South East Asia Currency Crisis - Essay Example

?1997 South East Asia Currency Crisis by Macro & Micro economics 2 December Table of Contents Table of Contents 2 0 Project description 3 2.0 Main reason for financial crisis 4 2.1 World factors 4 2.2 Internal factors 5 2.3 Direct factors 7 3.0 Remedies 7 4.0 Affected Countries 8 4.1 Thailand 8 4.2 South Korea 10 4.3 Hong Kong 12 4.4 Japan 14 5.0 Conclusion 17 ABDI. “Crisis and Recovery.” 2013. Web. 17 April, 2013. 18 Corsetti,G., Pesenti, P., and Roubini, N. “What caused the Asian currency and ?nancial crisis?” unimib.it. 1999. Web. 17 April, 2013. 19 “GDP growth 1997 t0 2002.” info.gov.hk. n.d. Web. 18 April, 2013. 19 “Hong Kong housing Bubble! Mainland Buyers Blamed.” globalpropertyguide.com. 6 November, 2009. Web. 18 April, 2013. 19 Lim, G. “South Korea, Brazil and the IMF: Coping with Financial Crisis.” worlddialogue.org. 2008. Web. 17 April, 2013. 20 Moreno, Ramon. “FRBSF Economic Letter 98-24; August 7, 1998: What caused East Asia’s Economic Crisis.” frbsf.org. n.d. web. 17 April, 2013. 20 Singh, A. “Japan’s Policy Response to its Financial Crisis: Parallels with the U.S. Today.”imf.org. 19 March , 2009. Web. 18 April, 2013. 21 Wharton School. “Attention, Speculators: Here's a Lesson from Hong Kong's Housing Bubble.” upenn.edu.18 may, 2005. Web. 18 April, 2013. 21 List of Figures and Tables Fig. 1............................................................................................................................................10 Fig. 2.............................................................................................................................................13 Table 1..........................................................................................................................................16 1.0 Project description The currency crisis occurred in the south east Asia region since 1997, at different intervals in each affected country and spread across other South East Asian countries after, beginning from Thailand. It was primarily caused by macroeconomic and financial factors, although the political other factors interfered with the correction of the crisis. These factors included currency speculation, financial imbalances, exchange rate collapse, high inflation rates, excess borrowing and investment in the these countries that were facing crisis, trade deficits, political inflexibilities, and to some extent restrictions imposed by IMF package. As a result, the impacts resulted in the stock market failure, currency depreciation, decline in per capita GDP, excessive borrowing to save the economies, investment withdrawal, international agencies bank ratings to those exposed to the crisis, and fluctuation of imports and exports affecting the countries’ return. Some countries relied on the IMF to provide capital to stabilize the exchange rates and prevent further liquidity in those countries. Other measures involved reforming the monetary policies, financial regulation and asset management. While a country like Japan solved their bankruptcy case with their reserves, other comparative nations in the crisis had depleted theirs. Studying the crisis is a constant reminder of how worse a currency and stock market failure can become a contagion in linked markets. It also allows researchers to examine how each economy solved the crisis after spreading from Thailand, exploring the differences in policies taken and their effect. The chances of the crisis occurring again in the future are rare, especially with policies and strategies placed to prevent stock markets and currency from external shocks. However, with the volatile stock assets in the market in different economies, such previous pegging to the dollar, which caused the Asian economic boom to look artificial after the crisis could occur again and though beneficial, it could spur the economies to another depression. 2.0 Main reason for financial crisis 2.1 World factors Pegging to the dollar: The currencies in the South East Asian countries had gained value leading to their overvaluation before the crisis. These countries had a long tradition of pegging to the dollar and looking back to the trend from early 1990s, their currencies appreciated as the US dollar appreciated. With reference to the Japanese and European currencies, the US dollar which the South East Asian countries had pegged to for over 10 years, sharply appreciated in the second half of 1995, causing a deterioration in the cost competitiveness among the pegged Asian countries (Corsetti, Pesenti, and Roubini 309). As the exports increased from neighboring countries (like China) competitive pressure increased, causing cumulative effects on financial exchange and market aspects of these countries, that they ended up being vulnerable to the financial crisis. The imbalances generated affected the capital inflow of the Asian countries, leading to devaluation and later the collapse of the regionss currency. Exchange rates collapse: The 1997 financial crisis resulted from the unexpected financial exchange rate collapse that generally affected the internal financial market. Considering that before the period of the crisis, the semiconductor prices, trading value of the Chinese remnimbi and Japanese yen declined due to the currency devaluation, repetitively affecting the revenue generated from exportations of South East Asia economies (Moreno, frbsf.org). In addition to the dollar peg, the foreign exchange rates in the region’s market were under pressure from the external shock. As a result, each affected country tried to defend their already appreciated currency and the overvalued exchange rates as much as possible, but the currencies were misaligned, contributing to the slow economic activities to catch up with the high financial bubbles accelerated by the foreign capital inflows. 2.2 Internal factors Political control: Asian countries had been struggling with the political leadership of their nations that obstructed economic development, especially in decision making. As the Asian countries continued to grow over the years, the leadership figures followed the dictatorship rule, which in the period of the crisis easily denied inflexibilities to make changes that would follow rectification of the internal financial market. Lack of adjustments not only affected the region’s countries, but those nations across the globe that had heavily invested and traded with the South East Asia nations. The political systems and the overstretched rule took advantage of their special privileges, spurred corruption and inequalities among the governed, effectively affecting the foreign investment and adjusting to growth targets that would counter the crisis in the situation. As a result, investors lost confidence with the political leadership and its inflexibilities, rapidly causing loss of confidence in the market. Reluctance to risk management: Most of these countries lacked proper incentives to address the financial crisis that occurred after the appreciation of their currencies, probably because it was not predicted by the IMF, the Asian development bank or by the financial experts in the specific countries. According to Bustelo, misguided macro economic management was what the result of some analysis indicated (3). The corporate government has also been criticized for its irresponsibility, failing to reconcile the financial markets and attend to the crisis early enough before the depreciation of the regions. To make the matters worse, financial intermediaries were limited to use the business criteria in allocating funds and not expected to bear the full cost of failures, which all reduced the incentives to manage risks properly (Moreno frbsf.org). The formula applied for credit allocation was insufficient to impose strict rules and observe the correct measures to prevent lending to unqualified companies, especially those that had demonstrated poor management that risked accumulation of debts and losses. External borrowing: The export had grown around the Asian countries, booming in a trend that led to its fastened economic development than other regions across the globe. A lot of foreign and domestic investment, and the government interventions for companies to continue providing liquidity to failing firms, caused both over investment and over borrowing. When a company seemed to fail, other affiliates in the group supported it, lowering the profit rates to a risky level for all; large companies bankruptcy was rescued by government and banks loans, causing a sharp rise in the debt equity ratio as of early 1997 (Wang 7-9). These countries had high inflation rates that contributed to higher borrowing within external and internal boundaries, affecting their balance of payments and eventually the crisis followed. 2.3 Direct factors With certain hardships that the countries were experiencing in higher inflation, the chances of the financial crisis were very high and well linked. These countries had heavily invested in the countries within the region, meaning a shock felt by one nation could be extended to other investing country. Similarly, the countries experienced high trade deficits connected with lower returns, and heavy external borrowing. The returns lacked to suppress the crisis and relieve the panic experienced by the governments. The currency speculation with respect to the changes in the financial market conditions, and bankruptcy of the internal banking systems in these countries exposed them to the crisis. The over lending of the banking systems and refinancing of their liabilities in the adverse internal developments made the banks vulnerable to the crisis any time. 3.0 Remedies Nations around the globe are linked to one another through investment and other financial factors. In case of crisis, the regions’ union and financial institutions are called to assist in resolving the crisis. During the South East Asia 1997 crisis, the International Monetary fund (IMF) came in as a means of protecting the region’s currency from external liquidity, and other external financial effects that would result from the crisis. The IMF plans were signed up between the seriously affected countries and the body, which later led to stabilization of the value of their currencies followed by the gradual appreciation afterwards. The loan packages from the IMF offered support to respective governments and central banks, on repayment of the debts and stabilizing the exchange rates (Radelet and Sachs 28). Other measures by individual countries included financial and corporate restructuring, revision of bankruptcy laws, and transparency in the management of financial institutions among others. 4.0 Affected Countries 4.1 Thailand The country was initially experiencing good economic growth and had a four times increase of its average wage in its previous three decades. However, with the growing imbalances in the economy in the 1990s, the pegging of the Thailand currency to the US dollar was turning difficult to maintain for the Government. As of 1995, Thailand was running a current account deficit of 8.1 percent equivalent to its GDP, and come 5th of February 1997 (beginning of Asian crisis), Somprasong land, a Thai land developer failed to meet a foreign debt payment due on that day, after the property prices fell in 1996: this was an indication of the consequent trouble to the to the financing companies that had heavily invested in the Bangkok property market (Radelet and Sachs 15). Previously, the stock markets had declined causing the baht to depreciate in value and affect investments, but it repeatedly and sharply fell in May, as a result of the strong selling pressure. Although there were market interventions, with the persistent fall of the baht, and the struggle to defend it, the government had to shift to a managed float, which effectively led to intense devaluation of the currency. Comparing the exchange rates of other countries, Thailand’s exchange rate currency versus the US dollar ranked the lowest first, before other countries followed suit (Ushikoshi nli-research.co.jp). (see fig.1). In connection to the crisis, the country experienced high real exchange rates, and the current account deficit was still large compared to other countries in the region. Large financial institutions were failing as the loans from the property market were increasing. As one of the internal remedies, the government and the Thailand central bank encouraged merging of troubled companies with the performing ones, which also contributed to a drag of the merged companies. The trading shares of finance were suspended in February 1997, the baht lost 18 percent of its value by July, short selling of the currency in the foreign exchange market for the dollar increased and the interest rates rose from 10 to 12.5 percent to promote and retain the baht (Hill, wright.edu). The IMF was called in and it provided Thailand with capital to prevent further liquidity, though imposing strict restrictions on the economy. The policies the government took to defend the baht and keep the finance companies afloat, before calling the IMF, had depleted the foreign exchange reserves of Thailand. Despite the $17.2 billion loan from the IMF, by the mid of 1999, the foreign exchange reserves had increased (above $16 billion from $2.8 billion in mid 1997) requiring no more from the IMF loan package (ADBI adbi.org). Though its GDP growth was still negative, it had substantially reduced, allowing the country to steer ahead for recovery. Fig 1. Ushikoshi, H. “Causes of the Asian Currency Crisis.” 2007. Web. 17 April, 2013. 4.2 South Korea In this case, the economic situation was worsened by the excessive bankruptcy cases of the businesses, combined with the political factors, especially because the elections were close and the government had to be effected. The government had resorted to extensive borrowing previously, which also contributed to the high debt/equity ratio of the country and most of the industries like the manufacturing sector. In Korea, there was high growth accompanied by low profits, arising from the high growth rate of the share capital and sales, and the total assets from all industries that also reflected low returns; in fact, between 1988 and 1997, the debt finance was 60, 28 and 12 percent for the investment, internal funds, and equity respectively (Wang 9-10). The southern Korea debt obligations were increasing, which caused the international credit agencies to downgrade the bank ratings in the region, especially those heavily linked to the failing chaebols. Along the months of 1997, Hanbo among other chaebols ran bankrupt with about $6 billion debt load, followed by Kia (car company) and Jinaro (largest liquor group) (Hill wright.edu). With regard to borrowing, South Korea had acquired accumulated loans for the manufacturing sector and development. Nations like France, Germany, Netherlands United States, Japan, and United kingdom loaned South Korea amounts worth of $10.1, $10.8, $2.8, $10, $23.7, and $6 billion respectively (Lim worlddialogue.org). The IMF provided a bail out to South Korea to pre-empt the financial crisis; even though there was criticism, the structural period and reforms under its supervision contributed to putting the economy back to a safe path of recovery. Rescheduling of the short term debt by the international banks exposed to the Korea crisis, further gave room for South Korea to heal. The country focused on ways to improve their labour industry, corporate, finance, and public sectors, as a way to harmonize the recovery in all the sectors. The 5plus 3 was one of the reform policy seeking to address the corporate governance and their interventions on the major financial institutions. Referring to Jang (3), the first five principle policies as set in February 1998 entailed reduction of debt by improving the financial structure, enhancing transparency, removing cross debt guarantees, improving accountability in shareholder and management control, and enhancing competence among the chaebol groups; as of august 1999, the three more policies involved strengthening taxation, the corporate governance of non financial institutions, preventing unfair transactions being conducted in the midst of affiliated companies and minimizing circuitous equity ownership. The policies strengthened management, regulations and allowed proper incentives to be put to work to prevent the recurrence of such crisis in the future. Just like Thailand, South Korea’s recovery began in 1999, demonstrating a GDP growth rate of 9.5 and 8.5 in 1999 and 2000 respectively (Lee and Rhee 147). The foreign direct investment and the foreign exchange reserves increased with the adjustment of the macroeconomic policies, IMF contribution and early amendment of the creditor’s panic. 4.3 Hong Kong The economic development and stability of Hong Kong had been driven by the dollar peg and even as the South East Asian currencies and the mainland yen dropped, the Hong Kong dollar remained valuable and strong. As the Thailand currency float attracted other Asian currencies to depreciation and economic downturns, the Hong Kong dollar was not spared from the attack and considering it was immune to the region’s crisis, it was attacked on 23rd of October 1997, later worsening to cause its stock market to drop, and closure of the future contracts of the August Hang Seng index (Pan et al 5). The currency speculations greatly affected the profits in the financial and foreign exchange market, whose effect was felt in the large asset market. One of the greatest causes was the public housing policy that contributed to the deterioration of the property and the stock market bubble. The Hong Kong housing market had a drastic fall of prices amounting to 57 percent decline between 1997 and 2002, which was preceded by a 50 percent real increase in price from 1995, to the beginning of the fall in 1997 (Wharton School upenn.edu). As a result, the housing prices seemed to control the domestic expenditure influencing the per capita GDPs. Fig 2. “Hong Kong housing Bubble! Mainland Buyers Blamed.” 6 November, 2009. Web. 18 April, 2013. The privatization program for the ownership of housing facilities under the high discount provided by the Hong Kong authority transpired to a deep economic slump, rather than the intended purpose of boosting consumption and economic growth. Since the crisis began in 1997, the per capital GDP dropped from HK$204,007 (US$26,400) to HK$187,700 (US$24,100) as of 2001 (GDP Growth nfo.gov.hk). By the time the Asian crisis was ending in 1999, the housing prices were still declining, because the recovery effort was too insignificant to solve the situation. One of the measures taken as a remedy was to separate the trading rights of ownership, as well as modernizing and improving the market infrastructure. The housing prices have been on and off making the Hong Kong housing market to be one of the volatile assets in the world market. The recovery felt around the early 2000s was followed by very slow growth in the industry that it again became vulnerable to the world economic crisis afterwards. However, after a fall from the peak in 1997, it began picking up again in July 2003 and the trend gave room for growth in consecutive years (“Hong Kong,” globalpropertyguide.com). As the housing policies were altered and the stimulus packages brought in, the housing market easily recovered and increased immunity against the external shocks. 4.4 Japan The Japanese economy is the most powerful in the Asian economies and contributes a lot in engaging with other countries in terms of investment and trade. During the 1997 period of the crisis felt in South East Asia, the Japanese GDP was very high compared to the sum GDP of the severely hit countries. In mid 1995, the Japanese yen depreciated with respect to the US dollar, which was followed by a slowdown in export earnings (stimulated by the deterioration of the trade in manufactured exports) (Bustelo 8). There is a very defined relationship between Japan and the South Asian countries, especially in terms of trade, linking the strong Japan economy to these countries as it exports and imports much from and to them. According to Ruggiero, Japan imports and exports 12 and 20 percent of its products respectively, from the Non Japan Asia, well connected to the South Korea, Hong Kong, China, Thailand, and Indonesian economies, it meant that the depreciation of the yen and the affected exportation and importation would affect the economic and financial situation of the exposed South Asian economies (angelfire.com). This depreciation had an impact on the exchange rates between the yen and the US Dollar, contributing to the decline of the trade and external accounts of Japan in the year 1997; borrowing and lending too were reluctant in the financial institutions and in government. The US dollar and the Japanese yen are critical to the economic development of Asian countries. However, because of the continued fluctuation of the exchange rates between the two currencies, the South East Asian countries are also affected because of pegging to the Dollar and Japanese heavy investment. Suppose the yen depreciates, the US Dollar and the pegged Asian currencies appreciate and vice versa. Hence, if the yen appreciated against the US dollar in the crisis, one would expect the Japanese to keep the cost of production low in manufacturing and increase their FDI to the Asian community, cause domestic inflation as goods in the country become more expensive, or loose competitiveness against the competitors. Those nations that had picked commercial loans in yen currency had accumulated debt burden when the yen appreciated. Otherwise most factors would turn in their favor when the yen depreciated against the dollar. Since Japan was a major lender and investor in the Asian countries, its financial institutions had invested heavily in these economies that were experiencing crisis, where most businesses were poor in loan servicing. The investment in those countries, declining private consumption, non performing loans, net exports and total investment caused by increased competitiveness led to failure of stock firms and financial institutions. By the end of 1997, Japanese Hokkaido Takushoku bank, Yamaichi and Sanyo Securities had declared bankrupty (Hill wright.edu). Due to this factor, Japan concentrated on solving the internal problem, hence failed to play an international role to assist the Asian countries to sway away from crisis. The government through the ministry of finance (MOF) took internal steps to stabilize their stock market. The suffering financial institutions were rescued from their huge debts by the government through the use of the public funds (amounting Y30, 000 billion) (Hill wright.edu). For Japan, the government did not embark on foreign borrowing to restore the financial institutions in their course, because it had accumulated reserves, supported by the great record of surpluses of its current accounts. Japan’s economy had experienced positive current account (see table 1) resulting in surpluses in the balance of payment that were used as the reserves. Table 1 1995 to 1997 current Account deficit of Thailand, South Korea, Hong Kong and Japan (% of the GDP). Country 1995 1996 1997 Average Thailand -7.9 -7.9 -2.2 -6.0 South Korea -4.4 -4.7 -2.0 -2.9 Hong Kong -3.9 -1.3 -1.5 -2.2 Japan +2.2 +1.4 +2.2 +1.9 Source: Bustelo, P. “ICEI Working Papers, No. 10 The East Asian Financial Crises: An Analytical Survey.” October, 1998. Web. 17 April. 2013. It provided adequate capital to strengthen the banks insurance system and balance sheets. The government also intervened in some cases for decision making, and strict asset classification was enforced by the financial regulatory authority. The Japanese banks endeavored in restructuring plans made in offering credit, putting prudent regulations on banks and management, avoiding conflicts of interest between the governments and bank sectors, enforcing macro economic supportive measures framework aimed and ensuring the monetary policy framework aimed at ensuring price stability in the long term. In Japan, although the excess reserves from the public funds stabilized the stock market in 1998, a more sustained recovery is said to have occurred in the early 2000s (Singh imf.org). This was attributed to the coordination of the government, central bank, other banks, financial regulation authorities and the stock market regulators efforts to enable changes and comply with the policies in the long term. 5.0 Conclusion The Asian crisis occurred after the massive economic development of the region commonly referred as the miracle of Asia that had made the South East Asian countries to grow in for some two previous decades before the crisis. The currencies had been pegged to the dollar, which faced stiff competition from the Yen currency allowing development of these countries when the dollar appreciated. However, the crisis began in Thailand after the devaluations of the baht, then spread to the Southern Korea, Hong Kong and Japan, attacking their currencies and stock markets that effectively spurred failure of other businesses in the countries. The impact was felt in both the domestic and foreign investment, especially in stock share and property prices across the countries. Other severe impacts occurred and as the internal measures by the government and other institutions failed to resolve effectively, the IMF stepped in and provided loan packages to solve financial and currency crisis. The South East Asian crisis is a constant reminder of the market failure in the economies and reminds economies to strengthen their immunity, control investment, monetary, and borrowing policies. Works Cited ABDI. “Crisis and Recovery.” 2013. Web. 17 April, 2013. Bustelo, P. “ICEI Working Papers, No. 10 The East Asian Financial Crises: An Analytical Survey” ucm.es. October, 1998. Web. 17 April. 2013. Corsetti,G., Pesenti, P., and Roubini, N. “What caused the Asian currency and ?nancial crisis?” unimib.it. 1999. Web. 17 April, 2013. “GDP growth 1997 t0 2002.” info.gov.hk. n.d. Web. 18 April, 2013. Hill, C. W. L. “The Asian Financial Crisis.” wright.edu. n.d. web. 17 April, 2013. “Hong Kong housing Bubble! Mainland Buyers Blamed.” globalpropertyguide.com. 6 November, 2009. Web. 18 April, 2013. Jang, H. “Evolution of Corporate Governance in Korea After the Economic Crisis: Corporate Governance from an international perspective; Diversity or Convergence RIETI.” rieti.go.jp.10 January, 2003. Web. 17 April, 2013. Lee, J., and Rhee, C. “Crisis and Recovery: What We Have Learned from the South Korean Experience?” tok2.com. 2007. Web. 18 April, 2013. Lim, G. “South Korea, Brazil and the IMF: Coping with Financial Crisis.” worlddialogue.org. 2008. Web. 17 April, 2013. Moreno, Ramon. “FRBSF Economic Letter 98-24; August 7, 1998: What caused East Asia’s Economic Crisis.” frbsf.org. n.d. web. 17 April, 2013. Pan, H., Wu, S., Zhang, H,. Dai, J., and Wang, H. “Strategic Games in Asian Financial Crises: the Case of Hong Kong.” unice.fr. n.d. Web. 18 April, 2013. Radelet, S., and Sachs, J. “The East Asian Financial Crisis: Diagnosis, Remedies, Prospects.” harvard.edu. n.d. web. 17 April. 2013 Ruggiero, M. “Asian Crisis.” angelfire.com. 29 April, 1999. Web. 17 April, 2013. Singh, A. “Japan’s Policy Response to its Financial Crisis: Parallels with the U.S. Today.”imf.org. 19 March , 2009. Web. 18 April, 2013. Ushikoshi, H. “Causes of the Asian Currency Crisis.” nli-research.co.jp. 2007. Web. 17 April, 2013. Wang, Y. K. “Causes and Prevention of External Debt Crisis.” 7, July, 2004. Web. 17 April. 2013. Wharton School. “Attention, Speculators: Here's a Lesson from Hong Kong's Housing Bubble.” upenn.edu.18 may, 2005. Web. 18 April, 2013. Read More