THE ASIAN CRISIS:DIZZY WITH

SUCCESS?

The Asian MiracleFastest Industrial Revolution The World Had Seen

• Japan - from 1% of World GDP in 1960 to 18% : the second largest economy (more than France & Germany)

• The original tigers had moved to exporting twice as many goods as all of Latin America

• By 1995 East Asia (ex Japan) accounted for 12% of world manufacturing output (3% LA and 2% EE)

• By 1997 Koreans had reached close to UK per capita ’65

• China’s per capita quadrupled in les than 20 years

• 1990s the economic center seemed to shift to the East

ADB

Possible Reasons

• “Asian values”

• Success of Market oriented policies

• Emphasis on importing foreign technology

• Wealth distribution

Culture

Confucian Model

Educational attitudesStrong top down philosophyDeference to authorityMinimal welfare state-citizen’s expectationFamily values

Culture and Politics

• Authoritarian power with ruling parties

• Centralization

• Asia’s Mandarin System:–E.G: Cohort education (Japan)–British “civil service” culture

–Interlocking/cross-border elite guanxi

Political Background

• Extreme poverty post WW ll

• Land distribution post war

• US direct influence

• Relatively equal income distribution

• External threats and war

Resource Management

• Land Reform

• Japan, South Korea & Taiwan land reform---created middle class

• Control of Minerals and Oil

• Private Companies aligned with governments

Productivity

• Meritocracy-Mandarin System

• Social mobility

• System trusted, with institutions that tend to be paternalistic

• Literacy and education penetrating throughout society

Institutions• Strong , high quality institutions & bureaucratic

structures – (Dirigisme)

• Mandarin philosophy –Japan, Korea, Taiwan, China & Singapore

• Some countries inherited British institutions-Hong Kong, Singapore, Malaysia

• BUT…

• Corruption high—cronyism and official corruption Indonesia, Philippines and China

Prevailing Government Policies

• Fixed peg to the US dollar for most Asian exchange rates

• Moderate over-valuation of local currencies beginning by 1996

• Adoption of core Western belief – “free capital movements underpin growth”

• Use of short-term foreign capital for growth• “hot money” • FDI and technology transfer

East Asia – Pre-crisis, ca. 1996

• The East Asia “miracle” - World Bank• Double digit economic growth • Trade surpluses in North Asia• Trade deficits in SE Asia • Washington Consensus pressure for capital account

liberalization; removal of capital controls in markets • Huge inflows of international portfolio capital - feeding

stock market and property booms

EASY MONEY BELIEF IN THEIR OWN PR

Up close, did business people see it coming? Maybe.

The FEER surveys

Easy Money• Each country had opened their markets and

with interest rates lower in world markets—they borrowed heavily -Expansion of offshore loans

• With money borrowed, banks turned around and lent it domestically for much higher rates becoming ripe for speculators and rate fluctuations

• “Crony capitalism” - no risk management• Moral hazard – belief that Asian banks were

too big to fail or governments would intervene

The result: unregulated private equity pouring in

Signs of TroublePrevailing Market Behavior

• Over-reliance on international banks & US dollars to finance growth

• A bubble in property and infrastructure finance• Lack of transparency and adequate capital &

supervision in domestic banks

Economic Liberalization Domestic Financial Systems Unable To

Intermediate Flows

– Effort to promote Thailand as regional center, freeing interest & abolishing ceilings

– Speculative money poured in taking advantage of newly developed financial markets

– Money from outside moved into short term and real estate vehicles, short term financing

– Korea’s deregulation of the Chaebol system—credit allocation was based on cronyism

– Investors worldwide looking to make quick killing

Financial Market Liberalization

• Domestic financial sector deregulation led to massive private external borrowings

• Proliferation of local financial institutions without adequate capital, controls or risk management systems

• Crony capitalism – including government directed lending and overlapping ownership of banks and industrialists

• Breakdown of government directed growth and controls over external borrowing (except – China, Singapore)

What Precipitated The Crisis?• Growing trade account deficits combined with unexpected

bank failure in Thailand and government intervention shake confidence

• Massive speculative shorting of the Thai Baht and Malaysian Ringgit by Hedge funds

• International banks began to pull short term credit lines or call swaps

• Lack of market depth (capital and banks) meant borrowers could not hedge currency mis-matches or refinance domestically as banks pulled credits.

1996-Tigers Begin to Hit Wall

• South Korea export growth plunged 32% to 4%

• Malaysia from 26% to 9%• Thailand 25% to less than 1%

Schuman, “Miracle”

The Critical Timeline • Autumn 1996- hedge funds start to target Thai baht and

Ringgit

• 1st Qtr 1997 – Major Bangkok banks fail and are taken over

• Thai regulators start “cover-up” of massive swaps to defend baht/ dollar peg which market begins to realize; speculation grows

• May 1997 – shift in $ / Yen balance draws speculative capital back to Japan

• July 2,1997 - BOT caves in and announces it will float the baht . Immediate 25% decline

Contagion

• Speculators move to ringgit , rupiah and peso

• IMF sends team to Thailand – imposes austerity and interest rate increases; currency continues to slide

• August 14th – Indonesia abandons peg (from 2500 to US $1, it goes first to 5,000 and will slide to 15,000 by Dec. 1997) . IMF enters

• November - banks pull most lines to S. Korea; rollover crisis for S-T loans late December forcing US Treasury w/ IMF to devise solution

• International banks agree to “bail-in” Korea with orchestrated rollovers and shared losses; Thailand & Indonesia flounder with longer term restructuring programs under IMF control

Other Asian Reactions

• Malaysia – refuses IMF / austerity. Against IMF recommendation imposes capital

controls and fixes peg to dollar

• Taiwan –will not defend currency; wards off speculators

• HK – maintains long standing dollar peg

• China – isolated by capital controls

Japan’s Role & Impact

• Vulnerable due to huge $ and Yen lending by both banks and trading companies

• Japan offers immediate G to G assistance for liquidity support. Rebuffed by US and IMF

• Japanese Banks begin to suffer massive NPL’s in already sick economy (early 1998)

Result-Crisis forces a fundamental overhaul of Japanese banking system; bursts long standing asset bubble in property and stock market

Financial system further weakened

• High interest rates force borrowers into default• Specter of bank bailout• Credibility of fixed exchange rate further undermined

Domestic economy weakens

• Bankruptcies/bank collapses• Increasing unemployment• Rising political unrest

Crisis• Speculative attack on currency

• Capital outflow

• Spectre of public debt default

Incentives to devalue increase

• Credibility of fixed exchange rate further undermined

International Financial Crises

Typical Government Response and Feedback Mechanisms

Depletion of foreign exchange

reserves• Credibility of fixed

exchange rate further undermined

Government raises

domestic interest rates

Exchange rate pegcomes under pressure

•Macroeconomic imbalances

•Competitive devaluation

Political Change Meets Recession

• Withdrawal portfolio/bank capital over the 3-5 yrs

• Negative growth rates

• Unemployment 6% to 20% in different markets

• “Regime change” in South Korea, Thailand and Indonesia

• Severe civil unrest in Indonesia (May ‘98)

IMF Reaction and Outcome

Riding to the rescue?

IMF Rx

• Floating rate currency

• Severe Government austerity

• Immediate phase out of subsidies

• Forced increases in interest rates to hold domestic capital

• “Market force restructuring” – against immediate government intervention to shore up banks

The Problem

• South East Asian currency markets reacted in the OPPOSITE way to expected outcomes of IMF in terms of currency values and stability

• Major capital flight- added to currency pressure in Indonesia

• First round of IMF money all lost and 2nd round bailouts of money needed

Why Did IMF Fail?

• IMF prescriptions were largely for sovereign debt crises in Latin America where government itself was over-extended

• Asia- private sector crises with too many lenders to control

• IMF did not understand system or depth of the structural crisis or how to fix it.

Collapse of Asian Banks

• Failure to save banks by government capital injections (except South Korea)

• Massive rise in Non Performing Loans

• Governments took bad assets or entire banks through “AMC” – Asset Management Companies

• Real recoveries on NPL very low – less than 40 cents and sometimes pennies on the dollar

Governmental Responses To Crises

• Bowing to Washington Consensus

• Bringing in outside experts (Jeffrey Sachs, etc.)

• Putting up blocs and barriers

• Government strengthening power

• Government Losing Power -deposing leader or political party in power

Market Changes

• Foreign Banks entered Asian markets (ex China) by 2000 in meaningful way –by building new businesses more than buying old banks

• Bank consolidations were forced among domestic players to meet international standards by regulators

• Capital markets massively impaired and still struggling to come back in SE Asia

• Continuing “rise” of China and India--as export competitors and as destinations for FDI

New Money Players Here To Stay

• Banks are no longer “risk players” in region

• Shifted focus to consumer banking for growth and profits

• Western private equity and hedge funds have provided “risk capital” for industry consolidation and made the big money out of the crisis

• Rising political protectionism in some markets

Still Struggling

• No more “Miracles” : Asian growth overall has not gone back to double digits in most markets despite huge surpluses

• Economies struggling to maintain 5-7% annual growth needed to control unemployment in their populations

China is now the Asian Region’s heart and engine

supplanting Japan

India: an emerging player

What’s next?

Crisis response: Mindset - SamsungManagement - Nissan: Ghosen, divestitures

Sony: need to overcome “stovepipes”Governance: Korea - reforming chaebols

not easyChinese family firms: succession issues, erosion

of the old “bamboo network” (a new one?),legal issues (insider transactions?)

Chinese SOEs: management reform, corruption,branding, NPLs