The Origin Of Asian Crisis Essay, Research Paper

PART 1 THE ORIGIN OF ASIAN CRISIS Which nations and regions are involved in the Asian Crisis? The nations and regions involved in the Asia Crisis are Thailand, Malaysia, Philippines, Singapore, South Korea, Japan, Hong Kong and Tai Wan. The maps are shown on appendix. What happened in the Asian crisis? 1. Summary of the crisis The Asian crisis happened in 1997. The year of 1997 was supposed to have been a year of celebration for Southeast Asia-30 years of glorious economic boom. Instead, it went wrong. The crisis erupted in Thailand in the summer of 1997. Starting in 1996, a confluence of domestic and external shocks revealed weaknesses in the Thai economy that until then had been masked by the rapid pace of economic growth and the weakness of the U.S. dollar to which the Thai currency, the baht, was pegged. To an extent, Thailand’s difficulties resulted from its earlier economic success. Strong growth, averaging almost 10 percent per year from 1987- 95 and generally prudent macroeconomic management, as seen in continuous public sector fiscal surpluses over the same period, had attracted large capital inflows, much of them short-term and many of them attracted by the establishment of the Bangkok International Banking Facility in 1993. And while these inflows had permitted faster growth, they had also allowed domestic banks to expand lending rapidly, fueling imprudent investments and unrealistic increases in asset prices. Past success also may have contributed to a sense of denial among the Thai authorities about the severity of Thailand’s problems and the need for policy action, which neither the IMP in its continuous dialogue with the Thais during the 18 months prior to the floating of the baht in July 1997, nor increasing exchange market pressure, could overcome. Finally, in the absence of convincing policy action, and after a desperate defense of the currency by the central bank, the crisis broke. 2. Chronology of the crisis + The first phase In July, on July 2, the Bank of Thailand announces a managed float of the baht and calls on the International Monetary Fund for ‘technical assistance.’ The announcement effectively devalues the baht by about 15–20 percent. This is a trigger for the East Asian crisis. It also caused panic in several neighboring countries. For an export- dependent Asia, as many countries in the region compete in similar products and regional markets (US, Europe and Japan), while the currency of Thailand start to depreciate, contagion to other economies in the region appeared relentless. And the speculators grew confident following their success at bringing down the baht and looked for more targets. Under intensive pressure, the region’s currencies snapped one by one. On July 9, Philippine president Fidel Ramos ruled the value of the peso. Two days later, he gave in. The Philippine central bank says in a statement that it will allow the peso to move in a wider range against the dollar. The same day, in Indonesia the rupiah is starting to be affected, Jakarta widened the rupiag’s trading bands. Three days later, it was Malaysia’s turn, with Malaysian central bank giving up its expensive defense of the ringgit and letting market pressure take hold. On July 17, the Singapore monetary authority allows the depreciation of the Singapore dollar. It falls to lowest level since February 1995. Then on July 21, Indonesia abandoned its crawling peg altogether. On July 24, Currency meltdown sweeps Asia. Within days, Malaysian Prime Minister Mahathir Mohamad accuses American trader George Soros of causing the Malaysian ringgit’s fall. Soros denied the charge. In August, on August 5, the Thailand unveils austerity plan and complete revamp of finance sector as part of IMF suggested policies for a rescue package. Central bank suspends 48 finance firms. On August 11, the IMF unveils in Tokyo a rescue package for Thailand including loans totaling $16 billion from the IMF and Asian nation. On August 13, The Indonesian rupiah begins to come under severe pressure. It hits a historic low of 2,682 to the dollar before ending at 2,655. The central bank actively intervenes in its defense. On August 15, Speculators attack Hong Kong dollar; overnight interest rates up 150 basis points from previous day to 8%. Stock market sharply lower. On August 20, IMF approves a $3.9 billion credit for Thailand. The package now totals $16.7 billion. On August 23, Malaysian PM Mahathir Mohamad blames US fianncier George Soros for leading attack on East Asian currencies: “All these countries have spent 40 years trying to build up their economies and a moron like Soros comes along”. In September, on Sept. 4, Carnage in the Philippine peso continues. It falls to a record low of 32.43 to the dollar before central bank intervention helps it up slightly to end at 32.38. On Sept. 16, Indonesia says it will postpone projects worth 39 trillion rupiah in an attempt to slash the budget shortfall. On Sept. 20, Mahathir tells delegates to the IMF/World Bank annual conference in Hong Kong that currency trading is immoral and should be stopped. In October, on Oct. 1, Mahathir repeats his siren call for tighter regulation, or a total ban, on foreign exchange trading. On Oct. 8, Indonesia says it will ask the IMF for financial assistance. On Oct. 14, the devaluation of the Taiwan dollar begins, which created doubt about Hong Kong changing its long-standing peg to the U.S. dollar. On Oct. 17, Malaysia presents a belt-tightening budget to try to stop the economy sliding into recession. On Oct. 20-23, the Hong Kong stock market suffers its heaviest drubbing ever, shedding nearly a quarter of its value in four days on fears over interest rates and pressures on the Hong Kong dollar. The fall, more severe than the 1987 crash, forces the Hang Seng index 23.34 percent down to 10,426.30. On Oct.27, stock markets throughout Latin America suffered record losses as Asia’s markets crisis rippled to other vulnerable emerging markets and investors frantically sold their holdings. On Oct. 31, IMP gives Indonesia $23B financial support package. The International Monetary Fund announces a $23 billion multilateral financial package involving the World Bank and Asian Development Bank to help Indonesia stabilize its financial system. The United States is willing to lend about $3 billion to Indonesia to back up the loan from the International Monetary Fund to help Indonesia stabilize its financial system. In November, on Nov.6, The Bank of Korea once again intervened in an attempt to halt the local currency’s slide versus the dollar. In fact Korea suffered a dramatic loss of competitiveness during the summer months because the large devaluation of its regional trade competitors implied an effective real appreciation of the won and loss of competitive position. On Nov. 8, market prices fell sharply as foreign investors pulled out, fearing South Korea faced an economic crisis on the scale of Southeast Asia’s. And Taiwan’s stock and currency markets plunged as traders cited fears that a collapse in the won would wipe out Taiwan’s competitiveness against South Korea in key industries such as electronics and refining. A weaker woe would likely force Japan to weaken the yen against the dollar as well, in order to keep its exports competitive in world markets. On Nov 20, dashing any early hope for controlling its financial turmoil, South Korea’s currency fell 10% in trading, a day after the country unveiled an emergency bailout package. Most regional currencies fell sharply following fall in the Korean Woe. South Korea acknowledged that it could not resolve its trouble without outside help, and South Korea begins talks with IMF for tens of billions in emergency aid. On Nov. 25, the yen tumbled to its lowest level against the dollar in more than five years and Tokyo stocks plunged five percent. Tokyo City Bank, a regional Japanese bank, closed. In December, on Dec. 3, Seoul agrees on 55 billion dollars international bailout package, IMF condition. On Dec. 11, ripples from South Korea’s economic crisis spread throughout Asia as Asian stock markets wilted from the contagion effect. Traders said equity investors throughout the Pacific Rim could not afford to ignore the economic meltdown currently occurring in South Korea. The ravaging of South Korea’s financial markets continued as the tide turned against the country’s effort to regain foreign confidence in its economy. The stock market slumped nearly six percent. On Dec. 17, Japan announces new measures including cut in income tax, bowing to foreign and domestic pressure to rescue Japan’s faltering economy, Japanese Prime Minister announced a special two billion yen ($15.7 billion) cut in personal income taxes. Stock market rallies, then weakens. On Dec.18, fed up with their economy’s falling, voters in South Korea elected longtime dissident Kim Dae-jung to serve a five-year term as president, leaving some concerned that the country’s financial markets will be further battered.

+ The second phase The management of the crisis entered a second phase on December 24. With Korea on the brink of default, the U.S. Government (led by the Federal Reserve Board and U.S. Treasury) decided to press the foreign commercial banks to roll over their short-term credits on an enforced basis, rather than waiting for market confidence to be restored. Initially, the banks and the Korean Government announced a standstill on debt servicing, pending a formal agreement. Till early 1998, the IMF provided $36 billion to support reform programs in the three worst-hit countries–Indonesia, Korea, and Thailand. The IMF gave this financial support as part of international support packages totaling almost $100 billion. In these three counties, unfortunately, the authorities’ initial hesitation in introducing reforms and in taking other measures to restore confidence led to a worsening of the crisis by causing declines in currency and stock markets that were greater than a reasonable assessment of economic fundamentals might have justified. This overshooting in financial markets worsened the panic and added to difficulties in both the corporate and financial sectors. In particular, the domestic currency value of foreign debt rose sharply. While uncertainties persisted longer in Indonesia, strengthened commitments were made elsewhere to carry out adjustment reform. And the Asia’s crisis may not be over yet. On June 11, the Japanese yen falls to an eight-year low against the U.S. dollar, driving down the prices of stocks and currencies around the world. On August 11, deepening gloom about the Japanese economy sends the yen tumbling to another eight-year low, and stock markets plunge around the world-including in the United Stated -in a dramatic display of financial contagion. On November 5, Japan’s already-low interest rates fall below zero on certain types of borrowing. What caused the Asian crisis? The Asia financial crisis is remarkable in several ways. The crisis hit the most rapidly flowing economies in the world, and prompted the largest financial bailouts in history. It is the sharpest financial crisis to hit the developing world since the 1982 debt crisis. It is the least anticipated financial crisis to hit the developing world since the 1982 debt crisis. It is the least anticipated crisis in years. What were the causes of the Asian economic, currency and financial crisis? There is multifaceted evidence about it. According to one view, sudden shifts in market expectations and confidence were the key sources of the initial financial turmoil, its propagation over time and regional contagion. According to other view, the crisis reflected structure and policy distortions in the countries of the region. Fundamental imbalances triggered the currency and financial crisis in 1997, even if, once the crisis started, market overreaction and herding caused the plunge of exchange rates, asset prices and economic activity to be more severe than warranted by the initial weak economic conditions. We identify five main types of reason for the crisis. + Large currency appreciation in the 1990s Several Asian currency had appreciated in real terms in the 1990s and large growing current account imbalances had emerged in the countries that faced a speculative attack in 1997. Between 1990 and 1997, the real appreciation in several countries whose currencies collapsed in the crisis exceeds 25 percent and especially rapid after 1994, when the US dollar began to appreciate against other major world currencies. The overvalue was due in part to the widespread choice of fixed exchange rate regimes in the region and the related large capital inflows in the 1990s. It was clear that several regional currencies were seriously overvalued and that such overvaluations appeared to be increasing needed to adjust the current account position to the deficit countries. + Large current account imbalance and related growth of foreign debt The current account imbalance and related growth of foreign debt was also driven by investment boom (as well as a consumption boom). The Asian countries were characterized by very high rates of investment throughout the 1990s, In most countries these rates were well above 30% of GDP. Such investment boom was excessive and often in wrong sectors (non-traded goods, real estate, speculative assets build-up). + Moral hazard problem created by government Because of a moral hazard problem created by government promises of a bailout, banks borrowed too much from abroad and lent too much for investment projects that were too risky, moreover, the interest rate at which domestic banks could borrow abroad and lend at home was too low (relative to the risks of the projects being financed) so that domestic firms invested too much in projects that were marginal if not outright not profitable. Once these investment projects turned out not to be profitable, the firms (and the banks that lent them large sum) found themselves with a huge amount of foreign debt (mostly in foreign currency) that could not be repaid. The exchange rate crisis that ensued exacerbated the problem as the currency depreciation dramatically increased real burden in domestic currencies of the debt that was denominated in foreign currencies. + Much borrowing and lending fund was to finance speculative asset A significant fraction of the borrowing and lending was not going to finance new investment projects (that would have increased the stock of capital); instead, the loans were financing speculative demand of assets in fixed supply (land, existing real estates, the outstanding stock of equity). Evidence on this is provided by the movements of asset prices (especially stock markets, land values and real estate prices) that were increasing faster than warranted by economic fundamentals. The asset price bubble (in stock markets, land and real estate prices) was fed by the excessive borrowing by banks in international capital markets; therefore, part of the accumulation of foreign liabilities went to the financing of the speculative asset bubble. When this bubble burst in 1997, the firms, banks and investors that had borrowed these funds were left with a large stock of foreign debt that could not be easily repaid. Again, the collapse of the currencies worsened this debt problem by increasing the real burden of the foreign liabilities. + Contagion of financial crisis in the region In order to understand the currency crisis in 1997 and its contagion from one country to the other, it is important to notice that the depreciation of some regional currency appreciated the “effective” real exchange rate and worsened the competitiveness of the other countries in the region that had not depreciated yet. As one after the other, the currencies of countries that were competing in the same world market came under attack and started to depreciate, the equilibrium fundamental value of other currencies that had not depreciated yet started to become lower and the pressure on such currencies to depreciate to regain some of the competitiveness loss became even higher. This game of competitive devaluation is an important factor that explains why the currency contagion and the domino effects were driven by fundamental factors rather than irrational contagion.