ERM of Selected Countries

Exchange Rate and Macro-Economic Policy Management of
Some Selected Countries
2.1 Introduction
Many developing nations, including India, are currently implementing massive financial liberalization and reform
programs. In the initial phases of the reforms these economies undertake structural changes and experience radical
challenges in productivity and prices. Following removal of controls, the domestic economies face new
challenges from the outside world, and normally experience large inflow of foreign capital. The capital flows
enter the nations quite slowly, and gradually, more and more capital flows in to take advantage of the higher
returns. However, at the slightest provocation, the capital moves out at speeds and volumes that can cause
debacles to any economy. ERM under such situations poses serious challenges to managers and policy planners.
The ERM is one of the areas of reform in these economies where optimal transitional policies may differ
from the long-range-operating policies. For example, there may be good reasons for countries at the start of
stabilization and liberalization programs to adopt a pegged exchange rate system as a part of the initial policy, even
if the countries decide to move subsequently to the flexible-rate system after few years. The different stages of
the process thus necessitate close monitoring of the direction of the domestic economic performance vis-à-
vis the rest of the world.
There is no clear set of policies that suit any particular nation. But as most developing nations shift to market-
determined economy with almost a common set of symptoms of imbalances (like high inflation, high foreign debt,
large tariff barriers, low foreign reserves etc.), one feels tempted to make a post-mortem study of management
policies in these nations so as to obtain valuable insights into possible causes of failure and success of some of
these policies. In this work we try to analyze the exchange rate and other macro-economic management policies of
a few selected countries vis-à-vis India. The countries selected for the study are China, Indonesia, Malaysia,
Mexico, New Zealand, South Korea and Thailand.
2.2 Republic of China

The Chinese path of reforms and liberalization was initiated in late 1970s on the basis of an egalitarian agrarian
structure as well as on the basis of continuing state control over the dominant segment of the economy makes. The
Chinese growth mostly relied on strong agricultural foundation, macro-economic stabilization, low inflation, and
government-fostered export push but they were distinctly followed in stages.
The Chinese reform process can be traced back to the early 1950s with the initiation of the 1.land reform
programs. The government seized excess land from landlords compensating them with the shares of the state
enterprises. The seized lands were then sold to the tillers at favorable credit terms. Simultaneously, the government
took steps to help the tillers upgrade agricultural production. The agriculture output grew. The agro-exports rose
and provided the country with foreign exchange for purchase of the much-needed foreign equipment and
machinery. After the successful land reforms the government’s focus shifted to 2.import-substitution and self-
sufficiency. It raised the import tariffs and almost completely shielded the domestic industry from foreign
competitions. Simultaneously, it invested heavily on infrastructure, mostly with the Japanese and the U.S. aid. And
when the domestic demand got saturated, from around 1958, the government adopted 3.export-promotion
measures to revive the falling industrial growth rate. Some of the export promotion measures included raising
import tariffs, lowering of cost of inputs for exports, credit availability to export industries at low interest rates and
30 Chapter II Exchange Rate Policy Management of Some Selected
Countries
exchange rate devaluation. These measures promoted the exports (from 12 per cent in 1953-1962 to 28 per cent
during 1963-1972).
Countries
In
the
early 1970s, the Chinese industries faced stiff challenges both from inside and outside forces. The economy faced
infrastructure shortages at home and competition from low-wage country products in the external markets. In 1974
the growth rate fell to 1.2 per cent, and inflation rose to 47 per cent. The government acted swiftly and looked
upon the heavy industries to boost exports. In 1978, after years of state control of all productive assets, China
initiated economic reforms. The central focus of the 1978 reform process was export promotion. It marked export-
oriented special economic zones and opened cities that provided export incentives to domestic and foreign firms.
Since then 4.self-efficiency in China meant getting increased access to foreign technology and capital.
The important features of the open door economic policy of 1978 are as follows:
 Acquiring foreign technology and investment to update the existing enterprises and trade by the end of the
decade;
 Speeding up the infrastructure development facilities like transportation, communication etc.;
 Framing laws to facilitate foreign ownership in domestic companies
 Imparting training to workers and professionals to keep pace with the new incoming technologies
 Providing special facilities to the foreign enterprises to enhance economic cooperation with the outside
world.
The reforms initiated in 1978 yielded results and China become one of the richest nations. In 1996, the Chinese per
capita income was $687. Since 1978 the nation is registering one of the world’s highest growth rates: an annual
average GDP growth rate of 9.3 per cent a year. In 2014 China was the world's largest merchandise trader, with
combined exports and imports worth US$4,303 billion and attracts more FDI than any other country, being next to
the United States & UK. The cumulative FDI, negligible before 1978, reached nearly U.S. $128 billion in 1995
and reached the cumulative Chinese FDI in the U.S. totaled 110 billion U.S. dollars. The value of exports and
imports as a share of GDP tripled between 1978-1995. The FDI rose from $2.3 billion in 1987 to $37 billion in
1997. The cumulative foreign investments are around $220 billion in 1997. The exports grew from $2.3 billion
(less than India’s) in 1970 to $18.1 billion in 1980 to $62.1 billion in 1990 to $182.7 billion in 1997. China’s share
in world exports rose to 3 per cent in 1995, from around 1 per cent in 1980 and 2 per cent in 1990. The foreign
exchange reserves also swelled from $2.3 billion in 1980 to $28.6 billion in 1990 to $140 billion in 1997 (next
only to Japan’s reserves in Asia). These sweeping changes have occurred against the backdrop of an economic
reform program characterized by gradualism and experimentation. The reform program has emphasized
decentralization, reliance on market forces, and openness to trade and foreign investment.
Sizeable portion of the China’s growth is said to be attributed to capital investment which has made the country
more productive. This suggests the Chinese growth to be mostly due to new investments, new technologies, and
infrastructure developments. Since 1978 the Chinese capital stocks grew with an average rate of seven per cent per
annum. The capital output ratio, up to the end of last century, almost remained constant (in contrast to the South
East Asian economies whose growth is mostly attributed to change in productivity). This further suggested that
capital deepening has not yet taken place by then in China, and the country could still absorb more of capital
investments. This also indicated that the then present growth rate in China is sustainable in the short and medium
run. The country also became the largest receiver of loans from the World Bank group since 1992. In the financial
year 1997, it received $2.8 billion of Bank funds, of which $2.5 billion was in the form of market-rate loans from
the International Bank for Reconstruction and Development (IBRD) and the rest in the form of concessionaire
credits from the International Development Association (IDA). Cumulative lending to China totals $28.5 billion,
of which $19.3 billion is from IBRD and $9.2 billion is IDA.
The yuan like most of the South-East Asian economies is pegged to the U.S. dollar. However, the yuan underwent
sharp depreciation intermittently to improve its trade and current account. The Chinese authorities combined the
export subsidy and import restriction policies along with devaluation to foster external trade and improve the
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current account balance. In 1958, the Chinese took a big step towards trade liberalization with a policy package
that included 25 per cent devaluation, a unified exchange rate, export incentives and reduction of import
restrictions. The currency underwent intermittent devaluation to boost exports. Unlike the South-East economies
the Chinese yuan did not experience any speculative attack in 1997. This was mostly due to China’s continuing
trade surplus and high foreign exchange reserves.
2.2.1 Major Policy Reforms

Exchange Rate Policy: The Chinese currency is pegged to the U.S. dollar. The currency underwent sharp
devaluation intermittently to boost exports. Some of the major devaluation of the yuan occurred in 1958 (25 per
cent), in 16 December 1989 (21.2 percent), in November 1990 (9.75 per cent), and again in January 1994 (by 50
per cent). Many economists cite the last yuan devaluation to be a possible cause for the fall of South-East
Asian exports.
Fiscal Policy: The Chinese fiscal deficits were often met through external aid or debt. The Chinese used a
complex tax structure. Income taxes generate only a small share of revenue in China because of extensive market
competition. Income from dividends and interest rate were tax-exempt until 1981, as was capital gains until
1989.
Monetary/Financial Sector Policy: In 1989 the interest rates were completely deregulated and a foreign exchange
call market for the U.S. dollar, DM and Yen was established. In the formative periods the Chinese had restrictions
on capital accounts, and the yuan is still not convertible on capital account.
Trade and Investment Policy: Macro-economic stabilization and trade liberalization had gone hand in hand for
China. The Chinese halted the import liberalization program often for long periods and heavily promoted
exports. It also enacted laws to protect the lawful rights and interests of foreign firms.
In 1990 China imposed tough import restrictions to discourage imports, and simultaneously provided
subsidies for exports. The import restrictions mostly included tariffs, quantitative restrictions, and selective credit
policies. Extensive corporate tax incentives were provided to boost exports. Some of the tax incentives include
the following: Research and Development expenditures was excluded from tax base, new industries receive five-
year tax holidays and the benefit of accelerated depreciation, and government-identified strategic industries receive
additional tax holidays. Restrictions prevailed on short-term investment capital flows. These measures had a
strong effect on the trade balance. In 1990 the Chinese exports grew by 18.1 per cent to $62.1 billion and
simultaneously the imports fell by 9.8 per cent to $53.4 billion thereby registering a net trade balance of $8.7
billions.
Comments on Chinese Exchange Rate Management: Chinese banking system was no better than many other
South-East Asian nations. The bank lending to the real estate was also high (around US $200 billion). Its
currency remained linked to the U.S. dollar like other South-East Asian countries. However, the country did
not face any immediate currency problem in 1997. Which was mostly due to the external trade surplus and the
huge foreign exchange reserves that the country possessed. This was made possible through import restrictions,
export promotions, avoidance of overvalued currencies by intermittent devaluation, enacting laws to protect
foreign firms’ interests, and restricting the short-term capital flows.
2.3 Indonesia
Indonesia followed a policy of protectionism since its independence in 1948. Like China, it also initially relied on
agriculture reforms. The systematic state intervention in agriculture through policy of support and subsidized
input (fertilizer subsidy and irrigation) made the country self sufficient in rice production by 1980s [Ghosh,
1997]. In the industrial front it initially adopted a policy of nationalization of private enterprises, and the state
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took
over
almost all activities of the economy. It nationalized the Dutch enterprises, imposed large trade restrictions on
imports, and followed a policy of import substitution. These measures had an adverse impact on the economy.
The per capita income fell (the 1965 per capita was 15 per cent lower than the 1958 level), and the economy was
on hyperinflation (1000 per cent in 1965). These events led to social and political unrest (fall of President
Sukarno’s government).
In subsequent years the government’s focus changed. A new private investment law was enacted. Some of the
previously nationalized enterprises were returned back to its owners. The oil price rise of the seventies also
provided a boost to its exports. During 1973 - 1983 the economy saw a steady inflow of oil revenue [Sen,
1998b]. The government, flush with funds, took to infrastructure and human capital formation. Due to
increased investments, public and private, the 1970s and 1980s saw a boost in economic growth averaging
around 8 per cent. However, the oil revenues did not last long and started to taper off from early 1980s. The
balance of payments deteriorated. The country then adopted open economic policies mostly to attract foreign
capital. The focus also shifted to the non-oil exports to supplement the fall in oil exports revenues. The
currency was devalued by a massive 51 per cent in 1978 mostly to correct the overvaluation of the currency that
affected the non-oil exports. The non-oil exports rose from less than 2 per cent during 1959-1966 to 26 per cent
during 1967-1973 [The East Asian Miracle]. The export revenues, both of oil and non-oil, started falling in the
1980s and with this the government attention also shifted to export promotion. In 1985 the government made
stiff tariff cuts. In 1986 the import-export procedures were simplified, export incentives were provided (like duty
free import for exports), and the currency (Indonesian rupiah) was devalued by a massive 45 per cent. The
private investments, domestic and foreign, were also deregulated, particularly in the infrastructure projects that
were export oriented.
The non-oil export growth slackened again in the late 1980s and 1990s (the non-oil exports grew by nearly 18%
per annum over the period 1985 through l997). The loss of competitiveness of Indonesia's exports was mostly due
to its low value and easily substitutable nature of labor intensive exports to similar products from other
countries. Indonesia faced deterioration of its trade balance. The falling oil revenues also saw a fall in the
government’s revenues. The government acted quickly. The government’s expenditures were cut. The rupiah
underwent two devaluations, one in 1983 (38 per cent) and again in 1986 (45 per cent) to restore the trade and
current account imbalance [The East Asian Miracle]. The adjustments were not painless, the economy registered
only one percent growth in 1985 and was clearly in recession. However, in the subsequent years the growth
and exports started rising (25 per cent during 1985-91). This promptness of reaction of the government helped
the economy to avoid severity of external shocks in long run. In the 1990s the government had fiscal and monetary
policy aimed at a balanced budget and low inflation. Between 1994 to 1996 the inflation remained below 10%, the
Central Government Budget was almost in balance - all without compromising overall economic growth.
The tapering of the oil revenues since the early 1980s and subsequent fall in government revenues saw the
subsidized credit system coming to an almost end. The interest rates firmed (in December 1997 it was around
38 per cent) [Sen, 1998b]. However, the country established a free and open foreign exchange policy to
encourage capital flows. This prompted the corporate and banks to borrow from abroad at low rates of
interest. Much of these loans were of short-term nature. All these had a significant effect on the level and
composition of the external debt (short-term debt to total external debt). According to the BIS the stock of
external debt stood at $58.7 billion in June 1998. Much of this, around $35 billion, is in the form of short-term
loans of less than 12 months maturity period [Sen, 1998b]. The exports also started declining. Three major
factors contributed to this loss of competitiveness. First, inflation in Indonesia exceeded the inflation in the
major trading partners. Second, manufacturing wages rose sharply between l993 and 1997. And, third, the rise
of the dollar against the yen since 1995 and the effective devaluation of the Chinese yuan in January 1994
further eroded the Indonesian competitiveness in labor-intensive products. The exports fell. The falling of exports
and expanding of the current account deficits (CAD) marked a systematic loss of investor’s confidence and
caused reversal of the capital flows in 1997. When the financial panic turned, the strong private capital inflows
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into
capital outflows, the weaknesses in the financial and of the corporate sectors got magnified leading to further
capital flight. The central bank tried for a short duration to support the currency and lost around $1.6 billion
before permitting the rupiah to float on 14 August 1997. The currency fell by around 176 per cent between
May 1997 and June 1998.
2.3.1 Genesis of the Crisis

Capital was initially attracted to Indonesia, as it was to other emerging economies, by the private investment
opportunities particularly when the nation opened up its economy. The reforms reduced barriers to international
trade, removed restrictions on the foreign investments, and increased the integration of our financial markets with
the global financial markets. The rising domestic interest rates made the economy rely on excessively foreign
borrowings that appeared cheaper than domestic credits. The foreign capital supplemented the domestic savings.
Investment and growth rose. However, the high capital inflows saw a part of it into investments of low returns
like speculative private investments, such as real estate. And when the county’s growth rate fell (GDP growth
rate fell from 8.2 per cent in 1995 to less than 2 percent in 1996) due to falling export demands, particularly of
electronic and computer parts [SocGen-Crosby, 1997], it exposed the economy to substantial systemic risk.
These risks were compounded by the unhedged short-term maturities that were used to finance the domestic long-
term investments.

Exchange Rate Policy: Indonesia established a free and open foreign exchange policy to encourage capital
flows. The rupiah was kept fixed to the U.S. dollar during 1971 to 1978. The higher inflation at home was
compensated with intermittent and sometimes massive devaluation. In 1978, the rupiah was devalued by 51
per cent probably to boost non-oil exports [The East Asian Miracle]). It underwent a devaluation of 43 per cent in
1983, and by 45 per cent in 1986 after which it was shifted to a managed float.
Fiscal Policy: The country was concerned with low inflation and low debt management. A balanced budget
was the cornerstone of government’s financial policy. In 1967 it enacted a law limiting the government
expenses to government revenue plus foreign assistance. This helped the nation to keep inflation under control.
The budget deficit, if any, had to be met by external borrowings only and not from the domestic sources. In
case the government failed to raise external loans it was forced to restrict its expenses to its revenues thereby
balancing the budget [Chhibber, A., The Economic Times, 28 April 1998].
In the early 1970s the government strongly relied heavily on oil revenues. With the falling revenues in 1985 the
first major tax reforms were introduced. Since then it aimed at tax simplification. The income and corporate
taxes were unified, VAT and urban real estate were introduced and the tax-based incentives were eliminated.
Monetary/Financial Sector Policy: The country had almost no restrictions on capital flows since 1966. [Sen,
1998a] It opened its capital account from as early as 1971 and freed the domestic interest rates since 1983.
However, it first opened the capital account and then went ahead to deregulate the financial sector in then late
1980s and early 1990s. Though this exposed the economy to several speculative attacks (in 1974 and in mid-
1980s), no attempts were made to impose capital controls.
To reduce the inflationary pressures of oil revenues the government induced credit ceilings and interest rate
ceilings on loans and deposits. But with the fall in oil revenues, in 1983, these ceilings were removed, to boost
non-oil exports. In 1983 interest rate restrictions on most bank deposits were removed and from 1990 the interest
rates are market determined. In the late 1980s the country also removed restriction on branch expansion of foreign
banks and simplified the tax treatments on Time Deposits in 1985. In 1988 the government introduced measures to
increase competition among banks and enhance financial sector efficiency. It also lowered reserve requirement for
banks. In 1989 the banks were prohibited from investing in stocks and equity. The country replaced the foreign
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borrowing limits with open position limits of 25 per cent. The banking sector reforms during 1982 - 1991
increased the banking efficiency; however the loans got freely available to wide range of borrowers including
the consumers, real estate and stock markets investors. But the sudden rise in liquidity conditions that led to
interest rate hikes put the banks at difficulty in covering their open positions.
Trade and Investment Policy: From an economy that was once heavily dependent on oil exports and farming, the
Government’s economic policy has been increasingly directed, over the past two decades of last century, towards
expansion of export-oriented manufacturing units. Deregulation in investment and trade attracted high levels of
foreign investment in the 1990s. These years the manufacturing, construction and financial service sectors fueled
the economic growth. Indonesia's manufacturing sector accounted for nearly 65% of all domestic and foreign
investment from 1968 to 1997. Manufacturing exports rose from $3.4 billion in 1984 to over $30 billion in 1997.
Lessons from the Indonesian Currency Crisis: The Indonesian problems clearly indicate a case of relaxed
government regulations. A completely free and unregulated open capital account could lead to large external
borrowings by the corporate sector. This could become serious and out of control if information on the extent
and nature of the borrowings are not immediately known. The external borrowings should be made public so as
to timely assess the country’s external position so that the policy makers can take immediate corrective action to
ratify the situation.
2.4 Malaysia
Malaysia is a case of one of the most successful economies by end of last century. In the 1960s it was a relatively
poor economy. It was mostly a primary goods producing economy. Its per capita income was around $300 in 1965.
Gradually over the years it has transformed itself to one of the most successful industrialized nations in the world
today. During 1965-1995 it recorded average growth rates of around 7-8 percent that saw the national per capita
income rise to $3,890 in 1995.
In the initial 15-20 years after independence, Malaysia essentially adopted the inherited free market trade and
industrial policies of the colonial government. However, it intervened to promote rural development, import-
substituting consumer goods industries and increasing the processing of natural resources to create employment
opportunities. In 1971 the government launched the New Economic Policy at the backdrop of ethnic conflicts that
demanded a reexamination of the previous developmental policies. The central focus of the new policy was to
create equitable growth with promotion of natural resource exports. The export incentives included credit
expansion at low interest rates, tax allowance, and accelerated depreciation for firms exporting more than 20 per
cent of their output. The country also created export processing-zones, free trade zones and licensed manufacturing
warehouses that permitted duty free imports for export promotion and import substitution. The new policy
attracted huge investments particularly from Japan. In 1986, in the face of large and growing trade and current
account deficit and the recession of 1985, the government further liberalized and increased the tax incentives for
exports, and reduced the tariffs. However, preference was given on a sectoral basis. It also relaxed domestic
participation requirements for potential foreign investors particularly those with better technology, export and
employment opportunities. The FDI that were very paltry till mid-eighties (averaging U.S. $30 million during
1983-1985) suddenly took an upturn (U.S. $2 billion in 1988). Much of the FDI were from Japan (about 25 per
cent). These investments were mostly directed into emerging areas like semiconductors.
Initially the Malaysian government favored the state firms. The state firms performed much less than expected (in
1984 the deficit of the public firms reached 3.7 per cent of GNP). The public sector losses widened the
government’s fiscal deficit. Since 1983, the government initiated measures to privatize the state owned enterprises.
Again, after the recessions of 1985-86, large fiscal and trade deficits, and declining investments saw the
government all-out for the FDI, especially for exports. It offered greater tax incentives to exports and relaxed
domestic equity participation requirement for potential investor with exports and employment opportunities. It also
liberalized the imports. These measures reduced protection to industry. The effective protection to industry
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declined from 31 per cent in 1979 to 17 per cent in 1987 [Edwards, 1990]. FDI, which averaged U.S. $300 million
in 1983-1985, rose to U.S. $2 billion by 1988. Around 25 per cent of the FDI came from Japan, followed by China
and the U.S.. New investments were mostly directed towards exports oriented industries like electrical and
electronic, chemical, rubber, basic metal products and petroleum industries. By mid-1980s Malaysia became one
of the world’s leading producers in semiconductors (U.S. $3 billion in 1986 – world’s third largest producer of
semiconductors) [The East Asian Miracle]. Against the backdrop of such sound macroeconomic policies the 1996-
1997 was a bad year for the Malaysian economy. The 1996 saw a sudden fall in the global demand for
semiconductors and with it the Malaysian exports growth rate fell from 30 per cent in 1995 to 0.9 per cent in
1996. The falling exports eroded the investor’s confidence and in early 1997 the ringgit fell prey to the
speculative attack. The central bank initially resisted by raising interest rates (to around 50 percent) and
intervening in the forex market to (around $1 billion) before abandoning the support to the currency on 14
July 1997 [Editor, Business Week, 28 July 1997]. The ringgit fell by more than 35 per cent in dollar terms by
end 1997 [Sen, 1998a].

The origin of the Malaysian mid-1997 currency crisis is similar to the other ASEAN economies like Thailand,
Indonesia and Phillippines. The currency was fully convertible since 1973 and had an open capital account since
the mid-1980s [Editor, Journal of Foreign Exchange and International Finance, Vol. XI, No.1, 1997]. This helped
the economy access cheap foreign loans. Some of the cheap loans also found its way into less productive and
unproductive assets like real estate and stock market. The property loans amounted to around 25 per cent of
aggregate bank loans in March 1997. The prices on these assets also inflated. The central bank, The Bank of
Nigra, in March 1997, tried to restrict credit expansion to the property and the asset market. This exposed the
magnitude and severity of the problem to the outside world and raised concerns among the foreign investors. The
falling export due to appreciation of the dollar against the yen since 1995 and the marked fall in the demand
for semiconductors suddenly saw a drastic fall in the export orders. The falling exports also made huge
production capacities idle and eroded corporate profits. The corporate default rose and increased bank’s non-
performing assets. These made easy access to the foreign loans suddenly difficult. In the absence of fresh foreign
loans rolling over of the short-term debt became very difficult. This generated pressure on the currency.

Exchange Rate Policy: In the Bretton Woods regime the ringgit was kept pegged to the British pound. After the
breakdown of the Bretton Woods it was pegged to a basket of currencies. The country had an open capital account.
Fiscal Policy: The Malaysian government exhibited great fiscal prudence. The government initiated privatization
measures to reduce the fiscal burden of the loss-making state enterprises and provided tax incentives for export
promotion.
Monetary/Financial Sector Policy: Malaysia had an open capital account. It deregulated commercial interest
rates as early as from 1978. The preferential interest rate on administered bank credits were also freed in 1983.
Since 1974 it continued to maintain ban on expansion of foreign branches, however, there was no restriction on the
domestic counterparts. Since 1988 the foreign banks were permitted to hold up to 49 per cent in local security
houses.
Trade and Investment Policy: Till date Malaysia, like Korea, maintained barriers to FDI even in the banking
sector. Initially the government followed a path of rural development combined with import-substitution with
emphasis on primary products and employment growth. It also favored the state-owned enterprises. But the
performance of the state-owned enterprises changed the government attitude. It then began a path of
privatization since 1983. Simultaneously, from mideighties, it also adopted export-promotion strategies like
creation of export zones and duty-free imports for export promotion. The firms with more than 20 per cent
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of
export output were provided with soft credit, tax allowance, and accelerated depreciation. The domestic
equity participation required for potential foreign firms was also relaxed.
Lessons from the Malaysian Currency crisis: For countries with fully convertible currencies, the effect of
relaxed control over foreign borrowings or domestic credit expansions is generally not visible during times of
growth and export boom. However, much relaxed control, if continued at times of recession, will lead to excess
liquidity that can fuel unproductive stock and real asset speculative-activity. If these artificially raised stock and
real estate prices fall, they create bank- and corporate-bankruptcy.
2.5 Mexico
The usual starting point of any international financial reform literature is Mexico. The nation suffered two major
financial crises in the recent past. The first occurred in 1982 and the next in December 1994. Until the mid-
seventies Mexico was a low-inflation country. The average annual inflation remained around three per cent
during 1960 and 1973. Its imports were about 8 per cent of the GDP. The principal components in imports
included capital goods necessary for growth and “luxury” consumer goods the demand for which was
sensitive to income. In the mid-seventies Mexico experienced healthy growth. This was made possible by new oil
discoveries and dramatic oil-price increase in the late 1970s. The public expenditure rose. However, in the
mid-seventies, the fall in oil revenues widened the government deficits. The government resorted to heavy
external borrowing instead of fiscal tightening. The inflation also soared to 15 per cent in the mid-seventies
and rose further during the late 1970’s mostly due to growing budget deficits. The imports also rose.
Fearing devaluation the country saw an outflow of $20 billion to $30 billion in 1981. The lack of foreign
reserves at the end of 1981 made government’s external debt service difficult. This initiated the government
to impose a series of capital controls. In February 1982 the Mexican government abandoned the quasi-fixed
exchange rate system and allowed the peso to float freely. The nation saw another series of capital flights
and the currency plunged (by nearly 67 per cent vis-à-vis the U.S. dollar by end February 1982). In August
1982, with the central bank almost out of reserves, a dual exchange-rate regime was adopted [Rao, 1997]. In
1982 the Mexico government nationalized its banks and increased the import controls.
After the recovery, however, around mid 1980s, Mexico started looking outward. It lowered the import tariffs and
import licensing. The average tariff on consumer goods fell from 65 percent in 1985 to less than 20 percent in
1992 [Editor, Economist, 18 March 1995]. It became a signatory of the General Agreement of Tariffs and Trade
(GATT) in 1986 and privatized state-owned enterprises. However, the country did not succeed in controlling
inflation in the 1980s. In 1987, the country witnessed a sudden withdrawal of foreign capital and its stock
market crashed. The exchange rate was allowed to depreciate. This further escalated inflation. From 1988,
the government adopted a policy of fixed exchange rate supported by price control and wage freeze . The
initiated measures brought the inflation down (from 159 per cent in 1987 to 7 per cent in 1994). The economic
growth recovered (from an average of almost zero during 1982-88 to about 4 percent during 1989 to mid-1991). It
slowed down thereafter. The restructuring of external debt also paved the way for a resumption of access to
international financial markets, and the private capital inflows surged. The foreign reserves ballooned from $2.23
billion in 1990-91 to $25 billion in 1993 end [Editor, Economist, 28 October 1995]. Land reforms resulted in
high agricultural output and the agribusiness boomed. The country also reached various trade accords with the
United States. The outstanding landmark of all the liberalization process was NAFTA – the North Atlantic Free
Trade Area. It aimed at eliminating import tariffs and non-import tariffs (like quotas) and import licensing
between United States, Canada and Mexico over 15 years. Some tariffs were reduced immediately and others
were to be done in a phased manner over 10 to 15 years.
In the light of all these reforms Mexico experienced heavy capital outflow in 1994. The central bank spent
an estimated $25 billion of its reserves and also borrowed an equal amount, $25 billion, to defend the peg
before devaluing the peso by 15 per cent on 20th December 1994. The crisis did not stop there. The credibility
of the new parity was at stake and within two days of the devaluation, the economy experienced massive capital
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outflows of the order of U.S. $5 billion, and the peso took a free fall. By late January 1995 the peso fell to 6 per
dollar and the stock market also fell by 50 per cent in dollar terms since December 20, 1994 [Rao, V. V.
B.,Economic Times, 20 February 1995].

Mexico had suffered a high inflation (an average of about 88 per cent for five years - 1983 to 1987) when it
pegged its peso to the dollar in December 1987. The nation primarily followed the fixed exchange rate policy as a
tool to control inflation. The government successfully used the pegged rate to end high inflation in the late 1980’s
but then got attached to the pegged rate as a measure of the government’s overall monetary credibility during the
1990’s. The exchange rate was kept fixed between 1988 and 1994 when the currency finally crashed. Between
December 1988 and November 1991 the exchange rate depreciation was pre announced. But considering Mexico’s
earlier high inflation these amounts were small. From November 1991, the government introduced an exchange
rate band, the upper edge of which was to rise slowly over time, most likely permitting slow depreciation, while
the floor of the band remained constant. Establishing a credible commitment to low inflation was clearly a primary
motive behind Mexico’s currency peg. The band of one and half per cent was widened to nine per cent at the end
of 1993.
With the high inflation and small doses of devaluation accompanied by large inflow of capital made the peso
overvalued [Cardoso, 1992]. The overvalued peso dampened the export performance. The sudden and large
reductions in import tariffs flooded the Mexican market with large foreign consumer goods. The imports
rose. The trade and the current accounts deficits widened, as a per cent of GDP the CAD rose from 2.8 per cent in
1990 to 7.0 per cent in 1994. The gross domestic savings also drastically reduced, as a per cent of GDP from
21.6 per cent in 1987 to 13.7 per cent in 1994. These deficits were partly compensated by the large capital flows
(around $93 billion between 1990-93) due to the initiation of financial sector liberalization process. However, two-
thirds of this went into easy-to-flow portfolio investments. The public debt also grew more than the country’s
foreign reserves. The public debt amount stood at 5.5 times the country’s foreign reserves at the time of the
peso’s collapse. A part of this debt was converted into dollar-denominated short-term Mexican bonds, the
Tesobonos, much of which was owned by the foreigners.
At the end of 1993, many eminent economists, both at the IMF and outside, suggested the peso to be overvalued.
The 1994 being an election year the government was not ready to devalue peso. Some think the overvaluation
of the peso as intentional manipulation by the Mexican government to create bilateral trade surplus with the United
States for obtaining political support for smooth passage of NAFTA in the U.S. senate . Some others think the peso
was intentionally kept overvalued to take advantage of the NAFTA by devaluing thereafter. As the year 1994 was
an election year, the government was inclined to adopt loose fiscal and monetary policies instead of tightening
them.
1994 was also politically a bad year. In March 1994 the ruling party’s presidential candidate, Luis Donaldo
Colosio, was murdered, and in September 1994 the party’s general secretary, Jose Francisco Ruiz Massieu, a close
friend of President Solinas, was killed. While these were going on the Fed interest rate rose and attracted funds
from the emerging markets in general and from Mexico in particular. The Mexican foreign reserves fell. The
authorities attempted to end speculation on December 20 with a peso devaluation of about 15 per cent. But within
two days of the peso devaluation the country saw a speculative attack on its currency and capital worth $5 billion
flew out of the country. On December 22, with reserves down to around $6 billion (less than a month of
imports), from $25 billion at the start of the year, the government decided to float the peso. Finally, the free
fall of the Mexican currency peso came not by the foreign investors but by its own people who had the prior
information of the devaluation plan (leaked by the Finance minister to a small group of businessmen).
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Exchange Rate Policy: Exchange rate was mostly used as a policy tool to control inflation. The country got used
to the peg and intentionally delayed devaluation. After abandoning the quasi-fixed exchange rate system in
February 1982 the peso was permitted to float freely. In August 1982, with the central bank almost out of reserves,
a dual-exchange-rate regime was adopted. The exchange rate was kept fixed for a brief period between March
1988 and November 1991, and thereafter the country adopted a policy of preannounce devaluation. From
December 1991 it resorted to a predetermined intervention band. The band was fixed at 1.5 per cent in
December 1991 and was widened to 9 per cent in December 1993. On 22 December 1994, with foreign
reserves down to around $6 billion (less than a month of imports) the peso was floated.
Fiscal Policy: Major tax reforms were adopted in 1987. The important steps taken were: reducing tax rate,
widening the tax base, complying with tax laws, and privatizing of state- owned public sector enterprises.
Monetary/Financial Sector Policy: The major focus of the monetary policy was to control inflation and to
facilitate availability of credit to the private sector firms. The financial sector reforms introduced during 1988-
1989 eliminated the bank’s reserve requirements, credit controls and restrictions to capital flows. It also
denationalized the previously nationalized banks during 1990-1992. These measures increased money supply and
inflation.
Trade and Investment Policy: Major trade reforms introduced in the late 1980s aimed at lowering import tariffs
and import licensing. The import tariffs were drastically reduced (the average tariff on consumer goods fell from
65 per cent in 1985 to 20 per cent in 1992). It became a signatory of the General Agreement of Tariffs and
Trade (GATT) in 1986, privatized state-owned enterprises and removed restriction on foreign investment
for the partner countries of NAFTA. Restriction on short-tem capital was completely removed by 1989.
Comments on the Peso’s collapse: The Mexican government used exchange rate policy as the tool to control the
already high and rising inflation. This may be possible for some time. However, in the long run, without proper
monetary measures and exchange rate management it is difficult to convince investors as to the country’s long-
term unconditional commitment to exchange rate management.
2.6 New Zealand

New Zealand was one of the world’s richest nations at the end of last century. Traditionally, the country had strong
links with Britain. Its major export items were meat, wool and dairy products to Britain and in return it
imported petroleum and manufactured goods from that country. The last century, however, saw constant
erosion of its economic performance. The per capita GNP, which was almost equal to that of the U.S. in the
1930s, fell to about half the U.S. level during 1980s. The country’s current account also deteriorated and external
debt grew. Encountered with a severe financial and constitutional crisis in 1984, the new government of New
Zealand adopted a series of economic reforms, which were mostly applauded in the economic circles.
In 1984, when the crisis surfaced, the country’s external debt as a per cent of GDP stood at 95 per cent
compared to 11 per cent in 1974. The current account deficit was 8.7 per cent of GDP and inflation was ruling
high mostly in double digits through out the previous decade. For the first time the country’s log-term public debt
was down rated by international credit rating agencies (from AAA to AA+ by Standard and Poor’s Corporation on
30 April 1984) [Evans et al., 1996]. A change in government and a likely devaluation marked sudden outflow
of foreign reserves in July 1984. The Reserve Bank of New Zealand suspended the conversion of New Zealand
dollars into foreign currencies. In July 1984, the newly elected government acted swiftly and embarked a series of
policy measures that changed the tightly regulated economy into one of the most liberalized ones. The major
policy changes initiated included fiscal austerity, removal of consumer and price subsidies, deregulation of
interest rates, floating of the New Zealand dollar, privatization of state owned enterprises, removal of
import licensing and reduction of tariffs. The most notable feature of the wide-ranging reforms was the pace of
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reforms [Henderson, 1995]. The reform process was extremely rapid particularly with respect to the financial
sector, export subsidies and tax reforms. These measures helped the government to gradually overcome the
crisis. In 1991 the inflation came down to 0.9 per cent and has remained within the central bank’s targets of 0  2
per cent since then. The government also undertook massive privatization programs of loss-making state-
owned enterprises. The sales from these firms were used to retire sovereign debt. This gradually reduced the
government’s external debt. The external debt, as a percent of GDP, fell to 32.4 per cent in 1996 and is expected to
fall to 20 per cent by 2000. The reduced debt service saw the government record a surplus of 0.9 per cent of GDP
in June 1994. The Reserve Bank of New Zealand Act was amended in 1989 thereby providing greater autonomy to
the central bank in setting a clear and specific target (mostly low inflation) for the monetary policy. This
increased the operational independence of the central bank in setting monetary targets and its accountability in
implementing the stated target. The government also sets a ten-year fiscal goal in each annual budget and any
deviation from the stated objective by any government in future is made public in advance . However, the
major concern that still hovers the minds of the economists is the country’s low household savings, of around
12 per cent of GDP (1.1 per cent of GDP in 1995).

Exchange Rate Policy: The exchange rate was devalued by 20 per cent on 18 th July 1984. But following a run on
the currency in early 1985, the New Zealand dollar was permitted to float from 4 March 1985. Since then the
currency has been floating freely with almost no subsequent government interventions.
Fiscal Policy: From 1984, the fiscal policy of the government aimed at achieving fiscal balance. In the early
periods of the reforms this was achieved through revenue increases. However, as the economy started growing the
revenues rose, and finally in 1993-1994, the government recorded fiscal surplus. In 1994 Fiscal Responsibility
Act was enacted which required governments to set a 10 year fiscal goal in each annual budget and justify any
deviation in the fiscal norms.
The tax structures were simplified and tax rates were lowered. The tax reforms also aimed at gradual
broadening the tax base. The personal income tax rates were reduced to half, from 66 percent just before the
beginning of the reforms to 33 per cent as on 1 April 1989. It imposed goods and service tax (initially kept at 10
per cent but raised to 12.5 per cent in 1989), and valued added tax ( VAT) and reduced export subsidies. In July
1996 the country experienced one of the largest tax cuts (around NZ $2.6 billion) and could still repay NZ $2.6
billion of government’s public debt.
It also undertook massive privatization programs of the state-owned enterprises in the face of fiscal burden and
public sector inefficiency. By the middle of 1997 most of the state-owned firms were privatized and the proceeds
were used to retire country’s external debt [Bhusnurmath, M., The Economic Times, 06 July 1998]. The state’s
role in the economy has gradually reduced (as a per cent of GDP the state expenditure fell from a peak of 42.1 per
cent in 1991 to 34.7 per cent in 1997 and is projected to come down to 32.1 per cent by 2000) [Auckland, 1997].
Monetary/Financial Sector Policy: The interest rate was completely deregulated in July 1984. It is perhaps the
first country to remove monetary policy (reserve) ratio restrictions on banks after the post war period.
Financial markets and capital account were liberalized jointly before the goods market liberalization.
Prior to the reform process, the multiple targets of the monetary policy and lack of accountability and transparency
in its implementation meant no consistent application of the policy towards any specific target. The fiscal deficits
are now to be fully funded by the government bonds at market yields. The Reserve Bank of New Zealand act was
also amended in 1989 thereby enabling the bank to set a clear and specific monetary target (mostly low inflation).
This has increased the operational independence of the central bank in setting monetary targets and also increased
its accountability in implementing the stated target.
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Trade and Investment Policy: Reforms in the goods market sector was long delayed. The growth rate of the
economy picked after the goods and labor markets were liberalized. The government abolished all export
subsidies and import tariffs, and from July 1990 the country also adopted a complete free trade of goods
with Australia.
Lessons: Contrary to the recommendation normally forwarded by economists to overcome short-term problems
such as unemployment and financial sector crisis, New Zealand followed an approach of rapid financial
reforms. In the process, short-run problems were not overcome but the medium- and long-run problems were
appropriately addressed. This was made possible by assigning autonomy to the central bank and by making the
government responsible for its fiscal imbalances.
The rapid deregulation and liberalization, particularly in the financial sector, increase bank competitions.
Privatization of inefficient public sector helps the government achieve fiscal balance in two ways. First, it reduces
the government expenditures, and second, the proceeds from the sale of the state-owned firms can be prudently
utilized in retiring foreign debt thus reducing the government’s debt service. Autonomous central bank acts and
fiscal-balance acts help provide a nation with necessary control over aggregate monetary targets and inflation. A
free float currency, without government interventions, helps exchange rates to adjust to fundamentals
continuously.
2.7 South Korea

After the Korean War of 1950-53 the South Korea was a charred wasteland. In the 1950s it was one of the
world’s poorest countries with high population density, and almost without any natural resource base. Since
the early 1960s a mixture of policies of state-enforced austerity and guided investments made the nation one
of the richest economies of the world today. In 1996 it was the 11 th largest economy. Korea, like China, in
1950 initiated land reforms in the initial stages of the reform process, and showed a universal reliance on
systematic state interventions in agriculture. The sweeping land reform programs transformed agriculture and laid
a more egalitarian base for development through demand for mass production goods. In the 1960s and early
1970s a policy of import substitution with close control over trade, industry, exchange rate, and financial
sector policies were adopted. From the 1970s the focus turned to heavy and chemical industries like steel,
petrochemical, electronics, shipbuilding, etc., through tax incentives and preferential credits. Since then the
nation is in the process of rapid industrialization. The post-1980s saw the export promotion strategies along
with the financial sector reforms to establish a free market economy.
Unlike the South-East economies, the Korean, from the very beginning, relied on export-promotion strategies
for long-term development and growth. However, its spectacular performance can be best considered as
forced growth. During the process of industrialization and capitalistic transformation the state guided
investments into specific sectors. The nation also favored domestic investments to foreign investments, as
FDI were thought to be associated with creation of external debt. Thus, it resisted large-scale foreign
investments, and generally favored and emphasized local capital accumulation throughout their major
phases of industrialization. The state-guided loans at low or negative real interest rates also helped boost
private investments (over 35 per cent of GDP during 1990-1995). Again compared to foreign direct investments,
the portfolio capital flows were very insignificant.
The Koreans government had been fast in dealing with external shocks. In late seventies the country encountered
deterioration in trade balance due to rising oil price, and fall in export demand (due to world recessions and the
real appreciation of its exchange rate during 1974-1979 - fixed exchange rate regime) the government adopted
stabilization measures in January 1980 with the help of standby credit from the IMF. It also devalued the exchange
rate and tightened the monetary and fiscal policies. In the short-run the economy faced a slowdown. In 1980 its
output fell by 5 per cent, inflation rose to 25 per cent, and the CAD widened to 8 per cent of GDP. However, after
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a
period of about 2  3 years, the economy started recovering. In 1983, the inflation fell to 3.4 per cent and the CAD
also came down to about 2 per cent of GDP.
The South Korean trade policies were directed mostly toward export promotion. Even during the times of BoP
crisis, in 1960 and in 1980, the government mostly relied on subsidized export promotion strategies to devaluation
to correct the imbalance. The Koreans identified certain industries as those with future export potentials.
Systematic government efforts were ensured to protect and promote these industries through policies of selective
credit allocation, protection, and also by limiting entry of firms into these specific areas. These firms were also
supported with tax benefits (like low interest rate credit and accelerated depreciation), preferential access to
imports (sometimes partially state financed), subsidized loans, export-insurance, etc. Failures to meet the export
target often confronted with cancellation of available government supports. These efforts saw an export boom. In
1995 it was the 13th largest world exporter. The exports grew from U.S. $33 milion in 1960 to U.S. $130 billion in
1997. And the economy, over the years has transformed itself from an agro-economy (garments, foot wear, textile
and wigs constituted around two-third of exports in 1970s) to the world’s largest producer of electronic chips and
microprocessors (technologically advanced products constituted around 60 per cent of its exports in 1995). In 1996
it was the 11th largest economy.
But the mid-1997 saw a sudden reversal of the investor’s confidence that led to a run on its currency. The currency
plunged by more than 50 per cent. The decline continued even after the daily exchange rate band was widened to
10 percent on 20 October 1997. By June 1998, eight of the thirty largest chaeboles collapsed and many others were
on shaky ground. The won (Korean currency) fell by around 145 per cent since 1 May 1997.

Till the mid-1990s the Korean exports were booming, and with this the investor confidence grew, investments
remained strong and production capacities were expanded. The 1996 suddenly saw a reversal in the export
demand. Export growth slowed, from 33 percent in 1995 to 3 percent in 1996. Some of the immediate causes in the
fall in the export demand can be ascribed to the decline in price of some of its major export commodities like
computer chips (due to large inventories in developed countries), and the fall in the yen (the dollar appreciation).
The political uncertainty of the then coming presidential polls marked a fall in growth in investments. The liquidity
in the system reduced and raised the external borrowings by the domestic banks. The falling export orders saw
much of the production capacities of the export houses underutilized. Additionally, the rising costs and weakening
of sales eroded the profit margins. Some firms even suffered losses. The short-term debts grew to almost $100
billion or about one-third of the country’s GDP in 1997. In the absence of fresh loans the servicing of the corporate
debts became difficult. Some of these firms went bankrupt, including some of the large conglomerates like Hanbo
Steel, Jinro, Dianong, New Core Group, and KIA motors. The corporate bankruptcy increased the banks’ bad loans
and non-performing assets and eroded the overseas creditors’ confidence in Korean banks. The premium on the
Korean overseas bank borrowing rose and made it difficult for the banks to raise new money. All these led to
liquidity problems and to almost virtual insolvency of the banking system. The government and the central bank,
Bank of Korea, responded by injecting liquidity into the system. However, these measures were largely ineffective
in restoring the overseas investor’s confidence.

Exchange Rate Policy: The exchange rate was used as a protection for exports, and as external debt management
tool. The country used exchange rate protection during 1986 to 1989 when it ran a current account surplus (which
peaked at a rate of 8 per cent of GDP in 1988). The desire to protect the export sector was a factor but the main
concern was to reduce the debt ratio and build up reserves to avoid a near foreign debt crisis as during 1984-1985.
Korea fixed its currency to the U.S. dollar but resorted to intermittent devaluation (four major devaluation
occurred between 1961 and 1980) before it adapted to managed float in 1980. The won/dollar fluctuation rate was
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maintained within 2¼ per cent of the average rate of the previous day, thus providing a strong boost for export
competitiveness. As a result the exchange reserves mounted steadily to over U.S. $32 billion by the end of 1996.
Fiscal Policy: Like. China, Korea had a complex tax structure mostly to promote exports and investments and to
direct the pattern of national developments. It constantly fine-tuned its tax structures to promote industrial
development. During 1953 to 1986, there were nine major tax reforms. The country is one of the early introducers
of value-added-tax (VAT) system. The revenues from VAT were mostly used to provide export incentives. The tax
incentives to exporters included credit at reduced interest rates and accelerated depreciation. South Korea’s fiscal
deficits were often kept limited to external aid or debt [Ghosh, 1997]
Monetary/Financial Sector Policy: The monetary policies aimed at long-term measures even during the periods
of crisis. The Korean financial system, since the 1960s have been dominated by the government. With
nationalization all financial institutions came under the government control during 1960-1979. It adopted a policy
of initial restrictions on capital accounts transactions. However, the interest rate was regulated and credit
allocations were made on the basis of strict priorities. It abolished the interest rate ceilings on bank lending from
1984. From 1980s the country took to a path of privatization of state-owned enterprises and abolished restrictions
on bank expansions, both domestic and foreign, and liberalized the capital accounts transactions.
Trade and Investment Policy: South Korea persuaded a state-directed and regulated, export-led growth strategy,
which only recently has given way to more liberalized regimes. The focus was not so much on freer market but on
a systematic government effort at assisted investment, restructuring industries, and on promoting export-oriented
industries with domestic capital and foreign investments. It thus adopted practices of selected credit allocation,
protection, and limited and guided entry of firms into specific areas and exchange rate devaluation. The
government constantly changed its tax system to promote investments. Those failed to meet the export target found
their credit cancelled or the management changed by the government. It also resisted large scale FDI and generally
favored and emphasized local capital accumulation throughout their major phases of industrialization. Compared
to FDI the portfolio capital flows are miniscule.
Lessons from the Korean Currency Crisis: The state directed credit controls work well when an economy and
its market are simple. But the practice of credit allocation on the basis of political whim, rather than the risk-return
relationship assessment, does not work well when the market grows and becomes complex. An economy which is
overdependent on export growth must aim at diversifying its export basket so as to withstand the sudden fall in
world demand for any particular commodity without much affecting its total exports and growth.
2.8 Thailand
Traditionally Thailand had been an agricultural and primary-product-exporting county. Its trade was heavily
controlled. Rice, the major commodity of exports, was controlled by a state market monopoly. Exports were
also discouraged through high export taxes and multiple exchange rates. In 1955 the government abolished the
state monopoly of rice exports to promote its export. The domestic industries, particularly the consumer goods
sector were highly protected (import tariffs on consumer goods were around 3035 per cent compared to the
1520 per cent for the capital and intermediate goods) during 1950s through 1970s. The oil shock of 1970s
changed the government’s outlook from import-substitution to export-promotion. This is evident from
Thailand’s trade policies of 1981. Some of the export-promotion strategies adopted include tax rebate, duty free
imports, rediscounting of export bills, etc. In 1981 it also devalued the exchange rate and reduced taxes on
exports. The export subsidies were combined with stricter compliance to meet the export targets. These measures
resulted in high export growth rates. In 1984 the exports and foreign investment were also liberalized, the
exchange rate was devalued before it was allowed to float.
The Thais authorities built special institutes like the Budget Bureau to plan and control the government budget.
The Bureau had the responsibility of both drafting a balanced budget and keeping control over the government
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expenses. The bureau, in consultation with the finance ministry, the Institute of National Economic and Social
Development, and the central bank, drafted the budget plan. The concerned ministries were permitted changes in
their allocations only to the extent that did not permit the budget to be revised upwards. The oil booms of the
early 1970s increased the government revenues. The government expenditures also rose. The decline in the
oil revenues in late 1970s did put pressure on the government revenues (the government deficits grew to 8 per cent
of GDP in 1981-1982) and on the current account deficits (7 per cent of GDP in 1980-1981). The government
acted swiftly. It adopted measures of fiscal tightening instead of external borrowings to reduce the fiscal deficits.
The government’s action plan included cutting down its expenses, raising of taxes (13 per cent in 1981-1982 to 16
per cent in 1986-1987), and adopting stricter tax compliance methods. These progressive fiscal consolidation
strategies helped the government avoid adopting expansionary monetary policies and/or foreign
borrowings. The government accounts recorded surplus starting from 1987-1988.
In Thailand foreign investments were welcome since the 1960s. However, in the initial periods the foreign
investments were permitted only in the import-substituting industries (keeping with the government’s import-
substitution strategies). With the government focus sifting to export-promotion strategies in early 1980s, the
foreign investments were also permitted in the export-oriented industries. The majority ownership criterion
for the foreign firms was relaxed in 1983 to provide grater freedom to the foreign firms. The new criterion
required majority local ownership for firms catering to domestic market, and the foreign firms whose total
products were exported were permitted to retain total foreign ownership. This created a healthy atmosphere for
industrial competition and growth. Thailand experienced a boom in foreign investment (it increased by 10 times
between 1986 and 1990  from around U.S. $250 million per annum in 1986 to U.S. $2500 million per annum in
1990) and by 1990 half of the country’s exports were from the foreign firms.
Much of these FDI funds were from Japan. The rising yen in the 1980s made many Japanese manufacturing
companies shift their manufacturing operations to its neighbors [Ghosh, 1997]. The low labor cost, the
Confucian culture and noninvolvement of Japan in Thailand during the World War II made Thailand a
base to start. The exports rose. Over a period of time, however, the labor cost rose and the productivity fell.
The exports started facing severe challenges from products of the low wage countries since the 1990s. The FDI
declined as funds sought cheaper destinations. The exports also fell due to weakening demand for semiconductors
in 1996. The CAD grew to 8 per cent in 1996. The Thai budget also showed a deficit for the first time in 1996. The
country resorted to external borrowings. The Bangkok International Banking Facility introduced earlier in
1992 helped the domestic investors access foreign funds at lower interest rates. The external debt rose. The
dollar debt of Thailand rose from $23 billion in 1989 to around $75-80 billions in 1997. Around half of the
external debt is held by Japanese banks. The bank credit expanded (27 per cent of GDP) and the average bank
lending rose more than 80 per cent during 1988-94 compared to 55 per cent during 1985-87. These cheap funds
mostly found their way into real estate. Property loans amounted to 15 per cent of aggregate bank loans in June
1997. The investments led to an oversupply of office space leading to vacancy rates of almost 20 per cent. With
real estate prices falling, stock price hitting low and without fresh loans, the corporate sector found it difficult to
service their debt. The bank bad debts and non-performing assets grew. Without fresh foreign loans and high
current account deficit the pressure on bhat rose. There was a speculative attack on the bhat in late 1996
and early 1997. The Bank of Thailand permitted the short-term interest rates to rise to extremely high levels
and thereby temporarily waived the speculative attacks. In May 1997, the bank established a ‘two-tier’
foreign exchange market by closing off bhat resources to foreign entities. Short-term interest rates soared
and domestic liquidity squeezed. The foreign reserves fell from U.S. $38 billion at end of 1996 to U.S. $28
billion at end-May 1997. The government announced a package of reforms including suspension of 16
financial companies. But the pressure on the currency rose and the bank of Thailand announced a managed
float of bhat on July 2, 1997. The bhat fell by around 40 per cent by end of November 1997
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The genesis of the problem can be traced back to the BoP crisis of the early 1980s and subsequent steps taken by
the government to liberalize the banking system and private investments. The interest rate was kept high with
the prime rate at 13 per cent to attract foreign funds. The domestic banks were permitted to borrow from
foreign banks. The open capital account permitted the private banks to borrow foreign loans at low interest
rates and act as intermediaries between foreign lenders and domestic borrowers. The rising costs, low
productivity and a strong dollar marked a decline in the exports. The fall in exports and consequently the
returns (Table 2.1) affected the foreign investments. The private investment and saving imbalance widened
current account deficits. As foreign banks were restricted to expand their operations in the domestic market, the
competition in the banking sector was almost absent. This resulted in large spread between domestic and
international borrowing rates. In 1993, the country instituted a major policy change with the introduction of
Bangkok International Banking Facility. This further extended the foreign financing of domestic and private
expenditures. These cheap funds mostly found their way into less productive assets like the property and
equity. The prices on these assets inflated. During the 1996 the country saw a sudden fall in semiconductor
export demands. The CAD grew to 8 per cent in 1996. The total external debt grew (around 50 per cent of GDP)
and the private sector debt constituted nearly 80 per cent of total external debt. Further, around 40 per cent of the
external debts were of short-term nature (maturity less than 12 months). The required annual turnover of short-
term debt was around U.S. $ 40 billion per year. All these led to attacks on the bhat in late 1996 and also again in
early 1997. The central bank for some time succeeded in taming speculation by increasing the short-term interest
rates and squeezing excess liquidity from the market. The Foreign loans were also not hedged due to constant
assurance from Bank of Thailand not to devalue the bhat in the near future. However, when the pressure on
the currency rose further the central bank had to give in and the bhat plunged.
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Table 2.1: Returns to U.S. investments in the developing countries

Country 1991 1992 1993 1994 1995
Malaysia 28.5 41.7 35.4 24.4 25.9
Thailand 20.1 16.8 15.7 19.0 17.6
Indonesia 46.7 34.4 25.9 26.3 23.6
Korea 2.4 4.9 7.8 10.7 13.2
China -2.8 0.4 14.0 4.0 3.8
India 14.0 13.6 12.0 14.9 10.9
Mexico 18.1 17.9 16.6 15.5 11.4
Source: Survey of Current Business, September 1996

Exchange Rate Policy: The exchange rate was as an instrument for export promotion. The bhat was kept fixed to
the U.S. dollar during 1954-1984. It underwent two devaluations during this period. The first occurred in
1981 and the next in 1984 after which it was allowed to float. The bhat was convertible till May 1997 for
capital account transactions. After May 1997 the bhat is convertible on trade account only. In the mid-
1990s, however, the government delayed the adjustment process for long leading to the crisis in mid-1997.
Fiscal Policy: It created public institutions that had the responsibility of budget drafting and control. The country
was concerned with low inflation and low debt management. This helped the government record continuous fiscal
surpluses. Thailand had one of the complex tax structures with high rates. On top of this the government mostly
adopted an array of tax incentives to direct investments to specific sectors and promotes exports. The
system’s complexity and lack of bureaucratic capacity resulted in its poor implementation. In contrast to
Korea and China where the tax incentive worked well the tax incentives did not yield the requisite results in
Thailand. To rectify the situation, in 1989, the government partly simplified the personal income tax structure and
introduced a 10 per cent VAT to replace the complex business taxes.
Monetary/Financial Sector Policy: The country initially maintained interest rate ceiling. From 1989 the ceiling
rates on deposits above one year were abolished; however, the ceilings on lending rates were regulated. The
foreign banks were restricted in the domestic market. An open capital account permitted the private banks
to borrow unlimited foreign loans at low interest rates and act as intermediaries between foreign lenders
and domestic borrowers at wide spreads.
Trade and Investment Policy: Initially trade and investment were heavily controlled. From 1981 the government
adopted export-promotion strategies. Some of the export-promotion strategies included tax rebate, duty free
imports, rediscounting of export bills, etc. Failures to meet the export target often resulted in cancellation of
the available government supports. The majority ownership criterion was also relaxed in 1983 for foreign
firms catering solely to the export market.
Lessons: Countries should keep a watch on foreign borrowings particularly during low-growth periods. During
these times the investment returns fall and cause a fall in the foreign capital inflows. At these junctures the
corporate external borrowings and investment should be closely monitored. A wider investment and saving
imbalance at these times result in either external borrowings or domestic credit expansion. Both the measures put
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pressure on money supply and inflation. If the external borrowings are of short-term nature it can also lead to
sudden and violent adverse exchange rate movements.
During times of fall in demand a central bank should be vigilant on corporate borrowings particularly that are of
short-term nature. A sound banking system with a strict central bank is a prerequisite for stability in today’s global
economy. Steps should be directed at periodic disclosure of financial positions of banks. This helps the financial
institutions improve their positions and thereby help the economy avoid financial crisis by keeping the investors’
confidence.
2.9 India
The pre-independence India was essentially an agrarian economy. The country received independence in 1947.
However, the partition of the nation during independence provided a heavy blow to the economy. The independent
India got 82 per cent of the population with only 62 per cent of the irrigated land. The agricultural rich parts like
west Punjab and Sind went to Pakistan. These measures along with the shackles of the World War II marked the
beginning of independent India in the grips of severe food shortages and mounting inflation. Under the then
prevailing situations Indian reforms, in the initial years after independence - the First Five Year Plan of 1951-
1956, were completely devoted to agricultural promotions. Efforts were directed at bringing more cultivable
land under irrigation (23 million hectares in 1950-1951 to 88 million hectares in 1994-1995), and raising
productivity mostly through the use of high yielding crops and chemical fertilizers (the fertilizer consumption
grew from 2.2 million tonnes in 1970-1971 to 13.5 million tonnes in 1994-1995). These measures helped the
nation to increase its food grain production from around 50 million tonnes in 1950-1951 to 191 million
tonnes in 1994-1995.
From the Second Five-Year Plan (1956-1961) onwards the government’s focus shifted to basic and heavy
industries. From here onwards the Public Sector Enterprises emerged in India. During the pre-independence
India the public sector was practically absent except for railways, posts and telegraphs, the port trust, the
ordnance and aircraft factories, and a few state-managed undertakings like government salt factories,
quinine factories, etc. The Industrial Policy formulated in 1948 and 1956 provided provisions for a mixed
economy. The public sector was assigned the responsibility of developing the basic and heavy industries, and
the private sector was assigned broadly the development of the consumer goods industries. The Industrial
Policy of 1956 also supported the small-scale industries through restriction of production in the large sector, by
differential taxation, direct subsidies and reservation in the spheres of production. The government enacted the
Monopoly and Restrictive Trade Practices (MRTP) Act in 1969 to regulate and restrict the working of the
corporate sector. This act aimed at preventing both restrictive trade practices and concentration of economic
power. Firms with assets of Rs. 20 crore and above (raised to Rs. 100 crore from 1985) came under the MRTP
act. The firms under this act required taking government permission for activities like expansion,
establishment of new undertakings, merger and acquisitions. These measures gradually saw the public sector
expanding and spreading to almost all sectors of the economy. In terms of percent of paid-up capital the public
sector’s share gradually grew from 6.8 per cent during 1957 to 48.7 per cent during 1996 , and the private
sector correspondingly shank from its share of 93.2 to 51.3 per cent during the same period. Lack of
competition resulted in the poor performance of the public sector enterprises. Against the plan target of 12 per
cent per annum, as envisaged in various government plans, the returns, gross profit as per cent of capital
employed, was only around 4-6 per cent during 1969-1970 and 1973-1974. The average annual returns of the
public sector rose very marginally after 1974 but remained around 7-8 per cent up to 1981. Again, few selected
firms like the petroleum sector that employed around 18 per cent of the capital accounted for about 40 per cent of
the total gross profits. The economy registered a low growth rate, of around 3.4 per annum, commonly referred
to as the “Hindu growth rate”. The long poor performance of the economy led the government to review its
policy measures and initiate economic reforms from 1980s.
Countries
The
first
phase of the reforms were initiated under the prime ministership of Mr. Rajiv Gandhi in 1985. The central role of
the reforms was a greater role of the private sector. The Export-Import Policy was amended and enacted from 12
April 1985. The policy liberalized imports to boost production and exports. It provided duty free access to
imported inputs for export production, freed many industrial items from the import restrictions, and on many
others items the restrictions were reduced. These measures had an adverse impact on the nation’s trade balance.
Much of imported items were elite consumer white goods, like the cars, color TVs, VCRs, washing
machines, etc., bought by the business houses under the liberalized imports scheme. The trade deficit widened
from Rs. 67.21 billion in 1984-85 to Rs. 95.86 billion in 1985-1986. The trend continued throughout the decade.
The annual average trade deficit under the Seventh Five-Year Plan (1985-1986 to 1989-1990) grew to Rs. 108.41
billion. The government’s deficits also started to rise at a faster rate in the 1980s. The foreign debt grew
from U.S. $23.5 billion in 1980-81 to U.S. $83.80 billion. This high level of external debt and its servicing cost
did clearly put the nation in a debt trap. The debt service as per cent of current receipts grew from 9.3 per cent
in 1980-1981 to 35.3 per cent in 1990-1991. The high external debt and its servicing cost increased the
government’s fiscal burden. The fiscal deficits as a per cent of GDP rose from 6.2 per cent in 1980-1981 to 8.3 per
cent in 1990-1991. The fiscal deficit was met by either borrowing from the central bank (monetised deficit) or
through market borrowings. Throughout the 1980 the monetised deficits as a per cent of GDP remained around
2.53 per cent. As a consequence the monetary aggregates and inflation grew.
With a balance-of-payments crisis, a rising debt burden, ever-widening budget deficit (8.4 per cent in 1990-
1991) [Editor, Economist, 21 January 1995] and mounting inflation (well over 13 per cent), India found it
impossible to raise commercial loans in the international markets. The over-dependence on relatively short-
term commercial borrowings combined with an oil price rise and sudden drop in the foreign remittances
due to the Gulf War, and the growing political uncertainty created adverse exchange rate expectations. The
nation saw a reversal in the flow of short-term NRI funds and depletion of its foreign reserves. To avoid default on
its foreign debt service the government mortgaged 46 tonnes of gold, for U.S. $400 million, with the Bank of
England. The Indian government also approached the IMF and the World Bank for loans of about $5.7 billion.
Simultaneously, the new government under the prime ministership of Mr. Narshima Rao launched a series of
economic reforms from July 1991. The central focus of the new economic reforms was ‘deregulation and
privatization’. On July 1991 a new Industrial Policy was announced. The new policy aimed at abolishing the
licence-raj and thereby freeing the economy from the controls and regulations (presently less than 10 per cent of
manufacturing activities require a prior government licence). In 1998-99 the government has resolved to reduce its
stake in all non-strategic public sector companies to 26 per cent. Private enterprise, rather than the State, is now
viewed as the prime vehicle of growth. The exchange rate was devalued in July 1991 and successively made
convertibility, the foreign investments were liberalized, and the majority ownership criterion for the foreign firms
was relaxed thereby provided grater freedom to foreign investments.
Following the crisis two significant exchange rate adjustments were made during the financial year 1991-1992.
The rupee was devalued by 22 per cent through the rupee-sterling rate in two stages, from £1 = Rs. 34.36 to Rs.
37.19 on July 1 1991 and thereafter to Rs. 41.56 on July 3 1991. The rupee depreciated against the U.S. dollar
from $1 = Rs. 21.2 to Rs. 25.8. A two-tier exchange rate in the name of Liberalized Exchange Rate Management
System (LERMS) was introduced in March 1992. According to the LERMS there were two exchange rates: an
official rate (40 per cent of all exports had to be surrendered at this rate) and a market rate (most imports and 60
per cent of the exports were to take place at this rate). On March 1, 1993, the dual exchange rates were unified into
one market rate determined by the forces of demand and supply. And since then, the changes in exchange rates
took the form of a continuous stream of adjustments.

Exchange Rate Policy: The rupee underwent a two-stage devaluation in 1 July and 3 July 1991 by around 20 per
and most exchange controls were lifted. The currency was permitted to be market determined..
Countries
Fiscal Policy: The tax reforms also aimed at reducing dependence on indirect taxes. The tax structure was
simplified, the tax slabs were reduced, and the top rates were gradually brought down. The top rate of income tax
fell to 30 per cent in 1997 (from 56 per cent in 1991). Similarly, top rate of corporate tax fell to 35 per cent in 1997
(from 57.5 per cent in 1991) for domestic companies and to 48 per cent for foreign companies. The fiscal policy
also aimed at wider tax base and stricter tax compliance to increase the tax revenue and simultaneously adopted
fiscal prudence to reduce the fiscal deficit. The complex structure of the excise duties was simplified, the rates
reduced, and were replaced by MODVAT, a tax structure similar to VAT. Disinvestment and privatization of
public sector stocks were also adopted to reduce the government’s fiscal deficit. It also adopted methods like
putting a cap on central government’s temporary borrowings through the issue of ad hoc treasury bills to control
money supply.
Monetary/Financial Sector Policy: The monetary policy aims at maintaining low inflation. The monetary policy
(reserve) ratio for the banking sector has been gradually reducing. Bank opening and expansions are now not
restricted and domestic banks are permitted to access the capital market. The introduction of new private sector
banks has led to competition and gradual reduction in the domestic interest rates. The interest rates were also
progressively deregulated, and presently market determined. The Nationalisation Act has been amended to enable
the state share in banks to come down to 51 per cent.
The capital account witnessed a partial liberalization as restrictions to capital inflows  both direct and portfolio-
based - were reduced. The nation is gradually liberalizing its capital account and plans to adopt full capital account
convertibility by 2000.
Trade and Investment Policy: The Trade Policy enacted on 4 July 1991 aimed at gradual tariffs reduction and
removal of obstructions to free flow of goods. The maximum tariffs come down from 400 percent in 1991 to 40
per cent in 1997. The average tariffs fell from 81 per cent to 25 per cent during the same period. Quantitative
restrictions on capital and intermediate goods were removed, there are still have some restrictions, however, on the
consumer goods.
The Industrial Policy Act, July 1991, liberalized the foreign investments. The act permitted 51 per cent foreign
investment, both FDI and portfolio investments, for existing companies. The domestic corporate sector is
permitted to borrow from the global capital markets through Global Depositary (GDR) mechanism. Automatic
approval of foreign investments up to 100 per cent is permitted on a case by case basis. However, capital controls
with respect to short-term capital flows still exist. A disinvestment committee has been set up to speed up the
disinvestment process.
2.9.2 Consequences of the Indian reforms

The reform process in India initiated since July 1991 has produced mixed results. The growth rate, the single most
important indicator of a national economy has outpaced the targeted growth rate of 5.6 per cent to 6.5 per cent
during the Eighth Plan period of 1992-1997. The corresponding figures for the Sixth Plan 1980-1985 and the
Seventh Plan 1985-1990 periods were 5.2 and 5.1 per cent respectively. Including the year 1991-1992, when the
reforms were introduced, the overall growth rate during 1991-1997 remained at 5.5 per cent. Importantly, during
the reform period the growth rate gradually rose: 0.8 per cent in 1991-1992 to 5.3 per cent in 1992-1993 to 6.0 per
cent in 1993-1994 to 7.2 per cent in 1994-1995 and 7.1 per cent in 1995-1996. The inflation (WPI) during the
period 1991-1997 averaged at 10.1 per cent per annum. It also showed a gradual reduction over the period. In 1997
the inflation remained at 7 per cent (7.7 per cent during 1995-1996). The pace of growth of external debt also fell.
The external debt rose to $99.01 in 1994-95 from $83.80 billion in 1990-1991. However, it declined to $92.20
billion in 1995-1996. The short-term debt as a per cent of GDP fell from 10.3 per cent in 1990-1991 to 5.3 per cent
in 1995-1996. The foreign reserves gradually rose from $3.2 billion in 1990-91 to $5.8 billion in 1991-1992 and to
$16.3 billion in 1995-1996. The fiscal deficits fell, as a per cent of GDP, from 8.3 per cent in 1990-1991 to 5.9 per
cent in 1991-1992 and to 5.7 per cent in 1992-1993 to 5.8 per cent in 1996-1997.
Countries
In
the external trade front the government’s little export promotion measures were however, more than nullified by
the import liberalization measures. The export subsidies (an important element in the South-East Asian countries
success) were removed. Except for the initial import compression year of 1991-1992, during which the exports
grew by 30.5 per cent outstripping the import growth of 10.8 per cent whereby the trade deficits remained narrow
at $1545 million (from $5930 million in 1990-1991), the trade deficits did not improve much. In subsequent years,
due to import liberalization measures, the imports rose at a faster rate but the exports did not rise by the same
proportion. The trade deficits gradually grew (U.S. $5257 million in 1996-1997).
Abolishment of the licensing system (except for 18 core industries), adoption of measures to cut down government
delays associated with government approvals, liberalization of foreign participation majority norms (foreign
ownership was raised up to 51 per cent for high priority industries and up to 100 per cent for foreign firms
exporting its total product), etc., boosted foreign investments, both direct and portfolio-based. During 1991-1992
and 1995-1996 the total foreign investments amounted to U.S. $13.95 billion. However, out of this $4.56 billion
(30.7 per cent) were in the form of FDI and $9.39 (67.3 per cent) were in the form of portfolio investments
(including the GDR and investment by FII and Euro-equities). And again of the total FDI of $4.56, nearly one-
third ($1.5 billion) were from Non-resident Indians. These short-term and easy to move out funds are quite risky
for any economy, particularly for India, which is adopting a path of reforms. A loss of confidence at these
junctures may demand high adjustment costs.
The foreign direct investments have concentrated in two major sectors, power and oil exploration and also in the
non-priority sectors like food-processing, service sector, hotel and tourism sectors, and in the consumer goods of
elitist consumption items like cold drinks and liquor. This has affected the small domestic counterparts resulting in
their increasing closing down or selling to foreign counterparts. Even in the disinvestment sphere the government
seem to lack a clear-cut policy at timing the disinvestment, pricing the stocks and at paying compensation to the
employees in process inviting opposition from employees and worker unions. The public firms are often suddenly
cut off from government budgetary support, which was vital for modernization and reengineering, and are
subsequently disinvested. Again, the proceeds from the PSUs disinvestments are utilized to finance government
deficits. To meet government deficits mostly the equity of the profitable and core sectors firms and banks (more
than 40 per cent of the country’s largest bank has been disinvested by 1997-1998) have been disinvested. The lack
of proper policy in disinvestment is bound to affect the economy in the long run. Majority of disinvested shares
have gone to foreign investors (the FIIs are permitted hold up to 49 per cent in these sectors). A large
concentration of domestic portfolios in the hands of FIIs can increase currency risks.
The pace and progress of reforms also seem to lack proper political support. Since the beginning of the reform
process of 1991, almost all governments lacked full strength in the parliament. The situation particularly worsened
from the mid-1995 when the nation saw a coalition government of 13 small parties with outside support from one
big party. The government could last for only two years against the full term of 5 years. The next general elections
held in February 1998 also produced similar results. The lack of full strength in the parliament, ideological
differences among the political parties forming the government, and varying interests of regional parties have led
to discontinuity and lack of proper political will at implementing and maintaining the pace of economic reforms.
Thus, to some extent, the reform process lost the continuity and direction, leading to a reduced growth rate.
2.10 Lessons from a Comparative Study

The phenomenal growth in communications has increased access to information on domestic markets and thereby
closely linked the domestic markets with the global markets. The international capital today instantly flows to
economies where the returns are higher, it is freely convertible, and the risk is lower. The enhanced investment and
development in capital-scarce, less-developed and developing countries have opened employment and growth
opportunities in these countries. Good projects today are not sacrificed for want of capital. The increased benefits
are associated with higher risks. If investors expect a sudden fall in returns or a rise in associated risks they
invariably pull out fast. This can lead to massive domestic adjustment costs in social, political and economic
Countries
spheres. In turn, it can lead to a shrinking of economic activity and growth, loss of employment, and a rise in
foreign debt burden in domestic currency. It can also produce spillover effects in other global markets. Though
there is no clear cut advantages visible with respect to the pace of reforms, the gradualistic approach seems to be
suitable for big and rural economies whereas a rapid pace of reforms is surely advantages to small and urban
economies. However, the more important is the direction of the reforms which may be overdelayed due to frequent
changeover of governments and/or coalition government which has become the order of many economies the
world over.
Though the financial liberalization process initiated world over is irreversible, the financial regulatory mechanism
should also be strengthened to keep a watch on credit expansion, and external borrowing limits of banks and
financial institutions. The financial liberalization - deregulation of interest rates, easing of reserve requirements,
easy entry and expansion of foreign banks and financial institutions – puts pressure on domestic banks, thereby
induces them to greater risk-taking attitudes. The domestic banks mostly borrow short-term from international
markets and lend them at home. The problem may be overshadowed when the economy is growing fast. But
during periods of falling aggregate demand the returns from investments diminishes and the easy funds then find
their way into less productive assets - the stock market and the real estate. The prices of these assets then rise
above their values. When the asset bubbles burst it raises bad loans and creates bankruptcy of corporate and banks.
In addition to short-term foreign debt, the other ‘leading indicators’ that need close monitoring are liquidity, fiscal
deficit, and trade deficit. A continuously high fiscal deficit affect liquidity and the interest rates. Similarly, a
widening trade deficit financed by short-term capital flows can overshadow the balance of payment situation
temporarily but magnifies the situation during crisis. The exchange rate should also be kept flexible to adjust to
fundamental of the economy.
Some of the various measures that can be adopted to stop reversal of investor confidence in any economy are
outlined below:
 A Strong Central Bank: The central bank must be autonomous and accountable to money targeting which will
help keep a close control over inflation and interest rates. It will facilitate a market-driven credit expansion.
 Strong Financial and Corporate Standards: The corporate and financial sector standard and practices must be
constantly updated to match the global standards. This will strengthen the domestic sector and facilitate the
government to take immediate actions to avoid large-scale bankruptcy.
 Improve Availability and Transparency of Information : The corporate and bank financial positions regarding
assets, liabilities, and policy decisions should be made available to the global investors at frequent intervals. The
grater transparency will enhance the banks and corporates to avoid large rent-seeking low investment activities like
investment in real estate and stock market thereby help retaining the investor’s confidence. This will also help
reduce the credit on the basis of political connections.
 Flexible Exchange Rate: Flexibility in exchange rate adjustments avoids sharp exchange rate movements. The
flexible exchange rate arrangements help realign a strong currency quickly to market forces when capital inflows
subside.
 Simple and Broad Based Tax System: High tax rates and complicated tax structures discourage the taxpayers.
Lower top rates and simple tax structures encourage tax collections. An increase in the tax base can be used to
supplement the tax revenue. The surveillance on tax compliance must be made strong so as not to penalize the
honest taxpayers with higher taxes at the cost of dishonest taxpayers.
 Reduction in Over Dependence on Particular Commodity of Exports Or Imports : The imports and exports of
any economy should be well diversified to reduce the effects of sudden fluctuation in the international price of the
commodity.
Countries

Transparency and Accountability in Fiscal Operations: The public policy and expenditures should be subjected to
public scrutiny and accountability to increase fiscal prudence.
 Regulation of Money Supply: The open capital account that enhances the investor’s confidence increases the
money supply. During periods of economic expansion this supplements the domestic investments and raises
growth rates, which negate the inflationary pressure due to excess money supply. However, the reverse happens at
times of economic contraction. Hence, during these periods of economic downturn, built-in stabilizing measures
should be designed in the system to keep money supply regulated.
2.11 Conclusions
This study has analyzed, for some selected countries, the policy decisions and their outcomes at different time
horizons. The success and crises of these policies in these countries with respect to currency behavior have been
studied vis-à-vis major policies like Fiscal Policy, Monetary/Financial Sector Policy, Trade and Investment Policy,
and Exchange Rate Policy.
From the study it is clear that when private funds were scarce the state controls worked well. The state-directed
funds to priority sectors fostered growth. The rising private funds have today weakened the state barriers, and in
the process bought economies over the world together. Today, the markets dictate the direction of funds and
thereby affect economies and governments. This has left the policy planners with little choice in not adopting the
proper set of policies in time. However, control over fiscal imbalance and over credit expansion particularly at
times of economic slowdown seems to reduce investor-confidence crisis. The economy should constantly keep a
watch on the nature and the purpose of the short-term capital inflows, as ultimately, they have to be paid back from
national savings. A constant watch on factors like foreign reserves, external short-term debt, etc., which the
international investors regard to be fundamentals to the economy, is necessary. In the era of growing global
integration, while designing macro-economic policies - economic, monetary, fiscal, trade, and labour - currency
stabilization should be built into the stabilization programs and adopted as a continuous process, and not as a series
of discrete events, to take advantage of the process of liberalization. This study finally suggests some policy
measures to avoid reversal of investors' confidence, which is the major for cause currency destabilization.

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Exchange Rate and Macro-Economic Policy Management of

Some Selected Countries

2.2 Republic of China

2.2.1 Major Policy Reforms

2.3.1 Genesis of the Crisis

2.3.2 Major Policy Reforms

2.4.1 Genesis of the Crisis

2.4.2 Major Policy Reforms

2.5.1 Genesis of the Crisis

2.5.2 Major Policy Reforms

2.6 New Zealand

2.6.1 Major Policy Reforms

2.7 South Korea

2.7.1 Genesis of the Crisis

2.7.2 Major Policy Reforms

2.8.1 Genesis of the Crisis

Table 2.1: Returns to U.S. investments in the developing countries

2.8.2 Major Policy Reforms

2.9.1 Major Policy Reforms

2.9.2 Consequences of the Indian reforms

2.10 Lessons from a Comparative Study

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