SOUTHEAST ASIAN FINANCIAL CRISIS AND ITS LESSONS FOR DEVELOPING COUNTRIES

KUNAL MISTRY-12051 VAISHALI SHAH-12151 KUNAL JANI - 12050 KARTIK.V - 12043 KRUNAL TRIVEDI-12049 BHANVI SINGH-12011

INTRODUCTION

SouthEast Asian Miracle Beginning of Crisis The role of financial panic as an essential element of the Asian crisis. Impact of Crisis Role of IMF Learnings Conclusion

S.EAST ASIAN COUNTRIES

South Korea

Indonesia
Philippines Thailand Hong Kong Singapore Malaysia Taiwan

FOUR ASIAN TIGERS

The Four Asian Tigers or Asian Dragons are the highly developed economies of Hong Kong, Singapore, South Korea and Taiwan (Republic of China). These regions were the first newly industrialized countries, noted for maintaining exceptionally high growth rates and rapid industrialization between the early 1960s and 1990s. All four Asian Tigers have a highly educated and skilled workforce and have specialized in areas where they had a competitive advantage .

FOUR ASIAN TIGERS

Their economic success stories became known as the Miracle on the Han River and the Taiwan Miracle . Role models for many developing countries, especially the Tiger Cub Economies. They sustained rate of double-digit growth for decades. Each nation was non-democratic and relatively authoritarian political systems.

S.EAST ASIA MIRACLE

Factors causing East Asia's relative success - outward orientation, high saving and investment rates, macroeconomic discipline, and other good public policies. Focused on exports to become rich industrialized nations. Asian Tigers had high tariffs on imports and undervalued currencies.

High interest rates attractive to foreign investors looking for high rate of return.

S.EAST ASIAN CRISIS

Financial crisis is a situation in which some financial institutions or assets suddenly lose a large part of their nominal value. It is a testament to the shortcomings of the international capital markets. Their vulnerability to sudden reversals of market confidence.

THE ECONOMIC CRISIS

1.

2.

3. 4.

The Southeast Asian Financial Crisis- period of financial crisis that gripped much of Asia beginning in July 1997 Raised fears of a worldwide economic meltdown due to financial contagion. The financial crisis involves four basic problems or issues: A shortage of foreign exchange that caused the value of currencies and equities to fall . Inadequately developed financial sectors and mechanisms for allocating capital in the troubled Asian economies. Effects of the crisis on both the United States and world The role, operations and replenishment of funds of the IMF.

CONTINUED
Thailand had acquired a burden of foreign debt..

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. High rates of economic growth and a booming economy, private firms and corporations looked to finance speculative investment projects. Firms overstretched themselves and a combination of factors caused a depreciation.

BEFORE CRISIS

Received large inflow of money High growth rate (8-12%GDP) Dramatic run up in asset prices Increase capital investment High per Capita Income 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.

BEGINNING OF CRISIS

The rapid reversal of private capital inflows into Asia. Net private inflows dropped from $93 billion to -$12.1 billion. Large increase in cross border bank loans. 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.

PER CAPITA GDP

Source : The onset of East Asia Crisis

TRIGGERING EVENTS

1997- Thailand Hanbo Steel, Sammi Steel and Kia Motors collapsed. Bankruptcies - several merchant banks under significant pressure. Bank of Thailand lent over Bt 200 billion ($8 billion) to distressed financial institutions through Financial Institutions Development Fund (FIDF). The BOT committed almost all of its liquid foreign exchange reserves in forward contracts, Usable reserve levels of Central Bank fell sharply

OTHER EVENTS

In late June 1997, the Thai Government removed support from a major finance company, Finance One. Shock accelerated the withdrawal of foreign funds, and prompted the currency depreciation on July 2, 1997. The Thai baht devaluation triggered the capital outflows from the rest of SouthEast Asia.

CAUSES OF WITHDRAWL

Bank failure. In Thailand, the failures of finance companies helped set off the exodus. Corporate failure. In Korea, the withdrawal of funds was based on concerns over the health of the corporate sector. Political uncertainty: hastened the credit withdrawals, since each country faced the potential for a change in government. Contagion. Many creditors appeared to treat the region as a whole, and assumed that if Thailand was in trouble, the other countries in the region probably had similar difficulties.

International Interventions. the IMF recommended immediate suspensions or closures of financial institutions, measures which actually helped to incite panic.

CONTINUED

The withdrawal of foreign funds triggered a chain reaction. The withdrawal of funds also set off a liquidity squeeze and a sharp rise in interest rates.

Offshore creditors grew reluctant to roll over short-term loans.

The lack of clear bankruptcy laws and workout mechanisms.

The losses on foreign exchange exposure and the rise in nonperforming loans eroded the capital base of the banks.

MISTAKES IN POLICIES

Rapid evolution into panic was aided by policy misjudgments and mistakes across the region. Thailand and Korea exhausted a substantial proportion of their foreign exchange reserves.

Malaysia and Thailand introduced mild controls on foreign exchange transactions.

Inflammatory statements by government officials and market participants added to the panicked withdrawal of funds.

ELEMENT OF PANIC
Substantial elements of panic and disorderly workout.

Largely unanticipated.

Lending to debtors that were not protected by state guarantees.

Sudden withdrawal of investor funds to the region, rather than

simply a deflation of asset values.

EFFECTS ON COUNTRIES
o o

What happened in Indonesia : Drastic devaluation of the rupiah: from 2,000 to 18,000 for 1 us$ Sharp price increase widespread rioting. What happened in S. Korea : Drastic devaluation of the won: from 1,000 to 1,700 per us$ National debt to GDP ratio more than doubled. Major setback in automobile industry.

EFFECTS ON COUNTRIES
o

What happened in Philippines : Growth dropped to virtually zero in 1998. Peso fell significantly, from 26/us$ to 55/us$ .
What happened in Japan : 40% of Japans export go to Asia, so it was affected even if the economy was strong GDP real growth rate slowed from 5% to 1.6% . Some companies went bankrupt The Japanese yen fell to 147 Japan was the world's largest holder of currency reserves at the time, so it was easily defended, and quickly bounced back.

EFFECTS ON COUNTRIES

What happened in Hong Kong : Hong Kong dollar came under attack in November as a result of currency depreciations. Hong Kong banks faced steeply rising interest rates on liabilities. What happened in Taiwan: New Taiwan dollar also came under pressure and fell sharply, despite Taiwan's huge stock of reserves.

EFFECTS ON COUNTRIES
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What happened in US : Markets did not collapse, NYSE severely hit . Dow Jones industrial average suffered as 3rd biggest point losses. Relationship with JAPAN changed forever.

Source : The Onset of East Asia Crisis

EFFECT ON CHINA
Currency, the renminbi (RMB), had been pegged to the

US dollar- ratio of 8.3 RMB to the dollar, in 1994. Heavy speculation forced to devaluate its currency to protect the competitiveness of its exports. RMB's non-convertibility protected its value from currency speculators, decision was made to maintain the peg of the currency, Improving the country's standing within Asia. Unaffected by the crisis compared to Southeast Asia and South Korea.

EFFECT ON GDP OF INDIA AND EAST ASIA

EFFECT ON INDIA
GDP growth was relatively unaffected by the South East

Asian crisis. No effect on Balance of payments (BoP) Below comparison as compared to USD
Countries currency India Thailand Depreciated by 15% 25-35%

Malaysia South Korea

Indonesia

25-35% 25-35%
70%

WHY WAS INDIA NOT AFFECTED MUCH?

Strong growth with services sector Floating exchange rate Declining External debt to GDP Banks in India are discouraged from making investments in real estate and the stock markets. Control on corporate exposure to external debt.

IMF ROLE

Provided $120 billion as bailout package.

The IMF programs generally called for six key actions: 1. Immediate bank closures; 2. Quick restoration of minimum capital adequacy standards; 3. Tight domestic credit; 4. High interest rates on central bank discount facilities; 5. Fiscal contraction; 6. Non-financial sector structural changes.

IMF ROLE

The de-capitalized banks restricted their lending in order to move towards capital-adequacy ratios required by IMF. Currency depreciation and stock market collapse continued long after the programs. The IMF crisis

WHY THE ASIAN CRISIS WAS NOT PREDICTED

The Countries maintained good budgetary positions Domestic savings and investment rates were very high throughout the region Interest rates were usually less in rest of the world (US and Japan). Massive capital inflows were attracted into the region during the 1990s. Healthy Forex reserves Thailand reached $38.6 billion in 1996 equivalent to over 7 months of imports

LEARNINGS
The lessons from developing country crises are summarized as:

Choosing the right exchange rate regime. The central importance of Banking. The proper sequence of reform measure.

The importance of contagion.

CONTINUED

Foreign exchange reserves are important; Information and transparency are key; The composition of capital inflows does matter; Exchange rate regimes are extremely difficult to maintain; Financial markets are not perfectly efficient; IMF programs should consist of both macroeconomic and structural reforms;

Inevitably, countries will have to raise interest rates and lower exchange rates.

CONCLUSION

South East Asian crisis resulted from financial panic that arose from certain emerging weaknesses in these economies It could have been largely avoided with relatively moderate adjustments and appropriate policy changes. There were macroeconomic imbalances, weak financial institutions, widespread corruption, and inadequate legal foundations.

Abrupt actions by domestic and international policy makers

can worsen an incipient crisis, by helping to trigger the capital outflow

THE ECONOMIC WAY OF SAYING THANKS`