The Asian Financial Crisis Causes, Consequences and Resolution

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The Asian Financial CrisisCauses, Consequences
and Resolution
A Presentation on
MAS Seminar for Pre-University Economics
Teachers, 22 Sep 1999 Economics
Department Monetary Authority of Singapore
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Outline

• Causes of the Crisis
• What Happened?
• Policy Responses
• Macroeconomic Stabilisation
• Structural Reforms
• Recovery Prospects and Risks

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Causes of the Crisis

• Macroeconomic vulnerabilities
• Foreign capital inflows
• Financial sector vulnerabilities

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Pre-crisis Macroeconomic Fundamentals
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High real GDP growth
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Low CPI inflation
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Sound fiscal balancesBudget balance as of GDP
Indonesia
Malaysia
Thailand
Korea
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Low Public Debt
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High Savings Rate
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Where were the warning signals? Sources of
Macroeconomic Vulnerabilities
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Sharp rise in domestic credit
Indonesia
Malaysia
Thailand
Korea
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High domestic leverage
Domestic Credit to GDP Ratio ()
Indonesia
Malaysia
Thailand
Korea
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Over-investment in

• Property and stock markets
• Industries with excess capacity
• Mega infrastructure projects

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Persistent current account deficits
Indonesia
Malaysia
Thailand
Korea
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The Role of Foreign Capital Inflows
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Impact of large, volatile capital flows

• Fuelling investment booms
• Dependence on short-term capital inflows makes
  economies vulnerable to a liquidity crisis when
  there is a sudden withdrawal
• Reversal of capital flows in a highly-integrated
  global financial market generates contagion
  effects on exchange rates, interest rates and
  stock prices

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Net Private Capital Inflows to Asia, Developing
Countries
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Euphoria in the 1990s.
Financial market opening
Low interest rates in the G3 countries
Good macroeconomic fundamentals in Asia
Massive capital inflows into Asia
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High ratios of short-term foreign debt to foreign
reserves
1996
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Financial Sector Vulnerabilities
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Areas of financial sector weaknesses

• Lax regulatory frameworks
• Weak financial supervision
• Implicit explicit guarantees
• Government-directed and connected lending
• Underdeveloped capital markets

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What actually happened?
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Distress in 1996/97

• Overheated asset markets
• Real exchange rate appreciation
• Export Slowdown
• Widening Current Account Deficits

Capital Outflows
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US strengthened against yen from mid-95
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Export Slowdown
Reasons Real exchange rate appreciation Global
electronics demand slowdown Competition from
China?
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Asian Financial Crisis
14 Aug Rupiah floated
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The Role of Hedge Funds

• What role hedge funds played (during the Asian
  financial crisis) in different countries is an
  empirical question, and not a matter of opinion.

DPM Lee Hsien Loong, Opening Address at the Fifth
Meeting of Finance And Central Bank Deputies On
The Manila Framework, 29 Aug 99
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Possible ways to regulating hedge funds?

• Banning hedge funds?
• Regulating hedge funds directly?
• Regulating indirectly through lenders who provide
  hedge funds with the financing?

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Policy Responses

• Macroeconomic stabilisation policies
• Structural Reforms

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The IMF Prescription
Thailand, Indonesia,South Korea

• Financing packages
• Tight monetary policies (high interest rates)

To stabilise exchange rates restore confidence
in financial markets
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Malaysia Going its own way with capital controls

• Achieves Macroeconomic Stabilisation by
• Discouraging short-term capital flows.
• Stopping currency depreciation by pegging the
  exchange rate at 3.8 ringgit/US.
• Allowing expansionary fiscal and monetary policy
  to reflate the economy.

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Main Thrusts of Structural Reforms

• Financial Sector
• Consolidate the financial sector through
• Closing down insolvent institutions
• Mergers and acquisitions
• Foreign acquisitions
• Resolve bad debt and recapitalise banks
• Strengthen financial supervision and regulation

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Main Thrusts of Structural Reforms

• Corporate Sector
• Restructure corporate debt
• Improve corporate governance
• Industrial consolidation
• Liberalise foreign direct investment

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Recovery Prospects RisksAs at Sep 99
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East Asias Rebound
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Drivers of Recovery
Expansionary Fiscal Policies Low Interest
Rates Stock Market Rallies Recovery in Private
Consumption
I
Upturn in External Demand
2
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Increased Public Spending
Fiscal balance as of GDP
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Low Domestic Interest Rates
1-month interest rate for Malaysia, Thailand and
Indonesia, 15-day interest rate for Korea
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Recovery in Private Consumption
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Private Consumption returns to pre-crisis levels
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Investment Growth bottoming out?
Chart refers to Total Investment in real terms
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External Demand Firming Up
Export Growth
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Export Markets of Asia-4
1999 Jan-May
Asia-4 referring to Indonesia, Malaysia,
Thailand, and South Korea.
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Trade amongst the Asia-4emerging from the
doldrums
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Exports from Asia-4 to Japan, US and EU Main
Sources of External Demand
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Main External Risks

• US - Sharp economic slowdown
• Japan - Sustainability of recovery
• China - Renminbi devaluation

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US - Domestic Imbalances

• Widening Current Account Deficit
• Falling Personal Savings Rate
• Rising Household Debt

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US - Current Account Deficit
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US - Gross Personal Savings Rate
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US - Consumer Credit
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US - Stock Market Bubble?
Dow Jones Industrial Average
1-13 Sep 1999
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Japan - Risks to Recovery

• US/Yen rate - Overshooting?
• Labour Market - Weak Conditions
• Fiscal Deficit - Unsustainable?

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Yen/US rate - risk of overshooting?
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JapanRecord high unemployment rate (SA)
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Japan - Unsustainable fiscal deficits?
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RMB Devaluation UnlikelyChinas trade balance
improving
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Main Domestic Risks

• Restructuring Difficulties
• Political Unrest

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Improved resilience (1) Current account surpluses
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Improved resilience (2) High foreign reserves
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Thank You