International Economics Report

Pauline Ng

ECONS 103
International Economics A

Individual Report on Asian Financial Crisis

Prepared For: Prof Leung Hing Man

Prepared By : Pauline Ng Wan Ching

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The Asian Financial Crisis erupted on the 2nd July 1997, and we are not sure whether or
not it caught investors by surprise. But it definitely caught the government off guard, or
at least they seem to be praying that it would not happen when it happened.

It was a financial world crisis which was so severely transferred into a real world
catastrophe when it struck. Suicide rates rose dramatically throughout the region, caused
millions of people to end up jobless 1, bankrupted the regions’ riches, sent long reigning
leaders of countries to their downfall and created major political upheaval in countries
that were once considered the Economic Miracles 2.

The severity of the situation would never be effectively justified in a thousand essays put
together. And many economists have presented diverse views regarding what had really
caused this financial/economic disaster of the decade. What was it that triggered and
caused the contagion effect 3 which crumbled the countries in the region, causing an
initial US$93 Billion of inflow to become a US$12 Billion outflow? 4 In this part of the
essay, I shall present some causes that were strongly argued by academics.

It has been widely debated amongst economists and academics such as Paul Krugman as
to whether or not the boom of the Asian economies has been a real miracle or myth 5.
During and after the crisis, political leaders started pointing fingers at the possible
causes and triggers. Listing a few, George Soros 6was accused by leaders from 10 ASEAN
countries to have been one of the investors who was “manipulating the currency market”
by shorting the Thai Baht, Indonesian Rupiah and other Asian currencies. It had led us
to consider whether or not it triggered the Herd Instinct 7 and eventually caused the
depreciation of Asian currencies by up to 8 folds, for example, the Rupiah depreciated
from 2000 to 18000 to 1 USD8 in the span of a few months.

1 Appendix A – Unemployment Rate Count

2 Appendix B – Trend of Per Capita GDP
3 http://www.sf.frb.org/econrsrch/workingp/pbc/wppb98-06.pdf
Appendix C – Map Overview
4 http://www.imf.org/external/pubs/ft/fandd/1998/06/imfstaff.htm
5 http://www.asiasociety.org/publications/epg.html
6 http://www.pbs.org/wgbh/pages/frontline/shows/crash/etc/cron.html
7 This term is used in the investing world to refer to the forces that cause unsubstantiated rallies or sell-offs.
8 http://en.wikipedia.org/wiki/Asian_financial_crisis

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The reason that was arguably true to a large extent, which I personally believe in, is that
the economy has been fundamentally weak 9, especially in its financial sector and bank
loan system. Most of the countries such as Thailand, Indonesia and South Korea has
extremely lax prudential rules and were financially over sighted as the financial
intermediaries have risky lending practices. Poor quality of supervision and
enforcements of the regulation was considered almost non-existent. Many of the loans
were made and approved based on “Relationship Lending” 10 , where lending decisions
were not based “on sound information about the fundamental economic value of specific
investment projects” but “on personal, business or governmental connections”.

This leads us to looking at the effects of Crony Capitalism 11 and the unveiling to
widespread corruption which was rampant in these affected countries. For example, the
Chaebols (Big Korean Conglomerates) usually has the financial “backing” of the
government, although having debt to equity ratios of 4 to 1 and total earnings at only 1.3
times their debt service 12. Foreign branches of Korean banks were able to build up huge
liabilities before the crisis, partly because foreign creditors correctly perceived that if
their parent banks found themselves in financial difficulty—as they did after the onset of
the crisis—they would receive assistance from the Korean government.

Therefore when the crisis struck, and when the banks and government needed the
liquidity, their inability to retrieve these debts resulted in the inability to manage their
currencies. In addition, there was interdependence amongst the Asian Economies for
example, with the Indonesian banks borrowing heavily from Korean and Japanese
banks, and these banks were unable to retrieve these debts as Indonesia was in dire
straits itself.
Another weak fundamental worth mentioning would be the pegging of the countries’
exchange rates against the USD, which made it vulnerable especially when investors &
Fund Managers started selling short which leads to excessive supply of Asian Currency in
Forex Market and forces devaluation pressure. The government did not un-peg the
currencies immediately when it started happening as they fear that this enormous rapid
selling of their currency in the Forex market would result in a sharp plunge, creating
further panic and selling.

9 http://www.cato.org/pubs/journal/cj18n3/cj18n3-9.pdf
10 http://www.digitalnpq.org/articles/economic/157/02-27-2007/janet_l._yellen
11 http://en.wikipedia.org/wiki/Crony_capitalism
12 http://www.koreatimes.co.kr/www/news/biz/2007/11/128_9349.html

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So they tried to buy back excess currency using their limited Foreign Reserves, increased
their domestic interest rates exceedingly high levels to minimize flight of capital.
However these efforts were futile as they have low foreign reserves and investors
confidence was not restored and the peg was eventually removed and currency allowed
to float 13.

One of the reason given for the shorting was the Currency Misalignment 14 with their
pegs, or at least the investors perceive that the currencies we “over-priced”, and with the
Asian Governments issuing dollar-denominated liabilities with returns in local currency
as they assume the pegs would hold, they felt that it would not be long before the bubble
would be burst.

On top of that, I feel that investors’ panic has a lot to do with the severity of the crisis.
Other than the mentioned hedge fund investors such as George Soros which puts a huge
depreciative pressure on the curry values, the failure of the Korean Chaebols such as
“Hanbo” and “Sammi Steel”, as well as Thailand non bank financial institution were a
major cause of panic. In addition, given that the Hong Kong handover was on the 1st July
and the first wave hitting on the 2nd July would be more than coincidence. It was argued
that the handover caused much uncertainty towards Hong Kong’s financial future15,
resulting in the pulling out of massive amounts of funds.

Firstly, I feel that another crisis of similar nature to that of the Asian Financial Crisis
would not happen again, at least not to that great a magnitude. After the AFC, many of
these countries have started to build up on their foreign reserves in terms of USD to
counter any possible attempts of currency speculation. In addition, governments have
tighten their belts with regards to their banking and financial systems. Now with a
sounder system kept in check, and adhering to IMF’s conditionality bail-out package 16 as
enforced during the AFC.

What the IMF did, was most probably meant to restructure and encourage changes to
prevent another of such catastrophe happening again, but with their short sighted
recommendations, the question of Morality comes in play regarding their actions then.
“Instead of austerity measures to restore macroeconomic balance, the centerpiece of

13 Appendix D
14 http://www.trilateral.org/annmtgs/trialog/trlgtxts/t53/gyo.htm
15 http://www.usip.org/pubs/specialreports/early/asiafinancial.html
16 http://www.washingtonpost.com/wp-srv/business/longterm/asiaecon/stories/bailout120497.htm

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each program is a set of forceful, far-reaching structural reforms aimed at restoring

market confidence. The reforms included in these programs will require vast changes in
domestic business practices, corporate culture, and government behavior.” 17

Other than taking measures to prevent the onset of the crisis, governments can also take
preventive measures to buffer the impact of a financial world crisis on the real world.
And this can be seen performed by the Singapore government during the AFC where they
prevented job losses by helping companies reduce labor costs by reducing employee’s
contribution to CPF. Although many people experience pay cuts, they at least preserved
their jobs.

For the final part, let us take a peek into the Sub-Prime Crisis 18 and whether or not it
would be the next major crisis. The subprime problem was created due to over confident
lending to borrowers with little or no financial credibility, with outstanding mortgages in
the US reaching a hefty US$1.3 Trillion. In addition, large banks were heavily vested in
property projects resulted in an asset bubble. With losses amounting at $11Billion for
Citigroup, $6 Billion for Merrill Lynch, $3 Billion for Barclays, and the list goes on for
banks around the world, are the investors getting panicky and are the governments
involved prepared?

I feel that the world is still safe from the crash that might lead from the current Sub
Prime crisis. This is largely because consumers’ confidence, represented by their
spending has not decreased 19. In addition, we are able to see certain jittery responses
from investors when every piece of news regarding the subprime results in dips in the
financial markets. However, these investors’ responses are far from what we saw during
the Asian Financial Crisis. It is true that there would be some jittery responses, but
governments around the world have taken up measures build back confidence. For
example, the Fed has reduced inter-bank borrowing interests rates, as well as interest
rates for the consumers. The Singapore government has announced the ability and
willingness to pump liquidity back into the economy if required. From these, I personally
feel that the subprime problem would not translate into a crisis of the AFC magnitude.

17 http://wopared.parl.net/library/Pubs/CIB/1997-98/98cib23.htm
18 http://en.wikipedia.org/wiki/2007_Subprime_mortgage_financial_crisis
19 http://news.goldseek.com/MillenniumWaveAdvisors/1163952000.php

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Appendix A

Appendix B

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Appendix C

Appendix D