South East Asian Currency Crisis 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.

The Asian financial crisis involves four basic problems or issues:

(1)A shortage of foreign exchange that has caused the value of currencies and equities

in Thailand, Indonesia, South Korea and other Asian countries to fall dramatically,

(2) Inadequately developed financial sectors and mechanisms for allocating capital in

the troubled Asian economies,

(3) Effects of the crisis on both the United States and the world, and

(4) The role, operations, and replenishment of funds of the International Monetary Fund.

Introduction of A.F.C Asian financial crisis Initiated by two rounds of currency depreciation in 1997. First round was a precipitous drop in the value

Thai baht

Malaysian ringgit

Philippine peso

Indonesian rupiah Second round began with downward pressures hitting

Taiwan dollar

South Korean won

Brazilian real

Singaporean dollar

Hong Kong dollar.

Before crisis Economies of south east Asia Maintained high interest rates attractive to foreign investors looking

for a high rate of return. Regional economies of Thailand, Malaysia, Indonesia, Singapore, and

South Korea experienced high growth rates, 8–12% GDP, in the late 1980s and early 1990s.

Thailand, Indonesia and South Korea had large private current account deficit

It led to excessive exposure to foreign exchange risk in both the financial and corporate sectors.

In 1990’s the U.S. Economy recovered from recession

ImpactIt began to raise U.S. interest rates to head off inflation.

At the same time, Southeast Asia's export growth slowed dramatically in the spring of 1996, deteriorating their current account position.

At the end of 1996, the proportion of loans with maturity of one year or less was 62% for Indonesia, 68% for South Korea, 50% for the Philippines, 65% for Thailand, and 84% for Taiwan.

Was there a crisis ?Over $100billion was pulled out of the region in 1997-98

which was 5 percent of the GDPUnemployment rose to .8 million in Indonesia, 1.5 million

in Thailand, 1.35 million in KoreaReal wages dropped by 12.5% in Korea and 6% in Thailand

Chain of eventsCorporate failure at KoreaBank failure at ThailandPolitical uncertainty at Korea, Thailand, PhilippinesPolicy mismanagement at Thailand and Korea – to defend

their pegged exchange rates exhaust their Forex reservesContagion effect hit Malaysia, Philippines, IndonesiaInternational intervention – IMF & Moody

Events from microeconomic point of viewExchange rates depreciatesForeign lenders concerned with the repayment of loans,

withdraw fundsDomestic interest rates soar upLack of bankruptcy laws and rising Non Performing Loans

added to the stress of the banksBanks become illiquid and decapitalizedThe fall of Korean stock exchange

East Asian Countries Initially secondly

Majorly Thailand, Indonesia South Korea

Fairly Malaysia, Philippines Hong Kong, Taiwan

Mild Singapore, Laos, Japan,Chaina

Rounds

Effects

Currency

Exchange rate(per US$1)[30] Change

June 1997 July 1998

Thai baht 24.5 41 – 40.2%

Indonesian rupiah 2,380 14,150 – 83.2%

Philippine peso 26.3 42 – 37.4%

Malaysian ringgit 2.5 4.1 – 39.0%

South Korean won 850 1,290 – 34.1%

CountryGNP (US$1 billion)[30]

ChangeJune 1997 July 1998

 Thailand 170 102 – 40.0%

 Indonesia 205 34 – 83.4%

 Philippines 75 47 – 37.3%

 Malaysia 90 55 – 38.9%

 South Korea 430 283 – 34.2%

Reasons for the crisisFaulty macro economic policy

Demise of Industrial Policy : government used to intervene and control inflow

End to policy of government coordinated investment allowed duplicative investment in key industries leading to excessive foreign borrowings between 1993-1997

Excessive risk in govt. favoured industriesCrony capitalism

The causes and structural factors contributing to the financial crises include: private-sector debt problems and poor loan quality, rising external liabilities for borrowing countries, the close alignment between the local currency and the U. S. dollar, weakening economic performance and balance-of-payments difficulties, currency speculation, technological changes in financial markets, and a lack of confidence in the ability of the governments in question to resolve

their problems successfully Declining exports

Categorization of crisisMacroeconomic policy induced – balance of payment crisisFinancial panic – sudden withdraw from solvent borrower

by short term creditorsBubble collapse – overvaluation of financial assetDisorderly workout – impediment to efficient provision of

working capital

Impacts Indonesia

Drastic devaluation of the rupiah from 2000 to 18000 for 1 US$

Excessive inflationRiots 16 major commercial banks were closedGovernor, Bank Indonesia was sackedPresident Suharto was forced to step down in may after 30

years in power

South Korea

Drastic devaluation of the won: from 1000 to 1700 for 1 US$

Credit rating of the country (moody’s): A1 to B2National debt-to-GDP ratio more than doubledMajor setback in automobile industry

Philippines

Growth dropped to virtually zero in 1998Peso fell significantly, from 26/US$ to even 55/US$President Joseph Estrada was forced to resign

Measures taken to overcome crisis

High saving and investment rate Strong emphasis on education Stable macroeconomic environment Free from high inflation or major economic slumps High share of trade in GDP

Role of IMFPrevent outright default on foreign obligationLimit the currency depreciationLimit inflationRebuild foreign exchange reservesReform the banking sector

Why was India not affected Full capital convertibility is not allowedLock in period for foreign investment in real estateFloating exchange rate with some influence by the RBI

during periods of crisisStrong fundamental growth with services sector being the

prime reasonExternal debt to GDP has been declining for the past few

years

U.S.& JAPAN U.S. The Dow Jones industrial plunged 554 points or 7.2%, amid ongoing

worries about the Asian economies. The New York Stock Exchange briefly suspended trading.

JAPAN Japan was affected because its economy is prominent in the region. Asian

countries usually run a trade deficit with Japan because the latter's economy was more than twice the size of the rest of Asia together; about 40% of Japan's exports go to Asia.

The Japanese yen fell to 147 as mass selling began, but Japan was the world's largest holder of currency reserves at the time, so it was easily defended, and quickly bounced back.

GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998, due to intense competition from cheapened rivals.

Learning'sThe lessons from developing country crises are

summarized as:Choosing the right exchange rate regimeThe central importance of bankingThe proper sequence of reform measuresThe importance of contagion