Financial Crisis Management

Sayed Hossain

Asian FINANCIAL crisis

 

 

 

BACKGROUND OF THE CRISIS

 

June 20, 2005: The East Asian Crisis was a financial crisis that commenced in July 1997 in Thailand and later, it extended to the rest of the neighboring economies. The crisis affected stock prices, currencies and other asset prices in most of the Asian economies. In other words, prices of the assets plunged to a record low. The Asian tigers turned into a slump for few years but they rebounded later. Indonesia, South Korea and Thailand affected most severely while Malaysia, the Philippines, Singapore, Taiwan and Laos had a moderate affect.

 

The crisis indeed began on July 2, 1997 when the Thai Central Bank withdrew its support on its currency Thai bhat which was tied to US dollar. The value of the Thai currency depreciated heavily against US dollar as soon as the support from Thai Central Bank withdrawn. Currency depreciation in Thailand brought a similar depreciation in all the neighbouring Asian currencies and hence financial crisis began. The first round of currency depreciation happened in Thai baht, Malaysian ringgit, Philippine peso and Indonesian rupiah. The second round of currency devaluation began with the Taiwan dollar, Brazilian dollar, South Korean won, Singapore dollar and Hong Kong dollar.

 

 

 

 

 

CAUSES OF THE CRISIS

 

There have been a number of schools of thoughts behind the causes of this crisis. Some of the causes are as follows.

 

 

Interest rate crisis

 

In the early 1990s, the US Federal Reserve (US Central Bank) had been increasing its interest rate to tackle possible inflation as the economy began to experience a growth. As we have observed, inflation intensifies with the economic growth and the Central Bank is likely to hike interest rate to reduce overall spending and price hike.

 

Since money always looks for higher interest rate or return from financial and real investment, there had been a flow to US assets that caused the US dollar to appreciate. Since many Asian currencies maintained a fixed or close align  to US dollar, their currencies had been appreciated with the appreciation of US dollar. With the appreciation, these Asian economies were loosing export competitiveness, hence continued to face current account balance deficit. Indeed, South East Asian exports were plummeting dramatically since the mid of 1990s just before the crisis.

 

 

 

Capital flow and hot money crisis

 

As mentioned before, since the US interest rate had been increasing since the beginning of 1990s it attracted fund mangers’ hot money in US assets to gain higher return compared to East Asian assets. This caused a plunge in the demand for Asian assets. Gradual withdrawal of hot money caused a plunge in security market.

 

Hot money is an investment made by fund managers for short term return generally in stock and bond, currency markets.

 

 

 

Confidence crisis

 

Mexico faced a currency crisis in 1994 just before the East Asian crises. Mexican crisis brought a bad impression about the sustainability of the growth in emerging economies like East Asia. This impression had prompted investors to pull out investment from East Asian economies.

 

 

 

Foreign reserve crisis

 

The amount of foreign reserve that Asian Central Banks had was not enough to defend their currencies especially when the currencies were under speculative attack at the end of 1997. With the plummeting the value of the local currencies, Central Banks intervened in the market to restore the value by selling foreign currency while buying local currency. After several attempts, the foreign reserve depleted without success. As a result, currency floating and IMF bailout were the outcomes.

 

We observe that all the Asian Central Banks of today are trying to pile up foreign reserve to defend their currencies to tackle future downturn.

 

Many economists commented that Asian currencies lost their values due to a deliberate attack of the currency speculators while others do not comply with this argument. They say that Asian economies were loosing confidence gradually since 1990s due to fragile and excessive liberalized system, which busted in the late of 1997. Native people and business rushed to banks to convert local currency to US dollar followed by speculators but central bank failed to supply required amount of dollar demanded and hence allowed to flow currency freely to tackle currency crisis. The currency crisis brought the East Asian financial crisis.

 

As soon as the currency floated, many local business and governments who borrowed in US dollar externally, they found it very expensive to pay the debt as the US dollar has become very expensive when we compare with local currency.

 

 

 

Liberalisation of financial system

 

East Asian governments liberalize the financial system very rapidly without much government regulation and control. The interest rate ceiling was lifted and the liberalization in the transaction of current and capital account and establishment of offshore banking. As a result, the control of Central Banks on financial system reduced considerably. On account of  liberalisation policy, private sector borrowed in foreign denominated from external sources at a large amount and re-lends them to local investment at a higher interest rate. Sometime they borrowed for short term and but lent it in long term project domestically. With the floating of currency, it became huge expensive to pay the debt.

 

 

 

 

 

 

CONSEQUENCES OF THE CRISIS

 

A large portion of the debt by the government and especially private sector was in foreign denominated currency. With the plummeting of local currency, it became very expensive for the government and private sector to pay the debt.

 

The stock market plunged, employment cut and political unrest were the outcomes. Indonesian president Suharto had to leave power.

 

South Korea, Indonesia and Thailand sought IMF assistance for recapitalizing their Central Banks. As per the IMF condition, the interest rate went up to attract foreign capital and government budget squeezed considerably. Floating exchange rate system had been in place. The higher interest rate caused interest-bearing securities more attractive. Governments adopted austerity measures in all its activities. In case of Malaysia, government bailed out the distressed banks by re-capitalizing them.

 

The national assets of these East Asian economies drastically dropped with the devaluation of currencies.

 

Trade deficits of the United States went up as Asian economies reduced their imports amount.

 

Malaysia introduced a very unconventional approach to tackle the crisis such as reduced the interest rate, pegged the exchange rate, introduced deficit budget and restricted capital flow. This expansionary policy brought a good result.

 

Currency speculators found to be an important factor in the financial system and a new type financial system had been a search. Dr Mahathir commented that currency trading was immoral and should be stopped.

 

Investors, local and foreigners had to accept billions of dollars loss due to a plunging in security market.

 

 

 

 

 

 You can visit my personal website as follows:

http://www.sayedhossain.com/

 

  

 

 

 

This website is produced and maintained by Sayed Hossain. My email :

sayed.hossain@yahoo.com

 

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