The paper discusses the phenomenon known as the Asian Financial Crisis, with an emphasis on the category of Asian economies that suffered from this event in the 1990s. The research provides some general background of the issue, shows the most significant causes for the crisis, the constitutive essence of it, and its main consequences, also providing insight into reasons behind the crisis of currency and banking system. The research has been conducted with the help of modern literature in the field. The investigation shows that during that time, when banks lent currency, they faced the credit risk based on the insolvency of the borrower. Deregulation of the financial sector in the absence of proper supervision and control over the activities of banks and other financial institutions led to an increase in the number of fraudulent transactions and diminished the possibility of banks to take excessive risks without being backed by financial resources, which in turn inevitably led to bankruptcy. The growth of the scale of the risks in the credit and financial sector contributed to the widespread merging of financial and industrial capitals, to the interlacement of system of mutual participation and capital, and to the appearance of the phenomenon of the “opacity” of operations in the financial market. The banks acted rather as a tool to stimulate the industry rather than as financial intermediaries called to ensure the redistribution of financial resources and the most effective use of the clients. The banks and industry groups were very closely linked. Banking regulation and supervision were inadequate, thus destroying the proper internal control in the banks. Credit risks were underestimated, and in many cases, any feasibility of lending did not exist. The practice of granting loans with unreasonably high credit risks started to become a widespread concept. As a result, public authorities of monetary and foreign exchange regulation lost control of the situation in the financial markets, which eventually led to the Asian financial crisis.
In 1997, the countries of the Association of the South-East Asian Nations (ASEAN) faced currency and financial problems, and many people were surprised by this because these countries were considered to be the most prosperous and served as an example for other developing countries. Even despite the crisis in the past, recently the East Asian “tigers” have demonstrated the highest growth rates again. Southeast Asia has become another country which along with the USA and the European Union is considered to be the “locomotive” of the global economy. The essence of the economic “miracle” that occurred in the 1960-1990s lied in an unusually rapid pace of economic restructuring. In the recent past of the country, it came close to the level of industrialization in a very short time.
On the eve of the Asian financial crisis, the stock markets of these countries flourished and were the objects of active investments of foreign capital. Nevertheless, soon the investors changed their behavior dramatically, refusing to trust the governments of Asian countries, which led to panic and a massive outflow of capital. Eventually, it plunged Asian national financial systems in a deep financial crisis, threatening economic stability. Such an obvious contrast between the recent success and sudden economic turmoil leads to the conclusion that there were certain reasons that had contributed to the appearance of the crisis.
The ASEAN countries had already experienced another cyclical recovery of the economy since the middle of the 1980s — in Thailand, Malaysia, and Indonesia, the economic growth rate reached 7-8% per year until 1996. The economic recovery in many ways contributed to the fixed exchange rate regime. The corporations from Japan and the newly industrialized countries transferred the export-oriented production to ASEAN in an effort to hedge against unfavorable changes in their currencies because of the dollar (Bautista, 2006). The glut of domestic and foreign investment was accompanied by large-scale imports of equipment and raw materials. Therefore, the paper focuses on the main causes and essential consequences of the Asian financial crisis.
High rates of economic development in most countries in Southeast Asia since the end of the 1980s until the beginning of 1997 had contributed to the increased inflow of foreign capital into them, in the form of direct and portfolio investments. Hoping to increase income in the period of low-interest rates and slowing GDP growth in the developed countries, the investors transferred the capital to the financial markets, underestimating the risks involved. According to Krugman (2012), in 1997, the Asian countries were a leading importer of foreign private capital from developing countries. According to Harvie and Van Hoa (2016), capital inflows contributed to a significant expansion of domestic demand, to a significant increase in the prices of stocks and real estate, to the accelerated growth of assets and liabilities of the banking sector, and to the emergence of the current account deficit of the balance of payments.
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The decision to finance the current account deficits with the help of foreign capital inflows helped to create fixed exchange rates. For foreign financial speculators, investing in Southeast Asia was attractive due to the higher interest rates than in the West and because of the prospects of big local stock markets. The bulk of external borrowing accrued to the private sector, while public budgets in most of the countries were significantly reduced for many years. The inflow of funds from abroad contributed to the rapid widening of the financial sector, which in turn led to a speculative fever in the real estate markets and to the boom of construction of new office space.
Credit and financial institutions in many of these countries invested a substantial share of short-term capital into high-risk investment projects, mainly those concerned with the purchase of the real estate. Due to the inflow of capital, the price of these assets quickly rose, attracting new flows of investments to the real estate sector. As the economy of Southeast Asia had been developing rapidly in the past years, the consequences of such a relocation of resources were not revealed immediately, although the asset prices soared so high that their instability along with the gap between the amounts of loans and mortgages became inevitable.
Another disastrous situation developed in South Korea. The rate of the Korean Republic Won was floating, and the rapid growth of investment-led to a deterioration in the trade balance. In the course of economic reforms in the 1990s, the conditions for obtaining loans from local banks for the Korean financial and industrial groups tightened, after which the businessmen shifted to external borrowing. As a result, the debt of the leading Korean companies in the middle of the 1990s reached 4-5 times the size of their share capital. Massive investments led to the phenomenon of considerable overcapacity.
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Things began to change with the beginning of 1996. The weakening of the Japanese yen against the dollar worsened the export competitiveness of Thailand and other south-east Asian economies with fixed exchange rates. According to Krugman (2012), it increased competition of ASEAN states with countries of open economies, especially with China. In Western markets, there was a glut of Asian export products, mainly of electronic nature. At the same time, in Thailand, Malaysia, and Indonesia, the phenomenon of overheated real estate markets became apparent, creating a huge gap between supply and demand, which in turn led to a sharp reduction in prices.
The speculative fever of the past years resulted in the rapid accumulation of non-performing loans in regard to the banking system. According to Bautista (2006), in Thailand, in financial companies that lent money to the real estate sector in the spring of 1997, the debt constituted 25 to 50% of the loan portfolios. In general, all these circumstances resulted in a change in the attitude of foreign investors to Asian markets. The principle diagram of the deployment of the Asian financial crisis can be summarized in several stages. First, there was a decrease in stock indexes (Bautista, 2006). Then, as the growth of negative sentiment among investors began, the speculative attacks on the national currency commenced. The high-interest rates exacerbated the problem of external debt, the costs of maintaining a fixed exchange rate eventually led to the devaluation, which further increased the costs of debt servicing. During the fall of the exchange rate, the stock market indices also fell, but at a much higher rate. The fall in stock prices and the exchange rate usually takes place in a spiral, where one event accelerates the other.
In 1992-1996, Thailand’s current account deficit rose to $ 14, 7 billion. Although the percentage of the USA trade deficit was relatively more, Thailand’s current account deficit constituted 8% of its GDP. The situation was further complicated by the opaque credit system. As it turned out, in Asia, a crucial factor in the provision of loans was personal relationships between the borrowers and the senior officials. According to Best (2010), it had an effect on many South Korean companies with high leverage, and the total amount of non-performing loans amounted to 7, 5% of GDP.
A similar situation with loans developed in Japan. In 1994, the Japanese government announced that the total amount of doubtful and non-performing loans amounted to $ 136 billion, but a year later the authorities recognized that this figure rose to $ 400 billion (Bautista, 2006). A huge amount of non-performing loans, combined with a weakened stock market, low prices for property, and dubious economic growth contributed to the devaluation of the yen.
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Trying to make a profit, the investors sold the currencies of other Asian countries and put pressure on their courses. When the Japanese “bubble” burst, the value of assets decreased by $ 10 trillion. According to Bautista (2006), the share of real estate in the fall was 65%, which was equal to the total volume of products being produced in Japan for 2 years. Impairment of assets triggered a banking crisis that began in the early 1990s and culminated in 1997, after the bankruptcy of several major Japanese banks. In response, the Japanese government announced a possible increase in base interest rates in the hope of protecting the national currency. Unfortunately, these expectations were not fulfilled, and a further fall could not be avoided. According to Best (2010), the course of the national currency of Thailand, baht, was first supported by central bank reserves, but when they ran out of it, the value of the baht began to quickly fall under the pressure of investors selling the currency.
As the governments of the countries of South-East Asia failed to protect the parity of their national currencies through interventions and increasing foreign exchange rates, the process of devaluation started to happen, bringing down the stock markets.
In June-August 1997, due to the outflow of short-term capital, the Asian financial crisis continued to fuel the process of a sharp devaluation of the currencies of the countries of Southeast Asia: Thai baht fell by almost 30% in September, and the currency of Indonesia, Malaysia, and the Philippines fell by 15-20%. The continuation followed in late October, when one day, due to the outflow of short-term capital, the share price in Hong Kong fell by 13% — from the beginning of August, a decline was more than 40%. According to Bautista (2006), after this, Hong Kong followed all the major and minor world stock exchanges, including Russian. The currencies of South Korea, Singapore, and Taiwan, which resisted the summer currency crisis, fell by 5-10% (Bautista, 2006). Subsequently, the stock index straightened, but the tension and instability in world markets remained, as even the leading developed countries started to lose control over the situation.
Firstly, the daily volume of foreign exchange transactions exceeded $ 1 trillion, which was 50 times more than the volume of all international trade, and accounted for 80% of all foreign exchange reserves. It turned out that there was no clear understanding of how governments, international financial institutions, and the national central banks should respond to such events. In this specific case, the government, the IMF, and the central banks could not stop the collapse if the markets did not stop falling themselves.
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Secondly, although the events in the stock markets in New York and London were the cause of instability in the countries of Southeast Asia in the last century, during this Asian financial crisis, the causes and effects reversed their roles for the first time ever. According to Bautista (2006), the rapidly growing economies of China, South Korea, and countries of South-East Asia, which already accounted for 20% of global exports value — more than that of the United States and Japan combined, became a new center of power in the world economy, where the Western countries became dependent rather than controlling.
Thirdly, there was a very large increase in the power of currency speculators. Managing funds in the tens of billions of dollars, those countries were perceived as a serious competitor of central banks and international financial institutions. For the undermining of currencies of South-East Asia, George Soros, the person who conducted multi-scale operations in the foreign exchange markets, was blamed. According to private speculators, the undermining of the currency and stock markets started to happen not only in small but also in medium-sized countries. In addition, during the Mexican crisis in December 1994, it became clear that good policy did not protect against the “attacks on the currency.”
In South-East Asia, with the exception of Thailand, the basic economic and financial indicators looked even better, characterized by strong growth, primarily due to the export sectors of the economy, high investment, low inflation, assets or a small budget deficit, relatively low external debt, and debt service payments. The current account balance deficit, although significant, was covered by capital inflows, and was mainly of a long-term nature.
The foreign exchange reserves seemed high enough to withstand the possible outflow of short-term capital. However, the countries were in the midst of the Asian financial crisis. Falling stock prices in October 1997 in Hong Kong occurred without any tangible reasons — the investors agreed that the Hong Kong dollar was reliably provided by their own foreign exchange reserves and by even more impressive reserves of China. However, they still transferred their investments in other currencies. According to experts, the countries of Southeast Asia became the “victims of their own success.”
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The initial success could be seen in the development of the countries’ export. The development of their economies became dependent on the development of export industries. At the same time, insufficient attention was paid to the production of the domestic market, thus expanding the domestic demand. For instance, the average annual growth rate of exports of Thailand, Malaysia, the Philippines, and Indonesia in the period from 1986 to 1996 amounted to 12, 4%, with average annual GDP growth over the same period of time of 9.6% (Harvie & Van Hoa, 2016).
Secondly, the countries of Southeast Asia became the victims of success because of the strengthening of the national currency. The exchange rates of national currencies of these countries were linked to the dollar. The growth of the dollar weakened the competitiveness of exports from these countries. Accordingly, the number of difficulties in expanding exports of Southeast Asian countries increased. An important factor that weakened the position of exporters of Southeast Asia in the global market lied in a powerful export expansion of China, which received a notable competitive advantage in the global market due to the RMB (yuan) devaluation in 1994.
Thirdly, the countries of Southeast Asia made significant progress in the liberalization and deregulation of the domestic financial market. Easing currency restrictions contributed to the growth of dollarization of the economy of these countries, especially in the banking sector. The banks were able to borrow from the world’s market at low rates and to lend money to the domestic economy at higher interest rates. If lending was carried out in the national currency, the banks faced foreign exchange risks.
The serious structural problems of the economy in the countries of Southeast Asia, aggravated in the middle of 1997, indicated a drop in stock prices in these countries and the reduction of the capitalization of the markets which began in 1996 (Harvie & Van Hoa, 2016). Thus, during the period from October 1996 to October 1997, the level of capitalization of Indonesia’s stock market fell by 35%, of Malaysia’s by 53%, of Thailand’s by 70%, of South Korea’s by 40%, and of the Philippines’ stock market by 53% (Harvie & Van Hoa, 2016).
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In the developed markets, the main reason for the fall in share prices was the “overheating” of the stock market, the relative overvaluation stock exchange that significantly contributed to a number of circumstances that characterized the development of the stock markets of Southeast Asian countries in 1997. First and foremost, there was a relatively favorable economic situation in the United States, where relatively low inflation combined with a stable pace of economic growth throughout the year and with a sufficiently high level of employment. Waiting for the growth of the corporate sector of the US economy whetted the appetite of the shares of US companies, especially those in the information technologies field, leading to the growth of their courses. The chairman of the US Federal Reserve System (FRS), Alan Greenspan, repeatedly warned about the “overheating” of the US market share.
Slowing of growth of state budget deficits in the USA and Western Europe, along with the decline in yielding of the government bonds, contributed to the flow of funds into the market of corporate securities and into the maintenance of particularly high demands for shares. It was expected that this situation would be of lasting nature, as in the USA, for instance, the federal budget deficit in 1998 amounted to only 0.5% of GDP, projecting a surplus in 2000-2002. In Western Europe, in accordance with the Maastricht agreement, the state budget deficit should not have exceeded 3% of GDP, and in 1997, for all countries, it amounted to 2% of GDP (Harvie & Van Hoa, 2016). It created the conditions for maintaining a high demand for corporate bonds in the long term.
The Asian financial crisis triggered changes in stock prices in western markets. Many private investors, frightened by the significant fall in stock prices in the countries of Southeast Asia, and especially by the collapse in Hong Kong, rushed to make profits. The large-scale sale of shares in New York caused a sharp drop in their rates on October 27, 1997 (Harvie & Van Hoa, 2016). The selling shares belonged not only to the US companies, but also to the foreign ones, such as Western European, Latin American, Eastern European, and Russian ones, all listed in the US. As a result, following the collapse of the New York Stock Exchange, the stock exchanges of other countries, including Russia, also went down. However, unlike the stock markets of the developed countries that we’re able to recover from instability by the beginning of 1998, the stock markets of other countries continued to remain in the doldrums.
On the thirtieth meeting of the ASEAN countries held in Subang Jaya in Malaysia, the foreign ministers issued a joint statement of 25 July 1997, expressing their serious concerns and calling to intensify the cooperation between the countries and to ensure mutual interests in the future. Also, on the same day, most of the central banks of the countries affected by the crisis became involved in the EMEAP — an exclusive meeting of the East Asia-Pacific region, held in Shanghai, where they tried to work to achieve “New Arrangements to Borrow.” A year earlier, on March 17, 1996, the finance ministers of the same countries participated in the third meeting of APEC — Asia-Pacific Economic Cooperation, held in Kyoto, Japan, and they were not able to double the amount of credit available under the “General Loan Agreement” and “Mechanism of emergency funding.”
Anxiety about the future of their economies was clearly voiced at the economic conference in Davos, at the end of 1997, where the participants looked for ways out of the crisis. One of them was to help the countries of South-East Asia through the IMF and private banks. Help provided to these countries by the IMF amounted to $ 68 billion. Even earlier, before the crisis of 1997, the IMF had rendered similar assistance for financial stabilization to Mexico in the amount of $ 50 billion (Harvie & Van Hoa, 2016).
As such, the situation can be regarded as a failure to adequately monitor the potential crisis and to prevent currency manipulation in time. According to Gill (2008), this hypothesis is particularly supported by economists, as opposed to saying that one investor can have quite an impact on the market in regard to the successful manipulation of currency of another country. In addition, there is a remote possibility of organizing and coordinating the mass of investors from the countries affected by the crisis, those who seek to manipulate their currencies.
The Asian financial crisis gradually developed into a global financial crisis in 1998, significantly undermining the stability of domestic capital markets as well as of the whole global financial market. According to Harvie and Van Hoa (2016), at the beginning of 1999, the financial crisis hit Brazil, causing a drop in share prices, foreign capital outflows, and devaluation of the national currency (Harvie & Van Hoa, 2016). All this led to negative consequences in the economic development of countries and to the instability of modern international economic relations. In particular, in the countries of South-East Asia, in 1998-1999, there was a reduction of production, the growing unemployment, and the continuing collapse of enterprises and credit and financial institutions.
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The decline in business activity led to a drop in world oil prices, which in turn had a negative impact on the financial position of its exporters, including Russia. According to Gill (2008), in addition, the devaluation of many currencies in Asia, Russia, and Brazil caused some tension in the balance of payments of the industrialized countries, due to the influx of cheaper imports (Harvie & Van Hoa, 2016). The main directions for the elimination of the consequences were the austerity measures and the stabilization of the monetary system carried out in countries that were most severely affected by the crisis — such as South-East Asian countries, including Japan, Russia, Brazil, and a number of others. The elimination was also ensured by the provision of economic aid in the form of loans from the IMF and the preparation of the reforms of global financial markets, including capital markets, foreign exchange, and securities markets.
The financial crisis of 1997-1998 demonstrated the interdependence of economies and their impact on the world currency markets. In addition, it showed the inability of central banks to effectively regulate the exchange rates when the powerful market forces and exchange rates are not supported by the main economic indicators. With the support of the IMF and the introduction of more stringent requirements, the four Asian “dragons” began to revive again. Southeast Asia has managed to regain its former status as one of the most developed regions of the world. Furthermore, the bitter experiences of the Asian “tiger economies” have made the countries take active measures to ensure that their central banks have sufficient reserves in order to protect themselves against possible attacks on currencies.