Term Paper

1. Term Paper Recent Financial Crisis in East Asian Countries Experiences and Lessons

2. Contents • Pre Crisis Period • Mexican crisis • East Asian crisis • Impact on the economy of the countries • Role of IMF • India Position in terms of economic stability

3. Pre-Crisis Period • East Asia had experienced phenomenal growth in early 1990’s. • Referred to as the East Asia Miracle. • Decreased poverty. • Governments were vital parts of the economy and privatization was not reasonable

4. The Mexican Financial Crisis • External Factor- Low interest rates in the U.S. combined with the recession there and in other countries. • The inflows in the country was short-term and aimed at making quick profits through financial speculation on stocks and other securities in the financial markets of Mexico • Gains from the foreign investments were more illusory than real. • Mexico was living beyond its means.

5. Contd.. • Decrease in domestic savings • Current account deficit. • During 1990 and 1994, portfolio investment inflow was $71.2 and 72% of it was used by the Mexican authorities to finance the current account deficit

6. Collapse of the peso and later of the economy • Increased interest rate in USA • Political agitations in Mexico eroded investor confidence • Mexico government announced a 13 percent peso devaluation which panicked foreign investors and they started pulling their money out of Mexico. • Over the next two days $5 billion fled the country. The Mexican stock market lost one half of its value over within months of the devaluation.

7. Impact of the crisis • Deterioration of the Mexican economy • Deterioration of living • Job loss • Fall in real wages • Increased interest rate • Credit crunch • Reduction in social sector spending • The rich have hardly been affected as they invested their savings in dollars

8. The Southeast Asian Currency Turmoil The case of Thailand • Increased short-term borrowing from international banks and put greater reliance on portfolio flows rather than on FDI to finance current account deficits. • By August 1997 the composition of Thailand’s foreign debt had become unbalanced. • Thailand began taking foreign loans in foreign currencies and the rate of 6-8 percent and started financing domestic companies and individuals at an interest rate of 14-20 percent in baht. • Since the opportunities in productive sectors of the economy were getting reduced largely due to the stagnation in exports, the banks and financé companies started financing short-term real estate businesses which was showing boom in early 1990s.

9. Contd.. • By the end of 1996 and in early 1997 the fall in prices of real estate had landed the majority of financial firms in serious trouble. • In February 1997, Somprasong Land became the first company to default on a Euro-convertible debenture. • When it was revealed that around two-third of the country’s 91 finance companies were in serious trouble, the investors lost confidence. Both foreign and domestic investors started buying dollars, taking advantage of the fixed exchange rates. • With the FIIs heavy selling in the stock markets, the share prices dropped to record low levels by 65 percent in May 1997.

10. Impact of the Crisis • The IMF’s conditions include budget expenditure cuts of about 100 billion baht; increase in the value-added tax from 7 to 10 percent and further reduction in subsidies and public investments. • Many companies have announced cost reduction measures, which largely include layoffs besides sharp cuts in wages and benefits • In rural areas, the small farmers have been affected by the increased cost of production because price of agricultural inputs such as chemical fertilizers, seeds, insecticides, etc. have risen by over 30 percent, while prices of agricultural produce have not correspondingly risen.

11. Contagion Effect on South Korea, Indonesia, Malaysia and Philippines South Korea: Victim of Heavy Commercial Borrowings • The real problem confronting South Koreas was not the unproductive investments in real estate and other speculative businesses, but the heavy short-term borrowings by the private sector financial institutions from foreign commercial banks • The IMF insistence to increase the interest rates in South Korea has led to a rise in interest rates at 19-20 percent, nearly 15 percent above the inflation rate. This move has made more companies bankrupt. • With the Korean domestic industry in deep trouble after the stock market crash coupled with high interest rates and deflationary pressures, many companies have very little option but to sell their stakes to foreign investors at throwaway prices.

12. Indonesia: The Mighty Fall of Rupiah • Short term investment by foreign players • In 1997, Indonesian companies had $55 billion outstanding in foreign debt, 59 percent of which was in the short-term category. • The rupiah lost 58 percent of its value against the dollar in 1997 as Indonesian companies with heavy foreign borrowings rushed to buy the currency • The devaluation of the rupiah has led to sharp rise in inflation thereby increasing the living expenses of the majority of the population. The shrinking economy had led to layoffs of thousands of workers.

13. Malaysia: Failed to avoid the Currency Crisis • Capital inflows to Malaysia in the mid 1990s were in the form of short-term loans and portfolio investments. • Short-term loans supplemented the domestic investments in the unproductive sectors such as consumer and property finance. • Anticipating an oversupply in the real estate business due to overcapacity and default on short-term borrowings, the speculative attacks on the ringgit began which seriously weakened it.

14. Private Profits, Public Losses: The Great Asian Bailout Programme Bailouts for Whom? • The role of the lenders in the creation of this crisis was ignored. • Under the bailout programmes the discipline was imposed primarily on the debtor. • The foreign banks alone are given huge subsidies so that they do not have to suffer for their mistakes, while local banks and companies were forded to go under.

15. Who Benefits from Bailout Programmes? • Trans National Corporations (TNC) operating in the region suffered short-term losses. • But in the long run, TNCs have emerged as the net gainers because labour costs and assets in dollar terms have sharply declined in the wake of currency depreciation in these countries. • To facilitate foreign ownership and takeover of domestic companies in these countries, the IMF has imposed conditions which ask for greater accessibility and ownership rights to foreign companies.

16. Who Loses? • Among the major sufferers, the workers are the worst affected. • In order to invite foreign capital to buy these public sector units, the governments had to first shed ‘excess’ workforce. • These factors have significantly contributed to the depression of wages and the weakening of the bargaining power of labour unions.

17. Washington Consensus • Growth occurs through liberalization, "freeing up" markets. Privatization, liberalization, and macro stability are supposed to create a climate to attract investment, including from abroad. • Foreign business brings with it technical expertise and access to foreign markets, creating new employment opportunities. • Foreign companies also have access to sources of finance, especially important in those developing countries where local financial institutions are weak.

18. The IMF and its Contributions to the Crisis • Capital account liberalization, the removal of restrictions relating to the flow of capital, in this case, currency. • The Western world encouraged East Asian countries to allow foreign investors easier access to the Asian markets. • Hot money flowed into the region rapidly but many of these countries did not have regulations in place to ensure foreign investment could not be pulled out without penalty. • When negative speculation occurred, this money flowed out of the region as fast as it was initially invested.

19. Reforms during the crisis • Increased interest rates, sometimes as high as 25 per cent. • Decreased government spending. Indonesia's government had to eliminate food and fuel subsidies in April 1998. • Countries had to close poorly performing domestic banks. • South Korea had to enact financial reforms and allow international firms to participate in its domestic markets. • Mass layoffs were experienced in many countries. • Political reforms

20. Globalization Discontentedly • Different countries require different economic strategies. • Nations are very interdependent. • Macroeconomic solutions are needed

21. Will India go the Southeast Asian Way? • The financial liberalisation of Indian markets with heavy reliance on hot money flows will have serious implications for the financing of current account deficit. • Spillover impact of Southeast Asian Currency Crisis on Indian Rupee • Hot Money Flows Constitute 80 percent of Forex Reserves • Dangers of Capital Account Convertibility

22. Should India pursue capital account convertibility? • Tarapore Committee (1997) defines CAC as "the freedom to convert local financial assets into foreign financial assets and vice-versa at market determined rates of exchange". • It is not immediately possible to give unlimited access to short-term external borrowings, and • Full capital account convertibility may encourage arbitrage operation. • Voluntary savings in India generated according to the time preference of the economic agents is mostly sufficient for the gross domestic investment and growth • High real rates of interest promotes both financial and total savings and private sector capital formation by facilitating the accumulation of finance necessary for undertaking investments.

23. Conclusion • Dangers of over reliance on volatile, short-term capital flows to finance unsustainable current account deficits. • These private capital flows are no substitute for domestic savings • A country can reduce its exposure to the volatility of external capital by increasing its national savings. • Financial liberalisation policies are less likely to succeed in the absence of a sound macro-economic situation

24. Thank You Awanish Kumar Santosh Kumar Sharma