Term Paper by fionan


									               Term Paper

Recent Financial Crisis in East Asian Countries
          Experiences and Lessons
•   Pre Crisis Period
•   Mexican crisis
•   East Asian crisis
•   Impact on the economy of the countries
•   Role of IMF
•   India Position in terms of economic
         Pre-Crisis Period
• East Asia had experienced phenomenal
  growth in early 1990’s.
• Referred to as the East Asia Miracle.
• Decreased poverty.
• Governments were vital parts of the
  economy and privatization was not
 The Mexican Financial Crisis
• External Factor- Low interest rates in the U.S.
  combined with the recession there and in other
• The inflows in the country was short-term and
  aimed at making quick profits through financial
  speculation on stocks and other securities in the
  financial markets of Mexico
• Gains from the foreign investments were more
  illusory than real.
• Mexico was living beyond its means.
• Decrease in domestic savings
• Current account deficit.
• During 1990 and 1994, portfolio investment inflow
  was $71.2 and 72% of it was used by the Mexican
  authorities to finance the current account deficit
 Collapse of the peso and later of the economy

 Increased interest rate in USA
 Political agitations in Mexico eroded investor
 Mexico government announced a 13 percent
  peso devaluation which panicked foreign
  investors and they started pulling their money out
  of Mexico.
 Over the next two days $5 billion fled the country.
  The Mexican stock market lost one half of its
  value over within months of the devaluation.
           Impact of the crisis
•   Deterioration of the Mexican economy
•   Deterioration of living
•   Job loss
•   Fall in real wages
•   Increased interest rate
•   Credit crunch
•   Reduction in social sector spending
•   The rich have hardly been affected as they
    invested their savings in dollars
  The Southeast Asian Currency Turmoil
The case of Thailand

• Increased short-term borrowing from international banks and put
  greater reliance on portfolio flows rather than on FDI to finance
   current account deficits.
• By August 1997 the composition of Thailand’s foreign debt had
   become unbalanced.
• Thailand began taking foreign loans in foreign currencies and the
  rate of 6-8 percent and started financing domestic companies and
  individuals at an interest rate of 14-20 percent in baht.
• Since the opportunities in productive sectors of the economy were
  getting reduced largely due to the stagnation in exports, the banks
  and financé companies started financing short-term real estate
  businesses which was showing boom in early 1990s.
• By the end of 1996 and in early 1997 the fall in prices of
  real estate had landed the majority of financial firms in
  serious trouble.
• In February 1997, Somprasong Land became the first
  company to default on a Euro-convertible debenture.
• When it was revealed that around two-third of the
  country’s 91 finance companies were in serious trouble,
  the investors lost confidence. Both foreign and domestic
  investors started buying dollars, taking advantage of the
  fixed exchange rates.
• With the FIIs heavy selling in the stock markets, the
  share prices dropped to record low levels by 65 percent
  in May 1997.
          Impact of the Crisis
• The IMF’s conditions include budget expenditure cuts of
  about 100 billion baht; increase in the value-added tax
  from 7 to 10 percent and further reduction in subsidies
  and public investments.
• Many companies have announced cost reduction
  measures, which largely include layoffs besides sharp
  cuts in wages and benefits
• In rural areas, the small farmers have been affected by
  the increased cost of production because price of
  agricultural inputs such as chemical fertilizers, seeds,
  insecticides, etc. have risen by over 30 percent, while
  prices of agricultural produce have not correspondingly
      Contagion Effect on South Korea,
     Indonesia, Malaysia and Philippines
South Korea: Victim of Heavy Commercial Borrowings
• The real problem confronting South Koreas was not the
  unproductive investments in real estate and other speculative
  businesses, but the heavy short-term borrowings by the private
  sector financial institutions from foreign commercial banks
• The IMF insistence to increase the interest rates in South Korea has
  led to a rise in interest rates at 19-20 percent, nearly 15 percent
  above the inflation rate. This move has made more companies
• With the Korean domestic industry in deep trouble after the stock
  market crash coupled with high interest rates and deflationary
  pressures, many companies have very little option but to sell their
  stakes to foreign investors at throwaway prices.
Indonesia: The Mighty Fall of Rupiah
• Short term investment by foreign players
• In 1997, Indonesian companies had $55 billion
  outstanding in foreign debt, 59 percent of which was in
  the short-term category.
• The rupiah lost 58 percent of its value against the dollar
  in 1997 as Indonesian companies with heavy foreign
  borrowings rushed to buy the currency
• The devaluation of the rupiah has led to sharp rise in
  inflation thereby increasing the living expenses of the
  majority of the population. The shrinking economy had
  led to layoffs of thousands of workers.
 Malaysia: Failed to avoid the Currency Crisis

• Capital inflows to Malaysia in the mid 1990s were in the
  form of short-term loans and portfolio investments.
• Short-term loans supplemented the domestic
  investments in the unproductive sectors such as
  consumer and property finance.
• Anticipating an oversupply in the real estate business
  due to overcapacity and default on short-term
  borrowings, the speculative attacks on the ringgit began
  which seriously weakened it.
Private Profits, Public Losses: The Great
        Asian Bailout Programme
  Bailouts for Whom?
• The role of the lenders in the creation of this crisis was
• Under the bailout programmes the discipline was
  imposed primarily on the debtor.
• The foreign banks alone are given huge subsidies so
  that they do not have to suffer for their mistakes, while
  local banks and companies were forded to go under.
Who Benefits from Bailout Programmes?
• Trans National Corporations (TNC) operating in the
  region suffered short-term losses.
• But in the long run, TNCs have emerged as the net
  gainers because labour costs and assets in dollar terms
  have sharply declined in the wake of currency
  depreciation in these countries.

• To facilitate foreign ownership and takeover of domestic
  companies in these countries, the IMF has imposed
  conditions which ask for greater accessibility and
  ownership rights to foreign companies.
                 Who Loses?
• Among the major sufferers, the workers are the worst
• In order to invite foreign capital to buy these public
  sector units, the governments had to first shed ‘excess’
• These factors have significantly contributed to the
  depression of wages and the weakening of the
  bargaining power of labour unions.
      Washington Consensus
• Growth occurs through liberalization, "freeing up"
  markets. Privatization, liberalization, and macro stability
  are supposed to create a climate to attract investment,
  including from abroad.
• Foreign business brings with it technical expertise and
  access to foreign markets, creating new employment
• Foreign companies also have access to sources of
  finance, especially important in those developing
  countries where local financial institutions are weak.
The IMF and its Contributions to the Crisis
 • Capital account liberalization, the removal of restrictions
   relating to the flow of capital, in this case, currency.
 • The Western world encouraged East Asian countries to
   allow foreign investors easier access to the Asian
 • Hot money flowed into the region rapidly but many of
   these countries did not have regulations in place to
   ensure foreign investment could not be pulled out
   without penalty.
 • When negative speculation occurred, this money flowed
   out of the region as fast as it was initially invested.
       Reforms during the crisis
• Increased interest rates, sometimes as high as
  25 per cent.
• Decreased government spending. Indonesia's
  government had to eliminate food and fuel
  subsidies in April 1998.
• Countries had to close poorly performing
  domestic banks.
• South Korea had to enact financial reforms and
  allow international firms to participate in its
  domestic markets.
• Mass layoffs were experienced in many
• Political reforms
 Globalization Discontentedly
• Different countries require different economic

• Nations are very interdependent.

• Macroeconomic solutions are needed
 Will India go the Southeast Asian Way?

• The financial liberalisation of Indian markets with
  heavy reliance on hot money flows will have
  serious implications for the financing of current
  account deficit.
• Spillover impact of Southeast Asian Currency
  Crisis on Indian Rupee
• Hot Money Flows Constitute 80 percent of Forex
• Dangers of Capital Account Convertibility
        Should India pursue capital account

• Tarapore Committee (1997) defines CAC as "the freedom to convert
  local financial assets into foreign financial assets and vice-versa at
  market determined rates of exchange".
• It is not immediately possible to give unlimited access to short-term
  external borrowings, and
• Full capital account convertibility may encourage arbitrage
• Voluntary savings in India generated according to the time
  preference of the economic agents is mostly sufficient for the gross
  domestic investment and growth
• High real rates of interest promotes both financial and total savings
  and private sector capital formation by facilitating the accumulation
  of finance necessary for undertaking investments.
 Dangers of over reliance on volatile, short-term
  capital flows to finance unsustainable current
  account deficits.
 These private capital flows are no substitute for
  domestic savings
 A country can reduce its exposure to the
  volatility of external capital by increasing its
  national savings.
 Financial liberalisation policies are less likely to
  succeed in the absence of a sound macro-
  economic situation

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