asian financial liberalization after 1990s crisis

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Asian Financial

Liberalization in 1990s:Rapid Growth Through CrisisMehmet Ali KARADEMR- 2008762180

22.12.2009

I. Abstract1. Introduction 12. Decades Before the Crisis 23. What Made the Financial Market Inefficiency Hidden? 34. The Reasons of the Recession in 1990s: The Crisis 5

4.1. Exchange Rate Problems 54.2. Lack of Risk Management- Major Role of Banking Sector 64.3. Inadequate Financial Regulations and Wrong Order of Liberalization 64.4. Rapid Broadening the Liberalization in 1990s 7

5. Were the Economies of the Region Affected from the Crisis Actually 86. Concluding Remarks 107. References 12

In my essay I tried to illuminate the liberalization process of Asian economy not only in 1990s but

before and after that period also. First I defined the undergoing context of liberalization and the

miracle growth in introduction and next section. In the third section I gave the reasons why the

inefficiencies were not uncovered or showed any negative effect on economic growth. Thereafter I

tried the mention the literature on the reasons that led the region to a crisis in 1997 with basic

reasons in sub-sections. Moreover I discussed the effects of liberalization and crisis on the economy

and financial structure in the fifth section mentioning recent data as well as the information from the

recession period. In the concluding remarks I have mentioned the literature on advices and criticismon Asian financial and economic situation in period and thereafter and tried to discuss the validity

and possibility of implementation of those advices and the validity of the forecasts made by scholars

in recession period and right after.

Abstarct:


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1. Introduction:In order to be able to discuss about the financial liberalization of Asia in and after 1990s

and to discuss how much they needed it as well as what are the consequences- I would first

like to focus on the undergoing context in Asian economy before 1990s a nd the reasons for

the 1997 crisis.

Asia was, compared to Latin America and Sub-Saharan Africa, more protectionist than

other emerging economies, or in other words, the economic policies in the region contained

more government intervention. However it is not appropriate to name the region as a closed

economy even before 1980s. As Eisuke Sakakibra utters in an intervie w for World Bank (in

2000) trade, direct investment and portfolio investment in those countries have taken

place extensively and it is not accurate to call Singapore and Malaysia closed economies.

Although just two Asian countries were named the situation for the others did not have any

difference in terms of openness.

However, although the main aim of the structural adjustments was the economic growth,

the context in which the miracle occurred was not appropriate for the way that was

proposed and advised by multilateral organizations. The conditionals of loans that were

imposed to developing economies asked to relax the fiscal policies and deteriorate the

restrictions in front of free capital movement. By the way economical circles responded to

the Asian crisis was the suggestion of adapting the structural adjustment programs (SAPs) in

order to recover (Glassman&Carmody-2000) especially by those who were under the shade

of IMFs patronage.

Despite the problem in the region was the lack of well organized, appropriately

functioning capital markets that has good financial linkages to both developing and

developed financial markets (Glassman&Carmody-2000, Shatz&Tarr-2000). Furthermore the

Asian countries started to liberalize their financial markets before and through 1990s and

that was the reason of the crisis although not directly.

, As those countries didnt have deep fin ancial infrastructure the liberalization process

brought a conflicting consequences for those developing economies. One of the main

reasons of the crisis, therefore, regarded to be the lack of robust financial market. As the

national financial markets didnt have necessary linkages to the international capital markets

contrary to some of the corporations which had the opportunity, the short -term investment

in domestic market which was volatile increased and relatively the long-term capital outflow

was also increasing. In other words, debt/equity ratio in domestic financial market was

steadily increasing in 1990s (Schmukler&Vesperoni-2000). Other reasons for the crisis were

regarded to be some of which are again related to liberalization or globalization- exposition

of unrealistic exchange rates; limitless dollarization etc. Some of the Asian economies

achieved historical success (such as Korea, Indonesia etc) (Shatz&Tarr-2000) while others like

Thailand lost competitiveness in the region by overvaluation of its currency especially


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because of pegging to U.S. dollar which was appreciated against Japanese and other regional

currencies (World Bank 2000, Shatz&Tarr-2000).

2. Decades Before the CrisisAsian economies since 1960s have never been completely closed or interventionist though

nor completely open or liberalized- although the progress in integration and joining to the

multilateral agreements on trade was slower than the developed economies (Cohn 2008) .

However liberalization in financial markets was not a s extensive as the trade liberalization.

Whatsoever the financial liberalization existed in many East Asian (EA) countries since 1960s

when Korea and some other countries liberalized their capital accounts (Ito-2001).

Through 1990s most of the finan cial markets in the region were liberalized except for

permanent restrictions when necessary. Malaysia, for example, had quite liberalized capital

account although they imposed some restrictions on non-trade and non-investment externalliabilities and prohibited banks from operating swap that are not related to trade in 1994

(Kaminsky&Schmukler 2001). The 1990s were in the mode putting restrictions and taking

back to liberalization rapidly. Portfolio inflows were not restricted in many Asian economies

although it was not approved by economists for developing countries. Attributing the

responsibility of the crisis to the ways led by liberalization those countries imposed severe

controls and restrictions on financial markets during the crisis though.

Furthermore the EA economies succeeded in some aspects more than the developed

countries (DCs). One of them was providing legal protections for the minority shareholders

of broad-based equity markets (Stiglitz-2001). Besides although the banking sector did notusually provide long-term loans for investment which had crucial importance for developing

countries- the government of the region encouraged and helped creating financial

institutions that would provide long -term loans for the corporations. That attitude enhanced

the both economic growth and growth of financial sectors. Another success of those Asian

countries was achieving the high saving and high growth equilibrium (Stiglitz -2001) which

brought high savings. The savings of both government and households were channeled to

investment by those banks. By the way the corporations could undertake riskier as well as

more profitable- projects by the help of low interest rates in domestic financial markets.

However the economic growth was basically attributed to the efficient industrialization inEA countries in most of the literature on Asian Miracle while the down turn trend was

attributed to financial market weakness instead of the financial market closeness. The over

reliance on bank loans on growth and the wrong in liberalization that led the institutional

mismatch (Babb-2005), were regarded as the basic tenants of the deterioration. Thus I will

try to discuss and provide the literature on how those weaknesses were shed and how were

they uncovered in the next sections.


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3. What Made the Financial Market Inefficiency Hidden?As I mentioned above the industrial miracle was so fascinating that the financial sector

weaknesses assumed to be insignificant or never expected to fail. The stable macroeconomi c

environment; high rates of savings and reinvestments; the increasing quality human capital;

reducing trend of income inequality; extensive export promotion; successfulindustrialization; natural resources; and cheap labor which attracted a great volume o f

foreign direct investment (FDI) and, by the way, flow of technological know -how (Ito-2001)

were the basic reasons that made the Asian economies miracle and shaded the capital

market inefficiencies. As it is obviously seen in Table 1 there occurred recor d

Table 1

World Bank Resources- 2007

growths till the 1997 crisis in most of the Asian economies thanks to the strength of

manufacturing industry especially. The situation savings and investments was no different

than the success of growth as we see in the Figure 1. The data is taken from six Asian

economies which shows recordsavings and investment GDP ratios. The average is around

25-30% of GDP both for investment and savings. We can easily imply from the date

mentioned above that the export growth was also in extensive amounts. Thus the Asianeconomies provided most of the savings from trade surplus (World Bank Report on Asia &

Pacific-2007) which was mentioned as one of basic reasons of not having efficient or fully

developed bond and equity markets ( to be discussed in the reasons of the crisis and risks

faced in 1990s).

Government intervention on exchange rates in most of the Asian economies- till 1990s

was another factor that enhanced the exports growth. Some of the Asian countries,


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However the situation has changed through 1990s as the existing regulations and

institutions could not bear the growth. As it is stated in World Banks report on EA and

Pacific Many economies can reach middle income status often quite quickly- few pass

through it because the policy and institutional changes needed are more complex and more

challenging technically , politically and socially (world bank - ten years after the crisis-2007).

The complex issue was namely a well functioning and deeply integrated capital market. Of

course there were other problems that those countries came across by g etting larger and

larger gradually and rapidly however there was such a panic inferred from the literature on

the issue- while realizing the fact that, countries in the region had put aside the gradualist

strategy (Stiglitz-2001) in the progression period of broader liberalization of financial

markets in order to provide more funds for investment.

4. The Reasons of the Recession in 1990s: The CrisisThrough 1990s more extended liberalization appeared in many Asian countries however it is

ambiguous to define a date or event that brought liberalization into existence but I will try tomention the process from the literature from which the reasoning ability could be derived.

Therefore I will try to mention the reasons of the recession some of which are pushed

forward by the domestic financial market weaknesses while the others were consequences

of liberalization (some of those included the government responsibility too).lack of an

efficient domestic bond or equity market; by the way over reliance on banking in t erms of

investment and growth and by the over and fast liberalization in the lack of money supply

that is enough for the growth pace; can be defined a much simplistic way of describing the

period to be discussed in detail in the sub sections of this topi c.

4.1.

Exchange Rate Problems:

Although controls on the exchange rates brought a great competitiveness to Asian

economies till 1990s it was a disaster for them through those years. Their currencies were

floating officially but they used other instrument to provide a stable exchange rate that

would be correlated to U.S. Dollar (Stiglitz-2001, Ito -2001, Sakakibra-2000). The currencies

acted like they were pegged to Dollar some were in fact- and that provided stable

environment for FDI although it was problematic for portfolio investment.

One of the effects of over dollarization was the extensive capital outflow on long -term

investments and short-term investment in domestic markets. By the way the debt equity

ratio increased dramatically (although another reason for that was the inefficiency of the

existing equity markets). Furthermore both the sudden depreciation of Dollar and the

appreciation caused harm in the domestic economy. To state clearly the depreciation caused

non-performing loans which were gre at problem for the banking sector who carried the

burden of the risks although the depreciation increased the competitiveness in exporting.

However the appreciation of the currencies in 1990s led many countries in the region lose

competitiveness as most of the countries trade partner was Japan basically and their


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currencies were appreciated against their trade partner. Therefore they liberalized (or made

the liberalization more efficient) the exchange rate regime except for China whose major

trade partner was already U.S. and therefore the stability maintained.

Another consequence that was led by dollarization is the currency mismatch, which

created problem for the banking sector (Ito-2001). The debt market was denominated byforeign currencies especially with Dollar that exchange rate fluctuations became one of the

basic problems of the domestic financial markets.

4.2. Lack of Risk Management- Major Role of Banking Sector:Although the EA countries attracted a large amount of FDI they mainly relied on in vestments

in terms of growth. As their trade surplus was enough for growth for a long time they did not

create efficient equity and bond markets to manage the hidden risks that may occur in

recessions and the burden of the risks were on the shoulders of th e financing institutions. It

was thought to be never possible to collapse. However the sudden appreciation of Dollar

against regional currencies led excess supply and therefore production surplus. That led to

great amount of non-performing loans in the capital market. Although those countries could

convert the short-term loans the debt market- to a partial equity (Stiglitz-2001) that was

out of the manageable area.

4.3. Inadequate Financial Regulations and Wrong Order of Liberalization:There were two major problems in the financial sectors of those EA countries, those which

were regarded as being responsible for the Asian crisis in 1997. The first one was the

adequacy problem in the financial regulations. By name they were stated by Stiglitz (2001) as

the lack of regulatory and supervisory framework; inadequate bankruptcy laws; inefficientaccounting rules which became significant for foreign investors after the recession period in

1990s- and the disclosure practice problem. The deregulations that were imposed by the

international monetary institutions was also failed it coincides the social reactions towards

the failure of structural adjustment programs- and understood that institutional regulation

in other words having effective and good government - was much more important than

having no government intervention.

Together with the institutional inefficiency and lack of advanced features in the financial

markets, another chronic problem of the region was the order of liberalization. It is also

related with the institutional problem . Liberalizing the financial instruments partially orwholly without improving the infrastructure to fit this differentiation brought hidden

problems together with them. Korea for example liberalized its capital account in 1980s. the

same problem occurred in Latin America too but they were much more hard hit than Asian

countries, because the liberalization process before 1990s in the region was autonomous

contrary to Americas which were liberalized wholly by the structural adjustment rules

without having the institutional regulations fi rst. The institutional mismatch occurred


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because of that problem (Babb-2005). However this problem was faced by Asians through

1990s, although not as much as Americas.

Those two major financial regulation problems combined with the currency proble ms

led a double recession both financial crisis and currency crisis in the same period.

4.4. Rapid Broadening the Liberalization in 1990s:In addition to the reasons I mentioned above increasing demand for funds because of the

rapid growth; giving the major role to the banking sector; lacking bond and equity markets;

relying on short-term loans instead of equities; excessive dollarization an d lack of

cooperation in exchange rate regime with trade partners etc - willingness to become a

member of OECD in some of large economies in the region, led them to rapid liberalization

in 1990s. Basically, they relaxed the portfolio investment inflow restr ictions and eased the

licensing of domestic subsidiaries of foreign banks. Together with the existing foreign owned

banks the new subsidiaries supplied excess lending to the corporations.

However the downturn in the economy, because of the currency p roblems, was not

solved by the fund supplies.I

umber of non -performing loans increased in that period. The

accumulated negative consequences led the economy to crisis. In fact not all of the countries

had exactly the same problems or received same effects from the recession but they were all

affected from the process because they were strongly contagion. The countries had both

financial linkages and trade linkages between themselves. And the generalized vantage point

for the whole region provided negative s ituation for all of the countries in the region , as they

had similar financial structure, although not contraction for all of them.

5. Were the Economies of the Region Affected from the Crisis Actually:Although orthodox liberals think exactly on the country way, some of the scholars thought

that macroeconomic policies did not have significant direct effect on national economic

growth (Rodrik-2006). Although the institutional conditions in those countries did not meet

the importance given by Dani Rodrik (2006 ) the rapid growth even through the crisis just

with a slow down- claims the same aspect to the literature. A considerable amount of the

countries, one of which is China as the largest economy in the region, did not even slow

down in state of growth.

As we see on the table presented in IMFs World Development Report (2009) the

highest average growth in overall output levels is observed in emerging economies,

especially in Asia. The average growth in Asia is 6% between 1991 and 2002 which is the

highest regional growth. Besides the highest individual country growth is again in the same

region, by 10.1% in China. In the following years the situation has no difference in terms of

relative growths.


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g R Ts

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h i pF-2009

q r U R ` b B

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q pe

b T X V e

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t g U V Y R X R y

Y U Y Q e

c T V d s

S R U W Y Q

R X Y es a U R ec X s Y eb a U R Y Q e e V b U a 2009q u s T X s Q U W s X R e ` X Y T ve y S R e X Y S R U W Y Q R X Y e X S X T V a U R 2009

h

3.7v w

. Those who weRe hard hit from thecrisis were thecountries who re

ied on foreign

capital for growth and whose unique advantage was thecheap labor basically and thegeneral interest on the region.

However thecountries which invested on human capitaland development of

technology were not strongly affected from either the1997crisis or from thecurrent crisis.

Whatsoever the recession period led them to regulate their financial institutions more

efficiently and liberalize thesocial and political processes.

Tablx 2y

Tablx 2 Taken fo

the IMF- wo

lddevelop

ent report2009


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Table 3- Regional Aggregate for Poverty Measures in East Asia

Table 3- derived from World Bank Report on East Asia & Pacific (2007): 10 Years after the Crisis

As we can also see from the aggregate poverty measures, it is obvious that the region

generally didnt cut human development investments or in other words the social

investments. Although there are high numbers of poor people in those countries we can

observe a rapid and constant improvement in the issue even through crisis. That implies the

fact that that the subject countries didnt cut budget on social investment which was the

primary expectation of the structural adjustment programs. High domestic savings provided

the ability to maintain investment on health care, education, social services etc. besides

reducing the income inequality.


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As well as the constant growth, the financial structure of the region has not been changed

dramatically although they were more liberalized. However the liberalization did not

affected the deep financial markets (Claessens&Glaessner-1998) and the Asian financial

market was relatively deeper than other developing economies which were exposed to the

effects of liberalization. The liberalization affected the financing choices of firms as I

mentioned above. The leverage ratios decreased for all types of debt however the maturity

structure shifted to short-term (Schmukler&Vesperoni-2000). Correlated with the financial

liberalization the density of internal financing increased in the same direction and

debt/equity ratio went up in late 1990s. Coming across the crisis restrictions took over again

through the end of the decade, and m any Asian countries limited the entry of portfolio

investment and foreign financial firms more than DCs (Claessens&Glaessner -1998) along the

crisis period although they eased the restrictions as soon as 1999 or 2000 (Shatz&Tarr -2000)

The liberalization instruments or modes took over the regulations more than

liberalization did in financial sectors after the crisis. The democratic institutions have been

being strengthened so far. More importantly the transparency both in governmental issuesand in corporate laws and operations increased more than it was before the crisis. The

number of people who lived under 2 U.S. Dollars a day after crisis is half as much as it was

before the crisis. Besides they differentiated their foreign currency reserves regime o r

enhanced it. Thus a rapid increase in the regional central banks can be observed from the

official data. According to World Bank data in 2006 Asian U.S. Dollar reserves was 2.06

trillion U.S. Dollar China holding the half. In 2008 it is more than 2 tril lion in China and

around 4 trillion totally in Asia.

6. Concluding RemarksAs we infer from the literature and data on Asian liberalization both in trade and financial

markets, it is not easy to say that a complete liberalization or a rigid globalization of capital

markets existed after the 1997 crisis. Moreover there occurred some restrictions after the

crisis although they were removed after the peak of the recession gradually. But it is sure

that the liberalization did not start exactly before or after the crisis. In fact the

manufacturing sector was distinctly more effective in the growth of the regional economy

although much of the reasoning for the crisis were global issues that were hard to control

individually; such as, the depreciation of U.S. Dollar with respect to the fact that all

countries which pegged their currencies to U.S. Dollar came across similar economic

recession in the same period. However in order to focus on financial issues again I would like

to mention some forecasts made for the future of the Asian economy and some advices on

financial regulations for the region.

Stiglitz (2001) forecasts that the Asian growth would slow down for the reasons that,

basically, diminishing returns will reduce the profitability of the region for ne w investments;

or the export oriented strategies were being imitated by other developing countries that it

wouldnt have competitive advantage anymore. Besides he claims that it would be harder


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for those governments to control foreign capital flows in libe ralized economy that they

wont be able to channel the savings to investment as easily as before(Stiglitz-2001). His

forecasting sounds logical but it has not been actual yet, so far. As we have seen from the

tables (recent data from IMF and World Bank) they are still steadily growing.

Institutional advices in the literature are highly frequent although it has not been possiblefor political, economical and especially historical restraints. Some of those were foundation

of an Asian Monetary Fund or some kind of regional debt market (World Bank-Sakakibra-

2000). It would be a good development dynamic for the region and provide independence

from the usual lenders, thats why it sounds good however it does not seem to be possible

for implementation in the near future.

Another advice could be made for the exchange rate regime. In fact there is wide range of

literature on the issue. However I chose the two most frequently mentioned that are related

with each other too. The first one is arranging a com mon exchange rate regime (Sakakibra-

200) and the other is arranging an exchange rate regime that would take trading partners

financial and monetary choices into consideration (Stiglitz-2001, Ito -2001).

The social aspects should not be ignored in orde r to maintain a sustainable growth. The

efficiency of the social public investment should be more efficient. There should be more

budget devoted to the infrastructure improvement,(Stiglitz-2001) as there exists a rapid

urbanization as well as economic grow th. Thus social institutions should be created or

regulated if they exist, in order to ensure the social equality and development as the GDP is

not basic measure tool of the development anymore.

One of the crucial factors for Asian economies is financ ial regulation, in which they are

already progressing, in order to strengthen the financial market and reduce the sensitivity to

global vulnerability. They, owing to the strong manufacturing sector and dynamic economy,

could sustain sharp and fast recovery but it does not ensure the future of the economy.

Therefore they need first of all a risk management strategy and they may provide it by

segmenting the financial institutions and distributing the risks among them as well as

strengthening those institutions. By the time government intervention is not, as we know

from the Monterrey Consensus, regarded as being the persona non grata of the

international economy anymore especially after the Latin American and Sub-Saharan African

failures. Both Ito and Sti glitz imply an optimum government intervention would be useful

instead of market fundamentalism (Stiglitz-2001, Ito-2001).


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References:

Dani Rodrik- Harvard University- Goodbye Washington Consensus, Hello Washington Confusion

(2006)

Garciela Kaminsky & Sergio Schmukler- Short and Long-run Integration: Do Capital Controls Matter?

(2001)

Hower J. Shatz & D. G. Tarr- Exchange Rates and Economic Performance in East Asia, Exchange Rate

Overvaluation and Trade Protection- Harvard University and The World Bank (2000)

IMF- World Development Report (2009)

Jim Glassman & Padraig Carmody- Structural Adjustment in East and Southeast Asia: lessons from

Latin America (revised in July 2000)

Joseph E. Stiglitz- From Miracle to Crisis to Recovery: Lessons from Four Decades East Asian

Experience, Rethinking The Asian Miracle ( the whole book, contains of different articles in each

chapter, is edited by Joseph E. Stiglitz & Shahid Yusuf 2001)

Sarah Babb- Social Consequences of Structural Adjustment 2005

Speech by Eisuke Sakakibra- East Asian Crisis- Two Years Later (at the twelfth annual bank

conference on development economics by The World Bank in Washington D.C., April 2000)

Sergio Schmukler & Esteban Vesperoni- Globalization and Firms Financial Choices; EEvidence From

Emerging Economies (World Bank Development Research Group-2000)

Stijn Claessens & Tom Glaessner- The Internationalization of Financial Services in Asia (1998)

Takatashi Ito- Growth, Crisis and Future of Economic Recovery in East Asia, Rethinking The Asian

Miracle ( the whole book, contains of different articles in each chapter, is edited by Joseph E. Stiglitz

& Shahid Yusuf 2001)

Theodore Cohn- Global Political Economy, Ch. 8 Global Trade Relations (2008-Pearson Education,

Inc.)

Theodore Cohn- Global Political Economy, Ch. 11 International Development (2008- Pearson

Education, Inc.)

World Bank- East Asia & Pacific Update- 10 Years After the Crisis (April 2007)

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asian financial liberalization after 1990s crisis