South East Asian Financial Crises 1997

The Asian Financial Crisis was a period of

financial crisis that gripped much of Asia

beginning in July 1997, and raised fears of a

worldwide economic meltdown due to

financial contagion(financial shock).

Introduction

The crisis started in Thailand with the

financial collapse of the Thai baht caused by

the decision of the Thai government to

float the baht, cutting its peg to the USD,

after exhaustive efforts to support it in the

face of a severe financial overextension that

was in part real estate driven.

At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. 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

The debt crisis in East Asia stemmed from inappropriate borrowing by the private sector. Due to high rates of economic growth and a booming economy, private firms and corporations looked to finance speculative investment projects. However, firms overstretched themselves and a combination of factors caused a depreciation in the exchange rate as they struggled to meet the payments

Countries Affected in the Contagion Thailand, July, 1997 Indonesia, June to August, 1997 Korea, July, 1997 Japan had already been through its own

crisis earlier and was in an economic depression

Russia and Mexico followed a little later with crises of their own.

Fixed exchange rate system pegged to the USD. When the Dollar rose,consequently the ASEAN currencies grew too, resulting in lower exports

Decline in Export competitiveness particularly in Electrical goods.

The decrease in exports resulted in increased Trade and Current Account deficit.

Unfolding of the Crisis

The crisis first emerged in Thailand when as a crisis of loan repayment. This led to fears of loan defaults and foreign short-term creditors withdrew funds from Thai financial institutions.

The withdrawal of ST credit led to pressure on forex reserves and the value of Baht. The Bank of Thailand in its attempt to save the Baht lost all its Reserves and had to request assistance from the IMF.

The contagion then spread to Philippines, Malaysia and Indonesia.

Weakness of Macro-Economic fundamentals

Low productivity and competitiveness Inadequate supervision of Financial

institutions worsened the situation.

Weak governments lacked the political autonomy.

Causes of the crisis in 1997

Overvalued Exchange Rate & Openness of Capital Account

Overvalued exchange rates tied to an appreciating U.S. dollar led to large current account deficits and inadequate or declining long-term capital inflows resulted in heavy dependence on short-term external debt and the depletion of foreign exchange reserves

The crisis led to weaker, unstable exchange rates and weakened Financial Institutions. To tackle this, the Government imposed higher domestic Interest rates, which led to a slowdown in manufacturing and industrial activity. This brought about huge unemployment and an undesirable social impact – on food, healthcare and education.

Impact of the crisis

12

From 1985 to 1996, growth rate averaging almost 9% annually - increased pressure on Thailand's currency, the baht

From 1985 until July 1997, Baht was pegged at 25 US$

Before it started…

13

Mid-May ‘97: Thai Baht was hit by massive speculative attack

Spark: End-June ‘97, Thai Prime Minister declared that he would not devaluate the Baht

Thai Government failed to defend the Baht against International speculators

Financial Crisis hits….

What happened in Thailand…

14

Booming Thai Economy ground to a halt, contracted by 1.9%

Massive lay-offs in Finance, Real Estate & Construction: unemployment rate all-time high

Huge numbers of workers returning to their villages in the countryside and 600,000 foreign workers sent back

Stock market dropped 75%,

“Finance One” collapsed

Baht reached 56 US$ in Jan ‘98

What happened in Thailand…

15

Drastic devaluation of the rupiah: from 2,000 to 18,000 for 1 US$

Sharp price increase

Wake of widespread rioting: 500 deaths in Jakarta alone

Governor, Bank Indonesia was sacked

President Suharto was forced to step down in May 1998 after 30 years in power

What happened in Indonesia…

16

Drastic devaluation of the won: from 1,000 to 1,700 for 1 US$

Credit rating of the country (Moody’s): A1 to B2

National Debt-to-GDP ratio more than doubled

Major setback in Automobile industry

What happened in S.Korea…

17

Growth dropped to virtually zero in 1998

Peso fell significantly, from 26/US$ to even 55/US$

President Joseph Estrada was forced to resign

What happened in Philippines..

18

40% of Japan’s export go to Asia, so it was affected even if the economy was strong

Japanese Yen fall to 147 as mass selling began

GDP real growth rate slowed from 5% to 1.6%

Some companies went Bankrupt

Being world’s largest currency holder, Japan could bounce back quickly

What happened in Japan…

19

Markets did not collapse, but were severely hit

NYSE briefly suspended trading, for the first time

Dow Jones Industrial Average suffered as 3rd biggest point losses ever

Relationship with Japan changed forever: US stopped supporting the highly artificial Trade environment and Exchange Rate

What happened in US...

Mistakes of Asian Lenders

The countries involved usually had some international indebtedness, and Asian banks and borrowers used short-term credits to finance long-term loans.

Asian borrowers (banks and firms) borrowed in foreign currencies and loaned in local currency. No hedging to counter foreign exchange risk.

Mistakes of Asian Lenders

Asian bankers often did not ask to see consolidated balance sheets. They didn’t monitor the total assets and liabilities of the borrowers.

The IMF paid the bills for such banks, finance ministries and countries. Moral hazard problems! Investors should pay for bad decisions.

1. Stabilizing the Exchange Rate and Debt Management- The idea here is to stabilize the exchange rate. The firms should not be allowed to take any further debt which would imply Debt Standstill.

2. Dealing with the Social impact- deal with the Social Impact the availability of food and healthcare at affordable prices.

Proposed Solutions

3. Strengthening the Financial sector 4. Adjustment of Industrial Structures 5. International Financial markets-

surveillance system to monitor flow of capital.

6. Revitalizing the Financial Markets