THE ASIAN DEBTCRISISNitesh KumarSameer VermaAshutosh Bharadwaj
THE STORY OF A BOOM AND A BUST ANDTHE CASCADE EFFECTCONTENTS: The anatomy of a disaster The boom years and the end of the beginning The beginning of the end The bust: And it all came falling down Contagion and aftermath Lessons and reflections
PROLOGUE: TIMES ARE GOOD IN THAILAND! Emerged as a major Industrial centre for Japan in the 1980s. Most investment is based on personal or institutional savings, less of debt and more of security. The Thai Baht is pegged to the dollar in order to make investors confident and encourage trust.
BUT WHY INVEST IN SOUTH EAST ASIA? The end of the cold war makes foreign investments After the Latin seem to be more American debt secure crisis, Investors looking for alternate, safer destinationsLow interest ratesin the developedworld: FII’slooking towards‘emergingmarkets’
AND SO THEY CAME IN DROVES! Capital inflow 1997: Economic growth $256 Billion Real estate boom Capital Availability of inflow credit 1990: $42 Billion
THE FUNDAMENTS OF PEGGING A CURRENCY: THE FLOATING CURRENCY REGIME In a floating currency regime the value of a currency is decided by the laws of demand and supply and is dynamic. Demand Supply
THE FUNDAMENTS OF PEGGING A CURRENCY: THE FIXED OR PEGGED CURRENCY REGIME The government through a central bank maintains the value of the currency with reference to another (Commonly the dollar) 25 baht = 1 US $
THE FUNDAMENTS OF PEGGING A CURRENCY: THE FIXED OR PEGGED CURRENCY REGIME Currency exchange• FII’s convert their • FII’s sell Baht and buy dollars to Baht so that • Outflow: Government buys dollars to pull money they can invest in Baht to prevent its value out of the country Thailand from plunging, reserves • Baht are converted to decrease. dollars to pay for • Inflow: Government prints imports more currency to supply Baht, foreign exchange Inflow of reserves increase. Outflow of foreign funds foreign funds
THE END OF THE BEGINNING! 1996 ABUBBLE EMERGES
THE BEGINNING OF THE END! 1996 -1997 Devaluation of the Yen makes south east Asia less attractive Speculators start going bust and financial companies go under, investor confidence slides The housing and stock market bubbles burst, investors start pulling out
INTERLUDE: CRONY CAPITALISMTHE TOPI GAME AND THE PONZI SCHEME!
THE THAI GOVERNMENT: IN BETWEEN AROCK AND A HARD PLACE!Option one: Increase interest ratesto attract and retain investment• Will negatively affect the economy and hit businesses that are already sufferingOption two: Let the currency slide• Dollar debts of Thai companies would magnify, government reputation tarnished
TO FLOAT OR NOT TO FLOAT, THAT IS THEQUESTION! Indecision by the Thai government to devalue currency encourages speculation against the baht • Businessmen and hedge funds sell Baht to buy dollars, buy US Bonds • Further pressure on the Baht and central bank, foreign exchange reserves plunge
THE ‘LONG’ AND ‘SHORT’ OF SPECULATIONAND THE HEDGE FUND Long: Stocks or real estate purchased at market price and sold when the rate rises to make a profit Short: You borrow stocks for some time, sell them and invest the proceeds. If the stocks lose value you gain as you purchase them at a lower price
INTERLUDE: HOW GEORGE SOROSCONQUERED BRITAIN! In 1990 as part of the European Monetary Exchange Rate Mechanism (ERM) Britain forced to keep its currency pegged at a high rate. Due to a recession it was inevitable that the pound would float sooner or later The Quantum fund with a credit line of $15 Billion establishes itself long in dollars and short in Pounds A high profile media attack further hits the pound, Britain spends $50 billion to peg the Pound and has to give up and make the currency float Soros gains $ 1 Billion!
INTERLUDE: THE HONG KONG PUNTERPARTY! (HEAD I WIN, TAIL YOU LOSE) In 1998 Hong Kong is hit by the financial crisis, thegovernment would either raise interest rates or make the currency float. Hedge funds take advantage of this Short in stocks and buy dollars, if interest rates are raised stocks fall and they gain Long is dollars so if currency is devalued they gain as well
THE BUST: AND IT ALL CAME FALLINGDOWN The value plunges Interest rates 2nd July 1997 raised sharply Thailand lets the baht go 50% to avoid a (expected meltdown fall 15%)
CONTAGION AND THE RIPPLE EFFECT Crisis even spreads to South Korea Currency crisis in Malaysia Indonesian Rupiah plunges by 30 % Faces the worst financial crisis in world history
REASONS FOR THE RIPPLE EFFECT Southeast Asian The ‘AsianDirect trade links investment funds miracle’ between lumped as perception countries ‘Emerging Market collapses in the Funds’ mind of investors
POSTMORTEM: SO WHY DID IT HAPPEN? • Devaluation of the Japanese and Chinese currency makes exports less competitive External factors • Cheap Chinese labor • So called ‘financial companies’ affiliated to politicians, large scale scams and embezzlementCronyism and corruption • Badly run economies more susceptible to panic Panic! • Flimsy economies crash like a pack of cards
THE IMF BAILOUT PACKAGE Stepped in for US $ 40 billion package Conditional relief – Demanded for Reformed Economic policies, Removing insolvent institutions
INTROSPECTION AND REFLECTIONS Crisis rose due to ‘Fast Track Capitalism’
REFERENCES Paul Niall The Krugman: Ferguson: economist The The online Return of Ascent of edition Depression Money Economics