The East Asian Currency Crisis and Recovery

The East Asian Currency Crisisand

Recovery

Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.)Kwoh-Ting Li Professor of Economic Development

Department of EconomicsStanford University

Stanford, CA 94305-6072, U.S.A.

October 2000

Phone: 1-650-723-3708; Fax: 1-650-723-7145Email: [email protected]; Website: http://www.stanford.edu/~ljlau

Lawrence J. Lau, Stanford University 2

Indexes of East Asian Exchange Rates:Local Currency per US$ (January 2, 1997=100)

Indices of East Asian Exchange Rates(Local Currency per U.S. Dollar, 1/2/97=100)

50

100

150

200

250

300

350

400

450

500

550

600

650

700

1/2/97 8/11/97 3/18/98 10/23/98 6/1/99 1/6/00 8/15/00

1/2

/97=

100

C. Yuan HK$

I. Rupiah K. Won

RM P. Peso

S$ NT$

T. Baht Japan Yen

Indian Rupee Brazilian Real


Indexes of East Asian Exchange Rates:Local Currency per US$ (January 2, 1997=100)

Indices of East Asian Exchange Rates(Local Currency per U.S. Dollar, 1/2/97=100)

80

100

120

140

160

180

200

220

240

1/2/97 8/11/97 3/18/98 10/23/98 6/1/99 1/6/00 8/15/00

1/2

/97=

100

C. Yuan HK$

K. Won RM

P. Peso S$

NT$ T. Baht

Japan Yen Brazilian Real

Indian Rupee


Fundamental Macroeconomic Causesof the East Asian Currency Crisisu Savings-investment imbalance--also reflected as current account

imbalanceu Dependence on short-term foreign capital (portfolio investment--

both equity and debt instruments--and loans) by private investorsu Equity is better than debtu Direct investment is better than portfolio investmentu Insolvency caused by the revaluation of foreign-currency denominated debts

and the rise in the rate of interestu Domino effects of insolvency and bankruptcyu Problems magnified by high leverage (or high debt to equity ratio)

u Inadequacy of foreign exchange reserves (working capital of a country) for supporting imports, debt service, and (potential) net short-term capital outflows

u Real exchange rate appreciation (loss of competitiveness) due to a domestic rate of inflation higher than the U.S. rate of inflation


Composition of Foreign Investment:Thailand (Quarterly Data)

Composition of Foreign Investment: Thailand

Foreign Direct Investment

Foreign Portfolio Investment

-800

200

1200

2200

3200

4200

19

86

Q1

19

86

Q4

19

87

Q3

19

88

Q2

19

89

Q1

19

89

Q4

19

90

Q3

19

91

Q2

19

92

Q1

19

92

Q4

19

93

Q3

19

94

Q2

19

95

Q1

19

95

Q4

19

96

Q3

19

97

Q2

19

98

Q1

19

98

Q4

19

99

Q3

Mil

lion

US

$




Composition of External DebtThailand

Stock of External Debt: Thailand

0

20

40

60

80

100

120

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

Bil

lio

n U

.S.$

Long-term Short-term


External Debt and Foreign Exchange ReservesThailand

Thailand's External Debt vs. Foreign Exchange Reserves

0

20

40

60

80

100

120

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Bil

lio

n U

S$

Total external debt

Foreign exchange reserves


Composition of Foreign Investment:South Korea (Quarterly Data)

Composition of Foreign Investment: Republic of Korea



-2000

-1000

0

1000

2000

3000

4000

5000

6000

7000

8000

1986Q1

1986Q4

1987Q3

1988Q2

1989Q1

1989Q4

1990Q3

1991Q2

1992Q1

1992Q4

1993Q3

1994Q2

1995Q1

1995Q4

1996Q3

1997Q2

1998Q1

1998Q4

1999Q3

Mil

lion

US

$




Composition of External DebtSouth Korea

Stock of External Debt: Korea

0

20

40

60

80

100

120

140

160

180

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

Billio

n U

.S.$

Long-term Short-term


External Debt and Foreign Exchange ReservesSouth Korea

Korea's External Debt vs. Foreign Exchange Reserves

0

20

40

60

80

100

120

140

160

180

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Bil

lio

n U

S$

Total external debt

Foreign exchange reserves


Fundamental Microeconomic Causes:Borrowing Too Much, Short-Term and in Wrong Currencyu Maturity mismatch--borrowing short and investing (lending) longu Currency mismatch--revenue and cost (liability) in different

currenciesu Vulnerability magnified by high debt to equity ratiou Insolvency caused directly or indirectly by declines in the exchange ratesu Oversold currencies create unnecessary bankruptcies and discourage re-

capitalization and re-structuringu Moral hazard on the parts of both lenders and borrowers

u Past bailouts (Latin American loans, Mexican loans) of developed country lenders encourage moral hazard on the part of lenders

u Implicit guarantee of banks and enterprises “too big to fail” by governments encourage moral hazard on the part of borrowers

u “Herd mentality”--too much money chasing too few good projects leading to mis-pricing by developed country investors and lenders (it is better to make the same mistake as everyone else)


Excessive Leverage Should be Discouraged/Preventedu Excessive leverage of enterprises magnifies the effects of a sharp

devaluation and the resulting rise in the rate of interestu Excessive leverage encourages moral hazard (recklessness) on the

part of the borrowers u The domino effect of excessive leverage on the financial systemu Excessive leverage also enables the hedge funds to engage in

predatory speculation on a large scale


Leading Indicators of Recoveryu Stabilization of the exchange rates (with the exception of the

Indonesian Rupiah)u Capital controls have been instituted in Malaysiau Hedge funds are no longer active

u Decline in the rate of interestu Rise in the stock marketu Improvement in the balance of paymentsu Rise in the official foreign exchange reservesu Real GDP stops shrinking and begins growing againu Leveling of the unemployment rateu Narrowing of yield spread on U.S. dollar-denominated sovereign

debt relative to U.S. Treasury securitiesu Upgrading of credit ratings by rating agencies such as Moody’s,

Standard & Poor and Fitch IBCA


The Interest Rates Have DeclinedShort-Term Rates of Interest, Selected East Asian Countries

(percent p.a.)

0

10

20

30

40

50

60

70

1/1/97 8/8/97 3/17/98 10/22/98 5/31/99 01/05/00 08/12/00

Pe

rce

nt

pe

r a

nn

um

CHINA HONG KONG

INDONESIA KOREA

MALAYSIA PHILIPPINES

SINGAPORE TAIWAN

THAILAND JAPAN

India


The Interest Rates Have DeclinedShort-Term Rates of Interest, Selected East Asian Countries

(percent p.a.)

-3

2

7

12

17

22

27

32

37

42

1/1/97 8/8/97 3/17/98 10/22/98 5/31/99 01/05/00 08/12/00

Pe

rce

nt

pe

r a

nn

um

CHINA HONG KONG

KOREA MALAYSIA

PHILIPPINES SINGAPORE

TAIWAN THAILAND

JAPAN India


The Stock Markets Have Rebounded from Their Troughs (Local Currency, 1/2/97=100)

Indexes of East Asian Stock Exchange Indexes(Local Currency, 1/2/97=100)

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40

60

80

100

120

140

160

180

1/1/97 8/8/97 3/17/98 10/22/98 5/31/99 1/5/00 8/12/00

1/2

/97=

100

China Hong Kong Indonesia

Korea Malaysia Philippines

Singapore Taiwan Thailand

Japan India


ThailandRelationship between Exchange Rate, Stock Market Index and Interest Rate,

Thailand

0

50

100

150

200

250

1/2/97 8/11/97 3/18/98 10/23/98 6/1/99 1/6/00 8/15/00

0

2

4

6

8

10

12

14

16

Exchange Rate Index, 1/2/97=100

Stock Market Index, 1/2/97=100

Interest Rate (right scale)


South KoreaRelationship between Exchange Rate, Stock Market Index and Interest Rate,

South Korea

0

50

100

150

200

250

1/2/97 8/11/97 3/18/98 10/23/98 6/1/99 1/6/00 8/15/00

0

5

10

15

20

25

30

Exchange Rate Index, 1/2/97=100

Stock Market Index, 1/2/97=100

Interest Rate (right scale)


Is the Recovery Real?u For most of the East Asian economies, the bottom has been reached

(0% rate of growth) in 2Q/1999u The recovery is most tentative in Indonesia, with its political

problemsu In quantity terms, exports have been growing very rapidlyu Foreign exchange reserves have been largely replenishedu Inflation caused by the devaluation has largely subsidedu The stock markets have reboundedu The recovery has been much stronger than expected because of

synchronization across the East Asian economies


The Rates of Growth of Real GDP Have Turned Significantly Positive

Quarterly Rates of Growth of Real GDP, Year-over-Year, Selected East Asian Economies

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

19

96

Q1

19

96

Q2

19

96

Q3

19

96

Q4

19

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Q1

19

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Q2

19

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Q3

19

97

Q4

19

98

Q1

19

98

Q2

19

98

Q3

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98

Q4

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99

Q1

19

99

Q2

19

99

Q3

19

99

Q4

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00

Q1

20

00

Q2

Quarter

An

nu

ali

ze

d R

ate

s in

Pe

rc

en

t


Korea Malaysia Philippines


Japan India


Rates of Growth of Exports in US$ Terms Have Turned Positive

Year-over-Year Quarterly Rates of Growth of Exports in U.S. Dollars (Percent)

-20.00

-10.00

0.00

10.00

20.00

30.00

40.00

Q1 97 Q2 97 Q3 97 Q4 97 Q1 98 Q2 98 Q3 98 Q4 98 Q1 99 Q2 99 Q3 99 Q4 99 Q1 00 Q2 00

Pe

rce

nt

p.a

.


South Korea Malaysia Philippines


Japan India


Rates of Growth of Imports in US$ Terms Have Also Turned Significantly Positive

Year-over-Year Quarterly Rates of Growth of Imports in U.S. Dollars (Percent)

-50.00

-40.00

-30.00

-20.00

-10.00

0.00

10.00

20.00

30.00

40.00

50.00

60.00

Q1 97 Q2 97 Q3 97 Q4 97 Q1 98 Q2 98 Q3 98 Q4 98 Q1 99 Q2 99 Q3 99 Q4 99 Q1 00 Q2 00Pe

rce

nt

p.a

.


South Korea Malaysia Philippines


Japan India


The Current Account Balances Have Turned Positive

The Current Account Surplus (Deficit) as a Percent of GDP

-12

-6

0

6

12

18

24

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Pe

rce

nt


Korea, Rep. of Malaysia Philippines


Mexico India


The Rates of Inflation (Consumer Price Indexes) Have Subsided

Rate of Change of the Consumer Price Index (Year-over-Year)

-10

0

10

20

30

40

50

60

70

80

1990Q1 1991Q1 1992Q1 1993Q1 1994Q1 1995Q1 1996Q1 1997Q1 1998Q1 1999Q1 2000Q1

Pe

rc

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t p

er

an

nu

m

CHINA HONG KONG

INDONESIA JAPAN

KOREA MALAYSIA

PHILIPPINES SINGAPORE

TAIWAN THAILAND

INDIA


Rates of Inflation (Consumer Price Index)--without Indonesia

Rate of Change of the Consumer Price Index (Year-over-Year)

-10

-5

0

5

10

15

20

25

30

1990Q1 1991Q1 1992Q1 1993Q1 1994Q1 1995Q1 1996Q1 1997Q1 1998Q1 1999Q1 2000Q1

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CHINA HONG KONGJAPAN KOREAMALAYSIA PHILIPPINESSINGAPORE TAIWAN

THAILAND INDIA


How Robust is the Recovery?The External Environment Has Stabilized (1)u Since 3Q/1998, there have not been any speculative attacks on the

Thai Baht or other East Asian currencies.u The hedge funds had a “credit crunch” due to losses, net redemption

and curtailment of available credit lines in the aftermath of the collapse of the Russian ruble and the “Long-Term Capital Management” crisis.

u The U.S. economy has been exceptionally strong but an asset-price bubble appears to be in the making and the economy may be heading towards a slowdown.

u The recovery of the Japanese economy is not imminent and likely to take some time; however, since it has been in recession since 1990, the East Asian recovery does not depend on an economic recovery in Japan. Moreover, the Yen has recovered from its low of almost 150 Yen/US$ to stabilize around 105 Yen/US$.


The External Environment Has Stabilized (2)u The Chinese economy grew 7.8% in 1998, 7.1% in 1999, and 8.2%

in the first half of 2000. Chinese exports have resumed its growth. The Renminbi should not need to be devalued.


How Robust is the Recovery?Aggregate Demand Stimulation (1)u The recovery is supported by the growth in public investment and in

exportsu Private consumption demand has gradually revived because of lower

rates of interest and stabilization of the unemployment ratesu Domestic fiscal stimulus necessary because of weak domestic

investment demand--International Monetary Fund conditions notwithstanding (IMF position on deficit financing by the affected East Asian countries has changed), e.g., South Korea, Thailand

u Turning around expectations and providing incentives are the keys to stimulating private consumption and new private investment

u The real devaluation in the East Asian currencies presents new opportunities for profitable investments once they are stabilized


Aggregate Demand Stimulation (2)u Recapitalizing the domestic banks so that new loans to new projects

are possibleu Bailing out of old failed projects should be avoidedu Recapitalization by the government should require capital contribution and

risk-sharing by new or existing shareholders to avoid moral hazardu The political economy--who will bear the costs--may prove to be the most

difficult problemu Maintaining domestic political and social stability


How Robust is the Recovery?Synchronization of Upturnsu Over the last decade, the proportions of East Asian exports to other

East Asian economies have been increasing rapidlyu By the late 1990s, approximately 50% of the exports of the East

Asian economies are destined for other East Asian economiesu While the simultaneous downturns in the East Asian economies

exacerbated the problems of one another, the simultaneous upturns have allowed the recovery to be extraordinarily rapid, with the rising import demands of each economy feeding into rising export demands of its trading partners


Is Another Crisis Likely?u Based on the early warning economic indicators, the East Asian

economies are unlikely to have another crisis in the foreseeablefuture

u The savings rates have remained high while the savings-investment gaps--also reflected as the current account gaps--have largely disappeared

u The dependence on short-term foreign capital (portfolio investment--both equity and debt instruments--and loans) has been significantly reduced

u Foreign investment now consists mostly of direct rather than portfolio investment

u Both total and short-term external debts have declinedu Foreign exchange reserves (working capital of a country) for supporting

imports, debt service, and (potential) net short-term capital outflows have risen both absolutely and as a percentage of annual imports

u Real exchange rates have depreciated significantly from their peaks in most of the affected economies


Was “Crony Capitalism” or the Primitive Financial System the Culprit?u The real mistake was to borrow too much short-term and in the

wrong currencyu Even a perfectly efficient enterprise cannot withstand the increase in

debt servicing required due to the massive exchange rate devaluationu Japan, despite its massive devaluation between 1995 and mid-1998,

has been able to muddle through because its firms have little net foreign debt

u Hong Kong, Singapore and Taiwan have also escaped relatively unscathed because they did not and do not have significant net foreign debt, especially short-term debt, relative to their foreign exchange reserves

u China has not been significantly affected because it retains capital control and its foreign debt is mostly medium to long-term


Was “Crony Capitalism” or the Primitive Financial System the Culprit?u The financial systems collapsed in the affected countries because of

the currency crisis--whatever weaknesses they might have had were not the direct causes of the crisis


The Major Uncertaintiesu The movements of the Yen-Dollar and Yuan-Dollar exchange ratesu The rates of growth of the U.S. and Japanese economiesu The U.S. rate of interest (one instrument, two targets--the prices of

goods and the prices of assets)u The possibility of a bursting of the U.S. asset prices bubble (Could

the reliance on an accommodative easing by the Federal Reserve Board after such an event create its own moral hazard?)

u The return of the hedge funds (are bubbles building in the East Asian stock markets again?)


Real Output per Labor HourReal Output per Labor Hour (1980 US$)

0

5

10

15

20

1953

1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1980 U

S$ p

er L

abor

Hour

China Hong Kong

Indonesia S. Korea

Malaysia Philippines

Singapore Taiwan

Thailand Japan

Non-Asian G5


The Findings of Kim & Lau (1992, 1994a, 1994b); Reported by Krugman (1994)u (1) No technical progress in the East Asian NIEs but significant

technical progress in the IEs u (2) East Asian economic growth input-driven, with tangible capital

accumulation as the most important source of economic growth (the latter applying also to Japan)

u Working harder as opposed to working smarteru (3) Technical progress is the most important source of economic

growth for the IEs, with the exception of Japanu NOTE THE UNIQUE POSITION OF JAPAN!

u (4) Technical progress is purely tangible capital-augmenting and hence complementary to tangible capital


The Sources of Economic Growth--Developing Economies in East Asiau Different types of measured inputs play different roles at different

stages of economic growthu Tangible capital accumulation is the most important source of

growth in the early stage of economic developmentu But simply accumulating tangible capital is not enough--it must also

be efficiently allocatedu Efficient tangible capital accumulation is the major accomplishment

of the East Asian NIEs in the postwar periodu Market-directed allocation of new investment, aided by export orientation,

promotes efficiencyu Private enterprises have the incentives for prompt self-correction

u Intangible capital accumulation becomes important only after a certain level of tangible capital per worker is achieved


The Sources of Economic Growth--Industrialized Countriesu The most important source of economic growth for industrialized

countries is technical progress, accounting for more than half of the growth of output

u Tangible capital is the next important source of economic growth, accounting for almost a third

u Technical progress reflects the effects of intangible capital--R&D capital, knowledge capital, goodwill, etc.

u The United States is a leader in human capital and R&D capital


Human CapitalAverage Human Capital (Years of Schooling per Working-Age Person)

0

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4

6

8

10

12

14

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1955

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1961

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Yea

rs p

er W

ork

ing-A

ge

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son

China Hong Kong

Indonesia S. Korea


Singapore Taiwan

Thailand Japan

Non-Asian G5


R&D CapitalR&D Capital Stock (Billion 1980 US$)

0

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n 1

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0 U

S$

US Canada France

W. Germany Italy UK

Japan S. Korea Singapore

Taiwan


Capital IntensityTangible Capital Stock per Labor Hour (1980 U.S.$)

0

10

20

30

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50

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1980 U

S$ p

er L

abor

Hour

China Hong Kong

Indonesia S. Korea


Singapore Taiwan

Thailand Japan

Non-Asian G5


Human Capital per Unit LaborHuman Capital per Labor Hour (Years of Schooling)

0

0.002

0.004

0.006

0.008

0.01

0.012

1953

1955

1957

1959

1961

1963

1965

1967

1969

1971

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1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

Yea

rs p

er L

abor

Hour

China Hong Kong

Indonesia S. Korea


Singapore Taiwan

Thailand Japan

Non-Asian G5


R&D Capital Stock per Unit LaborFigure 4.3 R&D Capital Stock per Labor Hour

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

1964 1967 1970 1973 1976 1979 1982 1985 1988 1991

1980

US

Dol

lars

USA FRA G E R

U K J P N K O R

SIN T W N


Is East Asian Economic Growth Sustainable?u Past economic growth neither a miracle nor a mere bubble

u Economic growth experience replicated in different East Asian economiesu Sustained economic growth over decadesu Recent crisis due to many factors, of which “irrational exuberanu Economic fundamentals remain sound--high savings rates, investment in

human capital, and more recently in R&D capital, entrepreneurship, market orientation

u Past economic growth input-driven rather than technical progress-driven--it is attributable to growth in inputs, particularly the efficient and rapid accumulation of tangible capital

u Considerable room for continuation of rapid tangible inputs-driven economic growth--tangible capital per unit labor still lags significantly behind the developed economies

u Intangible capital per unit labor, e.g., R&D capital, lags even further behind, offering additional opportunities for investment


Is East Asian Economic Growth Sustainable?u The attractiveness of investment in intangible capital depends on the

protection of intellectual property rights, which in turn depends on whether a country is a producer of intellectual property

u Intangible capital is different from tangible capital in three important aspects:

u Intangible capital is freely mobile across countriesu Intangible capital is simultaneously deployable in different locations without

diminution of its effectiveness (increasing returns in the utilization of intangible capital)

u Intangible capital enhances the productivity of existing tangible capital whereas additional tangible capital diminishes the productivity of existing tangible capital


Prospects for Future Economic Growth Remain Goodu The experience of developed economies, especially that of Japan,

suggests that investment in R&D capital and other forms of intangible capital has high returns

u Because of its complementarity with tangible capital, investment in intangible capital can retard the decline in the marginal productivity of tangible capital

u There is evidence of positive technical progress in the more recent period

u Simultaneous expansions increase aggregate demands in all East Asian developing economies because of their significant intra-regional trade

The East Asian Currency Crisis and Recovery

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Transcript of The East Asian Currency Crisis and Recovery