A Comparative Study of East Asia and India

Avinash ChandiramaniScott Dicks

Erin FitzpatrikSalil JayakarRuhi Khan

Chad Simon

Disaster Strikes East AsiaDisaster Strikes East Asia

Decades of impressive growth

The intensity and the duration of the crisis were inconceivableThe effects of the crisis spread through the Global economy

THE INDIAN ECONOMY ESCAPED THE CRISIS THE INDIAN ECONOMY ESCAPED THE CRISIS VIRTUALLY UNHARMEDVIRTUALLY UNHARMED

Crisis

Financial Markets Currency markets

AgendaAgenda

INTRODUCTION TO THE CRISISINTRODUCTION TO THE CRISIS Macroeconomic fundamentals Theories

FINANCIAL AND TRADE LIBERALIZATIONFINANCIAL AND TRADE LIBERALIZATION Banking Sector Capital flows Debt / equity markets Real Trade Linkages

EXCHANGE RATE REGIMESEXCHANGE RATE REGIMES Foreign reserves Banking sector Financial sector Trade

CONCLUDING REMARKS CONCLUDING REMARKS

– Bankruptcy rates skyrocket– Stock markets crash– Growth rates tumble– Currency speculation forces Thai Baht

depreciation

Introduction to the CrisisIntroduction to the Crisis

THIS IS A TRIGGER FOR THE CRISIS

1997: East Asia falls into crisis

- Following this, Malaysia, Indonesia and Philippines allow depreciation

-China, Hong Kong, Korea, Singapore and Taiwan

Introduction to the CrisesIntroduction to the Crises

TIGERS PAPER TIGERS

CREDIT CRUNCH

East Asia India

GDP Growth Exceptional Moderate

Inflation Low Low

Saving Rate High High

Current Account Deficit

Over 5 % of GDP Under 5 % of GDP

Exchange Regime Pegged Floating

Trade Very Important Less Important

Macroeconomic FundamentalsMacroeconomic Fundamentals

• Dramatic increase in credit

• Socially Risky behavior encouraged

• Moral hazard by monetary authorities

Bad Policy TheoryBad Policy Theory

Intense Liberalization

+

Inappropriate Policies

= Crisis

Financial Panic TheoryFinancial Panic Theory

Downturn in Real Economic Variables (GDP)

Systemic Risk

Expectations of Instability

Coordination Failure

Inherent Instability of Financial Markets

+

Loss of Investor Confidence= Crisis

Moral HazardMoral Hazard

Two Types:

“A situation which creates incentives to engage in risky

behavior. Decreased personal liability acts as an incentive”

Corporate Level

International Level

ContagionContagion

“The transmission of shocks to other countries or the cross-country correlation, beyond any fundamental link among the countries and beyond common shocks.”

This definition is usually referred to as excess co-movement, commonly explained by herd behavior.

Liberalization PolicyLiberalization Policy

• Banking sector• Privatization

• Capital Flows

• Debt/Equity Markets• Capital Account Convertibility (CAC)

• Introduction of financial institutions

Liberalization PolicyLiberalization Policy

Liberalization Policy

An influx of capital

More efficient and competitive markets

but…

Proper regulation is needed

Banking SectorBanking Sector

East AsiaEast Asia

High level of privatization

Regulation was not enforced&

Little diversity in investment

IndiaIndia

Low levels of privatization

Increased supervision&

Diversity in investments

Morally hazardous behavior Less moral hazard

ImplicitGuarantee

Capital FlowsCapital Flows

East AsiaEast Asia

Full Capital Account Convertibility

IndiaIndiaPartial Capital Account

Convertibility

Turnaround of short term capital flows

Less dependence on short term capital

Increasing portfolio investment

No change in portfolio investment

Debt/ Equity MarketsDebt/ Equity Markets

Financial assetsas collateral for loans

Corporate bankruptcy in East Asia

Ineffective rating and regulation agencies

Overvalued stock markets

Real Trade LinkagesReal Trade Linkages

Trade makes uplarge % of GDP

Trade makes up small % of GDP

East AsiaEast Asia IndiaIndia

Investors group Asian economies

India was not connected with East Asia

Competitive exports to similar countries.

Similar trading partners

Different exports than East Asia

Small amount of trade with East Asia

Exchange Rate RegimesExchange Rate Regimes

Pegged Exchange Rate RegimesPegged Exchange Rate Regimes

Advantages

• Associated with stability and low inflation

• Forces authorities to adhere to disciplined monetary and fiscal policies

Disadvantages

• Misalignments may occur when foreign and domestic countries face different economic conditions

• Maintaining pegs in the face of increased speculation can be costly

MOST EAST ASIAN COUNTRIES ADOPTED PEGGED RATES

Exchange Rate RegimesExchange Rate Regimes

Floating Exchange Rate RegimesFloating Exchange Rate Regimes

Advantages

• Currency moves with the relative performance of the economy

• Serves as an adjustment mechanism, insulating a currency from speculative attacks.

Disadvantages

• Fluctuations may reflect non-fundamental noise

INDIA ADOPTED A FLOATING EXCHANGE RATE IN 1994

Foreign Reserves

East Asia India

1990-96: foreign reserves grew

Short term debt rising

Capital Outflows in ‘97 reserves decrease

Pegs unsustainable depreciation

India’s reservesalso grew

India discouraged short term debt

Capital Inflows in ’97 reserves increase

Floating rate No dramatic depreciation

Banking Sector

East Asia India

Depreciation foreigndenominated debts

unsustainable

1997: High levels ofnon-performing assets

Decreased credit by banks

No depreciation Foreign debts sustainable

1997: Lower levels ofnon-performing assets

No decrease in credit by banks

Financial Sector

East Asia India

Switch to floating exchange rate rapid

depreciation, uncertainty

Further capital outflow ensued

India’s exchange rate provided a greater

predictability

1997 experienced an increase in capital inflows of 24%

Trade

East Asia India

Crisis depreciations did not competitiveness:

1. High levels of intra- regional trade

2. Increased cost of raw material imports

Trade played less influential role in Indian

economy

No dramatic swing in rates to alter competitiveness

Trade played an influential role in East

Asian economies

ConclusionConclusion

The financial crisis reflects three important The financial crisis reflects three important considerationsconsiderations

• Liberalization

• Exchange rate regimes

• Combination of the above two

Liberalization

• Partial capital account convertibility

• Less dependence on short term flows

• Diversified allocation of capital

ConclusionConclusion

ConclusionConclusion

Exchange Rate Regimes

East Asia

Pegged currency increased risk of speculative attack

India

Float allowed currency to reflect economic fundamentals

Combined EffectCombined Effect

FULL CAPITAL ACCOUNT CONVERTIBILITY

+

PEGGED EXCHANGE RATE

=

SPECULATIVE ATTACK

ConclusionConclusion

ConclusionConclusion

The East Asian and the Indian economies are fundamentally different and are at

different stages of growth and liberalization.

Summing up:

RecommendationsRecommendations

Considerations relevant for economic and financial policy:

• Controls on capital account convertibility or a

commitment to flexible exchange rates

• Less dependence on short term capital inflows

• Enforce regulation policies in financial and banking

sectors

• Increased transparency in all transactions

Any Questions?

Trade as a % of GDP (1997)Trade as a % of GDP (1997)

0

50

100

150

200

East Asia Trading Partners (1997)East Asia Trading Partners (1997)

0%

10%

20%

30%

40%

50%

United States East Asia (Including Japan)

India

Portfolio Investment as a % of GNPPortfolio Investment as a % of GNP

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

1990 1991 1992 1993 1994 1995 1996

IndiaEA Average

1994 1995 1996 1997 1998Korea 7.00% 5.00% -3.00% -62.00% 13.00%Malaysia 90.00% 44.00% 67.00% 37.00% -49.00%Thailand 53.00% -38.00% -27.00% 19.00% -21.00%

% Change in Credit from Deposit Money Banks

Credit ContractionCredit Contraction

Currency Depreciation Currency Depreciation

R2 = 0.998

0

5000

10000

15000

20000

25000

30000

1990 1991 1992 1993 1994 1995 1996 1997Year

$ m

ill.

SD

RS

KoreaMalaysiaThailandAVGIndonesiaPoly. (AVG)

International Reserves International Reserves ($mill. SDRS)($mill. SDRS)

0

5

10

15

20

25

30

1990 1991 1992 1993 1994 1995 1996 1997

Year

India’s International Reserves India’s International Reserves (USD$billions)(USD$billions)

9

1716 16

19

0

2

4

6

8

10

12

14

16

18

20

1

India

Indonesia

Korea

Malaysia

Thailand

% of Non-Performing Bank Assets in 1997% of Non-Performing Bank Assets in 1997

1994 1995 1996 1997India 42.11% -30.97% 35.47% 24.40%Indonesia 631.57% 48.78% 40.29% -32.81%Korea, Rep. 102.25% -37.02% 89.00% -37.94%Malaysia -24.89% 19.44% 26.75% -27.28%Thailand -41.21% 126.29% 35.23% -74.61%Philippines 18.39% 11.41% 15.76% -16.53%

% Change in Private Capital Flows

Capital OutflowsCapital Outflows

Foreign Res. ST Debt Foreign Res. ST Debt Foreign Res. ST DebtIndonesia 14.7 27.6 19.3 34.2 20.3 34.7

Korea 32.7 54.3 34.1 67.5 34.1 70.2

Thailand 37.0 43.6 38.7 45.7 34.1 67.5

Average 28.1 41.8 30.7 49.1 29.5 57.51 to 1.49 Ratio 1 to 1.60 Ratio 1 to 1.75 Ratio

End 1995 End 1996 Mid 1997

Foreign Reserves & Short Term Debt

Values in billions of US$

1990 1991 1992 1993 1994 1995 1996 1997

Inflation 8.97 13.87 11.79 6.36 10.21 10.22 8.98 7.36

Gross National Savings

21.99 22.20 22.43 20.70 28.90 25.37 23.92 22.57

Overall Budget Surplus

8.12 5.81 5.65 7.47 5.89 5.35 5.19 4.86

Selected Macroeconomic VariablesSelected Macroeconomic Variables

(India)(India)