A Comparative Study of East Asia and India Avinash Chandiramani Scott Dicks Erin Fitzpatrik Salil Jayakar Ruhi Khan Chad Simon

Disaster Strikes East Asia Decades of impressive growth The intensity and the duration of the crisis were inconceivable The effects of the crisis spread through the Global economy THE INDIAN ECONOMY ESCAPED THE CRISIS VIRTUALLY UNHARMED Crisis Financial Markets Currency markets

Agenda INTRODUCTION TO THE CRISIS Macroeconomic fundamentals Theories FINANCIAL AND TRADE LIBERALIZATION Banking Sector Capital flows Debt / equity markets Real Trade Linkages EXCHANGE RATE REGIMES Foreign reserves Banking sector Financial sector Trade CONCLUDING REMARKS

–Bankruptcy rates skyrocket –Stock markets crash –Growth rates tumble –Currency speculation forces Thai Baht depreciation Introduction to the Crisis THIS IS A TRIGGER FOR THE CRISIS 1997: East Asia falls into crisis

- Following this, Malaysia, Indonesia and Philippines allow depreciation -China, Hong Kong, Korea, Singapore and Taiwan Introduction to the Crises TIGERSPAPER TIGERS CREDIT CRUNCH

East AsiaIndia GDP GrowthExceptionalModerate InflationLow Saving RateHigh Current Account Deficit Over 5 % of GDPUnder 5 % of GDP Exchange RegimePeggedFloating TradeVery ImportantLess Important Macroeconomic Fundamentals

Dramatic increase in credit Socially Risky behavior encouraged Moral hazard by monetary authorities Bad Policy Theory Intense Liberalization + Inappropriate Policies = Crisis

Financial Panic Theory Downturn in Real Economic Variables (GDP) Systemic Risk Expectations of Instability Coordination Failure Inherent Instability of Financial Markets + Loss of Investor Confidence = Crisis

Moral Hazard Two Types: “A situation which creates incentives to engage in risky behavior. Decreased personal liability acts as an incentive” Corporate Level International Level

Contagion “The transmission of shocks to other countries or the cross-country correlation, beyond any fundamental link among the countries and beyond common shocks.” This definition is usually referred to as excess co- movement, commonly explained by herd behavior.

Liberalization Policy Banking sector Privatization Capital Flows Debt/Equity Markets Capital Account Convertibility (CAC) Introduction of financial institutions

Liberalization Policy An influx of capital More efficient and competitive markets but… Proper regulation is needed

Banking Sector East Asia High level of privatization Regulation was not enforced & Little diversity in investment India Low levels of privatization Increased supervision & Diversity in investments Morally hazardous behaviorLess moral hazard Implicit Guarantee

Capital Flows East Asia Full Capital Account Convertibility India Partial Capital Account Convertibility Turnaround of short term capital flows Less dependence on short term capital Increasing portfolio investment No change in portfolio investment

Debt/ Equity Markets Financial assets as collateral for loans Corporate bankruptcy in East Asia Ineffective rating and regulation agencies Overvalued stock markets

Real Trade Linkages Trade makes up large % of GDP Trade makes up small % of GDP East Asia India Investors group Asian economies India was not connected with East Asia Competitive exports to similar countries. Similar trading partners Different exports than East Asia Small amount of trade with East Asia

Exchange Rate Regimes Pegged Exchange Rate Regimes Advantages Associated with stability and low inflation Forces authorities to adhere to disciplined monetary and fiscal policies Disadvantages Misalignments may occur when foreign and domestic countries face different economic conditions Maintaining pegs in the face of increased speculation can be costly MOST EAST ASIAN COUNTRIES ADOPTED PEGGED RATES

Exchange Rate Regimes Floating Exchange Rate Regimes Advantages Currency moves with the relative performance of the economy Serves as an adjustment mechanism, insulating a currency from speculative attacks. Disadvantages Fluctuations may reflect non-fundamental noise INDIA ADOPTED A FLOATING EXCHANGE RATE IN 1994

Foreign Reserves East Asia India : foreign reserves grew Short term debt rising Capital Outflows in ‘97  reserves decrease Pegs unsustainable  depreciation India’s reserves also grew India discouraged short term debt Capital Inflows in ’97  reserves increase Floating rate  No dramatic depreciation

Banking Sector East AsiaIndia Depreciation  foreign denominated debts unsustainable 1997: High levels of non-performing assets Decreased credit by banks No depreciation  Foreign debts sustainable 1997: Lower levels of non-performing assets No decrease in credit by banks

Financial Sector East AsiaIndia Switch to floating exchange rate  rapid depreciation,  uncertainty Further capital outflow ensued India’s exchange rate provided a greater predictability 1997 experienced an increase in capital inflows of 24%

Trade East AsiaIndia Crisis depreciations did not  competitiveness: 1. High levels of intra- regional trade 2. Increased cost of raw material imports Trade played less influential role in Indian economy No dramatic swing in rates to alter competitiveness Trade played an influential role in East Asian economies

Conclusion The financial crisis reflects three important considerations Liberalization Exchange rate regimes Combination of the above two

Liberalization Partial capital account convertibility Less dependence on short term flows Diversified allocation of capital Conclusion

Conclusion Exchange Rate Regimes East Asia Pegged currency increased risk of speculative attack India Float allowed currency to reflect economic fundamentals

Combined Effect FULL CAPITAL ACCOUNT CONVERTIBILITY + PEGGED EXCHANGE RATE = SPECULATIVE ATTACK Conclusion

Conclusion The East Asian and the Indian economies are fundamentally different and are at different stages of growth and liberalization. Summing up:

Recommendations Considerations relevant for economic and financial policy: Controls on capital account convertibility or a commitment to flexible exchange rates Less dependence on short term capital inflows Enforce regulation policies in financial and banking sectors Increased transparency in all transactions

Any Questions?

Trade as a % of GDP (1997)

East Asia Trading Partners (1997)

Portfolio Investment as a % of GNP

Credit Contraction

Currency Depreciation

International Reserves ($mill. SDRS)

India’s International Reserves (USD$billions)

% of Non-Performing Bank Assets in 1997

Capital Outflows

Values in billions of US$

Inflation Gross National Savings Overall Budget Surplus Selected Macroeconomic Variables (India)