The International Monetary Fund’s (IMF) role is to help countries recover from financial crises by offering them loans, albeit with the caveat of imposing structural programmes, which is where the controversy begins.

The 1997 Asian Financial Crisis was a convoluted region-wide crisis. Thailand, Singapore, Malaysia, Indonesia and South Korea operated in a hot-money bubble in the 1980s and 1990s: a high-risk, high-reward system whereby high-interest rates and fixed currency rates were pegged to the US dollar. 

They enjoyed a boom as cheap, low-interest loans in the US enabled them to borrow massively. Furthermore, the exchange rate was made more favourable to exporters. As a result, these countries welcomed significant economic growth in what is called the Asian economic miracle, in the form of an eight to 12 per cent increase in their GDP. 

However, the risk in this was its basis on speculative investments in the non-tradable sector, especially real estate. This is because the investment behind this growth was foreign and the growth itself was mostly attributable to exports as well as speculation. When the US eventually raised its interest rates and the dollar became stronger, investment in the US bounced back. This led to the appreciation of the Asian currencies that were pegged to the US dollar. 

Exports from these countries became more expensive, hurting export growth, and foreign investment was diverted from them as it made its way to the US. Because of this, asset prices in Asia began to collapse. Foreign investors subsequently withdrew their investments, and Asian currencies began to depreciate. 

Thailand was the first one to run out of its currency. To support its exchange rate, it turned to a free-floating system. Their currency, the baht, thus collapsed. The growing lack of investor confidence in Thailand spilled over into other countries in the region, and so other Asian currencies followed suit. However, this wasn’t the only reason a financial crisis made its way to Asia. 

Between 1973 and 1985, because of its 36pc fall in trade, its undesirable GDP growth, high inflation, soaring current account deficit and increasing external debt, Thailand sought help from the IMF. Consequently, they were forced to implement more austere fiscal policies and devalue the baht. Although Thailand’s GDP grew, inflation decreased, and current account deficit improved, the IMF is criticised for the structural programme it offered to them. 

This is because, just ten years later, Thailand became the catalyst in the Asian Financial Crisis. Criticism of the IMF’s policy focuses on the way they were limited to the non-tradable sector instead of shifting them to the more export-favourable tradable sector. The fundamental problem of the Thai economy was left unaddressed, leaving it vulnerable to external shocks.

In addition, the improvements in Thailand’s economy that were seen after the IMF’s programme were due to speculative foreign investment in the non-tradable sector, such as real estate and stocks, which created an asset bubble. This meant that when foreign investment decreased, Thailand’s economy had nothing to stand upon.

In contrast, Dr Mahathir bin Mohamad, the Malaysian Prime Minister at the time of the crisis, rejected the IMF’s plan and refused to take its loan. Instead, he implemented internal policies to prevent the currency from falling into the free-floating exchange system. He termed the IMF’s desired control of the economy unadvisable as it would hinder affirmative action for the growth of vulnerable communities, criticising the IMF for focusing on debt repayment rather than sustainability and growth.

Pakistan, too, has had a contentious relationship with the IMF since 1958: a vicious and unescapable pattern leading to severe economic crises. Pakistan’s expenditure is more than one-fifth of its GDP, adding to the country’s growing debt. 

Not having enough reserves to pay back their loans has led to Pakistan being subjected to harsh economic policies upon which aid is contingent. These relate to interest rates and subsidy prohibitions and have resulted in hurting small and medium enterprises, stunting the country’s growth, higher inflation and soaring unemployment.

The IMF, as in Thailand, imposed high-interest rates on Pakistan in a bid to control inflation to attract investment and thus strengthen reserves. Here, too, this has faced failure because, in a developing country such as Pakistan, expenditure in the private sector is not ruled by credit. 

Short-term inflows are unstable for the country and bring with them long-term external liabilities. Furthermore, the imposed high-interest rates have flattened industry in the country and increased pressure on the budget. This has eaten up Rs 5.2trillion (more than half of tax revenues).

A look at how other countries have tackled financial repression shows that keeping interest rates low to address debt accumulation is advisable. IMF’s contrasting policy in Pakistan, which has increased interest rates from 11 to 20 per cent in three years, has added to public debt, which now stands at over four-fifths of the GDP. To escape further blame, the IMF’s policies must be tailored to address the unique needs of the developing economies it serves.

The writers are students at the Lahore University of Management Sciences

Published in Dawn, The Business and Finance Weekly, October 30th, 2023