1. East Asian
Economic Crisis
HUL 214
International Economics
Made by:
Ankit Kumar (2010ME20765)
Vatsal Dusad (2010TT10971)
1
2. AGENDA
• Countries Affected
• Before the Crisis
• Causes
• Speculative Attacks
• Thailand
• Effects
• Asian Weaknesses
• IMF’s role
2
3. COUNTRIES AFFECTED
Thailand.
Hong Kong
Taiwan
Singapore
South Korea.
Malaysia
Indonesia.
3
4. BEFORE THE CRISIS
In 1993 the World Bank had coined the term the East
Asian Miracle to describe the vilified economies of the
South East.
From 1985 to 1996, growth rate averaging almost 9%
annually - increased pressure on Thailand's currency,
the Baht.
4
5. CAUSES
Domestic:
1.) Weak and ineffective govt policies
2.) Ill judgment of the banks and financial institutions
3.) Over-speculation in real estate and the share
market
4.) Collusion between governments and businesses
5.) The bad policy of having fixed exchange rates
6.) High current account deficits
5
6. CAUSES
Global financial system:
1.) Liberalisation across the world (as the legal basis)
2.) The increasing interconnection of markets and
speed of transactions through computer
technology (as the technological basis)
6
8. CAPITAL FLOW ACROSS BORDERS
Foreign exchange
transactions
Short-term
investments
8
9. SPECULATIVE ATTACKS
In the past also, countries had faced a similar fate -
sudden currency depreciations due to speculative
attacks or large outflows of funds.
Latin American countries 1980s
Mexico 1994
and Norway early 1990s
Depriciation - as a result of un-predicted inflow and
outflow on capital
9
10. SPECULATIVE ATTACKS
Capital flow in developing Asian countries
200
150
In US $ (billions)
100
50
0
1994-95 1996 1997 (first half) 1997 (second
-50 half)
-100
-150
10
11. THAILAND
• Started with Thailand
• Thailand was suffering from huge current
account deficit which was financed by short-
term capital inflows
• Baht was pegged to the USD
• Thai government was forced to float the baht -
due to lack of foreign currency to support its
fixed exchange rate
11
12. EFFECTS (In Asia)
Sharp reductions in values of
• currencies,
• stock markets,
• asset prices of several Asian countries.
The nominal U.S. dollar GDP of ASEAN (Association of
South East Asian Nations) fell by US$9.2 billion in 1997
and $218.2 billion (31.7%) in 1998.
12
13. EFFECTS (In Asia)
Per capita income in
• Thailand declined from $8,800 to $8,300 between
1997 and 2005;
• Malaysia it declined from $11,100 to $10,400.
The unemployment rate in Korea increased to 6.8 per
cent in 1998 and then to 8.4 per cent in the first
quarter of 1999.
The crisis also led to a dramatic rise in lending rates
within the region, especially in Indonesia and the
Philippines. 13
14. EFFECTS (Outside Asia)
After the crisis, international investors were reluctant
to lend to developing countries, leading to economic
slowdowns in developing countries in many parts of
the world.
Many nations learned from this, and quickly built up
foreign exchange reserves as a hedge against
attacks, including Japan, China, South Korea.
14
15. ASIAN WEAKNESSES
Weaknesses that became apparent after the crisis:
1. Productivity: economic expansion before crisis
later explained by the rapid growth of production
inputs (capital and labor) – but relatively little
increase in productivity
2. Banking Regulation: Ineffective government
supervision
3. Exchange rate regimes- Mostly pegged exchange
rate system.
4. Legal Framework: lack of structured legal
framework to deal with bankruptcy
15
17. IMF’s Role
• IMF treated the Asian financial crisis like other situations where
countries could not meet their balance of payment obligations with a
condition to adopt structural adjustment policies.
• But the Asian crisis differed from the normal situation of countries with
difficulties paying off foreign loans. The Asian governments were
generally not running budget deficits. Yet the Fund instructed them to
cut spending -- a recessionary policy that deepened the economic
slowdown.
• The Fund also failed to manage an orderly roll over of short-term loans
to long-term loans, which was most needed; and it forced
governments, including in South Korea and Indonesia to guarantee
private debts owed to foreign creditors.
17
18. IMF’s Role
• Malaysia stood out as a country that refused
IMF assistance and advice. Instead of further
opening its economy, Malaysia imposed
capital controls, in an effort to eliminate
speculative trading in its currency. Malaysia
generally suffered less severe economic
problems than the other countries embroiled
in the Asian financial crisis.
18
19. CONCLUSIONS
Capital-account liberalization
• In terms of govt. strategy, the more important
decision is not to become more open to
capital flows, but in the how those
governments chose to become more open.
• Focusing on those measures that will enable
an economy to be more flexible and to adapt
more quickly to change ultimately will be a
more effective policy strategy.
20. AFTERMATH
• Recovery in the Asian crisis countries took time, but it
was stronger and more rapid than had been typical in
other emerging market financial crises. Barely 18
months after the crisis, for example, Korean GDP had
returned to pre-crisis levels
• The countries directly affected by the crises a decade
ago are fundamentally stronger. The balance sheet
weaknesses have been transformed into strength.
• Stronger legal and institutional frameworks have
helped create an environment in which enterprise is
thriving.
East Asia was a booming part of the world. With high rates of saving and investmentTherefore, the crisis was not foreseen and took all the countries by surprise.
The great debate on causes is whether to entirely blame the domestic policies and practices.or to the intrinsic and volatile nature of the global financial system.Ineffective financial institutions: Indonesia did not monitor international capital flows, and, as a result, the authorities did not collect information concerning external borrowing by private corporations to use that information for macroeconomic management. In Korea, the system of licensing and supervision of merchant banks was inadequate.Fixed Exchange Rate - Fixed exchange rate arrangements provided a perception that foreign-currency–denominated loans were not risky for domestic borrowers or foreign lenders.
In Thailand, Indonesia and South Korea foreign exchange was made convertible with local currency not only for trade and direct-investment purposes but also for autonomous capital inflows and outflows.This facilitated the large inflows of funds in the form of international bank loans to local banks and companies, purchase of bonds, and portfolio investment in the local stock markets
When the currencies depreciated, the burden of debt servicing rose correspondingly in terms of the local- currency amount required for loan repayment.Private companies wanting to borrow foreign-currency loans exceeding RM 5 million (Malaysian ringgits) must obtain the Bank's approval. The banks would further approve only those investments that would generate sufficient foreign exchange receipts to service the debts. This ruling saved Malaysia from the kind of excessive short-term private-sector borrowing that led the other three countries into a debt crisis.
Only one to two percent is accounted for by foreign exchange transactions relating to trade and foreign direct investment. The remainder is for speculation or short-term investments that can move very quickly when the speculators' or investors' perceptions change.
Short term investments can’t be predicted and come as a surprise to most developing nations which are not prepared to deal with the consequences; it thus opens itself to the possibility of tremendous shocks and instability associated with inflows and outflows of funds.In the past also, countries had faced a similar fate - sudden currency depreciations due to speculative attacks or large outflows of funds.
These figures help to show: 1.)how huge the flows (in and out) can be; 2.)how volatile and sudden the shifts can be, when inflow turns to outflow; And we are mainly talking about the short term investments only 3.) when a market operational leader starts to pull out; a panic withdrawal triggers and alarge number of institutional investors and players start falling like a set of dominoes
Current a/c deficit:Reached a high of 8% in 1996The floating of the domestic currency led to it’s financial collapse.
Over the same period, world per capita income rose from $6,500 to $9,300.Korea - the annual average unemployment rate from 1989 to 1997 remained low at around 2.2 per cent of the labour forceThe value of Asian currencies had fallen, thus banks increased interest rates in order to make up for their losses.
The IMF treated the Asian financial crisis like other situations where countries could not meet their balance of payment obligations. The Fund made loan arrangements to enable countries to meet foreign debt payments (largely to private banks in these cases) on the condition that the recipient countries adopt structural adjustment policies.But the Asian crisis differed from the normal situation of countries with difficulties paying off foreign loans. For example, the Asian governments were generally not running budget deficits. Yet the Fund instructed them to cut spending -- a recessionary policy that deepened the economic slowdown.The Fund also failed to manage an orderly roll over of short-term loans to long-term loans, which was most needed; and it forced governments, including in South Korea and Indonesia to guarantee private debts owed to foreign creditors.Malaysia stood out as a country that refused IMF assistance and advice. Instead of further opening its economy, Malaysia imposed capital controls, in an effort to eliminate speculative trading in its currency. Malaysia generally suffered less severe economic problems than the other countries embroiled in the Asian financial crisis.
The more promising approach is to invest in the complement of institutions and policies that enable an economy to live more comfortably with openness. It is politically more difficult, but economically more effective than those solutions that seem to offer protection from competition and volatility.
Recovery in the Asian crisis countries took time, but it was stronger and more rapid than had been typical in other emerging market financial crises. Barely 18 months after the crisis, for example, Korean GDP had returned to pre-crisis levels, and this was true for all the Asian crisis countries by 2003. Growth has been relatively strong and stable since, though at a pace somewhat below the unsustainable rates of the decade prior to the crises. The countries directly affected by the crises a decade ago are fundamentally stronger. The balance sheet weaknesses have been transformed into strength. Financial-sector reforms have been undertaken on a generally impressive scale. Stronger legal and institutional frameworks have helped create an environment in which enterprise is thriving. Macroeconomic policy has been reasonably prudent, and debt-to-GDP ratios are declining. Exchange rate regimes have become more flexible.These changes have made these economies far more resilient than they were a decade ago. They are much less likely to face the type of crisis, the acute, self-reinforcing panic produced by the balance sheet problems of that era.Is there more to be done? Of course, but the challenge now is not so much the challenge of building stronger defenses against crisis, but rather the longer-term challenge of building a greater capacity to adapt to change in this increasingly integrated and rapidly evolving global economy.