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Crisis of South Eastern Countries in an Open Economy framework

Content of the Assignment

Rise of the Asian Economies

Causes of Crisis

Effects of Crisis various south eastern Countries and on World

Bail Out Packages by IMF and Actions taken by Governments

Conclusion

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I. Rise of the Asia Economies

The economic development of the South Eastern Economies (Thailand,

Malaysia, Indonesia, Philippines, Singapore) started in the 1980s. The

development of these economies started through a structural adjustment

programs with the help of IMF. The structural adjustment program was

initiated as these economies had a massive balance of payment problem

due to rising imports and falling exports. The program was initiated for

liberalisation of the economies in financial sector and to increase the flow of

Foreign Direct Investment (FDI).

The opening up of the sector was followed with a massive investment by

countries like Japan, Taiwan, Korea and Hongkong. It was an ideal

investment scenario to set up a production facility in these South Eastern

Economies due to availability of cheap labour force and low cost ofoperations due to devalued currency. The high inflow of the FDI into these

countries resulted in a high growth rate for almost a decade (1980 to 1990).

As these investments were primarily into productive sectors it ensure that

the was a sustained growth momentum maintained due to rising exports,

high employment, increase in the standard of living.

The sustained growth of these economies resulted in a high standard of

living, rising middle class, low unemployment level in these countries. The

double digit growth maintained by these South eastern economies attracted

foreign capital investments. During the period from 1980 1995, theregions contribution increased nearly 1/4th of the total world output. The

high rate of return was also an attractive incentive to the developed

economies such as Japan, US

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II. Causes of Crisis

Reduction in the Export growth

The South eastern economies were having a sustained export growth after

opening up their economies in the mid-eighties. However, the export growth

rates started falling in the mid-nineties. There were various factors which

contributed to the reduction in the exports of these countries. The key

factors contributing to the slowdown in the export are:

Slow down in the economies of the developed nations such as US,

Japan which were the major importers from these economies. Japan

which had the major investment in these countries had gone into arecession during the mid-nineties contributed to the reduction in the

export sales of these economies.

There was growing competition with the emerging BRIC economies,

primarily from China which was emerging as a major exporting

nation. China due to certain inherent factors such as cheap labour

force, devalued currency and huge investment by the government by

creating Special Economic Zones had emerged as a major export hub

for the world.

The currencies of these economies were pegged to the US dollar, dueto which any appreciation in the US dollar resulted in the appreciation

of these currencies. During the period 1990-96, the currencies has

appreciated in a range of 20%-44% due to the appreciation of the US

dollar, this resulted in the reduction the export competiveness of

these economies.

Mismanagement of Borrowed Funds

The amount of borrowings has risen over a period of time in these

economies to sustain the economic development. This had resulted in a

massive foreign debt burden on these economies by the mid-nineties. The

loan borrowed by these countries where originally for tenure of 12-15 years

which came up for repayment during the period 1995-96. The servicing of

these debts was affected due balance of payment crisis due to decline in

the export growth.

The borrowings in these economies were primarily done by private sectors.

The private sector due to the booming economy had done massive

borrowings which was short term in nature. This resulted in a debt trap for

these economies due to servicing these high interest bearing short term

loans.

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Further, the borrowing done by these private players have been invested in

non-productive investments such as real estate, equities etc resulting in an

asset bubble and re-payment crisis. Due to re-payment crisis, fresh

borrowings dried up, as the foreign investors were not willing to provide the

funds for servicing the old debts and started removing the available funds

from the South eastern economy markets. This resulted in a liquidity crisis

for the domestic borrowers, who defaulted in their debt servicing.