Asian Financial Crisis of 1997-1998 - Term Paper Example

Asian Financial Crisis of 1997-1998 The economic crisis in Asia of 1997-99 was an exceptional event in the territory’s postwar history. Beginning from the growth period during 1950s and 1960s East Asia didn’t seem to experience massive shock of the happening. Huge amount of attention was given to economic scale specifically to forces of the market and choice of the economic policies that might have caused this contraction. More than that, the crisis itself went out to international political level that concentrated on the timeless clash between debtors and creditors within the world economic sphere. At the moment when economy starts to cry the thing creditors care about is the repayment and to be more concrete the certain reforms of the policy to help in restoring the confidence of the investor. Erroneously creditors usually thing the root of the crisis can be found in badly regulated financial systems or mismanaged exchange rates of the borrowing countries. On the other hand the debtor government tries to find financial help to make things easier with the social costs related to the crisis through forgiveness of the debt, new financing or rescheduling. Fortunately, the creditors and debtors are in equal circumstances when it comes to sharing responsibility of bad lending and all the problems do not fall on the borrowing country citizens. In the middle of the Asian crisis Malaysia disputed that the cause of the financial crisis was in growing financial integration and the reiteration might only be eliminated by reforms of the financial system on the international level. Considering the weakness of bargaining position and the will to bear the access to public and private credit flows, the governments of the debtor tend to make some typical adjustments in policy; their explicit lack of financial background is to guarantee this is the case. They might be interested or not in fulfilling all the amount of reforms sought by the institutions of finance such as IMF and creditors. More than that it is quite possible for the governments to show resistance to the reforms due to interest group and composite tension or just due to origin and nature of political organizations and the overall process of making decisions. Causes of the Crisis. The economy of Thailand displayed a significant rise path for more than ten-year period before the crisis began in 1997. The account deficit at that time slightly exceeded 5% and the high increase gave birth to budget excess for a number of years. Simultaneously, huge capital inflows were piled up along with a differential high interest rate and under the regime of fixed exchange rate, including deregulation of capital account. Thailand had been ready for undertaking a higher level of capital liberalization beginning from early 1990s. The Bangkok International Banking Facilities or BIBF model was created to make things easier with the process. Thus, the setting became a new way for earning low interest rate funds from other countries. Besides BIBF, policies including the preservation and protection of domestic currency as well as policy of high interest rate were supposed to support capital flows abroad. Due to introducing low currency risk for investors these policies greatly encouraged capital inflows. However, the advantageous time was not meant to last for too long. External funds were integrated into the country to make use of the high interest rate differential and to make profit from depreciation of baht. Short-time borrowing abroad worsened the circumstances significantly, basically to long-term projects, which resulted in mismatches of currency and maturity. Consequently, a crisis of balance sheet occurred due to unexpected capital outflows. In 1996 the foreign short term liabilities had overreached international reserves. And when the baht turned to be floated and external debt in local currency was exceeded greatly, the sovereign rate went dramatically down, and thus sentiments of the investors were disadvantageously disturbed. As a result, the significant economic increase of Thailand hid weak points, at this very time the financial crisis was launched by inadequate policies such as: Maintaining a fixed exchange rate at the time when it is not appropriate Giving permissions for a lot of short-term capital flows to gain with a high level of currency profiteering, Deficit of an efficient system of risk management at the internal level as well as external level. To sum it up, the financial crisis of Asian world includes all the basic features of capital account crisis in its classic look. To make my essay more understandable I have included a figure which explains the situation. The economic and social costs of an Asian crisis. The tiger economies of East Asia before crisis burst out were considered as example for development in economic sense, and they seemed to be not only prosperous taking into consideration per capita income increase generally but also managed to display reduction of poverty rate. Ranis and Stewart (1998) state a firm reduction in the ratios of the poor population taking into account their private revenues: talking about Indonesia this proportion went down from approximately 57 per cent in 1970s to 15 per cent by 1990; the numbers covering the same question for Malaysia are 50 per cent and 15 per cent. On the territory of South Korea the share of the population were stated as being poor in mid 1980s and at once in Thailand the percentage went down from 39 per cent at the end of the 1960s to 13 per cent in 1992 (Ranis and Stewart 1998, p 9). Elaborate admission to social services was significantly less interesting and essential, nevertheless slight improvement could be traced in this sphere as well: access to public health and education greatly influenced the overall situation on the territory. But despite of the circumstances that levels of government spending in general meaning were not high, social dispensation percentage – the proportion of expenditure of government intended for social needs – turned out to be high. The overall amount of health and education expenses as a per cent of spending in countries of East Asia was high and reached approximately 16.7 per cent at the time of the period 1990–1995 (Ranis and Stewart 1998). The key to this success in reduction of poverty rate was a maintained period of high and fairly adequate growth of private income but not the efforts of government at improved provision of social service as many seem to think. The external-oriented strategy of growth in matter of these economies concentrated on labor-intensive exports growing. This was conducted through absorption of labor within these sectors that widespread growth in private revenues was realized and reduction of poverty rates was reached. To sum it up I have to admit that right up to the first quarter of the 1990s most countries of this region had undergone quite high national income increase of around 8 per cent at annual rates. But , as nevertheless, as we all already know, this situation was not to last for too long and things changed dramatically. Crisis Prevention. It is common knowledge that there is general hypothesis that crisis is to be predicted and prevented in beforehand but this statement turns out to be no more than words when it comes to concrete policy measures. There has appeared an opinion that reasonable investment regulation in markets that emerge which could expand to creditor institutions in the source countries (Griffith-Jones 1997, Montes 1998, Stiglitz 1997). A suggestion put forward by Griffith-Jones (1997) would base such regulation on a risk weighted capital charge: source countries investors would be obliged to place a certain amount of money in deposits of interest bearing. The specific sum would be set up in accordance with a number of basic variables which are considered to be indicators of the target country’s risk. Griffith-Jones (1997) states that risk factors on macroeconomic level should also be taken into consideration. The process of investment in these countries would become considerably less profitable due to the fact that economic fundamentals worsen and the requirement of cash for the risk weighted capital charge undergoes dramatic growth. While capital charges are connected to an adequate list of risk factors this should result in step-by-step decrease in investment amount just before any build 15 up of speculative tension. And unexpected destructive adjustments of exchange rate might afterwards become less prevalent. This impact of stabilization is expected to very profitable for source or developed countries as well as developing or recipient. Taking into account institutional arrangements in international sense much of the attention was drawn to the crucial role of the IMF. Feldstein (1998) concentrates on the IMF´s overriding importance in question of liquidity in order to enable continued servicing of external payment obligations in case of crisis. This case is also stated by Eichengreen and Portes (1995). Feldstein states in afterwards that crisis of currency in a range of the countries of South East Asia could have been prevented in a bud if efficient emergency financial policies were available timely. In this respect, it has been offered that the IMF might provide some shadow programs with crisis inclined economies and sustain much softer requirements in situation free from crisis. In case of forthcoming financial crisis the country could access IMF credit, and as a result to be able to avoid problems with liquidity and give certain signal which is to be reassuring to international markets (Griffith-Jones 1998). Talking about Korea the crisis contamination has been seen as temporary phenomena, avoidable problems with liquidity. But the temporality of the crisis is to be argued due to cyclical origin and that early state of liquidity could have had advantageous effects. The economic circumstances of the country were already restoring from a temporary decrease in semiconductor prices when it was dramatically affected by unfavorable exogenous changes (Feldstein 1998). This aspect of policy is very important as compared to the grounds of probable multiple balance and self executive speculative crises: fast but nominal provision of emergency finance might not only let suffering countries to service grown external obligations without any disturbance but would also involve a component of signal which could finally transform the resulting outcome in a multiple balance setting (Eichengreen and Portes 1995). The great significance of the component of signal within this approach can hardly be overestimated as if the overall effect of versatile liquidity assistance were bounded to certain amount of funds along with unlikeliness of achieving any more than fixed reserve position in pursuit of protection of exchange rate from attack and one way or another speculative flows would definitely deplete official reserves. In his work Feldstein (1998) shows critical attitude towards the IMF which basically intruded measures of structural adjustment on Korea and these measures were equivalent to a negative signal of capital market and consequently led to a decrease in business confidence. The measures imposed simply overstated the true extent of the problems Korea was facing. After an impermanent deceleration in export operations all the economy of Korea really needed was temporary supportive actions providing efficient external reserves to fulfill current obligations until full recovery of the trade balance. After the malfunction of the basic policy approach had become clear, the IMF managed to provide specifically this type of support (Feldstein 1998). Wyplosz (1998) in his study develops the possible counterproductive influence of excessively restraining measures of adjustment . Being face to face with the sternness of the adjustment measurements enforced by IMF economies do their best to avoid requesting support till their situation gets worse and adjustment measures are unavoidable. Taking into account experience of the past there already exist methods of conducting sound management on macroeconomic level when facing debt situation with deficits in private sector. Measures in anti-cyclical stabilization may be considered as quite obvious variant in this situation but nevertheless the general problem is very persistent as this field of macroeconomic policy still remains unknown. A new and fresh vision towards institutional arrangements on international level has been offered by Soros (1997) , whose argument is in favor of a diversified SDR6 funded ‘International Credit Insurance Corporation’ in order to provide guarantees on international credit up to a set maximum level. Thus it would definitely result in rationing of the credit through determination of the maximum amount of credit adequate enough for a certain country and the maximum level at which country could borrow at prime rates (Soros 1997). This very statement has also been approved by Noland (1998), who mentions that it could be funded privately. Facing the circumstances of conditional multilateral liquidity provision, such mechanism of international guarantee would have made an effect not only through the service of insurance but also by signaling the increase to which credit provision to specific economies is considered maintainable. It is to be vital that such service of insurance is fairly priced due to its profits. The insurance service with a lower price would have created a moral danger issue with respect to investors in international depositors. To be more precise, this particular danger is more likely to be pronounced as compared to the predictable bailouts International Monetary Fund, that is investors are obliged to refer their decisions to guarantees which in their turn contain a certain element of risk and this issue could be removed from the guarantees provided by an International Credit Insurance Corporation assuming that the moral hazard risk in result would be much more serious in various aspects. Montes (1998) while working on his research states that regional contamination of currency crises provides a reasonable for regional co-operation in crisis elimination. While reasonable regulation and monitoring of the financial sphere would clearly be sited within the territory of national government competence, Montes (1998) disputes that governments are obliged co-operate by privately exchanging data on their respective sectors of finance. This measurement would make it possible government to predict forthcoming problems on regional level and apply their policy responses in the best way possible. Montes (1998) furthermore keeps arguing that a set of common standards are to be created and applied in order to prevent government from competitive relaxation in standards of regulation in pursuit of attracting investments. Prospects for recovery. Looking back and taking into account the experience of the countries that faced Asian crisis I would like to mention that the overall consequences have turned into significant reduction of consumption and investment along with a fast improvement of trade positions. Considering the circumstances the Asian countries found themselves in due to evolving crisis it would be necessary to point out three main elements that were put together and led these countries to critical vulnerability: a) the increase in external private indebtedness which was mainly unhedged and short-term b) certain mismatch in financial system along with low return intermediation c) financial position of the corporations which is stated to be highly leveraged The first factor is connected with macroeconomic policy, the second factor is related to financial sector policy, and the third factor is to deal with corporate governance and each if these elements is to present a lesson for the future. Financial crisis: nine lessons to learn from East Asia Lesson 1: Try hard to escape from huge current account deficits which are financed through short-term, unhedged private capital inflows Lesson 2: Regulate and supervise financial systems in aggressive manner to make sure that banks manage risks in beforehand Lesson 3: Put in place stimulus for adequate corporate finance in order to avoid high leverage level and overrated reliance on foreign borrowing Lesson 4: Conscript timely foreign liquidity of efficient magnitude in a sphere of adequate policies to recover market confidence Lesson 5: One-size-fits-all prescription for monetary and fiscal policy in order to crises does not exist Lesson 6: Bailing-in private creditors on international level at times of crisis is important; in those circumstances when official resources have limits relative to the volume of the crisis and private creditors are not corrigible to coordination, some unwitting private sector participation may be essential Lesson 7: Move rapidly in order to create domestic and international resolution methods for depressed assets and liabilities of nonviable corporations, organizations and banks Lesson 8: Be able to soften the effects of crises on low-income institutions through social policies to improve the inevitable social pressure related to adjustment Lesson 9: Work on mechanisms for crisis elimination, resolution management at the regional level in a way sequential with enhancement within framework on global level. The statements listed above are to show that crisis itself is a living organism which can be born, gain its development and contaminate its surroundings very rapidly provided with certain environment. The state of weakness at any level along with management malfunction and failure to react timely and apply sound financial policies might play a crucial role and lead to irreversible consequences. But as years go by and the mistakes are disclosed in details it would be essential to analyze whether these lessons are learnt or not. Taking into consideration the experience of the past years and looking at the present events in economic sense I would rather admit my view of this question is more depressive than optimistic. There are several reasons. It would be unfair to say the lessons were taken into account as over a decade later even a bigger financial crisis erupted and still remains persistent and state we are in today is disappointing. All the main features of the Asian crisis, all the deficiencies such as real estate bubbles, deregulation, and weak financial supervision – all of these elements came together once again to generate crisis of 2008-2009 period of even grater magnitude. It goes without saying that countries suffered hardest from Asian financial crisis such as Korea, Indonesia and Thailand tried their best in undertaking serious measures and steps. However, apart from that the overall picture is sad. I suppose the lessons suggested by Asian crisis were not taken too seriously by public sector referees and private sector players in the USA – the country that should display prudence and sophistication in financial affairs along with its status in economic relations on an international level. And speaking about nearest future I am wondering whether these lessons will be learnt and again I wouldn’t be optimistic. If we take a glance at long history of economic relations all over the world taking into account period of fifty years the reiteration of financial disasters and their resemblance is the indicator of inability of making serious decisions. It is much easer to dramatize the situation and simply settle back into the templates from which the crises had been born. But of course it would be appropriate to evaluate both sides of the problem and there seems to be bright side. My personal suggestion is that I see an option for considerable changes within IMF in fundamental institutional way. The possible trajectory is being discussed concerning reform in order to bring legitimacy to this organization to prevent and soften financial crisis. To close on a happier note, I will suggest that I see an opportunity right now for fundamental institutional change in the IMF. The proposed Charter amendments I referred to above relating to governance suggest a possible trajectory of reform that might bring needed legitimacy to that institution and its efforts to prevent and mitigate future financial crises. This is a great opportunity that I think has no precedent other than events of 1980s, when the debt crisis evolved a panic that managed to strengthen the International Monetary Fund. But nevertheless, until opportunity of today is in fact taken advantage of immediately, I am afraid it will be left behind until the other crisis—maybe twice as worse than the Asian Financial Crisis or the global financial crisis we are all in—breaks in and causes greater desolation to people around the globe. SUMMARY AND CONCLUDING REMARKS The trigger of Asian financial crisis was weaknesses in the financial system of Thailand. All the other countries of the Asian 5 were absorbed by the crisis as a chain reaction due the vulnerability of their financial systems. Of all the important issues on that problem there are two worth outlining: 1) the twin liberalizations caused the disasters in the financial system (Montes, 1998); and 2) the causes of structure (i.e. crony capitalism) are responsible. In my study I have emphasize though that the vulnerability and extreme weakness of the financial systems fail to give sound explanation of the magnitude of the crisis. And more than that neither can fundamentals of macro economy as the IMF claimed earlier. The findings made in my study show this through the issues of the Kaminsky-Reinhart EWS methodology in which the signals were not disclosed as timely and on regular basis as during the crises of the Scandinavian countries or at early periods of crises of the Asian 5. Basically I have to agree with the statements of Radelet and Sachs (1999) that the nature of the Asian crisis was an enormous and unexpected conversion of capital flows and the capital outflows were deemed a display of investor panic. The aim of this essay was to show that the measurements undertaken to originate the outflow of capital through growth in the interest rate appeared to be useless. The impacts of policies were supposed to permit the exchange rate to pursuit its balance and simultaneously timely maintenance the economic liquidity. The contradictive simulation utilizing the PIDS-NEDA Annual Macroeconometric model displays that this treatment would have made it possible for the Philippines to avoid the recession in early 1998. Taking into account all the prescriptions of the policy we should consider both sides – reforming international financial structure and strengthening internal financial system. Steps to be taken in order to deal with these problems are quite obvious, they involve reinforcement of the prudential regulation and timely monitoring and supervision programs conducted through adequate risks assessment instead of concentrating on credit risk. Moreover, it is essential to consider more strict requirements for disclosure of information, sound standards in accounting and auditing, along with transparent and clear regulations and rules in process of provisioning and classification (Intal and Llanto, 1998). In addition the emerging policies meant to cope with the reforms in international financial system still require much effort and detailed study. This set of measurements is sure be of a great help when speaking about the problem of capital flows regulatory issues. Even taking into account the enormous difficulty of the problem, the process has to be started as soon as possible as neglecting and inaction would consequently cause the next crisis and it might be destructive for the economy of the world. Works Cited "Asian Financial Crisis, 1997-1998." Asian Financial Crisis, 1997-1998. Web. 22 Apr. 2015. Bustelo, Pablo. "The East Asian Financial Crises: An Analytical Survey." Web. 22 Apr. 2015. Corsetti, Giancarlo. "What Caused East Asia’s Financial Crisis?" Web. 22 Apr. 2015. Griffith-Jones, Stephany. "THE EAST ASIAN FINANCIAL CRISIS : A REFLECTION ON ITS CAUSES, CONSEQUENCES AND POLICY IMPLICATIONS." Web. 22 Apr. 2015. Griffith-Jones, Stephany. "The East Asian Currency Crisis." Web. 22 Apr. 2015. Hale, Galina. "Could We Have Learned from the Asian Financial Crisis of 1997-98?" Economic Research. 28 Feb. 2011. Web. 22 Apr. 2015. Head, John. "THE ASIAN FINANCIAL CRISIS IN RETROSPECT – OBSERVATIONS ON LEGAL AND INSTITUTIONAL LESSONS LEARNED AFTER A DOZEN YEARS." Web. 22 Apr. 2015. Kee Jin, Ngiam. "Coping with the Asian Financial Crisis." Web. 22 Apr. 2015. Moreno, Ramon. "What Caused East Asia’s Financial Crisis?" Economic Research. Web. 22 Apr. 2015. Read More