Asian Financial Crisis

This essay has a total of 3153 words and 15 pages.

Asian Financial Crisis

In the summer of 1997, an economic and currency crisis rocked the Asian markets. One by
one, Southeast Asian countries such as Thailand, Indonesia, Korea and Japan saw their
economies crash in the wake of heavy foreign investment. An economic boom had made the
region an attractive investment opportunity for much of the 1990s. By 1997, however,
domestic production and development had stalled, and foreign investors grew nervous. A
divestment run on the Thai baht triggered the crash. Large corporations, extremely
dependent upon the confidence of foreign investors failed to meet debt obligations and
began to fail throughout Southeast Asia. Currencies throughout the region faltered and
nosedived from their mid-1990s positions of stability. The causes of the Asian economic
crisis are varied. Lax oversight of corporations had ramifications in economic downturns
that were not a concern in the mid-90s boom. Macroeconomic policies of the southeast Asian
countries made their economies vulnerable to the uncertain confidence of their foreign
investors. Despite this, Corsetti, Pesenti and Roubini (1998) make the point that, "market
overreaction and herding caused the plunge of exchange rates, asset prices and economic
activity to be more severe than warranted by the initial weak economic conditions." Much
of the crisis that began in 1997 has roots that go back further to the area's economic
growth that started in the early 1990s.

Although many economists consider the Asian economic collapse to have begun in Thailand,
conditions throughout the region meant that other countries' economies were destabilized
to the extent that they quickly followed Thailand.

Throughout the early 1990s, growth in Southeast Asia attracted much foreign capital.
However, by 1995 and 1996, Thailand's current account deficit had grown (from 5.7% in '93
to 8.5% in '96 [Pesenti et al., 1998]). When domestic production slowed, this account
imbalance represented an even greater percentage, when compared to GDP. Much of the
instability in Thailand's economy was brought about by heavy short-term borrowing that
required stringent debt maintenance. A boom in real estate and the Thai stock market
attracted foreign speculation that could not be sustained in the face of investor doubts.
The Thai government attempted to shore up shaky investor confidence by officially backing
the financial institutions that were heavily indebted abroad.

For instance, in the first quarter of 1997 the central bank's Financial Institutions
Development Fund (FIDF) had lent over USD 8bn, 17.5% of which to Finance
One - at the time, the largest finance company in the country - alone. (Pesenti et
al.,1998).

This support of the highly leveraged private sector by the Thai government lent the
appearance of stability to an unstable system and attracted more foreign loans (to shore
up the Thai economy) to Thai financial institutions.

In February of 1997, the Thai company Somprasong was unable to make maintenance payments
on its high level of foreign debt. This was the first large default in Southeast Asia's
economic crash.

By mid-May of 1997, investor confidence in Thailand was so shaky that Singapore and
Thailand had to step in to prop up the baht in the face of "speculators who decided
Thailand's slowing economy and political instability meant it was time to sell."
(Chronology…). In the face of such instability, Finance One (the largest finance company
in Thailand) failed at the end of May. Most of the company's lending was made up of risky
loans for real estate and stock market margin investments. Political instability resulted
from the resignation of the Thai finance minister, which further shook foreign investor
confidence. "The strong speculative attack on the baht that followed forced Thailand to
let the currency float on July 2, a key date in the chronology of the Asian crisis."
(Pesenti et al., 1998). Once the government was no longer backing the baht, currency
depreciation further devastated the Thai economy. The Thai government was forced to call
upon the IMF for economic assistance.

In South Korea, the economy was similarly compromised prior to the events of 1997. A boom
in the mid-1990s had also expanded the Korean economy and attracted much foreign
investment. Many of the Korean chaebols, or large corporations, had high levels of foreign
debt by 1997. In January of 1997, the first sign of significant trouble for South Korea
occurred with the failure of Hanbo Steel. (Another Korean steel company, Sammi Steel,
failed two months later). The string of collapses of Korean chaebols had serious
consequences for many of the Korean banks. Lending to the Korean conglomerates had been
financed with foreign borrowing that left much of the Korean banking sector beholden to
the confidence of foreign investment. As this confidence began to wane, more corporations
failed, and the South Korean currency and stock markets collapsed. Southeast Asian nations
found themselves fighting a losing public relations battle, as negative media coverage
further encouraged the international community's lack of confidence.

Lee points out (1998) that much of the crisis in South Korea was precipitated by political
factors that influenced the governance of the Korean chaebols. "The behaviors of
politicians, bureaucrats and interest groups had been influential for resource allocation
in the Korean economy."

The effect of the destabilization in South Korea was felt in the currency and the stock
markets. The South Korean won in 1997 declined 15% against the dollar (by November) and
the stock market was down 28%. (Chronology, n.d.). By the end of 1997, South Korea was
unable to meet its debt load obligations to foreign investors. A consortium of German,
Dutch and U.S. lenders, in addition to the IMF, put together a $60 billion South Korean
bailout package that involved rolling over short-term debt, as well as an initial transfer
of over $10 billion to stabilize the South Korean economy.

The economic crisis in South Korea was eased somewhat when credit-rating agencies boosted
Korea's rating in February, 1998, after having lowered it the year before. This had the
psychological effect of restoring a measure of investor confidence in the country.

Whereas South Korea felt much of the Asian crisis in its corporate bankruptcies, Malaysia,
Indonesia and the Philippines found themselves in a similar position to Thailand. Like
Thailand, these countries were determined to hold down interest rates despite the sharp
declines in the ringgit, the rupiah and the peso, respectively.

In Malaysia, foreign investment had increased, such that the current account deficit was
8.8% of GDP by 1995 (Cosettie et al., 1998). Like Thailand, the financial sector in
Malaysia was heavily reliant on loans to support real estate speculation. By March of
1997, Bank Negara, the Malaysian central bank intervened to impose limits on lending to
the property sector. The decline of the baht forced speculative pressure onto the
Malaysian ringgit as well, dropping 26% between January of 1997 and September (Pesenti et
al., 1998). By the end of the year, the Malaysian government abandoned its stance of
artificially suppressing the rising interest rates.

Initially, Southeast Asian central banks had sought to prevent interest rates from
soaring, thereby crippling domestic private banks and companies with large foreign debt.
This strategy, however, proved to be counter-productive. By holding down interest rates,
the banks of Thailand, Malaysia, Indonesia and the Philippines triggered a currency
decline that affected the opposite actual response.

Depreciation jeopardized the very financial viability of financial and non-financial
firms which a loose monetary policy was meant to preserve, while increasing the
cost of bail-out well beyond the fiscal means of these countries. (Pesenti et al.,
1998).

The summer of 1997 saw intense currency speculation that drove down the value of the
Malaysian ringgit. As the ringgit depreciated in Malaysia, the Kuala Lumpur stock exchange
followed suit, with the entire Malaysian economy suffering from the lack of investor
confidence.

By the end of 1997, the Malaysian government attempted to address their economic slide by
introducing vast policy changes. A boom in the 1990s focused on rapid growth and large
government infrastructure projects. Many of these projects (like the situation elsewhere
in southeast Asia, most notably, Indonesia) were financed by heavy borrowing and motivated
more by patronage and political sway than sound financial analysis. Several economists
have suggested that the crisis in Malaysia was brought about, in part, by the ambitious
growth targets of Prime Minister Mahathir. In the mid-90s, this strategy of heavy
borrowing to finance economic growth led to a Malaysian boom. However, as with Thailand,
when investor confidence levels faltered, the highly leveraged Malaysian economy crashed.

This political impetus for economic growth was characteristic of most of Southeast Asia.
Government guarantees (both implicit and explicit) of domestic borrowing to finance such
growth led to a reliance on foreign investment capital. "Financial intermediation played a
key role in channeling funds toward projects that were marginal if not outright
unprofitable from a social point of view." (Corsetti, 1998).

Indonesia had a similar mid-1990s investment boom to Thailand and Malaysia. In Indonesia,
however, the political influence of President Suharto had an even greater effect in terms
of what projects got funding and which companies received aid. Corsetti et al. (1998)
mention several examples of economic incentives, tariff supports, and tax exemptions that
were enjoyed by the companies of Suharto's sons. "Suharto inaugurated an…[exemption]
from sales tax and tariffs…the only firm to qualify was an obscure company owned by
Suharto's youngest son." Such political interference insured that projects that wouldn't
have been considered economically viable received more favorable consideration when a
Suharto family member or friend was involved. Additionally, the Indonesian government (as
well as the Philippines) was intent on its efforts to maintain low interest rates. Like
the baht and ringgit, the Indonesian rupiah and Philippine peso depreciated rapidly in the
last half of 1997 and beginning of 1998.

The currency crises in Thailand, Malaysia, Indonesia and the Philippines were so
pronounced that it soon had an effect on Taiwan, Singapore and Hong Kong as well. Currency
value and the stock markets declined here as well, upon shaken foreign investor
confidence.

Japan, in 1996, appeared to be recovering after sluggish growth throughout the 1990s. This
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