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Asian Financial Crisis
David Richardson
Economics, Commerce and Industrial Relations Group
29 June 1998
Contents
Introduction
July 1997 Meltdown
Beginnings
Japan
IMF role in Asian financial crisis
Thailand
Indonesia
Korea
The Philippines
Where will it end?
Endnotes
The beginning of the Asian financial crisis can be traced
back to 2 July 1997. That was the day the Thai Government announced a
managed float of the Baht and called on the International Monetary Fund
(IMF) for 'technical assistance'. That day the Baht fell around 20 per
cent against the $US. This became the trigger for the Asian currency crisis.
Within the week the Philippines and Malaysian Governments were heavily
intervening to defend their currencies, while Indonesia intervened and
also allowed the currency to move in a widened trading range-a sort of
a float but with a floor below which the monetary authority acts to defend
the currency against further falls. By the end of the month there was
a 'currency meltdown' during which the Malaysian Prime Minister Mahathir
attacked 'rogue speculators' and named the notorious speculator and hedge
fund manager, George Soros, as being personally responsible for the fall
in value of the ringgit. Soon other East Asian economies became involved,
Taiwan, Hong Kong, Singapore and others to varying degrees.(1) Stock and
property markets were also feeling the pressure though the declines in
stock prices tended to show a less volatile but nevertheless downward
trend over most of 1997.
By 27 October the crisis had had a world wide impact,
on that day provoking a massive response on Wall Street with the Dow Jones
industrial average falling by 554.26 or 7.18 per cent, its biggest point
fall in history, causing stock exchange officials to suspend trading.
There is now fairly common agreement that the affected
Asian currencies had been out of line with their economic fundamentals.
For years, if not decades, many of the Asian economies had fixed their
currencies against the $US. In earlier years they had probably kept their
values low as part of their export push. Virtually all of the Asian economies
that have been mentioned in the context of the Asian financial crisis
have based their economic strategies on export promotion. That certainly
includes Japan, the second wave(2) of economies-Korea and Taiwan, and
the third wave of economies which followed the Japanese industrial policy
model to varying degrees-especially Malaysia, Thailand, as well as Indonesia
and the Philippines.(3) Hong Kong has been different, relying on a laissez
faire economic policy. All but Japan had fixed exchange rates against
the $US, though some such as Singapore operated a loose link with the
$US.
The appreciation of the $US against the Japanese Yen
and third country currencies meant a decline in the competitiveness of
these East Asian countries so long as they continued to fix their currencies
against the $US. It seemed to be the case that under these fixed exchange
rates countries continued to try to defend over-valued exchange rates
for far too long, and long after everyone realised that the currency was
over-valued.
In that way the monetary authorities concerned were offering
everyone a good one way bet. If you bet against the currency the worst
thing that can happen is nothing and you get your money back. However,
the overwhelming odds are in favour of a win because the speculation itself
becomes overwhelming. With that sort of 'game' it is no wonder that a
country like Malaysia found a seemingly unlimited number of speculators
willing to have a bet against the ringgit.
In addition to the currency misalignment leading up to
1997, there were other factors that have been implicated in the Asian
crisis. Prior to this Asia had been the 'flavour of the month' as far
as investors around the world had been concerned. Australia, for example,
now has a number of listed companies that are basically investment funds
that invest in Asia. The Australian Stock Exchange has been very active
in the past trying to get Asian companies to list in Australia and now
quotes an Asian index, an index of all the listed companies in Australia
whose business is chiefly their operations or investments in Asia.
There is nothing to suggest that the Asian shares listed
in Australia were anything other than sound. However, that is not the
case elsewhere. A lot of speculative money went into real estate and property
development. The speculative activity fed on itself and produced asset
price inflation bubbles in countries like Thailand, Malaysia and the Philippines.
Now of course the speculative bubble has burst, as is evident in reduced
property values. In the second half of 1997 annual office occupancy costs
fell by 56 per cent in Bangkok, 37 per cent in Manila, 36 per cent in
Kuala Lumpur and 27 per cent in Hong Kong.(4) Business Week claims
that before the crisis there were 'white-elephant construction projects,
a bribe-based business ethic, and way too much capacity in too many industries.'(5)
Since the crisis broke there has been a lot of critical
comment as to issues such as corporate governance, accountability, transparency
of the financial system, and the like. These issues have been addressed
in the packages agreed with the IMF and have been pursued independently
by countries such as Malaysia without IMF prompting. All of those accountability
and transparency issues are important. However, the speculative activity
in Asian assets leading up to July 1997 was unlikely to be influenced
by more and better information on the underlying assets. It is in the
nature of speculative booms that such rational considerations are ignored.
Since the events of 1997, an important body of opinion
has developed, laying the blame for the Asian crisis on the interventionist
policies pursued by the governments in the economies concerned. The head
of the Australian Treasury, Mr Ted Evans, has put the blame squarely on
government intervention in the relevant Asian economies:
Asian countries have repeated the mistakes of many
of their western counterparts (in many of which, in varying degrees,
those errors persist). The desire to give government preference to
particular investments-rather than to get the overall economic climate
right-is a hard habit to shake. Though many governments now see the
problems in attempting to 'pick winners' they nevertheless lean towards
policies which seem more designed to pick losers. The most obvious
example of this is incentives given to investments on the basis that
they would not otherwise occur.
While there may be no apparent fiscal problem in
such circumstances, when the policies become unsustainable (for whatever
reason) there are inevitably pressures for the cost to be picked up
in the fiscal accounts. If the mechanisms used to create the investment
incentives include the direction of lending via the banking system,
while that system remains under implicit or explicit government guarantee,
the danger is extremely great-the more so because its magnitude is
hidden until the crisis occurs.(6)
It is true that there has been heavy government intervention
in many of the Asian economies. However, it seems unfair to blame government
intervention for the current financial problems without recognising the
role of government in producing the dramatic growth in economic activity
and living standards in the Asian region in earlier periods.
In a recent press statement the World Bank reminded us
that '[n]o other group of countries in the world has produced more rapid
economic growth and dramatic reduction in poverty than East Asia. Korea,
Malaysia, and Thailand have virtually eliminated poverty, and Indonesia
is within reach of that goal.'(7) The implication is that the East Asian
development model should not be dismissed quite so casually. Indeed, an
official from the United Nations Conference on Trade and Development (UNCTAD)
has suggested that the problems in 1997 can be ascribed to the attempts
to deregulate some of the Asian economies. Some of these economies had
liberalised their financial systems following pressure from the developed
countries. However, the institutional structure was not appropriate for
a market driven environment. Over-borrowing and over-investment on the
part of the Korean chaebol (the Korean corporate conglomerates)
followed as they became multinationals, and their activities became less
transparent and more difficult to monitor.(8) For example, the supervisory/regulatory/accountability
structures were inadequate to cope with temptations on financial institutions
to enter speculative real estate and similar ventures. Deregulation meant
that all of a sudden inexperienced banks were thrust into a competitive
and speculative environment, taking a mass of foreign deposits on the
one hand and facing property deals on the other.
The fact that the IMF has recognised the importance of
institutional failings supports the interpretation that the process of
deregulation in East Asian countries has not addressed the adequacy of
the institutional structures. Those institutional structures were designed
for a different period. Like any other social organisation, setting up
a free market also requires attention to the rules and the institutions
playing under the rules. Yet policy makers around the world often fall
into the trap of thinking that deregulation can be implemented by pulling
down structures without any thought as to what might or should replace
them.
In many respects the Asian economies are similar to the
emerging economies of the old Communist bloc. The IMF has been active
in providing advice to former Communist countries on the dismantling of
their regulatory apparatus. The former Communist countries pulled down
the apparatus of central planning but without establishing the legal and
institutional structures-the rules of the game-that might facilitate the
evolution towards capitalistic economies. There are similar dangers for
the Asian economies that attempt to dismantle the government/finance/industry
development model.
The Managing Director of the IMF, Michel Camdessus, commented
on the uniqueness of the IMF programs in Thailand, Indonesia and Korea
which represented a 'marked departure' from those traditionally supported
by the IMF:
Instead of austerity measures to restore macroeconomic
balance, the centerpiece of each program is a set of forceful, far-reaching
structural reforms aimed at restoring market confidence. The reforms
included in these programs will require vast changes in domestic business
practices, corporate culture, and government behaviour.(9)
One influential commentator, Martin Feldstein, President
of the National Bureau of Economic Research, has suggested that by the
time the IMF came to intervene in the Asian rescue packages it was keen
to apply the structural changes it had been applying in the former Soviet
Union and its satellites. In addition it was also keen to apply the traditional
Latin American mix of policy prescriptions. However, the analogy of shifting
from communism to a market economy was wrong and the Latin American policy
mix inappropriate. Moreover, the measures are unnecessary to address the
country's access to the international capital markets-the real issue at
stake. Instead we have an unnecessary interference in the internal workings
of the countries in question. In his own words:
The legitimate political institutions of the country
should determine the nation's economic structure and the nature of
its institutions. A nation's desperate need for short-term financial
help does not give the IMF the moral right to substitute its technical
judgements for the outcomes of the nation's political system.(10)
There has been pressure on Japan to stimulate its economy,
increase its imports from the region, and so contribute to economic recovery
among Asian economies. Japan is the major surplus country and in the best
position to accept a large surge in imports. The importance of Japan for
the rest of the region cannot be over-emphasised. Sales to Japan account
for 12 per cent of Malaysia's GDP, and in the range 5 to 7 per cent in
the case Indonesia, Korea, Taiwan and Thailand.(11) For that reason the
US has long been urging Japan to stimulate its economy and act as the
engine of growth for the Asian region.(12) If anything the impression
is that Japan has been doing the exact opposite. For example, Business
Week said:
All these measures [policy responses to the crisis]
will be meaningless unless Japan also makes some serious commitments.
So far, Tokyo has stood out as one of the chief villains in the crisis.
It has let the Yen slide to boost its own exports at the expense of
its neighbours. And it has clamped down on its domestic growth, ignoring
pleas to import more Asian goods...Corralling Japan into the effort
will be a major challenge.(13)
Japanese responsibility has been a growing concern as
the crisis continued. There is criticism that Japan has not acted as decisively
as the international community would have liked. On 27 March 1998 the
Japanese Government announced a fiscal stimulus package worth $US127 billion
to be spent on such public works as infrastructure for science, technology
and telecommunications. Australia's Treasurer, Peter Costello, welcomed
the package saying 'the Japanese economy has been in the doldrums for
most of the decade and it is important that it once again becomes a driver
in the region.'(14) One estimate suggested Japan's economic growth would
be boosted by 1.1 per cent.(15) Since that announcement the consensus
seems to be that much more needs to be done by the Japanese. For example,
there is concern that the Japanese fiscal stimulus will not compensate
for the slump in Japanese exports caused by the Asian crisis.(16)
In the context of continuing concern by the international
community, the Japanese yen has been in decline over most of the last
18 months or so. In mid June 1998 the yen had fallen to 147 to the $US,
down 23 per cent from 113 yen to the $US a year earlier. The fall in the
yen raised the prospect that the rest of the affected Asian economies
would be forced to engage in a new round of devaluations. China's fixed
exchange rate against the $US has been an important source of stability
in the region. However, that relationship was seen to be threatened by
the falling yen. Accordingly the US and Japanese Governments intervened
on 17 June with a package of measures including the purchase of the yen
by the US. For the moment this seems to have stabilised the yen/$US relationship.
Nevertheless there remain continuing calls for Japan to further stimulate
its economy to assist the region as a whole.
The IMF arranged rescue packages for three countries
facing severe crises-Thailand, Indonesia and Korea in that order. In looking
at the individual packages described below, it is important to note that
there are many initiatives which go beyond the type of responses needed
to quickly address currency problems. The packages include measures that
affect the structure of the economies concerned, such as the accountability
of the corporate sector, legislated monopoly privileges and prudential
regulation of the financial institutions. IMF packages have always had
their critics. However, criticism has been particularly severe as the
Asian packages have gone into such detail in areas that are arguably the
domain of domestic political determination.
From mid-1996 Thailand was experiencing a sharp downturn
in exports and slowdown in growth, difficulties in the property markets,
a sharp fall in the stock market and weakening of the fiscal position.
That was followed by 'a series of increasingly serious attacks on the
baht.'(17)
On 20 August, as part of an overall package of reform,
the IMF approved stand-by credit for Thailand of up to $US3.9 billion,
$US1.6 billion was available immediately and the rest subject to performance
targets and program review. The package of measures under the program
included:
- a new exchange rate regime based on floating of the baht
- fiscal policy designed to produce a surplus
- ending the support for insolvent financial institutions
- strengthened financial regulation and supervision
- accelerated privatisation, and
- increased emphasis on secondary education and training.
In discussions leading up to the announcement, Australia,
along with Hong Kong, Malaysia and Singapore each pledged $US 1 billion
while Japan pledged $US 4 billion. Indonesia and Korea pledged $US 0.5
billion each while the World Bank and Asian Development Bank agreed to
contribute $US 1.5 and 1.2 billions respectively.
Indonesia has been hardest hit by the Asian financial
crisis with massive falls in the exchange rate and stock prices. The IMF
believes that Indonesia's structural weaknesses made it especially vulnerable
to adverse external developments. It cites domestic trade regulations,
import monopolies, lack of transparency and data deficiencies in the business
environment, a weak banking system ill-prepared to withstand the financial
turmoil in SE Asia, and high levels of corporate overseas debt taken out
after a history of stable exchange rates which proved unsustainable.(18)
On 5 November the IMF announced a package including stand-by
credit of $US10.14 billion for Indonesia. The rest of the package includes:
- fiscal measures designed to maintain the surplus
- tight monetary policy
- closing unviable banks
- liberalising foreign trade and investment
- dismantling domestic monopolies
- private sector participation in infrastructure
- expanding the privatisation program, and
- increasing the transparency of public sector activities to enhance
the quality of governance.
In addition to the IMF credits the World Bank has pledged
$US 4.5 billion and the Asian Development Bank $US 3.5 billion. Indonesia's
own external assets, which are estimated at equivalent to 6 months imports,
are committed to the package. In addition, Australia, as well as China,
Hong Kong, Japan, Malaysia, Singapore and the US have indicated they would
be prepared to consider supplementary finance to support the program in
the event the IMF credit arrangements proved insufficient. Australia's
commitment is up to $US 1 billion.
Since the Indonesian package was agreed the Indonesian
Government appears to have lost faith in the IMF package and implementation
has been delayed or avoided. On 11 February 1998 the Indonesian Government
raised its proposal for a Currency Board for Indonesia. The IMF was concerned
about that and the fact that the Indonesian Government was looking for
solutions outside of the agreed package. The IMF warned Indonesia not
to adopt the proposal and the Indonesian Government criticised the IMF
program for not working to improve the Indonesian economy. In March the
IMF delayed payments to Indonesia under the program and warned that Indonesia's
crisis could worsen the situation throughout Asia. On 20 March Indonesia
announced a 5 per cent tax on short-term capital flows. This decision
was reversed on 23 March. It is probably something of an understatement
to suggest Indonesian economic policy was somewhat erratic during this
period. It is very likely that the erratic policy making of this period
actually worsened Indonesia's plight. Evidence for that is suggested by
the experience of the Indonesian rupiah. While other Asian currencies
hit bottom at the end of 1997 or early 1998, the others have bounced back
and are now no worse than 40 below their values (against the $US) at the
beginning of 1997. Unfortunately Indonesia's rupiah fell by over 80 per
cent against the $US to January 1998 and, after a brief recovery, had
fallen again to new lows by the end of June 1998.
Indonesia's economic instability has been reinforced
by its political instability. By May 1998 Indonesia was suffering from
riots and ethnic violence. On 21 May President Suharto resigned and was
succeeded by his deputy BJ Habibie. President Habibie soon announced a
series of political reforms as well as reforms aimed at overcoming cronyist
activities.(19) The IMF had been due to distribute funds for balance of
payments support in early June 1998 under a further revision of the agreement
with Indonesia. However, a necessary IMF review of Indonesia was unable
to take place in early May as a result of the political unrest. The IMF
now expects to make new funds available in early or mid-July.(20)
Korea's problems emerged earlier in 1997 as a number
of highly leveraged conglomerates or chaebols became bankrupt as a result
of over-investment in steel and cars, and weakened profitability with
the cyclical downturn. The bankruptcies weakened the financial system
with non-performing loans reaching 7.5 per cent of GDP. The decline in
stock prices further reduced the value of bank equity. All of this led
to a sharp fall in external finance.(21)
On 4 December the IMF announced a package including a
$US 21 billion stand-by credit for Korea. The package of measures agreed
by Korea includes:
- tight monetary policy with high interest rates to stabilise markets
- tight fiscal policy
- strengthening the financial system through a firm exit policy, market
and supervisory discipline and increased competition
- further trade liberalisation
- easing restrictions on foreign ownership, and
- making it easier to dismiss workers.
In addition to the IMF funding, the World Bank has indicated
it will provide $US 10 billion to support specific structural reform.
The Asian Development Bank has promised another $US 4 billion. As a second
line of defence, Australia along with Belgium, Canada, France, Germany,
Italy, Japan, the Netherlands, Sweden, Switzerland, the UK, and US have
indicated they are prepared, in the event that there is a need for additional
resources, to consider supplemental financing. This 'second line of defence'
is expected to be in excess of $US 20 billion.(22) The second line of
defence was being activated over Christmas and the Treasurer announced
an early drawing of $US 8 billion on the supplemental support arrangements.
Australia's share was expected to be $US 330 million.
In addition to the three countries above the Philippines
should be mentioned given that it is now part way through an IMF adjustment
program. This program pre-dates the 1997 Asian financial crisis and is
of a completely different order of magnitude. Following the extension
of the Extended Fund Facility in July 1997, the total amount available
to the Philippines is $US1037 million, considerably less than the amounts
involved in the other Asian countries.(23) However, the extension was
in response to the effects of the regional capital market turbulence and
the float of the baht on 2 July.
At the end of June, 1998, currency and stock markets
still seem to display a fair amount of volatility but the trend is no
longer downward and the markets seem to be well off their lows. Even Indonesia
had been off its lows in terms of the value of its currency and the behaviour
of the stock markets. However, Indonesia now seems to be back at currency
levels as low as they had ever been through the present episode. Of course,
the return of relatively healthy financial markets does not necessarily
mean the underlying economy has returned to health.
It will be recalled that following the 1987 Wall Street
crash, which, by the end of the day became a world stock market crash,
there was concern that the massive destruction of wealth could flow on
to the real economy. It was feared the crash might mean a flight to liquid
and safe assets and the withdrawing of credit for industrial purposes.
The world's central banks quickly intervened to make sure markets remained
liquid. Fortunately the crash did not make serious enough 'ripples' to
affect the real economy to any major extent. Concerns of a 1929 type crash
were allayed and the financial crisis remained confined largely to financial
circles. It is too soon to tell if the Asian financial crisis will have
such an effect on the most affected economies of East Asia. Indonesia's
plight is clearly the worst and the effect of the financial crisis has
been severe. There has been a massive decline in living standards among
most of the population and so the financial crisis there has become a
severe economic, social and political crisis. Hopefully the rest of the
region can escape with something closer to a 1987-type crash rather than
the 1929-type crash being endured by Indonesia. The consensus seems to
be that from 1999 onward there should be a tentative return to growth
throughout most of Asia, slowly at first but an eventual return to more
rapid growth rates.
Japan was once the prime example of the high growth Asian
economy, indeed, it was the inspiration for development strategies among
other developing Asian economies. Now Japan is perhaps partly seen as
an example of what might happen when governments delay deregulation for
too long.
Korea was the most sophisticated of the badly affected
Asian economies. However, some of its best-known chaebol, or conglomerates,
are under pressure. The chaebol had been experiencing problems before
the crisis-for example, Kia the car maker went broke in 1997, before the
crisis was apparent, and is now effectively nationalised. Its problems
stem in large part from the world over-capacity in cars and the additional
problems of new entrants into foreign car markets. Large companies that
had seemed healthy enough are now in difficulties. Samsung has a debt
to equity ratio of 267 per cent. Interest rates have increased dramatically
as part of the package of measures designed to overcome the crisis in
conjunction with the IMF. That means Samsung now has a huge interest bill
as a first call on its cash flow and is likely to make a loss this financial
year. One of the strategies it is trying in order to reduce its debt is
to sell off assets. Samsung's construction business has been sold to Volvo,
and its forklift business to an American company.(24) General Motors is
purchasing 35 per cent of Daewoo.(25) Australia's ANZ Bank and other companies
are also scouring the region for bargains.(26)
There may be a shakeout of the ownership of much of the
productive capacity in the most affected Asian countries. The private
sector in these countries, including the banks, have incurred heavy foreign
currency debts. But no matter how that pans out, the factories, machines,
the public and private infrastructure will still be there no matter how
many bankruptcies and asset fire sales take place. Foreign corporations
have been picking over undervalued assets. In most of the affected economies
we may well one day look back and find that the main enduring effect of
the 1997 crisis has been a change of ownership-especially an increase
in the foreign ownership of productive assets in Asian countries.
- N. Roubini, Chronology of the Asian Currency Crisis and its Global
Contagion, at web site: http://www.stern.nyu,edu/~nroubini/asia/AsiaChronology1.html
- The second wave of economies refers to those that tried to emulate
Japan's post war economic strategy beginning in the late 1960s and the
1970s. These are basically the two former Japanese colonies, Korea and
Taiwan. Not only did they try to copy the Japanese export-led and government-guided
strategies, but they also created similar institutional structures often
with the same names. They were followed in the 1980s by the third wave
Malaysia, Thailand, Indonesia and the Philippines. Again even the names
of the institutions were copied in many cases. China may now be thought
of as part of the fourth wave.
- Arguably Indonesia and the Philippines were less influenced by the
Japanese model though they nevertheless relied heavily on government
directed industry policy to achieve economic development.
- Australian Financial Review, 27 March 1998.
- Business Week (Asian Edition), 26 January 1998, p. 1.
- E. Evans, 'Asia, the IMF and Australia,' Address to the Sydney Institute,
17 February 1998, pp. 6-7.
- 'Responding to the crisis: Backing East Asia's social and financial
reforms. World Bank announces visit by its President, James D. Wolfensohn,
to East Asia,' World Bank Press Statement, 27 January 1998, at Web site:
http://www.worlbank.org/html
- Y Akyuz, 'The East Asian financial Crisis: Bank to the Future?' United
Nations Conference on Trade and Development web site: http://www.unicc.org/unctad/en/pressref/prasia98.htm
- IMF Survey, Vol 27(4), 23 February 1998, p. 49.
- M. Feldstein, 'Refocussing the IMF,' Foreign Affairs, forthcoming,
March/April 1998, p. 27.
- The Economist, 20 June 1998.
- See N. Roubini, Chronology of the Asian Currency Crisis and its Global
Contagion: 1998, web site: http://www.stern.nyu.edu/~nroubini/asia/AsianChronology1998.html
- Business Week, 26 January 1998, p. 17.
- AAP news service, 27 March 1998.
- Asia Pulse news service, 27 March 1998.
- The Economist, 20 June 1998.
- 'IMF approves Stand-by credit for Thailand,' IMF Press Release no.
97/37, 20 August 1997.
- 'IMF approves stand-by credit for Indonesia,' IMF Press Release no.
97/50, 5 November 1997.
- 'Indonesia: Post Suharto Reforms,' Oxford Analytica Daily Brief, 26
May 1998.
- 'Indonesia aid put on hold: IMF to conduct review of economic progress
before funding resumes,' CNN news service, 10 June 1998.
- 'IMF approves SRD 15.5 billion stand-by credit for Korea,' IMF Press
Release no. 97/55, 4 December 1997.
- Ibid.
- 'IMF approves extension and augmentation of EFF for the Philippines,'
IMF Press Release No 97/33, 18 July 1997.
- Business Week (Asian edition), 23 March 1998.
- Reuters news service, 29 April 1998.
- The Australian Financial Review, 18 June 1998.
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