The Asian Financial Crises - Case Study Example

EAST ASIAN ECONOMIES East Asian Economies June 24, 2009 Korean Experience The Asian Financial Crises was initiated when Thailand attempted to de-link the Thai Baht from the USD and decided to float the currency in July 1997. The country had a huge foreign debt of payment and quickly collapsed, becoming bankrupt and thus having a chain affect collapse in the South East Asian countries. The South Korean experience was vary bad and saw a huge deprecation of the currency Won that fell from 800 won to the dollar in 1997 July to 1700 Won in November 1997. South Korea banks had underwritten the huge export oriented plans and serviced the high debt equity loans of the major Chaebols or industrial families. The manner in which the South East Asian countries were linked by their economies mean that a crash in one market would have a domino effect on others. The markets quickly crashed and South Korean banks did not have any liquidity. The overseas markets in US and Europe had also gone into a contraction and since South Korea industries was export oriented, export revenues stopped and there was a total breakdown. The industry had vastly over invested in infrastructure, automobile and electronic industry and a result, there was a huge unutilized overcapacity. South Korean banks had lent the funds to the industries and if they demanded that loans be returned, the industries would collapse and if they did not, the banks would collapse. Moodys downgraded the credit rating of South Korea from A1 in 28 November 1997 to B2 by 11 December. The stock market fell by 18.2% from 7 November 1997 to 24 November 1997 (Pettis, 2001). The key vulnerabilities of South Korea was that the banks were driven by politics and industrial families and lending, investment was done as per political will and not as per any business sense. In their haste for export oriented growth, domestic markets were neglected and all efforts were directed for exports. Financial liberalization had led to reduced currency controls; there was no regulatory and accounting practices with fraud in the financial system being rampant. Moreover, there was a huge overcapacity and an economy that was very dependent on large firms that wanted to do everything themselves (Ito, 2006). The IMF granted South Koreas bailout money of 57 billion USD with strict requirements on certain compliance measures. To make the economy recover, the government led by President Kim Young-Sam, introduced several financial measures that curtailed excess expenditure and brought in financial austerity, stopped indiscriminate underwriting by banks for loans and corporate accountants had to observe firm accounting regulatory standards. The austerity measures have had the desired results and the nation has seen a huge growth in exports and the GDP, without the various problems associated with the earlier era (Ito, 2006). Chaebol were very large business families in South Korea that controlled almost 100% of the economy. Some examples are Hyundai, Kai automobiles, Samsung, LG and many others. These Chaebols were larger than the South Korean economy and were funded by banks; they had huge political affiliations and helped in the rapid industrialization. When the South Asian Financial crises hit the country, the Chaebols were squarely blamed for the mess. The government brought in a number of policies to control these conglomerates. They were banned from owning private banks and this policy was implemented to stop stock manipulation, underwriting of loans and accounting frauds. Laws were passed such as antitrust laws, inheritance taxes and accounting regulations to make operations more transparent and to prevent fraud. They were asked to concentrate on core industries and not expand indiscriminately and this measure ensured that the firms did not enter into non viable and loss making areas (Pettis, 2001). 2. China Experience China was a communist country and till 1979, the country had banned capitalism and private enterprise, driving the country deeper and deeper into backwardness. From 1979 onwards there was a transformation and liberalization of the economy, with an open door policy that encouraged private investment. The banking system was controlled by the Peoples Bank of China and it was just a closed and controlled system with no relation or integration with the world economy. The bank underwent a transformation and its role was that of regulatory and it allowed local banks to lend money at the market rates. Gross domestic product, current prices was 307.6 billion USD in 1980 had increased to 1198.48 by 1999 and current account balance that was 0.29 billion USD in 1979 rose to 20.52 billion USD in 1979. China was increasingly seen as the factory of the world and with very cheap labor, a no taxation regime, abandonment of workers rights, meant that factories could produce vast quantities of goods at very low process. Technology transfer, FDI were encouraged and China itself had an immense internal market, inviting hundreds of western firms such as Wal-Mart, GM, Ford, Cosmetic companies, to open factories and business centers with 100% FDI participation (Liu, 2004). ‘Growing out of the plan’ referred to certain unanticipated growth and reform that resulted from the economic transformation policies. China had a huge pool of hardworking and enterprising people and when the economic reforms were brought in, the country was transformed and many of the economic transformation were irreversible. The Chinese had attempted social reform while still restraining excessive freedom for the people and when the Tiananmen Square massacre took place in 1989, the Chinese government attempted to bring some control over the economic growth, but found that this was not possible and this is the growing out of plan phrase (Naughton, 1995). Township and village enterprises - TVEs played a crucial role in the economic transformation of second and three tier towns and villages. These are hybrid institution that have the structure of SOEs but have the efficiency of private capitalist firms. Managers obtain contracts with TVEs that are headed by the local chief and workers and may obtain concessions in the form of resource allocation and tax freedom. In return, the managers give some percentage of the profits along with the wages. TVEs created a large pool of workers who worked at much lower prices and helped the local economy to grow. Employment that was 28 million in 1978 grew to 135 million by 1996 production grew to 26^ of GDP from 6% for the same time. (Pettis, 2001). Before the economic reforms, the SOEs were the sole industries in China. These SOEs were hugely overstaffed, inefficient, corrupt and constantly lost money. They also used old technology and made outdated products, being a part of the collective work centers. Once the economic reforms came and private enterprises came into existence in China, the role of SOE as a provider of jobs was gone. The private firms could operate much faster, bring in new technology and make products at a much higher rate than SOE. In the face of TVEs capitalization, SOEs started to improve from 58 m in 1978 to 75m in 1996 – bulk of urban employment (Pettis, 2001). References Ito, Takatoshi and Andrew K. Rose, 2006. Financial Sector Development in the Pacific Rim. University of Chicago Press. Kaufman, GG., et all, 1999. The Asian Financial Crisis: Origins, Implications and Solutions. Springer Publications. Liu Minquan,. October 2004. Wage-related Labour Standards and FDI in China: Some Survey Findings from Guangdong Province. Journal of Pacific Economic Review. Volume 9. Number 3. pp. 225-243 Naughton Barry, 1995. Growing Out of the Plan: Chinese Economic Reform, 1978–1993. University of California, San Diego. Pettis, Michael, 2001. The Volatility Machine: Emerging Economies and the Threat of Financial Collapse. Oxford University Press. Read More