Multinational Business

Week 10 tutorialAsian Financial Crisis

HistoryBefore 1997, Asia was attractive

By developing countries

High interest rates

“Asian economic miracle”F

our Asian Tigers

IntroductionJuly 1997

Countries most affected by the Asian Financial Crisis.

IntroductionMost affected:

IndonesiaSouth KoreaThailandHong KongMalaysiaLaosPhilippines

IntroductionLeast affected

People’s Republic of China IndiaTaiwanSingaporeVietnam

IntroductionThailand

Thai bahtReal estateBurden of foreign debt

Southeast Asia and Japan Slumping currenciesDevalued stock marketSteep rise in private debt.

IMF Role$40 billion program to stabilize the

currencies of South Korea, Thailand, and Indonesia.

Bailouts (rescue packages) for the most affected economies to enable affected nations to avoid default.

Structural adjustment package

IMF conditionscut back on government spending to

reduce deficits,

allow insolvent banks and financial institutions to fail and aggressively raise interest rates.

The reasoning was that these steps would restore confidence in the nations’ fiscal solvency, penalize insolvent companies, and protect currency values.

The Currency exchange rate per USDJune 1997 compare to July 1998

Thai baht: 24.5 to 41

Indonesian rupiah: 2,380 to 14,150

Philippine peso: 26.3 to 42

Malaysian ringgit: 2.5 to 4.1

South Korean won: 850 to 1,290

Thailand

ThailandFrom 85-96 Thailand GDP grew 9% per year

Highest economic growth rate

Inflation was also low (3.4%-5.7%)

Baht value was 25 to the US Dollar

Investors were guaranteed US Dollar from their investment

ThailandMay 14-15, 1997 the Baht faced very bad

speculative attacks

In June, Prime Minister refused to devalue the baht

Thai government failed to defend the Baht, starting the crisis

Baht lost more then half it’s value

Thai stock market dropped 75%

ThailandAugust 11, 1997, IMF unveiled $17 billion rescue

package

August 20, 1997 IMF approved another $3.9 billion bailout package

Rumors that former Prime Minister profited from the devaluation

Finally recovered by 2001, paid off IMF debt in 2003

Thailand financial crisisInstability of currencies

Investor relies heavily on speculation

1.5 million US$ transaction everyday

Speculators are betting a money on how currency will move

Consequences As dollar appreciated, so did the currency

pegged to USD

As a result, export became expensive

Sales began to fall

Deficit began to grow

Speculative attack on Thailand

Early 1997, investors and hedge funds had a sharp eye for instability on Thailand

They were saying that Thailand had to devalue its money because it is borrowing too much money

They started betting on it

This would definitely had an effect as huge amount of money was on bet

Lots of banks from all over the world followed the speculation

Speculative attack on Thailand

As betting escalated, Thai Baht came under attack

Thai government was forced to buy more and more Baht by the dollar it kept in reserve to stabilize its currency

But the investor wanted to cash out their investment following the speculation

Each transaction was pulling money out of Thailand and bringing money back to US

People want to cash their deposit as well all at once

Reaches the point of exhaustion and as a result crisis

Speculative attack on Thailand

Government of Thailand lost its battle against speculator and ran out of cash

Within week currencies tumbled, and government fell down

This effect had severe effect on Malaysia, Indonesia and South Korea as well

There was generalised financial crisis

Role of IMFThailand asked help from IMF

Injected capital

In return government had to cut budgets, increase interest rates paid to foreign investors

They asked for restructuring of the entire economy

Consequence was of social costUnemploymentMiddle class now poorHuge protest

Indonesia

IndonesiaIndonesia was doing good in June 1997

Low inflation$900+ Million trade surplus$20 + Billion foreign exchange reservesGood banking sector

However, many corporations were borrowing in U.S. Dollars

In July 1997

IndonesiaOn August 14, 1997 the managed floating

exchange regime was replaced by a free-floating system, causing the rupiah to drop more

IMF created a rescue package of $23 Billion, but didn’t help

In Sept they hit a all time low, Moody’s rated Indonesia’s long-term debt to “junk bond” status

More effects were felt in Nov when the summer’s hits were felt in the corporate books

IndonesiaIn Feb, the President got rid of the governor of

the Bank of Indonesia, but this wasn’t enough and he was eventually forced to resign

EffectsRupiah was 200 to 1 USD, afterward hit 18,000 to

1 USDLost 13.5% of GDP

South Korea

South KoreaLarge corporations were funding big expansions,

however failed due to excess debt

Moody’s lowered their credit rating from A1 to B2

Seoul stock exchange dropped 4% on Nov 7, 7% on Nov 8, and 7.2% on Nov 24

In 1998 Hyundai took over Kia Motors and Daewoo was sold to American GM

Currency dropped from 800 per dollar to 1,700

National debt-GDP ratio went from 13%-30%

South KoreaSeptember: S.Korea’s foreign debt= $105 billion

($70 billion under 1 year maturity); its reserves =$25 billion.

This figures shows that South Korea is technically bankrupt

Therefore it has to accept the IMF’s $60 billion so called ‘rescue’ packae

South KoreaThe IMF conditions

Cuts in government spendingUnemployment to double from 4% to 8%12 Govt. owned banks to close immediatelyRestrictions on foreign ownership of Korean banks

to be endedForeigners to be allowed full access to Korean

govt. bond market

South Korea The IMF conditions (contd..)

Foreigners to be allowed to own up to 100% shares in top Chaebol firms (previous limit was 25%)

Foreign firms to be allowed entry into the domestic insurance and pension fund industry

Govt.-Chaebol links to be made transparent: privileges, subsidies etc. to be ended.

South KoreaThe terms were humiliating;

South Korea attempted to improve the terms by asking for only $30b as opposed to $60b loan.

The IMF refused, insisting that i) South Korea needed the entire $60b and, ii) not one dollar would be given unless all the

conditions were agreed to.

South KoreaWas the crisis used as a one-off opportunity to

prize open South Korea?

Answer: Definitely.

Hong Kong

Hong KongAfter UK gave control of Hong Kong to China the

Hong Kong dollar was under speculative pressure

Authorities spent more then US $1 Billion to defend local currency

Had more then US $80 billion in foreign reserves

Stock markets became volatile

In Oct the Hang Seng Index dropped 23%

In Aug 98, interest rates jumped from 8%-23% overnight, and even 500% once

Hong KongThe Hong Kong Monetary Authority (HKMA)

setup a system to establish rates, however speculators were taking advantage of this by short selling shares.

HKMA wound up buying HK$120 billion worth of shares in various companies to combat this

Started selling those share in 2001, profiting HK$30 billion

Malaysia

MalaysiaIn July 1997, the Malaysian ringgit jumped

overnight from 8% to over 40%

Ratings had fallen from investment grade to junk

Lost 50% of value, from 2.50 to 3.80 to the dollar

Output of real economy declinedConstruction dropped 23%Manufacturing 9%Agriculture 5.9%GDP 6.2%

MalaysiaIMF aid was refused

Various task forces were formed to fix economy

By 2005 had a surplus of US$14.04 billion

Singapore

SingaporeSingapore dipped into a short recession

Government kept very active management to ensure security

Government programs were put forward

Made no attempt to help capital markets, instead allowed a 60% drop, however within a year fully recovered and continued to grow

Less Affected CountriesChina, The US, and Japan were very strong

economies and were able to survive

China held most of it’s foreign investments were in factories rather then securities

U.S. didn’t collapse, but on Oct 27,1997 the Dow Jones fell 554 points (7.2%)

Japan was affected because the economy is so prominent (yen fell to 147), but it was world’s largest holder of currency reserves so it bounced back quickly

Asian financial contagionBecause of this crash in Asia, investment flowed

elsewhere in Moscow (1998)

Investor thought that Russia would not fail

Even if it fails, they thought that rich countries will bail them out

Russia defaulted on its debt and currency plummeted

Now investor realised that massive risk everywhere

USAThis did affect USA as well

One of the private investment fund LTCM (Long Term Capital Management) was in the brink of bankruptcy

LTCM directly controlled $100 billion of global assets and indirectly trillion dollar assets

September 1998, LTCM losses were out of control

Government could do impose its solution because it was private fund

USAFailure of single fund threatened the entire

global economy

Fate of global economy now on the hand of bankers

Bankers agreed to put up their own money to protect LTCM

As a result Wall Street avoided the disaster

ConclusionMany businesses collapsed and millions of

people fell below the poverty line

Indonesia, South Korea, and Thailand were most affected

Heavy U.S. investment shifted from Thailand to Europe

Many countries pushed for corporate governing to avoid problems later

Investors were reluctant to lend to developing countries

Assignment for workshopExplain why bank-based rather than capital

market-based finance has traditionally played the more dominant role in the Asian economic paradigm and why, in the current era of globalization, this continued dominance might be a problem.

ReferencesKaufman, GG., Krueger, TH., Hunter, WC. (1999)

The Asian Financial Crisis: Origins, Implications and Solutions. Springer.

Weisbrot, Mark (August 2007). Ten Years After: The Lasting Impact of the Asian Financial Crisis

Tecson, Marcelo L. (2009), "IMF Must Renounce Its Weapon of Mass Destruction: High Interest Rates"