The Causes and Impact of the Asian Financial Crisis
The events in Thailand prompted investors to reassess and test the robustness of currency pegs and financial systems in the region. The result was a wave of currency depreciations and stock market declines, first affecting Southeast Asia, then spreading to the rest of the region.
- Radiant Heating and Cooling Handbook.
- Search form.
- The Asian financial crisis: Lessons learned and unlearned!
- Korea and the Asian Financial Crisis.
Disruptions in bank and borrower balance sheets have led to widespread bankruptcies and an interruption in credit flows in the most severely affected economies. As a result, short-term economic activity has slowed or contracted severely in the most affected economies. Some argue that these runs reflected a classic financial panic that did not reflect poor economic policies or institutional arrangements. As is well known, even well-managed banks or financial intermediaries are vulnerable to panics, because they traditionally engage in maturity transformation.
That is, banks accept deposits with short maturities say, three months to finance loans with longer maturities say, a year or longer. Maturity transformation is beneficial because it can make more funds available to productive long-term investors than they would otherwise receive.
Under normal conditions, banks have no problem managing their portfolios to meet expected withdrawals. However, if all depositors decided to withdraw their funds from a given bank at the same time, as in the case of a panic, the bank would not have enough liquid assets to meet its obligations, threatening the viability of an otherwise solvent financial institution.
As pointed out by Radelet and Sachs , East Asian financial institutions had incurred a significant amount of external liquid liabilities that were not entirely backed by liquid assets, making them vulnerable to panics. As a result of this maturity transformation, some otherwise solvent financial institutions may indeed have been rendered insolvent because they were unable to deal with the sudden interruption in the international flow of funds. However, it is apparent that this is not the entire story, as the impact of the crisis varied significantly across economies.
In particular, as investors tested currency pegs and financial systems in the region, those economies with the most vulnerable financial sectors Indonesia, South Korea, and Thailand have experienced the most severe crises. In contrast, economies with more robust and well-capitalized financial institutions such as Singapore have not experienced similar disruptions, in spite of slowing economic activity and declining asset values.
Indeed the collapse of the Thai baht in July and of the Korean won in the last quarter of were preceded by signs of significant weaknesses in the domestic financial sector, notably an inability by domestic borrowers to service their debts. In Indonesia, it became apparent after the crisis that domestic lenders could not monitor adequately the financial condition of their borrowers, a situation that worsened the severity of the crisis.
This suggests that understanding what factors contributed to weaknesses in the financial sectors of the most affected economies may help make them less vulnerable to financial crises in the future. Two characteristics common in countries that have experienced financial crises were present in a number of East Asian economies. First , financial intermediaries were not always free to use business criteria in allocating credit.
In some cases, well-connected borrowers could not be refused credit; in others, poorly managed firms could obtain loans to meet some government policy objective. Hindsight reveals that the cumulative effect of this type of credit allocation can produce massive losses. Second, financial intermediaries or their owners were not expected to bear the full costs of failure , reducing the incentive to manage risk effectively.
Krugman points out that such guarantees can trigger asset price inflation, reduce economic welfare, and ultimately make the financial system vulnerable to collapse.
The Asian financial crisis: Lessons learned and unlearned
The importance of implicit government guarantees in the most affected economies is highlighted by the generous support given to financial institutions experiencing difficulties. This was confirmed by events in , when the government encouraged banks to extend emergency loans to some troubled conglomerates which were having difficulties servicing their debts and supplied special loans to weak banks. Buy Hardcover. FAQ Policy. About this book As witness to one of the world's great crises in recent times, academics and students, business people, national and international government analysts, policy makers and political leaders worldwide have been pre-occupied by an effort to adequately unravel or sufficiently understand the factors that have brought about the so-called Asian financial, currency or economic crisis and hopefully to find plausible cures or solutions to it.
Show all. Pages Harvie, Charles. Pages Ta, Guy. China: A Giant with an Achilles Heel? Local lending by foreign banks in all currencies, including foreign currencies, is now greater than their cross-border lending. As seen during the eurozone crisis, foreign banks tend to act as a conduit of financial instability in advanced economies, transmitting credit crunches from home to host countries, rather than insulating domestic credit markets from international financial shocks.
Sixth, in East Asia banking regulations and supervision have improved, promoting more prudent lending and restricting currency and maturity mismatches in bank balance sheets.
- International Business;
- Policy Challenges and Lessons.
- A Review of the Asian Crisis: Causes, Consequences and Policy Responses!
- Platinum Group Metals and Compounds;
- The Asian financial crisis: Lessons learned and unlearned.
However, banks now play a much less prominent role in the intermediation of international capital flows than in the s. International bond issues by corporations have grown much faster than cross-border bank lending directly or through local banks. More importantly, a very large part of capital inflows now go into local securities markets, bypassing the banking system. Seventh, the opening of domestic asset and credit markets to non-residents has been accompanied by extensive liberalization of the capital account for residents in East Asia and elsewhere.
Since the global crisis, there has been a massive accumulation of debt in dollars by non-financial corporations Non-financial corporations All economic agents that produce non-financial goods and services. They represent the greatest share of productive activity. In major emerging economies, such issues have also been made though foreign subsidiaries. These are not always repatriated and registered as capital inflows and external debt, but they have a similar impact on corporate fragility. In East Asia, dollar debt accumulation is particularly notable in Indonesia and Korea. This means that the reduction in currency mismatches in balance sheets is largely limited to the sovereign while private corporations have been building up debt in low-interest reserve currencies very much in the same way as in the s.
Eighth, most Asian emerging economies have also allowed and even encouraged corporations to invest abroad and become global players, occasionally by leveraging internationally. Limits on the acquisition of foreign securities, real estate assets and deposits by individuals and institutional investors Institutional investors Entities which pool large sums of money and invest those sums in securities, real property and other investment assets.
They are principally banks, insurance companies, pension funds and by extension all organizations that invest collectively in transferable securities. During the surges in capital inflows, a main motive for outward liberalization was to relieve upward pressures on currencies and avoid costly interventions in foreign exchange markets.
In other words, liberalization of resident outflows was used as a substitute for restrictions over non-resident inflows. Finally, like many others, East Asian economies have not been able to prevent ultra-easy monetary policies in the US, Europe and Japan from producing domestic credit and asset market bubbles in the past 10 years. Increases in non-financial corporate debt in Korea and Malaysia are among the fastest, between 15 and 20 percentage points of GDP, including both external and domestic debt.
Asian Financial Crisis in Indonesia
It includes the major industrialized countries and has 34 members as of January Thailand has also seen a significant increase in household indebtedness since , by some 25 percentage points of GDP. Capital account regimes of emerging economies, including in East Asia, are much more liberal today both for residents and for non-residents than in the s.
Foreign presence in credit, equity and debt markets has reached unprecedented levels, strongly affecting their liquidity and valuation dynamics and making them highly susceptible to global financial conditions. In the same vein, residents of these economies have increasingly become active in international financial markets as borrowers and investors. As a result, all emerging economies have now become susceptible to global financial cycles and shocks irrespective of their balance-of-payments, external debt, net foreign assets and international reserves positions although these play an important role in the way such shocks could impinge on them.
Indeed, asset and currency markets of all emerging economies, including China and other East Asian economies with strong international reserves and investment positions, were hit on several occasions in the past 10 years, starting with the collapse of Lehman Brothers in September The Lehman impact was strong but shortlived because of the easy money policy introduced in response by the US.
These bouts of instability did not inflict severe damage because they were temporary, shortlived dislocations caused by shifts in market sentiments without any fundamental departure from the policy of easy money. But they give strong warnings for the kind of turmoil emerging economies could face in the event of a normalization of monetary policy in the US, hikes in interest rates and contraction in global liquidity. After the Asian crisis, external vulnerability came to be assessed in terms of adequacy of reserves to meet short-term external debt in foreign currencies, defined as debt with a remaining maturity of up to one year.
While this is the most widely used indicator of external sustainability, empirical evidence does not always show a strong correlation between pressure on reserves and short-term external debt. Often, in countries suffering large reserve losses, sources other than short-term foreign currency debt played a greater role. Vulnerability to liquidity and currency crises is not restricted to short-term foreign currency debt. Countries with extensive foreign participation in equity, bond and deposit markets could be highly vulnerable even in the absence of high levels of short-term foreign-currency debt.
Currencies can come under stress if there is a significant foreign presence in domestic deposit and securities markets and the capital account is open for residents. A rapid and generalized exit could create significant turbulence with broader macroeconomic consequences, even though losses due to declines in asset prices and currencies fall on foreign investors and mitigate the drain of reserves. Financial turmoil could be aggravated if foreign exit is accompanied by resident capital flight.
Such market pressures have emerged in Malaysia from mid onwards mainly due to political instability when foreign holders of domestic securities started to unload ringgit-denominated assets. In October , the ringgit came under strong pressure, hitting the lowest level since September when it was pegged to the dollar. Although it showed some recovery subsequently, at the end of it reached below the lows seen during the turmoil in January as investors continued to download domestic assets, reacting to measures restricting currency speculation as well as prospects of higher US interest rates.
In all four East Asian countries directly hit by the crisis, international reserves now meet short-term external dollar debt. But they do not always leave much room to accommodate a sizeable and sustained exit of foreign investors from domestic securities and deposit markets and capital flight by residents. This is particularly the case in Malaysia where the margin of reserves over short-term dollar debt appears to be quite small while foreign holdings in local debt and equity markets are sizeable. However, the latter does not include long-term local-currency debt held by non-residents, which, together with large equity holdings by them, constitutes an important source of drain on reserves in the event of market stress, as seen after The country was included among the Fragile 5 in by Morgan Stanley economists for being too dependent on unreliable foreign investment to finance growth.
Thus a rapid exit from the securities market can also put pressure on the won.
There has been no severe financial crisis in major emerging economies in the last decade and a half when global financial conditions have remained highly favourable thanks to policies of easy money in the US, Europe and Japan. This has created addiction to cheap funds, a massive accumulation of debt and a sharp increase in foreign presence in securities, credit and property markets of emerging economies.
As a result, they have become highly vulnerable to a severe and sustained reversal of these conditions. The self-insurance they have built up in international reserves may prove inadequate in the event of a sudden stop in capital inflows, massive exit of foreign investors and capital flight by residents.
The CMIM is inadequate in size and flawed in design — some 1. It financed public and private projects in Third World and East European countries. It consists of several closely associated institutions, among which : 1. The International Bank for Reconstruction and Development IBRD, members in , which provides loans in productive sectors such as farming or energy ; 2.
The International Finance Corporation IFC , which provides both loan and equity finance for business ventures in developing countries. It is designed to complement rather than substitute the existing IMF facilities. Its size is even smaller and access beyond certain limits is also tied to the conclusion of an IMF programme. That leaves two options in the event of a serious liquidity crisis — seek assistance from the IMF and central banks of reserve-currency countries, or engineer an unorthodox response, even going beyond what Malaysia did during the crisis, bailing in international creditors and investors by introducing, inter alia, exchange restrictions and temporary debt standstills, and using selective controls in trade and finance to safeguard economic activity and employment.
The East Asian countries, like most emerging economies, appear to be determined not to go to the IMF again.