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Is the Crisis Over?
Three Regional Perspectives
Contents:
Introduction
East Asia - The Response to the Crisis
Russia - The Response to the Crisis
Brazil - The Response to the Crisis
A Global Look Ahead
The global financial crisis - which started in East Asia, spread to Russia, and sent shocks to Brazil - slowed world trade growth to 4.6 percent in 1998, compared with 10 percent in 1997. Prices for primary commodity exports, excluding oil, fell 16 percent. And net long-term finance dropped by US$58 billion, while interest rate spreads for these loans soared. While the impact of these factors varies widely among countries, their combined effect may have reduced overall demand in developing countries by 3 to 4 percent in 1998 from 1997 levels.
Average growth rates in developing and transition countries are likely to fall to just 1.5 percent in 1999, down from 1.9 percent in 1998, and 4.8 percent in 1997, making it the lowest growth rate since 1982.
INDONESIA
Over the past 18 months, the turmoil that has characterized Indonesia has led the World Bank to redirect virtually the entire program and resources in support of the government's efforts to hold the economy - and the country - together.
To help finance Indonesia's budget needs, at the July 1998 Consultative Group for Indonesia (CGI) meeting, the Bank committed US$3 billion in adjustment lending (to the total donor pledge of US$7.9 billion) of which US$2 billion was pledged at the CGI and US$1 billion was the Bank's contribution to the IMF-led US$6 billion special financing package to be delivered this fiscal year. In December 1998, improved macroeconomic conditions and slower-than-expected government disbursements reduced the gross financing needs of the budget by roughly US$4 billion, enabling the Bank to reduce its adjustment lending commitment to US$2 billion for this Bank fiscal year.
The US$1 billion Policy Reform Support Loan, disbursed in two tranches, fulfilled half of that commitment; the remainder is to be fulfilled by the US$1billion plus package of the US$600 million Social Safety Net Adjustment Loan (SSNAL), the US$500 million Policy Reform Support Loan II (PRSLII), and the US$100 million Water Structural Adjustment Loan (WatSAL) - which provide the necessary financing and budgetary support to Indonesia, providing fiscal stimulus without causing inflation.
The SSNAL is a performance-based loan, designed to put in place policy conditions seeking to safeguard key safety net programs, to protect expenditures crucial to the poor, and to improve design of new programs to allow the poor to be more effectively reached. The Bank will present the loan to its Board of Directors in Washington (tentatively scheduled for mid-May) when it is satisfied that the necessary structures are in place.
Financial and corporate restructuring are high priorities for the program in Indonesia. In the last year, Indonesia Bank Restructuring Agency (IBRA) was created to lead bank restructuring; weak banks were to be closed and their assets transferred to IBRA's Asset Management Unit. All private banks had been categorized based on independent audits of their loan portfolios. Those banks deemed eligible for government capital injections were subjected to a careful review of business plans and of the fitness of owners and management. The reviews were conducted by an independent consulting firm and by a series of interagency committees. The World Bank, IMF and ADB attended many of the interagency meetings as observers.
At the same time, the Bank moved to ease the impact on the poor. The World Bank amended ongoing projects to emphasize emergency needs in education, health, job creation, and maintenance of existing assets, and canceled US$1 billion from our portfolio. New lending was introduced for structural reform, poverty alleviation, and technical assistance for banking and corporate restructuring. Non-lending services were strengthened to provide continuous policy advice and enhance monitoring of the social impacts of the crisis.
In addition to IBRD lending, Indonesia has also requested that it be reconsidered for International Development Association (IDA) eligibility. Indonesia last received an IDA credit in FY80. With greatly diminished access to capital on commercial terms during the past year, and with declining per capita income, Bank management has determined that Indonesia is again IDA eligible, but that this will be for a limited time to assist the country to cope with social sector issues during the current difficulties. Assuming continued progress on structural and governance reform as well as demonstrated capacity to absorb IDA resources well (in line with IDA's performance criteria), we propose an IDA lending program of SDR 300 million (about US$400 million at the current exchange rate) during the three-year period FY00-02, for projects focusing on poverty alleviation and social sectors.
Responding to the social impacts of the crisis, the Bank has supported the Government of Indonesia by developing a three-pronged response: maintaining food security; expanding employment and income generation opportunities; and preserving access to critical social services. On the first, the Bank has played a central role in assisting the Government of Indonesia in monitoring the social impact of the food situation and to coordinate an effective response. On the employment side, the Bank has worked with the government to develop a crisis response project, the Urban Poverty Project, which is designed to generate employment and income opportunities in the poorest urban communities on Java, which surveys have shown were the hardest hit by the crisis. In addition, the Bank expanded the geographical coverage of the Kecamatan Development Project (US$225 million), which was designed to achieve these same objectives in poor rural areas.
The crisis is not only affecting current, but also future income earning power, by impeding the education and harming the health of Indonesians, especially the poor. The Bank has advocated protection of basic education and the health budgets and conditioned adjustment loans on those provisions. In the health sector, the Bank approved a US$21.5 million education loan for the Early Child Development Project to help protect the basic health, nutrition, and educational development needs of poor young children in selected provinces in Indonesia. In education, the Bank recently approved two education projects, the Sulawesi and Eastern Islands Basic Education Project and the Sumatra Basic Education Project, to benefit low-income school-age children, education personnel, their families, and communities in selected provinces and districts in Indonesia. Both projects support strategies of reinforcing social safety nets by delivering basic education services to the poor through the support of students and schools with a successful back-to-school campaign, and decentralizing delivery of basic education, improving its quality, and enhancing interagency cooperation.
KOREA
On December 3, 1997 the World Bank announced that it would resume lending to Korea in support of its economic reforms, and pledged up to US$10 billion as part of a larger US$57 billion IMF-engineered assistance program for the country. Korea is showing the clearest signs of recovery. The country has accomplished many of the big tasks of bank recapitalization and consolidation, as well as assuming some responsibility for non-performing bank loans, though it still needs more micro-level banking reforms to strengthen its management and credit culture. A good start has been made on corporate restructuring, but the process needs to go further.
Two adjustment loans totaling US$5 billion were approved by July 1998. This fiscal year, a US$2 billion Second Structural Adjustment Loan (SALII) was approved - and US$1 billion of it immediately disbursed. The SALII focused on financial sector reforms, including the resolution of weak financial institutions, strengthening of regulation and supervision, and capital market development. It also stipulated a set of corporate sector provisions, including the restructuring of corporate debt, reform of corporate governance and competition policies, and reform and privatization of state-owned corporations.
The Bank is also funding a US$48 million loan for the Financial and Corporate Restructuring Assistance project to provide technical assistance to support reforms aiming at effective management of the problems in the financial and corporate sectors and for sustained strong and stable growth in today's more integrated and competitive global economy.
Labor market reforms are a priority for the Government of Korea. The Bank is supporting the government's efforts to implement wide-ranging reforms, while at the same time building a stronger and more durable social safety net, including expanded unemployment insurance, a new public works program, introduction of a means-tested noncontributory pension for the unemployed poor, and strengthening of other anti-poverty programs. The Bank has actively supported social sector restructuring through policy-based lending with the Economic Reconstruction Loan and SALs, which have addressed comprehensive social sector reforms in the areas of labor markets, antipoverty programs, health insurance, and pension system reform. ASEM grants are supporting government implementation of social sector reforms agreed under the structural adjustment program in the areas of social protection for workers (US$900,000), protecting the poor (US$900,000) and protecting the elderly (US$900,000).
MALAYSIA
The Bank's 1999 Country Assistance Strategy for Malaysia focuses its lending support largely on the social sectors with a robust program of analytical work, policy advice, selective technical assistance, and country dialogue, particularly in the area of corporate and financial restructuring, medium term competitiveness and social issues.
Specifically within the financial sector, the World Bank will administer a US$735,000 ASEM Technical Assistance Grant which will be utilized to assist Bank Negara design and implement an Early Warning System for the banking sector, on an individual institution basis; and conduct a technical study on international practices regarding depositor protection and deposit insurance schemes and examine possible implications for Malaysia. Although stronger than most at the outset, Malaysia's corporate sector was hit hard by the sharp declines in domestic and foreign demand that exposed underlying fundamental problems, such as over-diversification and over-investment. In support of the restructuring strategy, the Bank is providing formal and informal technical assistance to the Government. A US$2.7 million PHRD grant is in the works to support corporate restructuring by financing macroeconomic analysis, advice regarding coordination of corporate and financial restructuring activities, and advice to Danaharta, the national asset management company, and the newly created Corporate Debt Restructuring Committee, which is charged with facilitating voluntary restructuring between debtors and creditors.
After a four-years hiatus, the Malaysian Government requested fast-disbursing assistance to offset the adverse social consequences of the crisis and finance its preemptive reform program. The Bank approved a US$300 million Economic Recovery and Social Sector Loan in June 1998. In addition, the recently approved US$60 million Social Sector Support Project will assist the Government's strategy for ameliorating the adverse impacts of the economic crisis on the poor and vulnerable through maintaining their welfare and access to, as well as use of, essential social services, particularly by those groups located in the poorest districts.
The US$244 million Education Sector Support Project will provide funding to continue core programs in basic education, and support polytechnic education to provide skilled technicians for the medium-term economic recovery. Efficiency improvements through further staff development and institutional strengthening is also being provided. In addition, the Social Sector Support Project includes an important component to strengthen the monitoring of poverty over time as well as of the effectiveness of programs designed to reduce poverty and to mitigate the adverse impact of the crisis.
PHILIPPINES
The Philippine economy has to date weathered the regional crisis relatively well. The economic downturn there was one of the least severe among the five crisis-affected countries in the region. The Philippines was probably in the best position, since its banks had higher capital adequacy rations and were better supervised and its corporations had lower leverage. There has been no need thus far for the Government to recapitalize private banks and the majority of large corporations remain current on their domestic and foreign obligations.
However, despite the absence of a systemic crisis in the banking and corporate sectors, Philippine banks and corporations are facing major strains. For example, non-performing loans among commercial banks, which hold 90 percent of banking system assets, have increased almost four times to 11.8 percent as of November 1998 and are expected to peak this year at 16-20 percent. The Bank's focus, therefore, is on helping the Philippines respond to the crisis but not forgetting the long-term investments in people, rural development, infrastructure development in partnership with the private sector, environmental protection and resumption of sustainable growth.
Unemployment rose sharply early in 1998, but by mid-1998, it was only marginally higher than a year earlier, while consumer price inflation was contained at around 10 percent, up from 6 percent prior to the crisis.
Projects in the rural development sector constitute about 33 percent of the portfolio, consistent with the Bank's strategy to promote broad-based economic growth and poverty reduction. The energy sector accounts for about 25 percent, infrastructure 16 percent, human development sector about 9 percent and others (including adjustment loan) about 17 percent. A Country Portfolio Performance Review (CPPR) with the Government of Philippines in December 1998 agreed on significant measures to restructure the existing portfolio in view of the crisis and performance issues.
On December 3, 1998, three loans totaling US$600 million were approved to shore up the banking system, support private enterprise credit, and bolster the rural micro-finance systems to alleviate poverty and better serve rural areas. The Banking System Reform Project (US$300 million) would support the country's banking reform program, whose goal is to strengthen the banking system and enable it to better withstand current difficulties and future shocks. To assist private sector enterprises affected by the credit crunch and currency crisis, the Private Enterprise Credit Support Project (US$150 million) would augment the long-term resources of the Development Bank of the Philippines. The Third Rural Finance Project would provide support to the rural economy to overcome the difficulties created by the regional financial crisis and the devaluation of the peso.
The Philippines was less successful than its faster growing neighbors in reducing poverty during the decades prior to the current crisis, but the initial impact on the poor of the current slowdown appears to have been less adverse.
In the social sector, enhancing human development and social safety nets for the poor are top priorities. With this in mind, the economic recovery program should be accompanied by measures to strengthen the social safety net and improving poverty targeting and action plans to reduce poverty and income inequalities. At the recent Consultative Group for the Philippines, a strong emphasis was placed on the need to address the social dimension of the crisis, and donors expressed satisfaction of the Government's increased attention to the social sectors, as well as to its priorities on rural development.
In addition to its lending program, the World Bank also manages special grants from Japan and the European Union. Recently approved grants aim to provide technical assistance to (a) the Central Bank, Philippine Deposit Insurance Corporation and Securities Exchange Commission to strengthen capacity to supervise the banking system and handle corporate bankruptcy filings; (b) the National Statistics Office to help it carry out a program of annual poverty incidence survey; and (c) public banks to enhance audits and strengthen the financial sector.
THAILAND
Thailand was the first in the crisis and may be poised for recovery.
Corporate debt restructuring is one of the most difficult challenges facing the Thai government. Non-performing loans in the banking system reached 46 percent of total debt in the most recent estimate from the Bank of Thailand, well over 2.2 trillion baht (US$60 billion). The debt problem is highly decentralized, unlike Korea, in tens of thousands of individual firms.
The Bank has participated actively in measures to speed corporate restructuring, including the development of intercreditor arbitration agreements, which will streamline approval of voluntary plans, and training programs for all participants in restructuring. The Bank has supported the Corporate Debt Restructuring Advisory Committee of the Bank of Thailand in its facilitation and monitoring role.
The Bank recently approved the second Economic and Financial Adjustment Loan (EFAL II) for US$600 million, with the Japanese government providing US$600 million in parallel financing. This loan will strengthen the competitive foundations of the economy, track reforms in the financial and corporate sectors, and support the government's proposed fiscal stimulus-particularly programs that enhance social protection. A Public Sector Reform Loan for US$400 million is also under preparation to assist the government in civil service reform, fiscal decentralization, and tax administration. In the social sector, the Bank's US$300 million Social Investment Program Loan aims to fund job creation for the poor and the unemployed, expand training for the jobless, and support low-income health insurance schemes. A follow-up loan to the Social Investment Program, and a skills development project that will address jobs, unemployment, and training needs, are also underway.
Other forms of Bank support comprise major analytical reports, informal policy notes, a program of international knowledge exchange; and a series of public policy seminars to raise awareness, stir debate, and promote consensus on key reform issues. For instance, a series of seminars are underway to share international expertise with Thai policy makers on privatization and creation of regulatory bodies for key infrastructure sectors.
Sharing growth and ensuring quality of life to help Thailand ensure that the benefits of development are both sustainable and shared among all segments of society, especially the poor and vulnerable are key. The Bank will continue to support Thailand in its efforts to mitigate the social costs of adjustment, empower local communities, reform the social security system, and preserve the natural environment. Special emphasis on protecting vulnerable groups, such as the poor, elderly, and unemployed workers, remains a top priority.
The August crisis has had an immediate, significant, and deleterious impact on project implementation. The collapse of the banking system resulted in the freezing of Special Accounts and lines of credit; a devaluation reduced the repayment capacity of final borrowers, including local governments, and weakened availability of counterpart funds. The crisis has also raised issues for the design of projects under preparation, such as sustainable levels of cost recovery. These negative developments notwithstanding, the Bank continues to supervise ongoing operations, process payment requests against active contracts, and review new procurement documentation as it is prepared by implementing agencies.
The crisis influenced the implementation and restructuring of the three existing structural adjustment loans: Third Structural Adjustment Loan (SAL 3) US$1.5 billion, of which US$1.2 billion remains undisbursed, Coal SECAL II, of US$800 million, of which US$400 million remains undisbursed, and Social Protection Adjustment Loan (SPAL) for US$800 million, of which US$250 million remains undisbursed.
In total, the Bank has pledged some US$2.3 billion in disbursements to Russia in 1999-2000. The net gain for Russia - including existing projects - thus amounts to slightly more than US$1 billion, considering the increase in debt service obligations which Russia will be assuming as the grace periods on the older loans in the Bank portfolio begin to expire over the next two years. However, the successful resumption of adjustment loans will depend on the progress of the Russian Government in implementing the reform programs to which it has committed itself and the maintenance of a stable macro-economic framework as certified with the IMF. Priority for FY99-00 lending to Russia would be given to socially targeted operations and operations supporting development of basic institutions, and with due attention to the risks assumed by the Bank.
Social Impact of the Crisis in Russia
In addition to the financial impact of the crisis on Russia, the social impact of the crisis is still unfolding and is likely to be profound. The immediate impacts fell primarily on employees in the financial sector - because of unemployment, household deposit holders experienced loss of the real value of deposits, and employees of budget sector organizations and pensioners were affected because of the build-up of arrears. The August 1998 shock did not create any new or unprecedented problems for Russia's social protection system. All of the problems existed in Russia before the crisis in the form of a persistent malaise. The crisis deepened the problems and made it clearer than ever that Russia cannot afford further postponement of reforms. Therefore, even though it is essential to confront the immediate social fallout of the crisis, it is also of crucial importance to shape responses in the context of medium-term changes and development challenges.
As the peak of the crisis is expected to come in about 12 months, rather than now, additional financing of social needs from the Bank could be provided in the time frame that fits the envisaged scenario. The additional Bank resources should focus on those areas and locations where the Bank can (i) at least moderately influence resource allocations to social protection and social investment needs; (ii) foster experiments in new designs of social assistance targeting that stand a chance of providing increased protection and can provide a sounder basis for long-term reform. These are relatively modest objectives, but still with significant risk of failure in view of serious economy-wide problems and uncertainties in Russia.
Since joining the World Bank in 1992, cumulative disbursements to Russia as of April 1, 1999 amounted to US$6.55 billion, of which US$2.12 billion constitute investment loans and US$4.4 billion take the form of quick-disbursing adjustment loans. The Bank's portfolio in Russia consists of 35 active projects; current commitments stand at US$11.8 billion.
The World Bank's support package for Brazil, for an amount of up to US$4.5 billion, is part of the international financial package for Brazil. This will support reforms and policies in the areas of social protection, social security, and administrative reforms. Of this amount, the Bank's Board approved two adjustment loans totalling US$1 billion on January 7th supporting social protection and social security reforms.
The Social Protection loan is supporting the Government's program of protected social expenditure during the expected period of increased fiscal austerity. The Social Security loan is supporting the first phase of the Social Security Reform Program.
On March 18th, when the Brazilian Senate approved the World Bank's two special adjustment loans, the Bank disbursed the US$1 billion. The Bank has now moved to the second phase of its program of support for Brazil, focusing on state-level reforms, particularly the Administrative Reform programs.
The World Bank strongly endorses the Brazilian government's commitment to keeping inflationary expectations low, protecting expenditure on those social programs which are of greatest importance for the poor and the vulnerable, and maintaining the programs of structural fiscal reform, at the national and sub-national levels, on which credibility and the recovery of growth will be based. The Bank shares the belief that real interest rates should decline in the course of the year as such fiscal credibility is gained. The consistent support that Brazil's Congress has provided the Executive over the last two months indicates broad political support for this difficult but necessary adjustment program. The Bank also welcomes signs that Brazil's state governments are willing to do their part.
The Bank stands ready to provide its continuing support as the Government's fiscal and structural reforms are implemented, following Board approval and in line with the IMF-led international package of support. In addition, the Bank's normal investment lending program of about US$1 billion through end June 1999, and project disbursements of US$1 to US$1.2 billion for the period July 1998 to June 1999, are expected to stay on schedule.
According to the Bank's recent report, Global Development Finance 1999, global output is forecast to slow further in 1999, to 1.8 percent, compared with a 1.9 percent increase in 1998. Growth may slow in Europe. Several large developing countries, including China, India, and Mexico, are expected to weather the difficult conjuncture relatively well. However, several Latin American economies, countries of the Former Soviet Union, and Middle Eastern and African oil exporters face stagnation or declines in output. Thus, global growth rates are unlikely to return to historical trends before 2001.
