The East Asian Financial Crisis in 1997 - Essay Example

The East Asian Financial Crisis in 1997 The East Asian financial crisis in 1997 downturn is believed to have occurred due to fundamental economic weaknesses. "Others have claimed that East Asia fell prey to a sudden shift in investor confidence," (Joosten para 2). The market sector contributed immensely towards the Asian economic growth. The economic weakness had more serious consequences to the upcoming market. Most of these emerging market economies were adversely impacted on and at the end collapsed. The International Monetary Fund (IMF) tried though it delayed in helping to curb the problem but recovery was observed at a faster rate even if still the situation has not been properly eradicated. There is much to be done on the Asian financial status and more so the financial architecture. It was believed that the crisis would only take few months but it surpassed this ideology and what are observed are cases of unemployment and the deterioration in the Gross National Produt (GNP). The crisis has gone beyond East Asia and other countries like Russia, South America and South Africa are also experiencing it. The development of advanced technology like the use of computers had a significant impact on the financial status of East Asia. However, Asia adopted the use of computers in carrying out its transactions and in which it was at a much higher rate than normal. On the other hand, screening of the repercussions of the global financial systems was zero and it rather encouraged it (Borthwick pp 121). East Asia also accepted the idea of interconnection of markets across the world and development of big institutional financial players. The combination of all this resulted into tremendous shocks and instability. Thailand as an example was struck by the crisis rapidly and within a short time, it crossed all over East Asia. The carrying out of this financial liberalization was done at a wrong time since its institutions did not have an idea or rather it was not prepared for any outcomes or consequences over it. In addition, the transaction that the country was making was at a high speed and in return it affected the short-term capital flowing across the boarders where by there were high and quick returns. "Only one to two percent is accounted for by foreign exchange transactions relating to trade and foreign direct investment. The remainder is for speculation or short-term investments that can move very quickly when the speculators' or investors' perceptions,"(Director Para 6). What took place in East Asia was not unique because even other countries across the world have already experienced the very problem, especially from the Latin America and this is to say, there is need to check on capital inflow so us to avoid the shocks and instability and also discouragement to the large institutional investors and players. Rumor had it that, East Asia currencies were being over valued but observation made stated market over-reaction which consequently led to overshooting of these currencies beyond unjustifiable levels by fundamentals. "A report ... revealed that hedge funds made big profits from speculative attacks on South East Asian currencies in July 1997", (Director para 12). The sudden depreciation of the currency of East Asia, led to short term debts which appeared to pose the threats. The depreciation was caused by the speculators attacks and reduction in their foreign reserves. As a result of these problems, the country's capability to repay the loan was deterred and the debt accumulated correspondingly. The foreign reserves dropped drastically and could not repel off the speculative attempts. The short term foreign funds also begun to fall too destabilizing further the reserves and this consequently affected the country terribly in a way that it could not manage to clear away the debts, obligation and the calamity necessitated assistance which finally it obtained from IMF. It is argued that financial crisis in East Asia was as a result of recession in the economy of production. Rise in trade surplus was due to fall in imports than increase in exports. This trade surplus depicts recession on falling imports instead of expanding exports. The influx of imports rather than exports consequently affected the country's foreign reserves and it also competed highly with the local goods. The deregulation of imports offset the country's budget and the expenditures were more than the gains, hence causing more serious problems to both GNP and Gross Domestic Product (GDP). Besides that, another dilemma was the outflow of short-term funds by either the people around or rather locals and the foreigners. This could be solved by encouraging people and local companies to return the funds back. The easing of fiscal and monetary policies are in place and it is believed that the problem the East Asian countries were encountering would hopefully be solved that is resolving on recessionary pressures and improving the economic conditions (World Bank Staff pp 83). IMF imposed high interest rates to this East Asian countries and it also advised on tight monetary and fiscal policies which to a larger extend affected the economic conditions in terms of its finances and hence caused the crisis. These countries were already hit by other problems like decline in currencies' value and IMF insult was a huge burden to bear. The hike in the interest rate and banks reluctance in offering new loans, caused tremendous problems to many firms and consumers and most of the firms went down and some collapsed because of lack of capital to re-service their normal operations and repayment of short-term loans proved to be difficult both to the consumers and the firms. However, these interest rates were reduced and it relieved the banks and the debtors, but it took some good period of time before it was alleviated. Increasing the interest rate is to discourage the company's performance and the country at large and its end result will be felt in terms of the economy (International Monetary Fund Independent Evaluation Office pp 20). Rapid investment in economies of boom-and-bust resulted to liberalization which dealt much on non traded goods prices. It is believed that profit is high when there is less or low non-traded goods prices and hence the birth of an investment boom. Increase in investment led to influx in supply in East Asia which encouraged more and more investment. However, when there were low non-traded goods prices, the profit was high and this called for more investments which at last led to rise in non-traded goods prices and the profit obtained was finally retrieved for more purchases and that eventually reversed most of the businesses into incurring many losses (Smith, Horisaka & Nishijima pp 208). There was more input and the turn out expected was negative thus driving the country into a financial shock and stress, hence also contributing to the crisis. The policies' legal institutional frame work was weak and the government was reluctant in its reinforcement. It however led to other problems such as lack of price control and banks enjoyed market power. Interest rates were high for the depositors and the supply of domestic funds dropped rapidly. There was no equilibrium or a balance set to counter check on the financial spread. The underlying problems, consequently affected the economy of the East Asian countries. The countries encountered a lot of debts and the common man had little on the side of savings since there was limited domestic funds supply. Inflation broke in and the prices of the commodities had no standard price hence little gain on the side of the market industry and the government at large. There is need for protection of debtors to also avoid further short comings like decline in the currency, and on the other hand regulation of the capital outflow and setting of equilibrium were some of the solutions that East Asian countries were to encompass while strengthening the policies frame work. The financial crisis in East Asia is a lesson that all countries should be eager to learn and correct on this draw backs. However financial sectors in East Asia were poorly supervised and greediness took the due course. There was no transparency either on capital inflows and risk on investments mounted. "... exchange rate regimes and implicit guarantees tilted incentives toward excessive short-term borrowing and capital inflows,"(Agnor, Vines, Miller, & Weber pp 10). Nominal exchange rate in East Asia in the era of capital inflow was not primarily devoted to reduce the inflation but it was to avoid currency over-valuation. The consequences that rose there after left the country in a total mess. Most of the investments deteriorated and less profit was realized. Huge debts befell the country and ways of repayment were not guaranteed. Offsetting of the loan took a long process where by up to now the debt has not been cleared yet. The borrowers were not open enough to their lenders either. There were mistrust between the two parties and assessment of the risks could not be captured. Back in 1990s, there was a sharp increase in the investments in East Asia. Countries like Indonesia, Malaysia and Korea celebrated over the net capital inflows increase. In 1994 to 1996, demand pressures of the domestic funds accumulated and the degree of consumption out weighed the investment (Akyz pp 4). There was less contribution towards the GDP sector and the economic growth was inevitably affected negatively. Increase in investment as early as 1990 in East Asia which was accelerated by surge of private capital inflows provided more money which motivated and enabled the banks and non-bank financial intermediaries to improve and increase lending. However, the monetary policy tightened up and sterilized the capital flows thus making the situations for the bank to be hard and to mitigate upon it, they raised the interest rates. Majority of the debtors could not manage the charges and the companies were the most hardly hit and there performance reduced since some could not manage the loan charges and alternatively operated with the little available. East Asia relied so much on the foreign resources. The economy of these countries could not meet the standards required and therefore there was a stiff competition. Interruptions over the capital inflows were inevitable. East Asia lost the competitiveness to their recipient. Foreign investors pulled out because of lack of confidence with these countries. Foreign investors like Japan that had a lot of firms in Asia retreated from its investment and the currency of the Asian countries fluctuated so much. This affected the Asian countries' financial economy and in the world market, the turn out was low. Some of these Asian countries like Thailand that engaged themselves with investors who were less experienced and the financial crisis hit were terrible to them as compared to others like Korea. The exchange rate stability was very vital for export oriented developments of East Asian countries. In 1980s, East Asia concentrated much on exports in dollar. The exchange rate remained stable for quite a couple of years. The yen appreciated against the dollar up to 1995 and it eventually slipped backward by the end of 1997 (Akyz pp 5). The yen's appreciation against the dollar resulted to lower interest rates and the Japanese investments in East Asia increased negligibly. The depreciation of the yen reduced the Japanese incentives and its withdrawal from investment of its firms in East Asia. China re-adjusted the value of the currency that is the dollar verses the yen, and the East Asian exporters were challenged by the China's competitiveness. There was high expectation of continuation in the growth of export in Asia in which it would have facilitated protection of the currency devaluations. China's competitiveness posed threats to other exporters that had invested in Asia and the exchange rate could not sustain the stability. In terms of risks evaluation on the foreign loans, nothing was done upon it and the same problem accompanied the creditors of the exporting firms and they did not also factor in the importance of screening the risks. Diminishing of the growth in exports was observed and firms were left with a lot of risks exposure that rendered others to collapse (Johnson & Turner pp 45). While motion on the causes and consequences of the east Asian goes on, there is need to draw and learn more lessons on how financial liberalization and others to mention but a few can cause risks and the need for evaluation of each action. There is need for control over international finance otherwise if no proper action taken, the crisis will still recur. It is important to note that the East Asia financial crisis had also a great effect on the developing countries. "Growth is slower, risks are higher, and patterns and terms of trade and capital flows have changed", (http://www1.worldbank.org/prem/premnotes/premnote1.pdf. pp 1). In conclusion, it can be argued that it might not be important to apportion the responsibilities between the East Asian debtors, the international investors and the government in the issues of the financial crisis. However, to be successful in the global markets, the business organizations need to be able to integrate properly in the markets. It can be noted that in general, the international markets are not stable and "capable of creating boom and bust cycles and gyrations in exchange rates and asset prices, and real economic crises with far-reaching consequences",(Akyz, pp 14). These consequences have been mostly felt in the developing countries, even though the crisis was not directly in those countries. Works Cited . Agnor P, Vines D, Miller M, & Weber A .The Asian Financial Crisis: Causes, Contagion and Consequences, ISBN: 0521770807; Cambridge University Press, 1999. Akyz, Yilmaz. Causes and Sources of the Asian Financial Crisis, 2000, retrieved on 7th May 2008 from http://www.unctad-10.org/pdfs/hi_akyuz.en.pdf. Borthwick, M. Pacific Century: The Emergence of Modern Pacific Asia, ISBN: 0813334713; Westview Press, 1998 Director, Martin Khor, THE ECONOMIC CRISIS IN EAST ASIA: CAUSES, EFFECTS, LESSONS retrieved on 7th May 2008 from http://www.ifg.org/khor.html East Asia's financial Crisis, retrieved on 7th May 2008 from http://www1.worldbank.org/prem/premnotes/premnote1.pdf. International Monetary Fund Independent Evaluation Office. The IMF and Recent Capital Account Crises: Indonesia, Korea, Brazil, ISBN: 1589061888; International Monetary Fund, 2003 Johnson D & Turner C. International Business: Themes and Issues in the Modern Global, ISBN: 0415248892; Routledge 2003 Joosten, Wink. The Asian Financial Crisis in Retrospect: What Happened What Can We Conclude Mar 2004, retrieved on 7th May 2008 from http://ideas.repec.org/p/cpb/memodm/87.html Smith P H, Horisaka K & Nishijima S. East Asia and Latin America: The Unlikely Alliance, ISBN: 0742523764; Rowman & Littlefield, 2003 World Bank Staff. The World Bank Research Program 2001: Abstracts of Current Studies, ISBN: 0821350420; World Bank Publications, 2001 Read More