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  1. The Asian Financial Crisis Hung-Gay Fung University of Missouri-St. Louis

  2. Presentation Outline • Discuss briefly the behavior of the Foreign Exchange (FX) of Southeast Asian Countries. • Assess different factors that lead to the currency crisis. • Opportunities and Implications for U.S. companies

  3. Foreign Exchange Rates • Since June 1997, FX rates in many Southeast Asian countries have experienced a substantial decline. • These countries include the Philippines, Malaysia, Thailand, Indonesia, and Korea. • Many of these countries linked their exchange rates to the U.S. dollar before the currency crisis.

  4. Change in FX rates (6/30/1998) FX:1 $US FX: 1 $US % 6/30/986/30/97change Chinese yuan 8.281 8.289 +0.09 HK dollar 7.745 7.747 +0.03 Indonesia rupiah 14568.89 1760 -87.92 Japanese yen 138.31 114.61 -17.58 Malaysian ringgit 4.1 1.827 -55.44 Korean won 1370 641.4 -53.18 Philippine peso 41.5 19.08 -54.02 Thai baht 42.16 17.9 -57.54

  5. Immediate Results of Crisis • In addition to currency devaluation: • Collapse of their Stock Markets (all Southeast countries); • Call for an IMF rescue plan in thePhilippines, Thailand, Indonesia and Korea; • Bankruptcy and financial reforms(all Southeast countries).

  6. What Happens to Capital Flows? 1994 1995 1996 1997* Private flows, net 40.5 77.4 93.0 -12.1 Equity Investment 12.2 15.5 19.1 -4.5 Private Creditors 28.2 61.8 74.0 -7.6 Source: Institute of International Finance, Inc., “Capital Flows to Emerging Economies,” January 1998.

  7. Reasons for the Currency Crisis • Decline in Export Earnings • Excessive and Risky Investment • Current Account Deficit • Overvalued Currency • Underdevelopment of credit market • Property market bubble

  8. Decline in Export Earnings Regional Annual Growth Rate of Exports (%) Country1990199119921993199419951996 China 18.2 15.8 18.1 7.1 33.1 22.9 1.6 Indonesia 15.9 13.5 16.6 8.4 8.8 13.4 9.7 Korea 4.2 10.5 6.6 7.3 16.8 30.3 3.7 Malaysia 17.4 16.8 18.5 15.7 24.7 24.7 26.0 Philippines 4.0 8.7 11.2 13.7 20.0 31.6 16.7 Thailand 14.9 23.2 14.2 13.3 22.7 25.1 -1.3 Mexico 17.7 0.7 1.4 9.2 14.2 40.3 22.6

  9. Excessive and Risky Investment Incremental Capital-Output (ICOR) Ratios Country 1987-1992 1993-1996 China 3.1 2.9 Hong Kong 3.7 6.1 Indonesia 3.8 4.9 Korea 4.0 4.9 Malaysia 3.7 4.8 Philippines 6.0 5.5 Singapore 3.6 4.0 Taiwan 2.4 3.9 Thailand 3.4 5.1 Source: Corsetti and Pesenti (1998)

  10. Current Account Deficit(% of GDP) 1990-1995 1996 Asian Country: (average) China 0.9 0.9 Hong Kong 3.3 -1.2 Korea -1.2 -4.8 Singapore 12.7 15.5 Taiwan 4.0 4.0 Indonesia -2.5 -3.7 Malaysia -5.9 -4.9 Philippines -3.8 -4.7 Thailand -6.7 -7.9

  11. Current Account (continued) Latin America 1990-95 1996 Argentina -1.6 -1.4 Brazil -0.6 -3.3 Chile -2.6 -5.4 Colombia -1.7 -5.5 Mexico -5.1 -0.6 Other countries: Israel -3.9 -7.4 Africa (average) -11.1 -7.8 Hungary -4.0 -3.7 Source: Bank for International Settlements

  12. Overvalued Currency Country1990199119921993199419951996 Hong Kong 99.7 103.9 108.5 115.9 114.5 116. 125.5 Indonesia 97.4 99.6 100.8 103.8 101.0 100.5 105.1 Korea 97.1 91.5 87.8 85.2 84.7 87.8 86.8 Malaysia 97.0 96.9 109.7 111.0 107.1 107.0 111.9 Philippines 92.3 103.1 107.1 97.4 111.6 109.5 116.0 Singapore 101.2 105.7 106.0 108.6 111.9 112.7 117.9 Thailand 102.2 99.0 99.7 101.9 98.3 101.7 107.6 Note: The base figure (100) is the average for the year 1990 Source: J.P. Morgan

  13. Japanese Model • Limit bond market to support long-term growth. • Keepsavingsin a small number of powerful banks which arenotproperly regulated . • Loans are made tofavoredcustomers and businesses with national ambitions, such as textiles, steel, shipbuilding, electronics, and automobiles (such as Japan, Thailand, Korea, and Indonesia).

  14. Size of Banking sector 1995 % of GDP Bond Bank MarketLending U.S. 110% 54% Japan 74 152 Malaysian 56 100 Philippine 39 54 Thailand 10 100 Indonesia 6 57

  15. Bank Credit to Private Sector Annual Rate of Expansion % of GDP Country1990-19971997 China 13 97 Hong Kong 8 157 Indonesia 18 57 Japan 1.5 111 Korea 12 64 Malaysia 16 95 Philippines 18 52 Singapore 12 97 Thailand 18 105 United States 0.5 65

  16. Short-Term Debt to Reserves June 1996June 1997 Indonesia 1.724 1.704 Korea 1.623 2.073 Malaysia 0.252 0.612 Philippines 0.405 0.848 Thailand 0.992 1.453 Other countries Argentina 1.325 1.210 Brazil 0.702 0.792 Mexico 1.721 1.187 Pakistan 0.740 2.440 South Africa 4.050 3.124 Zimbabwe 1.319 1.635

  17. Non-Performing Loans(% of Total Loans) 1990199419951996 Indonesia 4.5 12.0 10.4 8.8 Korea 2.1 1.0 0.9 0.8 Malaysia 20.4 8.1 5.5 3.9 Thailand 9.7 7.5 7.7 N/A Mexico 2.3 10.5 14.4 12.5 Argentina 16.0 8.6 12.3 9.4 Source: Bank for International Settlements.

  18. Property Market Bubble Sale Price: Capital Value PeriodBangkok (000B/m. sq.)Jakarta ($/m. sq.) Q4, ‘90 66.0 3019 Q4, ‘91 67.0 2788 Q4, ‘92 60.0 2482 Q4, ‘93 59.5 2327 Q4, ‘94 60.5 2358 Q4, ‘95 60.5 2179 Q4, ‘96 60.4 2250 Q2, ‘97 43.0 2267 Source: Data Stream and Jones Lang Wootten.

  19. Central Business District Office Vacancy Rates 1997 Bangkok 15.0% Hong Kong 6.0% Kakarta 10.0% Kuala Lumpur 3.0% Manila 1.0% Singapore 8.0% Shanghai 30.0% Source: JP Morgan “Asian Financial Markets,” January 1998.

  20. What Really Causes A Crisis? • Corruption? • Korea, Indonesia, Thailand -corruption • Italy and India have corruption, but no crisis • Bank Transparency • inadequate regulatory framework • irrational lenders?

  21. Fundamental Factors-GDP growth (%) 1993199419951996 Indonesia 6.5 7.54 8.22 7.98 Korea 5.75 8.58 8.92 7.13 Malaysia 8.41 9.24 9.46 8.20 Philippines 2.12 4.39 4.76 5.67 Thailand 8.27 8.85 8.68 6.66 Source: Corsetti, Pesenti and Roubini (1998).

  22. Inflation Rate 1993199419951996 Indonesia 9.60 8.53 9.43 8.03 Korea 4.82 6.24 4.49 4.96 Malaysia 3.57 3.71 5.28 3.56 Philippines 7.58 9.06 8.11 8.41 Thailand 3.36 5.19 5.69 5.85 Source: Corsetti, Pesenti and Roubini (1998).

  23. Savings Rates (% of GDP) Country 1990 1991 1992 1993 1994 1995 1996 China 38.1 38.3 37.7 40.6 42.6 41.0 42.9 Hong Kong 35.8 33.8 33.8 34.6 33.1 30.4 30.6 Indonesia 27.9 28.7 27.3 31.4 27.6 28.4 28.1 Japan 33.5 34.2 33.8 32.8 31.4 30.7 31.3 Korea 36.1 35.9 35.1 35.2 34.6 35.1 33.3 Malaysia 29.1 28.4 31.3 33.0 32.7 33.5 36.7 Philippines 18.7 18.0 19.5 18.4 19.4 17.8 19.7 Singapore 44.1 45.4 47.3 44.9 49.8 50.0 50.1 Taiwan 22.4 22.2 23.2 23.7 22.9 22.9 21.0 Thailand 32.6 35.2 34.3 34.9 34.9 34.3 33.1 Source: Statistical Appendix, IMF, 1997.

  24. Human Development Indicators Country Life-Expectancy Literacy Rate Average Income of (years) (%) Poorest 20% in ‘85 US$ 1970 1995 1970 1995 1970 1995 Indonesia 48 64 54 84 392 908 Korea 60 72 88 98 303 2071 Malaysia 62 72 60 85 431 1070 Philippines 57 66 83 95 218 435 Thailand 58 69 79 94 361 726 Source: Radelet and Sachs (1998).

  25. Fixed Exchange Rate System • FX rates more efficient. • Imposes impediments in the FX system. • Government guarantees investors potential upside return if FX devalues.

  26. Currency Model of Attackby Speculators • Due to the“fixed”exchange arrangement in many Southeast Asian countries, speculators start withlocal borrowings(i.e., borrowing from local banks). • They then sell the local currencies,convert into US dollars,andsell forward contracts. • They realize a profit if thecurrencies devalue,because their US holdings can be exchanged for more local currencies to pay off loans.

  27. Defenses by Governments • Buy up sales transactions - FX reserves can be exhausted quickly. • Jack up the interest rate to deter speculative borrowings, implying high cost for business that leads to: • bankruptcies • discouraging real investment • collapse of stock markets • Penalize banks who lend money to speculators.

  28. The Impact of Crisis on China • More imports from Korea due to lowered prices, e.g., products imported from Korea have increased, including steel (32.4%), petro-chemicals (11.8%), and textiles (9%). • China’s exports slow down. • Economic growth slows down.

  29. China’s Strategy • Under pressure to devalue its currency. • However, such a decision is political, not economic. • Could hurt its credibility as an Asian leader. • Devaluation will hurt Hong Kong, a place to raise external funds via initial public offerings (IPO) for its state-owned enterprises.

  30. China’s Strategy (continued) • Ease Export Credits by encouraging banks to make loans to export-oriented companies. • Relax export licenses and give tax rebates: • Ministry of Foreign Trade and Economic Cooperation issues more export licenses for base metals. • Exporters will receive full 17% value-added tax.

  31. Implications and Strategies • Lowered currency value implies products are cheaper to buy -- • Merger Activities in Asian countries • International trade implications • Financial reforms (bond market development and banks) • Corporate Strategies

  32. Corporate Hedging Strategies • Increased use of hedging instruments, given the volatile FX markets (use of forward, swaps and other derivative instruments). • As a long-term strategy, U.S. firms should pay closer attention in managing their economic exposure,e.g., Avon’s use of a balance sheet hedge in 1997.