Asian Financial Crisis of 1997

Before 1997, Asia attracted almost half of the total capital inflow into developing countries

High interest rates attractive to foreign investors

Asian economic miracle : 8% –12% GDP in the late 1980s and early 1990s

Dramatic run-up in asset prices - A bubble fueled by "hot money"

Early 1990s, U.S. economy recovered from a recession

Fed raised U.S. interest rates to head off inflation

This made the U.S. a more attractive investment destination relative to Southeast Asia

Thailand, Indonesia and South Korea had large private current account deficits

Excessive exposure to foreign exchange risk in both the financial and corporate sectors

Domino effect started from Malaysia

1997

Why did it happen ?

Economies Affected

Presented By

Asian Financial Crisis

Mohit Agarwal

Prateek Batra

Sanjeev Marwah

Anupam Mukherjee

Yogesh Sharma

Anshul Verdia

N. Sandeep

Bharath H.

Over-Dependence on Short-Term Foreign Funds

Backdrop to the Crisis

1. Domestic banks seeking foreign funds from the West to finance the lending. Motivated by profit

2. Took advantage of fixed exchange rates in order to reduce the cost of this borrowing.

3.Short-term nature of the foreign debts - need for the bank’s accounts always to be liquid.

4. Existing loans collateralised with stock/property assets were already failing.

5. Banks financed (sometimes with official guidance) corporate investments, focused on increasing market share. Inadequate attention to the returns generated

Causes

Poor Regulation of the Economy

1. Absence of an adequate regulatory framework for businesses, especially the banks - Chaebol

2. Crony capitalism

3. Politically influenced lending encouraged the channelization of international borrowing to corporations

• Banking sector burdened with non-performing loans
• Aggressive expansions by corporates but not enough returns and profitability
• Conglomerates controlled by the govt. absorbed more and more capital investments
• Downgrading of credit rating of South Korea
• From A1 to A3 on 28th Nov’97
• From A3 to B2 on 11th Dec’97
• Negative Investor sentiments in stock markets
• Seoul stock exchange fell by 4% on 7th Nov’97
• Plunged by 7% on 8th Nov’97 (biggest one-day drop to that date)
• Another fall of 7.2% on 24th Nov’97 due to anticipation of tough reform demands by IMF
• Automobile sector in dire straits
• Kia motors on the verge of bankruptcy later taken over by Hyundai motors
• Daewoo motors sold to American giant General Motors

Over-Inflated Asset Prices

• Unrealistically high asset values in most of the South East Asian countries.
• Excess credit - fueled speculative booms in real estate, factories and the stock market

Macroeconomic Policy: Fixed Exchange Rates

• Decision to unofficially fix the value of their currencies to the dollar
• Indirect currency appreciation post 1995 – Decrease in exports

10 year timeline

1985 - Plaza Accord - Yen moves from 240 to 120 against dollar

1989-90 - Japanese markets peak

1994 - Mexican crisis

1995 - Japanese yen peaks to 80

1996 - Japan introduces VAT, first signs of bank failure

1997 - Baht crisis, Indonesia, South Korea

1998 - Yen drops to 137, Malaysia, Hong Kong, Russia, Brazil, LCTM

1999 - Recovery in South Korea followed by others

Role of IMF

• Highest economic growth rate
• Inflation was also low (3.4%-5.7%)
• Baht value was 25 to the US Dollar (Fixed Exchange rate)
• May 14-15 1997, the Baht faced speculative attacks
• June 30 1997, Prime Minister Yongchaiyudh refused to devalue the baht
• Thai government failed to defend the Baht, starting the crisis
• 2 July 1997, Thai government was eventually forced to float the Baht
• Baht lost more then half it’s value
• Thai stock market dropped 75%
• August 11, 1997, IMF unveiled $17 billion rescue package
• August 20, 1997 IMF approved another $3.9 billion bailout package
• Finally recovered by 2001, paid off IMF debt in 2003

IMF stepped in to initiate a $40 billion program to stabilize the currencies of South Korea, Thailand, and Indonesia

Structural Adjustment Package (SAP)

Crisis-struck nations to reduce government spending and deficits

Allow insolvent banks and financial institutions to fail

Aggressively raise interest rates

The reasoning was that these steps would restore confidence in the nations’ fiscal solvency, penalize insolvent companies and protect currency values.

High Interest rates

Thank You

To attain the chain objectives of tightened money supply,

Discouraged currency speculation

Stabilized exchange rate

Curbed currency depreciation

Contained inflation

After devaluation of Thailand’s Baht

Criticism of the IMF

Pre crisis trends

KLSE composite index lost more than 50% and came down to below 600 levels from 1200

Ringgit fell from over 2.50 per dollar to 4.57 per dollar

Overnight rate rose from 8% to 40%

Ratings fell several notches from investment grade to junk status

Measures taken by Mahathir Mohammad

Introduced the peg at 3.80 ringgit per dollar(by Bank Negara)

Stopping overseas trading of ringgit and other ringgit assets

Foreign portfolio funds with a minimum one year “stay period”

Largely controlled by developed nations

"New Colonialism” austerity measures inhibit long term economic growth

Western style economic reforms and greater ownership by foreign firms

Monetarist priorities overlook public health, environment, and poverty

Repayment policies do not foster long-term growth

Current account deficit to GDP ratio was 5%

Very popular investment destination

Kuala Lumpur Stock exchange most active stock exchange

KLSE composite index at over 1200

Ringgit trading at over 2.50 per dollar

Overnight rate was at 7%

Indonesian Crisis

Despite Strong fundamentals of Indonesia

• Low inflation
• Trade surplus of 900 million dollars
• Huge foreign exchange reserves in excess of 20 billion dollars
• Robust banking sector

Indonesian Plight

• After floating of Thailand’s Baht, Indonesian Rupiah floating band increased from 8% to 12%
• On 14th Aug’97, managed float changed to free floating exchange rate mechanism which led to drop in Indonesian rupiah
• IMF rescue package of 23 billion dollars didn’t really help
• The Indonesian Rupiah and Jakarta Stock Exchange touched a historic low in Sep’97
• Moody’s downgraded Indonesian long term debt to junk bond
• In Nov’97, devaluation effects started showing in corporate books with huge dollar loans
• Many corporates started buying dollars by selling of Rupiah which further contributed in undermining of Rupiah
• President Suharto sacked Bank Indonesia Governor J. Soedradjad Djiwandono in Feb’98
• Suharto resigned under public pressure and Vice President B. J. Habibie was elevated in his place in May’98
• Rupiah was 2600 to 1 USD(before the crisis), afterward hit 14,000+ levels to 1 USD
• Indonesia lost 13.5% of GDP