Managing Openness Issues - Case Study Example

Impact of the 2008 global financial crisis and 1997 Asian crisis on Malaysia Introduction The 2008 global financial crisis and 1997 Asian crisis on Malaysia had varying impacts on Malaysia. The two crises had some similarities and differences. In addition, various reasons have been cited to be the main cause of the two crises. This essay discusses the impact of 2008 global financial crisis and 1997 Asian crisis on Malaysia, the similarities and differences between the two crises and the reason for their onset. Impact of the 2008 global financial crisis on Malaysia One of the impacts of the 2008 global financial crisis on Malaysia was spiraling inflation. Malaysia experienced the highest inflation rate in 2008 than ever before. Malaysia also suffered from the slumping commodities prices (Haddad and Shepherd, 2011). For instance, crude palm oil prices in 2008 fell from a high of Ringgit 4300 to a low of Ringgit 1760. This was a more than 60% drop. This impacted negatively on the budget of the country of the year 2008/2009 which had been prepared based on previous commodity prices (Oxford Business Group, 2009). The crisis also hit production and income because there was a drastic fall in exports in oil, manufacturing and agricultural products. The recorded fall in exports of Malaysia by the end of 2008 was 15%. Malaysia’s economic output in the last quarter of 2008 was RM 131.3 billion. This was a drastic drop by 3.6% when compared to the third quarter of 2008. Malaysia’s gross ex[orts fell by 18% as at the end of 2008 (Oxford Business Group, 2009). Malaysia also recorded 11% fall in the GDP between the third and fourth quarters of 2008 because of the crisis. All sectors of Malaysian economy were hit by deceleration of growth between the third and fourth quarters of 2008. For instance, manufacturing sector fell by 12% while agricultural fell from RM 10.8 to 9.9 billion as the construction sector fell from RM 4 to 3.9 billion. Prior to 2008 financial crisis, Malaysia had been experiencing high surplus in the overall balance of payments (BOP). Even though Malaysia had a positive surplus BOP of RM 26.2 billion in the second quarter of 2008, this fell in the third and fourth quarter and became a deficit of RM 31.5 billion and RM 62.5 billion respectively (Haddad and Shepherd, 2011). Malaysia also suffered from a big drop in funds flowing into Malaysia. The capital flows and portfolio investments recorded the highest net outflow of RM 84.4 billion in 2008 in comparison to RM18.4 billion recorded in 2007 (Oxford Business Group, 2009). The Kuala Lumpur Composite Index fell from 1393 points as at January 2008 to 876 by the end of 2008 due repatriation by foreign participants (Haddad and Shepherd, 2011). Foreign direct investment into Malaysia dropped by 98% from RM15.9 billion in the second to 0.3billion in third quarter of 2008. The decline in demand for exports and portfolio capital outflows for Malaysia led to depreciation of the ringgit by almost 6% by the beginning of 2009 (Haddad and Shepherd, 2011). The impact of 2008 global on Malaysian banking system was moderate because Malaysian domestic banks had negligible exposure to US subprime loan products in addition to having built significant buffers during the decade after the Asian financial crisis. Impact of the 1997 Asian crisis on Malaysia The impact of the 1997 Asian financial crisis on Malaysia was traumatic. It resulted in political and economic turmoil (Montes and Popov, 1999). The currency, the stock market and the property market nearly collapsed. The crisis resulted in expulsion of the deputy president Anwar Ibrahim from Malaysian dominant party UMNO when he disagreed with the then president Mahathir Mohamad over Mahathir’s rejection of loans from IMF. As at January 1998, the ringgit had fallen from a value of 2.52 to the US dollar in 1997 to 4.5 ringgit to the US dollar. The Kuala Lumpur Composite Index fell from 1271 points at the beginning of 1997 to 897.25 as at the end of 1997 immediately after the start of the crisis and fell further to a low of 262 as at the beginning of the fourth quarter of 1998. Similarities between the 2008 global financial crisis and 1997 Asian crisis The Asian countries and the US had domestic problems before the 1997 crisis and 2008 crisis respectively that necessitated the crises (Montes and Popov, 1999). The two crises are also common in the sense that there were weaknesses in the system of financial regulation and oversight prior to the onset of the two crises. Differences between the 2008 global financial crisis and 1997 Asian crisis The financial markets in the developed world were much mature and had strict regulation when the 2008 global financial crisis began as opposed to that which existed in Asian countries prior to 1997 Asian crisis (Montes and Popov, 1999). The mature financial markets in the developed countries were much resilient to shocks due to their depth and sophistication and their supervisory and insurance system and were thought to be able to function safely with less oversight and more leverage as opposed to what existed in Asian countries prior to 1997 crisis. Thus the reduced oversight and high leverage reduced transparency that facilitated 2008 financial crisis. Unlike Asian financial systems, developed world financial systems had proved to be capable of rebounding from external one time shocks before the investment bank Lehman Brothers. Reasons for the 2008 global financial crisis There are three main shocks which led to global financial crisis. First was the burst of the housing bubble. This caused reallocation of capital and loss of household wealth and reduced consumption (Salazar, 2007). Second was the sharp rise in the equity risk premium. This caused a rise in the capital cost, fall in private investment and collapse of demand for durable goods. The last shock was the reappraisal of risk by households. This led to discounting of future labor income and increased savings while decreasing household consumption (Salazar, 2007). The global financial crisis is also attributed to structural causes. This included deeply flawed institutions and practices that are often referred to as new financial architecture. This architecture had a globally integrated system of giant banks and shadow banking system of hedge funds, bank created special investment vehicles and investment banks (Salazar, 2007). It is argued that these institutions had poor regulatory systems in place. Reasons for the 1997 Asian crisis The weaknesses of the financial institutions were one of the key causes of the crisis. The insolvency laws which were rarely used were inadequate to address the crisis. There were no bankruptcy laws in countries like Thailand (Montes and Popov, 1999). Corporate accounts also lacked transparency and there was very little protection offered to minority shareholders. Thus very few investors were convinced to take stake in the local companies. Therefore, most of foreign and domestic investors shied away from local companies. The rapid liberalization of capital accounts could have been one of the reasons why this crisis occurred (Garnaut and McLeod, 2002). The liberalization was far too fast in relation to the strength of control systems in place at that time, that is, the institutions and financial systems were too weak to accommodate these fast track liberalization (Salazar, 2007). Thus, because the systems were weak the controls of cash in flows were out of reach. This culminated in high inflows of short term debts to finance projects which were mostly long term. The use of short term debts to finance long term debts is another key reason of why the crisis happened. This created imbalance and the payment of the debts was difficult resulting in the withdrawal of funding by foreign investors who lost confidence in the concerned economies. This caused massive outflow of funds (Montes and Popov, 1999). This was mainly caused the lack of controls to plug this outflow. Therefore little was left in terms of foreign currency reserves. As a result, the countries concerned could not stabilize their currencies’ value. Thus most of the currencies depreciated in value (Salazar, 2007). The depreciation of currencies resulted in the decline in stock markets and the prices of the assets fell drastically too. This then resulted in the financial crisis that rocked the Asian countries. Some of the currencies which were affected were Chinese currency, appreciation of the dollar against Japanese yen. Another cause of the crisis is attributed to the reduction of the prices of the semi-conductors (Salazar, 2007). This was one of the main foreign exchange earners in most of the Asian countries and its devaluation resulted in major losses and reduced foreign currency (Mera and Renaud, 2001). Thus little was being transmitted to the foreign reserves. The pegging of most Asian countries’ currency in United States of America’s dollar was also a key cause of the crisis. At the beginning of the 1990s the dollar was weak and encouraged more borrowing by the Asian countries. This was because the interest rates charged on the dollar were very low (Montes and Popov, 1999). As the American economy blossomed the interest rates increased and most of these countries found themselves in large short term debts that they could not pay (Lindgren, 1999). This drove most investors away from the Asian countries and most migrated toward the United States of America which was offering higher interest rates. This resulted in the collapse of many financial institutions and others became bankrupt. Conclusion The 2008 global financial crisis and 1997 Asian crisis had negative impact on Malaysia. These ranged from economic, political and social impacts. The two crises had some similarities and differences and various reasons have been pointed out to be the main causes of the two crises. Some of the reasons include weaknesses in the system of financial regulation and oversight prior to the onset of the two crises. Reference Garnaut, R., and McLeod, R. 2002. East Asia in Crisis: From Being a Miracle to Needing One? London: Routledge Haddad, M., and Shepherd, B. 2011. Managing Openness: Trade and Outward-Oriented Growth After the Crisis. New York: World Bank Publications. Lindgren, C. 1999. Financial sector crisis and restructuring: lessons from Asia. New York: International Monetary Fund. Mera, K., and Renaud, B. 2001. Asia's Financial Crisis and the Role of Real Estate. New York: M.E. Sharpe. Montes, M., and Popov, V. 1999. The Asian crisis turns global. London: Institute of Southeast Asian Studies. Oxford Business Group. 2009. Malaysia 2009. Oxford: Oxford Business Group. Salazar, L. 2007. Southeast Asian Affairs 2007. London: Institute of Southeast Asian Studies. Read More