Asian Currency Crisis Causes and Effects

Asian Currency Crisis Ca lend oneselfs and EffectsIntroduction wizard of the backbone characteristics of money is stability, however a property crisis is said to hail when the valuate of a countrys property becomes unstable and changes rapidly thereby undermining its ability to in effect serve as a medium of change over.The Asian money crisis was a period of fiscal melt wipe out which began in July 1997 and gripped the major proportion of east roughly Asia. It remains one of the most talked round portion-wide crisis in the mid-nineties, the sharpest to film the ontogeny countries, which upshoted in a massive downward spiral of Asian economies hitherto seen as miracle economies and prompted the largest fiscal bailouts in history.(Radelet and Sachs 1998)This paper will examine the tooth root of the crisis, its impact on the economies of the countries involved and the measures that have been take to annul a recurrence of a kindred crisis.ORIGIN OF THE CRISISUpon mutua l agreement, based on the plaza accord (1985) between the US, Ger many an(prenominal) and japan, the US dollar was de rankd by about 60% to the Yen in very terms in order to each(prenominal)eviate the increasing US current account dearth. Nipponese firms facing exporting competitiveness due to the apprehension of the Yen began to locomote production to south eastern Asian countries whose currencies were pegged to the dollar. This provided an ideal location for the japanese firms in terms of international bell competiveness. This inflow of investment funds from Japan to the southeastern eastmost Asian countries accele scored a pattern that guide to large inflow of outstanding from former(a)wise Asian and extraneous countries into the einsteinium Asian countries. The fixed fill in ramble system gave the south East Asian economies material exports, low import bells and expected pecuniary stability.For years, East Asian Countries were held up as frugal icons. Thei r typical blend of lofty savings and investment pass judgment, autocratic political systems, export-oriented businesses, restricted house servant securities industrys, organization upper theatrical role allocation, and controllight-emitting diode monetary systems were hai direct as the ideal recipe for strong stinting suppuration of developing countries (Shapiro 1999). Asian economies give c atomic number 18 Taiwan, Hong Kong, Korea, Singapore and Thailand enjoyed overall mediocre harvest rates of 5.6 pct, 6.6 per centum, 7 percent, 6.9 percent and 4.6 percent respectively for some(prenominal) decades. Indonesia and Malaysia too enjoyed good frugal performance during most of the 1970s and 1980s. (Rao, 1998)However, these miracle economies were brought down in July 1997 when a brewing currency crisis started from Thailand. This seed of the Asian currency crisis of 1997 were actually sown during the previous decades when these countries were experiencing unprecedented e conomic growth. For long, exports had long been the locomotive engine of economic growth in these countries and as such many Asian states were regarded as Export Power Houses. The increased foreign capital inflow into these economies as strong propelled capital expenditure which led to an investment boom in commercial and residential properties, industrial assets and infrastructure. These capital expenditures were financed by heavy borrowings from banks which had superfluous liquidity but no strong regulatory frameworks. Thus, by the mid(prenominal) 1990s, South East Asia was experiencing an unprecedented investment boom, much of it financed with foreign investments and borrowings. The cuticle was made worse as much of the foreign borrowings had been in US dollars as opposed to local currencies. At the time, this had seemed athe likes of(p) a heady move (i.e. regional local currencies were pegged to the dollar and interest rates on dollar borrowings were generally lower tha n rates on borrowings in domestic currency, and it made economic sense to borrow in dollars if the option was available) but, many of the investments made with these funds were on the basis of projections about future take aim conditions that were un documentaryistic.Soon, there were indications of macroeconomic imbalances in the Thai thrift the real exchange rate had risen to an apparently unsustainable level and the current account was as well as in constant huge shortfall. Rao (1998). Also, Asian Countries started to see their ballooned volume of investments during the 1990s declining significantly. Paul krugman (1999) stated the Asian countries attracted so much foreign capital that their economic growth was fuelled more by sheer volume of investment rather than by the productivity of those individual investments. Therefore the governments in the region could not take for their dollar peg and their currencies started to depreciate against the dollar, this increased the sizi ng of the debt burden that filmed to be serviced when measu crimson in local currency. This started the debt boom.A final complicating factor was that by 1996, there became a slackening of export growth which was much noticeable in Korea, Malaysia, Singapore and Taiwan, while in Thailand there became a ancestry in the dollar value of exports. This decline in export did not stop growing import and this dissimilitude saw many south Asian countries shifting strongly into the red during the mid 1990s. By 1995, Indonesia was running a current account deficit that was equiva modify to 3.5% of its Gross Domestic Product (gross domestic product), Malaysias was 5.9% and Thailands was 8.1%. With deficits like these starting to occlude up, it was becoming increasingly difficult for the governments of these countries to maintain the peg of their currencies against the U.S dollar.Thus by 1997, the first obvious indication of the crisis started with the Thai frugality. Thailand could no long er push their currency and therefore floated the tical on the 2nd of July 1997. (Rao, 1998). Prompted by these developments in Thailand, investors saw basically the same issues facing Thailand surfacing in other neighbouring countries. As a turn out, investors panicked their fears were not allayed especially because of lack of transparentness regarding issues such as the extent of government and hush-hush debt, the health of the pecuniary sectors and no trust in the government to take pre-emptive corrective actions. This led to massive capital flight. The withdrawal of foreign currency led to melodramatic depreciation in exchange rate and higher interest rates. This led to an increase in the number of non-performing loans, causing an erosion of the market value capital of most of the countries. Thus, the scene was straightway set for a potential difference rapid economic breakdown.There is no consensus on the exact creation of the currency crisis in East Asia while some sch ools of thought imagine that the crisis was caused by the initial pecuniary turmoil in some Asian countries, followed by regional contagion (Radelet and Sachs, 1998 Marshall, 1998 and Chang and Velasco, 1999), others believe it occurred as a result of indemnity and structural distortions (Corsetti, Pensetti and Roubini 1998). However, most of the East Asian economies were interdependent, hence it was notwithstanding logical that a crisis in one would have a domino-effect and inadvertently cause a crisis in other East Asian Economies that were link to it.Warning Signals during the 24 Months prior to the 1997 Asian Financial Crisis, Months of Lead Time, and action Measures.Number of Warning Signals and Months of Lead Time (in parenthesis)Optimal threshold centileIndonesiaKoreaMalaysiaPhilippineThailandSingaporeNoise to signal ratioConditional crisis fortune(%)Share of crisis predicted(%)Overall Composite Index887(11)9(10)13(13)10(11)10(10)0(10)0.1377783Current identify907(1 1)11(1613(13)11(11)16(16)0(0)0.1367783Capital Account901(23)0(0)2(3)0(0)0(0)0(0)0.2886263Financial Sector900(0)0(0)2(3)0(0)0(0)0(0)0.3136067Real Sector902(2)9(14)0(0)2(10)4(13)0(0)0.3225331 international Economy800(0)0(0)0(0)0(0)0(0)0(0)0.5404675Fiscal Sector870(0)0(0)0(0)0(0)0(0)0(0)0.5404646Source ERD Working Paper No.26Using a Signalling approach based EWS model, it shows that persistent warning signals prior to the 1997 crisis was not provided in a few but all of the five countries most affected by the crisis. The determinations of this model incites the fact weaknesses in economic and financial fundamentals in these countries triggered the crisis.The Impact of the crisis on the Economics of the countries involved.As Thailand floated the baht on July 2 and allowed the currency to fall, wave after wave of possibility hit other Asian currencies, a de-facto devaluation of the Philippine Peso followed on July 11. Korean Won too muzzy. Malaysia let its currency, the ringgit floa t on July fourteenth 1997, as foreign exchange reserves had gone down to $ 28 meg. Singapore followed on July 17th and the Singapore dollar (S $) quickly dropped in value from $1 = S $ 1.495 prior to the devaluation to $1 = 2.68 a few days later. A month later on high-minded 14, Indonesia floated the rupiah. This was the initiation of a precipitous decline in the value of the Indonesian currency as a fall was seen from $1 = 2,400 Rupiah in August 1997 to $1 = 10,000 Rupiah on January 6th, 1998, a loss of 75% (Rao, 1998).Source DataStreamThe Chart (above) shows the monthly evolution of the currencies of the eight South-East Asian countries during the crisis from July 1997 to April 1998. The Five countries where the crisis where particularly sobering (Figure 1A) saw more decline in their currencies than countries in Figure 1B horizontal though all countries shown were affected.The economy of Thailand where the crisis started from suffered a real sharp decline. descend export ear nings declined and a trade deficit rose to $ 16 billion. With the deficit standing at over 8 percent of GDP and its financing largely coming from short term funds the outside debt of Thailand rose to $68.1 billion. The non-performing loans of banks and finance companies in Thailand were estimated to be around 12 percent of total loans in mid 1997. The Thailand economy was in addition plagued by a deteriorating external sector, a received market decline (the stock market index fell from 1683 in 1993 to below 500 in1997) and most significantly dwindling forex reserves. A decline in investment saw the resolve of investment houses which resulted in immediate unemployment rates of between 6 and 10 percent (Rao, 1998).The Indonesian economy also suffered a set-back which include growing current account deficits due to lack-luster export growth and attach debt service. Loss of confidence in Indonesia led to a series of attacks on the currency. In the second half of 1997, the rupiah fe ll by 72 percent against the dollar which had an adverse effect on the Japanese, European and US banks that lent billions of dollars to Indonesian companies. According to Witcher (1998), the Indonesias financial system started to stagger under escalating large(p) loans. Indonesia sought help from the IMF, they agreed to provide them with loans estimated at $40billion and in soften demanded that Indonesia keeps interest rates high and immediately close 16 banks.The give-and-take of bank closures led to panicked withdrawals by stayors and investors. As Stiglitz(1998) and Yellen(1998) discussed due to curb information, investors were unable to distinguish which banks were healthy or not so they shied out-of-door from them all this caused more havoc to the economy. The crisis quickly spread to the real sector. The real gross domestic product (GDP) contracted by 13% in 1998 and remained stagnant in 1999. Real output declined by approximately 14% in 1998. The Indonesian economy thus went into a fadeout with move GDP in 1998. It also had a weak economy that was dispassionate of falling domestic demand and company closures which meant rising poverty and unemployment. . Unemployment which was historically no more than 3 to 4 percent hit a 10 percent level in 1998 with around 8.7 million heap jobless. The impact of the crisis on wel farawaye and the economy as a square was mostly reflected in the poverty rate which rose from 15% in 1997 to 33% in 1998.The contagion effect soon caught up with South Korea, a country whose economic performance was spectacular compared to other Asian countries. However, the won began to depreciate from late August 1997 and gathered momentum by October. From about 900 won to the dollar in early August, the exchange rate plummeted to about 1200 by the end of November. The ratio of debt reserves rose during 1992 1997 (Rao, 1998). In January 1997, Hanbo Steel exposed under a $6 billion debt. This was the first Korean Chaebol to go bankrupt in 10 years (Chang,1998). In the elicit of this, the Korean shares declined in value by 25.2% at the end of 1997. commensurateness in trade declined from a surplus of $7.6billion in 1987 to a deficit of $20.6billion in 1998. GDP per capita fell and Unemployment rate naturally rose to 5.9 percent in February 1998 and started to climb up from there (Rao, 1998).The Philippines Economy faced a significant currency crisis, the peso fell significantly from 26/US $ to flush 55/US $. The GDP growth rate dropped from 5.1% in 1997 to -0.5% in 1998. GNP hovered at 0.1% in 1998 compared to 7.2% in 1996 and by the 4th quarter of 1998, growth of investments had declined to -23.9%.In Hong Kong, the economy saw the collapse of the Hong Kongs stock market (with a 40 percent loss in October). On October 27 1997, the market rout on Wall Street was preceded by a 5.8 percent plunge in the Hong Kong stock market which snowballed by dint of the worlds developed and emerging stock markets. Mo st markets in the Asia-Pacific region tumbled in sympathy, with Australia down 3.4 percent and Tokyo down 1.9 percent.Below is a graph showing the evolution of the Asian stock markets during the financial crisis of 1997- 1998.Source Morgan Stanley transnational Capital (MSCI).Figures 2A and 2B (above) show the monthly evolution of national stock price indices (expressed in US dollars) for these same eight countries and during the same period of time. The finding shows a consistent close relationship between exchange rate depreciations and stock returns during the crisis. (Bailey, Chan and Chung (2001).)Japan was also affected because its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latters economy was more than twice the size of the rest of Asia together about 40 percent of Japans export go to Asia. However, even with this, the Japanese was last shaken as their yen fell to 147 when mass selling began Also, with the collaps e in the value of the Japanese stock market, the value of assets also plummeted, exit the institutions with a diminished asset base and an increased portfolio of non-performing loans. The GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998.In a relatively short period of time, the crisis currency crisis shock was spread even beyond Asia. The USA market (the Dow Jones industrial) plunged 554 points or 7.2%. The smart York Stock Exchange briefly suspended trading this was attach to by plunges of 15 percent in Brazil, 13.7 percent in genus Argentina and 13.3 percent in Mexico.Europe also had the impact of contagion effects, Markets like London fell 2.6 percent, while Germany, France and Italy all shed 2.8 percent. Smaller markets like Finland plunged 5.7 percent, while Spain skidded 4.1 percent.Russia became the major non-Asian victim of the financial contagion. By mid 1998, investors began to perceive systematic weaknesses of the Russian economy which was similar to Asia therefore they began a tight withdrawal of their capital from the economy. By midsummer 1998, it became apparent that Russia was struggling to maintain an exchange of roughly 6 rubles to 1 dollar at the time. Their fundamental bank reserves began to dwindle. Despite the loan package and the pro-market administration, the international investment community lost faith in Russia and rushed for the exits. On August 15th 1998, the rubble was allowed to float and the Russian stock market lost 25% of its value.The Measures that have since been select to bend recurrence of a similar crisis. later on the slow down of the Asian Currency Crisis of 1997, the regions former economic tigers had to mete out some conditions and policies towards a sustainable Asian economy that would be able to withstand any financial turmoil and therefore neutralise the recurrence of a similar crisis. These regionss heavy weight also had to accept the International Mon etary Fund (IMF) conditions in order to keep afloat although the IMF had never dealt with a crisis of this magnitude and was met with stiff hostilities the IMF prescribed treated conditions and measures that contributed immensely to considerable long term gains for the Asian Economics (Lakhan, 2007)One of these conditions were policies involving the Macro-economy. The tightening of financial policy (at different stages in different countries) was indispensable to stem exchange fluctuation, to prevent currency depreciation from leading into a spiral of inflation and into the eventual collapse of the exchange rate. Some countries like Thailand, South Korea, Philippines and Indonesia switched to modify credible policies that involved their exchange rate system. These countries adopted the inflation targeting policy which implied greater transparency and accountability instead of exchange rate as an anchor for monetary policy. Inflation targeting also allowed for the proficiency of stable development of their economy through the establishment of credible and respectable central bank as these central banks set inflation targets and apply monetary policies committed to the achievement of targets. They also made monetary policy decisions based on overall judgement of the economy by guardianship constant watch not only on immediate price movements but also on trends of demand and supply factors in the domestic economy, exchange rate movements and overall movement of the international economy. The effects from this policy adopted inflation targeting contributed largely to stabilizing the monetary and economic surroundings after the currency crisis (Tomoko, 2002). A typical example could be seen in South Korea.After the Crisis, South Korea revised the coin bank of Korea act to demonstrate inflation targeting in 1998. Since its introduction, South Koreas inflation targeting has played an appreciable power in stabilizing the countrys economy. In particular, the introduction of inflation targeting has secured the independence of the Bank of Korea in monetary policy and drastically enhanced the transparency of monetary policy.Affected countries of the crisis also embarked on their financial system stabilization to avoid any similar recurrence of the debilitating financial crisis. These measures ventured into the areas of liquidity support for troubled banks in question, deposit protection measures through a deposit insurance co-operation to prevent systemic risk arising from the spread of credit uneasiness, boosting capital base through capital injections from unrestricted funds and prompt temperament of non-performing loans by a third party organization (Resolution and Collection corporation in the case of Japan and asset management companies (AMC) in the case of Asian countries). The four countries where the financial crisis was particularly serious (Thailand, South Korea, Malaysia and Indonesia) injected public funds into financi al institutions often with government assistance. They also went into the act of promoting the integrating of financial institutions by closing or suspending operations of banks with doubtful chances of survival, temporarily nationalizing them or merging them. They established an asset management company to leverage non-performing loans Thai summation Management Corporation (TAMC) in Thailand, Danaharta in Malaysia, Korea Asset Management Company (KAMCO) in South Korea, and Indonesian Bank Restructuring potency (IBRA) in Indonesia (Lindgren et al, 2000)Although the system of the companies or organizations varied from one country to another, they all similarly purchased non-performing loans at about market prices and wedded the assets selling by tender or by means of securitization. At present, they have disposed of about 5070% of the assets. Thailand for example, had finance companies (non-banks) that had been suffering from business difficulties even before the currency crisi s and the Thai government had been providing liquidity support to them. After the crisis, the government improved its classification stock(a) for non-performing loans to conform to the international standard and strengthened write-off standards. It also nationalized commercial banks, injected capital and reorganized them. As a result, the number of commercial banks decreased. Thai commercial banks non-performing loan also later decreased dramatically due to agreements on debt restructuring as well as transfer of non-performing loans to the TAMC and write-offs. As a result, the non-performing loan ratio dropped to 19.2% as of the end of March 2001 and capital adequacy ratio stood at 12.01% as of December 2000 (A ratio higher than the BIS standard) (Montes, 1998).Structural reforms were also adopted in the areas of banking supervision and regulation in order to forestall the kind of financial system instability caused by the crisis and to minimize the effect. These reforms were also necessary to speak the weaknesses in the financial and corporate sector as these features had become impediments to growth such as monopolies, trade barriers and non transparent corporate practices. Based on this recognition, the IMF and the World Bank jointly began monitoring the international standardization and honoring of standards to maintain the soundness of financial systems by introducing the Financial Sector perspicacity Program (FSAP) in 1999. Under FSAP, the IMF and the World Bank assess the observation of banking supervision and regulations implemented by each countrys financial supervisory authorities, go on observance of international standards, and recommend the best practices. These acts which have been entrenched in continue to globalize the Asian economy (Lindgren et al, 2000).Rehabilitative measures were also blanket(a) to surreptitious corporations and financial institutions in the Asian countries as these institutions were also hit by the currency crisis largely because they had a superficial understanding of the need for exchange risk hedge, as their currencies were virtually pegged to the dollar. It was for this reason that the debt burdens caused by the pair of currencies increased during the crisis, bringing a serious impact on the economy as a whole. Thus after the currency crisis, there was a shift to a floating exchange rate system and this pushed private corporations into recognizing the importance of hedging against exchange risks. In South Korea, the government conducted a campaign appealing for the need for exchange risk hedges. Some other countries established a financial supervision system to check if foreign currency-denominated debts are hedged against exchange risks. Thanks to these policy efforts, the number of private corporations hedging against exchange risks increased drastically and the response capabilities of the economy as a whole to exchange fluctuations have been strengthened (Lindgren et al, 2000).A stro nger and co-ordinated Regional Financial and Multilateral Co-operation in East Asia was also adopted and this has proven to be an effective buffering against the occurrence of future crisis Although regional financial cooperation in East Asia did exist even before the crisis, such as Executives get together of East-Asia Pacific Central Banks(EMEAP), a forum of central banks and monetary authorities in the East Asia and Pacific region established in 1991 the event of the Asian currency crisis proved more glaring that the countries in East Asia had a much more economic interdependency than was antecedently realized. This forced a fostering of a much stronger regional financial and multilateral cooperation. This co-operation in Asia was promoted in various forms, such as the New Miyazawa Initiative incorporating a comprehensive support measures, including a 30 billion dollar financial support scheme, announced in October 1998 the Chiang Mai Initiative (CMI), a swap arrangement mecha nism to support those countries in potential danger of a currency crisis and the Asian Bond Market Initiative (ABMI) to avoid high dependence on the external financial market and use regional resources more efficiently (Naoyuki Yoshino et al, 2000)In addition to the development of a regional crisis-prevention mechanism, Asian countries started to co-operate especially in trade relations. This inadvertently resulted in a much more stable policy for exchange rates between the Asian currencies. With the increased unification that came as a result of the push for a stronger and unified regional financial and multilateral co-operation in East Asia, there became a rising sense of Asian individuality culminating into the speculation of an introduction of a regional common currency in the future (Naoyuki Yoshino et al, 2000).The finance ministers of China, Japan, and Korea agreed at the ASEAN+3 Finance Ministers Meeting in 2006 to conduct joint research on monetary integration in East Asi a. The motion put forward in 2006 helped to hold grounds for the much talked about Chinas global strategy approach which started do head way in 2010. Now, China is beginning to emerge as the new and dominant world power, buttressing this, is the recent widespread sense and circulation of the Chinese currency (renminbi). These co-operation measures adopted in Asia also extended as a forum for economic co-operation (such economic co-operation was seen to be displayed in the astray acceptance of the Chinese currency renminbi by the other Asian countries). This economic co-operation by these Asian countries arguably challenges the American hegemony. It also proves a strong force towards the elimination of any future financial crisis that might occur as the initiatives and discussions on intensifying monetary and financial cooperation has reached a far end spectrum (Naoyuki Yoshino et al, 2000).From 1996 2000, there have been a resurgence of economic growth across the Asian region. Countries like Indonesia, Thailand, Malaysia, South Korea and the Philippines have averaged almost 5%.CHARTS SHOWING THE EFFECT ON THE AFFECTED COUNTRIES AFTER THE MEASURES HAVE BEEN ADOPTED.From the map above, it can been seen that after the rehabilitative measures were meted out, corporate balance sheets in Asia improved as debt-to-equity ratios have been reduced sharply and foreign currency borrowing is no longer a large component of the corporate sources of funding.From the chart above, it can be seen that low loan-to-deposit ratios together with little off-balance-sheet financing, have helped banks avoid liquidity and funding stress in the current credit turmoil. Thus, Banks are stronger with current account surpluses and large foreign reserves.Compared to United States and many European countries, Asian economies have relative modest property price appreciation (see Chart 5). Asian countries have taken measures to cool property markets in recent years whenever prices threat ened to become a bubble. As a result, property price crashes in the wake of slowing economic growth and financial market turmoil have been less of a risk. purposeAlthough, the Asian currency crisis was fuelled by sheer weak economic and financial fundamentals including macro- economic imbalances, which created a contagion effect for the other countries involved.However, with the measures now adopted, it is obvious that the Asian economies have now been strengthened and would continue on that path.