A CASE ON

SOUTH EAST ASIAN

ECONOMIC CRISIS OF 1997
VAISHALI
RIHEN BATRA
[B. A. (H) ECONOMICS]

INTRODUCTION

The Asian Financial Crisis was a period of financial crisis that

gripped much of Asia beginning in July 1997, and raised fears
of a worldwide economic meltdown due to financial contagion.

Started in Thailand

Floating the pegged currency

Real estate driven financial over extension
Excessive foreign exposure
Resulting collapse of the Thai Baht

Also affected Indonesia, South Korea, Hong Kong, Malaysia,

Philippines.

IMF $40 billion to stabilize their currencies

THE ASIAN MIRACLE

1960s 1990s: Thailand, South Korea, Hong Kong,

Singapore, Taiwan, Indonesia
Maintained very high growth rates (8-12%)

Primarily due to:

Maintained High Interest rates to attract foreign investments
Rapid industrialization
Industrial Policies supporting exports
Below market interest rates for exporting industries, etc

PHASES
Initiated by two rounds of currency depreciation in 1997

1.
2.
3.
4.

.
1.
2.
3.
4.
5.

First round was a precipitous drop in value

Thai baht
Malaysian ringgit
Philippine peso
Indonesian rupiah
Second round began with downward pressures hitting
Taiwan dollar
South Korean Won
Brazilian real
Singaporean dollar
Hong Kong dollar

PRE CRISIS SCENARIO

Foreign Capital Inflows:

o US was in recession => Low interest rates
o Asian Tigers - 50% of capital inflows in Asia
o Dramatic run-up in Asset prices

Pegged Currencies
Encouraged external borrowing

High exports driving rapid economic growth

Export to GDP ratio grew from 35% to 55%

Excessive exposure to forex movements

THE BUBBLE

Thailands economy bubble fuelled by Hot money

Debt-GDP Ratios went upto 180%

More and more was required as the bubble grew

Development money went in a largely uncontrolled manner to

certain people only, not particularly the best suited or most efficient, but
those closest to the centers of power.

Real estate speculation

Countries became excessively dependent upon exports for their

economy

Very high leverage & exposure to forex risk

THE TIPPING POINT

U.S. economyrecovered from a recession in the early

1990s,

Began to raise U.S. interest rates to head off inflation.

This made the U.S. a more attractive investment destination
relative to Southeast Asia, which had been attracting hot
money flows through high short-term interest rates,
and raised the value of the U.S. dollar.
For Asian currencies pegged to the U.S. dollar, the higher
U.S. dollar caused their own exports to become more
expensive and less competitive in the global markets.
At the same time, Southeast Asia's export growth slowed
dramatically in the spring of 1996, deteriorating their
current account position.

THE DOWN TURN

Asset prices began to collapse

Causing individuals & companies to default
Panic among lenders led to withdrawal of funds
Credit crunch & bankruptcies

Depreciative pressures on exchange rates

Government action:
Raised interest rates tremendously to prevent capital flight
Buying up excess domestic currency at fixed rate to maintain the peg

Not sustainable in the long run (due to limited supply of forex reserves)

Capital fleeing could not be stopped

Central bank allowed currencies to float

Drastic Depreciation
Further increasing the debt obligations and worsening the crisis

WAS THERE A CRISIS ?

Over $100billion was pulled out of the region in 199798 which was 5 percent of the GDP

Unemployment rose to 0.8milliom in Indonesia, 1.5

million in Thailand , 1.35million in Korea

Real wages dropped by 12.5% in Korea and 6% in

Thailand

THAILAND

Prominent economy of South-east Asia.

During 1985-96 was growing at highest rate of 9%.

Real Estate sector was booming.

High interest rate attracted investments from US and west.

Export growth was very high.

REASON FOR FAILURE

Thailand Baht was pegged at 25 to US $.

At the same time US had increased interest rate to curb
inflation this made US investors to take their money from
Thailand and invest in US.
This trigger the outflow of $,resulted in devaluation of baht
and it reached its lowest point of 56 units per $.
This made foreign loan costlier by three times.
It resulted in collapsed of various company and biggest
financial corporation Finance One.
There was fear among foreign investors about their money
so they started pulling money from this markets.
This deepens crisis, due to this many people lost their jobs.
Political instability.

INDONESIA

Drastic devaluation of rupiah from 2000 to 18000 for 1US dollar

Excessive inflation

Riots

16 major commercial banks were closed

Governor, Bank Indonesia was sacked

President Suharto was forced to step down in may after 30 years in

power

This conditions improved when IMF provided bailout package.

SOUTH KOREA

Won: from 1000 to 1700 for 1 US dollar

Credit rating of the country (moody's) : A1 to B2

National debt-to-GDP ratio more than doubled

Major setback in automobile industry (Daewoo motors sold

to General motors)

PHILIPPINES

Growth dropped to virtually zero in 1998

Peso fell significantly , from 26/US$ to even 55/ US$

President Joseph Estrada was forced to resign

Stock market fell to 1000 points from 3000

Raised interest rates by 3.75%

Overnight rates jumped from 15% to 32%

Huge outflow of money

MALAYSIA

Attacked by Speculators

Overnight rates jumped from 8% to 40%

Stock markets fell by 50% from 1200 to 600

All sectors were hurt, construction sector contracted 23.5%,

manufacturing shrunk 9% and the agriculture sector 5.9%

3.80 peg against dollar

First ever recession

IMF INTERVENTION

The IMF treated the Asian financial crisis like other

situations where countries could not meet their balance of
payment obligations. The Fund made loan arrangements to
enable countries to meet foreign debt payments (largely to
private banks in these cases) on the condition that the
recipient countries adopt structural adjustment policies.
The policies being:
Reduce Spending
Privatization
Heavy Taxation

IMPACT OF IMF
INTERVENTION

In South Korea, a country whose income approaches European levels,

unemployment skyrocketed from approximately 3 percent to 10
percent. "IMF suicides" became common among workers who lost
their jobs and dignity.

In Indonesia, the worst hit country, poverty rates rose from an official
level of 11 percent before the crisis to 40 to 60 percent in varying
estimates. GDP declined by 15 percent in one year.

In September 1998, UNICEF reported that more than half the children
under two years old in Java, Indonesia's most populous island, were
suffering from malnutrition.

At one point, the food shortage became so severe that then-President

B.J. Habibie implored citizens to fast twice a week. Many had no
choice.

OVERCOMING THE CRISIS

High saving and investment rate

Strong emphasis on education
Stable macroeconomic environment
Free from high inflation or major economic slumps
High share of trade in GDP

LEARNINGS

Over dependence on foreign capital, especially short-term

foreign capital, makes an economy and its exchange rate
vulnerable
Foreign direct investment is better than foreign portfolio
investment or loans because it is less mobile
Long-term loans is better than short-term loans because
they are not subject to immediate withdrawal
Currency and maturity mismatch by domestic borrowers
aggravates the problem
Short-term foreign-currency denominated loans should be
carefully monitored and controlled in order to avoid the
compounding of currency mismatch by maturity mismatch
Short-term foreign funds are inherently different from shortterm domestic funds because the former is much more
likely to leave at
the first sign of real or imagined trouble

PRESENT SCENARIO
As was the case in 1997/98, markets are in a
certain state of disarray. Today we have
concerns over the extent of the Chinese
slowdown, the reversion in the Euro area
towards stagnation along with rising
deflationary risks, and the drive (aided and
abetted by the Organization of the Petroleum
Exporting Countries) for substantially lower
petrol prices.