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the asian crisis

the asian crisis The purpose of our paper is to explore the causes of the 1997 and 1998 Asian economic crisis; and to research the effects of the crisis in each of the following categories: 1. The effects of the crisis in the countries involved in the economic crisis of 1997-98. 2. The effects on the governments affected by the crash, and 3. The effects that the Asian crisis has had on the differing world markets as well as the effects that it will continue to have (if any) on the world markets in the near future. We will also present our analysis of the causes and our predictions as to what the future will be for the countries involved. The paper will first look at the causes behind the crash. We can see that the main factors include current-account imbalances, financial over-lending, banking problems, extremely open economies, and a list of other factors. After we look at the causes behind the crash, we will give an analysis of how to avoid these problems in the future and what the repercussions will be in the Asian and Global markets. And at the end of the paper will be our conclusions (including how this has helped to better prepare us in the area of International Financial Management). The countries affected by the 1997 Asian crisis include the following: The Asian economic crash of 1997 surprised more than a few people. Ever since the period after World War II, the Asian economies had been following an economic model developed by the Japanese. This model favored export markets, domestic investment, and lower savings vs. higher investment (current account imbalance) to list a few. This model saw strong, consistent growth in the GDP of the countries in the time that they used the model. Since 1960 the region's top performers---Japan, Hong Kong, South Korea, Singapore, Taiwan, Indonesia, Malaysia and Thailand---grew more than twice as fast as the rest of East Asia, three times as fast as Latin America and South Asia, and five times faster than sub-Saharan Africa. Average real income per person quadrupled in the five Northeast Asian countries and doubled among the three Southeast Asians. So why is it that after such incredible performances for such a sustained period of time that the model all of a sudden collapsed? Was it the fault of exchange rate speculators, as some seem to say? Or was the real root of the problem actually embedded in faulty macro-economic policies adopted by the governments of the Asian economies? Some (such as the president of Malaysia, Dr. Mahathir) seem to think that the crash was the result of speculators devaluating the currencies of the Asian nations as a result of a general panic in the market. He says that "morons" like Mr. Soros (a very wealthy U.S. speculator) played with the markets, took advantage of them, and devaluated the exchange rates of certain nation's currency at the expense of the individual nations. However, the evidence strongly supports that the real problems came not from speculators, but rather from faulty economic policies adopted by governments. In many such cases, the governmental policies seem to be absolutely devoid of macro-economic understanding. The problem stems from three differing, yet interrelated facets. There is the corporate level, the financial level, and the international level. After this, there is the study of the macro-economic facets of the Asian government's economic policies. At the corporate level in the individual Asian economies, we see that the individual governments highly pushed economic growth. They adopted policies that would result in growth (such as incentives on loans for larger corporations). One of the problems is that the emphasis on growth was so strong that the public sectors were insuring and guaranteeing loans, investments, and projects in the private sector. Some of these loans, investments, and projects had a risk factor that was extremely high... so high, in fact, that any other bank in the world wouldn't even consider funding a project with a risk that high. It seems that the governments especially favored investment in a particular firm or industry in which to invest (which was almost always the real estate industry). Many times, the projects that these firms came up with seemed to overlook the risk factor of their future endeavors altogether. Apparently, because the different governments were so eager to bail out and/or intervene on the part of a firm with a project-gone-bad , acting almost as "loan-insurance", everyone took that as all the more reason to throw money into whatever investment came along. Another facet to the corporate borrowing scheme was that often times the financial institutions were pulling out loans from overseas banks to make loans in the domestic sector. This is not necessarily a bad thing. For example, if a country with very high prospects for the returns on the investments follows this procedure then it can be a very successful way to raise capital. A country can successfully borrow and pay off the loan only when there are good prospects. However, a country that is less solvent will run into problems. When the return on the investment is lower than the cost of the investment (i.e.- the returns are not as high as the interest payments), the country will not be able to pay off its foreign debt. Of course, this just creates a dangerous cycle that is hard to break. This is what happened in Asia. Loans from foreign financial institutions were made to private and public lending institutions in Asia; however, the returns in the Asian markets were not yielding anything. And worse yet, even when the signs showed that the numbers were negative, loans were continually drawn from foreign banks to cover unsuccessful operations. It became, in essence, a matter of trying to keep things covered up until the last possible moment. This brings us to the financial sector scope of the problem. Although the corporations were the ones asking for the loans (facilitated by certain policies), it was the banking institutions that were most at fault. There was a serious lack of management on their part. It seems that all precaution was thrown to the wind in an attempt to see more growth. The banks and money institutions were borrowing and loaning money excessively. Again, the risk factor of loans was not even an issue. The main factors behind the banking debacle were: lax supervision on loans, weak regulation, lack of incentive-deposit insurance plans (incentives to have people save and deposit their money so that the banks will have a reserve in case a loan goes bad), lack of expertise in the regulatory institutions, and outright corruptive lending procedures. The consequences of these problems were only magnified when the financial markets in the region deregulated and became more liberal. This made it only easier to procure money from the exterior. Due to the large amounts of borrowed capital from the exterior, exchange rate policies were adopted to stabilize (and eventually peg) the exchange rates of most Asian currencies in comparison to the dollar. This, as was thought, would lower the risk-premium on dollar-denominated debt. By lowering the risk premium, the countries would look more attractive to international investors. The only problem with a fixed exchange rate is that it opened a pandora's box of potential problems--- most of these rooted in the international sector scope. As hard as it may seem to believe, it can be said that many of the foreign banks are just as much at fault as the Asian banks (well, in part) for the financial crisis. Why? Well, we see that the Asian banks were drawing a very high number of foreign loans. However, these loans were all approved by the international banks. Why didn't the foreign banks have stricter loan policies? Why did they so eagerly throw money into Asia? The foreign banks weren't compelled to keep making loans into the region. Obviously, once a bank had a huge amount of capital and investment tied up in Asia it would be more willing to make repeated loans if it thought that the sequential loans would help recover the lost capital. However, before the initial loans were made the banks should have taken a deep look into the heart of the Asian model. It seems that the foreign banks thought that whatever problems or short-term inter-bank liabilities might arise would be effectively guaranteed by government measures and intervention or by bailouts from the IMF. It seems that most of the foreign debt accumulated by the Asian banks was in the form of short-term, foreign currency denominated, bank-related, unhedged liabilities. These short-term liabilities accounted for 50% of the total foreign debt in the Asian nations involved in the crisis (and in a few nations, over 100%!!). This shows the financial fragility of the Asian nations. Earlier it was stated that the Asian economies were following a model developed by the Japanese in the years following World War II. This model relied heavily on exports. Well, the Japanese economy stagnated in the early 1990's. This meant a general slowdown/reduction in the amount of exports for many of the Asian nations. Starting around 1995, the American Dollar and the European Monetary Unit began to see serious appreciation. The dollar appreciated sharply around 1996. Now, the Asian nations whose currencies were pegged to the dollar experienced problems. In real exchange rates, their currencies also appreciated (although in the nominal rates just about all of them depreciated to extreme levels). This made their competitiveness in the area of exports drop. Many of the nations lost the competitive edge in their exports as they saw their currencies appreciate in value as their exports now became more expensive. However, since they were drawing so many foreign loans, they couldn't float the exchange rate or else it would result in instant suicide. If their currencies depreciated sharply with the dollar then all of their loans would default. If they kept their currency pegged, they would see their total exports fall and a have a trade deficit. Maybe the loss of exports does not seem to be that great of a factor, but just about all of the Asian economies were built on exports. The one factor that perhaps played more of a role in the area of loss-of-competitiveness was the growing weight of China in the region. China became more and more of a factor in the area of exports, and began to "steal" the exports of other nations. The decision between China and the U.S. (when the U.S. gave China their "favored nation trading status") helped to increment the amount of total exports that China had. The Asian economies as a general whole suffered from some serious macro-economic problems- principles that are so clear that if a truly smart investor had looked at in the early '90s he would not have poured capital into the Asian market at the time. Although there were some really attractive aspects to the Asian model (such as incredibly high GDP growth throughout many years) there were some not so pretty aspects. Any person digging beneath the surface of the paper tigers would have found some serious structural concerns. The following pages contain charts to give a visual picture of how the economies were operating in the years leading up to the crash. ______________________________________________________________________ Current Account NIA (% of GDP) 1990 1991 1992 1993 1994 1995 1996 1997 Korea -1.24 -3.16 -1.70 -0.16 -1.45 -1.91 -4.82 -1.90 Indonesia -4.40 -4.40 -2.46 -0.82 -1.54 -4.27 -3.30 -3.62 Malaysia -2.27 -14.01 -3.39 -10.11 -6.60 -8.85 -3.73 -3.50 Philippines -6.30 -2.46 -3.17 -6.69 -3.74 -5.06 -4.67 -6.07 Singapore 9.45 12.36 12.38 8.48 18.12 17.93 16.26 13.90 Thailand -8.74 -8.01 -6.23 -5.68 -6.38 -8.35 -8.51 -2.35 Hong Kong 8.40 6.58 5.26 8.14 1.98 -2.97 -2.43 -3.75 China 3.02 3.07 1.09 -2.19 1.16 0.03 0.52 3.61 Taiwan 7.42 6.97 4.03 3.52 3.12 3.05 4.67 3.23 Current Account BOP (% of GDP) 1990 1991 1992 1993 1994 1995 1996 1997 Korea -0.69 -2.83 -1.28 0.30 -1.02 -1.86 -4.75 -1.85 Indonesia -2.82 -3.65 -2.17 -1.33 -1.58 -3.18 -3.37 -2.24 Malaysia -2.03 -8.69 -3.74 -4.66 -6.24 -8.43 -4.89 -4.85 Philippines -6.08 -2.28 -1.89 -5.55 -4.60 -2.67 -4.77 -5.23 Singapore 8.33 11.29 11.38 7.57 16.12 16.81 15.65 15.37 Thailand -8.50 -7.71 -5.66 -5.08 -5.60 -8.06 -8.10 -1.90 China 3.09 3.27 1.33 -1.94 1.26 .023 .087 3.24 Taiwan 6.82 6.94 4.03 3.16 2.70 2.10 4.05 2.72 Trade Balance BOP (% of GDP) 1990 1991 1992 1993 1994 1995 1996 1997 Korea -0.81 -3.04 -1.42 0.06 -1.22 -1.63 -4.36 -1.44 Indonesia 1.68 0.91 1.81 1.48 0.72 -0.76 -1.14 0.22 Malaysia 2.10 -3.74 1.39 -0.11 -1.59 -3.75 0.58 Philippines -5.73 -3.00 -4.27 -8.53 -8.95 -8.80 -9.44 -12.30 Singapore 6.76 10.62 9.29 8.12 14.87 15.38 13.26 12.55 Thailand -7.75 -6.88 -4.70 -4.56 -5.18 -7.09 -6.65 0.14 China 2.75 2.86 1.03 -1.92 1.39 1.68 2.10 4.41 Taiwan 6.82 6.94 4.03 3.16 2.70 2.10 4.05 2.72 GDP Growth 1991 1992 1993 1994 1995 1996 1997 Korea 9.13 5.06 5.75 8.58 8.94 7.10 5.47 Indonesia 6.95 6.46 6.50 15.93 8.22 7.98 4.65 Malaysia 8.48 7.80 8.35 9.24 9.46 8.58 7.81 Philippines -0.58 0.34 2.12 4.38 4.77 5.76 9.66 Singapore 7.27 6.29 10.44 10.05 8.75 7.32 7.55 Thailand 8.18 8.08 8.38 8.94 8.84 5.52 -.043 Hong Kong 4.97 6.21 6.15 5.51 3.85 5.03 5.29 China 9.19 14.24 12.09 12.66 10.55 9.54 8.80 Taiwan 7.55 6.76 6.32 6.54 6.03 5.67 6.81 All Graphs Compliments of International Financial Statistics of the IMF Bibliography:

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