Asian Currency Crisis 1997-1998

Kaitlin Briscoe Doug Durkalski Allison Gott Jennifer Hooks

Getting to the Root of the Problem…

    Moral hazard: banking system inherently flawed  incentives were skewed; “relationship banking” resulted in too many nonperforming loans being issued (overlending) Japan: output slows down (exports from Asia fall) and consumption tax enacted Appreciation in currencies that were pegged to dollar caused decreased price competitiveness for these countries’ exports!

Drop in real estate and stock markets led to decline in collateral values  problematic for already struggling banks!

Current Account

 Deficits deemed problematic if exceeding 5% of GDP  Most Asian countries exceeded this threshold pre-crisis  Hardest-hit countries were those running deficits; depreciation against dollar of up to 151% (Indonesia)!

 Solvency: Deficits could persist so long as trade surpluses could be generated at some point in the future  GDP growth rates averaged 7 to 10% annually

Other Macro Fundamentals

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  Output Growth: Large current account deficits were perceived to be sustainable with high economic growth (1980 debt crisis); Asian growth rates averaged more than 7% of GDP at the time.

However, these high rates caused overly-optimistic expectations, downplayed the riskiness of investments, and resulted in excessive reliance on foreign capital and current account imbalances.

Investment Rates/Profitability: In the 1990s Asian countries had: High investment rates and slipping investment efficiency Bankruptcy occurred ROIC dropped below invested capital Heavy Speculation

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 Private & Public Savings: High savings rates Excessive credit growth in the banking system Growing amount of non-performing loans Eventual collapse of several financial institutions Inflation : Low Inflation…but people doubted these low levels were sustainable because of the banking and financial sector problems experienced in these Asian countries.

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   Openness : the more “open” the economy, the more susceptible to external trade shocks; measures of openness put many Asian countries above 50%!

Real Exchange Rate Appreciation: decreased cost competitiveness for Asian countries that were pegged to dollar; current account imbalances worsen Political Instability/Policy Uncertainty (“the icing on the cake”): IMF struggles to ascertain gravity of situation and then cannot get programs to take hold in these countries (Indonesia & Korea, in particular)

The Turning Point

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A number of shocks exacerbated the problems with Asian currencies:

     Slow Japanese economy resulted in a decrease of export growth with trading partners in Asia The imposition of a consumption tax created declines in 1997 and mitigated what seemed to be a Japanese recovery in 1996 Increasing Chinese influence on total exports led to increased competition in Asian countries Sector-specific shocks resulted in further slowdown of export growth in the region from 1996-1997 Expectations of US monetary policies tightening

IMF’s Response

 Immediate goal=restore confidence  Around $35 billion in financial support  Temporary tightening of monetary policy to stem depreciation

Structural Reform Programs

 Reopen and maintain lines of external financing  Remove monopolies and trade barriers  Increase transparency of corporate practices  Close unviable financial institutions  Supervision of weak institutions

Early Results

 Exchange rates began to recover  Interest rates in Korea and Thailand fell to pre-crisis levels  Current accounts turned from deficit to surplus  Equity prices in Korea and Thailand rose significantly

Lessons from the Crisis

 Sound macroeconomic policy is critical  The dangers of unsustainably large current account deficits  The importance of regulation, supervision, and transparency