Financial Crisis

Common Core CCGL9030 Individual Assignment 2 WANG XINRUI 3036128298

K. S. Maurice Tse
The University of Hong Kong
Fall 2023 Assignment 2 (15 points/15%) Deadline: November 15, 2023 (Wednesday)
Read the HBS article on “Financial Crisis in Asia 1997-1998”. BASED ON the materials and the information provided in the case, write a reading report by addressing the question below:
 How did the crisis erupt in Thailand and spread in a chain of events that no one, neither Asian financial authorities nor Western economists, had foreseen.

With the rapid growth of rate of approximately 11% each year and the increasing GDP from 8.1 to 8.9 in 1995
(Pill.H, 2008), the economic vitality of Thailand represents the general economic status of Asia. Mainstream
Asian and Western professionals share an optimistic estimation to the prospect of Asian economic within 5
years considering the seemingly healthy economic growth. Nevertheless, an unexpected default in the payment
of foreign debt occured on INC.Somprasong, with further financial failure occuring, revealing a financial
crisis which deteriorated the Asian financial market tremendously during 1997-1998. This assignment is going
to illustrate the development of the crisis while analyzing the cause of each stage and the reason of the crisis’s
unpredicability. The paragraph will be organized in the consequance of eruption of crisis, devlopment and
spread of crisis and general analysis to the cause of development and spread of the crisis.
Eruption of the crisis
To commence with, background analysis of Thailand is essential to understand factors contributing to the crisis
and failure of foreseeing the crisis.
From the social formation aspect, Thailand authorities share confidence in Thailand’s national power as
Thailand is the only country unsubjugated in history in South Asia, and has abandoned a bureaucratic
government within only 5 years. The remnant of bureaucratic ideology counldn’t be eliminated in short-term,
indicating that the proportion of democratic institutions controled by private owners in the market is limited.
Public ownership of financial institutions controled by the government remains around 700% higher compared
with other Asian countries such as China. Given that the self-regulating ability of free market has higher
flexibility than a controled market, Thailand is less efficient to respond to rapid and unpredicted market
changes, thus the regulative function of market is curbed, resulting in the formation of a crisis.
In addition, the self-confidence of the nation might lead to a blind arrogance of the country, namely the
unwillingness to admit a flaw has occured in the current financial system and the rejection to make adjustments
when crisis erupts. This is proved by Exhibit 2a of common source, which shows a stable CPI policy over the
mid-1990s. The arrogance thus results in over-confidence of the original prediction and consequently the
failure of prediction. After several small fluctuation of liability ratio, the crisis finally erupts when INC.
Somprasong fails to pay a foreign debt in May 1997.(common source)
Development and spread of the crisis
The development of the crisis can be roughly summarized as depreciation - inflation - negotiation with western
world, accompanied by the social issue of unemployment, rising domestic good price, social unrest,
bankruptcy, lost of confidence, and so on.
The spread of the crisis can be defined as the increase of the negative social and economical influence of the
crisis within one country and the increase of the coverage of affected areas, namely from Thailand to most
countries in Asia including China, Korea, Indonesia etc.
Stage 1: increase of current liability ratio
facing the pressure of crisis, most countries buy leases to maintain a sufficient storage of national fund which
is applied to address urgent domestic market turbulance. Though some countries like Korea initially rejected
the aid of IMF, the government was forced to purchase foreign lease after reaching an epic 28% loss in stock
market and bankruptcy of almost 25% of its largest private corporations. (common source, exhibit1)
This demonstrates that governments of countries amidst a crisis is merely capable to make temporary decisions
based on the unforeseeable and rapid change of the status quo. In addition, the decision to increase the
borrowing of foreign debt laid the basis for IMF to impose speculative attack, which may lead to a more
unpredicable future with increased risk.
Stage 2: depreciation and inflation
The increase of foreign lease enhances the demand for foreign currency, thus decreasing peg ratio of domestic
currency versus foreign currency, namely depreciation.
the proceeding analysis of the relationship and indication of depreciation and inflation will proceed in the
context of exportation/importation policy of Asian countries, intangible asset policies.
On one side, depreciation can cause inflation:
(in the context of export/inport)the crisis signals unpredictability of global financial activities, thus
discouraging the exportation from Asian countries to the western world. Supporting policies for exportation
decreases, leading to increased cost of exportation. As seen in common source Exhibit1, most Asian countries
listed demonstrate a decrease in external sector service and a negative data of external sector current account
balance, proving that exporting policies of Asian countries became more conservative under the pressure of
the crisis. With the rise of import ratio within most Asian countries, demand of foreign currencies surges,
enhancing the peg ratio of foreign currency versus domestic currency. The same imported good’s price
increases, thus resulting in inflation of these goods.(lecture 2 notes) However, although short-term
conservative exporting policy lowers the risk of capital loss at foreign market during a crisis, policy makers
should introduce long-term policies to encourage the development of exportation industry. The policy should
instruct the domestic manufacturers to develop new technology or enhance the efficiency of the
administration mode of corporations in order to increase the international reputation of domestic goods.
Although the improvement of exported domestic good industry are capital-demanding initially, they will
generate stable revenue at considerable amount once the goods’ international competivity increases. Citing
from common source, Korean government enacted a series of policies to increase the global competivity of
domestic industrial conglomerates, including the policies about wage restraint, infrastructure establishment
and corporation integration. The long-term reform was proved successful 10 years later with a 8.6% growth
in GNP. Despite the GNP drop caused by the crisis, a 6.2% percentage at 1995 still remains high compared
with temporary Asian mean.
(in the context of tangible asset price) Under the pressure of the crisis, the domestic purchase of properties and
land decreases, causing the increasing suspension of ownership of property and land. Compared with the entity
existence of asset, like a building, the statistic existence of asset, like an incompleted credit transaction online,
is more possible to loose value during a depreciation or inflation. This can be proved by the fact that China has
a higher average relative value of approximately 36 of fixed capital formation during 1993-1997 compared
with Kong Hong, which has a relative value of around 30. China exceeds Hong Kong of almost 50% in the rate
of GDP, and the annual decreasing rate of inflation rate was about 400% compared with Hong Kong. (common
source, exhibit1)
On the other side, inflation can reversely cause depreciation:
(in the context of export/inport)with increasing importations occupying domestic market, local producers are
forced to increase their exportation’s international competivity by lowering the export price of the same
product. This is often achieved by devaluing the domestic currency, which deteriorates its depreciation.
Therefore, the crisis decreases Asian countries’ exportation,
For the aspect of international spread of stage 2 crisis in Asia, the Asian countries are geologically bordered,
and thus the trade between countries are closely related, thus forming a collaborative economic unity.
Consequently the currency peg ratio or inflation ratio of a country influences the whole Asian market. If one
country accept the IMF treaty, then the country may be subjected to bankruptcy caused by the policy of IMF,
which undermines the market security of Asia, devalues average Asian currency, and adjoining countries will
increase foreign debt ratio with the aim of boosting the Asian economic growth and restoring its currency
value. This results in more Asian countries become burdened to repay debts. Though the borrowing policy
boosts economic growth within limited time, the large-scale increase of liability lowers the rate of
shareholder’s equity which generates revenue at a stable rate. Thus the unpredicability of the market’s profit
ability is enhances, which may lead to voilent turbulation of cash flow of Asian market.
Stage 3: liquidity and solvency crisis
The depraciation and inflation decrease the value of Asian currency, therefore vital financial programs such as
the government sponsored buy-back program may fail due to the insufficiency of capital to invest the
programs. As a result, programs such as the buy-back program which bails out domestic corporations facing
bankruptcy fails to ensure the safety of market. The protection mechanism of the market is disrupted, resulting
in market failure and the loss of market’s self-regulating ability. This then may contribute to stagnation,
namely the cease of economic activities, undermining the liquidity of capital.(lecture notes 3)
Low Shareholder’s Equity ratio resulted from the acquire of foreign lease undermines a country’s ability to
generate capital with shareholder’s equity, lowering its liability to repay debt. The payment to debts decreases
the remaining asset used to support domestic industries. According to common source, in the spring of 1997,
Thailand had closed more than 16 govenrment-sponsored large companies to decrease the government’s
domestic expenditure, inthe aim of paying a loan that runs the country 1-2% budget deficit each year.
Overall social impact
In parrallel with the three stages,various social issues rise across Asia: bankruptcy, unemployment, collapsing
trade, rising food prices, social unrest, lost of confidence, etc.(lecture 4 notes)
General analysis to the cause of development and spread of the crisis
The reason that enables the propagation of the crisis can be summarized into two aspects:
1) underperformance of the international financial markets
From the aspect of foreign investors, current risk-analysing systems adopted by the IMF is insufficient to
predict the rate of market failure. In February 1997, Michel Camdessus, the director manager of IMF, made
predictions and states that the crisis will cease to develop. However, he was contradicted as the crisis worsens
in the remaining of the year. Thus investors may fail to foresee potential risk before issuin leases. When crisis
arise, investors may withdraw capital within limited time, which contributes to the failure of the long-term
fixed exchange rate regime in Asia.
From the aspect of Fund managers, they are liable to compare with peers to determine their competence since
their profession lack a well-defined and objective competence-rating standard. Thus fund managers are likely
to follow the mainstream decision of peers after evaluating a project’s risk level. The insufficiency in solid
judgment regarding their skill levels and the unpredictability of the market activities lowers their confidence in
the ability to make rational decisions, therefore even mild disturbulance in the market can cause the dramatic
retreat of fund.
From the aspect of the debt borrowers, governments or private companie are likely to increase notes payable as
they face pressure to maintain operation under stagnancy caused by the crisis. However, the risk of debtors
violating the investment treaty also increases under the pressure of the crisis. Higher amount of liability with
lower insurance in stable support of the debtor doubles the unpredictability of the occurance of bankruptcy or
fund shortage.
2)the relationship between government and large private companies: overly-intertwined, dual-reliance
On one side, intimate collaboration between government and owners of large private institution owners is
necessary at the initial stage of a new regime, because the new government has yet to establish long-lasting
prestige within its sovereign, therefore relies on the support of local business owners who represents the
democratic force. However, if the government proceed the intimate bond in long-term, the large businesses
take the support of government as granted, which may lead to their misjudgement that the government will bail
them out. Thus the companies’ controllers may be encouraged to underestimate the risk of increasing the
corporate’s liability ratio, borrowing exceedingly amounts of foreign debt that they couldn’t repay.
Nevertheless, most of such companies with over-positive expectation confronts serious failure when
government retrieves its investment support or buy-back policies under the pressure of over draft of the
national treasury. Large companies are main contributors to GDP, thus their downfall reduces the country’s
total revenue, decreasing the government’s fund to support the country’s fiscal activity when confronted with
crisis. Their downclose also triggers long-lasting social issues such as unemployment, since those companies
control large proportion of domestic financial market and are the main contributor to offer jobs. The serious
effect of failure of government to large corporations can be proved by the fact that Thailand downclosed over
20 private firms of large quantity, with a 50% decrease in public sector balance at the end of 1997.
Conclusion
This paper firstly explains the eruption, development and spread proces of the crisis between 1997-1998, then
discusses the general reasons for the formation and propagation of the crisis in two aspects: the unperforming
international financial market,and the over-reliance between the government and the private corporation
owners. From the analysis of the 1997-1998 crisis, we can get insightful enlightenment on the methods to deal
with financial crises, such as implementing long-term policies to enhance the international recognition of
domestic goods. Nevertheless, we should also be aware of the unpredictability of market behaviors, and accept
the fact that it’s almost impossible to identify a crisis before its outbreak. Though we can’t prevent the future
occurence of financial crisis, we can be more prepared by developing more accurate risk analysis models and
strengthening infrastructure establishment. In the end, a prepared mind is always favored by opportunities.