1. East Asian Financial Crisis
Econ 437 Allstars:
Yan, Lauren, Kevin, John, Alex

2. Pre-Crisis
During the pre-crisis era, Asia attracted half of the capital inflow to developing countries.
Asian Economic Miracle.

3. The Sign Mexican Peso Crisis.
Princeton/MIT economist Paul Krugman’s argument.
Early May 1997, Japan hints that it might raise interest rates to defend the yen.

4. The Beginning
July 2, Thailand announces a managed float of the baht. The Philippines intervenes to defend its peso.
July 24, 97 - Asian currencies fall dramatically.
Aug The Indonesian rupiah comes under severe pressure.
Aug Asian stock markets plunge.

5. The Ripple
Oct The Hong Kong dollar comes under speculative attack. At the same time, The Hong Kong stock market drops.
Oct The value of the Korean won drops as investors sell Korean stocks.
Nov Japanese brokerage firm , largest securities firm, and 10 largest bank collapse.

6. The Ripple (Con.)
Nov 25 - At the APEC Summit, leaders of the 18 Asia Pacific economies endorse a framework to cope with financial crises.
Jan 12, Peregrine Investments Holdings of Hong Kong collapses.
Jan 31 - South Korea orders 10 of 14 ailing merchant banks to close.

7. IMF In Action
July 18, IMF approves an extension of credit to the Philippines of $1.1 billion.
Aug IMF announces $17.2 billion support package for Thailand with $3.9 billion from the IMF.
Nov. 5 - The IMF announces a stabilization package of about $40 billion for Indonesia. The United States pledges a standby credit of $3 billion.

8. IMF In Action (Con.)
Dec 25 - IMF and others provide $10 billion in loans to South Korea.
Jan 8 - IMF and S. Korea agree to a 90-day rollover of short-term debt.
Jan 15, IMF and Indonesia sign an agreement strengthening economic reforms.

9. Asian Financial Crisis
Occurred in 1997
Period of turbulence, not marked by single event
Unanticipated and followed a stretch of strong economic performance over previous 8-10 years.

10. Asian Financial Crisis-Onset
In 12 months regions stock market capitalization shrank by as much as 85% in US $ terms.
Once among the largest stock markets in the world.
Currencies depreciated sharply, falling 50%-80% against US $ by July 1998.

11. Contributing Factors of Crisis (Prior to Crisis)
A build up of overheating pressures.
Evident in large external deficits
Inflated stock prices and property market values
Prolonged maintenance of pegged exchange rates.
Unsustainably high levels
Complicated monetary policy response to crisis

12. Contributing Factors of Crisis (Prior to Crisis)
East Asia was hit by several international macroeconomic shocks period.
Increase in competitiveness
Reversal of the long-term trend of yen’s appreciations relative to the dollar
*These shocks believed to have impact on Asia’s economic performance in combinations with weaknesses of East Asian financial systems.

13. Contributing Factors of Crisis (Prior to Crisis)
Wide swings in the dollar/yen exchange rate
Underestimation of risks

14. Imbalances in External Sector Asian’s Economic Performance
Real Exchange Rate Appreciation
Slowing Export Growth
Large Current Account Deficits
Increasing Short Term External Debt

15. Real Exchange Rate Appreciation Asian’s Economic Performance
Fixed Exchange Rates (Nominal anchor for domestic price level, maintain competitive export position).
Early 90’s US$ depreciation (Depreciation of the REAL exchange rate of many East Asian economies).
1995 US stock market upward trend (Expectations of domestic interest rate increases, strengthen US$).
Lead to inflationary pressures in East Asia (Real exchange rate appreciation).
RESULT (Loss in competitiveness).

16. Asian Exports (Current Account) Asia’s Economic Performance
Increase in export prices (previous slide).
Decline in global demand for KEY Asian exports (semiconductors and electronics).
Decrease in export volume.
Current Account deficits grew.
(CA=Export-Import = S-I)

17. Foreign Capital Investment
Foreign investors flooded the region with funds until the onset of crisis
In 1996 private inflows to 5 countries (Indonesia, Korea, Malaysia, Philippines and Thailand) doubled from $40.5 billion to $90.3 billion
BUT in 1997 reversed, with a net outflow around $12.1

18. Foreign Capital Investment Weaknesses in Financial System
90’s decrease in global interest rates
No capital Regulations
Poor governance
Inadequate Supervision/Regulation
Inappropriate Policy Responses to K surges
Example: Lax Fiscal Policy and Non-sterilized inflows.

19. Foreign Capital Investment Weaknesses in Financial System
Lack of transparency in banking systems
Poorly enforced rules and inadequate supervision of financial systems
In addition, government-direct lending practices which led to a sharp deterioration in the quality of banks’ loan portfolios
Political and governance uncertainties
Lack of confidence

20. Foreign Capital Investment Weaknesses in the Financial System
Financial Crisis displays elements of a “SELF-FULFILLING” crisis, where capital withdrawals by creditors cascaded into a financial panic
Caused deep contraction

21. Onset of Crisis
Early 1997 Thai stock market and Thai $ baht experienced downward pressure (concern over short-term foreign debt).
Large Current Account deficit-raised concerns that baht would not maintain US-dollar peg.
Malaysian and Philippine experience similar pressures.
Same time South Korea stock market began to falter.

22. Where It Started and Spread
Thailand*
Philippines*
Malaysia
Indonesia*
South Korea*
Hong Kong
*Country to be discussed in detail

23. Thailand Thailand baht pegged to US dollar
US dollar appreciates (interest rates rise)
Baht forced to appreciate
Exports more expensive
Speculation of the baht
International reserves depleted
Baht floats freely and depreciates
Before crisis: 25 baht = 1 USD
After crisis: 56 baht = 1 USD
Baht forced to appreciate by decreasing money supply through selling foreign reserves. With the appreciation, Thailand exports become more expensive and investors decide to invest in Japanese market instead with the Yen depreciating.
Decline in exports gave investors uncertainty about exports to earn adequate returns for investments.
Thailand under speculation for borrowing too much money, would have to pay back in the future (currency overvalued).
International reserves depleted. Cannot keep up with appreciation of the dollar – force to float the baht.

24. Philippines Investors witness crisis in Thailand
Investors pull out of Philippine market
Low international reserves
Philippine peso forced to float currency and depreciate
Investors witness the crisis in Thailand and can only expect other East Asian countries to follow in suit. Investors get nervous and pull out their investments in the Philippine market. With severe speculation and low international reserves, the Philippine peso is forced to float freely in the exchange market and depreciate.

25. Indonesia
Pre-crisis: low inflation, trade surplus, huge foreign reserves
Corporations borrowing in US dollars
When Thailand floats baht, Indonesia widens rupiah trading band
Trading band grows drastically and forces rupiah to float freely
Corporations suffer heavy losses and bankruptcy
Before crisis: 2000 rupiah = 1 USD
After crisis: rupiah = 1 USD
Indonesia had low inflation and trade surplus of more than $900 million and huge foreign exchange reserves (more than $20 billion).
large number of Indonesian corporations, however, had been borrowing in US dollars. Pre-crsis: the effective levels of debt and financing costs had decreased as the local currency's value rose.
Thailand floated the baht, however, in order to maintain currency stablization, Indonesia widened the rupiah trading band from 8% to 12%. As the band keeps growing, however, it forces the rupiah to float freeley, triggering a plunge in the currency. The Indonesian corporate sector, however, did not experience the worst until November when the effects of 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 (selling rupiah, undermining the value of the latter even further).

26. South Korea Crisis exposes long standing weakness: Credit rating drops
Massive foreign borrowing
Credit rating drops
Stock market crisis
Before crisis: 1000 won = 1 USD
After crisis: 1700 won = 1 USD
Moddy’s lowers the credit rating of South Korea from A1 to A3 and then later to B2. This contributes to further decline in Korean shares (stocks fell to their lowest of 7.2% in November for fears that the IMF would demand tough reforms.

27. Exports Slowdown

28. East Asian Exchange Rates

29. How to Prevent it? There is no way to predict a financial crisis
Crises arise from unpredictable market reactions, but it is possible to identify the kinds of weaknesses that typically make economies vulnerable to financial crises.

30. Recognizing the Signs Signs of weakness include: overheated economy
high inflation
appreciation of real exchange rate
increase in current account deficit
rapid increase in domestic credit
inflated asset prices
low levels of official international reserves.

31. Lessons Learned
1. Monetary Policy: in class we learned that under a fixed exchange rate system, monetary policy is ineffective.
2. Regulations on Capital Inflows: Capital control and regulations can prevent the spill over of uncertainty and speculation about the markets.

32. Lessons Learned (Con.)
Governance: The government needs to tighten regulations on the financial sector in order to restore investor confidence, and ensure abuses will no longer exist.
Political patronage
Nepotism
Lax accounting practices
4. Fiscal Policies: Rely less on external saving and concentrate more on the costs of restructuring and recapitalizing banking systems. Money needs to be taken away from unproductive public expenditures and given to those needed to minimize the social costs of the crisis and strengthen social safety nets.