Washington Consensus implemented by emerging markets refers to economic policies created by John Williamson (Hooper, 2002; Rodrik, 2006). It is based on financial liberalization theory of McKinnon and Shaw, which emphasis on freeing financial markets from government intervention. Financial liberalization theory assumed perfect financial markets with perfect information, perfect competition and depends on institution-free analysis (Demetriades, 1999). These assumptions are irrelevant in the sense that market, as a whole is imperfect. Despite these deficiencies, emerging countries agree to implement Washington Consensus requested by International Monetary Policy (IMF) and World Bank as part of their loan contracts. According to Washington Consensus, emerging economies facing similar problems with developed markets should be treated with the same tools. Washington Consensus aims to encourage privatization with high level of economic openness. There are many criticisms regarding the policies content of Washington Consensus. Some critics argue that the policies are not being devised in a sequentially correct manner and did not consider emerging markets’ development stage (Hooper, 2002). There are several impacts of the implementation of Washington Consensus upon the emerging capital markets namely worsen economic growth and increase stock market’s volatility.
Implementation of the Washington Consensus through financial liberalization has affected economic growth of emerging capital markets. Financial liberalization is developed in the objective of improving economic growth by encouraging saving, investment and capital productivity. Before financial liberalization is introduced, many developing countries encounter financial repression, which is the process where government intervenes in the economy (Demetriades, 1999). In 1960s and 1970s, government intervention was needed to control pegged exchange rates under Bretton-Wood regime. Government controlled the markets by allocating high reserve requirement, interest rates ceiling, and controlling capital, credit as well as exchange rate. These interventions led to disequilibrium in interest rate, for example, interest rates were below equilibrium level (Hooper, 2002). In order to curb the problem, financial liberalization is introduced, for instance, by setting higher interest rates. High interest rates were aimed to encourage savings, which will attract investment through borrowing and thus improved economic growth. Unfortunately, financial liberalization did not result in greater savings instead high interest rate can destroy reformation in real sector (Hooper, 2002). In addition, financial liberalization exacerbates economic growth in the sense that ratio of reserves to foreign denominated short-term indebtedness had declined substantially (Stiglitz, 2000). Washington Consensus suggests emerging capital markets to deregulate their economies in order to achieve economic growth. However, lack of comprehensive regulation has led to Asian Financial Crisis in 1997. Moreover, dampen economic growth during Asian Financial Crisis came from maturity and currency mismatch. For example, long-term investment in local currency financed short-term liabilities in dollars. Besides, Washington Consensus did not emphasis on capital flow structure in liberalizing capital flows. Many emerging capital markets destabilized due to high level of capital flows. In Latin America (1980), economic crisis was a result of cash flow structuring problem with the increase in portfolio equity to replace portfolio debt. Asian Financial Crisis 1997 has been deteriorated due to regular flows of money between financial markets. This term hot money will flow from countries with low return to countries with the highest interest rates as banks attempt to get highest return as possible. These flows can affect balance of payments if exchange rates in the total is high (Hooper, 2002). Thus,...
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