ASIAN CRISIS AND CONSEQUENCES SM71.9005 Country Risk Management Asian Institute of Technology Instructor Dr. Henry Bouchet By Aurelien GOUTORBE 103780 Thoppil Sanju Thomas 103857 Somchoke Visuthiratsopon 103913 Hebli Sneha Vadiraj 104002 Ruethairat Sureephong 104019 INTRODUCTION The financial crisis which began in July 1997 in Thailand and affected currencies, stock markets, and other asset prices in several Asian countries, many considered East Asian Tigers. Growth rates in these countries which were in excess of five percent before 1997, turned sharply negative in 1998 and, at the time of this writing it is not yet clear when these economies will turn the corner and resume positive rates of growth. This report examines how "the Asian miracle" became the “Asian Meltdown”. This paper will analyze the different key factors that caused the crisis. In the recent years the main causes of financial crisis have been sometimes different. Some crises may be caused by macroeconomic imbalances, such as large budget deficits caused by overly expansionary fiscal policies. That was, for example the case in for the Argentina financial crisis in 2001. Some crisis may be caused by volatile capital flows. This case for the East Asian financial crisis of 1997–1998 as will explain this report. The economic crisis in Asia unfolded against the backdrop of several decades of outstanding economic performance. Annual GDP growth in the ASEAN-5 (Indonesia, Malaysia, the Philippines, Singapore, and Thailand) averaged close to 8 percent over the last decade. Moreover, during the 30 years proceeding the crisis per capita income levels had increased tenfold in Korea, fivefold in Thailand, and fourfold in Malaysia. Indeed, per capita income levels in Hong Kong and Singapore now exceed those in some Western industrial countries. And until the current crisis, Asia attracted almost half of total capital inflows to developing countries—nearly $100 billion in 1996. THE ACCESS TO THE ASIAN MIRACLE The Asian tigers achieved high growth mainly due to private domestic investment and rapidly growing human capital. High levels of domestic financial savings sustained the countries’ high investment levels. While the agricultural sector was decreasing in importance, it experienced rapid growth and productivity improvement. The population growth rates were declining more rapidly than in other parts of the developing world. An efficient system of public administration and a better educated labor force helped also the start of this impressive economical growth. Macroeconomic management was unusually good and macroeconomic performance unusually stable, providing the essential framework for private investment. The policies to increase the integrity of the banking system and to make it more accessible to nontraditional savers raised the levels of financial savings. With a focus on primary and secondary schools, the education policies generated rapid increases in labor force skills. Government intervention In most of these economies the government intervened to boost development, and in some cases the development of specific industries. The governments used multiple, shifting policy instruments in pursuit of more straightforward economic objectives such as macroeconomic stability, rapid export growth, and high savings. The government interventions took many forms:  Policies to bolster savings, build strong financial markets, and promote investment with equity included keeping deposit rates low and maintaining ceilings on borrowing rates to increase profits and retained earnings, establishing and financially supporting government banks, and sharing information widely between public and private sectors.  Policies to encourage private investment: o Tax, tariff, and exchange rate policies to keep the price of investment goods low o Subsidized interest rates for corporate investment o Policies to limit risk for private investors.  Policies to protect domestic import substitutes support declining industries, and establishing firm- and industry-specific export targets. Especially in Indonesia, Malaysia, and Thailand government interventions played a much less prominent and frequently less constructive role in economic success. These economies' capacity to administer and implement specific interventions may have been less than in northeast Asia. Investment, human capital, and productivity The Asian tiger also differ from other developing economies in three factors usually associated with economic growth:  Elevated rates of investment, exceeding 20 percent of GDP on average between 1960 and 1990, including remarkably high rates of private investment, combined  Rising endowments of human capital because of universal basic education  The best productivity growth. This performance comes from the combination of success at allocating capital to high-yielding investments and success at catching up technologically to the industrial economies. The Asian government benefited from respecting and applying the fundamentals well: encouraging macroeconomic stability, basic education, sound and solvent financial institutions, secure property rights and complementary public investments in infrastructure, and low relative prices of investment goods. THE ASIAN CRISIS  Until 1997, Asia attracted almost half of total capital inflow to developing countries. The economies of Southeast Asia in particular maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result the region's economies received a large inflow of hot money and experienced a dramatic run-up in asset prices.  At the same time, the regional economies of Thailand, Malaysia, Indonesia, the Philippines, Singapore, and South Korea experienced high, 8-12 percent GDP growth rates in the late 1980sand early 1990s.  This achievement was broadly acclaimed by economic institutions including the IMF and World Bank, and was known as part of the Asian economic miracle.  Triggered by events in Latin America, particularly after the Mexican peso crisis of 1994, Western investors lost confidence in securities in East Asia and began to pull money out, creating a snowball effect.  At the time Thailand, Indonesia and South Korea had large private current account deficits and the maintenance of pegged exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors.  As the U.S. economy recovered from a recession in the early 1990s, the U.S. Federal Reserve Bank under Alan Greenspan began to raise U.S. interest rates to head off inflation. This made the U.S. a more attractive investment destination relative to Southeast Asia, which had attracted hot money flows through high short-term interest rates, and raised the value of the U.S. dollar, to which many Southeast Asian nations' currencies were pegged, thus making their exports less competitive.  The foreign ministers of the ASEAN countries believed that the well co-ordinated manipulation of currencies was a deliberate attempt to destabilize the ASEAN economies.  Malaysian Prime Minister Mahathir Mohamad accused currency speculator George Sorosof ruining Malaysia's economy with massive currency speculation  At the 30th ASEAN Ministerial Meeting held in SubangJaya, Malaysiathey issued a joint declaration on 25 July 1997 expressing serious concern and called for further intensification of ASEAN's cooperation to safeguard and promote ASEAN's interest in this regard.  Coincidentally, the Central Bankers of most of the affected countries were at the EMEAP (Executive Meeting of East Asia Pacific) meeting in Shanghai, and they failed to make the New Arrangement to Borrow operational.  A year earlier, the finance ministers of these same countries had attended the 3rd APEC finance ministers meeting in Kyoto, Japan on 17 March 1996, and according to that joint declaration, they had been unable to double the amounts available under the General Agreement to Borrow and the Emergency Finance Mechanism. EFFECTS IN EACH COUNTRY Thailand Exchange rate: Baht per U.S. DollarFrom 1985 to 1995, Thailand's economy grew at an average of 9%. On 14 May and 15 May 1997, the baht, the local currency, was hit by massive speculative attacks. On 30 June, Prime Minister Chavalit Yongchaiyudh said that he would not devalue the baht, but Thailand's administration eventually floated the local currency, on 2 July. Some have claimed that future Thai Prime Minister Thaksin Shinawatra was behind the devaluation. In 1996, an American hedge fund had already sold $400 million of the Thai currency. From 1985 until 2 July 1997, the baht was pegged at 25 to the dollar. The baht dropped very swiftly and lost half of its value. The baht reached its lowest point of 56 to the dollar in January 1998. The Thai stock market dropped 75% in 1997. Finance One, the largest Thai finance company collapsed. On 11 August, the IMF unveiled a rescue package for Thailand with more than 16 billion dollars. The IMF approved on 20 August, another bailout package of 3.9 billion dollars. Philippines The Philippines central bank raised interest rates by 1.75 percentage points in May 1997 and again by 2 points on 19 June. Thailand triggered the crisis on 2 July. On 3 July, the Philippines central bank was forced to intervene heavily to defend the peso, raising the overnight rate from 15 %to 24 % The peso fell significantly, from 26 pesos per dollar at the start of the crisis, to 38 pesos in 2000, to 40 pesos by the end of the crisis. During the tenure of former President Joseph Estrada, the Philippine economy recovered from a contraction of .6 %in GDP during the worst part of the crisis to GDP growth of some 3 %by 2001. Unfortunately, scandals rocked his administration in 2001, most notably the "jueteng" scandal, became a significant factor to calls for his ouster which caused significant falls in the share prices of companies listed on the Philippine Stock Exchange. The PSE Composite Index, the main index of the PSE, fell to some 1000 points from a high of some 3000 points in 1997. The peso fell even further, trading from levels of about 35 pesos to 50 pesos. Later that year, he was impeached but was not voted out of office. Massive protests caused EDSA II, which led to his resignation and lifted Gloria Macapagal-Arroyo to the Philippine presidency. Arroyo did manage to end the crisis in the Philippines, which led to the recovery of the Philippine peso to about 45 pesos by the time Arroyo became as the president Hong Kong The collapse of the Thai baht on July 2, 1997, came 24 hours after the United Kingdom handed over soveriegnty over Hong Kong to the People's Republic of China. In October 1997, the HK dollar, which was pegged at 7.8 to the US dollar, came under speculative pressure since Hong Kong's inflation rate was significantly higher than that of the US for years. Monetary authorities spent more than US$1 billion to defend the local currency. Since Hong Kong has more than US$80 billion of foreign reserves, which is equivalent to 700% of M1 money supply and 45% of M3 money supply of Hong Kong, Hong Kong managed to keep the currency pegged to the US dollar despite the speculative attacks. Stock markets become more and more volatile; between 20 October and 23 October the Hang Seng Index dipped by 23%. Hong Kong Monetary Authority promised to protect the currency. On 15 August 1998, Hong Kong raised rates overnight from 8 %to 23 % and at one point, to 500%. While the Monetary Authority recognized that the speculative forces were taking advantage of the unique currency board system, in which the overnight rates would automatically increase proportionally when the currency is sold in the market heavily, which would in turn increase the downward pressure of the stock market and thus allowing the speculators to earn a large profit by short selling shares, the Monetary Authority started buying component shares of the Heng Seng Index in mid- August. The Monetary Authority and Donald Tsang, then Financial Secretary, declared war with speculators openly. The Government ended up buying approximately HK$120 billion (about US$15 billion) of shares of various companies, and becoming the largest shareholder of some of the companies (e.g. the government owned 10% of HSBC) at the end of August when hostilities ended with the closing of the August contract of Heng Seng Index Futures. The Government started to divest itself from the position in 2001 and made a profit of about HK$30 billion (about US$4 billion) in the process. Speculative actions against the Hong Kong Dollar and the stock market did not continue into September largely due to extraordinary reaction to speculators by the Malaysian authorities and the onset of the collapse of Russian bond and currency market, which caused massive loss to the speculators. The currency peg between the Hong Kong Dollar and the US Dollar at 7.8:1 continued to exist undeterred. South Korea South Korea is the world's 11th largest economy. Macroeconomic fundamentals were good but the banking sector was burdened with non-performing loans. Excess debt would eventually lead to major failures and take-overs. For example, in July, South Korea's third largest car maker, Kia Motors asked for emergency loans. In the wake of the Asian market downturn, Moody's lowered the credit rating of South Korea from A1 to A3, on November 28, 1997, and downgraded again to Baa2 on December 11. That contributed to a further decline in Korean shares since stock markets were already bearish in November. The Seoul stock exchange fell by 4 %on 7 November 1997. On November 8, it plunged by 7 % the biggest one-day drop recorded there to date. And on November 24, stocks fell another 7.2 %on fears that the IMF would demand tough reforms. In 1998, Hyundai Motor took over Kia Motors. Malaysia Pre-crisis, Malaysia had a large current account deficit of 5% of GDP. At the time, Malaysia was a top investment destination, and this was reflected in KLSE activity which was regularly the most active exchange in the world. (with turnover exceeding even markets with far higher capitalisation like the NYSE) . Expectations at the time were that the growth rate would continue, propelling Malaysia into developed status by 2020, a government policy articulated in Wawasan 2020. As at start of 1997, the KLSE Composite index was above 1,200, the ringgit was trading above 2.50 to the dollar, and the overnight rate was below 7%. In July, within days of the Thai baht devaluation, the Malaysian ringgit was "attacked" by speculators. The overnight rate jumped from under 8% to over 40%. This led to rating downgrades and a general sell off on the stock and currency markets. By end 1997, ratings had fallen many notches from investment grade to junk, the KLSE had lost more than 50% from above 1,200 to under 600, and the ringgit had lost 50% of its value, falling from above 2.50 to under 3.80 to the dollar. In 1998, the output of the real economy declined plunging the country into its first recession for many years. The construction sector contracted 23.5%, manufacturing shrunk 9% and the agriculture sector 5.9%. Overall, the country's gross domestic product plunged 6.2% in 1998. During the year, the ringgit plunged below 4.7 and the KLSE fell below 270. In September that year, various defensive measures were announced to overcome the crisis. The principal measure taken were to move the ringgit from a free float to a fixed exchange rate regime. Bank Negara fixed the ringgit at 3.8 to the dollar. Capital controls were imposed. Various agencies were formed. The CDRC ( Corporate Debt Restructuring Committee) dealt with corporate loans. Danaharta discounted and bought bad loans from banks to facilitate orderly asset realization. Danamodal recapitalised banks. Growth then settled at a slower but more sustainable pace. The massive current account deficit became a fairly substantial surplus. Banks were better capitalised and NPLs were realised in an orderly way. Small banks were bought out by strong ones. A large number of PLCs were unable to regularise their financial affairs and were de listed.Asset values however, have not returned to their pre crisis highs. In 2005 the last of the crisis measures was removed as the ringgit was taken off the fixed exchange system. But unlike pre-crisis days, it does not appear to be a free float, but a dirty managed float, like the Singapore dollar. Indonesia Further information: Reformation (Indonesia) In June 1997, Indonesia seemed far from crisis. Unlike Thailand, Indonesia had low inflation, a trade surplus of more than $900 million, huge foreign exchange reserves of more than $20 billion , and a good banking sector. But a large number of Indonesian corporations had been borrowing in U.S. dollars. During preceding years, as the rupiah had strengthened respective to the dollar, this practice had worked well for those corporations -- their effective levels of debt and financing costs had decreased as the local currency's value rose. In July, when Thailand floated the baht, Indonesia's monetary authorities widened the rupiah trading band from 8% to 12%. The rupiah came under severe attack in August. On 14 August 1997, the managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The rupiah dropped further. The IMF came forward with a rescue package of $23 billion, but the rupiah was sinking further amid fears over corporate debts, massive selling of rupiah, strong demand for dollars. The rupiah and Jakarta Stock Exchange touched a new historic low in September. Moody's eventually downgraded Indonesia's long-term debt to junk bond. Although the rupiah crisis began in July and August, it intensified in November when the effects of that summer devaluation showed up on corporate balance sheets. Companies that had borrowed in dollars had to face the higher costs imposed upon them by the rupiah's decline, and many reacted by buying dollars, i.e. selling rupiah, undermining the value of the latter further. The inflation of the rupiah and the resulting steep hikes in the prices of food staples led to riots throughout the country in which more than 500 people died alone in Jakarta. In February 1998, President Suharto sacked the governor of Bank Indonesia, but this proved insufficient. Suharto was forced to resign in mid-1998 and B. J. Habibie became President. Before the crisis, the exchange rate between the rupiah and the dollar was roughly 2000 rupiah to 1 USD. The rate had plunged to over 18000 rupiah to 1 USD at times during the crisis. Indonesia lost 13.5% of its GDP that year. Singapore The Singaporean economy dipped into a short recession almost purely as a result of contagion. The relatively short duration and milder effects can be credited to active management by the government. For example, the Monetary Authority of Singapore allowed for a gradual 20% depreciation of the Singapore dollar to cushion and guide the economy to a soft landing. The timing of government programmes such as the Interim Upgrading Program and other construction related projects were brought forward. Instead of allowing the labor markets to work, the National Wage Council pre-emptively agreed to CPF cuts to lower labor costs, with limited impact on disposable income and local demand. Unlike in Hong Kong, no attempt was made to directly intervene in the capital markets, and the Straits Times index was allowed to drop 60%. In less than a year, the Singapore economy recovered, and continued on its growth trajectory. Needless to say, the economic effects, although collectively much milder than in other economies, were, in absolute terms, still very devastating, to those badly affected. People's Republic of China (PRC) The Chinese currency, renminbi (RMB), had been pegged to the US dollar at a ratio of 8.3 RMB to the dollar, in 1994. Throughout 1998 there was heavy speculation in the Western press that China would soon be forced to devalue its currency to protect the competitiveness of Chinese exports vis-a-vis those of ASEAN nations, whose exports became cheaper relative to China's. However, the RMB's non-convertibility protected its value from currency speculators, and the decision was made to maintain the peg of the currency, improving the country's standing within Asia. The currency peg was partly scrapped in July 2005 rising (only) 2.3 % against the dollar, reflecting pressure from the United States. Unlike investments of many of the Southeast Asian nations, almost all of its foreign investment took the form of factories on the ground rather than securities, which insulated the country from rapid capital flight. While the PRC was relatively unaffected by the crisis compared to Southeast Asia and Korea, GDP growth slowed sharply in 1998 and 1999, calling attention to structural problems with the PRC economy. In particular, the Asian financial crisis convinced the Chinese government of the need to resolve the issue of non-performing loans within the banking system. Although most of the deposits in PRC banks are domestic and there was not a run on the banks, there was a fear within the Chinese government that weak banks would cause a future crisis lead to a scenario similar to the fall of Suharto in which the Communist Party of China would be overthrown. This led to measures to fix the banks and the industrial enterprises, which were largely complete by 2005. The United States and Japan The "Asian flu" also put pressure on the United States and Japan. Their economies did not collapse, but they were severely hit. On 27 October 1997, the Dow Jones industrial plunged 554-points, or 7.2%, amid ongoing worries about the Asian economies. The New York Stock Exchange briefly suspended trading. The crisis led to a drop in consumer and spending confidence. Japan was affected because its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latter's economy was more than twice the size of the rest of Asia together. About 40% of Japan's exports go to Asia. GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998. The Asian financial crisis also led to more bankruptcies in Japan. CONSEQUENCES IN ASIA The crisis had significant macro-level effects, including sharp reductions in values of currencies, stock markets, and other asset prices of several Asian countries. Many businesses collapsed, and as a consequence, millions of people fell below the poverty line in 1997-1998. Indonesia, South Korea and Thailand were the countries most affected by the crisis. The economic crisis also led to political upheaval, most notably culminating in the resignations of Suharto in Indonesia and Chavalit Yongchaiyudh in Thailand. There was a general rise in anti-Western sentiment, with George Soros and the International Monetary Fund in particular singled out as targets of criticisms. Culturally, the Asian financial crisis dealt a setback to the idea that there is a distinctive set of Asian values, i.e. that East Asia had found a political and economic structure that was superior to the West. More long-term consequences include reversal of the relative gains made in the boom years just preceding the crisis. For example, the CIA World Factbook reports that the per capita income (measured by purchasing power parity) in Thailand declined from $8,800 to $8,300 between 1997 and 2005; in Indonesia it declined from $4,600 to $3,700; in Malaysia it declined from $11,100 to $10,400. Over the same period, world per capita income rose from $6,500 to $9,300. Indeed, the CIA's analysis suggests the economy of Indonesia was still smaller in 2005 than it had been in 1997 despite a population increase of 30 million, suggesting an impact on that country similar to the Great Depression. Within East Asia, the bulk of investment and a significant amount of economic weight shifted from Japan and ASEAN to China. The crisis has been intensively analyzed by economists for its breadth, speed, and dynamism; it affected dozens of countries, had a direct impact on the livelihood of millions, happened within the course of a mere few months, and at each stage of the crisis leading economists, in particular the international institutions, seemed a step behind. Perhaps more interesting to economists is the speed with which it ended, leaving most of the developed economies unharmed. These curiosities have prompted an explosion of literature about financial economics and a litany of explanations why the crisis occurred. A number of critiques have been leveled against the conduct of the International Monetary Fund in the crisis, including one by former World Bank economist Joseph Stiglitz. IMF’s Role in immediate restructuring The IMF is charged with safeguarding the stability of the international monetary system. Thus, a central role for the IMF in resolving the Asian financial crisis was clear, and has been reaffirmed by the international community in various multilateral fora. The IMF's priority was also clear: to help restore confidence to the economies affected by the crisis. In pursuit of its immediate goal of restoring confidence in the region, the IMF responded quickly by:  Helping the three countries most affected by the crisis-Indonesia, Korea, and Thailand-arrange programs of economic stabilization and reform that could restore confidence and be supported by the IMF;  Approving in 1997 some SDR 26 billion or about US$35 billion of IMF financial support for reform programs in Indonesia, Korea, and Thailand, and spearheading the mobilization of some US$77 billion of additional financing from multilateral and bilateral sources in support of these reform programs. In July 1998, committed assistance for Indonesia was [...]... reserves and liabilities in particular) and fiscal data, and in the financial and corporate sectors The reform efforts have been invaluably aided by the World Bank, with its focus on the structural and sectoral issues that underpin the macro economy, and the Asian Development Bank (ADB), with its regional specialization The IMF's Interim Committee reviewed and endorsed the overall strategy adopted... of resident representative posts in Korea and Thailand (and the expansion of the existing post in Indonesia); and various activities through the IMF's newly opened Asia and Pacific Regional Office The IMF has been responding to the requests it has received from its members, from its own Interim Committee and from multilateral fora such as the Group of Seven and the Group of Twenty-Four nations, to investigate... notably the World Bank and the Asian Development Bank, and with bilateral donors was intensified, to muster truly international support for the affected countries' economic reform programs A strengthened level of dialogue between the IMF and a variety of constituencies in the program countries was initiated, including consultations with labor groups and extensive contacts with the press and the public The... efforts between international creditor banks and debtors in the affected countries to resolve the severe private sector financing problems at the heart of the crisis, and the IMF has provided support to this process as appropriate Thailand reached an early understanding on debt roll-over with key Japanese creditor banks in August 1997 Talks between Korea and a group of foreign creditor banks on the... Executive Board on national economic policies All three countries are subscribers to the IMF Special Data Dissemination Standard (SDDS), and Indonesia and Thailand have established hyperlinks from the IMF Dissemination Standards Bulletin Board (DSBB) to their respective national economic and financial data Ad hoc measures have been taken as necessary, including the appointment of former IMF Deputy Managing...augmented by an additional US$1.3 billion from the IMF and an estimated US$5 billion from multilateral and bilateral sources; and Intensifying its consultations with other members both within and outside the region that were affected by the crisis and needed to take policy steps to ward off the contagion effects, although not necessarily requiring IMF... from a wide range of commentators, and a healthy debate is taking place The IMF has undertaken and made public a rigorous, albeit preliminary, internal review of the design and early experiences with IMF-supported programs in Indonesia, Korea, and Thailand, in part to contribute to this debate However, some criticisms of the programs are based on fundamental misunderstandings about the IMF's response... response to events in Asia, including on village health centers and immunization programs; and student aid to minimize the decline in school enrollment Amid the sharp recessions and heavy social costs of the crisis, there are nonetheless indications that if countries persist in implementing programs of economic stabilization and reform, and if financial market confidence gradually returns which depends... contributed significantly to the crisis; Structural reforms to remove features of the economy that had become impediments to growth (such as monopolies, trade barriers, and nontransparent corporate practices) and to improve the efficiency of financial intermediation and the future soundness of financial systems; Efforts to assist in reopening or maintaining lines of external financing; and The maintenance of... bottoming out in Korea and Thailand The rate of decline in industrial production has begun to moderate in recent months; recently, the unemployment rate in Korea has declined slightly, and the sale of new vehicles in Thailand, an indicator of consumer confidence and of the strength of the non-bank financial sector, rose on a 12month basis for the first time since the beginning of the crisis . ASIAN CRISIS AND CONSEQUENCES SM71.9005 Country Risk Management Asian Institute of Technology Instructor Dr INTRODUCTION The financial crisis which began in July 1997 in Thailand and affected currencies, stock markets, and other asset prices in several Asian countries,