CHAPTER 4

The Asian Crisis and Recent Developments

(ECODEV)

Rebecca Q. Lising, MAED, MBA

Professor
Financial Crisis
• A financial crisis is any of a broad variety of situations in which
some financial assets suddenly lose a large part of their
nominal value. ... Other situations that are often called
financial crises include stock market crashes and the bursting
of other financial bubbles, currency crises, and sovereign
defaults.
The Asian Financial Crisis
• The Asian financial crisis was a period of financial crisis that
gripped much of East Asia and Southeast Asia beginning in July
1997 and raised fears of a worldwide economic meltdown due
to financial contagion. ... Indonesia, South Korea, and Thailand
were the countries most affected by the crisis.
• The 1997–98 Asian financial crisis began in Thailand and then
quickly spread to neighboring economies. It began as a
currency crisis when Bangkok unpegged the Thai baht from
the U.S. dollar, setting off a series of currency devaluations
and massive flights of capital
The Financial Crisis
• The crisis started in Thailand with the financial collapse of the
Thai baht after the Thai government was forced to float the
baht due to lack of foreign currency to support its currency
peg to the U.S. dollar.
• At the time, Thailand had acquired a burden of foreign debt
that made the country effectively bankrupt even before the
collapse of its currency.
• As the crisis spread, most of Southeast Asia and Japan saw
slumping currencies, devalued stock markets and other asset
prices, and a precipitous rise in private debt.
The Financial Crisis
• Indonesia, South Korea and Thailand were the countries most
affected by the crisis. Hong Kong, Laos, Malaysia and the
Philippines were also hurt by the slump. Brunei, China,
Singapore, Taiwan and Vietnam were less affected, although
all suffered from a loss of demand and confidence throughout
the region.
• Foreign debt-to-GDP ratios rose from 100% to 167% in the
four large Association of Southeast Asian Nations (ASEAN)
economies in 1993–96, then shot up beyond 180% during the
worst of the crisis.
The Financial Crisis
• In South Korea, the ratios rose from 13% to 21% and then as
high as 40%, while the other northern newly industrialized
countries fared much better. Only in Thailand and South Korea
did debt service- to-exports ratios rise.
• Although most of the governments of Asia had seemingly
sound fiscal policies, the International Monetary Fund (IMF)
stepped in to initiate a $40 billion program to stabilize the
currencies of South Korea, Thailand, and Indonesia,
economies particularly hard hit by the crisis.
• The efforts to stem a global economic crisis did little to
stabilize the domestic situation in Indonesia, however.
Factors in the Financial Sector which contributed to
the severity of the Asian Crisis include the following:
• INADEQUATE FUND MANAGEMENT SYSTEM
 The financial sectors in these countries were unable to
efficiently handle and disburse the massive inflows of foreign
funds, which allowed them to invest as much as 40-50% of
GDP when economic growth was in excess of 8% per annum.
 Stock market values also rose rapidly, and a property
boom ensued.
 This was unsustainable and inconsistent with efficient
resource allocation.
• INEFFECTIVE STERILIZATION OF CAPITAL INFLOWS
The sterilization mechanism that could have been used to
choke off some of the excess demand generated by the influx
of capital was constrained by thin markets for government
securities and a fixed exchange rate.
Factors in the Financial Sector which contributed to the severity of the Asian
Crisis include the following:
• RESTRICTIONS ON FOREIGN BANK’S ENTRY
Apart from Hongkong, and, to a lesser extent, Singapore, East Asian
countries do not encourage the entry of foreign firms providing
financial services, compared with other countries at similar levels of
development.
They are also more highly regulated.
The financial sectors were less “internationalized” in terms of
competitions from financial service providers based in other countries.
 NONPERFORMING LOANS
As the economies overheated in 1995 and 1996, banks made many
risky loans.
Supervision and regulation of the financial systems in these countries
were inadequate.
Unsound projects were approved, uncollateralized loans were made,
offshore dollar borrowing, which were unhedged, ballooned-taking
advantage of low interest rates in the United States.
Factors in the Financial Sector which contributed to the severity of the Asian
Crisis include the following:
• HIGH COSTS OF FINANCIAL SERVICES
Cross-country empirical evidence complied by the world Bank
suggests that the limited internationalization of the financial
sector also led to higher costs of financial services (higher
interest margins and lending rates) to borrowers and slower
institutional development.
 BALANCE SHEETS
The extent of balance-sheet troubles is difficult to measure
without careful country-by-country analysis.
As the crisis and post-crisis period evolved, the evidence
suggests that the balance sheets have been helped
considerably by the recovery in demand and the resumption
of economic growth in 1999, 2000, and 2001.
External Sector Difficulties
• RAPID GROWTH IN CURRENT ACCOUNT DIFFICULTIES
 As the boom of the early 1990s progressed, current-account deficits
grew as offshore borrowing increased.
 During this phase of rapid growth, current-account deficits of up to 5%
of GDP were thought to be easily sustainable, according to
conventional wisdom
 OVERVALUED EXCHANGE RATES
 Prior to the crisis, the exchange rates for most Asian currencies were
loosely tied to the US dollar
 Thai Baht was pegged to an exchange rate of 25 baht per US dollar
 Philippine peso moved more but not beyond a band of 25 – 27 pesos
per US dollar
 Indonesian rupiah devalued very slowly and deliberately against the
US dollar over time.
 Malaysian ringgit fluctuated somewhat more than the other three
currencies.
External Sector Difficulties
• THE COLLAPSE IN EXPORTS
 In 1996, export-growth performance fell substantially,
particularly from 1995 when exports had been performing
spectacularly.
Rising wages have been suggested as another possible cause
of the export collapse and it is true that wage increases were
eroding some of the competitiveness in labor-intensive
manufacturing industries in Thailand and Malaysia.
Another stronger factor was the decline of activity in the
computer-chip market
Finally, exchange rate appreciation also contributed to a loss in
export competitiveness.
Post-Crisis Experience
The World Economy
Commentators from International institutions were initially quick
to discount the impact of the current crisis on the world economy.
However, weaknesses in Korea and Japan surfaced toward the
end of 1997 and these tended to have wider implications.
The Organization for Economic Cooperation and Development
(OECD) countries, with the exception of Japan and Korea, were
not appreciably affected by the crisis.
In 2001, the US economy suffered a short and shallow recession
from which it recovered only slowly in 2002.
This reduced the demands for US imports and slowed the growth
of the Asian economies as they continued to recover from 1997
financial crisis
Post-Crisis Experience
• Economic Growth
1998 was a bad year for most countries in the Asian region.
Growth was negative in all the five crisis countries, as well as
Hongkong.
Singapore grew by only 0.1 percent compared with 8.5
percent growth in 1997
Between 2002 and 2007, economic growth in the Asian region
accelerated, led by India and China.
Living standards rose and poverty fell.
Post-Crisis Experience
• Economic Recovery
Recovery came through a revival of domestic demand
supported by exports and a restoration of investor confidence.
Softer budget deficits and lower interest rates also
underpinned the recovery.
Lessons and Prospects for the Future
• An Agenda for Reform
Based on the reform agenda prescribed by the international
banks and aid agencies after the crisis, the following items could
be helpful in speeding up reform in the crisis-affected countries
of Asia.
1. Debt Restructuring
 More difficult in Latin American case because there are more
lenders and borrowers, and the private sector is heavily involved.
2. Private Sector Credit Lines
 Given the limited resources of the IMF and the conceptual
difficulties with the notion of an international lender of last
resort, it may be useful for the government to establish credit
lines with the private sector.
3. Reform Exchange-Rate Regimes
 Many of the problems faced by the developing countries in Asia
were the result of “hot” money outflows during the crisis that
resulted in abrupt currency devaluations.
 As currencies devalued, they had great difficulty in meeting their
foreign obligations.
4. Capital Account Reform
 The regulation of short-term capital movements, such as
through the imposition of taxes, can be considered.
5. International Portfolio Controls
 These controls would involve monitoring and supervision of
international financial firms (banks, insurance companies,
pension funds, etc.
6. Establish Minimum International Standards of Financial Practice
 It would create a floor of credibility which will help to prevent
national problems from spilling over into international markets.
7. Information and Transparency
 The Asian crisis has reinforced the need to pay greater attention
to constructing uniform standards for accounting and financial
reporting.
8. Global Surveillance
 In the Asian crisis, and also in the Mexican crisis, the IMF warned
Mexico and Thailand regarding its external debt policies.
9. Reform of Financial Markets
 The details will depend upon the existing system of regulations in
individual countries.
10. Greater Competition
 Subsequent to the crisis in Latin America, foreign banks flocked to
the region, lured by bank privatization and the relaxation of
ownership rules.
11. Consolidation
 In Latin America, government move quickly to close the worst-
performing banks
12. Supervision and Regulation
 New regulations should follow principles, such as those laid
down by the Basle Committee on Banking supervision (1997)
 In Chile, the Central Bank regularly visit banks and classifies
them based on the quality of their loan portfolios and then
publishes the results.
13. Accounting and Disclosure
 Tougher accounting and disclosure rules will help to expose
weaknesses before they can fester.
 In Korea, for example, banks do not have to disclose, let alone
make provision for all of their suspect loans.
14. Stock Markets
 A major reform would be the introduction and development
of the derivatives market, particularly in Thailand, Malaysia,
and Indonesia, especially those permitting better hedging of
equities exposures.
15. Trade Policies
 Thailand and Malaysia have raised tariff rates after the crisis
and this could be harmful and unnecessary, particularly given
the large exchange –rate devaluations.
16. Human Capital
 Finally, more long-term measures need to be taken to address
the shortage of human capital required to upgrade the
productivity capacity in skilled and knowledge-intensive
industries.
Global Recession in 2008 and 2009, and
Developments in Asia
• The rapid deterioration in economic growth in the
industrialized countries that began in late 2007 and continued
and intensified in 2008 has created additional challenges for
the developing economies of Asia.
• Slower growth in Asia in 2009, and perhaps 2010, is
anticipated as a result of a slowdown in export demand from
Europe, Japan, and the United States.
• It is difficult how long this recession will last, when it will
bottom out, and when industrial economies will return to full
employment of labor and capital resources.