A CASE ON SOUTH EAST ASIAN ECONOMIC CRISIS OF 1997

A CASE ON SOUTH EAST ASIAN ECONOMIC CRISIS OF 1997VAISHALIRIHEN BATRA[B. A. (H) ECONOMICS]The Asian Financial Crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown due to financial contagion.

Started in ThailandFloating the pegged currency Real estate driven financial over extensionExcessive foreign exposureResulting collapse of the Thai Baht

Also affected Indonesia, South Korea, Hong Kong, Malaysia, Philippines.

IMF $40 billion to stabilize their currencies

INTRODUCTION1960s 1990s: Thailand, South Korea, Hong Kong, Singapore, Taiwan, IndonesiaMaintained very high growth rates (8-12%)

Primarily due to:Maintained High Interest rates to attract foreign investmentsRapid industrializationIndustrial Policies supporting exportsBelow market interest rates for exporting industries, etc

THE ASIAN MIRACLEInitiated by two rounds of currency depreciation in 1997

First round was a precipitous drop in valueThai bahtMalaysian ringgitPhilippine pesoIndonesian rupiah

Second round began with downward pressures hittingTaiwan dollarSouth Korean WonBrazilian realSingaporean dollarHong Kong dollar

PHASESForeign Capital Inflows:US was in recession => Low interest ratesAsian Tigers - 50% of capital inflows in AsiaDramatic run-up in Asset prices

Pegged CurrenciesEncouraged external borrowing

High exports driving rapid economic growthExport to GDP ratio grew from 35% to 55%

Excessive exposure to forex movements

PRE CRISIS SCENARIOThailands economy bubble fuelled by Hot money

Debt-GDP Ratios went upto 180%

More and more was required as the bubble grew

Development money went in a largely uncontrolled manner to certain people only, not particularly the best suited or most efficient, but those closest to the centers of power.

Real estate speculation

Countries became excessively dependent upon exports for their economy

Very high leverage & exposure to forex risk

THE BUBBLEU.S. economyrecovered from a recession in the early 1990s,

Began to raise U.S. interest rates to head off inflation.This made the U.S. a more attractive investment destination relative to Southeast Asia, which had been attracting hot money flows through high short-term interest rates, and raised the value of the U.S. dollar.For Asian currencies pegged to the U.S. dollar, the higher U.S. dollar caused their own exports to become more expensive and less competitive in the global markets. At the same time, Southeast Asia's export growth slowed dramatically in the spring of 1996, deteriorating their current account position.

THE TIPPING POINTAsset prices began to collapseCausing individuals & companies to defaultPanic among lenders led to withdrawal of fundsCredit crunch & bankruptcies

Depreciative pressures on exchange rates

Government action:Raised interest rates tremendously to prevent capital flightBuying up excess domestic currency at fixed rate to maintain the peg

Not sustainable in the long run (due to limited supply of forex reserves)

Capital fleeing could not be stopped

Central bank allowed currencies to floatDrastic DepreciationFurther increasing the debt obligations and worsening the crisis

THE DOWN TURNOver $100billion was pulled out of the region in 1997-98 which was 5 percent of the GDP

Unemployment rose to 0.8milliom in Indonesia, 1.5 million in Thailand , 1.35million in Korea

Real wages dropped by 12.5% in Korea and 6% in Thailand

WAS THERE A CRISIS ?Prominent economy of South-east Asia.

During 1985-96 was growing at highest rate of 9%.

Real Estate sector was booming.

High interest rate attracted investments from US and west.

Export growth was very high.

THAILANDThailand Baht was pegged at 25 to US $.At the same time US had increased interest rate to curb inflation this made US investors to take their money from Thailand and invest in US.This trigger the outflow of $,resulted in devaluation of baht and it reached its lowest point of 56 units per $.This made foreign loan costlier by three times.It resulted in collapsed of various company and biggest financial corporation Finance One. There was fear among foreign investors about their money so they started pulling money from this markets.This deepens crisis, due to this many people lost their jobs.Political instability.

REASON FOR FAILUREDrastic devaluation of rupiah from 2000 to 18000 for 1US dollar

Excessive inflation

Riots

16 major commercial banks were closed

Governor, Bank Indonesia was sacked

President Suharto was forced to step down in may after 30 years in power

This conditions improved when IMF provided bailout package.

INDONESIA Won: from 1000 to 1700 for 1 US dollar

Credit rating of the country (moody's) : A1 to B2

National debt-to-GDP ratio more than doubled

Major setback in automobile industry (Daewoo motors sold to General motors)

SOUTH KOREAGrowth dropped to virtually zero in 1998

Peso fell significantly , from 26/US$ to even 55/ US$

President Joseph Estrada was forced to resign

Stock market fell to 1000 points from 3000

Raised interest rates by 3.75%

Overnight rates jumped from 15% to 32%

Huge outflow of money

PHILIPPINESAttacked by Speculators

Overnight rates jumped from 8% to 40%

Stock markets fell by 50% from 1200 to 600

All sectors were hurt, construction sector contracted 23.5%, manufacturing shrunk 9% and the agriculture sector 5.9%

3.80 peg against dollar

First ever recession

MALAYSIAThe 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. The policies being:Reduce SpendingPrivatizationHeavy Taxation

IMF INTERVENTIONIn South Korea, a country whose income approaches European levels, unemployment skyrocketed from approximately 3 percent to 10 percent. "IMF suicides" became common among workers who lost their jobs and dignity.

In Indonesia, the worst hit country, poverty rates rose from an official level of 11 percent before the crisis to 40 to 60 percent in varying estimates. GDP declined by 15 percent in one year.

In September 1998, UNICEF reported that more than half the children under two years old in Java, Indonesia's most populous island, were suffering from malnutrition.

At one point, the food shortage became so severe that then-President B.J. Habibie implored citizens to fast twice a week. Many had no choice.

IMPACT OF IMF INTERVENTIONHigh saving and investment rateStrong emphasis on educationStable macroeconomic environmentFree from high inflation or major economic slumpsHigh share of trade in GDP

OVERCOMING THE CRISISOver dependence on foreign capital, especially short-term foreign capital, makes an economy and its exchange rate vulnerableForeign direct investment is better than foreign portfolio investment or loans because it is less mobileLong-term loans is better than short-term loans because they are not subject to immediate withdrawalCurrency and maturity mismatch by domestic borrowers aggravates the problemShort-term foreign-currency denominated loans should be carefully monitored and controlled in order to avoid the compounding of currency mismatch by maturity mismatchShort-term foreign funds are inherently different from short-term domestic funds because the former is much more likely to leave at the first sign of real or imagined trouble

LEARNINGSAs was the case in 1997/98, markets are in a certain state of disarray. Today we have concerns over the extent of the Chinese slowdown, the reversion in the Euro area towards stagnation along with rising deflationary risks, and the drive (aided and abetted by the Organization of the Petroleum Exporting Countries) for substantially lower petrol prices.PRESENT SCENARIO