Financial Liberalization in Emerging Economies - Coursework Example

Financial Liberalisation in Emerging Economies page Declaration Acknowledgements Table of contents Introduction: Asian Financial Markets - an Overview Research Studies: Financial Liberalisation in Asia Asian Regions and Financial Crises- Evidence from Specific Countries Risks and Solutions of Financial Liberalisation The Future of Asian Markets: Conclusion Abstract In this analysis, we discuss the impact of financial liberalisation policies on the Asian economy taking the cases of China, Japan, Malaysia, Taiwan and other Asian countries. The various factors that determine financial policies, the consequences of financial liberalisation and the risks associated with open market systems are discussed. The emphasis is on drawing a relationship between financial liberalisation and the Asian financial crises of 1997-98 to suggest that the financial crises may have broader implications and wider lessons for developing economies such as in Africa. The Asian financial crisis analysis exposes the risks and also suggests solutions to problems of a liberalised economy. The factors responsible for financial crises are highlighted in this study. Introduction: In this analysis of financial liberalisation in emerging markets of economies of Asia, we will concentrate on the business opportunities and changing economic scenario of Asian markets. The case of Asian markets such as China, India, and Malaysia will be considered and an analysis will be done to suggest why and how Asian economies seem to be more successful in adapting an open free market policy and how this has affected the global economy. The Asian business context and its lessons to the African countries could be examined considering the pros and cons, the risks and opportunities of financial liberalisation (also in Baharumshah et al, 2003). We will discuss how some countries shielded themselves from financial crises and what are the advantages and disadvantages of globalization and a globalised economy. Asian Financial Markets - An Overview Efficient and growing financial markets are capable of allocating resources to investors and sellers. Financial markets evolve over time and can reduce possibilities of instability in the economy. Asian financial markets consists of the whole gamut of Chinese, East Asian and Japanese economies and these are considered either as industrialised countries or emerging economies and are studied in the context of financial crises or financial liberalisation policies and their interlinking dynamics (Anuruo et al, 2002; Baharumshah et al 2003). Financial analysts tend to examine the evolution of Asian financial markets that can support its growth to full potential. Financial liberalisation policies seem to have added an international dimension to the structure of the financial system from the banking sector to the domestic market base. The Asian markets have shown large flows of capital and have been a model of integration of emerging economies although there are downsides to liberalisation as seen in high volatility of markets and competition to domestic businesses. International financial however has its advantages as it promotes an open economy, gross capital flows and implies a shift to a flexible exchange rate. Considering the factors that accompany financial liberalisation, the economic crises of the Asian economies could be discussed in perspective. The severe East Asian economic crisis in the late 1990s affected the domestic economy of several countries and led to banking failures and a fall in GDP. However by the late 1990s, the situation improved and production and consumption recovered. The main reasons of the crises were recognised as weaknesses of the corporate and financial sectors along with macroeconomic vulnerabilities and the banking and financial systems were revamped with reforms to end the crises (see Erturk, 2003; Gilpin 2003). This included improvement of banking regulations and supervisions, stricter control of institutional frameworks and promoting financial market transparency. Apart from the domestic factors that were identified and responded to for overcoming the crises, the international market being an integral part of the financial outputs, international capital flows were also considered. China has made significant progress with a strong financial system in place, especially after the introduction of the China Banking Regulatory Commission (CBRC) that is involved in the regulation and supervision of financial institutions. The financial liberalisation has necessitated the consideration of an international dimension of the domestic market and economy. Participation in a global economy as brought advantages and opened up the domestic market for Asian countries but it has also brought in additional pressures to find the right balance between domestic growth, financial intermediation and international financial liberalisation (Padoa-Schioppa, 2004). The Asian financial liberalisation phenomenon may be in some ways similar to European growth model that had become increasingly export oriented by the late twentieth century. Japan was quick to follow this model and developed and exported its technological products and rapidly became an emerging market and one of the most technologically advanced countries. Following the post-war era, around the mid-1960s the other Asian economies especially China became rapidly industrialised. A flexible exchange rate, growth of the domestic markets, and improvement of financial institutions seem to be some of the associated factors affecting a liberalised economy in the Asian markets. In the next section we discuss several approaches to research and studies on the changing Asian markets, the impact of liberalisation and the consequences of crises considering published reports and papers. Research Studies: Financial Liberalisation in Asia Several research studies on the general phenomenon of financial liberalisation and specific market conditions in Asian economies such a Singapore, Taiwan, Japan, china, Malaysia, India and Hon Kong could be compared to understand the similarities and differences of liberalization issues and effects in all these countries. The common issues that affect all the Asian countries, the crisis factors and the specific economic issues of each Asian country are considered in perspective. Rajan (2005) has explored the dynamics of Asian economies following the regional financial crises of 1997-98. He highlights the need to identify alternative liberalization paths and in this context suggest the relevance and importance of 'new regionalism' or new regional trade agreements (RTAs). The proliferation of bilateral and pluri-lateral trade pacts in the Asia-Pacific regions has been examined critically in the context of concerns as to whether such trade agreements facilitate or hinder multilateral trade liberalization. Dent (2003) also analyses trade agreements in the context of emergence and expansion of the Asia-Pacific bilateral free trade agreement (APBFTA) projects from 1990s. He mentions that 13 Asia Pacific states had either started or completed 35 such APBFTA projects since these were introduced. The reasons for introduction of these bilateral trade agreements seem to be a direct result of the confluent trade institution failures of the Asia-Pacific Economic Cooperation (APEC) forum, the World Trade Organization (WTO) and the Association of Southeast Asian Nations' (ASEAN) Free Trade Agreement (AFTA) to promote their trade liberalisation agendas after the 1997-98 financial crises. The APBFTA seems to have been taken up by many states and there are strategic purposes identified for which these agreements were made and trade projects implemented. The APBFTA seem to have had a major impact on the political economy of the Asia Pacific region with deals to implement micro networks and macro networks. Dent concludes that 'a bilateral-to-pluri lateral evolutionary progression of the APBFTA phenomenon could lead to a new 'lattice regionalist' form of economic integrational development in the Asia-Pacific' (2003, p.15-16). Thus the new trade regulations and agreements following the Asian financial crisis could just be instrumental in forging ahead a new era of regional development for the Asia Pacific. The role of trade agreements seem to be one of the factors that could be considered as crucial to international trade and financial liberalisation of Asian economies and consequent development, although there are issues of institutionalised control and volatility of markets. Erturk (2005) has argued that economic volatility has increased drastically with financial liberalization. The increased volatility has been explained by governmental inadequacies and problems with market regulations. Yet Erturk claims that Government overspending could be considered as the central reason for financial crises in Asian economies. Capital flow reversals became an important issue in the analysis of the Asian financial crises although the emphasis is largely on government deficits and Erturk bases his arguments on the claim that economic volatility is not explained by moral hazards or market distortions but by Government overspending. With the financial and capital account liberalisation two factors that can be discussed within the macroeconomic framework include liquidity preferences associated with currency substitution that destabilises bank credit systems; and asset prices that become increasingly predictable causing destabilising by speculations of foreign investors and profit seeking capital flows. Edwards et al (2003) have analysed the relationship between stock market cycles, financial liberalisation and volatility. The cycles of stock markets were analysed in the study including four from Latin America and two from Asian countries and these were compared. The financial liberalisation processes of the early 1990s were studied to show that cycles in emerging economies have shorter duration and larger amplitude and volatility than in developed countries. Edwards et al suggest that following the financial liberalisation Latin American stock markets have behaved more like developed economies whereas the Asian countries have shown different trends with higher volatility and less stability in market conditions. This suggests the rapid changes across Asian financial markets and the particular changes affected after financial liberalisation exposing the risks and opportunities of emerging economies. Wolf (2004) has focused on the role of the World Trade Organisation (WTO) and the International Monetary Fund (IMF) highlighting the valuable functions performed by these organisations. Wolf considers the criticisms and the praises of the WTO and the IMF analysing the role of these organisations in resolving financial crises situations as in the case of the Asian crisis. Although Wolf suggests that the WTO could be improved it seems to be essential to maintain a balance between the developed and the developing world. The criticisms against the IMF are also considered as exaggerated although the IMF has made some major mistakes in the promotion of capital market liberalisation prior to the Asian financial crisis (Wolf, 2004). Wolf sugests the possibility and necessity of creating new institutions to cover investment, migration, taxation, and the environment. Although the WTO and the IMF perfom the essential functions of advising economies in period of crises and aids with debt situatsion, there are several related issues that may have to be handled better for the growing economies and these existing organsations may not be equipped structurally to do this. Lin and Swanson (2004) discussed the Asian financial market crises considering the relationship between international equity flows and equity market returns for the eight largest emerging Asian markets. Their study focuses on four findings such as (1) minimal evidence of feedback trading, (2) identification of information dissemination for four of the eight countries with effects being short-term rather than long-term, (3) minimal evidence of significant volatility effects or significant crisis effect under feedback trading, and (4) strong evidence of significant volatility effects and significant crisis effects under information dissemination. The paper concluded that their findings suggest that there are significant crises effects under information dissemination which seems to play a greater role in crises situations than feedback trading. Willet et al (2005) have examined the various possible causes that may have led to the fincial crises in Asia. The various hypotheses and evidence for the Asian crises has been analysed and the paper suggests new evidence or casues of the crises. These may be included as high rates of credit expansion low ratios of international reserves to short-term debt substantially appreciated currencies large current account deficits and all these factors seem to have important role in the crises. There has also been a pre crisis over optimism on banking industry and financial markets performance and there was little or no premonition of an impending financial debacle. The limited flexibility of exchange rates, were also identified as causes of hazards and the impact of financial liberalisation was seen as perverse and negative. Although this may not reflect the real long term impact of the liberalisation policies, the Asian financial crises definitely necessitates a re-evaluation of liberalised market economies. Asian Regions and Financial Crises- Evidence from Specific Countries Considering specific cases and countries that have been affected by the financial crises, Amess et al (2001) discuss the relations between financial crises in South Korea and the policies of financial liberalisation. Amess performed a survey on the IMF and World Bank officials and the South Korean economists to determine the causes of the financial crises in South Korea. The survey revealed that over optimism and delayed or inadequate recognition of financial risks led to excessive and unnecessary risk taking by the South Korean financial intermediaries. Optimistic assessment of the Asian economies was found among the financial analysts of the media, World Bank and the IMF. However weaknesses in risk management were seen as the major cause of the crises and these weaknesses resulted from a lack of expertise in handling risks associated with capital flows, and lack of experience in managing risks because of a history of successful safety measures practised by the government that protected the industry and banking sectors until now. However financial liberalisation expanded the horizons of activity and risk taking and new risks came to the fore for which the industrial or banking sectors were not completely prepared. Liberalisation allowed lending opportunities to companies outside Korea and increased risks but also created intensified competition and eroded bank franchise values. The weaknesses in prudential regulations increased risks for markets and led to the liquidity crises and according to Amess this triggered a full blown financial crisis by the end of 1997. Japan's foreign economic policy has been discussed by Krauss (2004) and the paper mentions that Japan has gone through some crucial changes in the past decade which is reflected in the shift from US-Japan bilateralism to regional multilateralism; and extension to regional bilateral free trade agreements. These shifts in foreign economic policy seem to reflect Japan's wider purposes and goals. Krauss analyses the effects of American policy changes and developments of the US Japan relationship that have led to the pattern of developments in policy shifts for Japan. He uses a strategic interaction theory to suggest that there has been continuity in Japan's foreign economic goals in the post-war period. After the East Asian financial crisis, and debacle of trade liberalisation in APEC, Japan seems to have used a multi-tiered range of trade alternatives to advance a goal of maintaining the US military shield and promoting its own economic superiority in the region with strict policies and regulations. The case of Singapore may be distinctly different as an emerging and very successful economy that has successfully transformed an island state into one of the global destinations of foreign investments. Low (2001) argues that there has been a lack of good corporate governance since the Asian crisis in 1997and to avoid the next financial crisis, economic and corporate reforms and financial restructuring may have to be implemented. Singapore seems to stand out among Asian countries as being free from corruption, nepotism or dubious government spending that can lead to financial crisis situations. Singapore has remained committed to establish a developed state delivering homes, jobs, education, welfare and security since 1959 and the tradition of clean governance has continued since then. Low examines the resilience of the developmental state model that the Singapore government seems to have followed considering the globalized environment with information, communication technology (ICT), knowledge-based economy (KBE) and hyper-competition. The efficiency of the economy along with effectiveness seems to have affected the socio-political values, culture and behaviour. Low questions whether Singapore could reinvent itself economically without political reforms and yet meets the challenges of affluences, culture and democratization as well as the impact of technology on society The exact equation between political control and reforms and economic liberalisation seem to be crucial in defining the success of the developmental state model on which Singapore's foreign economic policy is largely based. Foreign economic policies have direct impact on the political economy and social milieu of a region and Singapore seems to be an important example in which the developmental of the state rather than a crisis situation seems to be the crucial point of economic analysis. Taking up the issues of difference between countries in implementing financial policies, Thurbon (2001) have showed the difference between financial liberalisation policies of South Korea and Taiwan. Thurbon points out that the Asian financial crises of 1997 have reopened a long standing debate on the relationship between financial liberalisation and financial crises. This debate that tends to establish relations between these two economic issues seem to have two distinct viewpoints. On the one hand the crisis is viewed as a result of insufficient financial liberalisation as in state controlled economies. On the other hand financial crisis has been seen as a result of excessive financial liberalisation with increased exposure to volatile capital flows as the primary cause of crisis. Thurbon argues that questioning whether too much or too little financial liberalisation may be ultimately responsible for financial crises overlooks the fact that there are several explanations to liberalisation. Thurbon claims that the question that should concern financial analysts is that 'what kind of liberalization can deliver the benefits of access to the opportunities of the 'global' marketplace whilst still maintaining the domestic foundations for economic growth and stability Thurbon draws upon a comparative analysis of South Korea and Taiwan to show that liberalisation can serve as a tool for economic growth and stability and need not always be interpreted in terms of financial crises. Cargill and Parker (2001) performs a case study on financial liberalisation effects in China and point out that China has used the Japanese financial regime as a model to reform old socialists banking institutions of China. This new adopted model from Japan seems to be effective for the Chinese banking industry although such adaptation can lead to serious economic problems as seen from the Asian financial crises and the related problems and consequences of the liberalisation. Despite China's strengthening economy, the Asian financial crises could present a few lessons on economy which would be useful not just for China but all other Asian countries. The Asian financial crises and the financial liberalisation policies seem to be related in several ways and both the issues relate to the changing Asian economy so the various factors identified in the Asian crises could be summarised as follows: 1. Volatility of the market conditions 2. Rapid changes in the economy 3. Inflexible exchange rates 4. Improper banking and industry regulations 5. Corruption and nepotism 6. Overspending by governmental authorities 7. Unpredictable capital flows 8. Lack of risk management strategies 9. Over-complacency on previous safety nets 10. Lack of an updated technical infrastructure within industry settings Financial liberalisation and an open market policy could be seen in increased mergers and acquisitions, increased competitiveness , updated information technology systems to compete with globally set standards, increased risks of lending, greater opportunities for both the domestic and international markets and long term economic growth of the country or region leading to stronger economy. However financial liberalisation and open market strategies do come with its own risks as exemplified by the Asian financial crises of the 1990s. Risks and Solutions of Financial Liberalisation One of the changes during the financial crises of Asia seems to have been focused on reforming the banking industry and introducing technological advances and administrative changes at the financial sectors and institutions. Mergers and acquisitions have been used as a method of reform in the banking industry and a study by Shanmugam and Nair (2004) relates to such mergers in the banking industry of Malaysia. Shanmugam and Nair write that globalization, liberalization and information technology developments have necessitated more competitive, resilient and robust financial systems in Malaysia. The need for an upgraded financial sector became all the more prominent after the Asian financial crisis of 1997 and this contributed, according to the authors, the rapid mergers and acquisitions process in the Malaysian banking sector. The financial crisis changes the entire banking industry in Malaysia and resulted in the formation of ten anchor banks from a total of 54 financial institutions by the end of 2001. The 1997 financial crises thus not only had economic impacts but brought in administrative and industrial changes within the Malaysian industries that seem to have widespread and long term consequences. Cargill and Parker (2002) have discussed the trasntion costs of fianicla liberalistaion by suggesting that brnakruptcy may [lay an important role in the alloctaion of cpaital and forms as a key distinction of the state diretced fiancila regimes of Japan, South Korea, and many other Asian economies. The paper focuses on the development of the Japanese banking system and how this has been used by the Chinese banking industry as well and the comparison that could be drawn with the American banking industry. The authors argue that the bank finance model used in Asian countries is based on minimization of bankruptcy risks. The paper evaluates the transition costs of switching from a state-directed to a market-directed financial regime and their simulation results suggest that the market approach results in a higher long run growth path as inefficient firms are eliminated through bankruptcy. Switching from a state directed to a market directed regime can be very expensive to an economy and transition costs are however lowered with liberalisation policies. The Future of Asian Markets: The UNCTAD has advised developing countries, emerging markets and transition economies to maintain flexibility of measures dealing with inward and outward capital flows. The WTO has advised the Asian countries suffering from crises that solution to crises measures would lie in greater financial liberalisation along with prudent regulations of financial systems (from UNCTAD caution, retrieved 2005). However all important world financial bodies recognise the differences in market conditions between each Asian country although financial crises may have some common causes of high debts, current account deficits, poor banking regulations, overvalued currency and lack of financial regulations (UNCTAD, retrieved 2005). To increase global competitiveness, Asian countries and manufacturing markets have been advised to diversify manufacturing base and upgrade technology. The help of IMF has been recognised as fundamental in aiding the debt stricken countries with weakening economy. The volatility of internal capital flows have been considered as causing disruptive effects in the global network of financial markets although Asian countries have responded to these effects by achieving support from central banks and financial institutions (UNCTAD, retrieved 2005). The need for a flexible market has been emphasised by all financial bodies and analysts although there is a general apathy to draw generalisations on Asian economies as the financial situation, flexibility conditions and open market policies and practices seem to vary considerably between one Asian country and another. Asian markets are definitely competing at a large scale within the global economy and countries such as Japan, South Korea, China and India are already counted as the growing economies with possible major economic contributions within the next few decades. In fact Asian economies and emerging markets are even seen as strong competitors of the western economy and can even overthrow economic supremacy of the West by the sheer number of consumer base and skilled labour available in these economies. Considering the tremendous growth of Asian economies and the relative stagnant position of the western economies, the African countries may have something to learn from the rapidly changing transition cultures. CONCLUSION: The Asian financial liberalisation taken up by most countries such as China, Japan, Singapore, Malaysia, India, South Korea and Taiwan among others has bee discussed in some detail suggesting the relationships between financial crises and financial liberalisation policies. As we have indicated, the relationships between financial liberalisation and financial crises may not be too evident as liberalization could be described in many ways and the result of liberalisation seems to vary from one country to another. The factors affecting crises situation and the consequences of liberalisation have been summarised to understand the dynamics of economic growth, and policies that seem to have affected and continue to affect most Asian economies. The Asian economic policies, financial liberalisation and open market systems may finally have a few lessons for third world countries like in Africa which have not yet started the process of developing as rapidly as Asian countries. The need to follow the Asian example to become industrial giants like Japan and China may not be urgent, but Africa needs to take stalk of the rapid growth in Asian economies and possibly follow liberalisation as a route to their own future growth and a prosperous trade policy. 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