Asian Financial Crisis

Sousan Urroz-Korori
2000
To understand a financial crisis one needs to know not only how the financial systems
work but also their relationship with the economy at large, and more importantly their
impact on the sustainability of economic growth ! will co"er some background
information on financial market restructuring, unifying fragmented markets, bankruptcy
and recognition of losses, credit crunch and output decline on #ednesday$s class %lso, in
these notes ! will try to link the abo"e elements into the real story of the %sian &conomic
'risis
#eak financial infrastructure and currencies with no fle(ibility or real international "alue
are the main sources of any economic crisis
)any financiers and economists belie"e that economic and financial crises in the global
market are una"oidable *owe"er, with solid financial markets and real currencies with
true "alue relati"e to hard currencies, a country can reduce both the numbers of such
crises, and their intensity
% li+uidity crunch was the primary reason for the %sian 'risis, and so the real +uestion is
why did the li+uidity crunch happen, The %sian li+uidity crunch took the market by
surprise, but it shouldn$t ha"e %ll the signs were there but none in the political
establishment were willing to incur the necessary hardship ahead of the storm, so they
simply let the wind hit their shores at full speed, took no shelter, and suffered a terrible
economic downfall
The crisis started in Thailand in late-../, and it spread so deeply and rapidly that by
0ebruary -..1, the Thai stock market, which had a market capitalization of 2-33 billion
in -..3, was worth merely 222 billions in -..1 The !ndonesian currency bought 4ust 20
percent of what in did in mid--..5, and Korea, the ele"enth economic power of the
world, ended up with an estimated 2-/6 billion in short-term debt
Korea
%sian financial institutions during that period of time had a practice of under-the-table
deals 7many still do8 that pre"ented e(posure of bank debt crises in a timely manner
)uch money had been lent to unsound pro4ects with o"er-"alued real estate as its
collateral 9"er-guaranteed and under-regulated banks led bankers to base their decisions
not on a pro4ect$s e(pected returns but on its return under perfect and growth-dominated
market conditions #hen the first bank whose in"estment failed to yield perfect returns
was bailed out, go"ernments started to rethink their future rescue attempts, resulting in a
general fall of asset prices, leading to many loan defaults and large losses for the banks
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:ack of prudent regulation and financial o"ersight had allowed banks to be in"ol"ed in
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;u ., The <ew =ork Times, 0ebruary -, -..1
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less than sound lending practices and the general population ended up paying the ultimate
price
9n >ecember -3, -..5, the &conomist ?ournal argued that in order to pre"ent future
crises in Korea @Adrastic reforms are re+uired >irected by successi"e go"ernments
Korean banks ha"e for years thrown free money at the 'haebol conglomerates with
political concentration Such la( credit has allowed the 'haebol to build recklessly huge
factories, and to di"ersify into businesses in which they ha"e no e(pertisebig companies
are deeply in debt, and the banks are o"erwhelmed by bad loansB )ore interestingly, in
)ay of 200- during the !)0 conference in Korea, @:essons from Korean &(perience,B
)r 'hopra
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considered the weakness in Korea$s banking system as the fundamental
reason for the Korean crisis
>uring the first few weeks after the start of financial crisis in Korea, the country recei"ed
-6 billion S>C 7Special >rawing Cight8, about 22 billion from !)0, 23 billion from the
#orld ;ank, 22 billion from %sian >e"elopment ;ank, and 21 billion from the group of
industrialized
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countries of the world, all in support of its stabilization and reform
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Korea, by using these direct loans and other long term guarantees with the help of the
0und, tried to consolidate its enormous short-term debt ;y ?anuary -..1, the total
financial commitment of the world to Korea reached 265 billion, the main contributors
being the !)0 722- billion8 and the group of industrialized nations 7222 billion8 >espite
of this massi"e inter"ention, support, reforms and ad4ustments, the Korean stock market
lost 50 percent of its "alue by ?anuary -..1 The operation of -D out of 30 Korean
merchant banks was also suspended
>r 0ischer
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, on ?anuary 22, -..1, addressing the )idwinter 'onference of the ;ankers$
%ssociation for 0oreign Trade referred to @the failure to dampen o"erheating
/
pressure
that had become e"ident in Thailand and many other countries in the region and
manifested in large e(ternal deficits and property and stock market bubblesB !t seems )r
0ischer was trying to blame an o"erheated economy as the source of the %sian problem
*owe"er if one looks "ery closely at these economies during that period, one sees a
pattern of growth that mainly was concentrated on consumption ! belie"e these countries
could ha"e sustained the same le"el of growth with no crisis if more off the growth was
concentrated on creating the much needed infrastructure 7roads, harbors, airportsA8, and
imports of fundamental goods 7train, ships8, The resulting e+uilibrium would ha"e
pre"ented o"erheating conditions %lso, if the financial infrastructure had built on sound
foundations, then the market automatically would slow down the allocation of funds
through short-term lending
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%4ai 'hopra, !)0$s %sian and Eacific >epartment, !)0 Sur"ey, ?uly -/, 200-
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%ustralia, ;elgium, 'anada, 0rance, Fermany, !taly, the <etherlands, <ew Gealand, Sweden, Switzerland,
the UK, and the US
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!nternational )onetary 0und <ews ;rief <o .5H32, #ashington, >'
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>r Stanley 0ischer was the first >eputy )anaging >irector of !)0 during %sian 'risis
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%"erage growth rate of 1 percent annually for almost a decade for many of the %sian countries
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7! want to bring out one factor which ! think has significant rele"ancy in our discussionI
during this crisis period the share of US e(ports to these countries increased
substantially The %sian countries imported -. percent of their goods from the US in
-../, up from -6 percent in -..0 &"en though at this point ! do not ha"e backing data, !
belie"e that many of the short-term consumption loans must ha"e supported this growth,
allowing consumers to go after more e(pensi"e %merican goods8
Thailand
There is a common acceptance that the %sian 'risis did start in Thailand in -../ The
growth in consumption in that market had attracted large capital inflows since the early
.0s mainly in US dollars
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Thailand had en4oyed many years of low short-term interest
rates which not only facilitated the capital inflow, but also had allowed domestic banks to
e(pand their lending capacity, fueled and backed by unreasonably o"erpriced real estate
)any of the loans, e"en though short-term, had financed real estate and commercial o"er-
de"elopment The Thai authorities, like other %sian go"ernments, failed either to
understand the depth of their problem, or to inter"ene !ncreasing the interest rate
gradually and on time could ha"e pre"ented a full-blown crisis *owe"er, as the pressure
in the market became unbearable, in ?uly of -../ Thailand began to float the Thai bath
>epreciation of the bath was the start of in"estor ner"ousness and the beginning of
li+uidation and e(patriation of capital out of Thailand The crisis broke out in full scale
at this time The go"ernment of Thailand once again inter"ened, but rather than allowing
for the closing of sick and inefficient financial units, that through their own greed had
created most of the problem, the ;ank of Thailand, from ?uly to %ugust of -../, lent out
more than 2-. billion 7o"er -0 percent of Thailand$s F>E8 to keep .- finance companies
afloat
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, most of which were insol"ent at the time
Thailand suffered from too much cheap money and a financial system that could not
allocate the money efficiently or effecti"ely
Thailand needed help, and of course the international community was ready to bail her
out The total financial commitment was for 2-52 billion, 2D billion from the !)0, 2-6
billion from the #orld ;ank, 2-2 billion from the %sian >e"elopment ;ank, and 2600
million each in guarantees from the neighboring !ndonesian and Korean go"ernments
#hy and how !ndonesia, with its own problems, was persuaded to 4oin this rescue is
beyond our discussion but deser"es some thought
Indonesia
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Thai ;ath was pegged in US dollars which allowed 4ust minor fluctuation in e(change rate, ideal position
for capital inflow with no fear from de"aluation
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Thailand Fets the ;ill, The &conomist ?ournal, %ugust ., -..5
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!n !ndonesia by the end of -..5, the banks were holding o"er 2/6 billion in pri"ate sector
loans #ithin a period less than si( months the rupiah, the !ndonesian currency, dropped
from 2,D60 to the dollar in ?uly of -..5, to -5,000 to the dollar by ?anuary -..1 Eeople
who had lost their trust in the banking system were withdrawing their money from banks
in sacks *owe"er, the lack of trust in the banking system was not the end of itJ there
was no trust in the rupiah either ;oth domestic and foreign in"estors, small and large,
were e(changing their rupiah to any hard currency, from dollars to yens % combination
of lack of trust to the go"ernment and the economy, had put !ndonesia in and economic
@ground zeroB 9n ?anuary 25, -..1, the go"ernment proposed state guarantees on all
bank deposits and loans, including foreign-dominated borrowing, and an independent
body to rehabilitate its troubled banks *owe"er, the problems of short-term corporate
debt and political uncertainty continued, which combined with the large go"ernment
deficit, deepened the crisis !n some estimates, at the time the country had 210 billion of
short-term foreign debt by its corporate sector, either through direct loans or letter of
credits !n most cases the domestic banks were the intermediaries who had facilitated this
crisis #eak banking regulation, lack of super"ision, deep-rooted corruption in the
banking sector, and by go"ernment officials were at the heart of the problem
!ndonesia lost its credit rating, which meant bankruptcy for hundreds of companies, and
millions lost their 4obs, while the cause of the problem K the banks K were being rescued
Since much of the foreign short-term debt belonged to the western banks, the !)0 was
forced to step in The !nternational )onetary 0und had its own re+uests which included
restructuring of the banking system, asking the go"ernment not to support insol"ent
institutions, and allowing them to go bankrupt <o special treatment was to be pro"ided
for shareholders of institutions that ha"e lost their capital, and support was to be gi"en to
financial institutions that were undercapitalized but sol"ent, but only if the institution was
willing to undertake incisi"e restructuring program as a milestone on the road to full
financial health
!n !ndonesia si(teen insol"ent banks were closed, and small depositors were compensated
through payments administered by ;ank !ndonesia The li+uidity support to sol"ent
banks was collateralized !t was also re+uested the state bank be downsized and
gradually pri"atized This is a task that the current go"ernment of !ndonesia is +uite
behind in, and reluctant to undertake
!ndonesia recei"ed total assistance of 2D0 billion for achie"ing stability, ten coming from
the 0und, D6 from the #orld ;ank, 36 from the %sian >e"elopment ;ank and 3 from
the United States 9ther %sian nations and %ustralia co"ered the rest
Taiwan
>uring this period of crisis in %sia, Taiwan stood high and alone in the storm &"en
though its currency slipped a modest -6 percent its stock e(change gained -5 percent
.
,
and the F>E grew /5L in -..5 The %sian financial crisis was triggered when foreign
lenders refused to renew loan to countries with current account deficits and large short-
.
0orbes, ?anuary -2, -..1
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term foreign debts <one of that applied to Taiwan, which at that time had a current
account surplus for se"enteen consecuti"e years and was a large net creditor to the world
The secret of Taiwan was 7and is8 an efficient capital market which was fairly informal,
that mo"ed sa"ings to small entrepreneurs through small, semi-regulated, super"ised,
pri"ate commercial banks, effecti"ely but carefully 0urther analysis of Taiwan banking
sector and financial market is beyond the scope of this class
0ollowing is a summary of potential topics for class discussionI
1- 'reation of an international organization to monitor and report on short-term capital
flow both regionally and internationally in order to a"oid credit crunch and rapid
li+uidity swings This body could be placed under super"ision of !)0 but should
ha"e an independent agenda, and not a political one
2- %ll financial firms who hold deposits and act as trustees for the public should be
re+uired to use internationally accepted accounting practices and to disclose material
financial information
3- The lack of financial transparency and the practice of under-the table deal making
needs to be e"aluated and addressed 9ften such financial practices are wo"en into
day-to-day business practices % change would re+uire drastic modification to the
business culture
4- The banks should be re+uired to put their own capital at risk, and the go"ernments
should stop the practice of co"ering bank losses % mandatory insurance should
pro"ide risk protection to all depositors within an acceptable margin The insurance
premium should be paid directly by banks as the cost of doing business
5- The capital market should be regulated but liberalized 9ften these two words ha"e
been used as opposites *owe"er, if financial institutions ha"e no barriers and can
compete anywhere in the world, the ser"ice charges to the consumer drops, resulting
in cheaper money being a"ailable for business de"elopment The business risk to
international banks drop when there is no fear of capital sterilization, and when the
market can allocate the funds solely based on creati"ity and soundness of the pro4ects
9f course such market is going to "ulnerable unless trained independent bank
e(aminers closely super"ise it The task should be a function of independent central
banks !f such independence does not e(ist, then an independent body should be
created
6- The go"ernments should stay away from trying to operate banksJ their tasks should be
limited to stabilization of currency and other monetary policies, and assessing the
health of banking system through an independent central bank
7- %ll attempts should be made to encourage informal rural banking to co"er higher risk
and di"ersified consumers 'redit unions and other cooperati"e financial institutions
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ha"e grown tremendously in de"eloped countries in recent years, with "ery positi"e
results !n addition to 'redit Unions, there is also a need and a market for
microfinance units that not only can mobilize small sa"ings but also can take higher-
risk clients and gi"e them financial means to start micro-enterprises These acti"ities
should be undertaken by supporting already e(isting commercial banks and non-
go"ernmental organizations 7<F9s8 Unfortunately, in recent years many problems
with <F9s ha"e surfaced, including corruption and lack of efficiency <ot e"ery
<F9 has had problems but a careful assessment is re+uired
!n general, financial creati"ity, transparency, support of pri"atized smaller banks, support
of competition, complemented with simplified regulation and strong banking super"ision
should guide us through this crises-a"oidance task % country that does not ha"e a solid,
creati"e, open financial system cannot mobilize capital !ntermediaries should be able to
allocate capital efficiently and attract long-term returns rather than 4ust short-term rent
International Monetary Fnd
The !nternational )onetary 0und was created after the Second #orld #ar with the
mandate of looking after the international monetary system @!ts rules were embodied in
the %rticles of %greement and an institution was established to interpret, ad4udicate and
police them and, by short-term lending, to facilitate adherence to themB
-0
!n order to
assure that links among trade, in"estment, and balance of payments policies were
recognized, a country had to be a member of !)0 The elimination of e(change controls
was a main ob4ecti"e of the fund The task was to assure reasonable stability of e(change
rate combined with national independence in monetary and fiscal policy
%s a condition for membership, each country had to subscribe an indi"idual +uota based
on its relati"e size and economic strength, of which 26 percent had to be in gold and the
remainder in its national currency %ny member could in effect borrow from these
resources up to 26 percent of its +uota each year for a period of fi"e years -- based on
their gold reser"es These @>rawing CightsB pro"ided accessible credit to supplement
members$ international reser"e in the form of a @stand byB agreement % member
confronting a @fundamental dise+uilibriumB in its balance of payments must consult with
!)0
>uring the financial crisis of %sia, the !)0 inter"ened, on the one hand with carrot and in
the other with stickJ it appro"ed loans in e(change for structural changes in banking,
business, and go"ernment functions
'ritics in recent years ha"e argued that @the knowledge that !)0 financing will be made
a"ailable with the e"ent of a financial crisis make the crisis more likely to occurB
--
These
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pp D65, ;aldwin, Cichardson, !nternational Trade and 0inance, -.5D, 'anada, :ittle ;rown M 'ompany
:imited
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:ane, Ehillips, !)0 0inancing and )oral *azard, #ashington >', 0inance and >e"elopment ?ournal,
?une 200-
/
critics may ha"e some basis for their argument, gi"en the fact that since -..6 the !)0 has
bailed out )e(ico, &ast %sia, Cussia, ;razil and %rgentina 7still ha"ing li+uidity
problems8 *owe"er :ane$s and Ehillips$ findings within the limited scope of work does
not support this phenomenaJ the fact remains that !)0 re+uirements often interfere with
internal decision process of independent countries !n general there is no real basis to
!)0 critics$ argument, since not enough imperical study has been done to support them
The 0und is a political body, since US 7-5-/L of all "otes8, ?apan 7/-/L8, Fermany
7/02L8 ha"e the bulk of the "ote There is no possibility for any agenda to be considered
unless one of the abo"e countries has an interest in it !n support of this statement ! will
share in class some !)0 decisions between -..3 and -..5
!n addition, e"en though historically the !)0 has talked about and re+uested transparency
from many go"ernments, its own acti"ity is much too secreti"e 0urther discussion in
this topic is beyond the scope of this class *owe"er, ! belie"e that a restructured,
streamlined, leaner !)0 is much needed, gi"en current le"els of globalization in finance
and trade
The <ew !)0 should aspire to become a pre"enti"e institution rather than a rescuing
body !t should be an ad"isory entity rather than enforcing institution !t should create a
set of regulations, including international banking super"ision, that can audit and assure
the health of the world$s financial institution
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CeferencesI
-- :ane, Ehillips, !)0 0inancing and )oral *azard, #ashington >', 0inance and
>e"elopment ?ournal, ?une 200-
2- &ast %sian &conomies, Tigers adrift, the &conomist ?ournal, )arch 5, -..1
3- 0orbes, ?anuary -2, -..1
D- Thailand Fets the ;ill, The &conomist ?ournal, %ugust -., -..5
6- The <ew =ork Times, ;u ., Sunday, 0ebruary -, -..1
/- !nternational )onetary 0und <ews ;rief, <o .5H32, #ashington >', !nternational
)onetary 0und
5- ;aldwin, Cichardon, !nternational Trade M 0inance, -.5D, 'anada, :ittle ;rown M
'ompany :imited
1- !ndonesia Sur"ey, Suharto$s end-game, the &conomist ?ournal, ?uly 2/
th
, -..5
.- &llsworth, :eith, The !nternational &conomy, -.56, <ew =ork, )acmillan Eublishing
'o
-0- The <ation !ndonesia, <ow the *ard Eart, %siaweek, ?anuary 30, -..1
--- % ;anking )eltdown, The &conomist ?ournal, ?anuary 23, -..1
-2- US!% Ceport, 0inancial !nstability in %siaI The US Cesponse, >ecember -..5,
?anuary -..1, httpH wwwusiago"HregionalHeaHasiafinHbailouthtm
-3- %sia, South Korea$s meltdown, the &conomist ?ournal, >ecember -3, -..5

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