The Asian Financial CrisisThe Asian Financial Crisis

Hung-Gay FungHung-Gay Fung

University of Missouri-St. LouisUniversity of Missouri-St. Louis

Presentation OutlinePresentation Outline

Discuss briefly the behavior of the Discuss briefly the behavior of the Foreign Exchange (FX) of Southeast Foreign Exchange (FX) of Southeast Asian Countries.Asian Countries.

Assess different factors that lead to Assess different factors that lead to the currency crisis.the currency crisis.

Opportunities and Implications for Opportunities and Implications for U.S. companiesU.S. companies

Foreign Exchange RatesForeign Exchange Rates Since June 1997, FX rates in many Since June 1997, FX rates in many

Southeast Asian countries have experienced Southeast Asian countries have experienced a substantial decline.a substantial decline.

These countries include the Philippines, These countries include the Philippines, Malaysia, Thailand, Indonesia, and Korea.Malaysia, Thailand, Indonesia, and Korea.

Many of these countries linked their Many of these countries linked their exchange rates to the U.S. dollar before the exchange rates to the U.S. dollar before the currency crisis.currency crisis.

Change in FX rates Change in FX rates (6/30/1998)(6/30/1998)

FX:1 $US FX:1 $US FX: 1 $USFX: 1 $US % %

6/30/986/30/98 6/30/976/30/97changechange

Chinese yuan 8.281 8.289 +0.09

HK dollar 7.745 7.747 +0.03

Indonesia rupiah 14568.89 1760 -87.92

Japanese yen 138.31 114.61 -17.58

Malaysian ringgit 4.1 1.827 -55.44

Korean won 1370 641.4 -53.18

Philippine peso 41.5 19.08 -54.02

Thai baht 42.16 17.9 -57.54

Immediate Results of CrisisImmediate Results of Crisis

In addition to currency devaluation:In addition to currency devaluation: Collapse of their Stock Markets Collapse of their Stock Markets

(all Southeast countries);(all Southeast countries); Call for an IMF rescue plan in theCall for an IMF rescue plan in the

Philippines, Thailand, Indonesia and Philippines, Thailand, Indonesia and Korea;Korea;

Bankruptcy and financial reformsBankruptcy and financial reforms(all Southeast countries).(all Southeast countries).

What Happens to Capital What Happens to Capital Flows?Flows?

19941994 19951995 19961996 1997*1997*Private flows, net 40.5 77.4 93.0 -12.1

Equity Investment 12.2 15.5 19.1 -4.5

Private Creditors 28.2 61.8 74.0 -7.6

Source: Institute of International Finance, Inc., “Capital Flows to Emerging Economies,” January 1998.

Reasons for the Currency Reasons for the Currency CrisisCrisis

Decline in Export EarningsDecline in Export Earnings Excessive and Risky InvestmentExcessive and Risky Investment Current Account DeficitCurrent Account Deficit Overvalued CurrencyOvervalued Currency Underdevelopment of credit marketUnderdevelopment of credit market Property market bubbleProperty market bubble

Regional Annual Growth Rate of Exports (%)Regional Annual Growth Rate of Exports (%)

CountryCountry 19901990 19911991 19921992 19931993 19941994 19951995 19961996

China 18.2 15.8 18.1 7.1 33.1 22.9 1.6

Indonesia 15.9 13.5 16.6 8.4 8.8 13.4 9.7

Korea 4.2 10.5 6.6 7.3 16.8 30.3 3.7

Malaysia 17.4 16.8 18.5 15.7 24.7 24.7 26.0

Philippines 4.0 8.7 11.2 13.7 20.0 31.6 16.7

Thailand 14.9 23.2 14.2 13.3 22.7 25.1 -1.3

Mexico 17.7 0.7 1.4 9.2 14.2 40.3 22.6

Decline in Export EarningsDecline in Export Earnings

Excessive and Risky InvestmentExcessive and Risky Investment

Incremental Capital-Output (ICOR) RatiosIncremental Capital-Output (ICOR) Ratios

CountryCountry 1987-19921987-1992 1993-19961993-1996

China 3.1 2.9

Hong Kong 3.7 6.1

Indonesia 3.8 4.9

Korea 4.0 4.9

Malaysia 3.7 4.8

Philippines 6.0 5.5

Singapore 3.6 4.0

Taiwan 2.4 3.9

Thailand 3.4 5.1Source: Corsetti and Pesenti (1998)

Current Account DeficitCurrent Account Deficit(% of GDP)(% of GDP)

1990-19951990-1995 19961996

Asian CountryAsian Country: : (average) (average)

China 0.9 0.9

Hong Kong 3.3 -1.2

Korea -1.2 -4.8

Singapore 12.7 15.5

Taiwan 4.0 4.0

Indonesia -2.5 -3.7

Malaysia -5.9 -4.9

Philippines -3.8 -4.7

Thailand -6.7 -7.9

Current Account Current Account (continued)(continued)

Latin AmericaLatin America 1990-951990-95 19961996

Argentina -1.6 -1.4

Brazil -0.6 -3.3

Chile -2.6 -5.4

Colombia -1.7 -5.5

Mexico -5.1 -0.6

Other countries:Other countries:

Israel -3.9 -7.4

Africa (average) -11.1 -7.8

Hungary -4.0 -3.7

Source: Bank for International Settlements

Overvalued CurrencyOvervalued CurrencyCountryCountry 19901990 19911991 19921992 19931993 19941994 19951995 19961996

Hong Kong 99.7 103.9 108.5 115.9 114.5 116. 125.5

Indonesia 97.4 99.6 100.8 103.8 101.0 100.5 105.1

Korea 97.1 91.5 87.8 85.2 84.7 87.8 86.8

Malaysia 97.0 96.9 109.7 111.0 107.1 107.0 111.9

Philippines 92.3 103.1 107.1 97.4 111.6 109.5 116.0

Singapore 101.2 105.7 106.0 108.6 111.9 112.7 117.9

Thailand 102.2 99.0 99.7 101.9 98.3 101.7 107.6

Note: The base figure (100) is the average for the year 1990

Source: J.P. Morgan

Japanese ModelJapanese Model

Limit bond market to support long-term Limit bond market to support long-term growth.growth.

KeepKeep savingssavings in a small number of powerful in a small number of powerful banks which arebanks which are notnot properly regulated .properly regulated .

Loans are made toLoans are made to favoredfavored customers and customers and businesses with national ambitions, such as businesses with national ambitions, such as textiles, steel, shipbuilding, electronics, and textiles, steel, shipbuilding, electronics, and automobiles (such as Japan, Thailand, automobiles (such as Japan, Thailand, Korea, and Indonesia).Korea, and Indonesia).

Size of Banking sectorSize of Banking sector

1995 % of GDP1995 % of GDP

BondBond Bank Bank

MarketMarket LendingLending

U.S. 110% 54%

Japan 74 152

Malaysian 56 100

Philippine 39 54

Thailand 10 100

Indonesia 6 57

Bank Credit to Private SectorBank Credit to Private SectorAnnual Rate of ExpansionAnnual Rate of Expansion % of GDP% of GDP

CountryCountry 1990-19971990-1997 19971997

China 13 97

Hong Kong 8 157

Indonesia 18 57

Japan 1.5 111

Korea 12 64

Malaysia 16 95

Philippines 18 52

Singapore 12 97

Thailand 18 105

United States 0.5 65

June 1996June 1996 June 1997June 1997Indonesia 1.724 1.704

Korea 1.623 2.073

Malaysia 0.252 0.612

Philippines 0.405 0.848

Thailand 0.992 1.453

Other countriesOther countriesArgentina 1.325 1.210

Brazil 0.702 0.792

Mexico 1.721 1.187

Pakistan 0.740 2.440

South Africa 4.050 3.124

Zimbabwe 1.319 1.635

Short-Term Debt to ReservesShort-Term Debt to Reserves

Non-Performing LoansNon-Performing Loans(% of Total Loans)(% of Total Loans)

19901990 19941994 19951995 19961996

Indonesia 4.5 12.0 10.4 8.8

Korea 2.1 1.0 0.9 0.8

Malaysia 20.4 8.1 5.5 3.9

Thailand 9.7 7.5 7.7 N/A

Mexico 2.3 10.5 14.4 12.5

Argentina 16.0 8.6 12.3 9.4

Source: Bank for International Settlements.

Property Market BubbleProperty Market Bubble

Sale Price:Sale Price: Capital Value Capital Value

PeriodPeriod Bangkok (000B/m. sq.)Bangkok (000B/m. sq.) Jakarta ($/m. sq.)Jakarta ($/m. sq.)

Q4, ‘90 66.0 3019

Q4, ‘91 67.0 2788

Q4, ‘92 60.0 2482

Q4, ‘93 59.5 2327

Q4, ‘94 60.5 2358

Q4, ‘95 60.5 2179

Q4, ‘96 60.4 2250

Q2, ‘97 43.0 2267

Source: Data Stream and Jones Lang Wootten.

Central Business District Office Central Business District Office Vacancy RatesVacancy Rates

19971997

Bangkok 15.0%

Hong Kong 6.0%

Kakarta 10.0%

Kuala Lumpur 3.0%

Manila 1.0%

Singapore 8.0%

Shanghai 30.0%

Source: JP Morgan “Asian Financial Markets,”

January 1998.

What Really Causes A What Really Causes A Crisis?Crisis?

Corruption?Corruption?Korea, Indonesia, Thailand -corruptionKorea, Indonesia, Thailand -corruptionItaly and India have corruption, but no Italy and India have corruption, but no

crisiscrisis

Bank TransparencyBank Transparencyinadequate regulatory frameworkinadequate regulatory frameworkirrational lenders?irrational lenders?

Fundamental Factors-GDP growth Fundamental Factors-GDP growth (%)(%)

19931993 19941994 19951995 19961996

Indonesia 6.5 7.54 8.22 7.98

Korea 5.75 8.58 8.92 7.13

Malaysia 8.41 9.24 9.46 8.20

Philippines 2.12 4.39 4.76 5.67

Thailand 8.27 8.85 8.68 6.66

Source: Corsetti, Pesenti and Roubini (1998).

Inflation RateInflation Rate

19931993 19941994 19951995 19961996

Indonesia 9.60 8.53 9.43 8.03

Korea 4.82 6.24 4.49 4.96

Malaysia 3.57 3.71 5.28 3.56

Philippines 7.58 9.06 8.11 8.41

Thailand 3.36 5.19 5.69 5.85

Source: Corsetti, Pesenti and Roubini (1998).

Savings Rates (% of GDP)Savings Rates (% of GDP)CountryCountry 19901990 19911991 19921992 19931993 19941994 19951995 19961996

China 38.1 38.3 37.7 40.6 42.6 41.0 42.9

Hong Kong 35.8 33.8 33.8 34.6 33.1 30.4 30.6

Indonesia 27.9 28.7 27.3 31.4 27.6 28.4 28.1

Japan 33.5 34.2 33.8 32.8 31.4 30.7 31.3

Korea 36.1 35.9 35.1 35.2 34.6 35.1 33.3

Malaysia 29.1 28.4 31.3 33.0 32.7 33.5 36.7

Philippines 18.7 18.0 19.5 18.4 19.4 17.8 19.7

Singapore 44.1 45.4 47.3 44.9 49.8 50.0 50.1

Taiwan 22.4 22.2 23.2 23.7 22.9 22.9 21.0

Thailand 32.6 35.2 34.3 34.9 34.9 34.3 33.1

Source: Statistical Appendix, IMF, 1997.

Human Development IndicatorsHuman Development Indicators

CountryCountry Life-ExpectancyLife-Expectancy Literacy RateLiteracy Rate Average Income Average Income ofof

(years)(years) (%) (%) Poorest 20% Poorest 20%

in ‘85 US$in ‘85 US$

19701970 19951995 19701970 19951995 19701970 19951995

Indonesia 48 64 54 84 392 908

Korea 60 72 88 98 303 2071

Malaysia 62 72 60 85 431 1070

Philippines 57 66 83 95 218 435

Thailand 58 69 79 94 361 726

Source: Radelet and Sachs (1998).

Fixed Exchange Rate SystemFixed Exchange Rate System

FX rates more efficient.FX rates more efficient. Imposes impediments in the FX Imposes impediments in the FX

system.system. Government guarantees investors Government guarantees investors

potential upside return if FX potential upside return if FX devalues.devalues.

Currency Model of AttackCurrency Model of Attackby Speculatorsby Speculators

Due to theDue to the ““fixedfixed”” exchange arrangement in exchange arrangement in many Southeast Asian countries, speculators many Southeast Asian countries, speculators start withstart with local borrowingslocal borrowings (i.e., borrowing (i.e., borrowing from local banks).from local banks).

They then sell the local currencies,They then sell the local currencies, convert convert into US dollars,into US dollars, andand sell forward contracts.sell forward contracts.

They realize a profit if theThey realize a profit if the currencies currencies devalue,devalue, because their US holdings can be because their US holdings can be exchanged for more local currencies to pay exchanged for more local currencies to pay off loans.off loans.

Defenses by GovernmentsDefenses by Governments

Buy up sales transactions - FX reserves can Buy up sales transactions - FX reserves can be exhausted quickly.be exhausted quickly.

Jack up the interest rate to deter Jack up the interest rate to deter speculative borrowings, implying high cost speculative borrowings, implying high cost for business that leads to:for business that leads to: bankruptciesbankruptcies discouraging real investmentdiscouraging real investment collapse of stock marketscollapse of stock markets

Penalize banks who lend money to Penalize banks who lend money to speculators.speculators.

The Impact of Crisis on ChinaThe Impact of Crisis on China

More imports from Korea due to More imports from Korea due to lowered prices, e.g., products lowered prices, e.g., products imported from Korea have increased, imported from Korea have increased, including steel (32.4%), petro-including steel (32.4%), petro-chemicals (11.8%), and textiles (9%).chemicals (11.8%), and textiles (9%).

China’s exports slow down.China’s exports slow down. Economic growth slows down.Economic growth slows down.

China’s StrategyChina’s Strategy Under pressure to devalue its currency.Under pressure to devalue its currency.

However, such a decision is political, not However, such a decision is political, not economic.economic.

Could hurt its credibility as an Asian Could hurt its credibility as an Asian leader.leader.

Devaluation will hurt Hong Kong, a Devaluation will hurt Hong Kong, a place to raise external funds via initial place to raise external funds via initial public offerings (IPO) for its state-public offerings (IPO) for its state-owned enterprises.owned enterprises.

China’s Strategy China’s Strategy (continued)(continued)

Ease Ease Export CreditsExport Credits by encouraging by encouraging banks to make loans to export-banks to make loans to export-oriented companies.oriented companies.

Relax export licenses and give tax Relax export licenses and give tax rebates: rebates: Ministry of Foreign Trade and Ministry of Foreign Trade and

Economic Cooperation issues more Economic Cooperation issues more export licenses for base metals.export licenses for base metals.

Exporters will receive full 17% value-Exporters will receive full 17% value-added tax.added tax.

Implications and StrategiesImplications and Strategies

Lowered currency value implies Lowered currency value implies products are cheaper to buy --products are cheaper to buy --Merger Activities in Asian countriesMerger Activities in Asian countries

International trade implicationsInternational trade implications Financial reforms (bond market Financial reforms (bond market

development and banks)development and banks) Corporate StrategiesCorporate Strategies

Corporate Hedging StrategiesCorporate Hedging Strategies

Increased use of hedging Increased use of hedging instruments, given the volatile FX instruments, given the volatile FX markets (markets (use of forward, swaps and use of forward, swaps and other derivative instrumentsother derivative instruments).).

As a long-term strategy, U.S. firms As a long-term strategy, U.S. firms should pay closer attention in should pay closer attention in managing their economic exposure,managing their economic exposure, e.g., Avon’s use of a balance sheet e.g., Avon’s use of a balance sheet hedge in 1997hedge in 1997..