3. Outline
1. Definition of Currency Crisis
2. Theoretical Models of Currency Crises and their
Applicability to Malaysia.
3. Asian Economic Outlook before the crisis
Outline
4. Causes of the Currency Crisis
5. Response to the Crisis
6. Lessons from Malaysian Currency Crisis
7. Malaysian Economic Outlook after the crisis
8. Conclusions
4. Definition of Financial Crisis
Currency crisis:
Defined as a situation in which an attack on the currency leads to
substantial reserves losses, or to a sharp depreciation of the
currency – if the speculative attack is ultimately successful – or to
both.
Banking crisis:
– Performance of bank stocks relative to the overall equity market
– Non-performing loans
– Bank runs " closure, merging or takeover by public
sector
5. Brief History of Crisis
Malaysian Currency Crisis 1997/98
“I can‘t imagine that 20 or 25 years ago my predecessors would
have been worried about an economic crisis in Thailand or
Indonesia, or even Korea” Robert Rubin, Former Secretary of the
Treasury
Much more heterogeneous than first two generations
Three main variants:
– Moral-hazard-driven lending
– Currency crises as the byproduct of a bank run
– Balance-sheet implications of currency depreciation
Short-term debt
Other key topics: Maturity mismatch, currency mismatch,
contagion, crony capitalism, etc.
6. Economic Outlook before Crisis
Graphs taken from:
WORLD ECONOMIC OUTLOOK
Interim Assessment
December 1997
A Survey by the Staff of the International Monetary
Fund
12. Causes
Broadly, the views about Malaysian financial crisis can
be divided into two categories:
Macroeconomic imbalances and structural
distortions.
Sudden shifts in market expectations and
confidence.
13. Causes (Continued)
Current account deficits and composition of
foreign liabilities.
Fixed exchange rates system and overvalued
currencies.
Failure of developmental state model.
Unfavorable changes in external environment.
Inadequate financial supervision and regulation.
Moral hazard.
Inherent flaws of global financial structure.
14. Current Account Deficits and Composition
of Foreign Liabilities
It has been widely agreed that a current account
deficit should be closely monitored if it is in
excess of 5% of GDP and largely financed in a
way that could lead to rapid reversals.
Large current account deficits mostly financed
by short-term reversible investments.
16. Short Term Debt as a Percentage of Total
Debt
1996
Korea 67
Indonesia 61
Malaysia 50
Philippines 58
Thailand 65
Hong Kong 82
Taiwan 84
17. Short Term Debt as Percentage of Foreign
Reserves
1990 1991 1992 1993 1994 1995 1996
Korea 72.13 81.75 69.62 60.31 54.06 171.45 203.23
Indonesia 149.28 154.62 172.81 159.70 160.36 189.42 176.59
Malaysia 19.54 19.05 21.12 25.51 24.34 30.60 40.98
Philippines 479.11 152.31 119.37 107.68 95.00 82.85 79.45
Thailand 62.55 71.31 72.34 92.49 99.48 114.21 99.69
Hong Kong 23.52 21.78 18.38 17.09 16.49 14.16 22.35
Taiwan 21.56 20.21 21.00 23.64 21.76 21.64 21.31
18. Debt-Service Plus Short-Term Debt as
Percentage of Foreign Reserves
1990 1991 1992 1993 1994 1995 1996
Korea 127.43 125.90 110.35 105.66 84.90 204.93 243.31
Indonesia 282.92 278.75 292.03 284.79 277.95 309.18 294.17
Malaysia 63.96 45.87 45.55 42.37 48.73 55.92 69.33
Philippines 867.64 256.99 217.08 212.60 171.98 166.60 137.06
Thailand 102.35 99.34 101.34 120.28 126.54 138.13 122.62
Hong Kong 30.51 26.87 22.82 20.64 22.02 16.82
Taiwan 23.92 22.29 23.08 25.21 23.69 24.20
19. Fixed Exchange Rates System and
Overvalued Currencies
Almost all these economies pursued export led
growth by keeping the currency fixed with USD.
When USD appreciated in 1995, the real
exchange rates appreciated and deteriorated the
cost competitiveness.
Problems arose when the central banks were
unable to support the currency against currency
speculation in view of their small international
reserves.
20. Failure of Developmental State Model
Most of these Asian countries followed Japanese
growth model with all its inefficiencies like
speculative investment, crony capitalism and
unsound business and economic decisions.
These decisions led to bad loans, unsustainable
growth and overvalued assets.
21. Unfavorable Changes in External
Environment
Changes in international financial system like
capital account liberalization and financial
market deregulation played a critical role.
Some aspects like intense competition from
China, Japan’s economic slow down and a
worldwide fall in demand of semi conductors
also significantly affected the exports from
Malaysia.
22. Inadequate Financial Supervision and
Regulation
Market liberalization was not accompanied by
sophisticated control systems and the
supervisory capacity was limited.
As a result of negligent supervision there were
low capital adequacy ratios, lack of deposit
insurance schemes and risky lending.
23. Moral Hazard
Krugman pointed out two dimensions of Moral Hazard:
Domestic banks were seldom concerned about
their investment and were anticipating a bail out
by Government.
International investors also anticipated a bail out
either by governments or IMF.
24. Inherent Flaws of Global Financial
Structure
According to this view roots of capital flows lie
in the Global Financial structure in which there
are repeated patterns of “Booms” and “Busts”
Increasing confidence leads to massive capital
inflows followed by busts created by panic by
investors.
25. IMF Conditionality
Tighten Macroeconomic Policies:
↓ Government deficit: ↑ T , ↓G
↓ Current account deficit: 2%
Tight monetary policy ↑interest rate
Financial Sector Reform:
Enhance regulations and supervisions
↑Transparency/Disclosure
Closure of troubled financial institutions
Real Sector Reform:
26. Measures Taken By Government
Only Three Measures Taken by Govt.
1- Freezing the External Ringgit Account
2- Fixing the Exchange Rate @3.80RM/$
3- Introduction of Twelve Month Rule
Source: The Malaysian Currency Crisis
Mahatire Bin Muhammad (1997)
28. Lessons: Malaysian Currency Crisis
Key Lessons:
Financial market reform
Manage investor confidence
Curb unproductive & speculative capital
Accumulate huge international reserve
Avoid excessive reliance on external fund &
short-term capital
Reform international financial architecture
Embrace flexible exchange mechanism
Temporary currency & capital control
29. Lessons: Financial Market Reform
Develop robust & resilient financial system. Strong
institutions with capabilities & expertise
Disclosure & accounting reform
(i.e. International Accounting Standards)
Adopt proven & stricter regulations
- International organizations
(i.e. IMF, World Bank, Asian Development
Bank)
- Developed financial centers
(i.e. New York, London)
30. Lessons: Manage Investor Confidence
Continuously improvement in investment climate by
enhancing regulations, intensifying supervision,
tackling corruption etc
Caprio (1998)
Ranking Country Ranking Country
1 Singapore 7 Malaysia
2 Argentina 8 Colombia
3 Hong Kong 9 South Korea
4 Chile 10 The Philippines
5 Brazil 11 Thailand
6 Peru 12 Indonesia
Source: “Asian Crisis: Distilling Critical Lessons”, Dilip K. Das
31. Lessons: Curb Unproductive &
Speculative Capital
Avoid or cut speculative activities in real
properties & securities
In Thailand 70% of foreign capital is invested in
securities
32. Lessons: Accumulate Huge International
Reserve
Feldstein (1999) supports this notion in view of
increasing integration of world capital market.
Singapore’s Experience ($194 billion or > 8 months
import as at end of February 2006).
Foreign Reserves (in months of imports)
1993 1994 1995 1996 1997
Korea 2.53 2.63 2.52 2.32 1.42
Indonesia 3.60 3.24 2.94 3.64 3.26
Malaysia 5.64 4.53 3.29 3.59 2.73
Philippines 2.59 2.81 2.33 2.95 1.79
Thailand 5.64 5.65 5.35 5.53 4.40
Hong Kong 3.33 3.27 3.10 3.47 4.80
Taiwan 10.64 10.90 8.90 8.68 7.56
33. Lessons: Avoid Excessive Reliance on
External Fund & Short-term Capital
Large capital inflows can potentially have a
destabilizing impact over the recipient economy,
particularly when the currency is convertible.
Short-term capital inflows are known to cause volatility
in financial markets, which leads to macroeconomic
instability.
Monetary authorities should keep strict watch over
short-term borrowings denominated in foreign
currencies.
34. Lessons: Reform International Financial
Architecture
Gordon Brown, former British Chancellor
“… focuses on the stability and integrity of the world financial system should be
directed on code of conduct; monetary policy, fiscal policy ...”
BBC February 21, 1998
Total assets of top international financial/hedge funds are
higher than reserves of some countries
Top International Fi nancial/ He dge Funds 2004 Key Economic Indicators
Reserves of
2004 External
Company Foreign Exch.
Assets Debts
& Gol d
Soros Fund Management $13.0 b Indonesia $141.5 b $35.8 b
Bridge water Associates $12.4 b Mal aysia $53.4 b $55.3 b
D.E. Shaw $11.4 b Philippi nes $55.6 b $16.1 b
Gol de n Sachs Assets Management $11.2 b Singapore $19.4 b $112.8 b
Farallon Capital Management $12.5 b S. Korea $160.0 b $199.1 b
Caxton Associate $11.9 b Thailand $50.6 b $48.3 b
Source: Absolute Return Magazine (Top International Financial/Hedge Funds)
35. Lessons: Embrace Flexible Exchange
Mechanism
Prior to crisis, monetary framework in most
Asian countries was anchored to the fixed
exchange regime.
Pegging is infeasible as international reserves
and financing were insufficient for developing
countries.
Fixed exchange rate vulnerable to speculators’
attack.
36. Lessons: Temporary Currency & Capital
Control
• Malaysia experience:
- Imposed currency & capital controls September 1,1998
- Reverting to floating exchange a day after China on July
22, 2005
- Supported by Prof. Bhagwati
- Refuted claims by many economists that Malaysian
economy not sustainable
GDP Growth (%)
1997: 7.3%
1998: -0.1%
1999: 5.8%
2000: 8.5%
Source: “Capital & Control: Lesson from Malaysia”, Rawi Abdelal & Laura Alfaro (2003)
37. Lessons: Temporary Currency & Capital
Control
2004 Key Economic Indicators
GDP
Purchasing power parity Real Growth Rate Per capital
Indonesia (Aid from IMF) $827 b 4.9% $ 3,500
Mal aysia $229 b 7.1% $ 9,700
Philippi nes $431 b 5.9% $ 5,000
Singapore $121 b 8.1% $ 27,800
S. Kore a (Aid from IMF) $925 b 4.6% $ 19,200
Thailand (Aid fro m IMF) $525 b 6.1% $ 8,000
Reserves of Foreign
Exc hange & Gol d
Indonesia $ 35.8 b
Mal aysia $ 55.3 b
Philippi nes $ 16.1 b
Singapore $ 112.8 b
S. Kore a $ 199.1 b
Thailand $ 48.3 b
China $ 610 b
India $ 120 b
Source: “World Factbook ” extracted from http://education.yahoo.com (2004 estimated data)
38. Conclusions
The Asian financial crisis represents a new
generation of crisis. It involved not only
currency exchange problems but also banking
problems.
Macroeconomic experts were unable to predict
it, since economic conditions remained
generally good and private foreign capital was
flowing in at a record pace and on very
attractive terms.
39. Conclusions (Continued)
Some key elements: failure to reduce
overheating pressures, current account deficits
funded with speculative short term debt, lack of
soundness, transparency, and supervision of
financial system, overvalued properties and
stock markets (bubbles), excessive exposure to
foreign exchange risk in both the financial and
corporate sectors and lax prudential rules.
40. Conclusions (Continued)
The failure of the IMF rescue package reinforced the
importance of the soundness in macroeconomic and
financial sector fundamentals.
The causes of the financial crisis in Asia are complex and
will need to be thoroughly analyzed both to reduce the
risk of similar occurrences in the future and to identify
appropriate lessons for economic policies.
