12/2/2014

Start of the Asian Crisis

June 1997, after a sustained attack
on the currency led by currency
hedge funds, the Thai baht
sustained a large devaluation.
Currency devaluations in Malaysia,
Indonesia and the Philippines
followed in July.

Economic Development in Asia

Chapter 3 The Asian Crisis and Recent
Developments

The currency weakness extended

to Australia, Hong Kong and Korea
currencies in October.

The Asian Crisis

By early 1998, currencies fell by 35% to 55% for

Korea, Philippines, Malaysia and Thailand, and
more than 15% for Singapore and Taiwan.

Indonesia suffered greatest fall of 80%.

Equity prices also fell as a result of investor

uncertainty and currency volatility (Table 3.1).

The Asian Crisis

Thin and restricted equity markets exaggerated the
decline.
Lack of hedging facilities forced investors to reduce
holdings dramatically.
Interest rates were raised to help stabilize currencies and
liquidity was reduced.
The result was a sharp decline in aggregate economic
activity in late 1997 and in 1998.

12/2/2014

Explanations for the Asian

Crisis
There are three broad
explanations, none of them alone
completely satisfactory.

Explanations for the Asian

Crisis
Second, external sector difficulties emerged
including slow export growth, loss of external
competitiveness and rapid growth in current
account deficits.

First, a speculative bubble in the

housing and equity markets arose
which was funded and sustained
by excessive lending by the
banking system.
Third, capital flight and investor panic spread
across the region through a contagion
mechanism as a result of globalization.

The Asian Crisis

The Bubble Economy (1)
First, the bubble economy was the result of interaction
between lenders (mostly banks) that borrowed offshore
at high interest rates and relend at higher rates to
domestic investors.
The domestic investors borrowed extensively to finance
speculative investments in the housing and equity
markets.

The Asian Crisis

The Bubble Economy (1)
These included risky long term lending in local currency
using short term dollar loans from overseas lenders.
When these borrowers defaulted it resulted in the
inability of the banks to repay these short term dollar
obligations.
This banking crisis was also influenced by moral hazard

The Asian Crisis

The Bubble Economy (1)
This created a speculative bubble that
depended on a stable exchange rate
and high profits.
High profits became more improbable
as the boom reached its peak, which
was further undermined by the
successive devaluations in all the
economies as the crisis unfolded.
Banking weakness was reinforced by
a lack of competition and unsound
lending practices.

The Asian Crisis

The Bubble Economy (1)
Moral hazard occurs when an agent takes more risk
because they are insured against the negative
consequence of such actions.
In the case of the Asian financial crisis banks thoughts
that governments would insure a stable exchange rate.
They also might have thought that the government would
bail them out if they found themselves in financial trouble

12/2/2014

The Asian Crisis

External Sector Difficulties (2)

The Asian Crisis

External Sector Difficulties (2)

Second, as the bubble of the early 1990s progressed,

current account deficits also grew as offshore
borrowing increased.

However, when export growth

began to sag in 1996 this
large current account deficits
became a growing liability
and worry for international
investors.

While exports were growing rapidly, this was viewed as a

sign of strong investment and growth enhancing capital
expansion.

The Asian Crisis

Contagion Effects (3)

Third, there was a strong contagion effect as the

financial crisis spread across the region.

Countries that had strong currencies and economies,

such as Hong Kong, Singapore and Taiwan were also
adversely affected.

The Asian Crisis

Contagion Effects (3)
There was also a dramatic
reversal in bank credit which
also amounted to about 10
percent of GDP.
Together, the reversal of capital
flows and bank credit created a
liquidity crisis that led to a
sharp fall in income and output.

Exchange rates were tied to

the dollar and exports were
hurt in international markets
as the dollar appreciated in
the mid 1990s.

The Asian Crisis

Contagion Effects (3)
As the foreign exchange crisis unfolded, there was a
dramatic turn around in net private capital flows to the
region from a $97 billion inflow in 1996 to a $12 billion
outflow in 1997.
This $109 billion reversal was about 10% of the GDP of
the five most affected economies Indonesia, Korea,
Malaysia, Philippines, and Thailand.

The Asian Crisis

Contagion Effects (3)
Indonesia, which had been a model of probity and
sensible policies was hardest hit by the crisis as its
exchange rate fell by over 50 percent and aggregate
incomes fell dramatically.
This contagion effect was the result of investors pulling
out of many economies simultaneously.

12/2/2014

The Asian Crisis

Contagion Effects (3)
The pressure that arose on all the currencies of the
region could have been a combination of this contagion
effect as well as a process of competitive
devaluations as investment funds left the region.

Post-Crisis Experience
The impact of the crisis was fully felt in 1998 when all the
crisis countries and most other countries had negative or
very small rates of positive growth.
PRC and Taiwan were the only exceptions.
Equity prices also fell across the region in 1998.

Post-Crisis Experience
Beginning in 1999, there has been a recovery in growth
and equity markets.
This recovery has been accompanied by a significant
amount of industrial and financial restructuring.
Many countries suffered from a high level of NonPerforming Loans (NPLs).

Post-Crisis Experience
To deal with these NPLs, the most affected countries
created separate agencies to deal with them. These
Asset Management Companies (AMCs) have taken
many of the bad loans and negotiated their liquidation.

Post-Crisis Experience
Thailand and Indonesia have been only moderately
successful while in the Philippines, the level of NPLs,
though small during the crisis, has crept up in recent
years.

Korea and Malaysia have been particularly successful in

reducing NPLs, enabling the banking system to begin to
extend new loans.

12/2/2014

Social Impact of the Crisis

The fall in output and employment created hardships
for many segments of the society in the affected
countries.
There was significant reverse migration to rural from
urban areas as job opportunities dried up.
Poverty levels increased between 1997 and 1998.

The Recovery Part 1

Social Impact of the Crisis

Disadvantaged groups
such as the poor,
women, children and
the elderly were the
worse hit by the crisis.
Some adverse affects
on school enrollment
and on health
indicators were
observed.

The Recovery Part 2

Between 2002 and 2007 economic growth in the Asian
region accelerated, led by India and China. Living
standards increased and poverty fell.
Domestic demand and foreign trade were both important
factors in the resumption of growth.
As the recover progressed financial restructuring
proceeded and the financial systems strengthened.

The Recovery Part 2

Thailand
Malaysia
Indonesia
Philippines
Hong Kong
Singapore
Korea
Taiwan
China

2005
4.5
5.3
5.7
5.0
7.1
7.3
4.2
4.2
10.4

2006
5.1
5.8
5.5
5.4
7.0
8.2
5.1
4.9
11.7

2007
4.8
6.3
6.3
7.2
6.4
7.7
5.0
5.7
11.9

The Recovery Part 2

The region has grown much richer in the decade since
the Asian crisis.
China has emerged as a regional economic
powerhouse.
Half the GDP of the region and one third of exports
originates in China
China is now the largest trader in Asia overtaking Japan.

12/2/2014

The Recovery Part 2

China joined WTO several years ago.
Import GDP ratio is 34% in China versus 9% for Japan.
Shows Japan is still somewhat protectionist.
Middle income countries are being squeezed by China.
In Southeast Asia in particular.

The Recovery Part 2

China competes in many different international markets
from labor intensive to skill intensive.

Innovation and new products are drivers of trade in Asia

now.
60% of export growth in Asia is in new varieties and
products not more of the same products.
Geography and outsourcing are important and locational
advantages are shaped by various factors.

The Recovery Part 2

History, availability of manpower, availability of capital,
cost of shipping and agglomeration economies all play a
role.
Shenzen in China and Bangalore in India are examples
of agglomeration economies.
Export processing zones help create incentives for high
growth export development and innovation.

Recovery Part 3
Most countries cut interest rates in last four months of 2008.

Falling energy and food prices should ameliorate any

tendencies toward inflation.
There has been general fiscal stimulus.
Chinas projected $850 billion additional spending on
infrastructure in next few years.
East Asia and Southeast Asia have current account surpluses.

Recovery Part 3
As the global economic crisis unfolds in 2009 Asia is
being adversely affected.
Slower growth in Asia in 2009 and perhaps 2010 is
anticipated.

There will be a slowdown in export demand from

Europe, Japan and the United States.

Asia is in good shape to offset these anticipated

weaknesses in the foreign sector with monetary and
fiscal stimulus.

Recovery Part 3
All countries in the region have ample foreign exchange
reserves.
India could have a more difficult time than the rest of the
region.
It has a large fiscal deficit which limits fiscal stimulus.
Lack of willingness of overseas lenders to investment.

12/2/2014

Recovery Part 3

Recovery Part 3

As the global recession deepens greater cuts in employment

and exports in Asia.

Thailands prospects will also be adversely affected by political

uncertainty.

Could create greater social tension.

Taiwan will have to fight its way through a recession that has already
begun.

Exacerbate poverty with reverse migration.

Korea has a lot of household debt which could slow the economy
further.

Singapore, Hong Kong and Malaysia most exposed to foreign

trade.

But a big fiscal stimulus and currency depreciation of around 30

percent in 2008 which should boost exports.

Both Hong Kong and Singapore adversely affected in Asian

crisis of 1997.

Recovery Part 3
Volatility in many markets will restrain risk taking and
investment.
Volatility causes sharp changes in balance of payments
Puts pressure on governments to adjust their budgets to
reflect these shifts.
It creates uncertainty in the business community

Recovery Part 3
The economic recovery continued into the second and
third quarter of 2009.
Industrial countries and developing countries in Asia all
benefited.
Stimulus packages were adopted by many countries
including fiscal and monetary measures.

Has a dampening impact on investment.

Recovery Part 3
Country
China

Fiscal stimulus 2009/2010

as a percent of GDP
4.8

India

0.5

Indonesia

2.5

Korea

2.7

Malaysia

5,5

Philippines

4.1

Agenda for Reform

In the wake of the Asian crisis,
there were a number of reforms
Continuation of the debt
restructuring process with help of
AMCs.
Arrangements of credit lines with
the private sector.
Reform of exchange rate regimes
to reduce the chance of abrupt
currency devaluation.

12/2/2014

Agenda for Reform

Agenda for Reform

The movement of hot money that takes advantage of

large short term interest differentials was discouraged or
made illegal.

Minimum international standards

of financial practice were
implemented.

Consideration of capital account reforms to include

possible taxes on short term capital but where not
approved.

Accountability and transparency

of business practices
strengthened.

Possible controls on international portfolio movements

were also considered but not implemented.

Increased international
surveillance to detect possible
future financial crises have been
considered but not
implemented.

Agenda for Reform

Basle accords used to strengthen supervision and
regulation of banking systems.
Introduce greater competition in financial markets while
strengthening prudential regulations.

Agenda for Reform

Introduce greater flexibility and depth into financial
markets including greater hedging and providing greater
access for foreign investors.
Maintain open trading environments in keeping with
WTO and regional trading arrangements.

Improve accounting and disclosure standards.

Agenda for Reform

Growth projections

Look into ways of restraining FDI concessions that

distort incentives and distort the flow of investment.

In this section we explore prospect for future growth and

structural change.

Enhance the flow of technical expertise, innovation and

human capital flows and exchanges.

We begin with a simple growth model

Continue to undertake research into the process of

financial and economic crises.

y = (ls) h + (1- ls) k + a

where y is growth income h is the rate of change in education

adjusted labor input, k is the rate of growth in capital, ls is
labors share in income, (1- ls ) is capitals share in income
and a is total factor productivity.

12/2/2014

Growth projections

Growth projections

If we assume that the capital to output ratio is fixed in the

short run then we can substitute y for k on the right hand
side of this equation and rearrange

The rest of the section looks at various assumptions

about these factors and projects growth into the future.

y = h + a/ ls

income growth (y) is a function of the growth of the

labor force adjusted for improved quality by higher
education and better health (h), the share of labor in total
income (ls) and TFP (a).

The main conclusion is that estimates for TFP (a) in

South Asia using the past tend to underestimate the rate
of growth.
We have also oversimplified because we havent looked
at saving potential.
You can read about this on pages 46 and 47.

Growth projections
By considering the factors in these simple growth models
we can get some insights into what causes rapid growth.
Investment

Summary
Causes of the Asian financial crisis.
Analysis of the impact and severity of the financial crisis
in affected countries.

TFP (a)
Policy implications gained.
Labor force growth (ls)
Education and health (h)
Governance, corruption, foreign investment also
important as indirect determinants of TFP

Supplementary Resources
The Asian Crisis Four Years On by IMF
The Asian Crisis: Cause & Cures by IMF