Topic 3 Recession & Crisis 2a

8/21/2019 Topic 3 Recession & Crisis 2a

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Malaysian Economy Oxford Fajar Sdn. Bhd. (008974-T) 2011


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Chapter3

Rajah Rasiah

The Malaysian Economy:Crisis & Recession


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Learning Objectives

Causes, Effects of the Asian Financial Crisis (19971998)

Causes, Effects of the Global Financial Crisis (2008)


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Causes of financial crisis

From the early 1990s up until 1997, Asia attractedalmost half of the total capital inflow intodeveloping countries.

High interest rates: The economies of SoutheastAsia in particular maintained high interest ratesattractive to foreign investors looking for a high rate ofreturn.

Inflow of money: As a result the region's economiesreceived a large inflow of money and experienced adramatic run-upin asset prices.


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Economies of Thailand, Malaysia, Indonesia,Singapore, and South Korea experienced high growthrates of 812% in the late 1980s and early 1990s.

In 1994, noted economist Paul Krugman argued thatEast Asia's economic growth had historically beenthe result of increasing the level of investment incapital. However, total factor productivity hadincreased only marginally or not at all.


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Thailand's economy developed into a bubble fueled by"hot money.

The South east Asian economies were :

1. Dependent upon exports: Indonesia, Philippines andThailand had seen their exports to GDP ratio growfrom average 35% in 1996 to over 55% in 1998

2. Susceptible to currency movements:Huge

dependence upon trade made these countriesvulnerable to currency movements.


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From 1985 to 1996, Thailand's economy grew atan average of over 9% per year, the highesteconomic growth rate of any country at the

time. Inflation was kept within the low range of 3.4

5.7%.

The baht was pegged at 25 to the US dollar.

Countries attempting to maintain a peg can runinto problems of either having persistentsurpluses or shortages



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Why did Bank of Thailand peg the Baht?

1. Pegging gave certainty to Thai exporter to the to theUnited States

2. It protected Thai firms that had taken out dollarloans.

The pegged exchange rate was 25.19 baht to thedollar, or about $0.04 to the baht.

By 1997, this exchange rate was well above themarket equilibrium exchange rate of 35 baht to thedollar, or about $0.03 to the baht.



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0.03

$0.04

The figure representsthe situation in the1990s when thegovernment ofThailand pegged theexchange ratebetween the dollarand the baht abovethe equilibriumexchange rate as

determined bydemand and supply

A currency pegged at a value above the market equilibrium exchangerate is said to be overvalued.



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The result was a surplus of baht on theforeign exchange market.

To keep the exchange rate at the pegged

level, the Thai central bank, the Bank ofThailand, had to buy these baht withdollars.

In buying baht with dollars, the Bank ofThailand gradually used up its holdingsof dollars, or its dollar reserves.



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To continue supporting the pegged exchange rate, theBank of Thailand had to:

1. borrow additional dollar reserves from theInternational Monetary Fund (IMF)

2. raise interest rates to attract more foreigninvestors to investments in Thailand, therebyincreasing the demand for the baht.

The Bank of Thailand took these actions even thoughallowing the value of the baht to decline against thedollar would have helped Thai firms exporting to theUS by reducing the dollar prices of their goods



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The Thai government was afraid of the negativeconsequences of abandoning the peg even thoughit had led to the baht being overvalued.

Higherdomestic interest rates helped attractforeign investors,but it made it more difficult forThai firms and households to borrow the funds theyneeded to finance their spending.

As a consequence, domestic investment andconsumption declined,pushing the Thai economyinto recession.



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International investors realized that there were limits:

1. to how high the Bank of Thailand would be willingto push interest rates

2. to how many dollar loans the IMF would be willingto extend to Thailand.

They began to speculate against the baht byexchanging baht for dollars at the official, pegged

exchange rate. If, as they expected, Thailand was forced to abandon

the peg, they would be able to buy back the baht at amuch lower exchange rate, making a substantial profit.



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Ch. 1: #Malaysian Economy Oxford Fajar Sdn. Bhd. (008974-T) 2011

Figure 30-4 shows the

results of this

destabilizing speculation.

The decreased demand

for baht shifted the

demand curve forbaht from D

1to D

2

increasing the quantity of

baht the Bank ofThailand needed to buy

in exchange for dollars.



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Because these actions by investors make it moredifficult to maintain a fixed exchange rate, they arereferred to as destabilizing speculation.

Foreign investors also began to sell off their

investments in Thailandand exchange the baht theyreceived for dollars.

Thailand abandoned its pegged exchange rateagainst the dollarand allowed the baht to float.

Thai firms that had borrowed dollars were nowfaced with interest payments that were much higherthan they had planned.



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Many firms wereforcedinto bankruptcy, and the Thaieconomy plunged into a deep recession.

Many currency traders became convinced that other

East Asian countries, such as South Korea,Indonesia, and Malaysia, would have to followThailand and abandon their pegged exchange rates.

The result was a wave of speculative selling of these

countries' currencies



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May 14, 1997

Thailand, with the intervention of Singapore, spends billions of dollars of its foreign

reserves to defend the Thai baht against speculative attacks

July 2, 1997Thailand devalues the baht. News of the devaluation drops the value of the baht by as

much as 20%--a record low. The Thai government requests "technical assistance" from

the International Monetary Fund (IMF).

July 8, 1997

Malaysia's central bank intervenes to defend its currency, the ringgit

July 11, 1997

The Philippine peso is devalued. Indonesia widens its trading band for the rupiah in a

move to discourage speculators.
http://www.pbs.org/wgbh/pages/frontline/shows/crash/imf/http://www.pbs.org/wgbh/pages/frontline/shows/crash/imf/


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U.S. economy recovers from a recession in the early1990s

1. The U.S. Federal Reserve Bank began to raise U.S.interest rates to reduce inflation.

2. US a more attractive investment destination relative toSoutheast Asia

For the Southeast Asian nations which had currenciespeggedto the U.S. dollar, the higher U.S. dollar causedtheir own exports to become more expensive and lesscompetitive in the global markets.


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Effects on the Malaysianeconomy

In July 1997 the Malaysian ringgit was "attacked" byspeculators. The overnight ratejumped from under 8%to over 40%.

This led to rating downgradesand a general sell off

on the stock and currency markets. By end of 1997,ratings had fallen many notches from investment gradeto junk.

The KLSE had lost more than 50% from above 1,200

to under 600. (Jan 23, 1998). The ringgit had lost 50% of its value to the dollar, falling

from above 2.50 to under 4.57 on (Jan 23, 1998).


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High interest rates, credit crunch and falling demandfor goods and services many firms were renderedbankrupt.

In 1998, the output of the real economy declined plunging

the country into its first recession for many years.1998

construction

sector

manufacturing

shrunk

agriculture

sector

Over

GDP

Ringgit and the KLSE.

Fell 23.5% Shrunk 9% Fell 5.9%. Fell 6.2% Below 4.7 % & 270pts


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Remedial steps taken by thegovernment of Malaysia

1. The offshore Ringgit market was eliminated andcurrency speculator no longer had access to Ringgitfunds. This was done by freezing the externalRinggit accounts of the non-residents in

Malaysia.They were not allowed to sell or lendthe Ringgit to another non-resident but couldinvest their fund freely in Malaysia. Thus thecurrency traders were unable to short-sell the Ringgit

and change its exchange rate. Only the governmentcould determine the exchange rate.

2. The government fixed the exchange rate at RM3.80to the US dollar.


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3. A twelve-month rule was imposed prohibiting therepatriation of portfolio funds for twelve months. Thisrule was necessary given the prevailing instability ofthe financial market. When the situation stabilized, six

months down the road, this twelve-month rule wasreplaced (for new funds) with a levy and subsequentlyeven this levy was diluted further to apply only todividends repatriated. The twelve-month rule expired

in September 1999.4. Government conducted an expansionary fiscal policy.

This was possible when the exchange rate was fixedand capital control were implemented.


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5. The rationales for the establishment of DanamodalNasional Berhad:

To ensure that the banking sector re-capitalization processis commercially driven and that investment decisions are

made according to market-based principles. Delays in addressing re-capitalization and non-performing

loans issues will have a drag effect on the financial systemand economic recovery.

Direct capital injection by the government into bankinginstitutions is not desirable and would lead to conflict ofinterest.


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Malaysia refused economic aid packages from theInternational Monetary Fund(IMF) and the WorldBank

There was massive government spending made

Malaysia to continuously recorded budget deficits inthe years that followed
http://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/International_Monetary_Fund


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Causes of the globalfinancial crisis 2008

Inflows of money from abroad -- along with lowinterest rates -- enabled more United Statesconsumers and businesses to obtain easy credit.

US economy experienced:

1. Easy credit.

2. Assumption that house prices would continue to rise.

3. Mortgage lenders were led to approve loans without

due regard to ability to pay, and borrowers to tookout larger loans than they could afford.

Optimismabout prices led to a boomin which morehouses were built than people were willing to buy.


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Causes of the globalfinancial crisis 2008

US economy began to cool in 2007.Subprime borrowers were unable to repay theirloans.

So that prices fell and borrowers - with housesworth less than they expected andpayments they could not afford - began todefault

Banks were consequently left with largeamounts of unsaleable assets,and manyfailed to meet their financial obligations.


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Effects of the financial crisis2008

Economic consequences The real economy was seriously damaged as a result of

attempts by banks holding toxic mortgage-basedsecurities, to deleverage their balance sheets.

Business and personal loans were restricted, creating acredit crunch e.g. even major firms such as AT&T found itimpossible to borrow money.

Prospective householders were also affected as

mortgage approvals plummetted. The immediate consequence was severe economic

downturnthat was to develop.


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1. Malaysia is highly dependent on its major tradingpartners which will see a global slowdown and isexpected to trigger a deeper and harder recession.

2. Slumping commodities prices on the concern of

global recession saw:

i. Crude oil fall more than 50 percent from its highin July 2008 to about US$ 73 per barrel

ii. Crude palm oil is now trading at a low of Ringgit1760 from a high of Ringgit 4300 dropping morethan 60 percent.



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Ch 1: #Malaysian Economy O f d F j Sd Bhd (008974 T) 2011

Throw out the financial budgetas it was drawn upbased on now outdated prices of these commodities ofwhich Malaysia is highly dependent on.

Demand for made-in-Asia exports weakened asgrowth in the region's biggest markets in the US,Europe and Japan slowed amid a global financialcrisis.


Topic 3 Recession & Crisis 2a

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