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East Asian Financial Crisis

East Asian Financial Crisis. Econ 437 Allstars: Yan, Lauren, Kevin, John, Alex. Pre-Crisis. During the pre-crisis era, Asia attracted half of the capital inflow to developing countries. Asian Economic Miracle. The Sign. Mexican Peso Crisis. Princeton/MIT economist Paul Krugman’s argument.

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East Asian Financial Crisis

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  1. East Asian Financial Crisis Econ 437 Allstars: Yan, Lauren, Kevin, John, Alex

  2. Pre-Crisis • During the pre-crisis era, Asia attracted half of the capital inflow to developing countries. • Asian Economic Miracle.

  3. The Sign • Mexican Peso Crisis. • Princeton/MIT economist Paul Krugman’s argument. • Early May 1997, Japan hints that it might raise interest rates to defend the yen.

  4. The Beginning • July 2, 1997 - Thailand announces a managed float of the baht. The Philippines intervenes to defend its peso. • July 24, 97 - Asian currencies fall dramatically. • Aug. 13-14 - The Indonesian rupiah comes under severe pressure. • Aug. 28 - Asian stock markets plunge.

  5. The Ripple • Oct. 20-23 - The Hong Kong dollar comes under speculative attack. At the same time, The Hong Kong stock market drops. • Oct. 28 - The value of the Korean won drops as investors sell Korean stocks. • Nov. 3-24 - Japanese brokerage firm , largest securities firm, and 10 largest bank collapse.

  6. The Ripple (Con.) • Nov 25 - At the APEC Summit, leaders of the 18 Asia Pacific economies endorse a framework to cope with financial crises. • Jan 12, 1998 - Peregrine Investments Holdings of Hong Kong collapses. • Jan 31 - South Korea orders 10 of 14 ailing merchant banks to close.

  7. IMF In Action • July 18, 1997 - IMF approves an extension of credit to the Philippines of $1.1 billion. • Aug. 20 - IMF announces $17.2 billion support package for Thailand with $3.9 billion from the IMF. • Nov. 5 - The IMF announces a stabilization package of about $40 billion for Indonesia. The United States pledges a standby credit of $3 billion.

  8. IMF In Action (Con.) • Dec 25 - IMF and others provide $10 billion in loans to South Korea. • Jan 8 - IMF and S. Korea agree to a 90-day rollover of short-term debt. • Jan 15, 1998 - IMF and Indonesia sign an agreement strengthening economic reforms.

  9. Asian Financial Crisis • Occurred in 1997 • Period of turbulence, not marked by single event • Unanticipated and followed a stretch of strong economic performance over previous 8-10 years.

  10. Asian Financial Crisis-Onset • In 12 months regions stock market capitalization shrank by as much as 85% in US $ terms. • Once among the largest stock markets in the world. • Currencies depreciated sharply, falling 50%-80% against US $ by July 1998.

  11. Contributing Factors of Crisis(Prior to Crisis) • A build up of overheating pressures. • Evident in large external deficits • Inflated stock prices and property market values • Prolonged maintenance of pegged exchange rates. • Unsustainably high levels • Complicated monetary policy response to crisis

  12. Contributing Factors of Crisis(Prior to Crisis) • East Asia was hit by several international macroeconomic shocks 1994-1996 period. • Increase in competitiveness • Reversal of the long-term trend of yen’s appreciations relative to the dollar *These shocks believed to have impact on Asia’s economic performance in combinations with weaknesses of East Asian financial systems.

  13. Contributing Factors of Crisis(Prior to Crisis) • Wide swings in the dollar/yen exchange rate • Underestimation of risks

  14. Imbalances in External Sector Asian’s Economic Performance • Real Exchange Rate Appreciation • Slowing Export Growth • Large Current Account Deficits • Increasing Short Term External Debt

  15. Real Exchange Rate AppreciationAsian’s Economic Performance • Fixed Exchange Rates (Nominal anchor for domestic price level, maintain competitive export position). • Early 90’s US$ depreciation (Depreciation of the REAL exchange rate of many East Asian economies). • 1995 US stock market upward trend (Expectations of domestic interest rate increases, strengthen US$). • Lead to inflationary pressures in East Asia (Real exchange rate appreciation). • RESULT (Loss in competitiveness).

  16. Asian Exports (Current Account)Asia’s Economic Performance • Increase in export prices (previous slide). • Decline in global demand for KEY Asian exports (semiconductors and electronics). • Decrease in export volume. • Current Account deficits grew. (CA=Export-Import = S-I)

  17. Foreign Capital Investment • Foreign investors flooded the region with funds until the onset of crisis • In 1996 private inflows to 5 countries (Indonesia, Korea, Malaysia, Philippines and Thailand) doubled from $40.5 billion to $90.3 billion • BUT in 1997 reversed, with a net outflow around $12.1

  18. Foreign Capital InvestmentWeaknesses in Financial System • 90’s decrease in global interest rates • No capital Regulations • Poor governance • Inadequate Supervision/Regulation • Inappropriate Policy Responses to K surges • Example: Lax Fiscal Policy and Non-sterilized inflows.

  19. Foreign Capital InvestmentWeaknesses in Financial System • Lack of transparency in banking systems • Poorly enforced rules and inadequate supervision of financial systems • In addition, government-direct lending practices which led to a sharp deterioration in the quality of banks’ loan portfolios • Political and governance uncertainties • Lack of confidence

  20. Foreign Capital InvestmentWeaknesses in the Financial System • Financial Crisis displays elements of a “SELF-FULFILLING” crisis, where capital withdrawals by creditors cascaded into a financial panic • Caused deep contraction

  21. Onset of Crisis • Early 1997 Thai stock market and Thai $ baht experienced downward pressure (concern over short-term foreign debt). • Large Current Account deficit-raised concerns that baht would not maintain US-dollar peg. • Malaysian and Philippine experience similar pressures. • Same time South Korea stock market began to falter.

  22. Where It Started and Spread • Thailand* • Philippines* • Malaysia • Indonesia* • South Korea* • Hong Kong • *Country to be discussed in detail

  23. Thailand • Thailand baht pegged to US dollar • US dollar appreciates (interest rates rise) • Baht forced to appreciate • Exports more expensive • Speculation of the baht • International reserves depleted • Baht floats freely and depreciates • Before crisis: 25 baht = 1 USD • After crisis: 56 baht = 1 USD

  24. Philippines • Investors witness crisis in Thailand • Investors pull out of Philippine market • Low international reserves • Philippine peso forced to float currency and depreciate

  25. Indonesia • Pre-crisis: low inflation, trade surplus, huge foreign reserves • Corporations borrowing in US dollars • When Thailand floats baht, Indonesia widens rupiah trading band • Trading band grows drastically and forces rupiah to float freely • Corporations suffer heavy losses and bankruptcy • Before crisis: 2000 rupiah = 1 USD • After crisis: 18000 rupiah = 1 USD

  26. South Korea • Crisis exposes long standing weakness: • Massive foreign borrowing • Credit rating drops • Stock market crisis • Before crisis: 1000 won = 1 USD • After crisis: 1700 won = 1 USD

  27. Exports Slowdown

  28. East Asian Exchange Rates

  29. How to Prevent it? • There is no way to predict a financial crisis • Crises arise from unpredictable market reactions, but it is possible to identify the kinds of weaknesses that typically make economies vulnerable to financial crises.

  30. Recognizing the Signs • Signs of weakness include: • overheated economy • high inflation • appreciation of real exchange rate • increase in current account deficit • rapid increase in domestic credit • inflated asset prices • low levels of official international reserves.

  31. Lessons Learned 1. Monetary Policy: in class we learned that under a fixed exchange rate system, monetary policy is ineffective. 2. Regulations on Capital Inflows: Capital control and regulations can prevent the spill over of uncertainty and speculation about the markets.

  32. Lessons Learned (Con.) • Governance: The government needs to tighten regulations on the financial sector in order to restore investor confidence, and ensure abuses will no longer exist. • Political patronage • Nepotism • Lax accounting practices 4. Fiscal Policies: Rely less on external saving and concentrate more on the costs of restructuring and recapitalizing banking systems. Money needs to be taken away from unproductive public expenditures and given to those needed to minimize the social costs of the crisis and strengthen social safety nets.

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