisis revisit East Asia in the near future? Today, Joseph Stiglitz says, the global surfeit of liquidity has once again resulted in comparably low risk premiums and a resurgence of capital flows despite a broad consensus that the world faces enormous risks. Although foreign exchange reserves are costly, the benefits in reducing the likelihood of another crisis and another loss of economic independence far outweigh these costs. This growth in reserves has created a new source of global volatility, particularly after the dollar lost its precious place under the Bush administration.

For those developing countries that remain heavily indebted, an increase in risk premiums would almost certainly bring economic turmoil, if not crisis. But the fact that so many countries hold large reserves means that the likelihood of the problem spreading into a global financial crisis is greatly reduced.