Asian Economic Crisis

Narasinha Sawaikar
Summary of Lecture
Background to the crisis
Brief Chronology of crisis
Experiences of different countries in
dealing with the crisis
Lessons learnt from the crisis
Why study the Asian Crisis?
Big impact on world economy including
India
Good illustration of the interaction
between the financial system and the
macroeconomy
Illustrates important themes like
contagion.
Had a big impact on the debate about
capital account convertibility in India
Background to the Crisis
•East Asia was the fastest
growing region in the decades
before the crisis

•Strong export orientation

especially compared to Latin
American, India

•High savings and investment

Rates

•Good demographics
Good education systems
Problems in the East Asian model
 Many of the countries had high current account deficits
 Fixed exchange rates encouraged borrowing in short-term foreign
debt at cheap international rates.
 Financial bubbles especially in the property sector
 Fixed rates also meant less effective monetary policy so central
banks couldn’t control overheating economies
 Weak financial systems with poor credit appraisal norms.
 Politicized lending. Little transparency in the lending process.
 Lending heavily concentrated in a few areas like property and
export oriented conglomerates
Eg. Top 30 chaebol had debt-equity ratios of 400% in 1996
 Current Account Deficits

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Start of Crisis
The crisis struck first in Thailand of 8%
of GDP in 1996which had a current
account deficit
Most of this debt was financed with short-
term capital flows
Thailand’s debt to foreign banks rose
from 29 billion dollars in 1993 to 69
billion in 1997 most of which had
maturity of less than a year
Brief Chronology
 May 14 1997. Speculative attacks on Thai baht. Thailand spends
billions of dollars defending its currency
 July 2, 1997: Thailand baht is devalued
 July 11, 1997: Philippine peso is devalued
 August 14, 1997: Indonesian rupiah falls sharply
 October 20-23, 1997: Hong Kong stock market panic
 Oct 27, 1997: Panic spreads to Western stock markets
 November 17, 1997: Korean won collapses
 August 1998: Russia defaults on its debt. Causes turmoil in the
international markets. Dow falls by 512 points in one day
 September 1998: Hedge fund LTCM bailed out after its collapse
threatens financial system
 Currencies and Stocks

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Feedback effects
Dealing with the Crisis
 Short run problems: Foreign exchange to pay for imports, pay off
foreign debt
 Most countries took IMF Loans, IMF conditionalities
 Long-run Problems: Restoring the health of the financial sector
 Debt overhang: Bad debts will discourage fresh lending even when
it is justified.
 Non-performing loans: estimates of 800 billion dollars
 Government needs to deal with NPL as well as restructure the
financial sector
IMF Strategy
 Focus on investor confidence and maintaining value of
the currency
 In favour of free capital flows
 The IMF provided stabilization funds in return
demanded conditionalities in the form of austerity
measures like cutting fiscal deficits, raising interest rates
and removing capital controls
 Such policies were quite successful in South Korea and
Thailand but critics claimed that they ignored political
realities in countries like Indonesia and created too
much suffering.
Malaysia and Capital Controls
 A crisis creates a policy dilemma: A recession requires low interest rates and
expansionary fiscal policy to boost the economy.
 However the economy also needs to maintain the confidence of investors and this
requires high interest rates
 A way out of this dilemma is for a temporary capital controls which reduces capital
flight. Once the economy recovers capital controls can be lifted and the strong
fundamentals will hopefully prevent capital flight.

 One of the most controversial policies of the crisis was Malaysia’s decision to raise
capital controls
 In contrast to the IMF prescriptions:

 Malaysia introduced controls on capital-account transactions

 Lowered interest rates
 Reflated the domestic economy
Other measures
 Asset management companies were created to reduce
the problem of non-performing loans
 Encouraged the consolidation of the banking sector. A
smaller number of healthier banks
 Opened up the financial sector to foreign banks
 Improved financial regulation with better disclosure and
prudential norms
 Greater balance between different sectors. Much bigger
role for consumer finance which in turn means that
economic growth is more balanced between external and
domestic sector
 Current account balance

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 Recovery from Asian Crisis

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Lessons learned from the Asian Crisis
 Macroeconomic crises don’t come out of nowhere.
 However financial markets can overreact
 Viscous feedback effects can make things worse.
 Importance of reserves as a buffer in cases of crisis.. This may create its
own problems and may have helped cause current crisis.
 Potential problems with fixed exchange rates
 The case for globalization is weaker for capital flows than goods flows
 Importance of financial supervision and credit-management norms
 Malaysian example tentatively suggests that temporary capital controls can
be justified