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Policy Discussion PaperNo. 0002
University of Adelaide • Adelaide • SA 5005 • Australia
EXAMINING THE CASE FOR AN ASIANMONETARY FUND
Ramkishen S. Rajan
January 2000
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CIES DISCUSSION PAPER 0002
EXAMINING THE CASE FOR AN ASIAN MONETARY FUND
Ramkishen Rajan*
Ramkishen RajanSchool of EconomicsUniversity of AdelaideSouth Australia 5005Tel: (+61 8) 8303 4666Fax: (+61 8) 8223 1460Email: [email protected]
January 2000--------------------------------------------------------------------------------------------------------------------
The paper was completed while the author was a visiting scholar at the Institute of Southeast Asian Studies(ISEAS), Singapore.
EXAMINING THE CASE FOR AN ASIAN MONETARY FUNDRamkishen Rajan
ABSTRACT
This paper explores the case for an Asian Monetary Fund (AMF)in light of the East Asian crisis. It discusses the role of such a regionalfacility, and attempts to clarify important issues such as its functionalrelationship to the IMF. It is noted that the facility should focus primarilyon crisis surveillance and prevention at a regional level; while the IMFcontinues to focus on surveillance at a global level, as well as crisismanagement and resolution. Any funds dispersed through the regionalfacility during a crisis period would be done in full consultation with theIMF and in conjunction with the potential recipient pursuing the IMFconditionalities.
Key words: contagion, crisis prevention, crisis resolution, currencycrisis, economic cooperation, IMF
JEL Classification: F30, F32, F34
Contact Author:Ramkishen RajanSchool of EconomicsUniversity of AdelaideSouth Australia 5005Tel: (+61 8) 8303 4666Fax: (+61 8) 8223 1460Email: [email protected]
EXAMINING THE CASE FOR AN ASIAN MONETARY FUNDRamkishen Rajan
1. Background
The Japanese government first proposed an “Asian Monetary Fund” (AMF) in
September 1997. The original aim of an AMF was to make available a pool of funds to be
quickly disbursed as a means of emergency balance of payments support for the crisis-hit
economies. The proposal was enthusiastically welcomed by most East Asian economies.
While the bulk of financing would have been from Japan, it reportedly received pledges
of contribution from Hong Kong, Taiwan and Singapore1. Potential mobilisation capacity
of an AMF was estimated to have been in the order of about US$100 billion (ADB, 1999
and Wade and Veneroso, 1998). However, as Wade and Veneroso (1998, p.19) note,
“(t)he United States Treasury pulled out all the stops to kill the proposal, and it died”, as
the US appeared to see it as a threat to its influence in Asia2.
While the proposal has entered policy debates every now and then, it made
headlines recently when the Malaysian prime minister, Mahathir bin Mohamad, tabled it
again at an East Asian Summit organised by the World Economic Forum (WEF) in
Singapore. He reportedly stated that an AMF should be:
1 There is some ambiguity about the reaction of China to an AMF proposal, with the ADB (1999)and Wade and Veneroso (1998) noting that China supported the scheme, while Bergsten (1998)suggesting that it was against it.
2 The AMF proposal was rejected at the fifth APEC meeting in Manila. This is in sharp contrast tothe US policy response to Mexico during the peso crisis, in which the Treasury tried to “strong-arm” the IMF, Europe and Japan into contributing to the ESF (Altbach, 1997). Some see theAPEC Manila Framework as a compromise between Japan’s call for greater regional cooperationand the US and the IMF’s rejection of the AMF proposal. An argument has been made that theprimary aim of Tokyo pushing the proposal in the first instance was to seek greater leveragewithin the IMF and US. These and other possible tactical and geopolitical motives andimplications are well beyond the scope of the discussion in this paper.
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a small compact wholly regional funding organisation which would bedeeply and constantly engaged in East Asian monetary cooperation andproblems on a daily basis3.
Most recently, ASEAN ministers mooted a version of the AMF proposal in their recent
“informal” summit in Manila. The Philippines president, Joseph Estrada, made specific
reference to the AMF proposal in his opening remarks to the summit. Former Japanese
financial vice minister, Eisuke Sakakibara, also reignited debate on the issue, urging the
creation of “credible mechanisms for regional cooperation both in trade and finance” in
view of what he considered as lack of substantive progress in reforming the international
financial architecture4.
This paper explores the case for an AMF in light of the East Asian crisis. The
paper is organised as follows. The next section discusses the rationale for an AMF in
general. Section 3 is devoted to defining and highlighting the various transmission
channels through which currency and financial crises may spread contagiously. Section 4
discusses the role of such a regional facility, and attempts to clarify important issues such
as its functional relationship to the IMF. The final section concludes the paper.
2. The Case For an AMF?
While one could find fault with the timing and manner in which Japan initially
tabled the AMF proposal, this ought to be kept distinct from the question of its potential
3 See the WEF Press Release (October 19, 1999).4 See the “Welcome Remarks” of the chairman of the Third ASEAN Informal SummitAt the Summit Opening Ceremonies PICC, 28 November 1999 (available onhttp://www.aseansec.org ).
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effectiveness. To be sure, one can, in general terms, think of many justifications for the
initiation of such a geographically concentrated facility, some of which are noted below.
First, bailout packages in Latin America and East Asia have, by and large, been
regional in any event. To be sure, half of the total US$42 billion financial assistance
committed to Indonesia through the IMF was bilateral aid, of which most was by regional
economies in East Asia. In the case of commitments to Thailand, about one third of the
US$34 billion package was bilateral, all of which was from the regional economies. The
US contributed US$5 billion to South Korea, US$3 billion to Indonesia and none to
Thailand (Table 1). Additionally, the East Asian economies such as Japan and Singapore
provided other forms of bilateral assistance to the crisis-hit regional economies (Chang
and Rajan, 1999).
Insert Table 1
Second, the East Asian crisis has emphasised the existence of “demand” by key
regional players for some form of a regional cooperative alliance (the obvious alternative
being ad hoc unilateralism5), while the potential “supply” of such a regional facility (in
terms of resource availability) seems in little doubt.
Third, there are pre-existing channels and organisations in East Asia and
elsewhere which promote regional economic cooperation in other spheres, with the
monetary facility being a “natural” intensification of such efforts.
Fourth, there may be a need for some sort of geographically concentrated facility
which allows the regional economies to work in concert to gain a larger voice in
5 Malaysia’s recent unilateral imposition of capital restraints is an obvious case in point. See Birdand Rajan (1999) for a discussion of capital restraints in general, and the Malaysian case inparticular.
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international monetary affairs, as has been quite successfully achieved in the case of
global trade. Apart from Indonesia, no other ASEAN economy has been included in the
G-20 finance ministers forum recently formed to look into issues regarding the shaping of
the international financial architecture, as they were considered “systematically
unimportant countries” (Rowley, 1999)6.
Fifth, Asia possesses neither a strong regional hegemon nor a regional monetary
institution7. In contrast, the US has provided the necessary economic and financial
leadership in the Americas (and is even seen as the region’s de facto regional lender of
last resort), while monetary integration has been successfully attained in Europe.
Sixth, regardless of the exact transmission mechanisms and definitions, it is clear
that economic policy slippages in any one economy can and do reverberate rapidly to
other economies in the region in the form of contagious currency crises, with consequent
detrimental effects on the real economies. Proponents of regionalism in the
macroeconomic and financial spheres emphasise “contagion” effects as providing the
analytical basis for some broader form of economic cooperation regionally. As such, the
next section is devoted to exploring this issue in some detail.
3. “Regional Contagion”: Definitions and Transmission Channels
The currency crises of the 1990s stress the importance of contagion or negative
spillover effects that are largely regional in scope (consequently, also referred to as
“neighbourhood effects”). This being said, contagion could, at times, take on a global
6 Other members of the G-20 forum are Argentina, Australia, Brazil, China, India, Mexico, Russia,Saudi Arabia, South Africa, Turkey; the G-7 group of industrialised economies (Britain, Canada,France, Germany, Italy, Japan and the US). The EU and IMF are also participants.7 There are, of course, historical reasons for the failure of Japan to accept or be accepted as a
5
dimension. A good instance of this was the across-the-board rise in emerging market risk
premia and bond spreads following the Russian sovereign debt default in August 1998
(BIS, 1999). Similarly, during the Tequila crisis, the currencies of Thailand, Hong Kong
and the Philippines underwent brief periods of speculative attacks. However, in a recent
paper using a sample of 20 countries covering the periods of the 1982 Mexican debt
crisis, the 1994-95 Tequila crisis and the 1997-98 East Asian crisis, De Gregario and
Valdes (1999) found that contagion is directly dependent on geographical horizon, i.e.
there are strong “neighbourhood effects”. Krueger et al (1998), using a panel of annual
data for 19 developing economies for the period 1977-93, concluded that a currency crisis
in a regional economy raises the probability of a speculative attack on the domestic
currency by about 8.5 percent points8.
Broadly, “contagion” refers to the simultaneous occurrence of currency crises in
two or more economies.. It may be more formally defined as a situation where a currency
crisis in one economy leads to a jump to a “bad” equilibrium in a neighbouring economy
(Masson, 1998)9. In other words, While there is a need to be very precise in defining the
term “currency crisis” in empirical analyses, we take it here to broadly involve an actual
break of an exchange rate peg and concomitant currency depreciation, or speculative
pressure which may not lead to an exchange rate depreciation, but does lead to an
regional economic hegemon.8 Other recent empirical studies confirming this regional dimension of currency crises includeCalvo and Reinhart (1996), Frankel and Schmukler (1996), Glick and Rose (1999), Kaminsky andReinhart (1999a).
9 Some have referred to contagion as an increase in asset price volatility across countries.Though not often done in the literature, strictly speaking, one ought also to distinguish carefullybetween “mild contagion” (that may be defined as “an overall increase in risk premia”) and “strongcontagion” (that may be defined as “a severe speculative attack”). As emphasised by Willett(1999), while there is evidence of mild contagion, the existence of contagion of the strong varietyis far from obvious.
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international reserve depletion or an interest rate hike.
Thus, in the case of East Asia, while the crisis spread initially from Thailand
(following the devaluation of the baht in July 2, 1997) to Indonesia, Malaysia and the
Philippines by the end of August that year, the South Korean won depreciated in
November. In turn, this had reverberations back to the rest of Southeast Asia. Singapore
and Taiwan also experienced “modest” currency depreciations during September-October
1997, while Hong Kong’s currency board came under severe pressures, resulting in a
sharp interest rate hike to maintain the currency peg10.
3.1 Exploring the Transmission Channels
What are the channels which cause the contagious spread of crises? Five possible
modes of transmission may be deciphered.
The first, and most direct, is the need to remain “cost competitive” vis-à-vis other
economies with similar areas of comparative advantage, as a real devaluation in one
economy enhances its export competitiveness at the expense of a trading partner (regional
competitor). Gerlach and Smets (1995), Huh and Kasa (1997) and Corsetti, et al. (1998b)
formalise the logic of this attack-induced competitive devaluation (i.e. regional
economies’ competitiveness vis-à-vis third markets as a result of currency
depreciations)11.
Second, in contrast to contagion due to the “competition” noted above, there may
10 Empirical work by Park and Song (1999) suggests that contagion spread from Taiwan(following the preemptive devaluation of the New Taiwan dollar in October) to Hong Kong andSouth Korea, which then reverberated back to Southeast Asia.
11 The broad similarity of comparative advantages of the East Asian economies has been shownto hold, at least ex-post (as measured by the index of revealed comparative advantage) (Kellmanand Chow 1993).
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be extensive and growing trade, investment and other intraregional interdependencies,
leading to contagion due to economic “complementarities” (including price and income
effects due to a currency devaluation and recession in a neighbouring, importing
economy). Hence, for instance, it is commonly noted that Japanese foreign direct
investment (FDI) has developed an intricate division of labour based on both horizontal
and vertical differentiation in East Asia12. This in turn has stimulated intraregional trade,
with intra-East Asian trade constituting roughly one half of the respective regions’ total
trade (based on IMF data).
Third, losses in one economy may lead open-end mutual funds or banks to
liquidate positions in other regional economies in which they have exposures. This so-
called “forced portfolio adjustment/rebalance” behaviour may occur for a number of
reasons. These include, an anticipation of increased redemptions; the need to cover losses
in other crisis-hit markets (“cash-in” effects); and in order to reduce portfolio risks and
improve the liquidity position (“flight to safety” effects)13. Of particular significance is
the contagious transmission of crises through the interbank lending channel as
12 Ng and Yeats (1999) provide new statistics detailing the extent of such intraregional productionand trade in component manufacturing parts in East Asia. Intraregional investment has also beenspurred by Singapore’s drive in recent years to build the external dimension of its economy tocomplement and supplement the domestic economy.
13 See Calvo (1999) for a model involving two sets of agents (informed and uninformed), in whichmargin calls necessitate asset sales in one economy following price declines in another. Folkerts-Landau and Garber (1998) stress risk control systems as a possible reason for region-wide assetsell-offs and resultant contagion; while Van Rijckeghem and Weder (1999) emphasise the valueat risk (VAR) technique in particular. However, Schinasi and Todd Smith (1999) show suchfinancial contagion could result from normal/textbook portfolio diversification rules, with riskmanagement techniques and rules not having any significantly different consequences on optimalsell-off periods/strategies. Baig and Goldfajn (1998) test for evidence of contagion in theexchange rates, interest rates, equity, and sovereign debt markets of Thailand, Malaysia,Indonesia, South Korea, and the Philippines. They find that while sovereign spreads show clearevidence of contagion (of the weak form), the same cannot be said of the regional equity markets.
8
emphasised by Eichengreen (1999) and Van Ricjkegham and Weder (1999)14.
Fourth, many extra-regional investors, such as mutual funds and even foreign
banks, tend to lump economies in the non-industrialised world into sub-regions, rather
than make country-specific evaluations and investments15. Insofar as the entire
geographical region is looked upon as a single investment class (i.e. “risk clusters”)
rather than as individual markets, a weakness or attack on one currency could lead to a
reassessment of the region’s “fundamentals” and the probability of a similar fate befalling
regional economies with broadly similar macroeconomic stances (whether actual or
perceived). This is popularly termed the “wake-up call” effect. Alternatively, this
phenomenon may also refer to the sudden realisation of how little market participants
truly understood about the regional economies, leading to a region-wide
downgrading/sell-off (Radelet and Sachs, 1998a). Drazen (1998) develops a contagion
model which is based on economies being in an implicit or explicit currency/monetary
union. Thus, a devaluation by one economy acts as a wake up call to investors in the
sense that it leads them to question the commitment of other regional economies to
maintain “club membership” by not devaluing. Dooley (1998) suggests that the
“bunching together” of crises may be due to revisions in the effective size of official lines
of credit available to the regional governments to defend the currency (either from
international agencies or ad hoc bilateral, multilateral agreements). The important point
here is that unlike the mechanistic portfolio rebalancing behaviour noted previously, in
this case, there do not have to exist any actual linkages between the emerging markets
14 This may also be referred to as the “credit crunch” or “liquidity” channel, as it entails a generalreduction in the availability of funds.
15 In other words, there are region-specific or dedicated funds such as the Asia Pacific Fund, the
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(discussed further below).
Fifth, there is also the possibility of “panic herding” (“bandwagon” effects), either
in the form of an international bank run (i.e. “race to the exits”) leading to illiquidity a la
Diamond and Dybvig (1983) or the Calvo (1999) capital-crisis model. The Calvo model
may be best interpreted as an open economy extension of the models of information-
friction that have been recently developed to explain herding behaviour in domestic
financial markets16. Of importance is that fact that there are a wide variety of models and
cases which could lead to rational herding. In other words, one does not have to appeal to
investor irrationality to motivate panic withdrawals, acute market volatility and busts.
An important agenda for empirical research is how relevant the various causes of
contagion were in the case of the East Asian crisis. In a recent study using a
comprehensive data set of financial statistics, product information, geographic data, and
stock returns involving 14,000 companies in 46 economies, Forbes (1999) found that all
the above transmission mechanisms were important in the case of the East Asian crisis,
particularly the product competitiveness channel. Liu et al. (1998) have also provided
empirical support for this product competitiveness channel in the case of the ASEAN
economies. A priori, it is surprising that the common creditor/credit crunch effect
(through banks) was not found to be as important. However, this may be explained by the
fact that Forbes focused on international rather than regional propagation, and did not
test for the herding channel. However, Kaminsky and Reinhart (1999a) and Van
Rijckeghem and Weder (1999) have concluded that the bank lender channel was
Asian Tigers Fund and others. See Frankel and Schlumker (1996) for a list of such Asia-basedfunds.
16 See, for instance, Banerjee (1992), Scharfstein and Stein (1990) and Shiller (1995). See Chang
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particularly important in the East Asian crisis, though the inclusion of a trade competition
variable tends to dilute their significance, due possibly to the high correlation between
competition for funds and trade. This result is not inconsistent with Glick and Rose
(1999), who have suggested that trade is an important channel for regional contagion.
3.2 “Pure Contagion”, Interdependencies and Common Shocks
A distinction should be made between transmission channels that are related to
investor sentiment or psychology (termed “pure contagion”) and linkages between
countries that are measurable/observable ex-ante (referred to as “spillovers” or “inter-
relatedness”). Common external shocks that impact all regional economies may be
termed “monsoonal” effects (Masson, 1998). Thus, in the case of East Asia, a number of
common shocks have been suggested. For instance, Eichengreen (1999) has emphasised
the anticipated rise in Japanese short-term interest rates in the Spring of 1997 as being the
trigger to a fall in regional capital flows; McKibbin (1998) stresses the role of the US
interest rate hike in late March 1997 and subsequent drop in the US stock market; yet
others such as the World Bank (1999) and Rajan (1999) have stressed the sharp export
growth slowdown in East Asia as being among the proximate external triggers of the
crisis. Others have suggested the steep appreciation of the Japanese yen vis-à-vis the US$
and the consequent trade-weighted real appreciations of the regional currencies as being
an important common external shock17.
and Velasco (1998, 1999) for open economy extensions of the Diamond-Dybvig framework ofpayoff externalities.17 Another common shock often suggested has been the devaluation of the Chinese renminbi (ofabout 35 percent) against the US$ in 1994 (see, for instance, Makin, 1997). The importance ofthis episode is very questionable, as the devaluation was on the official rate, while most of thetransactions were being carried out at the unofficial/market rate. Indeed, the primary aim of thedevaluation seems to have been to bring the official rate in line with the unofficial one, rather than
11
Masson (1998) shows how it is conceptually possible for “pure contagion” to
make an economy relatively more vulnerable to a currency crisis. To be sure, he notes
that:
pure contagion is only possible if changes in expectations are self-fulfilling, and this requires that financial markets be subject to multipleequilibra..(and)…(e)ven if each country separately is not subject tomultiple equilibra, together they may be, since the fear of crisis in one willincrease the devaluation probability in the other, making a crisis morelikely in both.
The important point here is that there must exist a range or zone of weakness within
which a currency is potentially vulnerable to a speculative attack in the first instance,
with pure contagion increasing the zone of vulnerability. This is consistent with the
escape clause based (ECB) second generation currency crises models pioneered by
Obstfeld (1994), of which contagion models are a subset18. All ECB second generation
models exhibit certain basic traits, which include the following: (a) there is a reason why
the government is tempted to abandon the prevailing peg19; (b) there is a reason why the
government would like to hang on to the fixed exchange rate. - Thus, there is a tension
between motives (a) and (b). The decision regarding the abandonment of the peg is
policy-determined, as an optimising policy-maker balances the various tradeoffs - ; and
(c) there exist two or more equilibra corresponding to various magnitudes of the post-
crisis depreciation.
All ECB models stress that while speculative attacks are not inevitable (on the
a mercantilist policy per se. Fernald et al. (1998), Liu et al. (1998) and Zhang (1998) discuss thisissue in detail.
18 These models are so named, as they have in common, “escape clauses” a la Flood and Isard(1989) and Obstfeld (1991), in which the policy makers use discretion in the event of exceptionalcircumstances, otherwise they follow a policy rule.
19 For the purposes of this paper, we make no distinction between fiscal and monetary authorities,
12
basis of underlying “fundamentals”)20, neither are they arbitrary, random or
undiscriminating (i.e. unanchored by fundamentals). Rather, there must exist some
weaknesses in the economic fundamentals of the economy for an attack to occur, as the
credibility of the fixed exchange rate regime is less than perfect. If the economy’s
fundamentals are either very “good” or very “bad”, it will respectively never or always be
attacked. Within those two extremes - which imply unique equilibrium (i.e. an attack with
close to 0 or 1 probabilities) - there is an intermediate range (grey area). Within this
“crisis zone”, there may exist some weaknesses in the economy that are neither strong
enough to completely preclude a speculative attack on the currency, nor sufficiently weak
to make an attack altogether unavoidable. Rather, there are a multiplicity of equilibra
such that an economy remains on what seems to be a sustainable path (“superior
equilibrium”), until some trigger or evidently minor event coalesces market expectations
to an “inferior” equilibrium that is realised.
Thus, shifts in market sentiments could lead to jumps between one equilibra to the
other, consequently introducing sharp volatility in financial markets. Theoretically,
anything can act as the coordinating device leading to a jump from a “good” to “bad”
equilibra. For instance, a devaluation in one country could lead to a major downward
spiralling of the currency and the domestic economy (given high interest rate policy
and/or unhedged foreign currency liabilities of the country), or precipitate depreciations
in regional countries (i.e. contagion).
assuming that the “policy maker” or “government” is a monolithic body.20 There is no firm consensus yet as to what these “fundamentals” are. However, empiricalanalyses have found that the strength of the domestic financial/banking sector; the extent oflending booms; the degree of currency overvaluation; and the size and maturity structure ofexternal debt are among the most important variables to be concerned about (see, for instance,Krueger et al., 1998 and Tornell, 1999). De Gregario and Valdes (1999) find that the likelihood ofa contagious attack is inversely related to the average debt maturity structure.
13
Against this analytical background, it is revealing to note that in almost all crises
experiences, the economies initially and worst affected by the crises were also the ones
with the worst fundamentals to begin with. On the other hand, even the strongest regional
economies can be and have been affected by weaknesses in neighbouring economies
because of trade and financial interdependencies. Thus, the term contagion is quite apt,
because, like a spreading virus, agents with the weakest immune system to begin with,
are the ones most severely impacted.
Table 2 in the case of the East Asian crisis nicely illustrates this point. It is fairy
clear that, by most counts, Thailand had the worst “fundamentals”, followed by
Indonesia, which was the most severely impacted by the crisis. Hong Kong and
Singapore, which seem to have had the best fundamentals, were the least affected, while
Malaysia and the Philippines were somewhere “in between”. On the other hand, even the
strongest regional economies can be and have been affected by weaknesses in
neighbouring economies because of trade and financial interdependencies21.
Insert Table 2
4. Key Issues Relating to an AMF
Regardless of the exact transmission mechanisms and definitions, the important
message that emanates from the previous section is that economic policy slippages in any
one economy can and do reverberate rapidly to other economies in the region in the form
of contagious currency crises, with consequent detrimental effects on the real
economies22. As noted, this in turn provides the analytical basis for some sort of regional
21 Similarly, in the case of the Tequila crisis, Chile, which was acknowledged to be by far thestrongest regional economy in Latin America, was relatively unaffected.
22 It is easy to show how an initial devaluation could actually prove to be contractionary in the
14
facility to deal with these contagious effects. In the case of Asia, this brings us back to
the AMF proposal. There are at least three important questions that need to be sorted out
with regard to an AMF.
First, would such a facility be focussed on crisis prevention, i.e. assisting in the
defence of a regional currency under speculative pressures (pre-crisis) and temporary
international payments imbalances, or crisis management and resolution, i.e. assisting in
the recovery and restructuring process (post-crisis)?
Second, and closely related to the previous question, what would be the
appropriate functional nexus between an AMF and the IMF?
Third, what is the appropriate membership of such a facility? For instance,
Bergsten (1998) has suggested that one should refer to such a facility as the “Asia Pacific
Monetary Fund” (APMF), arguing that membership could be along the lines of APEC,
with the US, in particular, needing to be included23. Others - such as prime minister
Mahathir - have in mind a more regionally concentrated facility involving ASEAN plus 3
(ASEAN+3) dialogue partners in East Asia, viz. Japan, China, South Korea only. Yet
other suggestions have been for membership to also be extended to other
important/potentially important Asian economies such as Taiwan and Hong Kong and
India.
There may, in fact, be sound rationale for the inclusion of Hong Kong, Taiwan
and India, along with Australia. For instance, Taiwan has one of the largest aggregate
short and medium terms, with the domestic financial and corporate sectors caught in a downwardspiral, leading to a sharp discrete decline in the domestic currency following the initial breakdownof the exchange rate peg. This point is developed within a simple “bank-centred” Mundell-Flemingframework (Rajan and Sugema, 1999).
23 But how many in East Asia would agree with Bergsten’s suggestion of using Japan’s/EastAsia’s capital but with US leadership?
15
reserve holdings in the world, and is closely interlinked with the ASEAN and other East
Asian economies. Along with Singapore, Hong Kong (the other regional financial center)
has been included as a member of the “Financial Stability Forum” established in early
1999. As India continues to liberalise its economy in a considered manner, it is expected
to be among the fastest growing economies in the world. India has been included in the
previously noted G-20 forum (fn 6). Australia too is a member of the G-20 forum, and
has been fairly proactive in the region, with assistance from Ausaid helping establish the
Asian Recovery Information Centre (ARIC) (launched in November 1999). The intention
of the ARIC is to consolidate all information (mainly data) on the economies most
directly impacted by the regional crisis. Both Hong Kong and Australia have contributed
to the IMF support packages (Table 1). Australia has also provided other forms of
technical assistance to the crisis-hit economies. In the end, however, membership is going
to be determined at least partly by geopolitical considerations and biases rather than pure
economic rationale. This being the case, let us focus on the first two issues in the
remainder of this section.
4.1 Exploring Possible Roles For an AMF
It is envisaged that the IMF’s role should be primarily one of crisis management
and resolution (see discussion in next subsection), while the comparative advantage of an
AMF would be in crisis prevention, something that the region has under-invested in. An
AMF would be responsible for coming to the aid of regional currencies that may be
susceptible to speculative pressures. However, in order to be an effective deterrent
against such attacks (i.e. monetary defence mechanisms), the monetary facility must be
16
“fairly large”, with appropriate contributions from member economies. Ability to access
this pool of funds and reduce moral hazard concerns (due to ready availability of
“easy/cheap money”) ought to be conditional on/tied to member economies maintaining
some pre-determined standards of macroeconomic and financial stability. In addition, if
and when necessary, the members must be willing to subject themselves to regional peer
pressure to undertake necessary policy adjustments. Needless to say, promotion of policy
dialogue will be a key function of such a facility.
Institutional and operational details regarding such a facility and terms of lending
would need to be worked out in detail. Broadly, following Bagehot (1853), lending must
be “automatic”, “sufficient” “expensive” (i.e. “penalty rate” over the market or normal
lending rates) and relatively short term, so as to maintain the subtle but critical balance
between establishing market confidence, on the one hand, while preventing “excessive”
moral hazard from developing, on the other.
Obviously, such macro-cum-prudential oversight needs to be accompanied by
both peer review and an effective regional surveillance process-cum-early warnings
system. Ideally, such a system should track national, regional and international
macroeconomic developments; pay attention to regional policy interdependence; and
facilitate necessary policy corrections in a timely manner when necessary. As noted by
the IMF’s first deputy managing director, Stanley Fischer (1999), “(s)urveillance and
policy coordination at regional levels can help reduce the risk of future crises and
promote regional dynamism.” Similarly, the OECD is responsible for surveillance of its
members. Seen in this light, one could easily envisage the recently established ASEAN
17
Surveillance Process (ASP) being expanded to include the other members of the regional
facility, and possibly even being housed in the latter (Chang and Rajan, 1999).
4.2 The AMF-IMF Nexus (Globalism versus Regionalism?)
The assumption - indeed, hope - is that, with a credible and well-funded regional
body which focuses on crisis prevention, and does so effectively, there may be less need
to be concerned about resolution (post-crisis) issues and strategies. As noted, this in turn
ought to allow for a fairly clear demarcation of the roles of the international and regional
monetary fund. But does it? In actuality, two factors complicate the seemingly clear
division of labour as suggested above. First, it is important to clarify the appropriate role
for a regional facility during the time of crisis management and resolution vis-à-vis the
IMF. Second, the IMF has, in recent times, significantly expanded its role from a crisis
manager to one of a crisis preventor.
Crisis Management and Resolution
One envisages that the regional monetary facility could act as the coordinating
regional body to work with the IMF, World Bank and ADB to raise and channel funds to
the crisis-hit economies and serve as a single, coherent voice as to the “appropriate”
policy conditionalities to be implemented. The facility could also help coordinate
bilateral aid initiatives such as the New Miyazawa Initiative and ensure timely aid
disbursements (which was a key issue in the crisis)24. The regional body would play a
24 Timely aid disbursement is an important issue, as Malaysia’s prime minister has reportedlystated of the Japanese package of assistance to Malaysia that “(b)y the time Malaysia eventuallygets to see the money, the crisis will be over. Japan has to think about the effectiveness of itsmoney” (Business Times, Singapore, January 14, 1999). See Chang and Rajan (1999) fordetails of the New Miyazawa initiative and consequent follow up proposals by the Japanese to aidthe crisis-hit regional economies.
18
major role in suggesting the appropriateness of various policies/conditionalities, given its
knowledge of regional circumstances25. This ought to sharply reduce any criticisms about
the international agencies not being aware or mindful of region-specific factors when
prescribing policies. This in turn should mitigate feelings of the conditionalities having
been “imposed externally”, without paying sufficient attention to regional sensitivities
and circumstances.
While there ought to be no question of conditional lending by the regional facility
being undertaken with the IMF, there is the important issue of whether it should be done
through the IMF. Bergsten (1998) suggests that the two should be done distinctly, with
the amounts being agreed upon in advance with the AMF. This is to ensure that the
supplementary regional funding is not limited by the IMF’s systems of quotas for
individual economies.
Radelet and Sachs (1998b) have suggested that the “arrival of the IMF gives all
the confidence of seeing an ambulance outside one’s door”. If so, from a “credibility”
perspective, there would seem to be a need for the IMF to work in tandem with a strong
regional body during future crises. This is particularly so, given that restoration of
“market confidence” has been among the stated goals of IMF conditionalities in East
Asia26.
Crisis Prevention
25 Lest it is misunderstood, what we have in mind here is that the regional body willdiscuss/debate these issues with the IMF, but will do so behind closed doors. The conditionalitiesso arrived at must be articulated with one voice and without any ambiguity (unlike the opendebate in the case of the World Bank and the IMF during the early stages of the East Asiancrisis).
26 Krugman (1998) and Rodrik (1999) provide general and interesting discussions of the issue ofmarket confidence and the IMF-mandated reform programs in crisis-hit economies. See Mukand(1999) for an attempt at providing the analytical underpinnings of these issues.
19
The IMF has historically been seen as playing a major role in helping member
economies overcome balance of payments crises through conditional lending27. However,
the IMF has always had a key role to play in surveillance of the economic situations of
member countries, and has promoted the adoption of sound domestic macroeconomic and
financial policies (IMF, 1999a). One could easily envisage the IMF lending its experience
and expertise to regional bodies such as an AMF in these crisis prevention areas, and
continuing to provide training and technical assistance for capacity building. The Thai
case has highlighted the limitations of IMF surveillance, in that it is neither able to
publicise the annual Article IV country analysis of economic policies without the
government’s permission28, nor does there exist any enforcement mechanism to ensure
governments pursue sustainable growth policies. A compact regional facility must be
given the mandate to force member countries to take appropriate actions if domestic
weaknesses and imbalances are apparent (i.e. the facility must have teeth).
Contingent Credit Lines (CCLs)
Following the Mexican-Tequila and East Asian crisis, the IMF has rapidly
expanded its crisis prevention role by establishing a new lending facility called the
Contingent Credit Line (CCL) in April 1999. The CCL is aimed at those countries which
the IMF views as being potential “innocent victims” of contagion effects, but otherwise
have “sound” domestic policies29. This is in addition to the Supplementary Reserve
27 The questions of appropriateness of policy conditionalities and successes remain controversialissues (Collier, 1999).28 The IMF is encouraging member countries to publish the Article IV country assessments, withGermany having done so recently for the first time. Of course, press information notices (PINs)which summarise - non-controversial(?) - elements of the Article IV reports are published for anumber of counties and are available on the IMF’s website.
29 See Davitte (1999) for a list of the criteria by which an application for a CCL will be judged.
20
Facility (SRF) established in December 1997 to aid emerging market economies faced
with crises of confidence30. However, these crises-loans by the IMF have come under
attack by some, who have emphasised the possibility of them engendering moral hazard.
Others have argued that there is an absence of clear guidelines as to the terms and
conditions that would apply to the new facility. Accordingly, it is sometimes charged that
the ultimate decision would largely be political, based on the strategic/security objectives
of the most important member, the US, which holds a disproportionate influence over the
institution (and has a de facto veto power). In this light, an argument may be made that
the countries in the Americas (Mexico in particular), extra-regional countries that are
OECD members (such as Korea), or of strategic importance (such as Russia), will always
be given “preference” over other emerging economies.
Indeed, an Independent Task Force on the Future of the International Financial
Architecture recently recommended outright abolishment of the CCL and SRF programs
and a significant reduction in “extraordinary” IMF lending more generally (so as to
reduce the moral hazard problems). They argued the operational guidelines for
qualification for a CCL are “unnecessarily complex”, and there is no “new money” set
aside for a CCL (Hill et al., 1999). In relation to this, questions have been raised
regarding whether the scale of funding through a CCL is sufficient to be effective. In
particular, disbursement of CCL funding is based on a range of 300-500 percent over a
member’s quota with the IMF. Taking even the higher figure and using data as of April
1999, this implies that South Korea and Thailand were eligible to receive US$11 billion
30 The SRF is meant for countries already facing a crisis, while the CCL is meant to be disbursedprior to a crisis (precautionary). Lending terms are similar, with the cost of credit being 300 basispoints (bps) above the IMF’s normal lending, with additional penalties every six months to a
21
and US$7.4 billion, respectively (Davitte, 1999). These figures pale in comparison to the
actual commitments to the two countries (Table 1).
The Task Force did recognise the existence of contagion and the need for some
sort of facility to deal with the problem. According to them, such a facility should work
in association with the IMF but not actually be part of IMF’s lending facility (Hill et al.,
1999). They further argued that only countries affected by “systematic crises” or episodes
of contagion ought to be provided the funding, which should be disbursed quickly and be
heavily front-loaded. Since the Task Force recommended the CCL be funded by the
members donating their respective shares of SDR allocation of the facility as start up
capital, they argued this would make it less susceptible to moral hazard (members not
contributing their own money)31.
What they failed to consider, however, was the alternative of having a regional
facility to deal with these issues. Indeed, as long as the focus is on crisis prevention, there
is no reason why the task should not fall on a regional facility such as an AMF, with
important technical expertise provided by the IMF. Arguably, a well-funded regional
facility (as opposed to an insufficiently funded, administratively constrained international
facility?) will be better able to disburse funds more quickly to its members when the need
arises.
The resources of the regional body can be further consolidated if it negotiates
guaranteed lines of credit with private banks on behalf of its member economies in times
of distress. This is not unlike the Argentine arrangement, in which the country has
maximum of 500 bps (Davitte, 1999 and IMF, 1999b).31 In any case, moral hazard is far more of a concern on the side of the (private) lenders than it ison the side of (sovereign) borrowers. Accordingly, what are needed are initiatives that ensuresome kind of “appropriate burden sharing” between both parties. By creditors also taking a
22
entered into an agreement in December 1996 with a group of 13 foreign banks to lend
Argentina up to US$6.1 billion against collateral at a premium over the LIBOR rate for a
certain “commitment fee”. In the case of East Asia, a large part of the lending pre-crisis
was by regional - mainly Japanese - banks (Chang and Rajan, 1999)32. Thus, a regional
facility ought, presumably, to have greater “leverage” over the private banking
community and be able to play a more effective coordinating role between them and
regional members. Constant surveillance by the regional member economies would allow
the regional facility to better distinguish between “systematic” versus “non-systematic”
crises as stressed by the Task Force.
The emphasis on sound domestic economic policies and a regional approach to
crisis prevention is consistent with the spirit of “subsidiarity” emphasised by the IMF
Managing Director, Michel Camadessus (1999). By this, he means that “authorities
must…become accustomed to acting at the world level only if national or regional action
is not sufficient” (emphasis added). Such a regional facility would also help alleviate the
liquidity problems that exist within the IMF. Consequently, this would allow it to refocus
efforts on medium and longer term structural adjustment lending through the Extended
Fund Facility (EFF) and the Enhanced Structural Adjustment Facility (ESAF) (renamed
the Poverty Reduction and Growth Facility), as well as joint strategies with the World
Bank to reduce world-wide poverty through the Heavily Indebted Poorest Countries
(HIPCs) initiative and related ones (Camdessus, 1999). The appropriate focus/objectives
of the IMF is by no means an uncontroversial issue. For instance, the US Treasury
“haircut”, this ought to help ensure that some degree of investor discipline is maintained.32 See Peek and Rosengren (1998) for a detailed discussion of Japanese bank lending to ASEANduring the crisis period. Also see Kaminsky and Reinhart (1999), who rightly emphasise that thesharp escalation in bank lending to East Asia just prior to the crisis was largely due to European
23
secretary, Lawrence Summers, has urged the IMF to focus less on medium and long-term
finance and more so on crisis prevention and emergency finance (Financial Times,
December 15, 1999). This view is not surprising, as the US is not in favour of regional
facilities (at least not in Asia), as noted previously. However, Summers did highlight two
important points in reaching his conclusion, viz. that contagion is an important
phenomenon, and that IMF funding is very limited. It is for these very reasons that this
paper has argued in favour of an AMF.
5. Concluding Remarks
To recap, available evidence stresses that contagion is largely a regional
phenomenon. As noted, it has become legion in the economics literature to separate
transmission channels that cause crises to be contagious across countries into two
categories. Those that are related to investor sentiment or psychology are termed “pure
contagion”. Those that are based on linkages between countries that are
measurable/observable pre-crisis, are referred to as “spillovers” or “interdependencies”
(these could be due to trade, direct investment or financial linkages).
Both theory and evidence suggest that pure contagion is not necessarily random
or arbitrary. Thus, in the case of the East Asian crisis, it is notable that the countries
initially and worst-impacted were the ones with the “worst economic fundamentals” to
begin with. Stronger, though much more open and regionally integrated economies (such
as Singapore), were much less affected. This underscores the need for the primary focus
to be placed squarely on the domestic policy arena. In the East Asian context, this
broadly involves strengthening the financial systems and corporate and industrial
banks.
24
structures. However, given the fact that regional spillovers or interdependencies are fairly
high and growing in East Asia, even relatively strong regional economies can be and
have been affected by crises in the weaker neighbouring economies. These policy
externalities suggest the need for some form of regional cooperation in the financial and
macroeconomic spheres.
Some might argue that pure contagion would be less important in the future, as
investors seem to have differentiated between the regional economies following the crisis
(Van Rijckeghem and Weder, 1999). This view is clearly debatable. In any case,
indications are that countries in the region will be more susceptible to the fundamentals
of the neighbouring ones, as the stronger economies like Singapore, have sharply
escalated their investments in economies such as Thailand, where asset prices remain
depreciated33. In other words, regional interdependencies can be expected to rise
significantly in the future.
In light of this, it has been suggested that there may be merit in considering the
creation of some sort of self-standing regional facility in Asia with limited membership
(at least initially). It has been noted that the facility should focus primarily on crisis
surveillance and prevention at a regional level; while the IMF continues to focus on
surveillance at a global level, as well as crisis management and resolution. Any funds
dispersed through the regional facility during a crisis period would be done in full
consultation with the IMF and in conjunction with the potential recipient pursuing the
IMF conditionalities.
33 Thus, figures from the Thai central bank show Singapore’s direct investment in Thailand tohave jumped to 31.7 billion baht in 1998, up from 9.9 billion baht in 1997, making Singapore thethird largest investor in the country after the US and Japan (Far Eastern Economic Review,October 21, 1999, p.68).
25
Asia has hitherto been averse to the creation on new institutional structures. In
this regard, it should be noted that the Asia and Pacific region does, in fact, already have
an existing co-operative scheme in place in the form of the EMEAP or the Executives'
Meeting of East Asia-Pacific Central Banks. The EMEAP is a co-operative organisation
comprising central banks and monetary authorities of eleven economies: Australia,
China, Hong Kong, Indonesia, Japan, South Korea, Malaysia, New Zealand, the
Philippines, Singapore and Thailand. Its primary objective is to strengthen the co-
operative relationship among its members. Spurred on by the Tequila crisis, there have
been substantive steps towards monetary cooperation taken by EMEAP. For instance, a
number of member economies signed bilateral repurchase (repo) agreements in 1995 and
1996. Hong Kong and Singapore also reached an agreement to intervene in foreign
exchange markets on behalf of the Bank of Japan (Moreno, 1997). These creditor
regional economies also attempted to help defend the Thai baht for some period before
the Bank of Thailand succumbed to the speculative pressures. Consideration might be
given the expansion of the EMEAP (in both functional terms as well as membership)
rather than create an entirely new institution.
Finally, it has sometimes been suggested that regional monetary facilities could
complement the IMF in a similar way that regional development banks (such as the
ADB) complement the World Bank’s operations34. As such, it seems only appropriate to
conclude with the ADB’s view of an AMF proposal as expressed in the latest Asian
Development Outlook (1999):
34 Of course, the flip side of this would be that the ADB and other regional development banks arelargely redundant and ought to be shut down, leaving only international institutions like the WorldBank, IMF and BIS as part of the new financial architecture (Dornbusch, 1999).
26
(The) AMF could play a potentially important role as a complement to theIMF in providing funds to crisis-affected countries and developing anearly warning system. The implementation of such regional institutions asthe AMF as part of the newly emerging financial architecture will helpboth to enhance the efficiency of global financial markets and to minimisesystematic risk.
27
Table 1IMF-led International Financial Assistance Committed to Thailand and
Indonesia,(US$ billions)
Country and Source of Assistance Amount ($billions)
Indonesia:IMFWorld BankADBCountries USA Japan Australia China, P.R.C. Hong Kong Malaysia Singapore OthersTotalIMF disbursements as of January 17,1999
11.2 5.5 4.5 21.1 3.0 5.0 1.0 1.0 1.0 1.0 5.0 4.1 42.3 8.8
Thailand:IMFWorld BankADBCountries Japan Australia Brunei China, P.R.C. Hong Kong Indonesia Korea Malaysia SingaporeTotalIMF disbursements as of January 17,1999
34.0 1.5 1.2 10.5 4.0 1.0 0.5 1.0 1.0 0.5 0.5 1.0 1.0 17.2 3.1
28
Mexico:IMFWorld Bank and Inter-American BankBIS/G10USATotal
17.8 2.8 10.0 20.0 50.6
Source: Chang and Rajan (1999)
29
Table 2Summary of Economic Fundamentals of Selected East Asian Economies
Fundamentals Country Rankingsa
1 2 3 4 5 6 7ExternalInternational Reservesb
Current Account/GDPc
Debt/GDPd
Export Slowdowne
Real Exchange Rate: deviation fromPPPf
Banking StrengthCapital Adequacyg
Nonperforming Loansh
Bank Ratingsi
Liquidity MismatchesExcess Credit growthj
Short-term external debt/Reservesk
Broad Money/Reservesl
Overall Averagem
Overall based on Thailand Weightsn
PTTTS
KMI
PKT
T
T
IKPSK
TTK
MII
I
I
MMIMH
IKT
TTP
K
K
TPMKM
MIP
IPK
P
P
KISHT
PPH
SMM
M
M
HHHPI
HSM
KHS
S
S
SSSIP
SHS
HSH
H
H
Notes: a) I - Indonesia, H - Hong Kong, K – South Korea, M - Malaysia, P -Philippines,
S - Singapore, T - Thailand. Ordinal ranking in descending order of“bad” fundamentals; b) in SDRs, June 1997; c) 1996; d) 1997; e) change (%)in 1996 less the average change (%) previous three years; f) June 1997; g)unclear from source, but probably average of 1996 and 1997; h) 1997estimates; i) May 1996; j) growth of credit to private sector relative to nominal GDP,1996; k) June 1997; I) June 1997; m) equal weights to all fundamentals (includingtwo others included in original sources); n) greater weights given to fundamentalsin which Thailand is weakest
Source: Goldstein and Hawkins (1998)
30
31
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For a full list of CIES publications, visit our CIES Web site or write, email or fax to theabove address for our List of Publications by CIES Researchers, 1989 to 1999.
0002 Rajan, Ramkishen S., "Examining a Case for an Asian Monetary Fund", January2000
0001 Matolini Jr., Raymond J., "A Method for Improved Comparisons of USMultinational Companies' Manufacturing Production Abroad", January 2000
99/29 Rajan, Ramkishen S., "Financial and Macroeconomic Cooperation in ASEAN:Issues and Policy Initiatives", December 1999
99/28 Anderson, Kym, "Agriculture, Developing Countries, and the WTO MillenniumRound", December 1999
99/27 Rajan, Ramkishen S., "Fragile Banks, Government Bailouts and the Collapse of theThai Baht", November 1999
99/26 Strutt, Anna and Kym Anderson, "Estimating Environmental Effects of TradeAgreements with Global CGE Models: a GTAP Application to Indonesia",November 1999. (Since published on the internet in Proceedings of the OECDWorkshop on Methodologies for Environmental Assessment of TradeLiberalization Agreements, 26-27 October 1999 at http://www.oecd.org/ech/26-27oct/26-27oct.htm)
99/25 Rajan, Ramkishen S. and Iman Sugema, "Capital Flows, Credit Transmission and theCurrency Crisis in Southeast Asia", November 1999.
99/24 Anderson, Kym, "Australia's Grape and Wine Industry into the 21st Century",November 1999.
99/23 Asher, Mukul G. and Ramkishen S. Rajan, "Globalization and Tax Structures:Implications for Developing Countries with Particular Reference to SoutheastAsia", October 1999.
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99/22 Rajan, Ramkishen S. and Iman Sugema, "Government Bailouts and MonetaryDisequilibrium: Common Fundamentals in the Mexican and East Asian Crises",October 1999.
99/21 Maskus, Keith E. and Yongmin Chen, "Vertical Price Control and Parallel Imports",October 1999.
99/20 Rajan, Ramkishen S., "Not Fixed, Not Floating: What About Optimal Basket Pegsfor Southeast Asia?" September 1999.
99/19 Findlay, Christopher and Tony Warren, "Trade in Services: Measuring Impedimentsand Providing a Framework for Liberalisation", September 1999.
99/18 Martin, Will and Devashish Mitra, "Productivity Growth and Convergence inAgriculture and Manufacturing", September 1999. (Forthcoming in EconomicDevelopment and Cultural Change Vol. 48, 2000)
99/17 Francois, Joseph F., "Investor Confidence and Trade Policy Transparency: DynamicImplications of an Effective Trade Policy Review Mechanism", August 1999.
99/16 Bird, Graham and Ramkishen S. Rajan, "Banks, Finanical Liberalization andFinancial Crises in Emerging Markets", August 1999.
99/15 Irwin, Gregor and David Vines, "A Krugman-Dooley-Sachs Third Generation Modelof the Asian Financial Crisis", August 1999.
99/14 Anderson, Kym, Bernard Hoekman and Anna Strutt, "Agriculture and the WTO:Next Steps", August 1999.
99/13 Bird, Graham and Ramkishen S. Rajan, "Coping with and Cashing in onInternational Capital Volatility", August 1999.
99/12 Rajan, Ramkishen S., "Banks, Financial Liberalization and the ‘Interest RatePremium Puzzle’ in East Asia", August 1999.
99/11 Bird, Graham and Ramkishen S. Rajan, "Would International Currency TaxationHelp Stabilise Exchange Rates in Developing Countries?" July 1999.
99/10 Spahni, Pierre, "World Wine Developments in the 1990's: An Update on TradeConsequences", May 1999.
99/09 Alston, Julian, James A. Chalfant and Nicholas E Piggott "Advertising andConsumer Welfare", May 1999.
99/08 Wittwer, Glyn and Kym Anderson, “Impact of Tax Reform on the Australian WineIndustry: a CGE Analysis”, May 1999.
99/07 Pomfret, Richard, “Transition and Democracy in Mongolia”, April 1999.99/06 James, Sallie and Kym Anderson, “Managing Health Risk in a Market-Liberalizing
Environment: An Economic Approach”, March 1999. (Since published in PlantHealth in the New Global Trading Environment: Managing Exotic Insects, Weedsand Pathogens, edited by C.F. McRae. and S.M. Dempsey, Canberra: NationalOffice of Animal and Plant Health, 1999.)
99/05 Soonthonsiripong, Nittaya, “Are Build-Transfer-Operate Regimes Justified?” March1999.
99/04 Soonthonsiripong, Nittaya, “Factors Affecting the Installation of New FixedTelephone Lines in Provincial Areas in Thailand”, March 1999.
99/03 Berger, Nicholas and Kym Anderson, “Consumer and Import Taxes in the WorldWine Market: Australia in International Perspective”, February 1999. (Sincepublished in Australian Agribusiness Review 7, June 1999.