Financial Crisis in Asia - Term Paper Example

Client’s November 2009 Financial Crisis in Asia The IMF crisis in Asia took the world by storm. Economies of Asian countries werethe ones which suffered the most from the IMF crisis. The IMF crisis triggered off in the beginning of July 1997 and impacted the Asian economies but it was not restricted to the Asian economies, the economies worldwide suffered because of the same. The crisis triggered off in Thailand, it was a result in the financial collapse of their currency Thai Baht. This paper will throw light upon how the IMF crisis had an adverse effect on the economy of South Korea and how the same gave rise to a financial crisis in the country. The Collapse of Thai Baht The last three decades saw Asian economies over achieve from the perspective of Economic Growth, this was known as the “Asian Miracle”. Countries like Thailand, Malaysia, and Indonesia witnessed tremendous economic growth in the late 1980s, but all this came to an abrupt end due to the financial crisis in Asia which severely affected the Economies of these countries. Thailand saw the emergence of the crisis and the same later had an inevitable affect on the other neighboring countries too. Japan, South Korea, Thailand, Philippines were among the most severely affected countries due to the crisis. On July 2 1997, Thai Baht the currency of Thailand was devalued and it was inevitably allowed to float, this resulted in a free fall of the currency when compared to the US dollar, Baht fell to an alarmingly high level of 15- 20 percent in comparison to the US Dollar. The free fall of Baht set the stage for the financial crisis in Asia which affected almost all the major economies in Asia. “The period following the devaluation of the Thai baht on July 2nd 1997 witnessed a sudden and unprecedented collapse in asset prices, corporate and financial fragility, and a drastic economic slowdown in East Asian markets. In just over 12 months, the regions stock markets-once among the largest in the world-saw their market capitalization shrink by as much as 85% in US dollar terms. Similarly, East Asian currencies depreciated sharply beyond the levels needed to maintain export competitiveness, with some currencies falling by 50-80% against the US dollar by end-July 1998. East European and Latin American currencies also experienced some speculative pressure in the latter half of 1997, but generally fared much better.” (Background to the Financial and Economic turbulence of 1997-98, 17 October 2008). The Origin of Financial Crisis in South Korea South Korea had a very strong economy but a high level of debt which existed in the economy was given very little attention. The borrowed funds by the South Korean economy were invested very wisely in assets so it made perfect sense and reassured the economic stability, but when the funds were invested in assets it also gave rise to various risks pertaining to the same. The short debts touched alarmingly high levels in the South Korean economy, “In 1992 short term debt constituted about one third of its total borrowing, but by 1996 short term debt had risen to two thirds of its total of $158 billion of foreign debt. South Korean firms were operating at a high degree of leverage. The typical leverage ratio for South Korean firms was in the neighborhood of six to one and some South Korean firms had leverage ratios of 600 to one.” (The South Korean Experience in Financial Crisis of 1997- 98, 17 October 2008). The crisis in South Korea was triggered by the collapse of Thai Baht (currency of Thailand) in 1997. The currency had devalued due to stemming of reserve outflows by the central bank in order to ensure growth for money supply in the crisis period. Bank of Thailand acted as the lender of last resort, one of the important functions of a central bank, in the face of domestic banking fragilities and an immediate threat of collapse of the banking sector. The strategies adopted by the South Korean economies always left them prone to many dangers, a classic example of the same follows: The Korean First Bank got itself in a vulnerable position because of the hefty amount of loan issued to Hanbo group, with in no time the Hanbo group went bankrupt and its inability to pay the loan back to the Korean first bank resulted in the bankruptcy of Korean Bank. The loan was estimated to be roughly about $ 800 million and this example clearly draws attention towards the uncalculated risks taken by the South Korean economy which eventually led to the financial crisis in the country. Many banks in South Korea were in crisis in 1997 because of the bad loans which they were unable to recover from the authorities they had issued loans to. The example of Hanbo was not the only case in point and Korean First Bank was not the only bank which witnessed bankruptcy, there were many other firms which faced the same crisis as Hanbo did, some of them were Jinro, a brewery and KIA which was into automobiles. The acquisition of KIA with Hyundai saved the blushes for the company; the acquisition ensured that KIA had very little impact of the crisis. The inability of the South Korean economy to handle the financial crunch saw them approach the IMF asking them for a whopping $20 billion to take care of their short term financial requirements. If the facts were to be believed, it was estimated that $ 20 billion was far from being what was required to clean up the financial mess in the country. The South Korean economy was quite strong when it came to the banking sector, but the Koreans wanted to compete with the top economies of the world and in the process, issued hefty amount of loans expecting a good rate of return, but to their dismay the loans turned out to be non- performing assets. There were so many businesses at that time which failed to give returns, the presence of excess debt triggered off the debacle. Another factor which affected the economy was the lowering of credit rating of South Korea and this rating was further downgraded to an extremely low level, this resulted in a sharp correction in the Korean Stock exchange which was already negative prior to this news. The Korean stock exchange plunged to unprecedented levels which sent shockwaves around the country and to other Asian countries which also got adversely affected by the same. Many leading companies had an inevitable effect of the crisis on their market share. The $5 Billion venture of Samsung motors came to an abrupt halt and was later dissolved because of the crisis. Many companies were taken over by the foreign companies which ensured that they made the most of the crisis; a classic example of the same was an American Company by the name General Motors acquiring Daewoo motors. The ultimate effect of the crisis was very clear from the national debt to GDP ratio, which had nearly doubled because of the crisis. The Role of IMF The IMF is very largely responsible for recovery from the financial crisis witness by South Korean economy. The bailout package arranged by the IMF was estimated to be around $ 58 billion; this brought significant changes in the economy and cleaned up the banks off their financial crunch. The crisis forced the South Korean government to take stern decisions which ultimately led to financial stability in the country and now South Korea is in a very comfortable position with companies like Samsung, biggest chip maker in the world. Had the government not taken stern steps to ensure financial and economic stability it would not have given rise to companies like Samsung, regarded as one of the finest companies in the world. “By the beginning of May 1999, that is, within a year and a half of seeking IMF assistance, South Koreas usable foreign exchange reserves had risen to $56 billion, and a severe economic downturn in 1998 had been converted into an expected rate of growth of 2-4 per cent for that year. South Korea has been the first of East Asian and South-East Asian countries to emerge out of the economic crisis that broke out in the wake of Thailands forced devaluation of its currency in July 1997. Thereby it has confounded both the critics and the supporters of the IMFs package of policies, and the critics of the irremediable structural faults from which South Korea was supposed to suffer.” (A Turnaround in South Korea, 17 October 2008). The country had many problems but has now recovered from most of its problems very effectively; some of the main problems were unemployment countless people tried really hard to get employed but were frustrated time and again. Illegal Immigration was another major issue but the recovery process has been rather swift and the South Korean economy has truly come of age. South Korea before and After the Financial Crisis The crisis badly affected the value of the Korean Won, The Won shed almost 50 % of its value and the same brought in a lot of imbalance in the economy before the crisis but after the crisis the Won has stabilize and looks promising from the perspective of future growth. “Several factors explain much of the decline in agricultural trade. The Korean economy, and most of its consumers, became poorer in 1998 because of rising unemployment, reduced asset value, and lower salaries. What money they had was worth less at the border, effectively raising the price of imported goods relative to domestic products. With most importers short on cash, inability to get credit severely limited transactions early in 1998.” (World Agriculture and trade, 17 October 2008). The alarmingly high level of unemployment reached its peak during the financial crisis but after the crisis the rate has again fallen down which is good for the country’s economic growth and economic stability. In 1998 the South Korean Economy witnessed a decline in the value of trade due to the financial crisis but the value of trade has become normal after the crisis and the country has truly benefitted from the same. The stock market plunged to unprecedented levels during the crisis but the stock market has been stable after the crisis giving a good indication of the fact that the South Korean Economy is doing quite well. The value of the agricultural imports fell very sharply during the financial crisis but the prices were back to normal as the country showed signs of recovery from the crisis. “The value of Korea’s imports of processed foods and beverages fell by over 40 percent in 1998. Although relatively new to Korea, these products accounted for 11 percent of total agricultural imports in 1997. Imports of processed foods and beverages had been insignificant until Korea began reducing trade barriers in 1989. Since then, imports have grown quickly, including items such as fruit juices, chocolate products, wine, beer, sausages, noodles, dairy foods, frozen French fries, cola bases, seasoning mixtures, tomato paste, ketchup, and canned vegetables and fruits.” .” (World Agriculture and trade, 17 October 2008). The quality of life in South Korea has drastically changed before and after the financial crisis. The quality of life has significantly improved after the crisis, there is over all growth in the country and it ultimately affects the quality of life. More the growth better the quality of life, so South Korea has witnessed tremendous growth in the economy and that has positively affected the quality of life in the country. Before the crisis, exports contributed to just 3% in the GDP on the other hand exports contribute 30% to the economy after the crisis. This goes to show that the level of exports have reached new heights. It is extremely beneficial to the economy of a country. The current account deficit touched high levels before the crisis and the same was stabilized by the bailout issued by IMF. So it is fair to say that the deficit has reduced after the crisis. Prior to the crisis the exchange rate did not give the precise value of Won but the real value could was easily and precisely derived after the crisis. The inflation rate rose to the highest in three years in the year 1998, it rose to about 7.5 but after the crisis the inflation rate has constantly stayed under a strict check. The external position of the South Korean economy was extremely vulnerable; on the other hand after the crisis it became very stable and was far from being vulnerable. Before the crisis, financial sector of the South Korean economy was not as strong as it got after the crisis. So all the above information goes to show that South Korea has recovered from the financial crisis much quicker than expected and it is one of the fastest growing economies in the world. References A Turnaround in South Korea, 17 October 2008. In World Affairs. Retrieved on November 1, 2009 from: http://www.hinduonnet.com/fline/fl1615/16150620.htm Background to the Financial and Economic turbulence of 1997-98. In The Causes of the Asian Financial and Economic Crisis. Retrieved on November 1 2009 from: http://riskinstitute.ch/145900.htm The South Korean Experience in Financial Crisis of 1997- 98. In San Jose State University. Retrieved on November 1 2009 from: http://www.sjsu.edu/faculty/watkins/korea2.htm World Agriculture and Trade. In Agricultural Outlook. Retrieved on November 1 2009 from: http://www.ers.usda.gov/publications/agoutlook/aug1999/ao263e.pdf Bibliography Heo, Uk and Sunwoong Kim. (2000), “Finanacial Crisis in South Kkorea: Failure of the Government-Led Development Paradigm,” Asian Survey, Vol. 40, No. 3, 492- 507. Park, Sung-Hoon and Hyungdo Ahn. (1999), “The Impact of the Korean Crisis on SMEs: A Case Study of Korea,” Working Paper. Read More