Provide a concise summary of the causes of the 1997 Asian financial crisis and he resulting damages. Students are advised to link concepts taught in class to their answer. Strong growth was typical of economies in the South East Asian region in the years leading up to the currency crisis (Mimicking 1997). Significant increases in stock and land prices in the region fueled foreign investments and lending, creating an economic boom. This lasted until the mid-sass when growing competition and a weakening Japanese yen slowed economic growth and reduced asset prices (Moreno 1998).
These events triggered collapsing currencies starting with the Thai baht. In retrospect, the growth witnessed in Thailand was cost likely caused by a large influx of foreign capital facilitated by a pegged exchange rate. Moreno suggests that poor credit allocation was also a factor, in which borrowers who were well connected were also granted credit. In addition, financial intermediaries were protected by government guarantees, creating severe moral hazard. This resulted in poor risk management and transformation and gave little incentive to banks to choose clients wisely.
This became apparent in South Korea where companies with unhealthy debt ratios were granted credit and had to rely on special government loans to service their debts. Since it is common for financial intermediaries to practice size and maturity transformation (Case 2006), a sudden withdrawal of deposits would make the system vulnerable to collapse and be unable to fulfill its obligations. This is because as liquid deposits, in the form of foreign investors, start to panic and withdraw, financial intermediaries are left with collateral, often in the form of illiquid and highly risky assets.
In addition, the risky lending practices that were present at that time suggests that a significant number of borrowers would have defaulted on their loans. A weakening currency and slowed economic growth old then cause these illiquid assets to fall in value and be difficult to convert into liquid funds. In April 1997, Thai authorities suspended trading in finance company shares on the Bangkok stock exchange. This brought attention to the weakness in the economy that had been disguised by large growth and investments.
Fearing that if financial institutions losing their credibility would do more harm to their currency, the Thai authorities chose to devalue the Thai baht instead. By November the same year, South East Asian currencies dropped by over fifty percent below their pegged levels. However, it was unlikely that a financial crisis old have been avoided either way as the revaluation depreciated the currency on bank balance sheets. The events in Thailand triggered panic and speculation in the region, affecting the Malaysian ringing and the Philippine peso shortly after.
The ringing depreciated against the dollar by nearly fifty percent in the middle of May 1997. Weeks later, the composite index of the Koala Lump Stock Exchange fell by 44. 9 percent (Riff 1999). In the Philippines, the peso fell twelve percent to the dollar when news spread that the country will loosen controls on the peso (Holey 1997). The Singapore dollar also suffered a decline of 18. 3 recent against the US dollar over a six month period and the Straits Times Index dropped approximately 60 percent over a year.
However, because of a gradual devaluation and measures to reduce labor costs, the impact in Singapore was relatively mild Ion 2000). In August the same year, Indonesia decides to float the currency freely and resulted in an immediate depreciation. Anna’s (1999) suggests that this is due to a lack of investor confidence in the currency. Additionally, government interventions distorted the market and frightened investors, preventing a natural rebound. Indonesian economy was also fundamentally flawed, in a animal fashion to Thailand, in which lenders were providing credit to either well connected clients or risky firms.
There was also little supervision and accountability which fueled panic in Indonesia. However, unlike in Thailand, Indonesian authorities refused to implement the International Monetary Fund’s (MIFF) policy recommendations, delaying the receipt of much needed funds in face of a plummeting rapid. Indonesian president would eventually agree to eliminate monopolies and insolvent financial institutions as per MIFF macroeconomic policies but only after the rapid reached 10,000 to the U. S dollar.
In October the same year, Hong Gong’s exchange, the Hang Seen index fell by 23 percent over four days (The University of Hong Kong 2001). Similar to Singapore, Hong Gong’s economy was robust and well-regulated, but was still subject to speculative attacks on its currency. However, with support from the People’s Republic of China and their reserves, in addition to Hong Gong’s own exchange reserves of US$billion, it was able to defend its currency from devaluation. This outcome was not without consequence, as interest rates rose to nearly 280% and the interbrain rate reached 20% (and subsequently 15% and 10%).
At its lowest point, the stock market index was 60% below its peak. Soon after the decline of the Hang Seen exchange, the South Korean won began to decline. At the beginning of the year, Korea was plagued by failing corporate entities. Domestic financial intermediaries funded these local corporations using the influx of foreign capital, often ignoring usual business criteria. However, as contagion spread from Thailand, Indonesia and Hong Kong, financial intermediaries no longer had the liquidity to fulfill their obligations.
This prompted government intervention to guarantee the debt of local institutions, essentially bailing them out. By the end of the year, the Won had dropped by 50% against the U. S dollar and the stock market had dropped by over 40%. This was the result of Korean financial intermediaries abandoning its efforts to defend the value of the won. Soon after, South Korea requested for MIFF aid. The crisis in Asia has effects that were felt in the rest of the world as the DOD Jones Industrial Average declined 7. 18% in the day of October 27, 1997.
In addition, the NASDAQ Composite fell 7% and the S&P 500 fell 6. 86 percent on the same day. It is estimated that $663 billion in market capitalization was wiped out (U. S SEC 1998). The panic caused US authorities to suspend stock market trading temporarily. In Japan, several top ranking firms started to fail, including Tussock Bank and Yamaha Securities, two of the largest financial institutions in Japan. These companies failed in spite of the government pledging to support them caused consumer confidence to drop and caused widespread panic in the country (Tit 1999).
Tit states that the Japanese economy was fundamentally flawed as it was still recovering from stagnation since 1992. Weak exportation from Japan was also a factor as trade and investments in Asia are closely tied between countries. Sharp declines in land and asset prices also resulted in many defaulted loans which weakened the banking system in addition to currency depreciation. The author suggests that Japan, among other countries, did not have the legal framework to close insolvent banks before the crisis hit in 1997.
By July 1997, the Japanese Yen had depreciated by over 30% from pre-crisis levels, although it should be noted that the Yen had already been plagued by depreciation since 1995. At the peak of the crisis, the MIFF had given funds to countries in the region to keep affected financial intermediaries lending and increasing real output. These entries most notably included Thailand, Korea and Indonesia. In addition to funds, the MIFF also required the authorities of these countries to adopt policy changes according to MIFF recommendations.
Such measures included structural reforms, in particular, the financial and corporate sectors, in order to facilitate lending and growth. Strict monetary policies were also adopted, such as the increasing of interest rates to stabilize exchange rates and fiscal policies to give governments adequate resources to finance the structural reforms. In certain countries, the MIFF had also demanded that certain conditions were met, such as n Indonesia when the president was required to close down insolvent financial institutions or in Korea where the MIFF demanded mass lay offs to restore its financial credibility.
Despite the injection of over US$110 billion to Thailand, Korea and Indonesia, foreign investments continued to pull out from these countries and continued on into 1999. The exchange rate also continued to decline in spite of MIFF funds, with currencies in the region recovering to only of what they were in pre-crisis levels. The Indonesian rapid was the worst hit as it only managed to recover to approximately 20% of its pre-crises value after the implementation of these programs. In Indonesia, the crisis had severe ramifications politically and socially.
The free- fall of the rapid triggered panic buying and soon store shelves were empty. Prices for basic food staples increased by as much as 80% which lead to the 1998 food riots of Indonesia. In addition, the failing economy resulted in mass unemployment which only fueled resentment with the ruling party. The violence was target particularly at ethnic Chinese, who were seen as being the cause of the financial crisis. At that point in time, 73% of publicly listed companies were wend by ethnic Chinese, despite making up only 3% of Indonesian population.
Religious differences, historical resentment and ignorance and fear about the Chinese served to fuel the spark that was the financial crisis. It is estimated that the riots caused approximately 3 trillion rapid in damage and over a thousand deaths (Purdue 2005). In the wake of the riots, President Short resigned following the severe economic and political crises in the past year. It could be suggested that the resentment of Short by the Indonesian people came from the fact that Short was unwilling to fulfill his end of the agreement with the MIFF early in 1998, which lead to delays in loan packages.
In South Korea, as part of MIFF reforms, South Korean firms have been conducted mass layoffs, averaging 1 0,000 workers laid off per day. This led to a two-day nationwide strike in protest of the unemployment in the country. In addition, high interest rates and restricted credit caused sales to decline, pushing Koreans largest firms to the verge of bankruptcy (Wolfe 1998) Although a $57 billion package was approved for South Korea, foreign investors continued to sell Korean assets and equities into late 1998, causing further damage to the won and the Korean stock market.
The outcome in Russia was similar to South East Asia, although it should be noted that Russia still had substantial sovereign debt inherited from the former Soviet Union. Prior to the events in 1997, Russian’s economy was undergoing reforms and had begun to stabilize and grow despite wages and unemployment still being a problem (Chided 2002). Although not directly affected by the crisis, the outcome is still significant. By the middle of 1998, the ruble had devalued from 5 to the U. S dollar to almost 30 to the U. S dollar. In addition, Russian’s main exports, oil and nonferrous metals, began to drop in price.
At this point in time, investor confidence was not good, despite talk of MIFF funds to alleviate the situation. Internal strife within the ruling party proved to harm investor further, when President Yellows fired his entire government. In August 1 998, the Russian stock market had dropped 65% over 7 months amidst fears that the Russian government would devalue the ruble (which it later did) and default on its domestic debt. At the end of 1 998, real output for the year decreased 4. 9% and the current ruling party seemed unable to successfully reform its economy.
Similar to the countries in South East Asia, Russia also faced increased interest dates which increased its debt rapidly as interest payments mounted. The panic in Russia spreads to Latin America which causes stock and bond markets to plunge. Soon after, the DOD Industrial average starts to decline, dropping a total of 512 points, or 6. 4% on August 31 1998 (Gang 1998). Conclusion Although the crisis lasted for less than two years, it is likely that the debts created by accepting MIFF bailout packages will take a long time to repay.
The crisis had a worldwide impact starting with the decline of one currency. There are some traits that are shared amongst many of the countries involved in the crisis. Firstly, financial intermediaries spurred on by the large influx of foreign depositors were eager to lend as much as possible to generate income. This resulted in poor, almost non existent credit risk management often influenced by connections or individuals in positions of power. This was most prevalent in Indonesia where President Short would keep insolvent financial institutions with family ties running.
Second, government guarantees to assume defaulted liabilities create severe moral hazard on the part of financial intermediaries. Loans were often granted to companies with unhealthy financial ratios. This was cost prevalent in South Korea. Third, excessive inflow of capital often disguised weaknesses in the market or financial systems in these countries, which distorted true market and operational risk. Examples of this can be found in Thailand, Indonesia and Russia. Contagion and panic played a large role in the crisis.
Although the crisis affected the entire region, it could be argued that certain countries with sound macroeconomic policies, growth and banking regulations would have been strong had it not been for fear and speculative attacks. Countries such as Malaysia, Philippines, Singapore and Hong Kong only came under attack because f the events that occurred in Thailand. This is natural as the region is closely linked by trade and investments. Additionally, Russia, which is a country that is relatively more remote to the South East Asian region, should have been able to fend off the crisis.
However, it was fear and speculation that triggered a mass withdrawal of investments which subsequently revealed weaknesses in a country that has just started to recover from a recession. It is likely that if the contagion was isolated in Thailand, many of the other economies, which were robust to begin with, would not have suffered such a severe outcome. The end result of the above factors was a chain reaction in various countries where financial intermediaries were in a position where their assets (devalued by currency, decline in prices, defaulted loans) could not cover their liabilities and mass withdrawals.