CONCEPT – THE ASIAN FINANCIAL CRISIS 1997

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CONCEPT – THE ASIAN FINANCIAL CRISIS 1997

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Read more on - Polity | Economy | Schemes | S&T | Environment

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Read more on - Polity | Economy | Schemes | S&T | Environment

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• Crisis comes calling: In 1997, a massive financial crisis struck Southeast Asian nations – starting with a single event – the devaluation of the Thai baht. The baht dropped sharply, and there was strong speculation against the currencies of  Malaysia, Indonesia and South Korea as well. Singapore, Philippines and Japan also were hurt badly. It was a full-blown financial contagion (something different was experienced in 2007 starting from the USA).
• Primary causes of the crisis: There were three main reasons: 

1. Collapse in domestic assets markets, 
2. Lots of bank failures, and 
3. Corporate bankruptcies. Broadly experts agree that the property price bubble coupled with big macroeconomic mistakes like supporting a nominally fixed exchange rate for too long, created the crisis.

• The Asian model of capitalism: This was the chicken that came home to roost. Critics have said that too much deregulation led to misallocation of capital ( too much investments into property sector for example). Heavily leveraged corporations (e.g. in Japan) having huge debt / equity ratios can falter if government starts liberalisation processes.
• Two decades have gone by: 2017 marked 20  years of that historic disaster. It’s time to learn lessons from such problems, as most haven’t been learnt! There were two sides to the argument over why did it happen – the Western side, and the Asian side.
• As per the Western logic – Asian nations lacked transparency (in fiscal matters) and crony capitalism was rampant. That refers to extremely close and perhaps unethical relations between corporations and governments. The Asian nations’ disagreed, and put out their list of reasons – The rampant destabilization in regional financial markets brought about by the Hedge Funds, and IMF’s extremely wrong approach to solving the crisis.
• The truth is somewhere in between: Both these perspectives seem correct to some extent. The Bank of Thailand’s  published balance sheet had extremely high (and wrong) estimates of its forex reserves. That prompted foreign  nvestors to “bet against the baht” and short-sellers were not just the Hedge funds but also investment banks. One  such bank was an advisor to the Thai govt. on how to defend its currency! (complete immorality)
• IMF to blame? At this very moment, IMF advised fiscal austerity for Asian nations – they were asked to tighten their belts. Later on, in 2000, all these nations came together and created the Chiang Mai initiative. In 1997, Japan had called for an Asian Monetary Fund (fed up of the IMF etc.), but China was still a small power then, unsure and vacillating. It did not support, but now we have the AIIB.
• Rules followed by these nations: They kept artificially stable exchange rates (“rigid dollar-pegged rates”), to keep pushing exports (their main source of prosperity). They wanted double digit GDP growth, and that called for investments – excessive loads of it. Foreign borrowing was done excessively to keep capital formation going. All of this is good when you are on an upward prosperity curve, but when you have already become rich, brute force investments do not generate high growth rates.
• Other factors: South Korea got was admitted to OECD, and had to let go its capital controls. IMF and US both forced countries to relax capital controls (allowing “hot money” to flow in). Pegged rates are difficult in such a scenario.
• Lessons learnt? Yes. 

1. In 20 years post the crisis, these nations have slowed down their investment rates, and also growth expectations to levels more sustainable, 
2. More flexible exchange rates have arrived, and rigid pegs are gone, 
3. Large external deficits have been turned to surpluses, reducing any dependence on foreign capital flows (to fund  those deficits), 
4. Due to these surpluses, they have large forex reserves, an insurance during crisis which they lacked  in 1997, 
5. They have come together for protection – the Chiang Mai Initiative 2000 – which is a regional financial  credit and swap network, 
6. Now there is the AIIB (Asian Infrastructure Investment Bank) to regionalize development  finance, 
7. 20 years of robust Chinese growth has changed all regional dynamics.

• More things change, more they remain the same! But if you look carefully, China still follows the same model that brought the Asian crisis in the first place – higher rates of growth at any cost! Economic engine always keeps whirring no matter how the liquidity is to be managed. That is what Thailand was doing prior to 1997. Many Chinese companies (with close govt. links) have very high foreign debt levels (overall Chinese debt to GDP is 300% +). And China doesn’t want its currency to float. If China now falls, everyone will be hit.

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