Asian Economic 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 effected 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 exhange 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 optimism was shortlived, however, when signs of trouble first appeared in Thailand and South Korea. Many Japanese banks held large lending portfolios throughout southeast Asia. As other economies faltered, the Japanese economy also suffered. “Banks and firms in South East Asia that had borrowed from Japan were hit by the currency shocks: the financial outlook of Japanese banks and securities firms correspondingly deteriorated.” (Pesenti et al., 1998).

It is also worth considering the role the IMF played in helping or hindering the recovery from the 1997/98 Asian economic crisis. When countries of southeast Asia found themselves over-leveraged and unable to meet foreign debt obligations, they turned to the IMF for help. In return for aid, countries had to agree to certain policy condition set out by the Fund. Thailand was the first country to solicit help, and in August, 1997, the IMF approved a loan for 3.9 billion (USD). This agreement stipulated the maintenance of a level of government reserves, the increase of the VAT, government cuts and a restructuring of the financial sector. A second bail-out was necessitated by the sharp decline of the baht, with subsequent aid packages (through 1998) that put further conditions on the Thai government.

Indonesia also approached the IMF for assistance in 1997. Credit was approved with similar conditions that the Thai government had agreed to, including closer oversight for the banking sector. Although few of the strict loan conditions were adhered to, the Indonesian government also received billions in IMF aid.

Korea also relied upon IMF support during the economic crisis of the late 90s. Several aid packages introduced growth targets, and improvement of oversight for the banking industry. The Korean government was called upon to “dismantle the non-transparent and inefficient ties among government banks and business.” (Corsetti et al., 1998).

There are many reasons frequently given for the wide reach and severity of the Asian economic crisis. An investment boom in the early- to mid-1990s saw the economies of southeast Asian countries grow rapidly. However, much of this investment was in very speculative areas. Real estate and stock market (margin) investments constituted a high proportion of foreign investment and destabilized the Asian economies when investor confidence changed.

In addition, the currencies of many of these Asian countries had appreciated to unsustainable levels. Many of the countries in question (Thailand, Malaysia, Indonesia…) operated a fixed exchange rate system that artificially maintained their currencies’ value. The result of this policy was to create large current account deficits, and set up these economies for monetary speculative attack.

A further problem that exacerbated the Asian currency and economic crisis was the tendency for governments and their central banks to promise bail-outs for foundering companies. The effect of these guarantees on the world market was to enable even more borrowing on the part of an already highly-leveraged society. Furthermore, the borrowing rate for domestic banks abroad was artificially low as a result of this government backing. Coupled with the currency depreciation that most countries were experiencing, this level of foreign debt proved to be too much of a burden.

The ‘domino effect’ was also seen due to the extreme interconnectedness of the Asian countries’ economies. When the currency of one country depreciated, this had a negative effect on the competitiveness of the other countries. So, when the Thai baht began to sink, this had a depreciating effect on other currencies such as the ringgit and the rupiah. For this reason, the spread of the crisis throughout southeast Asia was based on real monetary effects and not solely on investor psychology. “This game of competitive devaluations is an important factor that explains why the currency contagion and the domino effects were driven by fundamental factors rather than irrational contagion.” (Roubini, 1998). Market panic certainly played a role, however, as conditions deteriorated from 1997 to the spring of 1998.

The international community also had some responsibility for the severity of the Asian economic crisis. By continuing to lend money to various southeast Asian governments and companies without the requisite risk assessment, foreign banks effectively increased the precarious situation of these economies. Further currency speculation led to an illiquid market that exacerbated the currencies’ downward spiral.

The global impact of the Asian economic crisis of 1997/98 is still being felt. Despite speculation that recovery would be swift, the recession in this area lasted beyond 2000. “One of the only positive results of the recession is that the current account is now swinging strongly into surplus.” (Khor, 2000). There has also been a call for balance between the trend toward globalization (and financial liberalization) and a careful management of domestic monetary policy. A further result of the Asian economic crisis is a more careful attention to foreign debt levels. Borrowing is watched more carefully, particularly borrowing that is to finance speculative endeavors.

In a time of increased globalization and market inter-reliance it is interesting to consider the causes of the Asian economic crash and how such a crisis might be avoided in the future. It is naive to assume in today’s world economy that events that take place around the world won’t have ramifications throughout the world markets.

Bibliography

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Corsetti, G., Peneti, P., & Roubini, N. (1998). What caused the Asian currency and Financial crisis? Part I: A macroeconomic overview. Downloaded June 26, 2004 from Stern School of Business, NYU, Web site: http://www.stern.nyu.edu/globalmacro/asiacri1.pdf

Khor, M. (2000). The economic crisis in East Asia: Causes, effects, lessons. Downloaded June 28, 2004 from World Bank. Web site: http://www.worldbank.org/poverty / wdrpoverty/malaysia/khor.pdf

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Peneti, P., Roubini, N., & Corsetti, G. (1998). What caused the Asian currency and Financial crisis? Part II: The Policy Debate. Downloaded June 27, 2004 from Stern School of Business, NYU, Web site: http://www.stern.nyu.edu/globalmacro/asiacri2.pdf

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And the asian crisis. Downloaded July 1, 2004 from Stern School of Business, NYU, Web site: http://pages.stern.nyu.edu/~nroubini/NOTES/macro5.htm

Appendix A: Financial Tables (tables from Corsetti et al., 1998)

Table 1. Current Account (% of GDP)

1990 1991 1992 1993 1994 1995 1996 1997

Korea -1.24 -3.16 -1.70 -0.16 -1.45 -1.91 -4.82 -1.90

Indonesia -4.40 -4.40 -2.46 -0.82 -1.54 -4.27 -3.30 -3.62

Malaysia -2.27 -14.01 -3.39 -10.11 -6.60 -8.85 -3.73 -3.50

Philippines -6.30 -2.46 -3.17 -6.69 -3.74 -5.06 -4.67 -6.07

Singapore 9.45-12.36-12.38 8.48-18.12-17.93-16.26-13.90

Thailand -8.74 -8.01 -6.23 -5.68 -6.38 -8.35 -8.51 -2.35

Hong Kong 8.40 6.58 5.26 8.14 1.98 -2.97 -2.43 -3.75

China 3.02 3.07 1.09 -2.19 1.16 0.03 0.52 3.61

Taiwan 7.42 6.97 4.03 3.52 3.12 3.05 4.67 3.23

Note: The source of all data in these Tables is the International Financial Statistics of the International

Monetary Fund (unless otherwise noted). The data for Taiwan are from various sources (Economist Intelligence

Unit Reports, IMF’s December 1997 World Economic Outlook and Asian Development Bank). The data for Singapore for 1997 are from the Economist Intelligence Unit Country Report, 2nd quarter 1998.

Table 2. Non-Performing Loans (as proportion of total lending in 1996)

Korea 8%

Thailand 13%

Indonesia 13%

Hong Kong 3%

Malaysia 10%

China 14%

Philippines 14%

Taiwan 4%

Singapore 4%

Source: 1997 BIS Annual Report; Jardine Fleming.

Table 3. Debt Service plus Short-Term Debt, World Bank Data (% of foreign reserves).

1990 1991 1992 1993 1994 1995 1996

Korea 127.4 125.9 110.4 105.7-84.9 204.9 243.3

Indonesia 282.9 278.8 292.0 284.8 278.0 309.2 294.2

Malaysia 64.0-45.9-45.6-42.4-48.7-55.9-69.3

Philippines 867.6 257.0 217.1 212.6 172.0 166.6 137.1

Thailand 102.4-99.3 101.3 120.3 126.6 138.1 122.6

Hong Kong 30.5-26.9-22.8-20.6-22.0-16.8

China 55.3-43.7 108.6 113.7-54.1-49.6-38.5

Taiwan 23.9-22.3-23.1-25.2-23.7-24.2

The Thai government reneged on this guarantee in June, 1997, further destabilizing the economy

Malaysian Prime Minister, Mahathir Mohamad blamed this currency speculation on U.S. hedge fund manager, George Soros. “These countries have spent 40 years trying to build up their economies and a moron like Soros comes along.” (Chronology, n.d.).

To make matters worse, investor confidence was further undermined by questions about Suharto’s health.