Financial Crises

East Asia 1997, Russia 1998, Brazil ?

Background to 1997 East Asian crisis

• Fundamentalist view• Contagion view

Three factors:• Macro policy in OECD• Domestic mismanagement• Investor panic

Exchange Rates6-12.97 1-5.98

Thailand -48.7% 24.7%Malaysia -35 2.1Indonesia -44.4 -53Philippines -33.9 1.3Hong Kong 0.0 0.0S. Korea -47.7 21.9Taiwan -14.8 1.2Singapore -15 4.0

Goldstein 1998

Stock Markets6-12.97 1-5.98

Thailand -29.3% 3.7%Malaysia -44.8 -2.4Indonesia -44.4 8.2Philippines -33.5 18.2Hong Kong -29.4 -6.2S. Korea -49.5 -.9Taiwan -9.3 .3Singapore -23.0 -7.1

Goldstein 1998

IMF Growth Forecasts for 1998May ’97 April ’98 Change

Indonesia 7.4 -5.0 -12.4Thailand 7.0 -3.1 -10.1S. Korea 6.3 -0.8 -7.1Malaysia 7.9 2.5 -5.4Philippines 6.4 2.5 -3.9Singapore 6.1 3.5 -2.6Hong Kong 5.0 3.0 -2.0China 8.8 7.0 -1.8Taiwan 6.3 5.0 -1.3

Goldstein 1998

External Causes

• Credit boom in the 1990s– Low interest rates in the U.S. and Japan– Expansion of portfolio funds– $420 billion net flows to Asian emerging

markets• Deteriorating current account

– Overvalued real exchange rates– Slowing exports and increasing competition

External SectorReal Ex Rate Overvalued

Current Acct (% GDP)

Thailand 6.7% -7.9%Malaysia 9.3 - 4.9Indonesia 4.2 -3.3Philippines 11.9 -4.7Hong Kong 22.0 -1.3S. Korea -7.6 -4.9Taiwan -5.5 4.0Singapore 13.5 15.7

Goldstein 1998

Financial Market Vulnerabilities

Capital inflows concentrated:– Real estate (30-40% of bank lending)– Equities – Borrowing in foreign currencies w/ short

maturities

Why?

Financial Market Supervision

• Weak banking sectors—high ratios of nonperforming loans

• Lack of transparency, sound accounting procedures

• Inadequate loan-loss reserves• Corrupt lending• Banks as quasi-fiscal agents

Precipitating event

• Thailand—CB reserves depleted, rolling over government debt

• S. Korea—rolling over foreign-currency denominated bank liabilities

• Indonesia—corporations attempt to hedge their currency positions

Contagion

• Trade linkages?– Hard to explain contagion from small

countries to large ones• Competitive devaluation?

– Same objection• Goldstein’s “wake-up call” hypothesis

– Do capital markets sleep?– Rational buffalo

Russia 1998• Fixed exchange rate, overvalued in real

terms• Incentive to run a fiscal deficit

– Election of 1996– Collapse of tax revenues

• Nominal debt• High interest rates• Central Banking dilemmas• Bail-out of 1998

Why not Brazil in 2002?

• Public debt to GDP: 60%• Of which, linked to the dollar: 40%• Spread over U.S. treasuries: 18%• Devaluation: >40% in 2002• $30 billion IMF program in August• Luiz Inacio Lula da Silva (Lula) elected

in October

First Steps

• Reaffirm primary surplus goal of 3.75% of GDP, an IMF condition

• Propose legislation to strengthen Central Bank’s independence

• Conservative appointments• Postponing populist agenda

Discussion

Do IMF rescue packages help countries that face financial

crises?