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Asian Financial Crisis

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ASIAN FINANCIAL CRISIS
Key terms
Foreign Exchange Rate
 The price of one country's currency expressed in
another country's currency. In other words, the rate
at which one currency can be exchanged for another.
 For example, the higher the exchange rate for one
euro in terms of one yen, the lower the relative value
of the yen.
Exchange-rate regime
 An exchange-rate regime is the way an authority
manages its currency in relation to other currencies
and the foreign exchange market.
 Basic types of regime:
 Floating exchange rate
 Fixed exchange rate
Floating exchange rate
A country's exchange rate regime where its
currency is set by the foreign-exchange
market through supply and demand for that
particular currency relative to other
currencies. Thus, floating exchange rates
change freely and are determined by trading
in the forex market.
US Dollar, British Pound, Euro, Australian
dollar, Hong Kong dollar, Japanese Yen
Fixed exchange rate
 A country's exchange rate regime under which the
government or central bank ties the official exchange rate to
another country's currency (or the price of gold). The
purpose of a fixed exchange rate system is to maintain a
country's currency value within a very narrow band. Also
known as pegged exchange rate.
 Fixed rates provide greater certainty for exporters and
importers.
 Prior to Asian Financial Crisis, most of the Asia Pacific
nations used fixed exchanged rate against US Dollar
(Thailand, Malaysia, Indonesia, Philippines, South Korea,
and China)
6 Factors That Influence Exchange
Rates
1. Differentials in Inflation
 As a general rule, a country with a consistently lower
inflation rate exhibits a rising currency value, as its
purchasing power increases relative to other
currencies.
 Those countries with higher inflation typically see
depreciation in their currency in relation to the
currencies of their trading partners.
2. Differentials in Interest Rates
 Higher interest rates offer lenders in an economy a
higher return relative to other countries. Therefore,
higher interest rates attract foreign capital and cause
the exchange rate to rise.
 The opposite relationship exists for decreasing
interest rates - that is, lower interest rates tend to
decrease exchange rates.
3. Current-Account Deficits
 The Current-Account is the balance of trade
between a country and its trading partners,
reflecting all payments between countries for goods,
services, interest and dividends.
 A deficit in the current account shows the country is
spending more on foreign trade than it is earning,
and that it is borrowing capital from foreign sources
to make up the deficit.
 The excess demand for foreign currency lowers the
country's exchange rate.
4. Public Debt
 Nations with large public deficits and debts are less
attractive to foreign investors.
 A large debt encourages inflation .
 If a government is not able to service its deficit through
domestic means (selling domestic bonds), then it must
increase the supply of securities for sale to foreigners,
thereby lowering their prices.
 Foreigners will be less willing to own securities
denominated in that currency if the risk of default is
great. For this reason, the country's debt rating is a
crucial determinant of its exchange rate.
5. Terms of Trade
 If the price of a country's exports rises by a greater
rate than that of its imports, its terms of trade have
favorably improved.
 Increasing terms of trade shows greater demand for
the country's exports.
 This, in turn, results in rising revenues from exports,
which provides increased demand for the country's
currency (and an increase in the currency's value).
6. Political Stability and Economic
Performance
 Foreign investors inevitably seek out stable
countries with strong economic performance in
which to invest their capital. A country with such
positive attributes will draw investment funds away
from other countries perceived to have more
political and economic risk. Political turmoil, for
example, can cause a loss of confidence in a currency
and a movement of capital to the currencies of more
stable countries.
Components Of Current Account
And Current Account Deficit
Balance of Payments
 A country’s transactions with the rest of the world
are summarized by a set of accounts called the
balance of payments.
 It has two parts: current account and capital account
 Export, import, foreign investment, foreign aid,
donations etc. are the elements or balance of
payments.
The US Balance of Payments, 1998, in Billions of US Dollars.
Current Account
Exports 931
Imports 1100
Trade Balance (deficit = -) (1) -169
Investment income received (US holdings of foreign assets) 242
Investment income paid (Foreign holdings of US assets) 265
Net investment income (2) -23
Net transfers received (foreign aids - Donations) (3) -41
Current account balance (deficit = -)(1) + (2) + (3) -233
Capital Account
Increase in foreign holdings of US assets 542
Increase in US holdings of foreign assets 305
Net increase in foreign holdings/Net capital flows to the US 237
Statistical Discrepancy 4
Financial Deregulation
 Financial deregulation can refer to a variety of changes
in the law which allow financial institutions more
freedom in how they compete.
 Deregulation means giving the banks the power to make
their own rules. The less regulation, the more power the
banks have to make rules that benefit the bankers but
not necessarily the people.
 Congress repealed sections of the Glass-Steagall Act
1999. This act, passed in 1933 during the depression,
meant that any one company could only act as a
commercial bank, an investment bank or an insurance
company.
Analysis and Chronology of
Events
Dollar had declined steadily over ten years
(1985-1995)
Most of the Asian currencies are pegged with
dollar
These currencies softened too
Making export
cheap
Boom in export-
economy
Becoming export
oriented economies
1. Semi Authoritarian
Govt.
2. Cheap currency
3. GDP Mania
Over optimism and
over investment
Foreign banks and foreign investors poured
money into the region in search for higher yields
An economy full of
capital
Easy for domestic banks and investors to finance
their projects (what kind of projects?)
Financial deregulation on advice from IMF that
made massive funds transfer possible
In 1995 dollar started to increase in value
Asian exports become more expensive
Growth of export slowed
Meanwhile economic boom led to excessive imports (a
significant portion was luxury goods)
Thailand was first hit with large current
account deficit and shrinking foreign exchange
reserves
From Thailand, the crisis spread to Malaysia,
Indonesia, the Philippines, and South Korea
Severe devaluation of currencies
and massive drop in stock market
PROJECTS AND INVESTMENTS
Projects were undertaken without considering market risk
Building overcapacities in industries (for export oriented
industries, fall of export hurt the industry growth and
survival)
The projects were financed with heavy debt
(debt/equity ratio: 4:1)
Short Term fund financed long term
investments (risky, aggressive, and fatal)
A large amount of debt were in foreign
currencies (particularly in US dollar)
It mismatched with project earnings that were in
local currencies
How did the crisis deepen?
When the crisis began, banks (specially
foreign banks) refused to roll over short-
term funds
Current Account Deficit
No foreign currency cash inflows
Asian currencies depreciated
Asian economy couldn’t meet foreign
debt obligations
Substantial depreciation of Asian
currencies and domestic currency
value of foreign debt ballooned
Equity and portfolio investments from
abroad that had flooded into these
five countries started to be withdrawn
IMF harsh austerity
and tight monetary
policies with high
interest rate deepened
the crisis
Three main causes:
Very high level of debt financing through banks
Reliance of foreign-denominated
Short term loans
Massively devaluated local currencies
Maturity Distribution
PhilippinesIndonesia SouthKorea Thailand Taiwan
0
10
20
30
40
50
60
70
80
90
(Proportion of loans with maturity one year or less at the end of 1996)
62
68
84
65
50
Devaluation of currencies
10014
0
2000
4000
6000
8000
10000
12000
1996 1997 1998 1999 2000
MalaysiaIndonesia
Devaluation of currencies
40.89
20
25
30
35
40
45
50
1996 1997 1998 1999 2000
PhilippinesThailand
Related Causes
 Unsustainable Current Account Deficits
(Table 2 page 12)
 Over-Dependence on Short-Term Foreign
Funds (Table 4 page 15)
 Poor Regulation of the Economy
 Over-Inflated Asset Prices
 Macroeconomic Policy: Pegged Exchange
Rates
Initial Triggers of the Events in South
East Asia
 Changed Sentiment Amongst Investors in
South East Asia
 Speculation by Participants in the Currency
Markets
 Financial deregulation
Effects of the Crisis on Economies in
the Region
 Large number of bankruptcies in financial and
manufacturing sectors
 Sharp falls in the stock markets
 Financial crisis evolved into economic crisis
 Interest rates increased significantly
 Credit crunch, no working capital, business
operations came to a halt,
 Massive layoff, fall of living standard
The handling of the crisis:
 Cost cutting, financial austerity programs
 Sales of assets
 Debt forgiveness
 Selling financial sectors to foreign banks
 Renationalization
 Restructure, recapitalization, merger
 Financial assistance from IMF
Bankruptcies were less than expected
 Reluctance of lenders to take legal action
 Lack of proper bankruptcy laws
 Application of creative accounting (writing off, fund
transfers among different sectors)
 Good connections of financially distressed
companies with govt. or political leaders

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Asian financial crisis

  • 3. Foreign Exchange Rate  The price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another.  For example, the higher the exchange rate for one euro in terms of one yen, the lower the relative value of the yen.
  • 4. Exchange-rate regime  An exchange-rate regime is the way an authority manages its currency in relation to other currencies and the foreign exchange market.  Basic types of regime:  Floating exchange rate  Fixed exchange rate
  • 5. Floating exchange rate A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that particular currency relative to other currencies. Thus, floating exchange rates change freely and are determined by trading in the forex market. US Dollar, British Pound, Euro, Australian dollar, Hong Kong dollar, Japanese Yen
  • 6. Fixed exchange rate  A country's exchange rate regime under which the government or central bank ties the official exchange rate to another country's currency (or the price of gold). The purpose of a fixed exchange rate system is to maintain a country's currency value within a very narrow band. Also known as pegged exchange rate.  Fixed rates provide greater certainty for exporters and importers.  Prior to Asian Financial Crisis, most of the Asia Pacific nations used fixed exchanged rate against US Dollar (Thailand, Malaysia, Indonesia, Philippines, South Korea, and China)
  • 7. 6 Factors That Influence Exchange Rates
  • 8. 1. Differentials in Inflation  As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies.  Those countries with higher inflation typically see depreciation in their currency in relation to the currencies of their trading partners.
  • 9. 2. Differentials in Interest Rates  Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise.  The opposite relationship exists for decreasing interest rates - that is, lower interest rates tend to decrease exchange rates.
  • 10. 3. Current-Account Deficits  The Current-Account is the balance of trade between a country and its trading partners, reflecting all payments between countries for goods, services, interest and dividends.  A deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit.  The excess demand for foreign currency lowers the country's exchange rate.
  • 11. 4. Public Debt  Nations with large public deficits and debts are less attractive to foreign investors.  A large debt encourages inflation .  If a government is not able to service its deficit through domestic means (selling domestic bonds), then it must increase the supply of securities for sale to foreigners, thereby lowering their prices.  Foreigners will be less willing to own securities denominated in that currency if the risk of default is great. For this reason, the country's debt rating is a crucial determinant of its exchange rate.
  • 12. 5. Terms of Trade  If the price of a country's exports rises by a greater rate than that of its imports, its terms of trade have favorably improved.  Increasing terms of trade shows greater demand for the country's exports.  This, in turn, results in rising revenues from exports, which provides increased demand for the country's currency (and an increase in the currency's value).
  • 13. 6. Political Stability and Economic Performance  Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries.
  • 14. Components Of Current Account And Current Account Deficit
  • 15. Balance of Payments  A country’s transactions with the rest of the world are summarized by a set of accounts called the balance of payments.  It has two parts: current account and capital account  Export, import, foreign investment, foreign aid, donations etc. are the elements or balance of payments.
  • 16. The US Balance of Payments, 1998, in Billions of US Dollars. Current Account Exports 931 Imports 1100 Trade Balance (deficit = -) (1) -169 Investment income received (US holdings of foreign assets) 242 Investment income paid (Foreign holdings of US assets) 265 Net investment income (2) -23 Net transfers received (foreign aids - Donations) (3) -41 Current account balance (deficit = -)(1) + (2) + (3) -233 Capital Account Increase in foreign holdings of US assets 542 Increase in US holdings of foreign assets 305 Net increase in foreign holdings/Net capital flows to the US 237 Statistical Discrepancy 4
  • 17. Financial Deregulation  Financial deregulation can refer to a variety of changes in the law which allow financial institutions more freedom in how they compete.  Deregulation means giving the banks the power to make their own rules. The less regulation, the more power the banks have to make rules that benefit the bankers but not necessarily the people.  Congress repealed sections of the Glass-Steagall Act 1999. This act, passed in 1933 during the depression, meant that any one company could only act as a commercial bank, an investment bank or an insurance company.
  • 19. Dollar had declined steadily over ten years (1985-1995) Most of the Asian currencies are pegged with dollar These currencies softened too
  • 20. Making export cheap Boom in export- economy Becoming export oriented economies 1. Semi Authoritarian Govt. 2. Cheap currency 3. GDP Mania
  • 21. Over optimism and over investment Foreign banks and foreign investors poured money into the region in search for higher yields An economy full of capital
  • 22. Easy for domestic banks and investors to finance their projects (what kind of projects?) Financial deregulation on advice from IMF that made massive funds transfer possible In 1995 dollar started to increase in value
  • 23. Asian exports become more expensive Growth of export slowed Meanwhile economic boom led to excessive imports (a significant portion was luxury goods)
  • 24. Thailand was first hit with large current account deficit and shrinking foreign exchange reserves From Thailand, the crisis spread to Malaysia, Indonesia, the Philippines, and South Korea Severe devaluation of currencies and massive drop in stock market
  • 25. PROJECTS AND INVESTMENTS Projects were undertaken without considering market risk Building overcapacities in industries (for export oriented industries, fall of export hurt the industry growth and survival) The projects were financed with heavy debt (debt/equity ratio: 4:1)
  • 26. Short Term fund financed long term investments (risky, aggressive, and fatal) A large amount of debt were in foreign currencies (particularly in US dollar) It mismatched with project earnings that were in local currencies
  • 27. How did the crisis deepen? When the crisis began, banks (specially foreign banks) refused to roll over short- term funds Current Account Deficit No foreign currency cash inflows Asian currencies depreciated
  • 28. Asian economy couldn’t meet foreign debt obligations Substantial depreciation of Asian currencies and domestic currency value of foreign debt ballooned Equity and portfolio investments from abroad that had flooded into these five countries started to be withdrawn
  • 29. IMF harsh austerity and tight monetary policies with high interest rate deepened the crisis
  • 30. Three main causes: Very high level of debt financing through banks Reliance of foreign-denominated Short term loans Massively devaluated local currencies
  • 31. Maturity Distribution PhilippinesIndonesia SouthKorea Thailand Taiwan 0 10 20 30 40 50 60 70 80 90 (Proportion of loans with maturity one year or less at the end of 1996) 62 68 84 65 50
  • 33. Devaluation of currencies 40.89 20 25 30 35 40 45 50 1996 1997 1998 1999 2000 PhilippinesThailand
  • 34. Related Causes  Unsustainable Current Account Deficits (Table 2 page 12)  Over-Dependence on Short-Term Foreign Funds (Table 4 page 15)  Poor Regulation of the Economy  Over-Inflated Asset Prices  Macroeconomic Policy: Pegged Exchange Rates
  • 35. Initial Triggers of the Events in South East Asia  Changed Sentiment Amongst Investors in South East Asia  Speculation by Participants in the Currency Markets  Financial deregulation
  • 36. Effects of the Crisis on Economies in the Region  Large number of bankruptcies in financial and manufacturing sectors  Sharp falls in the stock markets  Financial crisis evolved into economic crisis  Interest rates increased significantly  Credit crunch, no working capital, business operations came to a halt,  Massive layoff, fall of living standard
  • 37. The handling of the crisis:  Cost cutting, financial austerity programs  Sales of assets  Debt forgiveness  Selling financial sectors to foreign banks  Renationalization  Restructure, recapitalization, merger  Financial assistance from IMF
  • 38. Bankruptcies were less than expected  Reluctance of lenders to take legal action  Lack of proper bankruptcy laws  Application of creative accounting (writing off, fund transfers among different sectors)  Good connections of financially distressed companies with govt. or political leaders