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Abstract

During 1998, the world economy entered a slowdown, which was originated in EastAsia. The East Asian financial crises were generally unpredicted. They not only

revived the longstanding debate on the causes of currency crises, but also representa new kind of crises, as they do not seem to conform to the first-generation andsecond-generation literature on currency crises.

Moreover, current explanations of the Asian chaos (based on misguided macro-management, self-fulfilling foreign financial panic, or fragile domestic financialmarkets) might be simplisticUnder the scope of a students assignment, we would like to examine this issuebased on our knowledge and many experts opinions stated on newspapers andwebsites.

At the very firs, we will review the East Asias economic background and itscondition until 1997, and describe the onset and development of crises in an orderof time.After that, the five main reasons for the crises such as the overdependence on exportand on short-term foreign debts, the capability in regulating the economy ofauthorities, the speculation of real estate and currency markets, along with thecontribution from macroeconomic polices.Following will be the crises impacts under both regional and global scale (theinfluences on stock market, currencies, interest rates, international trade, FDI, andso forth)The next part is devoted to represent the IMFs approaches, the Government actionsin fiscal and monetary policies, as well as the restructuring in response to thegloomy economyLast but not least, we will come up with a case study which focus on answeringthree questions: How was Vietnam affected? The potential causes of crisis inVietnam under current condition. And the valuable lessons derived from the crisis.

Introduction

The East Asian crises, which erupted in mid-1997, have been one of the mostserious and challenging economic events of the 1990s.

The Asian Crisis has caused severe economic turbulence in the economies of SouthEast Asia since the summer of 1997. There have been two distinct phases to theAsian Crisis: the first from July 1997 to December 1997, when the first internationalassistance was provided, and the second since mid-1998, when the turbulence hasspread beyond the region as Russia, China and Brazil have shown signs of contagion.

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To begin with, the Asian turmoils certainly represent a new kind of financial crises,as the traditional theoretical models (those represented in the so-called firstgeneration or second-generation literature on currency crises) fail to render anaccurate picture of their causes, consequences and remedies. (According to first-

generation models (Krugman, 1979), crises arise as a result of loose macroeconomicpolicies (for instance, of excessive public sector deficits, which are monetizedresorting to international reserves), and which become thus inconsistent with theexchange rate system. Second-generation models (Obstfeld, 1994 and 1995) analyzethe possibility of self-fulfilling crises, due to herding behavior by foreign investorsexpecting currency realignments, or to contagion effects, and mainly independentfrom the position of fundamentals). The Asian crises have not been simply the resultof bad fundamentals due to fiscal irresponsibility, as in Latin America in the early-1980s, nor the mere outcome of a self-fulfilling foreign financial panic againstslowing economies with rising unemployment, as in Western Europe in 1992-1993or in Mexico in 1994-1995.

The Asian crises were, to an extent, which is difficult to understand today,unanimously unpredicted. Debt ratings by international credit rating agencies,spreads on foreign lending, and stock indexes (except, in the latter case, minorcorrections in Thailand and South Korea in early 1996) did not change significantlybefore the turmoil. Furthermore, both the Asian Development Bank (ADB) and theInternational Monetary Fund (IMF) failed to anticipate even any kind of economicand financial problems.

Moreover, there is no consensus on the diagnosis of the crises. Explanations of theAsian crises abound (see a survey in Corbett and Vines, 1998), but those with a realinsight may be divided in three main categories. Firstly, some analysis have insisted

on a misguided macro-management as the main factor, albeit conceding thatfundamentals were sounder than in previous cases

Secondly, other strands of thought have blamed the herding, irresponsible, and

over-reactive behavior of external financial (e.g., capital and currency) markets asthe culprit of the Asian crises

Finally, a third set of explanations has stressed the importance of a combination offragile domestic financial markets (a result of inadequately administered financialderegulation and opening) and large and volatile capital inflows and outflows.

Besides, the Asian turbulences are also different from previous episodes of currencycrises in their significant regional and international impact. According to theimportance of East Asia in the world economy (30% of world GDP measured inpurchasing power parity), its crisis is having severe regional and worldwideimplications. Following a recent survey on the state of the world economy by TheEconomist, East Asia is mired in a deep and long-lasting recession; Russia is incritical condition and has virtually defaulted on its debt; China may respond to theslowdown in its traditionally high rate of growth by devaluating its currency; theHong Kong dollar is under severe pressure and the economy of the new Chinese

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Special Administrative Region is beginning to contract sharply; growth is slowing insome developed economies, especially in the United States and the United Kingdom;share prices have tumbled across the whole world, wiping out at least US$ 4 trillionin assets during the summer of 1998; commodity prices have fallen precipitously;and investors confidence is at an all-time low. At the time of writing (early October

1998), there is even a risk of a global recession, if the crisis in emerging marketsdeepens, if the IMF runs short of money, if Japan continues to delay the rescuing ofits financial system and, more obviously, if Wall Street crashes, if the FederalReserve refuses to cut interest rates significantly, if the new European Central Banksticks to monetary orthodoxy, and if developed economies react to the newinternational environment retreating towards protectionism. In mid-September1998, according to a report in Business Week, most U.S. stocks are down 25% or

more from their highs as the outlook for profit growth darkens. Asia sinks furtherinto depression as Hong Kong, Thailand, and Malaysia try to insulate their marketsfrom the forces of international capital. Japan heads into its fourth quarter ofcontraction as policy remains paralyzed, and Latin America teeters on the edge of

yet another recessionFurthermore, the international communitys response to the Asian turmoil and the

IMFs approach to the Asian crises, and more specifically the Funds programs in

Thailand, Indonesia and South Korea, have been widely criticized, even by scholarsand analysts willing to defend the conventional stance of the Fund.

The main regional consequences of the Asian crises have been considerabledepreciations of national currencies, a sharp drop in stock indexes, and a recessionin most of the dynamic economies

Conclusions

The analysis of the East Asian financial crises is a challenging but necessary task.The Asian turmoils, which erupted in 1997, represent a new kind of crises, differentin many aspects to those depicted in the first-generation and second-generationliterature on currency crises in developing countries. This might explain why theAsian episodes were largely unpredicted. It also calls for a third-generationtheoretical model of currency crises and for a new set of indicators or predictors.The Asian crises highlight the importance of sound macroeconomic policies and,especially, the need to avoid large current account balances in a context ofsubstantial real currency appreciation. But the preceding analysis has tried to show

that these were not the main culprits of the crises in East Asia, except, and onlypartially, in Thailand and Malaysia. Instead, the paper has insisted on adverse non-conventional indicators such as overinvestment, imprudent domestic financialliberalization and capital account opening, and accumulation of a large foreign debt(mainly private, short-term, denominated in foreign exchange, and largelyunhedged).

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One of the main lessons of the Asian crises has been that imprudent and improperlysequenced financial liberalization in emerging economies increases theirvulnerability to speculative attacks. Domestic financial deregulation should beattempted only after creating an adequate supervisory and prudential regulatoryframework. Moreover, financial opening should follow, and not precede, the

strengthening of the domestic financial sector. More precisely, regulating and taxingshort-term and potentially volatile international capital flows seem to be necessarysteps in order to avoid disruptive processes in a macroeconomic environment.

Turning now to the international implications of the Asian crises, the role of the IMFas a manager of the turmoils has been widely criticized. It seems that the IMF isunable to deal with financial crises in the present era of financial globalization.Therefore, a reassessment of its functions and programs in developing economies issurely needed. Moreover, several international measures to encourage more stablecapital flows to emerging markets (such as regulating and supervising short-termbank loans and portfolio investments) should be explored in order to reduceinternational financial fragility.

As the World Bank has recently acknowledged, the initial response to the Asiancrisis has clearly failed, especially because combining very high interest rates withstrict fiscal restraints has intensified the recession in the region. Interest ratesshould be allowed to fall and a concerted fiscal stimulus should be undertaken, inorder to spur growth and to alleviate the expected increase in poverty (World Bank,1998).

But there are other reasons to reject traditional recipes of deflation andderegulation. These measures also jeopardize the foundations of the East Asiandevelopmental path, which, has been based upon a large state intervention (Lall,1996) and upon a strategic (rather than close) integration with the world economy(Singh, 1995 and 1998). The real danger of the Asian crises is that, if a change ofapproach is not undertaken on national and international levels, a very successfulpath towards industrialization and economic and social development might, notonly be fully at risk, but simply disappear.