September 10, 2011
South East Asian Crisis
South East Asian Crisis
The South East Asian financial crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown due to financial contagion. The crisis started in Thailand with the financial collapse of the Thai Baht caused by the decision of the Thai government to float the Baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt. Though there has been general agreement on the existence of a crisis and its consequences, the exact reasons of this financial crisis are still debatable.
South East Asian economies had maintained high interest rate which promised high return rate for foreign investors looking for investment. Regional economies Thailand, Malaysia, Indonesia, Singapore and South Korea experienced 8-12% GDP growth in the late 1980s and early 1990s. US $184 billion entered in the developing countries during 1994-96 according to the Bank of International Settlements. In the first half of 1997 $70 billion came in but in 2nd half of 1997 (Onset of crisis) this inflow suddenly turned into outflow of US $102 Billion, creating a wide spread panic among the investors and governments alike.
Key Drivers of South East Asian Crisis:
Economists believe that the South East Asian crisis which mainly affected Thailand, Indonesia & South Korea was created not by market psychology, but by policies that distorted incentives within the lender-borrower relationship. * Unregulated Financial Liberalization:
East Asia's economic growth was mainly the result of capital investment, leading to growth in productivity. Most of these countries had carried out a process of financial liberalization where foreign exchange was made convertible with local currency not only for trade and direct investment but also for autonomous capital inflows and outflows. This facilitated large inflow of funds in the form of international bank loans to local banks and companies, purchase of bonds and portfolio investment in local stock markets. However, as argued by Notable economist Paul Krugman, only growth in total factor productivity, and not capital investment, could lead to long-term prosperity.
* Local asset boom, bust and liquidity squeeze:
Owning to excessive real estate speculation the high amount of investment flowed from different countries in Thailand which resulted into a bubble. This bubble needed more and more money as its size grew. The short term capital flow was expensive and often highly conditioned for quick profit. Also, under the ambience of the corrupt government, the development money went in a largely uncontrolled manner to certain people only, not particularly the best suited or most efficient, but those closest to the centres of power.
* Currency depreciation:
At the time, there was a huge build-up of short term debt among the countries most affected. What transformed this into crisis for Thailand, Indonesia and South Korea was the sharp and sudden depreciation of their currencies, coupled with reduction of their foreign exchange reserves in anti-speculation attempts. When the currencies depreciated, the burden of debt servicing rose significantly in terms of the local currency amount required for loan repayment.
* Competition in export:
Another reason for this crisis was competition from china due to its export – oriented reforms in 1990s. China had begun to compete effectively with other Asian exporters...