Assignment Requirements
The causes and effects as well as the extent of the Asian crisis in 1997-1998.
The recovery from the crisis, what was done, how was it was planned, executed and made successful. Include a reference page.
Solution
The Causes, Effects, and Extent of the Asian Crisis
In June 1997, Asia was gripped by a financial crisis which lasted till January 1998. It begun in Thailand with the massive depreciation of the country’s domestic currency and spread to other states. Some of the other states that were worst struck by the crisis include Indonesia and South Korea. Before the crisis these countries together with Malaysia and Hong Kong were characterized by strong economic growth. “Over the 1990-1996 period, for example, the value of exports from Malaysia had grown by 18% per year, Thai exports had grown by 16% per year, Singapore’s by 15% per year, Hong Kong’s by 14% per year, and those of South Korea and Indonesia by 12% per year” (Hill, 2003). Most authors agree that this period of unprecedented development in the Asian economy which is popularly known as the ‘East Asian miracle’ (Sundaram, 2009 p. 33) contributed towards the crisis. The crisis posed a threat of financial contagion and therefore attracted worldwide attention that necessitated the intervention of the international monetary fund (IMF). This essay highlights the main causes, effects and extent of the crisis.
Like most financial crises, there was no consensus over the root cause of the Asian crisis so there are many theories that have been advanced to explain the reason behind it. Some of the causes include, lack of well established fiscal and monetary policies, overreliance on foreign debt by the private sector, poor foreign exchange policies and corruption (Nadine, 2008). The financial crisis had adverse economic effects in Asia which were felt on a global scale.
Most Asian counties had several weaknesses in their financial sectors due to poor fiscal and monetary policies. These countries could not effectively control the supply of money and interest rates in the economy. There was excess supply of money in the economy due to the high rate of credit creation from commercial banks and non-bank financial institutions. The interest rates were also high and therefore attracted large capital inflows because foreign investors expected a high rate of return on their investment, most of these inflows were channeled towards equities and real estate. The effect of the high rate at which financial institutions were extending credit was that the economies of these countries were made vulnerable to credit shifts and cyclical conditions (Goldstein, 1998).
Overreliance on foreign debt by the private sector which resulted in a deficit in the current account of countries like Thailand was also a major cause of the financial crisis. In Thailand, such deficits were perceived to be sustainable because they did not reflect a savings-investment deficit in the public sector. Moreover, foreign debt was mainly channeled towards investment as opposed to consumption therefore the country was assumed to be building its capacity to repay these debts. Nevertheless, emphasis was being laid on the quantity of investments rather than the quality. The quality of investments was very low because of poor corporate governance and the fact speculative activities such as purchase of real estate and equities constituted the bulk of these investments. Part of this debt was also used to finance overambitious infrastructure projects and state owned enterprises which were poorly managed.
Another factor that fueled the crisis was poor foreign exchange policies which undermined the overall competitiveness of Eastern Asia. The local currencies were overvalued against foreign currencies like the US dollar which saw a drop in receipts from merchandise exports. Merchandise exports in Thailand exhibited stagnant growth at just 0.5 percent in 1996, a contrast from 1995 when they had increased by 23 percent. A similar trend was witnessed in South Korea, Malaysia, Indonesia and the Philippines. The downward trend could however also be attributed to the general decline in world trade. (Goldstein, 1998). Unhealthy competition among the Asian countries also contributed to the crisis, there was excess supply of commodities such as automobiles, pharmaceuticals, steel and base metals due to overproduction in some industries. At the same time the United States started to exercise protection of its local industries against imports from Asia after experiencing a current account deficit in 1997. Because Asian countries have historically relied heavily exports, they suffered a big blow with this decline in exports.
Last but not least was the issue of corruption which is rampant in most third world countries. Effects of corruption are mostly felt in government corporations where embezzlement of funds is the order of the day. Unfortunately, most foreign debt in invested in state owned corporations which lack the capacity to generate enough returns to service their debts, they only pose an extra burden on the tax payer. Other than that, corruption also curtails the effectiveness of fiscal and monetary policies hence limiting the ability of the government to regulate money supply and interest rates.
The aftermath and extent of the financial crisis is felt even to date not only in Asia but also around the world. Due to the rapid economic growth in Asia in the early 90’s there was massive direct foreign investment in the continent with high expectations that the trend would continue. After the sudden halt in economic growth most businesses that had a stake in the region suffered great loses. ‘The Asian Economic Model’ (Hill, 2003 para. 59) which was perceived to be superior to the economic model applied in western countries because of its combination of dynamism and central governance slowly lost popularity. The crisis posed a big a challenge to the IMF whose main role is to bail out countries experiencing a deficit in balance of payments. The institution committed a lot of funds to Asian countries which were of course issued with a lot of conditions. The countries had to revise their macroeconomic policies to reduce government spending and deregulate some of their sectors which were initially protected from unhealthy foreign competition. They also had to improve financial reporting standards in the banking sector forcing them to abandon their capitalism model.
For the crisis to be resolved there had to be restructuring and reforms in the financial sectors and prudent oversight of the Asian economies. Supervision and regulation of the financial sector also needed to be stepped up. Furthermore, Asian countries had to abandon the fixed exchange rate system and adopted a flexible exchange rate system. The IMF particularly initiated support programs such as official financing packages to some countries including Indonesia, Korea and Thailand. (Lane, 1999). These programs were accompanied by actions to retain private financing, macroeconomic policies that were designed to counter the crisis and a structural body of reforms. The support program was carried out in phases to ensure that the authorities of the Asian countries had the incentive to adjust their policies. Most countries were initially reluctant to follow the strict guidelines given by the IMF but eventually yielded to their demands. State-owned corporations and cartels were reformed to enhance competition and transparency. Moreover, social sector reforms were also establildhed to enhance employment creation and income transfers to protect the poor and vulnerable in society.
In conclusion the financial crisis in Asia had a lot of undesirable effects on the continent and the world as whole. There are several factors that led to the crisis which include lack of well established fiscal and monetary policies, overreliance on foreign debt by the private sector, failure of foreign exchange policies and corruption. There are many lessons to be learned form the crisis which should be evaluated to come up with viable solutions. The effects of such crises not only affect a single country but also have a domino effect that could spark financial contagion resulting in a global financial crisis, necessary measures should therefore be put in place to avoid financial crisis which has dire consequences on the global economy.
References
Goldstein, M. (1998). The Asian financial crisis : causes, cures, and systemic implications. Washington, DC : Institute for International Economics.
Hill, C. W. (2003). The Asian Financial Crisis. Retrieved April 23, 2013, from Wright State University: http://www.wright.edu/~tdung/asiancrisis-hill.htm
Lane, T. (1999, September). The Asian Financial Crisis. Finance and Development , http://www.imf.org/external/pubs/ft/fandd/1999/09/lane.htm#author.
Nadine, P. (2008). The Asian Financial Crisis. München: GRIN Verlag. https://books.google.je/books/about/The_Asian_Financial_Crisis.html?id=MZwRkp1Z6scC&utm_source=gb-gplus-shareThe
Sundaram, J. K. (2009). Causes of the 1997-1998 East Asian Crisis and obstacles to implementing lessons. In R. Carney, Lessons from the financial Crisis (pp. 33-46). New York: Routledge. https://www.un.org/esa/desa/papers/2008/wp66_2008.pdf