1997 Asian Currency Crisis Main

1997 Asian Currency Crisis

Main explanations of the 1997 Asian currency crisis:

The Asian currency crisis started in two phases of currency depreciations which were underway since the initial part of summer of 1997. The first round was marked by a steep decline of the Thai Bhat, the Malaysian Ringgit, the Philippine Peso and the Rupiah of Indonesia. Following the stabilization of the currencies, the second round set off with downward pressures hitting the Taiwan dollar, Won of S. Korea, Singaporean and Hong Kong Dollar. The governments of these nations had countered weakness in their currencies through the process of selling foreign exchange reserves and raising interest rates that in effect rendered economic growth sluggish and have made interest-bearing securities more appealing compared to equities. The currency crises also brought to light acute problems within the banking and financial sectors of the burdened Asian economies. (Nanto, 1998) distinctive characteristic of the currency crisis has been the assortment currency banking and debt crisis. Banking crisis, in the shape of huge nonperforming loans -- NPLs, banking insolvencies or near banks, low capital adequacy ratios -- CARs, or also outright runs on individual banks or other non-banking financial intermediaries was especially acute for east-Asian economies like Thailand, Indonesia, and S. Korea. In Japan, a long-lasting banking crisis was replete since the bursting of the bubble economy during 1990 which is yet to fully resolve. The Hong-Kong dollar in the first place had to bear the onslaught of the Asian crisis with the banking system getting affected. (Jao, 2001, p. 47)

On the same lines, the Indonesia Rupiah went down 25%, creating it to be the worst-functioning currency as it got reduced to abysmal standards from the time the crisis evolved in 1997-98. In the same manner the concern brought about a ripple effect through Southeast Asia. Since March 1997, the bhat fell 6.5% and the peso of Philippines by 9.5%. Bank of America's analyst termed the turmoil as a 'slow motion' currency crisis. The main reason ascribed is the political uncertainty along with the economic problems that are specific to each nation. During the height of the currency crisis, there were dangerously increased standards of foreign debt which were short-term and economic mismanagement which was serious enough that compelled a foreign investors' exodus from the complete area in large numbers and majority of the investors never returned. It is truer in case of Indonesia in particular. In that particular country corporations holding on to foreign-based debt becoming due has been in the process of trading rupiah for the purpose of greenbacks. In Thailand for instance, in spite of the rise in exports-based growth, consumer spending in domestic terms is 20% off the pre-turmoil standards. Non-functioning loans continue to constitute 36% with regard to the overall debt. Plus, the foreign debt has been calculated to be a whopping $90 billion. Although weak currencies support exporters, equity investors are scared, who do not want to view stock holdings decline in terms of failure of the currencies. The Thai index was from then reduced by about 42% in U.S. dollars. The Indonesian currency was also reduced by 43%. (Einhorn; Shari, 2000, p. 11)

Several Asian governments made substantial investments in specific targeted industries, decisions that sometimes invested into sectors that were not profitable. In S. Korea for instance, companies borrowed heavily and started accumulating huge debts in order to finance in such mature industries like electronics and steel. When the fortunes of these industries turned worse, it triggered a bout of corporate failures inclusive of the bankruptcy in January 1997 of the conglomerate Hanbo that had a $6 billion in debt. In July 1997, the crisis prolonged with Thailand allowing its currency to float freely causing panic in a lot of neighboring nations. For an export-dependent Asia, the situation of a devalued baht implied cheaper Thai exports as against those from Malaysia, Indonesia, Korea, Philippines and the Hong Kong. In order to remain competitive, a lot of nations devalued their own currencies which automatically heightened the debt owned by those companies whose loan contracts made an obligation to devalued local funds to repay in foreign currencies that were still strong. (Ito, 1999, p. 7)

Getting to the facts in understanding the crux of the problem, 1997 was a year marked by an economic slowdown in Asian economies. Average GDP growth had slipped from 8.2% in 1995 to 7.5% in 1996 and still more to 6.1% in 1997. Similarly, the growth of exports had come down from 19.2% and 21.6% during 1994 & 1995 respectively to 4.3% & 6.7% in 1996 & 1997 respectively. Within April 1995 and April 1997, the Japanese Yen came down by almost 60% against the dollar seriously eating into the price competitiveness of these economies in world markets. As a lot of Asian currencies were closely pegged to the dollar, their currencies went up in tandem with that of the dollar. By 1997, the dollar underwent a serious overvaluation similar to the currencies of those Asian economies which had persisted to appreciate with it. The Asian economies had drawn large capital inflows during the 1990s that was responsible for currency appreciations. In order to maintain the competitiveness of their exports, these economies made an all out effort to keep their real effective exchange rate -- REER from rising. (Das, 1999, p. 3)

In this pursuit, they tweaked some of their policies. For example, these policies broadened interest rate differentials that triggered the crisis which resulted soon after. The heavy capital inflows were mostly in the shape of short-term debts denominated in the currency of the lending nations, especially the Yen and the dollar. During the sharp decline of the valuation of the Asian currencies, this came to be an important constituent of the problem of the Asian economies. The domestic currency values of their external debt went up sharply. Besides, Asian companies wee unable to generate sufficient local currency to be capable enough to convert it into foreign exchange resources in order to fulfill their debt repayment needs. (Das, 1999, p. 3)

The five main causal factors are easy to locate (i) first, the past economic success of these Asian economies were easy targets for good locations for FDI. (ii) Secondly, several elements in their external economic environment which were earlier conducive, later did not find enough favor in a lot of respects during 1996-97. (iii) Thirdly, restrictions were imposed and inconsistencies in domestic macroeconomic and exchange rate policies. (iv) Fourthly, the economies had weak and vulnerable financial sector that included weaknesses in the institutional mechanism. (v) Fifthly, their economies were laid with structural weakness and defects in corporate weakness inclusive of nepotism and rampant red-tapism. (Das, 1999, p. 4)

Apart from the above five main factors, the most important intangible, market sentiment, contributed in a decisive manner in ushering the crisis to a forefront and in building the corruption effect. It is worthwhile to state that regardless of the huge current account deficits, the macroeconomic state of affairs in these countries were far from unstable during 1997. The heart of the crisis lay in the banking sector because of the unsystematic growth and diversification within the domestic financial markets financed through short-term private borrowings. Besides, the other factor that was responsible for the currency crisis is the speedy rise in private capital flows to Asian economies during the initial and middle part of the 1990s that was the slowdown in asset yields in the industrial economies. Comparatively weaker GDP growth in a lot of industrial economies at that period was responsible for the accommodative monetary policies and abysmal interest rates. (Das, 1999, p. 5-6)

Lower asset yields in industrial nations rendered emerging markets in general and Asian nations in particular, a rising attractive investment proposal. This showed in a close narrowing of yield spreads for the Asian economies, representing a rising choice among asset holders for investment in these countries. Apart from that, the risk premium narrowed down in asset markets, symbolizing a rising eagerness to accept risk by the wealth holders. This was the outcome of the wish to diversify their portfolios as also as enhanced confidence in the performance of the emerging Asian economies. (Das, 1999, p. 6)

Implications of the crisis for the Asian economic paradigm:

The Asian currency began and snowballed suddenly, when Thailand faced problems while maintaining its currency exchange rate during July 2, 1997. From then onwards it spread like a wildfire to other nations of the East-Asian region catching up with S. Korea and Japan as well. The crisis went down in history as the one of the most important events towards the end of the 20th century. As regards its timing and extent, the heavy impact it put has been borne into the 21st century. The collapse of the Asian current was interalia fueled by overinvestment in production capacity which was more than the domestic demand of the nation. The idea that exports would take care of the overcapacity definitely was wrong footed. Presently, Asian companies are needed to make and sustain real changes within their businesses in order to remain competitive. (Richter, 2002, p. 126)

The Asian currency crisis put a heavy toll on the Asian economic paradigm sweeping across economies of Singapore, Taiwan and Korea. For instance, the implication of the regional crisis on Korea has been acute. It was compelled to approach the IMF for emergency credit and received $57 billion aid package with 7.5% of the Korean employable people without jobs by July 1998. Labor problems surfaced across the nation and the economy went limp by 5.3% during the initial half of the year. The Asian currency crisis caught everybody unaware particularly those who visualized Asia crafting for itself a new road to capitalist development. After all, the crisis put its highest impact in some of the economies which were earlier commended as part of the Asian economic miracle. This is especially true of Thailand, where the crisis struck for the first time. The then Prime Minister Chuan Leepai acknowledged that the nation has fallen. The social outcomes of this will be acute and have triggered a process of de-development, wherein a lot of the income and other benefits of the better periods are in jeopardy due to the looming recession. Till the middle period of 1998, when the Asian financial crisis shaped in a recession and, then appeared like a crisis of global capitalism and the causes were misalignments, weak F.I.s, decline in exports and 'moral hazard'. (Robison; Beeson; Jayasuriya; Kim, 2000, p. 83)

Next it was Thailand's turn where the recently ongoing perception of its emergent economy and its "good" management practice underwent a radical change during the beginning of the Asian economic crisis during 1997. Thailand's economy went into disarray. There was a collapse of the exchange rate after the decision to float the currency in July 1997 and IMF agreed to be the savior. This resulted in the breakdown of the overall confidence of the nation's economic institutions. Every industry witnessed a significant decrease in volume of output. (Richter, 2000, p. 131) view held in that there was nothing intrinsically incorrect with the East Asian economies that have been traditionally faring exceeding well. These economies experienced a surge in capital inflows to finance high yielding investments that rendered them vulnerable to financial alarm. That alarm coupled inadequate policy responses fueled a financial crisis across the region and the economic disruption that came after that. Besides, the economic shocks were not followed by normal cyclical downturn, however some ascribe as 'runs' on the financial systems and currencies. These runs displayed a classic financial alarm which did not show poor economic policies or institutional arrangements. Since it is properly known that even well-managed banks or financial intermediaries remain vulnerable to alarms, since they over the years remain occupied in maturity transformation. This means banks accept deposits with short-term maturities for instance three months to finance loans having maturities of longer period for instance a year or more. (Moreno, 1998, p. 25)

It is important to note that maturity transformation is good as it is able to make more funds available to productive long-term investors compared to what they would otherwise get. Under normal circumstances, banks do not experience problems while managing their portfolios in order to meet expected withdrawals. It has been pointed out by Radelet and Sachs in 1998 that the East Asian FIs has incurred a considerable amount of external liquid liabilities which were not completely backed by liquid assets, rendering them susceptible to panics. Because of this maturity transformation, some otherwise solvent financial institutions might definitely have become insolvent as they were not able to deal with the abrupt interruption in the global flow of funds. (Moreno, 1998)

The Asian threshold limit for very high levels of debt, in some instances as much as five times equity is no more wanted or sustainable in post-crisis scenario where the identical measure of international companies would be upsetting at debt of two times equity. High private sector debt levels rendered the whole economies vulnerable to collapse since their short-term creditors were alarmed as their domestic medium-to-long-term financial intermediaries continually nurtured non-performing loans till they were decently given the face-saving chance to enforce central bank closure. Till equity markets replace debt markets as a competitive source of funds, levering up will continue to be the main mode of finance in Asia, although the things financed are smaller and less diversified in their operations compared to the onset of the financial crisis. Dependence on debt militates against wealth creation is construed in the Western nation as maximizing shareholder's wealth at the expense of other stakeholders. Dependence on debt also flourishes on relationship, confidence and extremely privileged information. However, it is by its very nature, not transparent. (Bush, 2005, p. 38)