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Causes and Prevention of External Debt Crisis

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Causes and Prevention of External Debt Crisis Powered By Docstoc
					Causes and Prevention of
  External Debt Crises


      Yen Kyun Wang
  Department of Economics
 Chung-Ang University, Seoul
        July 6-7, 2004
    UNESCAP, Bangkok
                               1
•         Introduction
• Asian financial crisis was a debt
  crisis (over-borrowing by private
  firms).




                                      2
• Many changes after the crisis.
• -But slow structural adjustment
• -Directions for reforms on corporate
  governance, and conglomerate
  (chabol) are debated: Western style
  or Traditional style?
• Not adequate measures yet against
  volatile short-term capital flows-
  receiving, source country or global
  level
                                         3
• In Korea: per capita income:$10,000 in
  2003, same as that of 1996
• A Author: Causes- weak fundamentals and
  policy distortions, aggravated by herding
  and contagion




                                         4
            Will Discuss
•   Over-investment mechanism
•   New method of calculating real
    effective exchange rates: showing
    large degree of overvaluation in East
    Asian currencies before 1997
•   Others
•   Crisis prevention measures


                                            5
 Causes of external debt crisis in East
 Asia
• Mechanism of over-investment and
  over- borrowing : a mix of
  export-oriented , conglomerates-
  based economies, excessive
  governmental intervention




                                          6
• Boom period: rapid expansion of
  investments of large corporations and
  chabols
• Downturn period: further expansion,and no
  contraction of facilities of firms due to
 - implicit government guarantees, too-big-
    to-fail legacies to large firms and banks
- Government rescuing failed large firm
- loans based on mutual payment
  guarantees among chabol affiliate
  companies
- no strict screening by banks of investment
  projects
                                            7
- Weak corporate and financial
  governance system-small
  shareholders with no voice
- Convoy-style management of chabol:
  saving weak firms,setting up new
  firms by funds of strong firms
- Lay-off was illegal, weak social
  security net
- Strong labor unions

                                   8
• Desire of large shareholder to prevent
  dilution of ownership: prefer debt to other
  means
• Average debt/equity ratio, 1988-1996
 - Indonesia, Thailand, Japan 200%.
    Korea 347%
 - in manufacturing sector in 1997:
  Korea 396%. Japan 200%, US 150%,
  Taiwan 82%



                                                9
• Bank loan growth – GDP growth:
-Korea 17.1%, Phil. 22.8%, Thailand
  10.4%, Indonesia 5.8% Singapore
  2.8%,Japan –1.28%
  Bank loan growth – industrial
  production growth:
- Indonesia 22.0%, Korea 9.4%,
  Singapore 6.9%, Japan –1.1%


                                      10
• Growth rates (total assets, share
  capital, sales) of firms of Korea much
  higher than those of Taiwan
• Net Profits of firms of Korea: a
  quarter of those of Taiwan, half of
  those of US.
• Investment rates of East Asian
  countries: 30-40% of GNP
   -Philippines, Taiwan: 20-25%

                                           11
• Incremental capital output ratio
  increased substantially in the
  region,1987- 1992 to 1993-1996
• Interest Coverage Ratio less than
  1(business profit before tax and
  interest payment is less than interest
  cost) in Korea: 11 out of 30 top
  chabols


                                           12
• In 1979-1980, external debt crisis
  occurred in Korea, due to over-
  investment in heavy and chemical
  investment projects by government
  during 1973-79,
   aided by oil shocks, high interest
  rates, internal political turmoil
• -19.7% depreciation, industrial
  restructuring and economic
  Stabilization programs
                                        13
Overvaluation and large current account
  deficits
-Many writers(e.g., Ann Krugman, Ronald
  Mackinon, Roubini): no overvaluatin in East
  Asia before 1997
 - they used CPI or WPI as deflator in
  calculating real exchange rates
- years before 1997, export prices did not
  increase much, low inflation, but rapid
  increase in wage rates in East Asia due to
  boom and shortage of skilled labor
-New calculation of real effective exchange
  rates using unit labor cost( base
  year=1985)
                                           14
• Exchange rates in Korea: 30%
   overvalued in 1996 (pegged nominal
   rate, 59% increase in ULC) using ULC
   as a deflator
• -If WPI is used, 6% overvalued.
• -if CPIs are used, 16% overvalued:
      similar in other countries
  In China in 1994, 50 depreciation
  In Japan in 1996, 16% depreciation
  - eroding competitiveness of export
   goods of EA countries
                                      15
• Current A/C deficits/GDP(danger
  level: 4-5%): 9% in Thailand in 1995
  and 1996
 - Malaysia: 10%and 3.7%in 995,1996.
  Korea 5% in 1996.
   Indonesia 4%, 1995-97.
   Philippines 5-7% , 1993-97


                                     16
• Conventional rules of thumb for danger
  levels: external debt: should not exceed of
  40% of GNP or 200% of exports, and debt
  service ratio not exceed 25%
• Foreign /GDP: Indonesia 56-69%, Phil.
  50-71 in the 1990s. Malaysia 40%, Korea
  28% in 1996
• Foreign debt/exports: 220% in
  Indonesia(danger). 127% in Thailand,
  120% in Philippines
• Debt service ratio: 37% in Indonesia in
  1996, Phil 14%
                                            17
• Foreign liabilities/assets(relative to
  BIS reporting banks)
• -1103% in Thailand. 400% in
  Indonesia, 375% in Korea
• -Serious mismatch. Borrowed short,
  lent long in foreign currency



                                           18
• Boom-bust cycle, busting of asset
 price bubble
• -Asset price bubbling, building
  permit declined drastically, many
  construction companies bankrupt
• -In South East Asia, drastic decline
  in asset prices,stock prices, property
  stock prices,


                                       19
• Poor corporate and financial governance
• -maximizing interests of chabol oweners
• -group chairman had big power, but no
  legal responsibilities, standing above law
• -financial institutions under direction of
  the government, government-directed
  loans.




                                               20
• Deterioration of terms of trade
• In Korea: -12% in 1996, -11% in
  1997
• Unit value index of electronic exports
   : 100 in 1995, to 31 in 1996
• Share of electronic exports in total
  exports in 1996: 19%
• UVI of total exports: 100 in 1995 to
  86.6 in 1996

                                       21
• Lack of transparency in financial
 statements of corporations and
 banks
• -Was different from western
  accounting practices: announced
  bad loan rate-6%. Perceived rate-
  30%


                                      22
• High share of short-term debt in the total
• Thailand 61-72% in 1994-95, Korea 50%
  in 1996 (58% end of 1996)
• Short- term debt/foreign reserves:
• -In 1996, 203% in Korea.
• -177% in Indonesia. 100% in Thailand.
  Philippines 80%
 (Short term-debt + debt service)/foreign
  reserves in 1996: Korea 243%, Indonesia
  294%, Thailand 123%, Philippines 137%

                                               23
  M2/foreign reserves, years before
  1997:
• - Korea 6-7. Phil 5, Thailand 4,
  China 9-26 Taiwan 5-6
 Average annual ratio of Net FDI/GDP
  in 1992-96
• -Korea –0.2%. 0.7% in Thail, 1.8% in
  Indonesia, 1.7% in Phil, Malay 6.2%


                                     24
• Rigid labor market and inadequate
 education system
• -lay off was illegal
• -enrollment in secondary school in
  the same age cohort: in Thailand
  30%,, Indonesia 20%.




                                       25
  Wrong sequence of liberalization
• Capital liberalization first before
  strengthening financial institutions
• Weak financial system, not exposed
  to foreign competition, very
  vulnerable to short-term capital flows
• Low profit rates of banks, large bad
  loans, large share of government
  directed loans

                                       26
• Poor supervision and regulation of
 financial institutions
• - lack of information on transactions
  of funds abroad, no limit to risk
  exposure of financial institutions
• - no strict evaluation of lending
  projects



                                       27
Moral hazard on the side of
 international lenders
• Over-lent, believing in bail-out by
  the government
Gov. policy failure in handling failed
 companies
• -direction to keep lending failed large
  firms
• -Congress holding submitted laws to
  allow firing by firms
                                         28
         Prevention measures
•   Export-oriented growth
•   Economic reform and market opening
•   -deregulation
•   -reducing government intervention
•     Correction of over-borrowing mechanism
•   -Ceilings on total investments (25% of net
    assets) and maximum debt/equity ratio of
    200% of chabol member firms - restricting
    investments in Korea

                                                 29
• Strong corporate and financial
  governance
• Transparency in business
  management and accounting
• Correction of continuous current
  account deficits and large debt
• Managing boom: inflows of s-t
  capital, macro and micro policy

                                     30
    Exchange rate system
• Flexible basket currency system, ensuring
  constant real exchange rates and current
  account balances would be better than
  floating or fixed exchange rate system
• use unit labor cost indices as a deflator,
  when calculating real effective exchange
  rates- better indicator of international
  competitiveness of tradabe sector


                                               31
Control of excessive short-term
 capital flows:
• Short-term loans, portfolio capital
• -Impose tax such as Chilean reserve
  requirement w/o interests
• Development of domestic demand
  oriented and service industries
• - deregulation, free economic zones,
  market opening and reforms.

                                     32
  Structural adjustment
• Leave non-viable firms to creditors,
  not government
• Strengthening regulations and
  supervision-limit exposure to risk
• Competitive education system , more
  investments by the government.


                                         33
• Collection Action clauses and
  Sovereign Debt Restructuring
  mechanism
• Avoid moral hazard to international
  lenders
• Provide information on the
  international capital market to
  developing countries


                                        34
  Regional surveillance and financial
  cooperation
• Real side: business tie-ups, FTAs in some
  or all industries, education and training,
  environment, arms reduction
• Financial side:
• -Exchange rate cooperation
• -Pooling some of international reserves at
  private banks and use it in need
• -Asian Monetary Fund
• -Establish a regional crisis prevention
  framework, conducting on-the –ground
  analyses using data collected within the
  region
                                               35

				
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