Causes and Consequences of the Asian Financial Crisis
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Presentation delivered on November 1, 2013 for East Asia Political Economy class at the University of Pennsylvania
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Causes and Consequences of the Asian Financial Crisis
- 1. Desmond Wee PSCI214 East Asia Political Economy University of Pennsylvania
- 2. Background: Chain Reaction Thailand (early 1997): Exports decline →Loss of investors’ confidence → Currency depreciation due to lack of foreign reserve → IMF’s aid package required currency devaluation & higher domestic interest rate → Increase in non-performing loans → Local stock market tumbles Domino effect: spread from Indonesia to the Philippines, Malaysia and Korea. Trade effect: Taiwan and China
- 3. Inflow of International Capital Most fundamental change in the majority of East Asian economies is the 1990s Private capital flows Access to foreign funds Increasing internationalization of the activities of East Asian firms Most governments at least partially liberalized foreign capital movement
- 4. Liberalization within a Flawed Policy Framework Inadequate regulation to cope with foreign capital inflows Governments lacked the experience Predominance of short-term debt High short-term debt to reserves ratio → vulnerable to speculative attack Newly-licensed banks Risky lending practices Unproductive, speculative investments
- 5. Liberalization within a Flawed Policy Framework Fixed exchange rates worsened the vulnerability of economies to crisis Uncontrolled capital inflow → inflation Domestic inflation harmed export competitiveness Moral hazard problem: domestic borrower of foreign currencies with no risk of exchange rate
- 6. Distinguishing Crisis and Non-crisis economies China and Taiwan were not affected as much as Thailand, Indonesia and Korea. Heavily-affected countries Less-affected countries Capital account liberalization + Inflexible exchange rate Prudential regulation Sizeable foreign exchange reserves
- 7. Cause of the Financial Crisis? Fundamentalists Panic-stricken Root causes of the crisis lay in misguided economic policies, & liberalization of their financial system was not enough Fundamentals of East Asian economies were sound and hasty liberalization of their financial systems, followed by asset bubbles was root cause.
- 8. The Politics of Financial Policy: Behind the Fundamentals Influences on financial arrangements in Asia: Relative strength of social coalitions & economic sectors. Korea The degree of concentration of the financial sector Thailand The particular links between individual financial institutions and state organs, ruling parties and leading politicians. The degree of foreign participation in the financial sector.
- 9. The Politics of Financial Policy: Behind the Fundamentals Supply-side approach MOF and the central bank are powerful and insulated from social and political forces? Influence of parties and elections
- 10. Domestic Responses Financial liberalization carries substantial risks as well as benefits Capital controls (exit controls & entry taxes) Decrease speculative money Opposition grew: e.g. IMF and the international community Reintroduction difficult in its implementation Discourage investment and growth
- 11. Domestic Responses Selective actions to limit trading currencies and derivatives or limit repatriation of profits Taiwan The Philippines Hong Kong
- 12. Domestic Responses Measures to improve prudential regulation Increase in the ratio of banks’ capital relative to risk-adjusted assets to 8% or higher Increase provisions for reserves agaisnt non-performing loans Stricter assessment of non-performing loans Increase in independence and unity of oversight agencies The extent of financial and corporate restructuring in the most severely affected economies remained limited.
- 13. Reforming the Global Financial Architecture The crisis led to various proposals of global financial reforms. Panic-stricken: restrictions on speculative capital Additional disbursed assistance to governments whose currencies were speculative attack Cooperation on monetary affairs at the regional level Division between twinWashington-based institutions – IMF and World Bank was deepened.
- 14. Reforming the Global Financial Architecture Reforming the IMF Calls for abolition of IMF IMF is internationalizing the moral hazard problem Encouraged speculators to undertake dubious investments Need for greater transparency of IMF Criticism against conditionality by IMF Worsened the recession by Tight fsical policy Increase interest rates Ill-timed closure of financial institutions Criticism agaisnt private sector actors for not bearing the cost of the crisis
- 15. Regional Responses Proposal for establishing the Asian Monetary Fund (AMF) Killed by opposition from the US Bilateral programs by Japan The crisis has drawn East Asian economies together, realizing that they do not have an effective voice in the governance of the monetary system. This led to efforts to establish a representational organization or regime, the outcome remains to be seen.