Financial Crisis in Asia: (Abridged)

Transcription

1 OCTOBER 31, 2008 HUW PILL Financial Crisis in Asia: (Abridged) January 1998:... nobody anticipated anything like the current crisis in Asia... we expected [a] longerterm slowdown in growth to emerge only gradually. What we have actually seen is... likely to be much more of a severe real downturn than even the most negative-minded anticipated. 1 Paul Krugman, MIT economist In the face of continued speculative attack and the near total depletion of useable foreign exchange reserves, Thai Finance Minister Thanong Bidaya allowed the currency to float freely on July 2, For 13 years of unparalleled economic growth, the baht had been pegged to a basket of foreign currencies dominated by the U.S. dollar. Now subject to the vagaries of the market, it instantly lost 15% of its value. The devaluation set off a chain of events that no one had predicted. In the ensuing contagion, investors pulled funds out of Asia as rapidly as possible, causing a broad collapse of the fixed exchange rate regime that nations in the region had maintained for years. Real estate and other asset prices had become inflated, at least partly because of large foreign capital inflows into the region. As they plunged, they highlighted the shaky positions of banks from Thailand to South Korea, which had many loans backed by real estate. Since both banks and firms owed large amounts of foreign debt denominated in dollars and the dollar kept rising in value against local currencies they they faced liquidity and solvency crises. The crisis led to bankruptcies, unemployment, collapsing trade, rising food prices, social unrest, and a broad loss of confidence. It was perhaps the most cataclysmic economic melt-down in Asia s modern history. In months, a region previously known for its miracle economic performance collapsed. Cries for help addressed to the world community and answered principally by the International Monetary Fund (IMF) did not result in a quick recovery. The Asian economic crisis raised serious questions about the management of international capital flows, the IMF package of reforms, and emerging market development policies. (See Exhibits 1 7 for data on the Asian economic crisis). Explanations of Currency Crises There are several explanations for the collapse of fixed exchange rates: domestic macroeconomic problems of excessive inflation and fiscal indiscipline; failures in international financial markets; and too-cozy crony relationships between government officials and big-business owners. Domestic Macroeconomic Problems If a country pegs its exchange rate to the U.S. dollar while domestic inflation remains higher than in the United States, the price of goods made at home rises faster than the price of goods made abroad. As the nation s exports become more expensive, they decline, while as imports become less expensive, they increase. Domestic production slows, Professor Huw Pill and Don Mathis (MBA 1998) prepared the original version of this case, Bahtulism, Collapse, Resurrection? Financial Crisis in Asia: , HBS No This abridged version was prepared by Professor Rafael Di Tella and Research Associate Jonathan Schlefer. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright 2008 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call , write Harvard Business School Publishing, Boston, MA 02163, or go to This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

2 Financial Crisis in Asia: (Abridged) unemployment rises, and the trade balance moves into deficit. Fearing that the country may not be able to repay loans, foreigners may refuse to lend to it. If these problems continue, they may force the government to devalue to improve competitiveness. 2 If a government running a large budget deficit prints money to finance it, it may also find itself being pushed toward the need to devalue. Whatever the route toward possible devaluation, speculators anticipate that it will create losses for holders of domestic currency and gains for holders of foreign currency. At some point, a critical mass of speculators may immediately purchase foreign reserves in a speculative attack rather than letting reserves run out gradually, and thus precipitate the devaluation. 3 Failures in International Capital Markets When returns in industrialized nations are low, international banks and investment funds tend to channel their capital into higher-return emerging market economies. Many observers doubt that these investors systems for assessing the associated risks are adequate. If they believe they will be bailed out by the IMF or other international pressure in the event of a crisis, the resulting moral hazard will further undermine their incentives to assess risks correctly. Then, when real or imagined trouble does arise, foreign investors may become desperate and suddenly withdraw capital. Local financial systems are likely to have become increasingly dependent on foreign capital and may collapse under the strain. The way international financial markets work can exacerbate these problems. Fund managers are often evaluated against peers rather than against any objective criteria: if managers of similar funds do well, they know they had also better do well, but if managers of similar funds do badly, they have excuses for also doing badly. Thus, they are motivated to copy peers in herd behavior, seeking high returns in emerging markets without paying sufficient regard to the risks. Small and possibly arbitrary changes in sentiment can send them all rushing for the exits. Such behavior may produce dramatic, destabilizing swings between massive capital inflows and outflows. Crony capitalism Developing countries often intervene heavily in economies, allowing officials to favor cronies friends or family members who own major banks or firms. These businesses often have access to low-cost loans from the central bank, and because it is assumed that their political friends will bail them out if things go wrong, they may also have privileged access to foreign capital. Since they themselves also assume that their political friends will bail them out, they have incentives to seek high returns by investing too freely in risky projects: heads they win, tails the taxpayers lose. When such projects proliferate, for example, producing a nationwide real-estate bubble, a sudden realization that they look shaky may undermine the financial system s soundness. Domestic financial deregulation may exacerbate these problems. It usually requires financial institutions to assume new tasks for which they are unprepared, for example, applying portfolio management techniques that are standard in industrialized countries. Furthermore, the banking system may simply be inadequate to handle the vast flows of international capital that often surge into liberalizing economies. Whatever the source of financial fragility, it can make the currency vulnerable to speculative attacks. A conventional defense against such attacks is to raise interest rates, offering the capital that remains a higher return. But where the banking system is weak and has many bad loans, higher interest rates may cause borrowers to default, precipitating a banking crisis. Constrained in this way, the authorities are unable to defend their currency peg and are forced to float the exchange rate. At the same time, if banks or their borrowers have large liabilities denominated in foreign currency, the float and consequent rapid depreciation may itself catalyze insolvency and bankruptcy. 2

3 Financial Crisis in Asia: (Abridged) The Countries Facing Crisis Thailand 4 The pillars of the Thai social order, according to historians, were a common form of Buddhism, support for the constitutional monarchy, and citizens pride as the only Southeast Asian nation never subjugated by outsiders. 5 Beginning in the mid twentieth century, a bureaucratic elite and the military dominated Thai politics. In 1992, after at least 50 people were killed in civil unrest, the last military regime was forced from power and replaced by an elected government. In the late 1980s many Thai manufacturing industries expanded, and textile production, mostly for export, increased nearly 50% annually. In the early 1990s, Exports continued to drive growth and raise living standards. But the economy began to show weaknesses in the mid-1990s. Thailand s competitiveness fell as wage levels rose compared with those of other Asian export economies. While Thai exports grew 26% in 1995, they were flat in The country began to accumulate short-term debt as the current account deficit rose to 8.1% of GDP by High short-term interest rates to prop up the baht against foreign currencies weakened the economy. South Korea 6 South Korea emerged from the Korean War in the early 1950s. Under President Chung Hee Park ( ), development surged, but he restricted unions and prohibited political opposition. For such poor people like the South Koreans, on the verge of near starvation, he observed, economics takes precedence over politics in their daily lives, and enforcing democracy is meaningless. 7 Korea s economic strategy was based on massive investment in manufacturing. At first it was inward-looking, but policy deliberately turned outward-looking in the 1980s. A series of economic plans sought to help jaebol integrated industrial conglomerates become globally competitive. They emphasized the provision of low-cost capital, trade protection for new industries, infrastructure development, training, and wage restraint. But imports of capital equipment exceeded exports, causing current account deficits. These were financed by massive borrowing from the United States. By the mid-1990s Korea seemed enormously successful, having joined the club of advanced nations. Income per capita stood at U.S. $9,250 in Real GNP had grown 8.6% annually since the mid-1960s. Inflation averaged 6.9% between 1985 and 1993, falling to 6.2% in Indonesia 8 Soeharto, a former general, ruled over Indonesia beginning in the late 1960s. His regime was characterized by stability, if not human rights or democracy. Economic growth averaging 6% of GDP was led by manufacturing and was also supported by agriculture. Beginning in the 1980s, Westerneducated technocrats appointed by Soeharto to manage the economy promoted trade liberalization and tax reform, while easing restrictions on foreign direct investment. By 1995, Indonesia was a middle-income nation with a per capita income of $1,030. But inflation was rising, and foreign borrowing was increasing. Indeed, the country s external debt had grown steadily since the mid-1960s. The economy showed signs of overheating, and the funding needs of Indonesia s development exceeded its capacity to raise capital. 3

4 Financial Crisis in Asia: (Abridged) Malaysia 9 During the 1950s and 1960s, Malaysia relied heavily on import substitution, that is, producing domestic goods to replace imports. In the late 1960s, recognizing that such an inward-focused strategy was not viable in the country s small domestic market, the government shifted toward export-led growth. The government intervened widely to promote its heavy industrialization plan of 1981, as petrochemical and auto plants and iron and steel mills were constructed, but is shifted strategies in 1986, introducing deregulation and turning to the private sector as the engine of growth. It encouraged foreign investment in export-oriented high-technology firms. Real GNP grew 8.5% annually from 1988 to 1995, bringing per capita income to $4,000, while inflation remained moderate. In the late 1980s, the current account shifted into deficit, financed primarily by private inflows of capital. By July 1997, while most observers remained confident about Malaysia s continued economic growth, some were warning that the economy was overheating. The Crisis Unfolds 10 In mid-1997, analysts were still asking how the Asian miracle could be emulated elsewhere. They saw economic conditions as favorable: Growth was strong and unemployment low. Both foreign direct investment and financial inflows were strong. Exchange rates were credibly fixed, and interest rates were appropriately higher than in advanced nations. Banking sectors were growing rapidly, and stock markets were buoyant. On the negative side, public and private debt was rising. But many analysts said the debt looked manageable based on published data. Current account deficits were increasing. But even though its account deficit was 8% of GDP, the Financial Times argued, Thailand could still finance one of the highest rates of investment in the world without a cent of net capital inflow. 11 Some wondered if Asia s growth was driven simply by mobilizing capital and labor, like the Communist miracle of the 1950s and 1960s. 12 Others argued that it was based on sustainable productivity growth. In particular, foreign fund managers and credit analysts liked what they saw. Foreign capital in the form of short-term lending, especially by European and Japanese banks, portfolio flows into the region s emerging securities markets, and FDI in productive capacity flooded in on an unprecedented scale, hardly pausing to draw breath after the Mexican peso crisis of Chronology of the Crisis January March 1997 Hanbo Steel, a leading South Korean jaebol, fails with debts of more than $6 billion. Sammi Steel subsequently fails. Somprasong, a Thai company, misses foreign debt payments. Recognizing that financial companies are threatened by bad real estate loans, the Thai government pledges to purchase $3.9 billion of them but later rescinds the pledge. The Malaysian central bank seeks to prevent a bubble by restricting banks from purchasing real estate and stocks. IMF Managing Director Michel Camdessus states that the crisis will not develop further. April May 1997 As problems with Thailand s finance companies persist, Thai authorities are forced to suspend trading in their shares on the Bangkok Stock Exchange. 4

5 Financial Crisis in Asia: (Abridged) Bank of Japan officials hint that they may raise interest rates to halt the yen s depreciation. Fear of a possible interest rate hike possibly leads some investors to withdraw funds from Southeast Asia and Korea. The Thai baht is attacked by speculators. Spillover tremors cause the Philippine central bank to raise the overnight interest rates that it charges commercial banks to 13%. June July 1997 The attack on the Thai baht continues. Prime Minister Chavalit Yongchaiyudh states that he will not devalue. Finance Minister Amnuay Viravan adds that devaluing would cause the bankruptcy of many financial institutions, which have large foreign debts; a rise in the cost of critical imports; and the failure of many firms. The Ministry of Finance uses foreign reserves to buy baht and raises interest rates, bringing the cost of overnight funds to 20% for banks and 25% for finance companies. Amnuay resigns on June 19. The new finance minister, Thanong Bidaya, faces a grave situation: Foreign debt is high; the current account deficit is 8% of GDP; exports are becoming less competitive; and the Bank of Thailand has lent over U.S. $8 billion (in baht) to weak financial institutions. Of Thailand s supposed $30 billion in foreign reserves, only $1.14 billion remain available, barely enough to cover two days imports. Bidaya ends support for financial institutions, and 16 of them shut down, including the prestigious Finance One. Having assumed authorities would not let these institutions fail, investors had underestimated the risks of investing in Thailand, and now they panic. On July 2, Thanong floats the baht, and foreign investors flee, causing a 15% collapse in its value. Thailand begins negotiations with the IMF, which sets stringent conditions for overhauling the economy. As a first step, Thailand allows foreign ownership of financial firms above the previous 25% limit. In the bahtulism effect, international investors re-evaluate Asian economies. The Philippines raise the overnight lending rate to 24% and indicates that it will allow the peso to move in a wider band relative to the U.S. dollar. The IMF grants the Philippines $1.1 billion in emergency assistance. As the Indonesian rupiah suffers speculative attack, the central bank widens the trading band from 8% to 12%. Singapore s currency depreciates. The Malaysian central bank spends substantial foreign currency reserves to defend the ringgit but lets it float on July 14, and within ten days it hits a 38-month low. Prime Minister Mahathir Mohamad claims that rogue speculators caused the problems and calls George Soros a moron. Infamous for having profited from and, some argued, helped to cause the British pound to crash 1992, Soros also gained by shorting the baht. Kia, South Korea s third largest car maker, petitions the government for emergency loans. August September 1997 Thailand announces a financial-sector restructuring, suspending 48 finance companies. The IMF responds by announcing a rescue package of loans totaling $17 billion, but in September it states that it is growing impatient with the slow progress of the financial restructuring. The Indonesian rupiah comes under speculative pressure and hits a record low on August 13. Indonesia allows it to float on August 14, and it sinks to another record low. The central bank significantly raises interest rates, while the government announces reforms delaying major infrastructure projects and lifting restrictions on foreign purchases of newly offered public companies. The rupiah continues to depreciate. 5

6 Financial Crisis in Asia: (Abridged) Speculators attack the Malaysian ringgit. Mahathir announces the delay of several multi-billion dollar construction projects, but the ringgit and stock market continue to decline. Mahathir suggests that currency trading and convertibility may be restricted, but international pressure forces him to back down. At the annual conference of the IMF and World Bank in Hong Kong, he makes a speech declaring, Currency trading is immoral and should be stopped. 13 George Soros responds, Dr. Mahathir is a menace to his own country. 14 The Hong Kong dollar is attacked, the Monetary Authority pushes interest rates up, and the stock market sinks. The Philippine peso continues to fall, hitting a record low, but central bank intervention arrests its slide. China announces a new long-range goal of major privatization of state-owned enterprises. The president discusses overhauling capital markets to provide increased support for public offerings and mergers and to allow more bankruptcies. Some analysts say that China may be acting preemptively to stave off contagion. October November 1997 In early October, the Indonesian rupiah drops to a new low. Indonesia gets a $28 billion rescue package from the IMF in exchange for announced reforms. IMF Managing Director Michael Camdessus states that the package should end Asia s economic destabilization. As part of the reform, 16 commercial banks are closed. Some commentators, notably Jeffrey Sachs of Harvard University, attack the decision to close them, arguing that it will lead to an unnecessary tightening of domestic credit at a time when solvent companies are failing due to liquidity problems. 15 The stock market and the rupiah continue to decline. After only 11 months in power, the Thai prime minister resigns. The legislature loosens rules restricting foreign ownership of financial institutions. The IMF agrees to more lenient conditions for assistance. The Malaysian stock market and currency continue to decline. Taiwan is forced to devalue. Hong Kong is shaken by the crisis. In four days the stock market loses 25% of its value, a scare widely attributed to Taiwan s devaluation. Soon the market loses another 5.8%, sending ripples through global equity markets. The Dow Jones posts its biggest single point loss ever. Stocks in Brazil, Argentina and Mexico post their biggest single-day loss. To tighten control over its currency China announces new rules restricting the types of institutions that may hold foreign exchange. The government also announces that mutual funds will be established. South Korea devalues the won and allows it to fluctuate by 10% per day, up from the previous 2.5% limit. The Finance and Economy Ministry claims that sheer speculative foreign press articles is putting pressure on the currency. He declares that Korea will never seek IMF assistance and asks Japan to help roll over short-term loans. But the trade deficit is ballooning; the financial system is burdened with billions of dollars of bad loans; and 8 of the 30 largest jaebol are bankrupt or under severe strain. Ratings agencies downgrade Korea s foreign debt. The still-falling currency has lost 14% of its value, the stock market 28% in The finance minister is fired. The new minister says that Korea does need IMF assistance. A public outcry erupts. South Korea s financial turmoil raises fears of global contagion. Brazil announces $18 billion in budget cutbacks and raises interest rates to reassure investors that it will defend the currency. December 1997 Thailand closes 56 finance companies, the baht hits its lowest level on record, and government debt is downgraded to junk bond status. The IMF forecasts that the economy will stagnate in

7 Financial Crisis in Asia: (Abridged) The Malaysian ringgit has declined 33% and the stock market 50% since July. Finance companies have eased credit in response to many firms severe liquidity problems, but as a result the financial companies non-performing loans have swelled. It is feared that the economy could be dragged down in a vicious circle of corporate and banking failures. The government announces an austerity program cutting public spending 18%, reducing the current account deficit from 5% to 3% of GNP, letting banks terminate credit to borrowers, allowing bad banks to fail, and limiting new bank credits. Government debt is downgraded to junk bond status. South Korea s currency and stock prices have lost half of their value. New information reveals that only $6 billion of the supposed $23.9 billion of foreign reserves on December 2 are usable. The remainder has been devoted to repaying foreign debt of the central bank and commercial banks that was not renewed. Coryo Investment & Securities declares bankruptcy, the first Korean financial institution to fail in over 30 years. The authorities negotiate a U.S. $57 billion bail-out plan with the IMF in exchange for reforms. Foreigners, formerly only allowed to own 7% of Korean firms, can immediately acquire up to 55% of their stock and will be allowed to acquire 100% of it by the end of the year. 16 Foreign banks may now buy Korean banks. Korea floats the won; orders jaebol to increase transparency; and requires banks to meet stricter prudential standards. Many South Koreans express rage and humiliation, and unions threaten all-out strikes if companies lay off workers. Newspaper editorials accuse the U.S. and Japan of using the financial crisis to force South Korea to open its markets further. On December 18, voters elect former dissident Kim Dae-Jung as president. Kim was highly critical of the IMF bailout during his campaign and declared that Korea was close to bankruptcy. But by the end of the December, he appears committed to IMF reforms after all. On December 30, several major international banks announce they will roll over South Korea s $100 billion in short-term debt. Indonesian President Soeharto takes an unprecedented 10-day home rest, raising fears that he is ill. 17 Revelations indicate that the country s total debt is nearly $200 billion, as compared with the official figure of $117 billion, and analysts worry that Indonesia is not taking its reforms seriously enough. A severe drought and food shortages, it is feared, could lead to civil unrest. Having declined 58% since July, the rupiah continues falling. Government debt is downgraded to junk bond status. China vows it will not devalue, reassuring analysts who fear that a Chinese devaluation would set off another round of regional devaluations and potentially cause Hong Kong to lose its peg to the U.S. dollar. Many analysts believe Asian currencies are now undervalued in terms of fundamental economic measures. Even so, they do not predict a quick rebound. Some say that downward pressure on currencies could continue. The IMF forecasts that world economic growth will be 3.5%, down from 4.3% in September. It calls the slowdown an unavoidable consequence of the type of crisis affecting a number of the Asian economies. 18 January 1998 China announces major reforms, among them reorganizing the central bank, closing 150 trust companies and 12 informal OTC exchanges, and granting more autonomy to the top four state-owned commercial banks, so they can shut down unprofitable branches and accelerate write-offs of bad debts. Investors are questioning Indonesia s commitment to reform. The head of Asian currency trading at a German bank in Jakarta states: We basically want to see if Indonesia will do anything to achieve the necessary compliance with the IMF.... [T]he rupiah s direction hangs on this. 19 Some news 7

8 Financial Crisis in Asia: (Abridged) aggravates doubts. The liquidation of PT Bank Jakarta, owned by Soeharto s brother and scheduled to be closed in December, is delayed. Research and Technology Minister Jusuf Habibie, viewed as a proponent of large-scale industrial policy, is rumored to be President Soeharto s vice-presidential candidate in upcoming March elections. There are reports of panic food buying, and social cohesion is threatened. Soeharto is under pressure to step down. A new IMF agreement requires new financial reforms but does little to restore confidence. It allows foreign investment in domestic banks and guarantees commercial bank obligations. Debt payments are frozen pending a solution to the problem of 228 firms that are unable to service their debt. Indonesian stocks decline sharply. The rupiah falls to 17,000 per dollar, thus losing 80% of its value since July, but recovers to about 10,000. As Thai growth slows, labor unions threaten mass protests if nothing is done to mitigate expected increases in unemployment. The government implements austerity programs and cuts its 1998 budget from 982 billion to 800 billion baht but petitions the IMF to further ease the terms of its bailout package. The baht continues to decline, dipping through the psychological barrier of 50 to the dollar for the first time half its July 1997 value. South Korea closes 10 of its 30 merchant banks, which specialize in short-term corporate lending and were responsible for billions of dollars of bad loans. President-elect Kim says: We re just entering a dark IMF tunnel.... It s very much clear that in an era of a global economy, we can t survive without foreign investment.... [B]y allowing layoffs, we ll lose 20% but save the other 80%. 20 Foreign exchange reserves stabilize. The Philippine peso drops to a new all-time low against the U.S. dollar, as does the Malaysian ringgit. February March 1998 Following the Asian New Year, equities and currency markets throughout the region post sharply higher returns. There is widespread sentiment that the Asian crisis is over. Confidence in South Korea is recovering as it makes progress toward economic reform. Standard & Poor s upgrades its credit rating, and the IMF raises its lending to $15 billion. Foreign banks restructure over 95% of the short-term debt that had been threatening the financial system, rolling more than 80% of it over into bonds with two- to three-year maturities. The government says that the banking system s bad debts in 1997 only amounted to 6% of total loans, but some critics suggest that the real figure could be as high as 15% to 20%. Thailand wins concessions in its IMF agreement. The Fund will let it run a 1-2% budget deficit in lieu of a budget surplus and will allow a reduction in interest rates. An IMF official remarks: The government has control of the financial system and is creating stability. 21 Equity and currency markets rise based on the perception that Thailand is implementing the appropriate IMF-sponsored policies. In March the 76-year-old Soeharto is re-elected president of Indonesia and Habibie is, indeed, elected vice-president. As inflation reaches 12.8% per month, the government warns that the economy is on the brink of hyperinflation. As food prices rise especially rapidly, mobs loot and burn shops owned by ethnic Chinese. Troops fire on the mobs. Despite an IMF prohibition, Indonesia announces that it will subsidize imports of food and other essentials. The government warns that any IMF delay in disbursing funds will hurt regional currencies. Soeharto s cabinet appointments marginalize Western-trained technocrats and undermine confidence in his commitment to reform. He makes his daughter social affairs minister. She presides 8

9 Financial Crisis in Asia: (Abridged) over a conglomerate that stands to lose government contracts if IMF-sponsored regulations for public bidding are enforced. He appoints a golf partner, who heads a conglomerate targeted by the IMF for its dominance of the forestry industry, to oversee the Ministry of Trade and Industry. His new finance minister sits on the board of two state banks that have made loans to his family businesses. And his new coordinating minister for economy, finance, and development is known for opposing IMF-style market liberalization. Even so, by the end of March Indonesia s prospects appear to be improving. The World Bank announces it will coordinate an international effort to provide $1.5 billion worth of food and other essentials. The IMF announces that it is making considerable progress towards a new agreement with Indonesia that will maintain subsidies for food and basic medicines. The central bank raises key interests rates to 45% per month, a decision that encourages the IMF, and abandons a proposed 5% tax on foreign currency purchases. Confidence in IMF-sponsored reforms helps the Philippine peso to rise in value, and China s new premier inspires confidence by stating that China will defend the Hong Kong currency board at any cost. However, Malaysia announces that one of its top 10 banks requires a capital infusion of more than 1 billion ringgit and that the second-largest bank and two finance companies may also require significant new capital injections. The announcement weakens currency and equity markets throughout the region. Japan s Economic Planning Agency declares the economy stagnant with the worst performance for over 20 years. Japan s ruling party announces a package of economic reforms, the fourth since October designed to stimulate the economy. Analysts widely criticize the plan as being a half measure at best. The latest trade report of the United States suggests that the Asian financial crisis is beginning to affect its economy. The trade deficit increased 24% in December; the deficit for 1997 was the largest in nine years. April 1998 South Korea gets strong interest in a U.S. $4 billion bond sale, and officials meet with North Korean counterparts, the first official bilateral contact in four years. The government lifts restrictions against foreign-led takeovers of domestic firms and, for the first time, allows foreign brokerages and banks to open wholly owned subsidiaries in Korea. But the economy still faces troubles. In the first quarter, 10,000 firms have failed, as compared to 14,000 in the previous year. Jaebols Debt-to-equity ratios run an average of 200% to 400%. Indonesia signs its third agreement with the IMF since the onset of the crisis. Jakarta secures a new plan to restructure $68 billion in foreign corporate debt, and it is allowed to maintain some subsidies for foods, medicines, fuel, other commodities, as well as limit interest rates for small firms and cooperatives. In return, the government commits itself to dismantling monopolies, pledges to expedite the pace of bank reform, and promises to maintain high interest rates to stabilize the rupiah. Indonesia announces that 95% of the country s 200 banks will require new capital. A total of 54 troubled banks are under supervision of the Indonesian Bank Restructuring Agency. Thailand announces that its central bank will set more stringent bank accounting standards for loans. One-quarter of all bank loans are listed as non-performing. Malaysia reports difficulty in implementing reforms to force consolidation in its banking industry. Japan adopts the first measures of the country s Big Bang deregulation of financial markets, lifting most restraints on foreign exchange trading and letting markets determine formerly fixed commissions on large equity transactions. But the economy is doing badly. The chairman of Sony warns that it is on the brink of a collapse and could cause a world-wide recession. Moody s 9

10 Financial Crisis in Asia: (Abridged) speculates about downgrading Japan. The prime minister promises efforts to reinvigorate growth, including tax cuts totaling 30.5 billion. The Future... In mid-1998, it was difficult to predict what would develop next. The IMF faced sharp criticism for its handling of the crisis. 22 Joseph Stiglitz, chief World Bank economist, blamed it for advancing the interests of Wall Street over those of Asian nations. The fund had forced up interest rates, thus stabilizing Asian currencies and rewarding foreign investors, but driving the economies into deep recession. The fact that foreign investors had not paid all the consequences of their risk-taking could encourage more of risky behavior in the future. Stiglitz also criticized the IMF for using the crisis to force Asian nations to open up their financial sectors to Wall Street. Even the conservative Nobel laureate Milton Friedman charged that the IMF was hurting the countries [banks were] lending to, and benefiting the foreigners who lent to them. The liberal Harvard economist Jeffrey Sachs proclaimed, Asia would have been better if the IMF had never set foot in these countries. Still, many observers were becoming optimistic about the economic prospects of the majority of affected countries. Thailand, Malaysia, and South Korea seemed to be making important steps toward recovery. Even Indonesia despite its political and social instability and inability to meet IMF requirements appeared to be preparing for a credible recovery. In a report on the crisis, Goldman Sachs economists emphasized their optimism: The time may soon be right to invest in a basket of Asian currencies, to take advantage of greater stability in nominal exchange rates. Yet they acknowledged that there is no quick-fix available for the Asian crisis. 23 The broader implications of the crisis for future global investment and trade remained uncertain. 10

11 Financial Crisis in Asia: (Abridged) Exhibit 1 Selected Asian Economies: Basic Economic Data a China Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance External sector service Hong Kong SAR Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b ` Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance External sector service Indonesia Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance External sector service

12 Financial Crisis in Asia: (Abridged) a Japan Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance External sector service Korea Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance External sector service Malaysia Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance External sector service

13 Financial Crisis in Asia: (Abridged) a Philippines Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance l External sector service Singapore Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance External sector service Taiwan Province of China Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance External sector service 13

14 Financial Crisis in Asia: (Abridged) a Thailand Real sector Real GDP growth b Inflation b,c Domestic saving Fixed capital formation Public sector General government balance Public sector balance Monetary sector M2 growth (end of year) b Domestic credit growth (end of year) b Foreign liabilities of banks d External sector Current account balance External sector service Source: Compiled from International Monetary Fund (IMF), World Economic Outlook, December a Estimate. b Annual percentage rate. c Consumer price index. d In percent of total liabilities of the banking system. e Includes only goods and nonfactor services. f Excludes prepayments and refinancing and includes staff estimates of short-term interest payments. 14

15 Exhibit 2a General Economic Indicators Exhibit 2b Selected Asian Economies (and U.S.): GDP per capita Average Korea, Indonesia, Malaysia, Philippines, Thailand Current Account Balance (%GDP) Real GDP Growth CPI % 5 0 Japan Hong Kong Singapore Taiwan Korea Thailand Malaysia Philippines Indonesia China U.S GDP per capita (thousands U.S.$ at ppp) Exhibit 2c Selected Asian Economies (and U.S.): Real GDP Growth Exhibit 2d Selected Asian Economies (and U.S.): Real GDP Growth 12 Malaysia Singapore Indonesia Hong Kong Korea U.S Taiwan Philippines U.S. Thailand % % Source: Exhibits 2a-d: Calculated based on data from EIU Country Data, September 2004.

16 Exhibit 3a Selected Asian Economies: Manufacturing Wages Exhibit 3b Selected Asian Economies: Investment Spending (% GDP, 1996) $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $- $7.40 $7.28 $4.29 $6.14 $5.82 $4.85 $1.20 $ Hourly Compensation 1995 Hourly Compensation in End-of-Year 1997 Dollars $0.61 $0.51 $0.33 $0.22 $0.25 $ Korea Singapore Taiwain Malaysia Thailand Indonesia China % Malaysia Thailand Korea China Indonesia U.S. Source: Adapted from Fidelity Investments. Source: Adapted from IMF, World Economic Outlook, December Exhibit 3c Thailand: Investment, Consumption, and Current Account Exhibit 3d Mexico & Thailand: Priv. Consump and Fixed Inv. (% GDP) % of GDP 10 Private consumption Gross fixed investment Thai gross fixed investment Mexican private consumption Thai private consumption Current account balance Mexican gross fixed investment % of GDP Source: Calculated based on data from EIU Country Data, September Source: Adapted from IMF, IFS CD-ROM, February 2004 and EIU Country Data, September 2004.

17 Exhibit 4a Selected Asian Economies: Corporate Leverage Exhibit 4b Selected Asian Economies: Export Market Growth 350% 300% 250% 200% 150% 100% 50% 0% 300% Debt-to-Equity Ratio, % 140% 87% 65% Korea Japan Thailand Taiwan Indonesia annual % change, USD basis China Indonesia Korea Malaysia Philippines Thailand (1.3) 3.3 Source: Adapted from André Perold, HBS lecture, Source: Calculated based on data from EIU Country Data, September Exhibit 4c Selected Economy Long-term Interest Rates Exhibit 4d Selected Asian Economies: Exchange Rates 12 Real effective exchange rate (CPI-based, 1990=100) United Kingdom U.S China Indonesia Korea Malaysia Philippines Thailand Germany Japan Nominal exchange rate (end-year against USD, 1990=100) China Indonesia Korea Malaysia Philippines Thailand Source: Compiled from IMF, International Financial Statistics CD-ROM, February Source: Calculated based on data from EIU Country Data, September Note: Increase implies depreciation.

18 Exhibit 5a Local Bank Lending (% GDP) Exhibit 5b Selected Asian Economies: Financial Institutions Claims on the Private Sector (as % GDP) % 120% 100% 80% 60% 40% 20% 0% 89% Korea, Indonesia, Malaysia, Philippines, Thailand 96% 104% 110% 116% Korea Malaysia Thailand Philippines Indonesia Taiwan Source: Adapted from Radelet and Sachs, "Onset of the East Asian Financial Crisis," Source: Compiled from EIU Country Data, September Exhibit 5c Net External Private Capital Flows Exhibit 5d Claims Held by Foreign Banks (USD274.4 bn as of June, 1997) 100 Korea, Indonesia, Malaysia, Thailand, Philippines USD billions 20 Private lending Equity investment Philippines Malaysia Indonesia Thailand Public Banks U.S. Germany Japan USD billions, June 1997 Corporate Others Korea Total outstanding By sector By country of origin Source: Adapted from Institute of International Finance, Capital Flows to Emerging Source: Adapted from Radelet and Sachs, Onset of the East Asian Financial Crisis, Market Economies, 1998.

19 Financial Crisis in Asia: (Abridged) Exhibit 6 Selected Asian Economies: Public Equities Markets (USD billions) Malaysia Indonesia Thailand Korea Singapore Japan U.S. Market Value on 12/ ,301 3,643 Date of Market Peak Feb-97 Jan-97 Jan-96 Oct-95 Jul-97 Apr-96 na Peak Market Value ,777 na Market Value on 12/ ,218 8,929 Source: Adapted from André Perold, HBS lecture, Exhibit 7 Interdependence on Interaction between Japan and Asia Transmission Mechanism of the Asia Crisis Asia Japan Non-performing loans of financial institutions High level of external debt Weak export High-cost economy Aftermath of collapse of bubble economy Capital outflows 4 Non-performing loans of financial institutions Vicious circle Depreciation of currencies 1 4 Long economic doldrums Instability in Financial system Depreciation of Yen Weak import Decline of Economic Activities 2 3 Deterioration of business results of Japanese foreign affiliates 3 Deterioration of corporate profits Decline in stock prices Loss of confidence In Asian economy Decrease in foreign direct Investment to Asia Source: Adapted from the Research Division, the Bank of Tokyo-Mitsubishi Ltd. 19