Global Analysis on 1997 Hong Kong Financial Crisis

1997 Hong Kong Financial CrisisFNCE 101 001

04/24/14Group 2

Tianyu Guan, Tianran Hang, Tianni Lin, Yiran Zhang

Roadmap

• Macroeconomic Overview

• Analysis on Macroeconomic Issues & Policies Implemented

• Exchange rate

• Interest rate

• Outcome of the Crisis

Macroeconomic Overview

• Started in other Southeast Asia countries contagion

• Thailand, Philippine, Malaysia, Indonesia, Taiwan, Hong Kong, South Korea

• Hit Hong Kong on 23 Oct 1997

• 2 rounds of speculative attacks

• Lasted until end of 1998

• Pegged Exchange Rate

• Since 1983

• USD:HKD=1:7.8


• GDP growth rate decreased


• High inflation


• Consumer spending decreased


• Investment declined


• Housing bubble burst


• Interest rate skyrocketed


• Unemployment rate rose from 2% to 6%


HKD Pegged to USD

• HKD had been pegged at 7.8 to the U.S. dollar since 1983

• Benefits• Eliminates exchange rate risks

• Attracts foreign investors

Reasons of Overvalue of HKD

• High Inflation compared to the US

• Significantly higher inflation than US for a few years

• HKD devaluation

Reasons of Overvalue of HKD (Cont’d)

• Depreciation of Southeast Asian currencies

• Southeast Asian currency (e.g. Thai baht) depreciation

• Pegged floating

• USD appreciation

• HKD (pegged) appreciation

• Underlying economic conditions unchanged

Overvalue of Hong Kong Dollar

Speculative Run on HKD

• In October 1997, speculators, such as George Soros, initiated speculative attack

on HKD

• Borrowed HKD

• Converted HKD to USD at the overvalued exchange rate

• Increased supply of HKD

• HKMA had to spend reserves to maintain the demand of HKD


• Speculators’ idea:

• Everyone wanted sell HKD.

HKMA needed to buy HKD, and

its reserves ran out quickly

• Fundamental exchange rate

further decreased

• Even more loss of reserves

occurred HKD devalues

profit from speculation


• Speculators’ assumptions

• HKMA would run out of foreign exchange reserves

• Declining export

• Decreasing reserves


• Speculators’ assumptions

• HKMA would run out of foreign exchange reserves

• Little government intervention on its economy prior to the crisis

• Chinese government was not likely to help out Hong Kong

Policy to combat the speculative attack

• Pegged floating exchange rate

• Thailand, Philippine, Taiwan

• Foreign exchange reserve shortage

Policy to combat the speculative attack

• Increase demand for local currency

• Hong Kong Monetary Authority

• More than US $80 billion in foreign reserve

• Spent more than US$1 billion to defend the local currency

• Chinese government guaranteed to maintain Hong Kong’s economic stability

• Interest rate skyrocketed

Interest Rate

Reasons of Increased Interest Rate

• Increase of US interest rate

(1+iHK)=(1+iUS)enom,t/eenom,t+1

Reasons of Increased Interest Rate

• Currency board system

Second Round of Speculative Attacks

• Short selling HK stocks

• Double-play

• Interest rate

• 15 Aug 1998

• Overnight interests rate:

8% 23%

• Briefly touching 280%

Second Round of Speculative Attacks

• Heng Seng Index

• 1997 peak: 16,673 23 Oct 1997: 9,060 Oct 1998: 6,660

Policy to save the stock market

• Government purchased US $15 billion of stocks

• Owned 7% of stock market

• Sell off in 1999

• Tracker Fund of Hong Kong

• US $4 billion profit

• HKD still pegged to USD

• All other Asian countries floating exchange rate

Outcome of the Crisis

• Took 10 years to return to GDP level before the crisis



• Deflation and then moderate inflation (~4%)

• Risks of future currency crisis?

• Lower inflation

• No contagion risk

• Successful defense of currency fended off speculative attacks


Questions?

Documents

Global Analysis on 1997 Hong Kong Financial Crisis