ASIAN FINANCIAL CRISIS

1997-98
Kubsha Ameen
10247
Overview
Unlike the Debt crisis in Latin America, the debt
crisis in East Asia stemmed from
inappropriate borrowing by the private sector.
Due to high rates of economic growth and a
booming economy, private firms and
corporations looked to finance speculative
investment projects. However, firms
overstretched themselves and a combination of
factors caused a depreciation in the exchange
rate as they struggled to meet the payments
On July 2, 1997, the Government of Thailand abandoned its
efforts to maintain a fixed- exchange rate the Baht had been
pegged to a basket of currencies dominated by the U.S. dollar
and allowed the Baht to float. This Baht quickly depreciated,
falling 18% on the first day alone. The collapse of the Thai Baht
was followed by speculative attacks on other countries
currencies (including the Indonesian Rupiah, the Malaysia
Ringitt, the Philippine Peso, and the Korean Won) and to a
further round of forced devaluations. The collapse of fixed
exchange rates was accompanied by a series of more general
financial sector crises in several of these countries. Although
the precise details vary, the immediate cause appears to be a
mismatch between assets and liabilities in the corporate and
banking sectors (in both currency and term length) and a sharp
decline in asset values. These immediate problems were
exacerbated by general financial sector weakness due to
inadequate supervision and rampant insider lending.

The visible problems with macroeconomic stability were
large, and potentially unsustainable, current account
deficits
rapid appreciation of currencies which were pegged to the
dollar
a slowdown in growth due to sectoral weakness (especially
in semi-conductors) and stagnation in Japan.
The large current account deficits made the
countries vulnerable to shifts in investor
confidence or to a slowdown in economic
growth while the rapid appreciation of the
U.S. dollar led the currencies to become
overvalued. When Thailand had floated its
currency, this increased pressure on other
countries to do the same to maintain comp
The current account deficits were not the
result of dis-saving by the government (i.e.,
fiscal deficits), but were caused by large
inflows of private investment. effectiveness in
export markets.
Causes
Foreign debt-to-GDP ratios rose from 100% to
167% in the four large ASIAN economies in 1993-
96.
Countries like Thailand, Indonesia, South Korea
had large current account deficits. Financed by
hot money flows (on capital account). Hot money
flows were accumulated because of higher
interest rates in the East.
Financial deregulation encouraged more loans
and helped to create asset bubbles.

Booming economy and booming property
markets encouraged expansive borrowing
by firms.
In the late 1990s, the US
increased interest rates to reduce
inflationary pressures. Higher interest
rates in the US, made the East less
attractive as a place to move hot money
flows. As hot money flows into the east
dried up, currencies started to fall and
governments struggled to keep exchange
rates at their fixed level against the US
Dollar.

Thailand was the first to have to float the
Thai Bhat, this caused a rapid devaluation,
which triggered a loss of confidence
throughout the Asian economies. Soon,
other countries were forced to devalue as
investors wanted to get out of Asian
currencies.
The devaluation caused debt to be even
more difficult to repay and countries
started to default.
At this stage the IMF intervened to try and
stabilise the crisis. However, their
intervention has proved very controversial,
with many arguing that their intervention
made things worse.
The IMF insisted on fiscal restraint lower
spending, higher taxes and privatization.
This contractionary fiscal policy caused the
economic downturn to exacerbate and the
economy plunged into recession.
Bankruptcies increased and there was a
flight of capital.
Inadequate bank regulation and
supervision.
Over-valued exchange rates that were
often pegged to the U.S. dollar which was,
at that time, appreciating quite rapidly.
A currency mismatch between assets and
liabilities that left banks and enterprises
vulnerable to exchange rate devaluations.


Basic Issues
a shortage of foreign exchange in Thailand,
Indonesia, South Korea and other Asian
countries that has caused the value of
currencies and equities to fall dramatically.
inadequately developed financial sectors and
mechanisms for allocating capital in the
troubled Asian economies.
effects of the crisis on both the United States
and the world.
the role, operations, and replenishment of
funds of the IMF.
The crisis was initiated by two rounds of currency
depreciation that began in early summer 1997. The first
round was a precipitous drop in the value of the Thai baht,
Malaysian ringgit, Philippine peso, and Indonesian rupiah .
As these currencies stabilized at lower values, the second
round began with downward pressures hitting the Taiwan
dollar, South Korean won, Brazilian real, Singaporean dollar,
and Hong Kong dollar.
In countering the downward pressures on currencies,
governments have sold dollars from their holdings of foreign
exchange reserves, bought their own currencies, and have
raised interest rates to foil speculators and to attract foreign
capital. The higher interest rates, in turn, have slowed
economic growth and have made interest-bearing securities
more attractive than equities.
Stock prices have fallen. In November 1997,
this decline in stock values was transmitted to
other stock markets in the world, although U.
S. and European markets have subsequently
recovered.

Financial crisis as a matter of interest
for the U.S. government
Firstly financial markets are interlinked, What
happens in Asian financial markets also may
affect U.S. markets.
Secondly American banks and companies are
significant lenders and/or investors in the
region, in terms of bank loans, subsidiaries of
U. S. companies, and investments in financial
instruments.
Third, attempts to resolve the problems have
been led by the International Monetary Fund
(IMF) with cooperation from the World Bank
and Asian Development Bank.
Fourth, the turmoil affects U.S. imports
and exports as well as capital flows and
the value of the U.S. dollar. The U.S.
deficit on trade is now rising as these
countries import less and export more.
Fifth, the crisis is exposing weaknesses in
many financial institutions in Asia. Some
have gone bankrupt. The economic
problems of the so-called Asian Tigers not
only are adversely affecting the
economies of Japan and others in the
region, but, to some extent, an economic
slowdown could spread to Latin America
and the United States.
Sixth, the crisis may impede the progress
of trade and investment liberalization
under the World Trade Organization and
the Asia Pacific Economic Cooperation
(APEC) forum.
IMF Support Packages
So far, the International Monetary Fund has
arranged support packages for Thailand,
Indonesia, and South Korea, and extended and
augmented a credit to the Philippines to support
its exchange rate and other economic policies.
The support package for Thailand was $17.2
billion, for Indonesia about $40 billion, and for
South Korea $57 billion. The United States
pledged $3 billion for Indonesia and $5 billion for
South Korea from its Exchange Stabilization Fund
(ESF) as a standby credit that may be tapped in an
emergency. The U. S. Treasury lends money from
the ESF at appropriate interest rates and with
what it considers to be proper safeguards to limit
the risk to American taxpayers.
In addition to support packages by the IMF, other
international organizations have been addressing the
Asian financial crisis. On November 3-5, 1997, the
Group of Fifteen developing nations met in Malaysia
developed a plan to avert renewed currency
turbulence.
In preparation for the Asia Pacific Economic
Cooperation (APEC) summit meeting, senior finance
officials of APEC met in Manila on November 18-19
and developed a framework for dealing with financial
crises in the region. This Manila Framework was
endorsed by the eighteen leaders of the economies of
APEC at the forum's annual summit in Vancouver, BC,
on November 25, 1997. The Manila Framework
recognized that the role of the IMF would remain
central and included enhanced regional surveillance,
intensified economic and technical cooperation to
improve domestic financial systems regulatory
capacities, adoption of new IMF mechanisms on
appropriate terms in support of strong adjustment
programs, and a cooperative financing arrangement
to supplement, when necessary IMF resources.
On December 1, 1997, the finance ministers
of the Association of Southeast Asian Nations
(ASEAN-Indonesia, the Philippines, Singapore,
Thailand, Malaysia, Myanmar, Brunei, Laos,
and Vietnam) agreed to make additional
funding available for any future bailouts for
troubled economies in the region. It would be
provided only if a country accepted an IMF
support package and if ASEAN members
consider IMF funds to be inadequate.
On December 15, 1997, ASEAN heads of state
endorsed the Manila Framework, efforts of
the IMF, decided to develop a regional
surveillance mechanism that would
emphasize preventive efforts to avoid
financial crises, and reaffirmed their
commitment to maintain an open trade and
investment environment in ASEAN.
The IMF and Stabilization Packages
The International Monetary Fund has been
the key player in coordinating support
packages for the troubled Asian economies.
The IMF says that it has learned from the
Mexican Peso crisis in 1995 and had instituted
emergency procedures that enabled it to
respond to each the crises in each Asian
country in record time.
The major objectives of the IMF are to
promote stability, balanced expansion of
trade, and growth, but because of the Asian
financial crisis, it has deepened its activities in
four directions:
strengthening IMF surveillance over member
countries' policies,
helping to strengthen the operation of
financial markets (technical assistance),
providing policy advice and financial
assistance quickly when crises emerge, and
helping to ensure that no member country is
marginalized (being left behind in the
expansion of world trade and being unable to
attract significant amounts of private
investment).
Questions raised on IMF operations
First whether such crises have increased in scale and
whether IMF resources are sufficient to cope with
them.
The second is whether the Fund's willingness to lend
in a crisis contributes to moral hazard (a tendency for
a potential recipient country to behave recklessly
knowing that the IMF will likely bail them out in an
emergency).
The third is whether the contagion of financial crises
can be stopped effectively.
The fourth is conditionality-whether the changes in
economic policy and performance targets that the
IMF requires of the recipient countries are
appropriate and effective.
The fifth is transparency-whether the IMF releases
sufficient information to the public, including
investors, on its program design and provisions
imposed as a condition for borrowing allow for
accurate assessment and accountability.
The sixth is prevention-whether the IMF has sufficient
leverage over non-borrowing member countries to
prevent financial crises from occurring.
Scale of financial crisis
With respect to the scale of financial crises, it
is clear that recent liberalization of capital
markets and advances in telecommunications
have increased the scale of financial crises.
The size of the support packages for South
Korea and Indonesia have been
unprecedented. The question is whether the
IMF has sufficient resources to handle more
financial crises, particularly if they occur
simultaneously.
Moral hazard
With respect to moral hazard, the opinion of the IMF is that
governments in trouble usually are too slow in approaching
the Fund for help because of the conditions the IMF places
on such support.
According to the IMF, the real moral hazard is not with
governments engaging in unsound lending but that,
because IMF support is available, the private sector may be
too willing to lend. Private sector financial institutions know
that a country in trouble will go to the Fund rather than
default on international loans.
Others, moreover, assert that the IMF is perpetuating the
moral hazard that lies at the heart of the problem for
troubled economies like South Korea-the absence of
bankruptcy. Some corporations in certain countries have
not been allowed to fail because of political or other
reasons is no systematic means of controlling sinful
excesses.
Contagion and Conditionality
With respect to contagion, the track record of the
IMF in stopping the spread of the financial crisis
within Asia has not been reassuring. Outside of
Asia, however, the crisis has yet to spread,
although currencies in Brazil and other countries
also have depreciated somewhat.
With respect to IMF conditionality, this continues
to be hotly debated with each IMF support
package. Some claim the monetary and fiscal
policies required by the IMF are too stringent and
slow economic growth too much. The World
Bank, in particular, reportedly fears that the
slowdown in economic growth in the troubled
Asian economies will only worsen their economic
problems.
Transparency
With respect to transparency, critics of the
IMF claim that the institution does not release
sufficient data to the public and investors who
have financial interests in the success or
failure of the IMF support packages and who
need more information to devise effective
strategies to cope with the crises.9 The IMF,
however, does release more information now
that it did previously. Also, the IMF may leave
it to the borrowing country to release detailed
information.
Prevention
With respect to prevention, the IMF has little
leverage over member countries who are not
borrowers. Countries also have to assess the
possibility of a future crisis in light of
immediate political exigencies-particularly
elections. For example, prior to the financial
crisis in Thailand, even though the IMF might
have warned the country that it was headed
for trouble, it was difficult for the Thai leaders
to muster the political support to restructure
the 58 financial institutions that eventually
became insolvent.
Support package for Thailand by IMF
(August 20, 1997)
an IMF stand-by credit of up to SDR 2.9 billion 10
(about US$3 .9 billion) over the ensuing 34 months to
support the government's economic program [Of the
total, SDR 1.2 billion (about US$1.6 billion) was
available immediately and a further SDR 600 million
(about US$810 million) was to be made available after
November 30, 1997, provided that end-September
performance targets had been met and the first review
of the program has been completed. Subsequent
disbursements, on a quarterly basis, would be made
available subject to the attainment of performance
targets and program reviews.],
loans of up to $1.5 billion from the World Bank, and
loans of up to $1.2 billion from the Asian Development
Bank.
The package also included the following
pledges
credit of $4 billion from Japan' s Export-
Import Bank, and
credits of $1 billion each from Australia,
Hong Kong, Malaysia, Singapore, and
China, and
credits of $0.5 billion from Indonesia,
Brunei, and Korea (Korea's was later
retracted). According to the IMF, the
proceeds from the credits extended by
the IMF and the bilateral lenders are to
be used solely to help finance the balance
of payments gap in Thailand and to
rebuild the official reserves of the Bank of
Thailand.

Conditions imposed by IMF
These reportedly included that the country
commit itself to maintaining foreign exchange
reserves at $23 billion in 1997 and $25 billion
in 1998, slash its current account deficit to
about 5% of GDP in 1997 and to 3% of GDP in
1998, and show a budget surplus equal to 1%
of its GDP in FY1998.
Support Package for Indonesia by imf
(November 5, 1997)
IMF standby credit of SDR 7.338 billion (about
$10.14 billion) with SDR 2.2 billion (about
$3.04 billion) available immediately and
further disbursements after March 15, 1998,
provided that certain targets have been met;
technical assistance and loans from the World
Bank of $4.5 billion,
technical assistance and loans from the Asian
Development Bank of $3.5 billion, and
$5.0 billion from Indonesia's contingency
reserves.
In addition, a number of other countries or
monetary authorities have committed to
provide a second line of supplemental
financing "in the event that unanticipated
adverse external circumstances create the
need for additional resources to
supplement Indonesia's reserves and the
resources made available by the IMF.
Japan-$5.0 billion,
Singapore-$5.0 billion,
United States-$3.0 billion
$1.0 billion each from Australia, Malaysia,
China, and Hong Kong

Conditions imposed by imf
As part of the support package, Indonesia was
required to restructure certain banks,
dismantle a quasi-governmental monopoly on
all commodities (except rice), cut fuel
subsidies, increase electricity rates, increase
the transparency of public policy and budget-
making processes, and speed up privatization
and reform of state enterprises. It was not
required, however, to change its national car
policy or aircraft development program.
Support Package for South Korea by
imf (December 3, 1997)
World Bank-$10 billion,
Asian Development Bank-$4 billion.
United States-$5 billion from its Exchange
Stabilization Fund,l7
Japan-$10 billion,
$ 1 billion each from the United Kingdom,
Germany, France, Australia, Canada, and
Italy,
additional support from Belgium, the
Netherlands, ana Switzerland. The funds
are contingent upon South Korea' s
remaining in compliance with the IMF
arrangement.
Conditions imposed by imf
reducing its current-account deficit to no more
than 1% of GDP for 1998 and 1999 (about $5
billion),
capping its yearly inflation rate at 5% in 1998 and
1999,
building international reserves to more than two
months of imports by the end of 1998, and
recognizing that economic growth (in terms of
GDP) for 1998 would likely fall from 6% to around
3%. In terms of financial restructuring, the IMF
required a comprehensive restructuring and
strengthening of Korea' s financial system in order
to make it more sound, transparent, and efficient.
The strategy comprised three broad elements: a
clear and firm exit policy, strong market and
supervisory discipline, and increased
competition.

criticism about IMF assistance
IMF assistance to the above three
countries has been criticized for "bailing
out" commercial banks and private
investors at the expense of other less-
favored groups and U. S. taxpayers. The
IMF insists, however, that its assistance
has been provided to support programs
that are designed to deal with economy
wide, structural imbalances and not to
protect commercial banks and private
investors from financial losses. A more
stable exchange rate may contribute to a
recovery on stock markets or better
business conditions, but there is no IMF
"bailout" of specific investors.
Bank Borrowing and Lending
The financial difficulties in Asia stemmed primarily from the
questionable borrowing and lending practices of banks and
finance companies in the troubled Asian economies.
Companies in Asia tend to rely more on bank borrowing to
raise capital than on issuing bonds or stock. Governments
also have preferred developing financial systems with banks
as key players. This is the Japanese model for channeling
savings and other funds into production rather than
consumption. With bank lending, the government is able to
exert much more control over who has access to loans
when funds are scarce. As part of their industrial policy,
governments have directed funds toward favored industries
at low rates of interest while consumers have had to pay
higher rates (or could not obtain loans) for purchasing
products that the government has considered to be
undesirable (such as foreign cars).
A weakness of this system is that the
business culture in Asia relies heavily on
personal relationships. The businesses
which are well-connected (both with
banks and with the government
bureaucracy) tend to have the best
access to financing. This leads to excess
lending to the companies that are well-
connected and who may have bought
influence with government officials.
Korean banks and large businesses borrow
in international markets at sovereign
(national) rates and re-lend the funds to
domestic businesses. The government
bureaucrats often can direct the lending to
favored and well-connected companies.
The bureaucrats also write laws regulating
businesses, receive approval from the
parliament, write the implementing
regulations, and then enforce those
regulations. They have had great authority
in the Korean economic system. The
politicians receive legal (and sometimes
illegal) contributions from businesses. They
approve legislation and use their influence
with the bureaucrats to direct scarce
capital toward favored companies.
Two risks of international borrowing
The first is in the maturity distribution of
accounts.
The other is whether the debt is private or
sovereign.
As for maturity distribution, many banks and
businesses in the troubled Asian economies
appear to have borrowed short-term for longer-
term projects. Many economists blame such
loans for the Asian crisis. Some of this debt is to
finance trade and is self-extinguishing as the
trade transactions are completed.
Mostly, however, these short-term loans have
fallen due before projects are operational or
before they are generating enough profits to
enable repayments to be made, particularly if
they go into real estate development.
As long as an economy is growing and
not facing particular financial
difficulties, rolling over these loans
(obtaining new loans as existing ones
mature) may not be particularly difficult.
Competition among banks is intense. In
the Asian case, as U. S. banks began to
restrict lending in certain Asian
countries in 1996 and 1997, European
banks took up much of the slack. When
a financial crisis hits, however, loans
suddenly become more difficult to
procure, and lenders may decline to
refinance debts. Private-sector financing
virtually evaporates for a time.
Proportion of loans
For the six Asian countries shown, all have
relied heavily on debt with a maturity of one
year or less. At the end of 1996, the
proportion of loans with maturity of one year
or less was
62% for Indonesia
68% for South Korea
50% for the Philippines
65% for Thailand
84% for Taiwan.
Structural change
The nature of the borrowing by these Asian
countries is that the type of borrowing has
shifted away from the government and banks
borrowing from international financial
institutions (such as the World Bank) or
receiving development assistance funds
through foreign aid programs to borrowing by
private corporations.
Bank exposure
How exposed are the banks of the major
industrial countries to borrowers in these
Asian economies? Bank lending data pose a
particular problem because of offshore
banking centers, such as Aruba, the Bahamas,
Hong Kong, and Singapore. Often the banks in
these centers simply provide a conduit for
funds that ultimately are used outside the
center.
At the end of 1996, the U.S. banks
reported
$29.1 billion in loans outstanding to
Indonesia, South Korea, Malaysia, the
Philippines, Taiwan, and Thailand.
There was an additional $14.4 billion
loaned to Hong Kong and Singapore for a
total of $57.9 billion.
This amounted to 34.9% of all U.S.
international lending (including offshore
banking centers). The greatest U.S.
exposure was in Hong Kong and South
Korea.
As for other major lending countries the
United Kingdom reported 50.8% of its
loans to these eight Asian economies and
Germany 33.6%.
Pegged Exchange Rates
The structural factor that initially enabled the
crisis to occur was that the exchange rates of
most of these currencies had been aligned
with the dollar or a basket of currencies
dominated by the dollar. These pegged
exchange values had not been allowed to
adjust sufficiently in response to changing
economic conditions. Governments allowed
their exchange rates to fluctuate only within
narrow bands.
The advantage of this system to the countries
involved was that it kept the countries'
exchange rates relatively constant with
respect to the dollar and allowed their
traders to import from and export to dollar
areas, particularly the United States, with
little exchange rate risk. It also provided a
stable financial environment that encouraged
foreign sources of capital for loans or
investments. The Thai monetary authorities,
for example, had pursued a "stable baht"
policy that had kept the official rate for their
currency at about 25 baht per dollar since
1987. This linking of official exchange rates to
the dollar, however, had one major
drawback. As the value of the dollar
changed, so did the value of these currencies
relative to others, such as the Japanese yen
and German mark, that were not tied to the
U.S. dollar.
As the dollar depreciated after 1985, the
arrangement worked reasonably well,
even though macroeconomic conditions
in these countries differed widely from
those in the United States (particularly,
rates of inflation and growth). Problems
began to arise in 1996 and 1997, however,
as the dollar appreciated and the official
values of these currencies deviated from
their underlying market values. While the
dollar was pulling up the value of these
currencies, some of the countries in
question encountered increasing difficulty
in balancing their international accounts.
Their exports grew more costly to non-
dollar buyers, and their imports from non-
dollar areas cheaper.
When downward pressures on a currency
occur in foreign exchange markets, if the
exchange rate is allowed to adjust freely, an
initial depreciation tends to lessen pressures
for more depreciation. The rewards for
speculating in the market (by betting on a
future depreciation) diminish. With an
exchange rate tied to the dollar, however,
government attempts to maintain the rate
often raise the expectations of traders that
the currency is headed for a fall. This places
even more downward pressure on the
currency as traders rush to sell it in
anticipation that they will be able to buy it
later at a lower price. If the governments
involved do not have sufficient foreign
exchange reserves to stave off the
speculators and others in the market, they
eventually have to concede failure and allow
the currency to depreciate.
Currency depreciation, in turn, places an
additional burden on local borrowers whose debts
are denominated in dollars. They now are faced
with debt service costs that have risen in
proportion to the currency depreciation. These
debtors respond to the weakening currency by
attempting to hedge external liabilities which
intensifies exchange rate and interest rate
pressures.
Nominal exchange rates also may change in
response to differing rates of inflation among
countries. A high inflation rate will cause a
nation's currency to depreciate, but the real
exchange rate (adjusted for inflation) may remain
the same. In some of the Asian countries with
currency problems, inflation rates have been
higher than those in the United States. Still a
depreciation of 20 or 30% far exceeds inflation
rates in 1997 of about 3% in Malaysia and Taiwan,
5% in South Korea, and 7% in Indonesia, the
Philippines, and Thailand.
Lessons learned from asian financial
crisis
Lawsons Rule that it is okay to run a current account
deficit without a budget deficit has proven to be a
fallacy;
Foreign exchange reserves are important;
Information and transparency are key;
The composition of capital inflows does matter;
Exchange rate regimes are extremely difficult to
maintain;
Financial markets are not perfectly efficient;
Moral hazard is the central market failure;
IMF programs should consist of both macroeconomic
and structural reforms;
Inevitably, countries will have to raise interest rates
and lower exchange rates; and
Keynesianism is alive and well in Asia.