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Asia Crisis - Bloom 'killed' by imbalance and corruption
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Asia Crisis - Bloom 'killed' by imbalance and corruption

created Forex Club9 May 2022

The Asian crisis is one of the most interesting economic crises in history - not least because very deep, but at the same time it was very short. Despite the downturn in Southeast Asia, the economies of developed countries have passed through it (including China). However, for many Asian countries the years 1997-1998 are still one of the most important economic events of the last few decades. But how did it happen and what specific consequences did it have for the entire region?

Asia's economic miracle

The XNUMXs and XNUMXs were a period of rapid economic development in Southeast Asia and other Asian countries such as China and South Korea. The reason for economic growth was the opening of many economies to foreign investment and the inclusion of these countries in global supply chains. The process of moving economic production from developed countries to peripheral countries has begun. The beneficiaries of these changes were, inter alia, Asia. Additionally, many Asian countries implemented similar solutions as Japan in the post-war period (emphasis on exports).

The Asian economic model was touted as one example of wise government policies that supported the comparative advantages of the domestic economy. However, economic growth in countries such as Thailand, Malaysia and Indonesia was not sustainable. The problems, however, were hidden under the fantastic growth Gross Domestic Product. For example, Malaysia's GDP per capita (after taking into account the purchasing power parity) increased by as much as 1990% between 1997 and 80. In turn, the same indicator for Thailand it increased in 1990 - 1996 by about 70%. Economic growth resulted from the pressure on exporting products to more developed countries and keeping the currency pegged to the dollar. The lack of exchange rate risk (in theory) encouraged speculative capital to invest in rapidly developing countries. The funds were invested in the real estate market and in the developing capital market. Another development impulse were foreign loans, which stimulated the development of certain economic branches.

The Asian crisis and its causes

Growth based on external sources of financing is always prone to a "crisis" if it is based on short-term venture capital. Capital flowed mainly into countries with currencies linked to the US dollar. Thanks to this, short-term investors did not have to worry about the exchange rate risk. At the same time in many countries of Southeast Asia the current account deficit was growing. In short, it meant countries became net debtors.

Additionally, there was a problem lack of efficient financial supervision in many Asian countries. As a result, the risk of a financial crisis in the event of a sudden outflow of foreign capital increased. This was due to the fact that the supervision was unable or unwilling to introduce regulations reducing the risk of a speculative bubble.

Another feature of several Asian economies is worth adding. Ruled by the so-called dudes capitalism ( ), where people closely related to the political environment benefited from the economic successes. Tenders were set and competing companies were hindered from operating in the market. This resulted in greater inefficiency in capital allocation. Banks very often granted loans not on the basis of an economic account, but on the basis of personal ties. There was also a conviction that states would not allow the bankruptcy of national champions who were strongly associated with the political class. This concerned, inter alia, South Korean cheeboli or Indonesian companies belonging to the leading family clans.

The course of the crisis

The growing imbalance within the economies could not go on indefinitely. Adjusting to the new macroeconomic conditions was hampered by a fixed exchange rate. Eventually, central banks had to react. There was a domino effect. One country with financial problems sent a signal that the entire region could have problems in the future. The panic spread to other countries in the region. In this part of the text, we will take a closer look at the economic situation of selected countries in the crisis region.

Tajlandia

The Asian crisis began in July 1997 in Thailand. This country has fought speculative attacks on the Thai whip (THB) since May. The attacks stemmed from the fact that some high-walled investors noticed an imbalance in many Southeast Asian countries. Thailand has tried to stay pegged both through currency interventions and through political declarations. In order to calm moods, June 30, 1997 Thailand's Prime Minister Chavalit Yongchaiyudh announced that he did not intend to devalue the whip. However, despite the government's declaration, there was a shortage of foreign exchange reserves to keep the whip pegged to the US dollar. However, it was announced on July 2 that Thailand must devalue the whip against the dollar.

This led to panic among investors. Attempts were made to save the situation through loans. August 11, 1998 International Monetary Fund (IMF) announced a $ 17 billion aid plan for Thailand. However, it was a drop in the ocean of needs. After 9 days, the IMF announced another aid package, this time for about $ 3 billion. This did not improve the situation. Thailand's economy has experienced a sharp outflow of capital. This resulted in massive layoffs in the financial, construction and real estate sectors. As a result, one of the largest financial institutions in the country went bankrupt - FinanceOne. The increase in the unemployment rate meant that many workers, seeing no prospects of finding a job, returned to their villages. This reduced the demand for urban housing, which hit the real estate sector even more. The Thai stock market has performed poorly since the second half of 1996. The country's economic problems accelerated, which meant a decline in the broad market by several dozen percent.

Thailand emerged from the crisis with more unemployment, more poverty and greater social inequality. The loans granted by the IMF were repaid in 2003. In the following years, the country returned to the path of economic growth.

00 Thailand

Source: world Bank

The level of foreign exchange reserves to be was also increased "insurance policy" in case of another economic crisis. However, the Thai baht against the dollar has not returned to pre-Asian levels.

Indonesia

Indonesia is another country that has experienced the economic problems resulting from the outbreak of the Asian Crisis. Taking a quick look at the macroeconomic indicators in early 1997, it seemed that this country was far from instability. Indonesia, unlike Thailand, did not struggle with high inflation and had significant foreign exchange reserves amounting to $ 20 billion. Additionally, Indonesia had a trade surplus and a stable banking sector. However, these were only appearances. Many Indonesian companies preferred to borrow funds in US dollars in order to take advantage of lower interest costs. Additionally, the dollar loan was profitable in previous years as the Indonesian rupee (IDR) appreciated against the dollar. As a result, a company that was indebted in dollars and earning in rupees paid lower installments, which encouraged them to increase leverage.

The release of the Thai whip caused Indonesia to expand the allowable range of currency fluctuations from 8% to 12%. On August 14, Indonesia decided to release the rupee exchange rate, which caused it to sell off sharply. Many companies found themselves in a difficult liquidity situation as revenues in rupees were worth less and less in relation to the dollars. So there was an escape from the rupee and a sharp increase in demand for dollarsbecause those with free cash wanted to somehow protect themselves against the "fall of the rupee". The central bank did not have the resources to fight a panic of this magnitude. As a result, the IMF announced an aid package worth $ 23 billion. Its purpose was to stabilize Indonesia's financial situation.

In December 1997 Moody's Investors Services announced that Indonesia's credit rating was downgraded to junk status (i.e. junk-bond status). This was due to concerns about the country's ability to cope with debt service due to falling tax revenues and rising costs. At the end of January 1998 the rupee dropped to the level of 14 Indonesian rupees for $ 000. It is worth mentioning that before the crisis the exchange rate was 2 600 rupees for 1 US dollar. Economic crisis, increase of unemployment and the pauperization of citizens caused, in May 1998, there were riots among the population, mainly of an anti-Chinese nature. The riots brought down President Suharto, who ruled Indonesia for 32 years. In 1999, Indonesia returned to economic development. Economic reforms that liberalized many sectors also helped.

01 Indonesia

Source: World Bank

South Korea

Before the crisis 1997-1998 South Korea has been viewed by many economists as an exemplary example of economic policies that stimulate long-term economic development. South Korea's economy was export-oriented. The characteristic feature was cheebole, which began to appear in the seventies. They belonged to the largest cheeboli Daewoo, Hyundai, LG i Samsung. Chebole was supported by Korean authorities (first military, then "civil") subsidies. Preferential loans helped cheebolom fight against foreign competition. At the beginning, cheebole was not innovative and competed on price. However, over time, they became more and more technologically advanced. They had strong political influence, which allowed them to receive government support. This reduced competitiveness within the Korean economy and meant that loans were granted not on the basis of economic rationale, but due to the network of contacts. This increased risk in the banking sector, but as long as export growth continued, the situation seemed under control.

South Korea's economy was one of the region's most stable economies. For this reason The Asian crisis hit Korea much later than it did with Thailand or Indonesia. In 1997, the South Korean stock market performed much better than the Asian region. Despite this, the South Korean economy also had its problems. One of the problems was the sizable amount of non-performing loans (NLPs) that were borne by the banking sector.

In 1997, there was an image blow which was the so-called Hanbo scandal. It was a corruption scandal involving government officials and the senior management of Hanbo Steel. The scandal concerned the corruption of officials who put pressure on banks to grant preferential loans to this cheebol. Losses resulting from the granting of non-market loans were estimated at several billion dollars. In June 1997, Hanbo's founder, Chung Tae Soo, was sentenced to 15 years. Hanbo Steel itself filed for bankruptcy in January 1997, making it the 14th largest cheebol in South Korea. At the time of bankruptcy, he had liabilities of approximately $ 6 billion. At the time, it was the largest bankruptcy in South Korea's economic history.

The Hanbo scandal showed investors that South Korea's success also had its dark sides. Corruption scandals intensified in the following years, as is the case here Daewoo story. After the bankruptcy of the second largest company in South Korea, a series of investigations began to detect irregularities in the company. Daewoo went bankrupt in 2 with liabilities estimated at $ 1999-50 billion. Investigators found that Daewoo had corrupted officials for at least $ 80 million. Daewoo CEO Kim Woo-choong himself was prosecuted in connection with multi-billion dollar financial fraud. Before being held accountable, he fled to Vietnamhowever, in 2005 he returned to South Korea and stood trial. He was charged with accounting frauds of more than $ 40 billion, illegal granting of loans amounting to $ 9 billion, and illegal removal of more than $ 3 billion from the country.

South Korea was forced to accept $ 58,4 billion of aid from the IMF. The loan was conditional on the adoption of economic and financial sector reforms. As a result of reforms, by June 2003, 787 institutions were closed or merged. It was supposed to clear the financial market of the weakest entities. As a result of the crisis, the Korean economy has become more open to foreign investment. General Motors took over part of the Daewoo business, and India's Tata Motors took over Daewoo's trucks and heavy machinery division.  

The South Korean economy recovered quickly from the Asian crisis. In the following years, it achieved very fast economic growth. This was helped by the restructuring of cheebola, the dynamic development of Asia (China is currently the most important export destination) and the development of the semiconductor segment (including Samsung).

02 South Korea

Source: World Bank

Malezja

The country is very close to Thailand. For this reason Neighbor's problems immediately translated into problems in Malaysia. A few days after the devaluation of the Thai whip, speculative attacks against the Malaysian ringgit ensued. To stop the outflow of currency, overnight rate increased from 8% to 40%. However, this did not stop investors from the ringgit panic sell-off (MYR). At the end of January 1998, $ 1 was worth 4,57 ringgits (before the crisis, the rate was 2,5). The crisis also hit the Thai stock exchange, which lost half its value within a few months. The authorities decided to use a drastic solution to deal with the crisis.

By decision of the Prime Minister of Thailand - Mahathir Mohamad - a tight capital control was introduced and the dollar was tied at 3,8. Such actions were intended to hinder speculators from further speculative attacks and to limit the outflow of currency by wealthy Malaysian citizens. Malaysia, unlike Thailand, Indonesia and South Korea, refused to use the support of the International Monetary Fund. Khazanah Nasional Berhad (a government fund) bought up toxic assets, which allowed for bank recapitalization.

1998 was a difficult year for the economy. GDP fell by 7,4%. It was the first economic contraction since the low recession of 1985. In 1998, inflation also increased (5,3%), the highest level since 1982. After a deep recession, Malaysia returned to rapid economic growth within a year. Between 1999 and 2008, the GDP growth in only one year was lower than 4,5% (2000).

03 Malaysia

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Philippines

Even before the crisis broke out, the Philippines was under pressure from foreign capital. In order to avoid the capital outflow, the Central Bank of the Philippines already in May 1997 interest rates increased by 1,75%, and on June 19 by another 2 percentage points. After Thailand announced the devaluation, monetary authorities decided to defend the Philippine peso (PHP). In effect, the overnight rate (O / N) was raised from 15% to 32%. Despite this, the peso was under pressure of sell-off. At the beginning of the crisis, $ 1 was worth 26 pesos, and by the beginning of 1998, the dollar was worth 46,5 pesos. Despite the collapse of the national currency, the economy suffered a relatively dry foot. The country's GDP declined little in 1998 before resuming its rapid growth path.

04 Philippines

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The role of the IMF in the crisis

The International Monetary Fund has prepared financial support for countries to reduce the magnitude of the crisis in Southeast Asian countries. The IMF prepared packages of reforms, which were called SAP (Structural Adjustment Package). The main assumptions were:

  • limiting the government deficit,
  • raising interest rates,
  • cleaning up the financial market.

Ultimately, SAP was to increase the competitiveness of the economy by preventing the emergence of zombie companies (dependent on government aid). However, critics of SAP have argued that the restructuring plan runs counter to Keynesian policies. According to these economists, raising rates and limiting government spending will rather deepen the crisis (shock therapy accusation).

The increase in interest rates was to restore confidence in the national currencies of Asian countries. The purpose of the interest rate hike was therefore to weaken the depreciation of currencies in order to ease debtors in foreign currencies and to stop the outflow of foreign capital. The disadvantage of this solution was the growing interest costs for enterprises and citizens borrowing in national currencies. The role of the IMF in the Asian crisis was criticized, and the fuel for criticism was also fueled by the unsuccessful treatment of Argentina during the country's currency crisis at the turn of the XNUMXth and XNUMXst centuries.

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