Term Paper on "What Are the Main Explanations for the 1997 Asian Currency Crisis?"

Term Paper 7 pages (2916 words) Sources: 12

[EXCERPT] . . . .

1997 Asian Currency Crisis

Main explanations of the 1997 Asian currency crisis:

The Asian currency crisis started in two phases of currency depreciations which were underway since the initial part of summer of 1997. The first round was marked by a steep decline of the Thai Bhat, the Malaysian Ringgit, the Philippine Peso and the Rupiah of Indonesia. Following the stabilization of the currencies, the second round set off with downward pressures hitting the Taiwan dollar, Won of S. Korea, Singaporean and Hong Kong Dollar. The governments of these nations had countered weakness in their currencies through the process of selling foreign exchange reserves and raising interest rates that in effect rendered economic growth sluggish and have made interest-bearing securities more appealing compared to equities. The currency crises also brought to light acute problems within the banking and financial sectors of the burdened Asian economies. (Nanto, 1998) distinctive characteristic of the currency crisis has been the assortment currency banking and debt crisis. Banking crisis, in the shape of huge nonperforming loans -- NPLs, banking insolvencies or near banks, low capital adequacy ratios -- CARs, or also outright runs on individual banks or other non-banking financial intermediaries was especially acute for east-Asian economies like Thailand, Indonesia, and S. Korea. In Japan, a long-lasting banking crisis was replete since the bursting of the bubble economy during 1990 which is yet to fully resolve. The Hong-Kong dollar in the first place had to bear the onslaught of the Asian crisis with the banking system getting affected. (Jao, 2001, p. 47)

On the same lines, the Indonesia Rupiah went down 25%, creating it to be the worst-functioning currency as it got reduced to abysmal standards from the time the crisis evolved in 1997-98. In the same manner the concern brought about a ripple effect through Southeast Asia. Since March 1997, the bhat fell 6.5% and the peso of Philippines by 9.5%. Bank of America's analyst termed the turmoil as a 'slow motion' currency crisis. The main reason ascribed is the political uncertainty along with the economic problems that are specific to each nation. During the height of the currency crisis, there were dangerously increased standards of foreign debt which were short-term and economic mismanagement which was serious enough that compelled a foreign investors' exodus from the complete area in large numbers and majority of the investors never returned. It is truer in case of Indonesia in particular. In that particular country corporations holding on to foreign-based debt becoming due has been in the process of trading rupiah for the purpose of greenbacks. In Thailand for instance, in spite of the rise in exports-based growth, consumer spending in domestic terms is 20% off the pre-turmoil standards. Non-functioning loans continue to constitute 36% with regard to the overall debt. Plus, the foreign debt has been calculated to be a whopping $90 billion. Although weak currencies support exporters, equity investors are scared, who do not want to view stock holdings decline in terms of failure of the currencies. The Thai index was from then reduced by about 42% in U.S. dollars. The Indonesian currency was also reduced by 43%. (Einhorn; Shari, 2000, p. 11)

Several Asian governments made substantial investments in specific targeted industries, decisions that sometimes invested into sectors that were not profitable. In S. Korea for instance, companies borrowed heavily and started accumulating huge debts in order to finance in such mature industries like electronics and steel. When the fortunes of these industries turned worse, it triggered a bout of corporate failures inclusive of the bankruptcy in January 1997 of the conglomerate Hanbo that had a $6 billion in debt. In July 1997, the crisis prolonged with Thailand allowing its currency to float freely causing panic in a lot of neighboring nations. For an export-dependent Asia, the situation of a devalued baht implied cheaper Thai exports as against those from Malaysia, Indonesia, Korea, Philippines and the Hong Kong. In order to remain competitive, a lot of nations devalued their own currencies which automatically heightened the debt owned by those companies whose loan contracts made an obligation to devalued local funds to repay in foreign currencies that were still strong. (Ito, 1999, p. 7)

Getting to the facts in understanding the crux of the problem, 1997 was a year marked by an economic slowdown in Asian economies. Average GDP growth had slipped from 8.2% in 1995 to 7.5% in 1996 and still more to 6.1% in 1997. Similarly, the growth of exports had come down from 19.2% and 21.6% during 1994 & 1995 respectively to 4.3% & 6.7% in 1996 & 1997 respectively. Within April 1995 and April 1997, the Japanese Yen came down by almost 60% against the dollar seriously eating into the price competitiveness of these economies in world markets. As a lot of Asian currencies were closely pegged to the dollar, their currencies went up in tandem with that of the dollar. By 1997, the dollar underwent a serious overvaluation similar to the currencies of those Asian economies which had persisted to appreciate with it. The Asian economies had drawn large capital inflows during the 1990s that was responsible for currency appreciations. In order to maintain the competitiveness of their exports, these economies made an all out effort to keep their real effective exchange rate -- REER from rising. (Das, 1999, p. 3)

In this pursuit, they tweaked some of their policies. For example, these policies broadened interest rate differentials that triggered the crisis which resulted soon after. The heavy capital inflows were mostly in the shape of short-term debts denominated in the currency of the lending nations, especially the Yen and the dollar. During the sharp decline of the valuation of the Asian currencies, this came to be an important constituent of the problem of the Asian economies. The domestic currency values of their external debt went up sharply. Besides, Asian companies wee unable to generate sufficient local currency to be capable enough to convert it into foreign exchange resources in order to fulfill their debt repayment needs. (Das, 1999, p. 3)

The five main causal factors are easy to locate (i) first, the past economic success of these Asian economies were easy targets for good locations for FDI. (ii) Secondly, several elements in their external economic environment which were earlier conducive, later did not find enough favor in a lot of respects during 1996-97. (iii) Thirdly, restrictions were imposed and inconsistencies in domestic macroeconomic and exchange rate policies. (iv) Fourthly, the economies had weak and vulnerable financial sector that included weaknesses in the institutional mechanism. (v) Fifthly, their economies were laid with structural weakness and defects in corporate weakness inclusive of nepotism and rampant red-tapism. (Das, 1999, p. 4)

Apart from the above five main factors, the most important intangible, market sentiment, contributed in a decisive manner in ushering the crisis to a forefront and in building the corruption effect. It is worthwhile to state that regardless of the huge current account deficits, the macroeconomic state of affairs in these countries were far from unstable during 1997. The heart of the crisis lay in the banking sector because of the unsystematic growth and diversification within the domestic financial markets financed through short-term private borrowings. Besides, the other factor that was responsible for the currency crisis is the speedy rise in private capital flows to Asian economies during the initial and middle part of the 1990s that was the slowdown in asset yields in the industrial economies. Comparatively weaker GDP growth in a lot of industrial economies at that period was responsible for the accommodative monetary policies and abysmal interest rates. (Das, 1999, p. 5-6)

Lower asset yields in industrial nations rendered emerging markets in general and Asian nations in particular, a rising attractive investment proposal. This showed in a close narrowing of yield spreads for the Asian economies, representing a rising choice among asset holders for investment in these countries. Apart from that, the risk premium narrowed down in asset markets, symbolizing a rising eagerness to accept risk by the wealth holders. This was the outcome of the wish to diversify their portfolios as also as enhanced confidence in the performance of the emerging Asian economies. (Das, 1999, p. 6)

Implications of the crisis for the Asian economic paradigm:

The Asian currency began and snowballed suddenly, when Thailand faced problems while maintaining its currency exchange rate during July 2, 1997. From then onwards it spread like a wildfire to other nations of the East-Asian region catching up with S. Korea and Japan as well. The crisis went down in history as the one of the most important events towards the end of the 20th century. As regards its timing and extent, the heavy impact it put has been borne into the 21st century. The collapse of the Asian current was interalia fueled by overinvestment in production capacity which was more than the domestic demand of the nation. The idea that exports would take care of the overcapacity definitely was wrong footed.… READ MORE

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