South East asian financial crisis and its lessons for developing countries.

Sr. No. Topic Inroduction 1 Chronology 2 Diagnosis of financial crises 3 Economic impact of the crises 4 Evolution of crises 5 Effect on countries 6 Consequences 7 Role of IMF 8 Conclusion 9 Lesson 10 11 Bibliography Page no. 02 03 06 08 13 18 24 27 29 31 32

Introduction
The South East Asian financial crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown due to financial contagion. The crisis started in Thailand with the financial collapse of the Thai Baht caused by the decision of the Thai government to float the Baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt. Though there has been general agreement on the existence of a crisis and its consequences, the exact reasons of this financial crisis are still debatable. Since the middle of 1997, East Asia has been gripped by an economic, and more latterly a political crisis that shows few signs of abating. In the space of less than a year the international standing and domestic situations of what were formerly taken to be miracle economies has been dramatically transformed. Major companies have defaulted on their foreign debt repayments, anxious domestic and international investors have relocated or withdrawn vast amounts of capital, inflation and unemployment have soared, and political instability has risen to dangerous levels. Within this context, the expectations of many observers that the East Asian miracle would continue indefinitely have been replaced by more sober predictions of recession and deflation. Even the most optimistic observers suggested that economic recovery for the region would take at least three years away. Pessimists suggested that the region could take decades to recover and that the present crisis thus marks the end of the East Asian miracle. South East Asian economies had maintained high interest rate which promised high return rate for foreign investors looking for investment. Regional

economies Thailand, Malaysia, Indonesia, Singapore and South Korea experienced 8-12% GDP growth in the late 1980s and early 1990s. US $184 billion entered in the developing countries during 1994-96 according to the Bank of International Settlements. In the first half of 1997 $70 billion came in but in 2nd half of 1997 (Onset of crisis) this inflow suddenly turned into outflow of US $102 Billion, creating a wide spread panic among the investors and governments alike.

A CHRONOLOGY OF THE CRISIS 1997 January The Korean industrial conglomerate (chaebol), Hanbo Steel collapses under $6 billion in debts, raising questions about the sustainability of a rapid growth strategy dependent on large, potentially unsustainable external borrowings. May The Thai baht comes under speculative attack from foreign currency traders. Doubts emerge about the continuing competitiveness of the Thai economy given the bahts loose pegging to the $US. June - July Thai insurance and finance companies begin to collapse. At the same time the contagion effect begins, initially affecting the Philippines and Indonesia. In July, Thailand calls in the IMF for technical assistance. The IMF also offers the Philippines financial assistance. Malaysia abandons the defense of the ringgit as the contagion spreads. August The rupiah falls dramatically following the governments decision to abandon its managed float exchange rate policy. Mahathir blames Soros for initiating the crisis. The IMF increases assistance to Thailand to over US$17 billion. October As the crisis deepens, Indonesia calls in the IMF. Late in the month the IMF offers the Indonesian government a $23 billion support package. November South Korean stock market prices collapse triggering debt and confidence crises. By November 21, Korea is also forced to ask the IMF for assistance.

December The IMF puts together a multi-billion dollar rescue package for Korea. As the financial crisis continues to intensify, Japan tries to stimulate its domestic economy, but its own banking sector is downgraded by ratings agencies.

1998 January The Indonesian currency continues on a downward path, partly driven by Suhartos decisions to continue as President and appoint Habibie as Vice Presidentthe currency breaks Rp. 15,000 to US$1 barrier. February Stock markets in the region rebound during February, but remain characterized by extreme volatility. A standoff over a currency board proposal continues between Indonesia and the IMF. March The Indonesian economy is on the brink of hyper-inflation. Unemployment escalates. Japanese proposals to stimulate its domestic economy are poorly received. The IMF adopts a more flexible position towards Indonesias reform program. April Japans Nikkei stock market index plunges at the start of the new fi nancial year. Moodys Investor Service lowers Japans sovereign debt rating. G7 leaders fail to give support the Yen which continues its steady decline in value. May

Massive student protest and riots erupt in Indonesia for Suharto to resign. VicePresident B.J. Habibie takes over. The transition fails to bring stability to the Indonesian economy. The yen continues to fall against the dollar, undercutting the competitive position of other Asian nations and sparking fears of a fresh round of currency collapses. June The crisis begins to affect Australia more directly steady decline in the value of the Australia dollar despite Reserve Bank intervention sees interest rates begin to move up. Pauline Hansons One Nation Party has electoral success in Queensland. The Japanese economy officially moved into recession following second successive quarter of negative growth.

Diagnosing Financial Crises Not all financial crises are alike, even though superficial appearances may deceive. Only a close historical analysis, guided by theory, can disentangle the key features of any particular financial crisis, including the Asian crisis. We identify five main types of financial crises, which may in fact be intertwined in any particular historical episode. 1. Macroeconomic Policy-Induced Crisis: Following the canonical Krugman (1 979) model, a balance-of-payments crisis (currency depreciation, loss of foreign exchange reserves, collapse of a pegged exchange rate) arises when domestic credit expansion by the central bank is inconsistent with the pegged exchange rate. Often, as in the Krugman model, the credit expansion results from the monetization of budget deficits. Foreign exchange reserves fall gradually until the central bank is vulnerable to a sudden run, which exhausts the remaining reserves and pushes the economy to a floating rate. 2. Financial Panic: Following the Diamond-Dybvig (1983) model of a bank run, a financial panic is a case of multiple equilibrium in the financial markets. A panic is an adverse equilibrium outcome in which short-term creditors suddenly withdraw their loans from a solvent borrower. In general terms, a panic can occur when three conditions hold: short-term debts exceed short-term assets, no single private

market creditor is large enough to supply all of the credits necessary to pay off existing short-term debts, and there is no lender of last resort. In this case, it becomes rational for each creditor to withdraw its credits if the other creditors are also fleeing from the borrower, even though each creditor would also be prepared to lend if the other creditors were to do the same. The panic may result in large economic losses (premature suspension of investment projects, liquidation of the borrower, creditor grab race, etc.). 3. Bubble Collapse: Following Blanchard and Watson (1982) and others, a stochastic financial bubble occurs when speculators purchase a financial asset at a price above its fundamental value in the expectation of a subsequent capital gain. In each period, the bubble (measured as the deviation of the asset price from its fundamental price) may continue to grow or may collapse with a positive probability. The collapse, when it occurs, is unexpected but not completely unforeseen since market participants are aware of the bubble and the probability distribution regarding its collapse. A considerable amount of modeling has examined the conditions in which a speculative bubble can be a rational equilibrium. 4. Moral Hazard Crisis: Following Akerlof and Romer (1994), a moral hazard crisis arises because banks are able to borrow funds on the basis of implicit or explicit public guarantees of bank liabilities. If banks are undercapitalized or underregulated, they may use these funds in overly risky or even criminal ventures. Akerlof and Romer argue that the economics of looting, in which banks use their state backing to purloin deposits, is more common than is generally perceived and played a large role in the U.S. savings and loan crisis. Krugman (1998) similarly argues that the Asian crisis is a reflection of excessive gambling and indeed stealing by banks that gained access to domestic and foreign deposits by virtue of state guarantees on these deposits.

5. Disorderly Workout: Following Sachs (1995), a disorderly workout occurs when an illiquid or insolvent borrower provokes a creditor grab race and a forced liquidation even though the borrower is worth more as an ongoing enterprise. A disorderly workout occurs especially when markets operate without the benefit of creditor coordination via bankruptcy law. The problem is sometimes known as a debt overhang. In essence, coordination problems among creditors prevent the efficient provision of working capital to the financially distressed borrower and delay or prevent the eventual discharge of bad debts ( e g , via debt-equity conversions or debt reduction).

THE ECONOMIC IMPACT OF THE CRISIS We shall see the major impacts of the crisis and provide some empirical evidence of their magnitude. Currency Rates By far the most dramatic and destabilising consequence of the East Asian crisis has been a collapse in the value of the currencies within the region (See Table 1). Of these, the Indonesian rupiah, the South Korean won, the Thai baht, the Philippine peso, and the Malaysian ringgit have been the worst affected. The Hong Kong dollar has been the only currency not to record a fall over the past 12 months. Significantly, Hong Kong utilises a currency board system in which the Hong Kong dollar is pegged to the US dollar. Unlike Indonesia, however, which also considered adopting a currency board system until International Monetary Fund (IMF) pressure and declining investor confidence persuaded it not to, Hong Kong has foreign reserves of its own and the implicit support of mainland China which also has substantial reserves. Chinas currency has been similarly unaffected as it is not fully convertible. Table 1. Currency Rates (equivalent of $US1)

Capital Flows Although there are a number of interpretations about the ultimate causes of the crisis, there is little doubt that flows of capital in and out of the region have been a major influence on both the regions rapid development and its

subsequent collapse. Huge inflows of private capital were instrumental in causing both the appreciation of regional currencies and the value of domestic assets, particularly in areas like real estate. Indeed, it is important to remember that it was the bursting of Thailands speculative real estate bubble that was one of the first clear indicators and triggers of the initial crisis. The other factor that needs to be borne in mind with regard to capital flows is their sheer volume compared to what are still comparatively small Southeast Asian economies. By some estimates, US$ 2 trillion passes through the worlds financial markets every day. This compares with Indonesias entire annual GNP of US$ 136 billion. The subsequent loss of investor confidenceor outright paniccaused significant withdrawals of capital from the region. According to the Institute of International Finance, private capital flows to the five countries worst affected by the crisisIndonesia, South Korea, the Philippines, Thailand, and Malaysiafell from +$US93 billion in 1996 to -$12.1 billion in 1997 and are forecast to be -$9.4 billion for 1998. As Table 2 illustrates, most of this fall resulted from a decline in commercial bank lending, although outflows of equity capital also had a significant impact. Table 2. External Financing for Five Asian Economies ($US billions)

Interest Rates The crisis has also led to a dramatic rise in prime lending rates within the region, especially in Indonesia and the Philippines (See Figure 1). As the value of Asian currencies has fallen, banks have increased interest rates in order to stem capital flight and maintain liquidity. At the same time, governments have been forced to raise interest rates in order to contain the inflationary pressures caused by the currency collapse. Two points are worth noting in connection with interest rates. First, comparatively high interest rates were actually used by a number of governments to attract capital prior to the crisisa strategy that was fraught with potential risk. Second, the current high interest rate levels in the region make any rapid regeneration of domestic activity more problematic.

Economic Growth Another important element of the crisis has been a substantial drop in economic growth rates within the region. In May of last year, the IMF was forecasting continued strong growth for the region for 1997 and 1998. By December, however, it had dramatically revised its growth forecasts, predicting a substantial drop in growth in all countries with the partial exception of South Korea (See Table 3). This is an especially serious concern in a region in which the legitimacy of government has often been directly bound up with its ability to deliver rising living standards.

Consumer Demand Compounding the impact of the crisis has been a substantial fall in consumer confidence and spending. For instance, as Table 4 illustrates, automobile sales within the region are expected to decline significantly during 1997-1998. The contraction of domestic markets is potentially important for a number of reasons. First, economic recovery will be more dependent on maintaining or increasing exports to key markets in North America and Europe. Given Europes own modest economic performance and the possibility of further trade tensions over the United States increasing deficits with the East Asian region, this is clearly a strategy that faces a number of potential obstacles. Second, the regions deteriorating economic performance may make inflows of foreign direct investment (FDI) in productive activities less likely in the short term, further constraining local economic activity. Third, the IMFs influential policy prescriptions of fiscal restraint make any government-led economic recovery less likely.

Default on Foreign Debts and Corporate Collapses The crisis has also increased many Asian countries foreign debt burdens. As Table 5 shows, Asian companies have borrowed heavily from international banks in recent years, especially short-term. As the value of Asian currencies has fallen, these companies have found it difficult to meet their debt repayments because their incomes are overwhelmingly in local currencies whilst their debts are largely denominated in foreign ones. In some cases this has led to defaults on debt repayments. Perhaps the best known example of this was the Indonesian taxi company, PT Steady Safe, whose inability to repay its debts resulted in the collapse of the Peregrine investment House in Hong Kong last year. Many other companies, especially in Indonesia, Thailand and South Korea, are having trouble repaying their foreign loans, something which makes any short-term resolution of the crisis all the more problematic.

Non-Performing Loans In addition to being unable to repay their foreign debts, many Asian companies have also had difficulty servicing their local debts since the crisis began. The result of this, as Table 6 shows, has been a substantial increase in the level of non-performing loans within the region. Not only does this make the position of these companies more uncertain and the possibility of a domestic-led recovery more remote, but it also acts as a continuing disincentive to further investment in the region in the short-term.

Inflation Finally, as Table 7 illustrates, the crisis has also led to inflationary pressures within the region. These pressures have been by far the greatest in Indonesia where panic buying occurred in mid-January and the central bank, Bank Indonesia, increased the money supply in an attempt to maintain liquidity. The most immediate impact of this inflationary trend has been to compound the impact of the general economic downturn across the social spectrum, raising the possibility, especially in Indonesia, of widespread social unrest.

The Evolution of the Crisis Triggering Events The cracks began to appear at almost the same time in Korea and Thailand in early 1997. In January, Hanbo Steel collapsed under $6 billion in debts. Hanbo was the first bankruptcy of a Korean chaebol in a decade. In the months that followed, Sammi Steel and Kia Motors suffered a similar fate. These bankruptcies, in turn, put several merchant banks under significant pressure, since much of the foreign borrowing of these companies had been, in effect, channeled through (and in some cases guaranteed by) the merchant banks. In Thailand, Samprasong Land missed payments due on its foreign debt in early February, signaling the fall in the property markets and the beginning of the end of the financial companies that had lent heavily to property companies. During the ensuing six months, the Bank of Thailand lent over Bt 200 billion ($8 billion) to distressed financial institutions through its Financial Institutions Development Fund (FIDF). As concerns began to mount, the Bank of Thailand also committed almost all of its liquid foreign exchange reserves in forward contracts, much of it to speculators who correctly guessed that the combination of slow export growth and financial distress would ultimately require a devaluation. By late June, net forward sales of reserves approximately equalled gross reserves. This does not mean that the central bank had run out of usable reserves (since the open forward positions could be closed at a partial, not complete, loss), but usable reserve levels had fallen sharply. In late June 1997, the Thai government removed support from a major finance company, Finance One, announcing that creditors (including foreign creditors) would incur losses, contrary to previous announcements and market expectations. This shock accelerated the withdrawal of foreign funds and prompted the currency depreciation on 2 July 1997. In turn, the Thai baht devaluation triggered the capital outflows from the rest of East Asia.

Panic amongst lenders and withdrawal of credit

The resulting panic among lenders led to a large withdrawal of credit from the crisis countries, causing a credit crunch and further bankruptcies. In addition, as foreign investors attempted to withdraw their money, the exchange market was flooded with the currencies of the crisis countries, putting depreciative pressure on their exchange rates. To prevent currency values collapsing, these countries' governments raised domestic interest rates to exceedingly high levels (to help diminish flight of capital by making lending more attractive to investors) and to intervene in the exchange market, buying up any excess domestic currency at the fixed exchange rate with foreign reserves. Neither of these policy responses could be sustained for long.

Very high interest rates, which can be extremely damaging to an economy that is healthy, wreaked further havoc on economies in an already fragile state, while the central banks were hemorrhaging foreign reserves, of which they had finite amounts. When it became clear that the tide of capital fleeing these countries was not to be stopped, the authorities ceased defending their fixed exchange rates and allowed their currencies to float. The resulting depreciated value of those currencies meant that foreign currency-denominated liabilities grew substantially in domestic currency terms, causing more bankruptcies and further deepening the crisis. Other economists, including Joseph Stiglitz and Jeffrey Sachs, have downplayed the role of the real economy in the crisis compared to the financial markets. The rapidity with which the crisis happened has prompted Sachs and others to compare it to a classic bank run prompted by a sudden risk shock. Sachs pointed to strict monetary and contractory fiscal policies implemented by the governments on the advice of the IMF in the wake of the crisis, while Frederic Mishkin points to the role of asymmetric information in the financial markets that led to a "herd mentality" among investors that magnified a small risk in the real economy. The crisis has thus attracted interest from behavioral economists interested in market psychology. Another possible cause of the sudden risk shock may also be attributable to the handover of Hong Kong sovereignty on 1 July 1997. During the 1990s, hot money flew into the Southeast Asia region through financial hubs, especially Hong Kong. The investors were often ignorant of the actual fundamentals or risk profiles of the respective economies, and once the crisis gripped the region, coupled with the political uncertainty regarding the future of Hong Kong as an Asian financial centre led some investors to withdraw from Asia altogether. This shrink in investments only worsened the financial conditions in Asia (subsequently leading to the depreciation of the Thai baht on 2 July 1997). Several case studies on the topic Application of network analysis of a financial system; explains the interconnectivity of financial markets, and the significance of the robustness of hubs or the main nodes. Any negative externalities in the hubs creates a ripple effect through the financial system and the economy (and, the connected economies) as a whole. The foreign ministers of the 10 ASEAN countries believed that the well coordinated manipulation of their currencies was a deliberate attempt to destabilize the ASEAN economies. Former Malaysian Prime Minister Mahathir Mohamad accused George Soros of ruining Malaysia's economy with "massive currency speculation." (Soros claims to have been a buyer of the ringgit during its fall, having sold it short in 1997.) At the 30th ASEAN Ministerial Meeting held in Subang Jaya, Malaysia, the foreign ministers issued a joint declaration on 25 July 1997 expressing serious

concern and called for further intensification of ASEAN's cooperation to safeguard and promote ASEAN's interest in this regard. Coincidentally, on that same day, the central bankers of most of the affected countries were at the EMEAP (Executive Meeting of East Asia Pacific) meeting in Shanghai, and they failed to make the 'New Arrangement to Borrow' operational. A year earlier, the finance ministers of these same countries had attended the 3rd APEC finance ministers meeting in Kyoto, Japan on 17 March 1996, and according to that joint declaration, they had been unable to double the amounts available under the 'General Agreement to Borrow' and the 'Emergency Finance Mechanism'. As such, the crisis could be seen as the failure to adequately build capacity in time to prevent Currency Manipulation. This hypothesis enjoyed little support among economists, however, who argue that no single investor could have had enough impact on the market to successfully manipulate the currencies' values. In addition, the level of organization necessary to coordinate a massive exodus of investors from Southeast Asian currencies in order to manipulate their values rendered this possibility remote.

The proximate causes of the withdrawal differed somewhat across the region: Bank failure: The failure of finance companies in Thailand and the bank closures in Indonesia helped set off the exodus. Corporate failure: In Korea, the withdrawal of funds was based on concerns about the health of the corporate sector. Political Uncertainty: In Korea, Thailand, the Philippines, and Indonesia, political uncertainty hastened the credit withdrawals, since each country faced a potential change in government. (Korea and Thailand have both changed governments since the onset of the crisis. A new president will be elected in the Philippines in May 1998. Elections are scheduled for mid-March 1998 in Indonesia, though with no chance of a change through the ballot box. Suhartos weakening health, along with the absence of a clear successor, and growing discomfort with the

economic role played by the presidents family-rather than the presidents electoral vulnerability-are the notable features of Indonesian political uncertainty.) Contagion: Many creditors appeared to treat the region as a whole and assumed that if Thailand was in trouble, the other countries in the region probably had similar difficulties. Part of the contagion effect was the sudden loss of government credibility throughout the region. After all, the Thai government had pledged for months that Finance One was in good shape, that plenty of foreign exchange reserves were available, and that the baht would not be devalued. Malaysia, the Philippines, and Indonesia were all hit hard by contagion effects.

International interventions: Although at times the IMF can help restore confidence in battered economies, it can also send a signal to creditors of impending crisis, leading to an accelerated outflow of foreign funds.This depends especially on the specific measures that the IMF recommends. In the case of the Asian programs, the IMF recommended immediate suspensions or closures of financial institutions, measures that actually helped to incite panic.

Effect on other countries Thailand

From 1985 to 1996, Thailand's economy grew at an average of over 9% per year, the highest economic growth rate of any country at the time. Inflation was kept reasonably low within a range of 3.45.7%. The baht was pegged at 25 to the US dollar. On 14 May and 15 May 1997, the Thai baht was hit by massive speculative attacks. On 30 June 1997, Prime Minister Chavalit Yongchaiyudh said that he would not devalue the baht. This was the spark that ignited the Asian financial crisis as the Thai government failed to defend the baht, which was pegged to the basket of currencies in which the U.S. dollar was the main component against international speculators. Thailand's booming economy came to a halt amid massive layoffs in finance, real estate, and construction that resulted in huge numbers of workers returning to their villages in the countryside and 600,000 foreign workers being sent back to their home countries. The baht devalued swiftly and lost more than half of its value. The baht reached its lowest point of 56 units to the US dollar in January 1998. The Thai stock market dropped 75%. Finance One, the largest Thai finance company until then, collapsed. Without foreign reserves to support the US-Baht currency peg, the Thai government was eventually forced to float the Baht, on 2 July 1997, allowing the value of the Baht to be set by the currency market. On 11 August 1997, the IMF unveiled a rescue package for Thailand with more than $17 billion, subject to conditions such as passing laws relating to bankruptcy (reorganizing and restructuring) procedures and establishing strong regulation frameworks for banks and other financial institutions. The IMF approved on 20 August 1997, another bailout package of $3.9 billion. By 2001, Thailand's economy had recovered. The increasing tax revenues allowed the country to balance its budget and repay its debts to the IMF in 2003, four years ahead of schedule. The Thai baht continued to appreciate to 29 Baht to the Dollar in October 2010.

Indonesia

In June 1997, Indonesia seemed far from crisis. Unlike Thailand, Indonesia had low inflation, a trade surplus of more than $900 million, huge foreign exchange reserves of more than $20 billion, and a good banking sector. But a large number of Indonesian corporations had been borrowing in U.S. dollars. During the preceding years, as the rupiah had strengthened respective to the dollar, this practice had worked well for these corporations; their effective levels of debt and financing costs had decreased as the local currency's value rose. In July 1997, when Thailand floated the baht, Indonesia's monetary authorities widened the rupiah currency trading band from 8% to 12%. The rupiah suddenly came under severe attack in August. On 14 August 1997, the managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The rupiah dropped further. The IMF came forward with a rescue package of $23 billion, but the rupiah was sinking further amid fears over corporate debts, massive selling of rupiah, and strong demand for dollars. The rupiah and the Jakarta Stock Exchange touched a historic low in September. Moody's eventually downgraded Indonesia's long-term debt to 'junk bond'. Although the rupiah crisis began in July and August 1997, it intensified in November when the effects of that summer devaluation showed up on corporate balance sheets. Companies that had borrowed in dollars had to face the higher costs imposed upon them by the rupiah's decline, and many reacted by buying dollars through selling rupiah, undermining the value of the latter further. In February 1998, President Suharto sacked Bank Indonesia Governor J. Soedradjad Djiwandono, but this proved insufficient. Suharto resigned under public pressure in May 1998 and Vice President B. J. Habibie was elevated in his place. Before the crisis, the exchange rate between the rupiah and the dollar was roughly 2,600 rupiah to 1 USD. The rate plunged to over 11,000 rupiah to 1 USD on 9 January 1998, with spot rates over 14,000 during 2326 January and trading again over 14,000 for about six weeks during JuneJuly 1998. On 31 December 1998, the rate was almost exactly 8,000 to 1 USD. Indonesia lost 13.5% of its GDP that year. After the crisis, on 2000, the Malaysia's SOE acquired Indonesia's SOE, the example is the banking sector, Maybank (Malaysian Banking Berhad, Malaysia state-owned bank) acquired BNI(Bank Negara Indonesia, Indonesia state-owned bank) on December 29, 1999-January 1, 2000 with the agreement signature by Abdurrahman Wahid (4th President of Indonesia) and Salahuddin of Selangor (11th Yang di-Pertuan Agong of Malaysia). (See also : Bank Negara Indonesia#BNI Maybank)

South Korea
The banking sector was burdened with non-performing loans as its large corporations were funding aggressive expansions. During that time, there was a haste to build great conglomerates to compete on the world stage. Many businesses ultimately failed to ensure returns and profitability. The chaebol, South Korean conglomerate, simply absorbed more and more capital investment. Eventually, excess debt led to major failures and takeovers. For example, in July 1997, South Korea's third-largest car maker, Kia Motors, asked for emergency loans. In the wake of the Asian market downturn, Moody's lowered the credit rating of South Korea from A1 to A3, on 28 November 1997, and downgraded again to B2 on 11 December. That contributed to a further decline in South Korean shares since stock markets were already bearish in November. The Seoul stock exchange fell by 4% on 7 November 1997. On 8 November, it plunged by 7%, its biggest one-day drop to that date. And on 24 November, stocks fell a further 7.2% on fears that the IMF would demand tough reforms. In 1998, Hyundai Motors took over Kia Motors. Samsung Motors' $5 billion venture was dissolved due to the crisis, and eventually DaewooMotors was sold to the American company General Motors (GM). The South Korean won, meanwhile, weakened to more than 1,700 per U.S. dollar from around 800. Despite an initial sharp economic slowdown and numerous corporate bankruptcies, South Korea has managed to triple its per capita GDP in dollar terms since 1997. Indeed, it resumed its role as the world's fastest-growing economysince 1960, per capita GDP has grown from $80 in nominal terms to more than $21,000 as of 2007. However, like the chaebol, South Korea's government did not escape unscathed. Its national debt-to-GDP ratio more than doubled (approximately 13% to 30%) as a result of the crisis. In South Korea, the crisis is also commonly referred to as the IMF crisis.

Philippines
The Philippine central bank raised interest rates by 1.75 percentage points in May 1997 and again by 2 points on 19 June. Thailand triggered the crisis on 2 July and on 3 July, the Philippine Central Bank intervened to defend the peso, raising the overnight rate from 15% to 32% at the onset of the Asian crisis in mid-July 1997. The peso dropped from 26 pesos per dollar at the start of the crisis to 38 pesos in mid-1999 to 54 pesos as in early August 2001. The Philippine GDP contracted by 0.6% during the worst part of the crisis, but grew by 3% by 2001, despite scandals of the administration of Joseph Estrada in 2001, most notably the "jueteng" scandal, causing the PSE Composite Index, the main index of the Philippine Stock Exchange, to fall to 1000 points from a high of 3000 points in 1997. The peso's value declined to about 55 pesos to the US dollar. Later that year, Estrada was on the verge of impeachment but his allies in the senate voted against continuing the proceedings. This led to popular protests culminating in the "EDSA II Revolution", which effected his resignation and elevated Gloria Macapagal-Arroyo to the presidency. Arroyo lessened the crisis in the country. The Philippine peso rose to about 50 pesos by the year's end and traded at around 41 pesos to a dollar in late 2007. The stock market also reached an all-time high in 2007 and the economy was growing by more than 7 percent, its highest in nearly two decades.

Hong Kong
In October 1997, the Hong Kong dollar, which had been pegged at 7.8 to the U.S. dollar since 1983, came under speculative pressure because Hong Kong's inflation rate had been significantly higher than the U.S.'s for years. Monetary authorities spent more than US$1 billion to defend the local currency. Since Hong Kong had more than US$80 billion in foreign reserves, which is equivalent to 700% of its M1 money supply and 45% of its M3 money supply, the Hong Kong Monetary Authority (effectively the city's central bank) managed to maintain the peg. Stock markets became more and more volatile; between 20 and 23 October the Hang Seng Index dropped 23%. The Hong Kong Monetary Authority then promised to protect the currency. On 15 August 1998, it raised overnight interest rates from 8% to 23%, and at one point to 500%. The HKMA had recognized that speculators were taking advantage of the city's unique currencyboard system, in which overnight rates automatically increase in proportion to large net sales of the local currency. The rate hike, however, increased

downward pressure on the stock market, allowing speculators to profit by short selling shares. The HKMA started buying component shares of the Hang Seng Index in mid-August. The HKMA and Donald Tsang, then the Financial Secretary, declared war on speculators. The Government ended up buying approximately HK$120 billion (US$15 billion) worth of shares in various companies, and became the largest shareholder of some of those companies (e.g., the government owned 10% of HSBC) at the end of August, when hostilities ended with the closing of the August Hang Seng Index futures contract. In 1999, the Government started selling those shares by launching the Tracker Fund of Hong Kong, making a profit of about HK$30 billion (US$4 billion).

Malaysia
Before the crisis, Malaysia had a large current account deficit of 5% of its GDP. At the time, Malaysia was a popular investment destination, and this was reflected in KLSE activity which was regularly the most active stock exchange in the world (with turnover exceeding even markets with far higher capitalization like the New York Stock Exchange). Expectations at the time were that the growth rate would continue, propelling Malaysia to developed status by 2020, a government policy articulated in Wawasan 2020. At the start of 1997, the KLSE Composite index was above 1,200, the ringgit was trading above 2.50 to the dollar, and the overnight rate was below 7%. In July 1997, within days of the Thai baht devaluation, the Malaysian ringgit was "attacked" by speculators. The overnight rate jumped from under 8% to over 40%. This led to rating downgrades and a general sell off on the stock and currency markets. By end of 1997, ratings had fallen many notches from investment grade to junk, the KLSE had lost more than 50% from above 1,200 to under 600, and the ringgit had lost 50% of its value, falling from above 2.50 to under 4.57 on (23 January 1998) to the dollar. The then premier, Mahathir Mohammad imposed strict capital controls and introduced a 3.80 peg against the US dollar. Malaysian moves involved fixing the local currency to the US dollar, stopping the overseas trade in ringgit currency and other ringgit assets therefore making offshore use of the ringgit invalid, restricting the amount of currency and investments that residents can take abroad, and imposed for foreign portfolio funds, a minimum one-year "stay period" which since has been converted to an exit tax. The decision to make ringgit held abroad invalid has also dried up

sources of ringgit held abroad that speculators borrow from to manipulate the ringgit, for example by "selling short." Those who do, have to purchase back the limited ringgit at higher prices, making it unattractive to them. In addition, it also fully suspended the trading of CLOB (Central Limit Order Book) counters, indefinitely freezing approximately US$4.47 billion worth of shares and affecting 172,000 investors, most of them Singaporeans. In 1998, the output of the real economy declined plunging the country into its first recession for many years. The construction sector contracted 23.5%, manufacturing shrunk 9% and the agriculture sector 5.9%. Overall, the country's gross domestic product plunged 6.2% in 1998. During that year, the ringgit plunged below 4.7 and the KLSE fell below 270 points. In September that year, various defensive measures were announced to overcome the crisis. The principal measure taken were to move the ringgit from a free float to a fixed exchange rate regime. Bank Negara fixed the ringgit at 3.8 to the dollar. Capital controls were imposed while aid offered from the IMF was refused. Various task force agencies were formed. The Corporate Debt Restructuring Committee dealt with corporate loans. Danaharta discounted and bought bad loans from banks to facilitate orderly asset realization. Danamodal recapitalized banks. Growth then settled at a slower but more sustainable pace. The massive current account deficit became a fairly substantial surplus. Banks were better capitalized and NPLs were realised in an orderly way. Small banks were bought out by strong ones. A large number of PLCs were unable to regulate their financial affairs and were delisted. Compared to the 1997 current account, by 2005, Malaysia was estimated to have a US$14.06 billion surplus. Asset values however, have not returned to their pre-crisis highs. In 2005 the last of the crisis measures were removed as the ringgit was taken off the fixed exchange system. But unlike the pre-crisis days, it did not appear to be a free float, but a managed float, like the Singapore dollar.

Singapore
As the financial crisis spread the economy of Singapore dipped into a short recession. The short duration and milder effect on its economy was credited to the active management by the government. For example, the Monetary Authority of Singapore allowed for a gradual 20% depreciation of the Singapore dollar to cushion and guide the economy to a soft landing. The timing of government programs such as the Interim Upgrading Program and other construction related projects were brought forward.

Instead of allowing the labor markets to work, the National Wage Council preemptively agreed to Central Provident Fund cuts to lower labor costs, with limited impact on disposable income and local demand. Unlike in Hong Kong, no attempt was made to directly intervene in the capital markets and the Straits Times Index was allowed to drop 60%. In less than a year, the Singaporean economy fully recovered and continued on its growth trajectory.

China
The Chinese currency, the renminbi (RMB), had been pegged to the US dollar at a ratio of 8.3 RMB to the dollar, in 1994. Having largely kept itself above the fray throughout 19971998 there was heavy speculation in the Western press that China would soon be forced to devalue its currency to protect the competitiveness of its exports vis-a-vis those of the ASEAN nations, whose exports became cheaper relative to China's. However, the RMB's nonconvertibility protected its value from currency speculators, and the decision was made to maintain the peg of the currency, thereby improving the country's standing within Asia. The currency peg was partly scrapped in July 2005 rising 2.3% against the dollar, reflecting pressure from the United States. Unlike investments of many of the Southeast Asian nations, almost all of China's foreign investment took the form of factories on the ground rather than securities, which insulated the country from rapid capital flight. While China was unaffected by the crisis compared to Southeast Asia and South Korea, GDP growth slowed sharply in 1998 and 1999, calling attention to structural problems within its economy. In particular, the Asian financial crisis convinced the Chinese government of the need to resolve the issues of its enormous financial weaknesses, such as having too manynon-performing loans within its banking system, and relying heavily on trade with the United States.

United States and Japan

The "Asian flu" had also put pressure on the United States and Japan. Their markets did not collapse, but they were severely hit. On 27 October 1997, the Dow Jones industrial plunge 554 points or 7.2%, amid ongoing worries about the Asian economies. The New York Stock Exchange briefly suspended trading. The crisis led to a drop in consumer and spending confidence (see 27 October 1997 mini-crash). Indirect effects included the dot-com bubble, and years later the housing bubble and the Subprime mortgage crisis. Japan was affected because its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latter's economy was more than twice the size of the rest of Asia together; about 40% of Japan's exports go to Asia. The Japanese yen fell to 147 as mass selling began, but Japan was the world's largest holder of currency reserves at the time, so it was easily defended, and quickly bounced back. GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998, due to intense competition from cheapened rivals. The Asian financial crisis also led to more bankruptcies in Japan. In addition, with South Korea's devalued currency, and China's steady gains, many companies complained outright that they could not compete.

Consequences
Asia

The crisis had significant macroeconomic-level effects, including sharp reductions in values of currencies, stock markets, and other asset prices of several Asian countries. The nominal U.S. dollar GDP of ASEAN fell by US$9.2 billion in 1997 and $218.2 billion (31.7%) in 1998. In South Korea, the $170.9 billion fall in 1998 was equal to 33.1% of the 1997 GDP. Many businesses collapsed, and as a consequence, millions of people fell below the poverty line in 19971998. Indonesia, South Korea and Thailand were the countries most affected by the crisis. The above tabulation shows that despite the prompt raising of interest rates to 32% in the Philippines upon the onset of crisis in mid-July 1997, and to 65% in Indonesia upon the intensification of crisis in 1998, their local currencies depreciated just the same and did not perform better than those of South Korea, Thailand, and Malaysia, which countries had their high interest rates set at generally lower than 20% during the Asian crisis. This created grave doubts on the credibility of IMF and the validity of its high-interest-rate prescription to economic crisis.

The economic crisis also led to a political upheaval, most notably culminating in the resignations of President Suharto in Indonesia and Prime Minister General Chavalit Yongchaiyudh in Thailand. There was a general rise in antiWestern sentiment, with George Soros and the IMF in particular singled out as targets of criticisms. Heavy U.S. investment in Thailand ended, replaced by mostly European investment, though Japanese investment was sustained. Islamic and other separatist movements intensified in Southeast Asia as central authorities weakened. New regulations weakened the influence of the bamboo network, a network of overseas Chinese family-owned businesses that dominate the private sector of Southeast Asia. After the crisis, business relationships were more frequently based on contracts, rather than the trust and family ties of the traditional bamboo network. More long-term consequences included reversal of the relative gains made in the boom years just preceding the crisis. Nominal US dollar GDP per capital fell 42.3% in Indonesia in 1997, 21.2% in Thailand, 19% in Malaysia, 18.5% in South Korea and 12.5% in the Philippines. The CIA World Factbook reported that the per capita income (measured by purchasing power parity) in Thailand declined from $8,800 to $8,300 between 1997 and 2005; in Indonesia it increased from $2,628 to $3,185; in Malaysia it declined from $11,100 to $10,400. Over the same period, world per capita income rose from $6,500 to $9,300. Indeed, the Central Intelligence Agency's analysis asserted that the economy of Indonesia was still smaller in 2005 than it had been in 1997, suggesting an impact on that country similar to that of the Great Depression. Within East Asia, the bulk of investment and a significant amount of economic weight shifted from Japan and ASEAN to China and India. The crisis has been intensively analyzed by economists for its breadth, speed, and dynamism; it affected dozens of countries, had a direct impact on the livelihood of millions, happened within the course of a mere few months, and at each stage of the crisis leading economists, in particular the international institutions, seemed a step behind. Perhaps more interesting to economists was the speed with which it ended, leaving most of the developed economies unharmed. These curiosities have prompted an explosion of literature about financial economics and a litany of explanations why the crisis occurred. A number of critiques have been leveled against the conduct of the IMF in the crisis, including one by former World Bank economist Joseph Stiglitz. Politically there were some benefits. In several countries, particularly South Korea and Indonesia, there was renewed push for improved corporate governance. Rampaging inflation weakened the authority of the Suharto regime and led to its toppling in 1998, as well as accelerating East Timr's independence.

Outside Asia

After the Asian crisis, international investors were reluctant to lend to developing countries, leading to economic slowdowns in developing countries in many parts of the world. The powerful negative shock also sharply reduced the price of oil, which reached a low of about $11 per barrel towards the end of 1998, causing a financial pinch in OPEC nations and other oil exporters. In response to a severe fall in oil prices, the supermajors that emerged in the late1990s, undertook some major mergers and acquisitions between 1998 and 2002 often in an effort to improveeconomies of scale, hedge against oil price volatility, and reduce large cash reserves through reinvestment. The reduction in oil revenue also contributed to the 1998 Russian financial crisis, which in turn caused Long-Term Capital Management in the United States to collapse after losing $4.6 billion in 4 months. A wider collapse in the financial markets was avoided when Alan Greenspan and the Federal Reserve Bank of New York organized a $3.625 billion bailout. Major emerging economiesBrazil and Argentina also fell into crisis in the late 1990s (see Argentine debt crisis). The crisis in general was part of a global backlash against the Washington Consensus and institutions such as the IMF and World Bank, which simultaneously became unpopular in developed countries following the rise of the anti-globalization movement in 1999. Four major rounds of world trade talks since the crisis, in Seattle, Doha, Cancn, and Hong Kong, have failed to produce a significant agreement as developing countries have become more assertive, and nations are increasingly turning toward regional or bilateral free trade agreements (FTAs) as an alternative to global institutions. Many nations learned from this, and quickly built up foreign exchange reserves as a hedge against attacks, including Japan, China, South Korea. Pan Asian currency swaps were introduced in the event of another crisis. However, interestingly enough, such nations as Brazil, Russia, and India as well as most of East Asia began copying the Japanese model of weakening their currencies, restructuring their economies so as to create a current account surplus to build large foreign currency reserves. This has led to an ever increasing funding for US treasury bonds, allowing or aiding housing (in 20012005) and stock asset bubbles (in 19962000) to develop in the United States.

Role of IMF The IMF Programs One month after Thailand floated the baht, it announced on 5 August a policy reform package that had been formulated in cooperation with the IMF. The thirty-four-month, $17.2 billion standby arrangement was approved by the Fund board on 20 August. The IMF contributed $4 billion, the World Bank and Asian Development Bank (ADB) $2.7 billion, and individual governments the balance of $10.5 billion (including $3.5 billion from neighbouring Southeast Asian countries). Japan contributed $4 billion; the United States did not contribute to the package. Indonesia followed suit by signing a thirty-six-month, $40 billion package on 31 October. The IMF contributed $10 billion, the World Bank and the ADB $8 billion, and other governments the balance (including $5 billion and $3 billion in a second line of defense from Japan and the United States, respectively). Somehow, the official figure of $40 billion includes $5 billion of assistance from Indonesias own reserves! Korea signed its $57 billion three-year standby on 4 December, with $21 billion from the IMF, $14 billion from the World Bank and the ADB, and $22 billion from a group of industrial countries. With the Philippines continuing its previously signed standby program, four of the five afflicted economies came under the tutelage of the IMF. The IMF programs have had nine main declared goals: 1. Prevent outright default on foreign obligations. 2. Limit the extent of currency depreciation. 3. Preserve a fiscal balance. 4. Limit the rise in inflation. 5. Rebuild foreign exchange reserves. 6. Restructure and reform the banking sector. 7. Remove monopolies and otherwise reform the domestic nonfinancial 8. Preserve confidence and creditworthiness. 9. Limit the decline of output.

To achieve these objectives, the programs have been based on six key policy components: Fiscalpolicy:

The IMF placed fiscal contraction at the very heart of the programs. For example, the official press release on the Thai program states that fiscal policy is the key to the overall credibility of the program. The press release on Indonesia similarly put fiscal policy at the forefront: First, the authorities will maintain tight fiscal and monetary policies. The objectives of fiscal contraction were to (1) support the monetary contraction and defend the exchange rate and (2) provide funds necessary to inject into the financial system. Bank closures: In Thailand, 58 out of 91 finance companies were immediately suspended, and 56 of these were eventually liquidated. In Indonesia, 16 commercial banks were closed. In Korea, 14 (of 30) merchant banks were suspended. The goals of these actions were to limit the losses being accumulated by these institutions and to send a strong signal that governments were serious about implementing reforms in order to restore confidence in the banking system. Enforcement of capital-adequacy standards: While banks were facing rapid decapitalization because of losses on foreign exchange exposure and an increase in nonperforming loans, the initial Fund programs pushed for a rapid recapitalization. The goal was to return the banking system to a solid footing as quickly as possible.

LESSONS LEARNED FROM THE ASIAN FINANCIAL CRISIS

1. Lawsons Rule that it is okay to run a current account deficit without a budget deficit has proven to be a fallacy; 2. Foreign exchange reserves are important; 3. Information and transparency are key; 4. The composition of capital inflows does matter; 5. Exchange rate regimes are extremely difficult to maintain; 6. Financial markets are not perfectly efficient; 7. Moral hazard is the central market failure; 8. IMF programs should consist of both macroeconomic and structural reforms; 9. Inevitably, countries will have to raise interest rates and lower exchange rates; and 10. Keynesianism is alive and well in Asia.

Financial Market Vulnerabilities

Many government officials had forgotten the lesson that financial markets are not always perfectly efficient. Hedge funds should not be blamed for this; rather, bandwagoning presents a major challenge to emerging financial markets. Financial contagion is not new, but the Asian crisis was the first time that unrelated countries in different regions were hit by such a crisis. This implies the need for a greater role for governments in the domestic financial system, but governments are not perfect either. Capital controls must be used sparingly, as in the case of Chile.

Moral Hazard and IMF Conditionality

The lesson learned about the central role of moral hazard in the crisis is both important and useful. U.S. congressmen now seem to have a grasp of the issue. To say that the IMF programs cause moral hazard is wrong; domestic practices are crucial. The next lesson is equally important: There must be conditionality when the IMF makes loans. Macroeconomic policies had been fairly good in the crisis countries; the financial and corporate sectors were the problems. Latin Americas experience demonstrates that reform may be easier during a crisis, and the downside risk of social unrest may not be as great as feared. International financial institutions must also evolve, but there are three important reasons why conditions should be attached to loans. First, loan conditions must address the root causes of the crisis. Second, conditions imposed by international financial institutions (IFIs) provide great political cover for the required bitter reform medicine. Finally, IFI conditions reassure investors that positive changes are in fact being made.

The Role of Government

Governments may have to devalue the local currency, raise interest rates, and experience a recession in order to stabilize the economy. High interest rates alone do not sufficiently reassure investors. The effect of a devaluation is much greater in the first year than originally predicted. It is also important to realize that Keynesianism is alive and well. The initial budget cuts in Korea and Thailand proved to be too severe. The governments can now play a key role in reflating the economy.

Conclusions
The analysis of the East Asian financial crises is a challengy but necessary task. The Asian turmoils, which erupted in 1997, represent a new kind of crises, different in many aspects to those depicted in the first-generation and secondgeneration literature on currency crises in developing countries. This might explain why the Asian episodes were largely unpredicted. It also calls for a third-generation theoretical model of currency crises and for a new set of indicators or predictors. The Asian crises highlight the importance of sound macroeconomic policies and, especially, the need to avoid large current account balances in a context of substantial real currency appreciation. But the preceding analysis has tried to show that these were not the main culprits of the crises in East Asia, except, and only partially, in Thailand and Malaysia. Instead, the paper has insisted on adverse non-conventional indicators such as overinvestment, imprudent domestic financial liberalization and capital account opening, and accumulation of a large foreign debt (mainly private, short-term, denominated in foreign exchange, and largely unhedged). One of the main lessons of the Asian crises has been that imprudent and unproperly sequenced financial liberalization in emerging economies increases their vulnerability to speculative attacks. Domestic financial deregulation should be attempted only after creating an adequate supervisory and prudential regulatory framework. Moreover, financial opening should follow, and not precede, the strenghtening of the domestic financial sector. More precisely, regulating and taxing short-term and potentially volatile international capital flows seem to be necessary steps in order to avoid disruptive processes in an otherwise sound macroeconomic environment. Turning now to the international implications of the Asian crises, the role of the IMF as a manager of the turmoils has been widely criticized. It seems that the IMF is unable to deal with financial crises in the present era of financial globalization. Therefore, a reassessment of its functions and programs in developing economies is surely needed. Moreover, several international

measures to encourage more stable capital flows to emerging markets (such as regulating and supervising short-term bank loans and portfolio investments) should be explored in order to reduce international financial fragility (Singh, 1998). As the World Bank has recently acknowledged, the initial response to the Asian crisis has clearly failed, especially because combining very high interest rates with strict fiscal restraints has intensified the recession in the region. Interest rates should be allowed to fall and a concerted fiscal stimulus should be undertaken, in order to spur growth and to alleviate the expected increase in poverty (World Bank, 1998). But there are other reasons to reject traditional recipes of deflation and deregulation. These measures also jeopardize the foundations of the East Asian developmental path, which, especially in economies such as South Korea and Taiwan, has been based upon a large state intervention (Lall, 1996) and upon a strategic (rather than close) integration with the world economy (Singh, 1995 and 1998). If the East Asian model was successful, and thus so appealing to other developing economies, it was precisely because it departed substantially from the so-called Washington Consensus on development issues, a view which the World Bank has already rejected (Stiglitz, 1998a). The real danger of the Asian crises is that, if a change of approach is not undertaken on national and international levels, a very successful path towards industrialization and economic and social development might, not only be fully at risk, but simply disappear.

Bibliography
www.wikipedia.com www.google.com www.imf.org www.statisticsviews.com