Asian Financial Crisis of 1997 - Case Study Example

Running Header: Asian Financial crisis of 1997 Student’s Name: Instructor’s Name: Course Code & Name: Date of Submission: Asian Financial crisis of 1997 Introduction The recent political shifts have resulted to mismatch between the global financial market and state policies. In 1997, the Asian financial crisis generated fears of a global meltdown of the economy which resulted from financial corruption. Held et al. (1999) describes that the financial crisis first begun in Thailand through a decision initiated by the government of floating baht. Thailand had also accumulated foreign debt and this led to bankruptcy and collapse of the countries currency. The crisis then spread to Asia and Japan which led to a slump on the currencies, increase of foreign debt, devaluing of stock markets and asset prices. The above study compares and contrasts the impact of the Asian Financial Crisis of 1997 and the Global Financial Crisis of 2008 in Dubai and Indonesia. The Asian financial crisis of 1997 collapsed the long term capital management hedge fund. The effect of this was the reduction of asset prices, increase in risk premium and reduced liquidity. The decline of competitiveness in Asia led to the reduction of investment in other parts of the region. This therefore led to the fall of currency values causing a significant loss in the foreign currency and increased debts in banks. The reduction of foreign currencies needed intervention from the IMF in countries such as Thailand and Indonesia so as to be able to rescue various financial institutions. Noland et al. (1998) explains that the causes of the Asian financial crisis are connected to how businesses and government operate in Asian region. These include use of fixed exchange rates, implementation of large capital inflows, poor investments and failure of resolving financial crises in other countries such as Japan. Other major causes included poor operations in the international financial system, poor policies and weaknesses experienced in various financial institutions. Countries affected by the 1997 financial crisis suffered high rates of unemployment, increased rates of interest rates, high inflation and reduced growth rates as well as banks closure. Effect on Indonesia Indonesia as a country saw a great loss in their currency as a result of the Asian financial crisis. Indonesia was affected by a low inflation rate, large surplus and foreign reserves as well as stable banking sector. Companies in Indonesia used U.S dollars in borrowing before the crisis and their currency was strengthened as a result of this as its value rose. In 1997, the rupiah trading band widened by 4 percent and the floating exchange rate used as that moment was changed to free-floating exchange rate which led to a great drop of rupiah value. The countries that had borrowed in U.S dollars faced increased costs as a result of the decline of their local currency (Smith 2007). Indonesia was given much support by IMF which included a mixture of funds with conditions of meeting the additional loans. Countries affected by the 1997 financial crisis suffered high rates of unemployment, increased rates of interest rates, high inflation and reduced growth rates as well as banks closure. Indonesia experienced crisis in the balance of payments and prices were eroded therefore causing a major impact on investment. The crisis also changed the structure of the economy though Indonesia was able to confront the financial crisis for example through the establishment of Asian Commission that identified capabilities of recovery in the countries that were mostly affected. The commission also identified various opportunities of solving the crisis. The other method used in confronting the Asian financial crisis was by ensuring that they were prepared for change in the economic activities that followed and involvement of various initiatives. The country also ensured that it maintained investor confidence for example by implementing real productivity gains in the countries economy. Planning for eventuality was also necessary as a solution for dealing with the crisis and also ensuring that financial institutions are stable and capable of coping with the situation. Chossudovsky (1997) Australia also offered technical assistance that enabled Indonesia in meeting the IMF requirements. It also increased its aid program in East Asia by about 11 percent. Australia also provided support services for about 4 million children in primary school as a way of responding to the crisis. Effect on Dubai As compared to Indonesia, Dubai is one of the 7 emirates of the United Arab Emirates (UAE) and is located south of Persian Gulf and in West Asia. Dubai is estimated to have the largest population among the emirates and is also the second largest territory after Abu Dhabi. Pempel (1999) shows in 2006, the Dubai economy was valued at 46 million dollars and the construction had boomed which was then slowed down by the recession experienced in late 2007-2010. The economy can be describes as centrally-planned free market capitalism which is built by the oil industry, petroleum revenue and natural gas. Tourism has also contributed much in development of the economy. In 2009, the Dubai government announced its intention of asking financial institutions not to lend any money to the public and this was to be extended up to May 2010. Hall (2009) describes that about 10,000 employees were laid off world wide due to the standing debt of about 59 billion dollars. The financial crisis experienced in Dubai resulted to more than half of the construction projects being put on hold as the amount totaled to about 582 billion dollars. Smith (2007) puts it that these projects have include the Nakheel Harbour & Tower of 38 billion dollars, the other projects put on hold include Al Salam City, Asia Hotel, Dolphin City, Falcon City of Wonders, Plaza Major among others. The major cause of Dubai’s trouble is by being over ambitious development plan which included world famous infrastructures and the construction of tallest buildings on earth. Strategies by the government and central banks According to Watts (2009) the Dubai government announced asking its creditors to corporate and freeze debt repayment and if the proposal was to be rejected, Dubai would sell its real estate assets. Watts (2009) also shows that though Abu Dhabi is the wealthiest among other emirates extended a loan of 10 billion dollars to cover for some of the debt and in order to help Dubai avert some of its problems. Dubai had come to an agreement with most of its bank lenders in restructuring a debt worth 23.5 billion dollars and the remaining was 14.4 billion dollars. Hall (2009) puts it that the terms involved in restructuring included the conversion of about 8.9 billion dollars of government debt to equity. The UAE has pledged to support the economy of Dubai that for example the Central Bank has offered 10 billion dollars to ease the mounting debt default (Jeff 2010). The Central Bank also announced new liquidity measures which are expected to strengthen consumers and market confidence in the economy. Hall (2009) shows Emaar Company that built Burj Khalifa is also considering selling some of its assets and Dubai Holdings plans to sell about 40 percent of its shares. This credit promotes growth of an economy and employment opportunity but when poorly used it turns to be a catastrophic which is what happened in the 2008-2010 financial crisis. The bail out involves changes in lending regulations and having an oversight of the industry. Causes of Global financial crisis According to Jeff (2010) the events experienced before the crisis included the overvaluation of the house market in 2006 in United States. The price of housing was increased because of easy credit and over assumption on the belief that housing prices always increase. The other cause of the financial crisis was the low initial rates put on adjustable rate mortgages as well as the experienced low down payment requirements. These encouraged short-term speculation where seller hoped for favourable terms in future. The interest rates also rose therefore building a poor refinancing environment. The major financial institutions suffered losses due to drop on house prices and at the same time, the housing bubble grew (Hall, 2009).  According to Jeff (2010) the global financial crisis was majorly caused by market instability for example a change in creating new lines of credit. This reduced the flow of money therefore slowing new economic growth and the buying and selling of assets. This affected individuals, businesses and financial institutions, which were left holding mortgage, backed assets that had dropped in prices and could not amount to the expected money for payment of loans. The effect of this was drying up reserve cash at the same time restricting credit. The other cause of global crisis was as a result of cheap credit making it easy for people to purchase houses making their investment base on speculation. This created more money therefore increased consumer spending. This increased demand for houses leading to inflation. The other causes included speculation on oil prices and higher unemployment rates. Credit promotes growth of an economy and employment opportunity but when poorly used it turns to be a catastrophic which is what happened in the 2008-2010 financial crisis. The bail out involves changes in lending regulations and having an oversight of the industry. Chossudovsky (1997) describes that since the 10 billion-rescue package from the UAE Central Bank will not be enough, Dubai will continue to struggle with its debts and from massive construction projects. The main issue is lack of transparency as the government is not clear of the causes of debts. The real estate investment market underwent a dramatic fall in 2009 after the annual returns in 2007 (Jeff, 2010). Future of global financial market According to Smith (2007) the recent political shifts have however resulted to mismatch between the global financial market and state policies. This gap is therefore left for managers to formulate strategies for managing the structural and managerial issues. Some of the issues faced by firms that market their products globally include; cultural issues. For multinational firms for example the Mc Donald’s to succeed in the global market the cultural dominance is necessary. International finance involves various risks since assets traded in the financial markets are claims to flow of return that is used for many years. Muchhala (2007) explains that one example of dangers caused by the volatile financial market is the mismanagement of mortgage lending experienced in 2008 in US. This also led to banking failures and shortages in credit. Such sudden flows of capita lead to financial crises in most developing countries. Financial crises have a great impact on the economy and for this reason governments have imposes strict policies over which banks operate. The policies control activities and conducts of various financial institutions to achieve efficiency gains. The other reason for imposing great restrictions is to create a flexible international financial system (Watts, 2009). A complex interactive system is usually difficult to analyse and it may result to a financial crisis for example the Asian financial crisis of 1997 which collapsed the long-term capital management hedge fund. June (2008) shows the consequence of this is decrease of asset prices, increase in risk premium and reduced liquidity. Globalisation increase has posed several benefits for example recessions have been shared among different countries since market failure in one country leads to a reduction in activities in another country. However there are some setbacks where it is argued that benefits of globalisations are not equally spread among countries and this therefore leads to income inequalities. The result of this is that the parent countries lose social capital and the receiving countries lose on social strain caused by immigration (Ito and Andrew 2006). Conclusion Financial crises have a great impact on the economy and for this reason governments have imposes strict policies over which banks operate. The introduction of globalisation can be described as a way of spreading communication, production and technological processes across the globe. These spread is facilitated by several economic and cultures activities. Globalisation is also an effort used by international financial markets such as IMF and World Bank in promoting a free market where goods and services are exchanged. IMF helps in encouraging international cooperation and dealings in money matters. It also enhances stability in various exchange rates thus creating a payment system that is employed internationally to ensure that there is no other financial crisis to be experienced in years to come. References Chossudovsky, M 1997, The globalization of poverty, Impacts of the IMF and World Bank reforms, London: Zed Books. Hall, C 2009, Dubai government statements on Nakheel, $5 Billion, viewed 4 October 2011, Held, D, McGrew, A, Goldblatt, D & Perraton, J 1999, Global transformations, politics, economics and culture, Cambridge: Polity Press. Ito, T & Andrew, K 2006, Financial sector development in the Pacific Rim, University of Chicago Press.  Jeff, J 2010, The Dubai financial crisis: An oasis of debt, the Palm Islands, Dubai World and the Burj Khalifa | Suite101.com, viewed 4 October 2011, June, F 2008, International economics, The New Palgrave Dictionary of Economics, 2nd ed. Muchhala, B 2007, Ten Years After, Revisiting the Asian Financial Crisis, Washington, DC: Woodrow Wilson International Center for Scholars Asia Program. Noland, M, Li-gang, L, Sherman, R & Zhi, W 1998, Global economic effects of the Asian currency devaluations, Policy Analyses in International Economics, Washington, DC: Institute for International Economics. Pempel, T 1999, The politics of the Asian Economic Crisis, Ithaca, NY: Cornell University Press. Smith, C 2007, International trade and globalisation, 3rd ed. Stocksfield: Anforme. Watts, W 2009, Dubai woes roil financial markets: Stocks fall and government bonds rise on flight to quality. Market Watch, viewed 4 October 2011,   Read More