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Asian Financial Crisis
This research paper discusses the financial and currency crisis experienced in South East Asia at the beginning of 1997. The paper highlights the major causes of the crisis as intertwined in the International Political Economy (IPE). The paper further discusses the mercantilist theory as applied to the Asian Financial Crisis debate. Then, the paper reviews contemporary issues relating to the crisis. It assesses the role the IMF played in recovering suppression of the Asian countries. In the light of facts the paper reviews the aftermath of the crisis.
Asian Financial Crisis occurred in 1997. It affected almost all countries in South East Asia. It started in Thailand and spread to other countries. Thailand government was forced to allow the currency price to float. There was shortage of foreign currency to support fixed exchange rate. Thailand began swimming in a pool of foreign debts. The country was almost approaching bankruptcy.
The Asian financial crisis was caused by a number of reasons. Many countries had attracted foreign investors who flocked the countries prior to the crisis. They had prospected a high rate of return. They invested heavily in almost all the countries within the South Eastern Asia in uncontrolled manner.
This kind of investment made the countries to rely on their exports to sustain their economy. As a result, there were deficits of current accounts. In order to maintain fixed exchange rates, countries such as Thailand, Indonesia, Malaysia, South Korea and Taiwan were forced to turn to external borrowing. This exposed their economies into risk. During the same period, the US was recovering from a financial recession occurred in the early 1990s. The Federal Reserve Bank in the US started to raise the interest rates. In comparison to the prevailing conditions in South East Asia, investors were attracted to the USA. Many countries affected by the crisis pegged their currency to the US dollar. It became very expensive to export. Their economies suffered harsh conditions as competition became stiff. By 1996, export has been lowered. The asset prices started to decline at a very high rate. Individuals and companies were forced to honor their debt obligations with a lot of difficulties.
Money lenders began to panic and started to withdraw their credit from the Association of South Eastern Asia Nations (ASEAN) countries. These countries became unattractive to investors. In an attempt to protect their currencies from collapse they were forced to raise domestic interest rates. This was done in an attempt to build confidence for investors as well as to buy excess currencies using foreign reserves.
All these policies proved to be inefficient. It was impossible to sustain these measures since there was no political will from the government. On the contrary, the introduction of high interest rates continued to weaken many nations economically. It became difficult for them to defend their fixed exchange rates. All currencies started floating. The first one was the Thai baht which finally depreciated in July 1997.
ASEAN tried to intensify their cooperation in an attempt to safeguard and promote their interests. The region’s stock market was among the largest in the world. It started to shrink at an alarming rate, as compared to the US dollar. Sharp depreciation of currencies went beyond levels that could maintain export competitiveness. This meant that their real purchasing power had to fall eventually. Consequently, their economic growth kept going down. The continent’s GDP growth was far below 5.5% in 1997. In the previous year it had been 6.6% while by the end of 1998 it was only about 4.1%.
Thailand was forced to request IMF to offer technical support. The country had been hit by social unrest due to the rising prices of commodities, electricity, transport which had risen to unprecedented levels. Major cities and towns witnessed demonstrations, riots and looting. The Japanese yen was also not spared. China and other nations that had trade links followed suit. The intervention of the USA was aimed at interrupting the depreciation of the Japanese yen. Ryutaro Hashimoto, Japan`s Prime Minister was forced to resign.
Different historical perspectives have been raised trying to explain the causes of the Asian financial crisis. Many have attributed these countries` weakness in financial sector and economic structures as the main contributor. There had been robust growth and a moderate inflation in the countries prior to the crisis. An increase in asset such as land and stock has been witnessed since the second half of 1980s. This resulted to a rapid economic growth. Investors heavily borrowed from abroad.
The export revenues underwent sharp revenues by the mid-1990s. The main cause of this had been the fluctuation of the Chinese remnimbi and the Japanese yen. Major economic activities kept on slowing down. Asset prices for many nations suffered constant down turns. Thailand was most affected by the Asian financial crisis. This was attributed to pressure of the fall in the foreign exchange markets. Investors employed speculative measures causing currencies to depreciate further. This caused instability in stock markets, especially in 1997.
Poor economic policies and arrangements by the financial institutions have also been cited as contributors of Asian financial crisis. Banks and investors panicked and took speculative measures resulting to practicing maturity transition. Other intermediaries in the financial sector began to accept deposits with short maturity period. They obtained these deposits to help them get loans with longer maturity period.
The banks were determined to manage their portfolios in order to meet their expected withdrawals.This meant banks could not get enough liquid assets they required and this made it difficult to meet their obligations. Financial institutions in the South East Asia accrued huge amounts external liquid liabilities. However, this was not backed up by liquid assets. It increased panic. There was interruption of international funds flow resulting to some institutions becoming insolvent.
The Asian Financial Crisis has also been attributed to the absence of incentives required for risk management. Credit was also easily available to financial intermediaries. Some individuals and corporates were well connected and could fail to honor the government directions on loan acquisitions. This made the financial sector very vulnerable. Inflation began to affect major assets and resulted to the reduction of economic welfare.
Weakness in financial system in South East Asia resulted to financial crisis. There were numerous risky lending practices. Poor financial policies kept on escalating losses to investors. Uncertainty was always very high. The risky loans without taking precautions were not pleasant to investors who kept on speculating on the behavior of currencies. It became difficult for the governments to assure holders of domestic assets that they would be able to meet the demands of foreign currencies. Some countries had foreign exchange reserves that were larger relative to their short-term borrowing. This included Philippines, Taiwan and Malaysia. The countries were better placed when it came to providing assurance to investors. On the other hand, Indonesia, South Korea and Thailand had relatively low foreign exchange reserves. It is known that the governments of ASEAN countries had some difficulties in managing their domestic interest rates. During the crisis some governments run out of ideas.
The Asian financial crisis had adverse effects on many Asian and abroad countries. Regional demand for exports diminished. This was attributed to the collapse of the currencies such as the Thai baht and the Japanese yen. The Thai baht had been pegged to the US dollar but was finally freed in July 1997. It immediately fell by over 15%. By the end of the year, it had fallen by over 80%. The Singapore dollar was neither spared; even the other regional currencies followed the same path. They fully depreciated, for instance, the Indonesian rupiah fell by 70%, while the Philippine peso fell by 35% (Anis Chowdhury, Iyanatul Islam, 2001).
The stock and asset markets were badly hit by the Asian financial prices. The concerned governments had failed to take drastic measures. Private residential property market had signaled a likely prices but little was done. In the Asian region, banks were operating nonperforming loans that kept going on. These loans had set aside substantial provisions and collaterals to back those regional loans that exceeded the outstanding nonperforming loans.
The Asian financial crises triggered adverse economic shocks in such countries as Singapore. Singapore had laid some foundations to maintain strong economic fundamentals. Such included a healthy banking centre that was on viable status. The country had also adopted manageable exchange rate systems. Singapore also controlled banks involved in lending, using the Singapore dollar. At this stage we need to analyze the political situation in South Eastern Asia during the financial crisis. At that time Asia was characterized by intense political instability. Massive cabinet reshuffles were being experienced. Thai government had almost collapsed. Domestic political unrest contributed to fleeing of investors. There was a threat of regional labor unrest. The IMF’s plans to counter the crisis were not effectively addressed by the governments.
The Asian financial crisis that first had been a regional economic crisis of East Asia became a global problem in 1998. There was economic slowdown in many countries when recession on East Asia became widespread. The Japanese economy also deteriorated. China and HongKong were in threat due to competition in the entire Asian region. TheIMF bank forecasted a fall in the world economic growth, and the prices of commodities in 1997-1998 kept fluctuating and there was a slowdown in global economy. Mexico in Latin America witnessed fall in oil prices. Venezuela was also hurt due to the fall of copper prices; these two countries had a good trade link with East Asia but these factors led to decline of trade activities. Crucial commodity prices also depreciated. Russia experienced crisis as a result of prevailing condition in South East Asia. A lot of other countries in the world suffered the same risk.
Between August and September 1998, there were attempts to recover investors’ confidence. The US Federal Bank reduced the interest rates. This was in commitment to prevent global and domestic crisis. The government was also committed to support these countries so they can stabilize their conditions. They offered supplementary fiscal packages to help with the recovery of Asian asset market. The Japanese yen increased in value and China got out of the risk of devaluation in its currency. The IMF provided support through the emergency fund to help these countries in their recovery. Countries such as Indonesia, Korea and Thailand had to experience harsh economic condition throughout 1998.
Banks in the South Eastern Asia experienced stressing times as the competent with other financial institutions during their state of bankruptcy. They had increased the rates of their non-performing loans in order to capture the rapid race at which the competition was running. They severely cut credits to firms. The banks reduced corporate debts and provided firms with debts and mortgages and some firms became solvent due to this approach. There was a rapid recovery of investors1 confidence by the end of 1998. This led to a progressive recovery of the economies of East Asia.
Currencies that had depreciated such as Korean won, Indonesian rupiah and Thai baht started to appreciate. Real and nominal interest rates were moving to the levels that had been before the crisis and the international investors gained confidence as a result of the recovery. The governments started easing monetary policies and this improved the performance of the stock market. By the mid-1999, some results of economic recovery were witnessed in many countries.
GDP of Korea, Thailand and Malaysia showed positive growth in the beginning of 1999. Other nations in East Asia, including Singapore and Hong Kong, undertook serious economic policies and political measures that enabled corporations and banks to restructure. By the end of 1999, the risk of diminishing of world trade gained a significant outlook. There was deduction in interest rates in most countries that had been hit by the crisis. The IMF plans were executed in many nations and this helped in the recovery of economies. The recovery of other nations was experienced due to the improved conditions of the crisis hit nations.
During this time Indonesia was under authoritarian regime full of corruption. The regime did not honor commitments that had been agreed upon in 1997. Korea was approaching elections in December after the implementation of the first IMF plan. Thailand was not spared. The previous government was not committed to economic reforms. However, when the new government was installed, the value of bank started to stabilize. Due to this crisis the Asian foreign debt rose to the high levels and it was around 167 percent.
Increased competition among the countries that were affected by the crisis raised their level of efficiency as well as their level of economic systems. The crisis revealed that though liberalization is good it must be approached using appropriate market strategy. However, failure to do this may result in unstable financial system which would attract large costs. The Asian financial crisis can be termed as a process of market liberalization that was accompanied by ineffective supervision. Financial intermediaries were not regulated and this made the countries vulnerable to the crisis that arose. When we look at the Asian crisis we realize that the external or foreign investors contributed to it. They magnified the existing weaknesses in the financial sector of Asian countries.
The countries where the crisis hit required reforms in order to adopt liberalization, lack of political will caused the crisis to escalate to unmanageable levels. Their countries financial status suffered deficiency. They had opened their economic system to foreign competition. In Asia weaknesses of their financial sector would have been looked at and attended prior to the crisis. For instance, the government should have looked at the allocation of credit by both banks and financial intermediaries and put the necessary measure to curb the crisis. However, the government’s influence was limited due to the spread of corruption and authoritarian rule in many South-Eastern countries. In some countries government went ahead to guarantee high returns to investors. Thus, this imposed the standards of security markets that could not sustain such weak economies. There was limited bank supervision where financial policies which had been formulated proved to be ineffective. There was lacked transparency in the data that was disseminated by such banks and other corporations that would have assisted the government in taking precautionary measures.
The insolvency that hit majority of these countries ought to have been avoided. If politics were not involved, stability would have prevailed. However, the rising price of commodities made the citizens lack confidence in their administration, thus taking them to the streets to demonstrate riot and cause looting of properties. The balance of power between different classes in the crisis-affected nations would have been checked to avoid the crisis if there had been a good political will. Some leaders were forced to resign or call for early elections in their countries. The participation of IMF in the countries hit by the crisis helped to solve the situation. The IMF came up with plans, though the implementation plan by various governments was never executed as required. It helped to restructure financial markets of the countries hit by the crisis. It faced a thorny task in enforcing its standards in attempt to recover the economy of these countries.
The Asian crisis presented important lessons to many world countries. For example, measures to prevent accumulation of large stock of a foreign currency should be given a high priority. Measures should be taken to control the magnitude and maturing required addressing the mismatch of assets and reliabilities of a country’s financial institutions including corporate firms. External short term borrowing should also be discouraged. This is possible by use of prudent regulations to govern the borrowing and lending in the financial sector of any country. Therefore, high reserve requirements should be encouraged when dealing with foreign currency to limit opening foreign currency to a country’s economy. These should be applied to banks and nonbank financial institutions as well as nonfinancial firms.
Regulations should also be put in place to focus on banks that will control their activities regarding capital inflows and reducing foreign inflows. The Asian financial crisis also involved currency crisis. Currencies such as Thai baht and Japanese yen among many other depreciated and eventually they were floated. It is necessary for any state to control private investors as well as to take measures to discourage capital flows. We observe from the Asian financial crisis the necessity of setting incentives for domestic financial institutions where banks fail to honor prudential government regulations.
By the end of 1998, all South East Asian countries required to strengthen their financial institutions to increase their GDP and recover from the economic hardships. There was urgency to solve fiscal problems experienced by suppliers and money lenders. The recommendations of IMF were necessary to bailout the countries from the financial crisis. It made fiscal recommendations that initially faced a lot of criticism but were later reconsidered. Confidence had to be restored to investors by invoking any necessary measure. The South East Asian countries adopted flexible approaches to get out of the crisis. Adjustments were made in the current account resulting to a fall in domestic demand and fiscal deficits.
In the aftermath of the crisis, the affected countries as well as the international community had to face a trade-off of the benefits of implementing the restructuring policies and the cost of choosing plans using limited information. The benefits consisted of measures aimed to avoiding a further deterioration of the financial and economic hardships of domestic private corporations and their access to capital market. Close analysis of structures of incentives reveals that the Asian 1997 meltdown revealed how corporate and financial institutions and the region worked. Over lending in Asia contributed to the crisis in several ways. There was an upward trend to the private sector lending ratio. Philippines leading was followed by Thailand, Malaysia, Singapore, while there was least lending in China. Financial deregulation contributed to the emergency of new financial institutions different from the banks. An example was the finance companies in Thailand. They played a vital role in the lending boom. These non-bank financial institutions played the role of commercial banks in black market system. As a consequence, the fiscal policy authorities lost control of both the monetary and fiscal policies.
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