The Asian Debt Crisis of the 1990's

THE ASIAN DEBT CRISISNitesh Kumar

Sameer Verma

Ashutosh Bharadwaj

THE STORY OF A BOOM AND A BUST AND THE CASCADE EFFECTCONTENTS:

The anatomy of a disaster The boom years and the end of the beginning The beginning of the end The bust: And it all came falling down Contagion and aftermath Lessons and reflections

ASIAN TIGERS :THE ECONOMIC MIRACLE

PROLOGUE: TIMES ARE GOOD IN THAILAND!

Emerged as a major Industrial centre for Japan in the 1980s.

Most investment is based on personal or institutional savings, less of debt and more of security.

The Thai Baht is pegged to the dollar in order to make investors confident and encourage trust.

BUT WHY INVEST IN SOUTH EAST ASIA?

Low interest rates in the developed world: FII’s looking towards ‘emerging markets’

After the Latin American debt crisis, Investors looking for alternate, safer destinations

The end of the cold war makes foreign investments seem to be more secure

AND SO THEY CAME IN DROVES!

Capital inflow 1997:$256 Billion

Capital inflow 1990:

$42 Billion

Availability of credit

Real estate boom

Economic

growth

THE FUNDAMENTS OF PEGGING A CURRENCY:

THE FLOATING CURRENCY REGIME

Demand Supply

In a floating currency regime the value of a currency is decided by

the laws of demand and supply and is dynamic.

THE FUNDAMENTS OF PEGGING A CURRENCY:

THE FIXED OR PEGGED CURRENCY REGIME

The government through a central bank maintains the value of the currency with reference to

another (Commonly the dollar)25 baht = 1 US $

THE FUNDAMENTS OF PEGGING A CURRENCY:THE FIXED OR PEGGED CURRENCY REGIME

• FII’s convert their dollars to Baht so that they can invest in Thailand

Inflow of foreign funds

THE END OF THE BEGINNING! 1996 A BUBBLE EMERGES

Investments and rise in affluence increased imports and hence the trade deficit

Rise in wages make Thai goods less competitive and exports affected

Dubious ‘Finance companies’ encourage real estate and stock bubbles

THE BEGINNING OF THE END! 1996 - 1997

Devaluation of the Yen makes south east Asia less

attractive

Speculators start going bust and financial

companies go under, investor confidence slides

The housing and stock market bubbles burst,

investors start pulling out

INTERLUDE: CRONY CAPITALISMTHE TOPI GAME AND THE PONZI SCHEME!

THE THAI GOVERNMENT: IN BETWEEN A ROCK AND A HARD PLACE!

Option one: Increase interest rates to attract and retain investment• Will negatively affect the economy and

hit businesses that are already suffering

Option two: Let the currency slide• Dollar debts of Thai companies would

magnify, government reputation tarnished

TO FLOAT OR NOT TO FLOAT, THAT IS THE QUESTION!

Indecision by the Thai government to devalue currency encourages speculation against the baht• Businessmen and hedge funds sell

Baht to buy dollars, buy US Bonds• Further pressure on the Baht and

central bank, foreign exchange reserves plunge

THE ‘LONG’ AND ‘SHORT’ OF SPECULATION AND THE HEDGE FUND

Long: Stocks or real estate purchased at market price and sold when the rate rises to make a profit

Short: You borrow stocks for some time, sell them and invest the proceeds. If the stocks lose value you gain as you purchase them at a lower price

INTERLUDE: HOW GEORGE SOROS CONQUERED BRITAIN! In 1990 as part of the European Monetary

Exchange Rate Mechanism (ERM) Britain forced to keep its currency pegged at a high rate. Due to a recession it was inevitable that the pound would float sooner or later

The Quantum fund with a credit line of $15 Billion establishes itself long in dollars and short in Pounds

A high profile media attack further hits the pound, Britain spends $50 billion to peg the Pound and has to give up and make the currency float

Soros gains $ 1 Billion!

INTERLUDE: THE HONG KONG PUNTER PARTY! (HEAD I WIN, TAIL YOU LOSE)

Short in stocks and buy dollars, if interest rates

are raised stocks fall and

they gain

Long is dollars so if currency is devalued they gain as well

In 1998 Hong Kong is hit by the financial crisis, the government would either raise interest rates or make the currency float. Hedge funds take advantage of this

THE BUST: AND IT ALL CAME FALLING DOWN

2nd July 1997 Thailand lets the baht go

The value plunges

50% (expected fall 15%)

Interest rates raised

sharply to avoid a

meltdown

THE VICIOUS CIRCLE OF A FINANCIAL CRISISFinancial problems

for companies, banks, households

Plunging currency, rising interest

rates, slumping economy

Loss of Confidence

CONTAGION AND THE RIPPLE EFFECT

Indonesian Rupiah plunges by 30 %Faces the worst financial crisis inworld history

Currency crisis in Malaysia

Crisis even spreads to South Korea

REASONS FOR THE RIPPLE EFFECT

Direct trade links between

countries

Southeast Asian

investment funds lumped as ‘Emerging Market Funds’

The ‘Asian miracle’

perception collapses in the

mind of investors

POSTMORTEM: SO WHY DID IT HAPPEN?

External factors •Devaluation of the Japanese and Chinese currency makes exports less competitive •Cheap Chinese labor

Cronyism and corruption •So called ‘financial companies’ affiliated to politicians, large scale scams and embezzlement

Panic! •Badly run economies more susceptible to panic•Flimsy economies crash like a pack of cards

THE IMF BAILOUT PACKAGE Stepped in for US $ 40 billion package Conditional relief – Demanded for Reformed

Economic policies, Removing insolvent institutions

INTROSPECTION AND REFLECTIONS

Crisis rose due to ‘Fast Track Capitalism’

REFERENCES

Paul Krugman: The

Return of Depression Economics

Niall Ferguson: The

Ascent of Money

The economist

online edition

THANK YOU