ASIAN FINANCIAL CRISIS 1997

PRESENTED BY: SAAD JAMAL

INTRODUCTION

The Asian Financial Crisis of 1997 started in June. It was the fourth major crisis in the world after the

•The Wall Street crash (1929) followed by the ‘Great Depression in 1930s

•Black Monday (1987) – The largest global stock market crashes in a single day

•The economic crisis in Mexico (1994)

The Asian countries mostly affected by this crisis include

•Thailand

•Indonesia

•South Korea

•Malaysia

•Hong Kong

•and Philippines

These countries enjoyed a very high economic growth rate of 8-10% prior to the crisis.

How it Started?

Before the crisis started in 1997, the Asian countries, especially the Southeast Asian countries, attracted almost the half of the total capital inflow into the developing countries.

High interest rates attracted many foreign investors who were looking for higher returns in the region.

The regional economies of Indonesia, Malaysia, Thailand, Singapore and South Korea experienced high growth rates up to 8-12% in the late 1980s and early 1990s. This achievement was widely acclaimed by financial institutions including the IMF and World Bank, and was known as part of the "Asian economic miracle".

In 1994, Paul Krugman, a noted economist, published an article against the idea of this Asian economic miracle. He argued in his article that the economic growth in East Asian countries was a result of increasing capital investment.

However, he mentioned that the total factor productivity had increased only marginally or not at all. Krugman argued that only growth in total factor productivity and not capital investment could lead to long-term prosperity.

Although Krugman’s article was acknowledged after the Asian crisis, Krugman himself stated that he did not predict the Asian crisis and the extent to which it occurred.

The crisis started in June 1997 in Thailand. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.

Though there has been general agreement on the existence of a crisis and its consequences, what is less clear are the causes of the crisis, as well as its scope and resolution.

Indonesia, South Korea and Thailand were the countries most affected by the crisis.

Hong Kong, Malaysia, and the Philippines were also hurt by the slump.

Crisis in Thailand

From 1985 to 1996, Thailand's economy grew at an average of over 9% per year, the highest economic growth rate of any country at the time. Inflation was kept reasonably low within a range of 3.4–5.7%. The baht was pegged at 25 to the US dollar.

Crisis in ThailandOn 14 May and 15 May 1997, the Thai baht was hit by massive speculative attacks. On 30 June 1997, Thai Prime Minister said that he would not devalue the baht.

This was the spark that ignited the Asian financial crisis as the Thai government failed to defend the baht, which was pegged to the basket of currencies, where U.S. dollar was the main component, against international speculators.

The baht devalued swiftly and lost more than half of its value. The baht reached its lowest point of 56 units to the US dollar in January 1998.

The Thai stock market dropped 75%. Thai’s largest financial company back then, Finance One, collapsed.

Crisis in Indonesia

In June 1997, Indonesia seemed far from crisis. Unlike Thailand, Indonesia had low inflation

A trade surplus of more than $900 million, huge foreign exchange reserves of more than $20 billion, and a good banking sector.

Alarge number of Indonesian corporations had been borrowing in U.S. dollars. During the preceding years, as the rupiah had strengthened respective to the dollar, this practice had worked well for these corporations; their effective levels of debt and financing costs had decreased as the local currency's value rose.

In July 1997, when Thailand floated the baht, Indonesia's monetary authorities widened the rupiah trading band from 8% to 12%.

The rupiah suddenly came under severe attack in August. On 14 August 1997, the managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The rupiah dropped further.

The rupiah sank further amid fears over corporate debts, massive selling of rupiah, and strong demand for dollars. The rupiah and the Jakarta Stock Exchange touched a historic low in September. Moody's eventually downgraded Indonesia's long-term debt to 'junk bond'.

Crisis in Indonesia

The rupiah crisis intensified in November when the effects of that summer devaluation showed up on corporate balance sheets. Companies that had borrowed in dollars had to face the higher costs imposed upon them by the rupiah's decline, and many reacted by buying dollars through selling rupiah, undermining the value of the latter further.

Before the crisis, the exchange rate between the rupiah and the dollar was roughly 2,600 rupiah to 1 USD. The rate plunged to over 11,000 rupiah to 1 USD in January 1998, with spot rates over 14,000 during January 23–26 and trading again over 14,000 for about six weeks during June–July 1998.

Crisis in Indonesia

Crisis in South Korea

Macroeconomic fundamentals in South Korea were good but the banking sector was burdened with non-performing loans as its large corporations were funding aggressive expansions.

During that time, there was a haste to build great conglomerates to compete on the world stage. Many businesses ultimately failed to ensure returns and profitability.

The South Korean conglomerates, more or less completely controlled by the government, simply absorbed more and more capital investment. Eventually, excess debt led to major failures and takeovers.

In the wake of the Asian market downturn, Moody's lowered the credit rating of South Korea from A1 to A3, on 28 November 1997, and downgraded again to B2 on 11 December.

That contributed to a further decline in South Korean shares since stock markets were already bearish in November. The Seoul stock exchange fell by 4% on 7 November 1997. On 8 November, it plunged by 7%, its biggest one-day drop to that date. And on 24 November, stocks fell a further 7.2% on fears that the IMF would demand tough reforms.

The South Korean won, meanwhile, weakened to more than 1,700 per dollar from around 800, a 53% decline in the value of the currency.

Crisis in Malaysia

Before the crisis, Malaysia was a popular investment destination, and this was reflected in KLSE activity which was regularly the most active stock exchange in the world

Expectations at the time were that the growth rate would continue, propelling Malaysia to developed status by 2020. At the start of 1997, the KLSE Composite index was above 1,200, the ringgit was trading above 2.50 to the dollar.

In July 1997, within days of the Thai baht devaluation, the Malaysian ringgit was "attacked" by speculators.

The overnight rate jumped from under 8% to over 40%. This led to rating downgrades and a general sell off on the stock and currency markets.

By end of 1997, ratings had fallen many notches from investment grade to junk. The KLSE had lost more than 50% from above 1,200 to below 600, and the ringgit had lost 50% of its value, falling from above 2.50 to under 4.10 to the dollar.

In 1998, the output of the real economy declined plunging the country into its first recession for many years. Overall, the country's gross domestic product plunged 6.2% in 1998. During that year, the ringgit plunged below 4.7 and the KLSE fell below 270 points.

ConsequencesIN ASIA

The crisis had significant macro-level effects, including sharp reductions in values of currencies, stock markets, and other asset prices of several Asian countries.

Many businesses collapsed, and as a consequence, millions of people fell below the poverty line in 1997–1998. Indonesia, South Korea and Thailand were the countries most affected by the crisis.

More long-term consequences included reversal of the relative gains made in the boom years just preceding the crisis.

Nominal US dollar GDP per capital fell 42.3% in Indonesia in 1997, 21.2% in Thailand, 19% in Malaysia, 18.5% in South Korea and 12.5% in the Philippines.

The CIA World Factbook reported that the per capita income in Thailand declined from $8,800 to $8,300 between 1997 and 2005; in Indonesia it declined from $4,600 to $3,700; in Malaysia it declined from $11,100 to $10,400.

Over the same period, world per capita income rose from $6,500 to $9,300. Within East Asia, the bulk of investment and a significant amount of economic weight shifted from Japan and ASEAN to China and India.

Outside Asia

After the Asian crisis, international investors were reluctant to lend to developing countries, leading to economic slowdowns in developing countries in many parts of the world.

The powerful negative shock also sharply reduced the price of oil, which reached a low of $8 per barrel towards the end of 1998, causing a financial pinch in OPEC nations and other oil exporters.

Consequences

This reduction in oil revenue contributed to the 1998 Russian financial crisis. During the ensuing decline in world commodity prices, Russia heavily dependent on the export of raw materials that were among those most severely hit. Petroleum, natural gas, metals, and timber accounted for more than 80% of Russian exports, leaving the country vulnerable to swings in world prices. Oil was also a major source of government tax revenue. This in turn impacted the foreign exchange reserves of Russia.

The Asian crisis followed by the Russian crisis caused the Long-Term Capital Management in the United States to collapse after losing $4.6 billion in 4 months. The LTCM which carried out its hedging activities in the region suffered a huge loss from its investments, therefore resulting in the company to collapse.

Major emerging economies Brazil and Argentina also fell into crisis in the late 1990s.

CAUSES OF THE CRISIS: TWO THEORIES

The Fundamentalist View

The fundamentalist view holds that flawed financial systems were at the root of the crisis and its spread. The seeds for the financial crisis were actually shown several years before currency pressures began. Most East-Asian countries had tied their currencies to the dollar. This tie served them well until 1995 because it promoted low inflation, supported currency stability, and boosted exports.

The appreciation of the dollar against the yen and other major currencies since 1995 caused East Asian countries to lose their competitiveness in export markets. From April 1995, the US dollar appreciated continuously and significantly. The dollar linked Asian currencies appreciated accordingly and this made their exports uncompetitive leading to large currency account deficits. Thus, the US dollar appreciation in 1995-97 contributed to 1997 financial crisis.

The fundamentalist view holds that such a bubble was about to burst in the face of a shock.

By late 1996, asset prices fell, causing nonperforming loans to rise and the value of collateral to fall; domestic lending then declined and asset prices fell yet again.

When capital started to flow out of the region, monetary authorities raised interest rates to defend their currency pegs.

These higher interest rates raised the cost of funds to banks and made it more difficult for borrowers to service their debts. The monetary authorities soon ran out of hard currencies, thereby causing them to abandon the pegs. Because practically none of some $275 billion in foreign loans owed by these five countries was hedged, the currency depreciations led to widespread bankruptcies and slow economic growth.

The crisis was then touched off when local investors began to dump their own currencies for dollars and foreign lenders refused to renew their loans.

It was aggravated by politicians in these affected countries who preferred to blame foreigners for their problems rather than seek structural reforms of their economies.

Both domestic and foreign investors, already spooked by the crisis, lost yet more confidence in these nations and dumped more of their currencies and stocks, driving them to record lows.

The Panic View

The panic view admits that there were vulnerabilities: increasing current account deficits, falling foreign exchange reserves, fragile financial systems, highly leveraged corporations, and overvaluation of the real exchange rate.

But these vulnerabilities were not enough to explain the abruptness and depth of the crisis. They argue that economic fundamentals in Asia were essentially sound.

The absence of the macroeconomic imbalances typical of past crises led some to argue that the Asian crisis was not caused by problems with the economic fundamentals.

Rather, a swift change in expectations was the catalyst for the massive capital outflows that triggered the crisis. T

he panic view holds that problems in Thailand were turned into the Asian crisis because of international investors' irrational behavior and the overly harsh fiscal and momentary policies prescribed by the International Monetary Fund as the crisis broke.

Several factors support the premise that the crisis was panic-induced.

First, there were no warning signs, such as an increase in interest rates on the region's debt or downgrading on the region's debt by debt rating agencies.

Second, prior to the crisis, international banks made substantial loans to private firms and banks that did not have any sort of government guarantees or insurance. It is consistent, however, with the notion that international investors panicked in unison and withdrew money from all investments--good or bad.

Third, once the crisis was under way, the affected countries experienced widespread credit crunches. For example, even viable domestic exporters with confirmed sales could not get credit, again suggesting irrationality on the part of lenders.

Finally, the trigger for the crisis was not the deflation of asset values, as the fundamentalists argue, but the sudden withdrawal of funds from the region triggered the crisis.

Many argue that some of the conditions the IMF imposed on these crisis countries for financial assistance added to, rather than alleviated, the panic.

CONCLUSION AND AFTERMATH

International capital flows caused "booms and busts" for Thailand's economy. Thailand's economy surged until early 1997 partly because the Thais found they could borrow money at low interest rates overseas, in dollars, more cheaply than they could at home, in baht.

By late 1996, foreign investors began to move their money out of Thailand because they worried about Thais' ability to repay. In February 1997, foreign investors and Thai companies rushed to convert their baht to dollars. The Thai central bank responded by buying baht with its dollar reserves and raising interest rates.

The rise in interest rates drove down prices for stocks and land. This dynamic situation drew attention to serious problems in the Thai economy: the huge foreign debt, trade deficits, and a banking system weakened by a heavy burden of unpaid loans.

The Thai central bank ran out of dollars to support the baht. On July 2, the central bank stopped to defend the baht's fixed value against the dollar. And then the currency lost 16 percent of its value in one day.

Investors and companies in the Philippine, Malaysia, Indonesia, and Korea realized that these economies shared all of Thailand's problems. So, investors and companies rushed to convert local currencies into dollars.

And then, the pesos, ringgit, Rupiah, and won toppled in value like dominos in a row.

In the fourth quarter of 1997, the International Monetary Fund (IMF) arranged emergency rescue packages of $18 billion for Thailand, $43 billion for Indonesia, and $58 billion for Korea.

By 2001, Thailand's economy had recovered. The increasing tax revenues allowed the country to balance its budget and repay its debts to the IMF in 2003, four years ahead of schedule. The Thai baht continued to appreciate to 29 Baht to the Dollar in October 2010 from its lowest point of 56 Baht to the Dollar.

In 2001 Philippines, managed to lessen the crisis in the country, which led to the recovery of the Philippine peso to about 50 pesos by the year's end from its lowest of 56 pesos, and traded at around 41 pesos to a dollar by end 2007.

The stock market also reached an all time high in 2007 and the economy is growing by at least more than 7 percent, it’s highest in nearly 2 decades.

Though the crisis resulted in a huge loss to the Southeast Asian countries, it also resulted in benefits in the mode of changes in policies. For the first time, corporate governance was implemented in these countries to ensure that triggers to such crisis are avoided at all times.

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