Causes of the 1997 South East Asian Financial Crises & its

Impact on the Financial MarketsPresented by – Group 3

Krutika PanariKaushal Bhansali

Rohan SarkarNeha SharmaVivek Mishra

Shrishti VishnoiRicha MalhotraKushagra Kapur

Asian financial crisis

o A period of financial crisis – Beginning July 1997

o Started in Thailand

o Floating the pegged currency

o Real estate driven financial over extension

o Excessive foreign exposure

o Resulting collapse of the Thai Baht

o Also affected Indonesia, South Korea, Hong Kong, Malaysia, Philippines.

o IMF – $40 billion to stabilize their currencies

AREAS AFFECTED

• Foreign debt-to-GDP ratios rose from 100% to 167% in the four large ASEAN 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.

Underlying Causes for the Crisis

• 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 stabilize 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.

• Economists such as Stieglitz and Sachs emphasized the importance of market sentiment in increasing the magnitude of the problem. The initial problem was containable but because confidence evaporated there was a flight of investors – like a classic bank run causing an unstoppable downward momentum.

CONTINUED

Thailand

• Baht was pegged at 25 USD (1985-1996)

• On 30 June 1997, Prime Minister Chavalit Yongchaiyudh said that he would not

devalue the baht.

• However, Thailand lacked the foreign reserves to support the USD Baht currency peg,

and the Thai government was eventually forced to float the Baht allowing the value of

the Baht to be set by the currency market.

• The baht devalued swiftly and lost more than half of its value.

• Baht reached its lowest point of 56 units to the U.S. dollar in January 1998.

• The Thai stock market dropped 75%. Finance One, the largest Thai finance company

until then, collapsed.

Indonesia

• Its currency Rupiah was appreciating due to this various company borrowed loans from foreign institutes.

• Thailand floated its currency due to this Indonesian authority also widened rupiah band from 8% to 12%.

• In August rupiah comes under severe speculative attacks which devalued it to greater extent.

• Same condition occurred in Indonesia foreign corporate loans became costlier.

• Due to this Jakarta Stock Exchange touched historic low and Indonesia lost 13.5% of its GDP.

• Before crisis 1USD cost 2600 rupiah but during crisis it reached historic low of 11000 rupiah for 1USD.

• This conditions improved when IMF provided bailout package.

South Korea

• High NPA’s ( Non Performing Assets)

• Great Conglomerates owned by government

• Debt to Equity : 30%

• No returns and Profit on these NPA’s

• Excessive debt lead to takeovers

• The International Monetary Fund (IMF) provided

US$57billion as a bailout package

Philippines• 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

• 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

Malaysia

USA

• The Dow Jones industrial plunged 554 points or 7.2%, amid ongoing worries about the Asian

economies.

• New York Stock Exchange briefly suspended trading.

JAPAN

• Japan was affected because its economy is prominent in the region. Asian countries usually run a

trade deficit with Japan because the latter's economy was more than twice the size of the rest of Asia

together; about 40% of Japan's exports go to Asia.

• Japanese yen fell to 147 as mass selling began, but Japan was the world's largest holder of currency

reserves at the time, so it was easily defended, and quickly bounced back.

• GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in

1998, due to intense competition from cheapened rivals.

International Monetary Fund role

• Bailouts

• Conditional Financing

• Structural Adjustment Package

• IMF and Interest Rates

• Sharp reductions in values of currencies, stock markets, and other asset prices of several Asian countries.

• U.S. dollar GDP of ASEAN fell by $9.2 billion in 1997 and $218.2 billion (31.7%) in 1998

• created grave doubts on the credibility of IMF and the validity of its high-interest-rate prescription to economic

crisis.

• despite the prompt raising of interest rates to 32% in the Philippines upon the onset of crisis in mid-July 1997,

and to 65% in Indonesia upon the intensification of crisis in 1998, their local currencies depreciated just the

same and did not perform better than those of South Korea, Thailand, and Malaysia, which countries had their

high interest rates set at generally lower than 20% during the Asian crisis

• Nominal U.S. dollar GDP per capital fell 42.3% in Indonesia in 1997, 21.2% in Thailand, 19% in Malaysia, 18.5% in

South Korea and 12.5% in the Philippines

• Within East Asia, the bulk of investment and a significant amount of economic weight shifted from Japan and

ASEAN to China and India.

Consequences in ASIA

Consequences Outside Asia

• International investors were reluctant to lend to developing countries

• sharply reduced the price of oil, which reached a low of about $11 per barrel towards the end of 1998,

causing a financial pinch in OPEC nations and other oil exporters. Some major mergers and acquisitions

between 1998 and 2002 – often in an effort to improve economies of scale, hedge against oil price

volatility, and reduce large cash reserves through reinvestment.

• Contributed to the 1998 Russian financial crisis, which in turn caused Long-Term Capital Management in

the United States to collapse after losing $4.6 billion in 4 months.

• Collapse in the financial markets was avoided when Alan Greenspan and the Federal Reserve Bank of

New York organized a $3.625 billion bailout.

• Major emerging economies Brazil and Argentina also fell into crisis in the late 1990s (see Argentine debt

crisis). The September 11 attacks contributed to major shockwave in Developed and Developing

economies Stock market downturn of 2002

Consequences Outside Asia (cont.)

• The crisis in general was part of a global backlash against the Washington Consensus and institutions such as

the IMF and World Bank, which simultaneously became unpopular in developed countries following the rise

of the anti-globalization movement in 1999

• nations are increasingly turning toward regional or bilateral free trade agreements (FTAs) as an alternative

to global institutions

• Quickly built up foreign exchange reserves as a hedge against attacks, including Japan, China, South Korea.

• Pan Asian currency swaps were introduced in the event of another crisis.

• Nations as Brazil, Russia, and India as well as most of East Asia began copying the Japanese model of

weakening their currencies, restructuring their economies so as to create a current account surplus to build

large foreign currency reserves. This has led to an ever-increasing funding for U.S. treasury bonds, allowing

or aiding housing (in 2001–2005) and stock asset bubbles (in 1996–2000) to develop in the United States.