EAST ASIA CRISIS

Main Reference:The Onset of the East Asian Financial Crisis

Steven Radelet and Jeffrey SachsHarvard Institute for International Development

March 30,1998

Introduction • East Asian Miracle• Types of Crisis• Beginning of Crisis• the role of financial panic as an essential element

of the Asian crisis.• Impact of Crisis• Role of IMF

East Asia Miracle

East Asian Countries• South Korea• Indonesia• Philippines• Thailand• Hong kong• Singapore• Malaysia• Taiwan

Source : Google Images

Four Asian Tigers• The Four Asian Tigers or Asian Dragons are

the highly developed economies of Hong Kong, Singapore, South Korea and Taiwan (Republic of China)

• These regions were the first newly industrialized countries, noted for maintaining exceptionally high growth rates and rapid industrialization between the early 1960s and 1990s.

• All four Asian Tigers have a highly educated and skilled workforce and have specialized in areas where they had a competitive advantage

Four Asian Tigers• Their economic success stories became known as

the Miracle on the Han River and the Taiwan Miracle and have served as role models for many developing countries, especially the Tiger Cub Economies.

• They sustained rate of double-digit growth for

decades.

• Each nation was non-democratic and relatively authoritarian political systems during the early years.

East Asia Miracle• Many factors have been identified as the

cause of East Asia's relative success - outward orientation, high saving and investment rates, macroeconomic discipline, and other good public policies

• Each focused on exports to rich industrialized nations.

• Each of the Asian Tigers had high tariffs on imports and undervalued currencies.

• They had high interest rates attractive to foreign investors looking for high rate of return.

GDP growth rate of Asian Countries

East Asian Crisis

Financial crisis is a situation in which some financial institutions or assets

suddenly lose a large part of their value.

It is a testament to the shortcomings of the international capital markets and

their vulnerability to sudden reversals of market confidence.

Diagnosing Financial Crises

• Five Type of Crisis1. Macroeconomic policy-induced crisis:

o Balance of payment crisiso currency depreciation;o loss of foreign exchange reserves;

2. Financial panic:o case of multiple equilibria in the financial

marketso short-term creditors suddenly withdraw their

loans from a solvent borrower

Diagnosing Financial Crises

3. Bubble collapse:o occurs when speculators purchase a financial asset at a

price above its fundamental value o In each period, the bubble may continue to grow, or may

collapse4. Moral-hazard crisis:

o arises because banks are able to borrow funds on the basis of implicit or explicit public guarantees of bank liabilities.

o undercapitalized or under-regulated banks may use these funds in overly risky or even criminal ventures

5. Disorderly workout:o occurs when an illiquid or insolvent borrower provokes a

creditor grab race o a forced liquidation even though the borrower is worth

more as an ongoing enterprise.

Before Crisis• Received large inflow of money• High growth rate (8-12%GDP)• Dramatic run up in asset prices• Increase capital investment• High per Capita Income• Thailand, Indonesia and South Korea had large

private current account deficit • It led to excessive exposure to foreign exchange

risk in both the financial and corporate sectors.

Beginning of Crisis• The rapid reversal of private capital inflows into

Asia.• Net private inflows dropped from $93 billion to

-$12.1 billion.• The sudden drop in bank lending followed a

sustained period of large increases in cross border bank loans.

• At the end of 1996, the proportion of loans with maturity of one year or less was 62% for Indonesia, 68% for South Korea, 50% for the Philippines, 65% for Thailand, and 84% for Taiwan.

Estimated breakdown of the reversal of flows

Per Capita GDP

Source : The onset of East Asia Crisis

Triggering Events• In early 1997 in Thailand Hanbo Steel, Sammi Steel

and Kia Motors collapsed.• These bankruptcies, in turn, put several merchant

banks under significant pressure• The Bank of Thailand lent over Bt 200 billion ($8

billion) to distressed financial institutions through Financial Institutions Development Fund (FIDF).

• The BOT committed almost all of its liquid foreign exchange reserves in forward contracts,

• usable reserve levels of Central Bank fell sharply

Other Events• In late June 1997, the Thai Government

removed support from a major finance company, Finance One.

• This shock accelerated the withdrawal of foreign funds, and prompted the currency depreciation on July 2, 1997.

• The Thai baht devaluation triggered the capital outflows from the rest of East Asia.

Causes of withdrawl• Bank failure. In Thailand, the failures of finance

companies helped set off the exodus.• Corporate failure. In Korea, the withdrawal of funds

was based on concerns over the health of the corporate sector.

• Political uncertainty: hastened the credit withdrawals, since each country faced the potential for a change in government.

• Contagion. Many creditors appeared to treat the region as a whole, and assumed that if Thailand was in trouble, the other countries in the region probably had similar difficulties.

• International Interventions. the IMF recommended immediate suspensions or closures of financial institutions, measures which actually helped to incite panic.

• The withdrawal of foreign funds triggered a chain reaction which quickly developed into a financial panic.

• The withdrawal of funds also set off a liquidity squeeze and a sharp rise in interest rates

• Offshore creditors grew reluctant to roll over short-term loans.

• The lack of clear bankruptcy laws and workout mechanisms

• The losses on foreign exchange exposure and the rise in non-performing loans eroded the capital base of the banks

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Mistakes in Policies• Rapid evolution into panic was aided by policy

misjudgements and mistakes across the region.• Thailand and Korea, to defend their

exchange rate peg, exhausted a substantial proportion of their foreign exchange reserves.

• Malaysia and Thailand introduced mild controls on foreign exchange transactions.

• Inflammatory statements by government officials and market participants added to the panicked withdrawal of funds

Element of Panic• The Asian financial crisis had substantial

elements of panic and disorderly workout.• The crisis was largely unanticipated.• The crisis involved considerable lending to

debtors that were not protected by state guarantees

• The sudden withdrawal of investor funds to the region, rather than simply a deflation of asset values

Effects on Countrieso What happened in Indonesia : • Drastic devaluation of the rupiah: from 2,000 to 18000

for 1 us$ • Sharp price increase • widespread rioting. o

What happened in S. Korea : • Drastic devaluation of the won: from 1,000 to 1,700 per

us$ • National debt to GDP ratio more than doubled. • Major setback in automobile industry.

Effects on Countrieso What happened in Philippines : • Growth dropped to virtually zero in 1998.• Peso fell significantly, from 26/us$ to 55/us$ .

o What happened in Japan : • 40% of Japan’s export go to Asia, so it was affected even if the

economy was strong • GDP real growth rate slowed from 5% to 1.6% .• Some companies went bankrupt • The Japanese yen fell to 147• Japan was the world's largest holder of currency reserves at the

time, so it was easily defended, and quickly bounced back.

Effects on Countries• What happened in Hong Kong : 

o Hong Kong dollar came under attack in November as a result of currency depreciations.

o Hong Kong banks faced steeply rising interest rates on liabilities

• What happened in Taiwan: o New Taiwan dollar also came under pressure

and fell sharply, despite Taiwan's huge stock of reserves.

Effects on Countrieso What happened in US… : • Markets did not collapse, NYSE severely hit • Dow Jones industrial average suffered as 3rd

biggest point losses • Relationship with JAPAN changed forever:

Source : The Onset of East Asia Crisis

Source : The Onset of East Asia Crisis

Effect on China• The Chinese currency, the renminbi (RMB), had

been pegged to the US dollar at a ratio of 8.3 RMB to the dollar, in 1994.

• Heavy speculation that China would soon be forced to devalue its currency to protect the competitiveness of its exports.

• RMB's non-convertibility protected its value from currency speculators, and the decision was made to maintain the peg of the currency, thereby improving the country's standing within Asia.

• China was unaffected by the crisis compared to Southeast Asia and South Korea.

Effect on GDP of India and East Asia

Effect on India• India was two large countries where GDP growth

was relatively unaffected by the East Asian crisis• India’s balance of payments (BoP) was also

spared the effects of the East Asian turmoil.• Indian rupee depreciated by 15% against the US

dollar, compared to declines of between 25 and 35% in the Thai, Malaysian, and South Korean currencies and a 70% fall in the Indonesian rupiah

Why was India not affected much?

• Floating exchange rate with some influence by the RBI during periods of crisis

• Strong fundamental growth with services sector being the prime reason

• External debt to GDP has been declining for the past few years

• India does not have capital account convertibility so capital outflows through a contagion effect could not destabilize the economy.

• Banks in India are discouraged from making investments in real estate and the stock markets, while corporate exposure to external debt has been controlled.

IMF role• Provided $120 billion as bailout package. Imposed

restrictive condition• IMF programs up till the end of 1997 apparently added

to the panic.• The IMF programs generally called for six key actions:

1. immediate bank closures; 2. quick restoration of minimum capital adequacy

standards; 3. tight domestic credit;4. high interest rates on central bank discount

facilities;5. fiscal contraction;6. non-financial sector structural changes.

• Domestic bank lending stopped abruptly in countries with Fund programs.

IMF role• The de-capitalized banks restricted their lending in order

to move towards capital-adequacy ratios required by bank supervisors and by the IMF.

• Currency depreciation and stock market collapse continued long after the programs were signed

• More bankruptcies

• Local called the financial crisis “the IMF crisis” due to its controversial role.

Why the Asian Crisis was not Predicted

• The Countries maintained good budgetary positions

• Domestic savings and investment rates were very high throughout the region

• Interest rates were usually less in rest of the world (US and Japan).

• Massive capital inflows were attracted into the region during the 1990s.

• Healthy Forex reserves – Thailand reached $38.6 billion in 1996 equivalent to over 7 months of imports

CONCLUSION• East Asian crisis resulted from financial panic that

arose from certain emerging weaknesses in these economies

• It could have been largely avoided with relatively moderate adjustments and appropriate policy changes.

• There were macroeconomic imbalances, weak financial institutions, widespread corruption, and inadequate legal foundations.

• Abrupt actions by domestic and international policy makers can worsen an incipient crisis, by helping to trigger the capital outflow

References• Main Reference: The Onset of the East Asian

Financial Crisis by Steven Radelet and Jeffrey Sachs

• IMF's Role in the Asian Financial Crisis by Walden Bello.

• India, the Washington Consensus and the East Asian crisis by C. Rammanohar Reddy

• http://wikipedia.en.org/• Google images