Asian Financial Crisis 1997

Introduction

• The Asian Financial Crisis was a period of financial crisis that gripped much of Asia beginning in July 1997.

• The crisis started in Thailand with the financial collapse of the Thai Baht.

• Indonesia, South Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump.

• 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.

Asian Miracle

• Attracted half of total capital inflow.

• High savings and investment rate.

• Robust growth – (8-12% GDP).

• Moderate inflation.

• Export to rich nations.

• Increase in asset values ( land and stock prices).

• Acknowledged by IMF and World

The Bubble

• Thailand’s economy – bubble fuelled by ‘Hot money’• Debt-GDP Ratios went up to 180%• More and more was required as the bubble grew• Development money went in a largely uncontrolled manner to

certain people only, not particularly the best suited or most efficient, but those closest to the centers of power.

• Real estate speculation• Countries became excessively dependent upon exports for their

economy• Very high leverage & exposure to forex risk

The Tripping Point

• U.S. economy recovered from a recession in the early 1990s, • 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 been attracting hot money flows through high short-term interest rates, and raised the value of the U.S. dollar.

• For Asian currencies pegged to the U.S. dollar, the higher U.S. dollar caused their own exports to become more expensive and less competitive in the global markets.

• At the same time, Southeast Asia's export growth slowed dramatically in the spring of 1996, deteriorating their current account position.

The Downturn

• Asset prices began to collapse• Causing individuals & companies to default• Panic among lenders – led to withdrawal of funds• Credit crunch & bankruptcies

• Depreciative pressures on exchange rates

• Government action:• Raised interest rates tremendously to prevent capital flight• Buying up excess domestic currency at fixed rate to maintain the peg

• Capital fleeing could not be stopped

• Central bank allowed currencies to float• Drastic Depreciation• Further increasing the debt obligations and worsening the crisis.

The Start…Thailand

• 1985-96 , Thailand grew at an average of 9% per year.

• Low Inflation – within (3.4 to 5.7%)

• Until July 97 – Baht was pegged to 25 US $

• Economy attractive to speculators

• Huge capital inflow.

• By 1995, Net capital inflow of US$ 14.239 billion.

Cont…

• Stock market 175% , Property sector 395%.

• 50 banks and non banks financial institutes emerged.

• FDI to Thai economy fell from 33.57% to 15.90%

• Mismatch between foreign assets and liabilities.

• Starting 1995, economy slows down

Cont…

• May 1997 , Baht hit by Massive Speculative Attack.

• June End , Thai PM declared he wont devaluate Baht.

• 90% of country’s foreign reserve used to defend Baht.

• Govt Fails, July moves to flexible exchange rate.

• Thailand’s booming economy comes to a halt.

• Thailand approached IMF.

CONTAGIONSPREADS TO OTHER COUNTRIES

Indonesia

• Devaluation of Rupiah from 2000 to 18000 per US $.

• 16 major commercial banks were closed.

• Bank of Indonesia governor sacked.

• President Suharto , steps down after 30 yrs in Power.

• Moody’s downgrades long term debt to “Junk Bond”.

Malaysia

• July 1997, Malaysian Ringgit jumped overnight from 8% to over 40%.

• Ratings had fallen from investment grade to junk

• Lost 50% of value, from 2.50 to 3.80 to the dollar

• Output of real economy declined : Construction dropped 23%,Manufacturing 9%, Agriculture 5.9%,GDP 6.2%

South Korea

• Devaluation of Won: from 1000 to 1700 Per US $

• Moody downgrades credit rating from A1 - B2

• National debt-GDP ratio went from 13%-30%

• Seoul stock exchange dropped 4% on Nov 7, 7% on Nov 8, and 7.2% on Nov 24

• 1998 Hyundai took over Kia Motors, Samsung was dissolved, and Daewoo was sold to American GM

Philippines

• 1998, Growth dropped to virtually zero.

• Peso fell significantly from 26 US $ to 55 US $.

• President Estrada forced to Resign.

Japan

• 40% of Japan’s export go to Asia.

• Japanese Yen fell to 147 as mass selling began.

• GDP growth rate slowed from 5% to 1.6%.

• Some companies went bankrupt.

Effects On Currency

Causes Of The Crisis

• Foreign debt-to-GDP ratios rose from 100% to 167% in the four large ASEAN economies in 1993-96

• Large CAD

• Financed by hot money flows (on capital account). Hot money flows were accumulated because of higher interest rates in the East.

• Financial deregulation encouraged more loans and helped to create asset bubbles

• Booming economy and booming property markets encouraged expansive borrowing by firms.

• In the late 1990s, the US increased interest rates to reduce inflationary pressures. Higher interest rates in the US, made the East less attractive as a place to move hot money flows. As hot money flows into the east dried up, currencies started to fall and governments struggled to keep exchange rates at their fixed level against the US Dollar.

• The devaluation caused debt to be even more difficult to repay and countries started to default.

RECOVERY

Role Of IMF

• Created a series of bailout for most affected economy.

• Provided $120 billion as bailout package.

• SAP –Structural Adjustment Package.

1. Change currency, banking and financial system.

2. Reduced Govt spending and deficits.

3. Close insolvent banks and financial institutions.

4. Raise interest rate.

Effects Of IMF Intervention

• At this stage the IMF intervened to try and stabilise the crisis. However, their intervention has proved very controversial, with many arguing that their intervention made things worse.

• The IMF insisted on fiscal restraint – lower spending, higher taxes and privatisation. This contractionary fiscal policy caused the economic downturn to exacerbate and the economy plunged into recession. Bankruptcies increased and there was a flight of capital.

Why India was not affected by the crisis?

• Full Capital Convertibility was not allowed.

• Lock in Period for foreign investment in real estate.

• Floating exchange rate with some influence by the RBI during periods of crisis.

• Strong Fundamental growth with services sector being the prime reason.

• External Debt to GDP has been declining for the past few years.