The global economy has proved that countries are interdependent and not closed economies. Thereby, the economic advancement of one country often depends on how a given country interacts with another country. Investors who have embraced capitalism and the mobility of funds across borders can invest across borders, therefore, taking international finance to a whole new level. Investors are like bees and thus swarm where there is the highest rate of return for their investment in both the short run and long run. Although greed has been accused of leading to economic downturns the truth is that many governments are responsible for using unsound monetary and fiscal policies to control the investor community and their investment activities thereby leading to crises such as the Asian currency crises (Kindleberger, 67). Financial institutions must run investor activities smoothly and ensure that there is a symmetric flow of information and thus when financial institutions fail to supply the required information that empowers investors to make the right decisions then investors will most likely make the wrong decisions that may put economies under risk. The Asian currency crisis was triggered by the failure of the economy of ASEAN (cooperation of Indonesia, Malaysia, Philippines, Singapore and Thailand) and fast spread across other Asian nations through panic and financial Contagion. The decision to help these counties through bailout by IMF and other members of the international community assisted the region to recover from the Asian currency crises of 1997. It is thus clear that governments and other regulatory bodies such as the IMF and World Bank should work hand in hand in developing sound fiscal and monetary policies that will help govern the investment activities mainly when it comes to international finance.
The rise of a global economy has made borders obsolete and hence investors can move from country to county in search of investment opportunities that guarantee them higher returns. The mobility of funds across borders has its advantages and disadvantages but investors are willing to face higher risks to assure that they enjoy much bigger returns when they invest in other foreign markets (Kline & Kevin 103). International Investors always find themselves moving from one area to another depending on how attractive a market is. International fiscal and monetary policies also play a big part in ensuring that the money and stock market activities run smoothly and that there is no chance of large economies affecting the international monetary framework. This is the reason why IMF (The International Monetary Fund) makes sure that it monitors investment activities of investors as far as international finance is involved (Kindleberger 81-90). The activities of the international financial market are mainly motivated not only by the availability of funds, sound fiscal and monetary policies and higher return rates but also by the level of investor confidence. Investors like investing in markets where they have high levels of confidence, hence when investor confidence levels go down then the investors are most likely to panic and take emergency actions that will ensure that they recover their investments. In most instances it is the financial panic that causes mayhem and makes the situation even much dangerous because it spreads like world fire (Krugman 23). The consequences of panic and massive withdrawal of funds are what usually leads to financial crises and economies often end up experiencing capital investment withdrawal that leads their economies into financial depression (Krugman 73). This is thus some of the dangers of capitalism and international investment that has come about as a result of globalization and it is the duty of financial analysts to come up with a financial framework that will ensure that the international financial markets are well regulated and secure to ensure that the incase of widespread panic and loss of consumer confidence can be easily controlled so that the negative effects of such occurrences can be easily controlled in order to prevent failure of economies.
The Asian Crises
The Asian financial crisis gripped Asian economies in July 1997 and its effects spread up to the end of 1999 with most economies within Asia feeling the heat after a ripple effect emanating from the ASEAN nations spread throughout the ASIAN economy. The Asian financial crisis was very serious and spread through most of the Asian economy affecting every economy in Asia (Radelet 39-43). In the early ’90s when the U.S.A was hit by the recession, the Asian economy became a hot spot for foreign investment and more than half of all global investments moved into the continent. Many investors rushed to invest in the ASEAN region due to increasing, and elevated economic growth which boosted the confidence and morale of individuals within the foreign investor’s community (Joelle, Tae-Hee & Jane 56). The fact that there was financial deregulation within the ASEAN region banks and other domestic corporations were able to borrow foreign capital from a wide array of foreign investors in order to finance domestic investments within the ASEAN economies at competitive rates (Diamond & Phillip 411). The main problem is that the deregulation process was not carried out properly especially in Thailand thereby giving room to gross behavior especially because reduced supervision gave rise to an environment where financial investors did not operate with the appropriate financial principles of investment by promising high rates of returns that were unsustainable. The governments of the ASEAN region Governments gave special incentives that encouraged borrowing and foreign investment into the region and this led to a lot of borrowing that later led the region into financial mayhem (Kindleberger 3).
The economic meltdown occurred mostly due to financial contagion which emanated from the collapse of the Thailand economy. Financial Contagion is a situation where panic and worry triggered by the financial collapse in one economy spreads like ripples or wildfire and affects the financial confidence of investors over an entire region or economic block (Diamond & Phillip 419). When investors rush to invest in highly attractive markets then this market usually experiences a large inflow of capital investment which comes from investors but when panic starts to spread through the economy then investors may suddenly withdraw their funds abruptly in this market and these actions may cause simultaneous ripples in other economies that interacted with this economy. Liquidity preference shocks, Speculative attacks and shortage of currency may as a result come about lowering investor confidence in the financial markets (Krugman 1994, 75). With such events occurring then the investor community is more likely to panic and decide to withdraw their funds all at once thus leading those economies which were holding lots of foreign-denominated deposits that were capital investment fall into an economic depression and currency crises.
This was the case in Asia when the Thailand economy went into trouble many investors mainly from the west withdrew the funds that they had invested in this economy. The most affected economies were Indonesia, South Korea, Thailand, Hong Kong, Malaysia, and Laos other economies like China, India, Taiwan, Singapore, Brunei and Vietnam were also affected in a smaller magnitude’. As soon the Thai baht lost value and the Thai Authorities decided to float the baht by cutting value as compared US dollar investors immediately went it panic fearing that the devaluation that came about of the actions of the Thai government would affect their investment by reducing the value of the stocks and real estate rates and also other assets which were held by the investors (Krugman 1994, 76). Investors assumed that other governments would decide to follow the same path and because such actions would devalue the investments they decided to draw the funds that they had invested in the Asian economies.
The simultaneous outflow of capital investment and foreign funds that were held in the Asian economy was very serious that most governments including the Thai government went virtually bankrupt and even had an economic growth rate of 0% in 1998.As a result the ratio of foreign debt to GDP of this Asian country in the ASEAN region rose from 100% to 167% in the biggest ASEAN economies before the onset of the crises but the rates further rose to over 180% when the crises hit in 1997 ( Rakshit 15).This meant that those economies were in trouble and were accumulating foreign debt at a very fast rate. The South Korean economy was fairly strong but the crisis also ensured that the economy also plummeted and its debt to GDP ratio also grew to over 40% (Radelet 34). This happening did not only affect the economic situation of this country but the cost of living in this country rocketed due to the fact that the cost of living in these countries had gone high leading the citizens of these countries to go into the streets and riot. Suddenly the boom that the Asian economies had enjoyed over the years disappeared as soon as the massive outflow of capital investment ensued, and thus the negative effects of free capital mobility and the capitalistic economy were felt across Asian economies (Kindleberger, 17-23). As soon as cash was withdrawn from these economies the citizens of the regions within third region experienced a shortfall of money supply, with the demand for money being high and the supply of money being low then the region entered into a currency crisis ( Radelet & Sachs 219-222).
Tight money when introduced in a financial economy can result in either attraction of funds or repulsion, depending on what the investor expectations are expectations that therefore the result can be a fall or a rise in interest rates. With inelastic expectations whereby investors are very hopeful and do not expect the value of their deposits to fall and raise in the discount rate will definitely trigger capital inflows into an economy thereby ensuring that the economy enjoys high liquidity levels that are good for the economy a while on the other hand with elastic expectations which are unsuitably associated with declining prices, bankruptcies, exchange depreciation together with raising the discount rate may suggest to foreigners the need to take more funds out rather than bring new funds in and therefore if an economy lacks the ability to control this funds and maintain investor confidence levels at a very high rate then the results may not be very pleasing for the economy. It is thus necessary for financial institutions to have a sound framework that will allow investors to share symmetric information that is normally useful in ensuring that investment decisions are made in a climate where investors are fully aware of the most likely outcome.
The Path Leading to the Crisis
The Asian financial crisis was triggered by interlinked phenomena, the single most, responsible defining element that brought about the crisis was the rapid reversal of private capital inflows into Asia by investors who had lost confidence in the markets and were in panic mode from the net capital inflows fell from over $90 billion to $12 billion, a move backward and forward of $105 billion on a combined pre-shock GDP of approximately $940 billion, or a dangle of 11 percent of ASEAN countries Gross Domestic product, $77 billion of the $105 billion the decline came about from activities of commercial bank lending (Rakshit 50-77). Although direct investment stabilized at approximately $7 billion, the rest of the decline comes from a $24.1 billion reduction in portfolio equity together with a $ 4.98 billion reduction in non-bank lending activities within the economy (Radelet (a) 71).
Foreign bank lending in ASEAN countries increased rapidly to over $210 billion by the end of 1995 and to $261 billion in the fall of 1996, this represented a 24 percent in a single year. From the last quarter of 1996 to mid-1997 bank lending expanded further to $274 billion, which represents a further annual increase of 10%. The growth in bank loans might have slowed down in the first quarter of 1997, especially in Thailand; however, outside Thailand, other ASEAN nations continued borrowing heavily until mid-1997 even making the situation worse (Rakshit 78-91). Thus in a short period, the first quarter of 1997 the ASEAN countries according to IIF and BIS had borrowed close to $ 34billion which was approximately 3% of their $ 935bilion GDP and no money was coming into their economies thus making it even more unlikely for these countries to repay these loans and some of them went bankrupt. Consequently the move back and forth in bank loans between 1996 and the second half of 1997 is an outstanding 10% percent of Gross Domestic Product of these ASEAN countries (Rakshit 114-117).
Signs and reasons Behind the Crisis
The most unusual thing about the Asian currency crises is that the crises were hardly predicted by analysts and participants of the financial market. Even though observers did expect this they did not even think that the failure of these economies would result in the possibility of a crisis that big (Kindleberger 23-25). The fact that the ASEAN financial systems do not warn participants in advance made it more critical that analysts needed to understand what was going on and prevent any other future occurrences. Although some analysts had dismissed that the Asian market was a good market for investors by claiming that the growth experienced between 1990-96 was only as a result of hot cash being injected in the Asian economy as a result of foreign investment. Many investors ignored the argument that insisted the high rate of returns was only a result of a speculative bubble that was not backed by a real increase in total factor productivity (Diamond & Phillip 413). This argument further stated that therefore would reach a time that some of the ASEAN economies would no longer be able to sustain the high rate of returns that they offered on foreign investments and that this would push their countries into debt and economic downturn. Despite the fact that capital inflows were relatively stable in 1996, and up to mid-1997, it was only equity markets in Thailand and Korea, where investors had started panicking in 1996.
Some economists argued that policies governing the borrower-lender relationship contributed a lot to the deterioration of the Asian financial market. The fact that the governments loosened their grip and deregulated the financial industry typically encouraged risky financial behavior in the financial community of most Asian countries. The Equity markets started declining in March 1997, but funny enough bank inflows persistently continued to be very strong until the end of the second quarter that year. Risk premia linked to loans to the up-and-coming market economies are usually high to attract investors from developed nations (Kindleberger 103). The extent that markets anticipated in the case of the Asian economy the growing risks of capital inflows, lending terms and circumstances would have tightened in advance before the crisis occurred, but this was not the case the exact opposite happened. The risk spread of American-held securities drastically went down in emerging markets, especially in Asia and when mid-1997 came the levels were then below what could be justified by economic nitty-gritty in this region (Radelet & Jeffrey 213). Correspondingly, syndicated loan spreads also went down drastically in Indonesia, Malaysia, the Philippines, and Korea, although syndicated loan spreads were the first quarter of 1997 as compared to 1996, Thailand was the only country where its spread continued rising in early 1997 but commencing from a very low base. The spread on Thai Radelet, Sachs “The beginning of the currency crisis (ASEAN)“sovereign bonds were extremely low 39 basis points mid-1996, and they rose to a mere 43 points at the end of 1996 (Rakshit 233-237).
Apart from deregulation, the role of credit rating agencies can be blamed for contributing a lot to the occurrence of the Asian currency crises. This is because information asymmetry did not exist in this market then, If the markets anticipated an economic crisis and public sector bailouts, the ratings of autonomous bonds are supposed to go down as the crisis approached, but instead credit rating bodies gave no clues to investors that this was likely to happen until the crisis finally came to be and hit most of the Asian economies (Diamond & Phillip 405). The same also applied to Long term autonomous debt ratings which remained majorly unchanged during the same except for the Philippines, where the ratings were upgraded in the first quarter of 1997. The economic forecasts thus described the situation in each country following their reviews as positive/suitable/good through June 1997 giving the investors confidence in these financial markets. It only took a few weeks after the crisis hit the Asian economy that credit rating agencies decided to downgrade the region’s debt to junk status. The credit rating Agencies had therefore let down the investor public because rather than assisting the investors to assess risks the agencies had failed and therefore the only option that was left was for the investors to panic and withdraw their funds at a very fast pace ( Radelet & Jeffrey 98).
Besides the credit rating agencies, a number of independent firms had stepped in to provide ongoing risk Analysis. Euro money Country Risk is one such independent firm that traced the changes in risk attached to the key Asian economies according to the Euro money rankings. But their findings just like the findings of the credit rating agencies were completely useless and of no help to the investor community because in most cases, Asian country rankings changed little or even improved between March 1993 and March 1997. The findings were thus misleading and deceptive to the investors and these investors had the wrong information as far as risk assessment was concerned (Diamond & Phillip 404). The ratings given by the Euro money rankings handed Philippines’ that was very encouraging to the investor community and also went ahead to convince investors that Indonesia’s and Malaysia’s credit ratings were steady and thus a good investing environment. Just like the credit rating agency reports the Euro money reports indicated that Thailand’s and South Korea’s rankings had fallen tremendously. These rankings were wrong and inaccurate because it only took 5 months for the real picture to occur and many investors within Asia especially in the ASEAN market to be hit by the worst financial crises to ever hit Asia (Radelet (b) 55).
Some economists also argue that the fact that the American economy pulled itself out of the recession that hit the economy in the early ’90s then there was no reason for investors to continue investing in Asia because back then the rate of return on investments within America was very high, in fact, higher than Asia making it logical for investors to rush back into the American economy in order to invest (Kindleberger 11-115). This in turn meant that raised interest rates in America made Asia less attractive than America, therefore Asian economies that held a lot of cash deposits in Dollar Denominated currency were destined to see deteriorating current accounts because these countries were expected to pay more for their imports and earn less from their exports. If the boom of the American economy made the exports of these countries far much less attractive and reduced the competitive edge of these countries then the logical thing for investors to do was to transfer their funds from Asian economies and take the capital investments back to America (Rakshit 22-231). Thus if investors and credit rating agencies had taken a look at the whole picture and compared Asia relative to America in the mid to late90’s then this information would have been useful to investors because it would have enabled the investors to assess the risks that they faced in a much better way and avoid plunging the whole region into economic chaos or losing money.
Now that the economic crises had gone full scale it was up to the international community through the IMF to intervene in the situation and help this region pull itself out of the financial mayhem that the region had plunged into. One month after Thailand floated the baht; on August 4th, 1997 the country announced that it had come together with IMF in order to ensure the current economic situation back then using a well-structured stimulus and reform package. The arrangement stated that IMF had a 34-month; $17.2 billion standby program which was approved by the Fund Board. The fund came about as a result of contributions by The IMF $4 billion, World Bank and Asian Development Bank $2.7 billion, individual governments the balance of $10.5 billion, $3.5 billion from ASEAN countries (Rakshit 56-60). Japan contributed $4 billion but surprisingly the U.S.A did not contribute to the fund. Indonesia signed a 36-month, $40 billion package on October 31st, 1997 (Rakshit 133). Although IMGF facilitated and played a big role in ensuring that the stimulus package was put in place the body together with the government made sure that they would embark on treating the root cause of the problem and not only dwell on the symptoms. IMF therefore ensured that it was part of the policy drafting team that would give birth to a more healthy financial system in the region. IMF assisted the countries in the region to put in place debt repayment systems, create a clear non-financial and financial sector structure, and develop tight domestic lending regulations that would reduce risks and reduce the likelihood of default.imf also played a big role in remodeling the banking system by advising the movement on how to close down certain banks and recapitalizing other banks (Diamond & Phillip 419). The entire Fiscal and monetary policy was reviewed to find out where weaknesses existed and how these weaknesses could be overcome by creating the right policies in place.
It can be held that the East Asian currency crisis that crippled and affected the whole of Asia happened because of the vulnerability to the financial system that led to widespread panic that arose from the fact that the ASEAN economies had poor investment policies and the fact that many investors never foresaw the downfall of these economies. It is thus clear that there was a macroeconomic imbalance, weak financial institutions such as credit rating agencies and poor financial practices that led to the crises in the first place. Even though Korea, Indonesia, the Philippines and other ASEAN nations have been able to attract $211 billion in investments between1994 and 1996, the investment framework of this region was weak enough to handle the hot cash and transform the money into total factor productivity, instead the economic growth turned out to be some kind of bubble whereby investor confidence was the only thing running that market and that no real value was being created.
The fact that a good portion of the loans by international banks and almost all of the portfolio and direct equity investments went to non-bank enterprises for which state guarantees were far from assured is a good example of risky commercial behavior that led to the fall of this economy leading to a currency crisis. The role of credit rating agencies can not also be forgotten because they played a big role in encouraging investors by allowing investors to continue investing recognizing by giving good ratings. In other words, the flaws that existed in these Asian economies contributed a lot by allowing the region to enter into the financial crises. Radical policies should thus ensure that investors are supplied with a lot of information that they can use to make critical decisions and reduce the likelihood where unexpected occurrences initiate massive panic which has a shock effect.
For any similar future occurrences to be avoided the governments of the affected countries and especially ASEAN countries should come together and embark on crafting sound fiscal policies that will not only protect their economies but also recover these economies from such an event if it occurs again. These policies should ensure that countries limit the extent of currency depreciation to avoid any future contagion/ or panic from taking place as a result of the devaluation of currencies. Secondly, this should ensure that the environment has a well fiscal balance and that inflation of currency especially in the forex market is controlled by setting confines of countering inflation. Thirdly, sound policies should ensure that once an economy faces such an event then the county has sound frameworks and policies that will assist the country or region to re-establish foreign exchange reserves. During a recession or currency crisis, the confidence in financial institutions and the banking sector usually plummets and it is the role of the government to create financial policies that will be used to restore and reform such institutions.
Diamond, Douglas & Phillip Dybvig. “Bank Runs, Liquidity, and Deposit Insurance.” Journal of Political Economy, vol. 91, 1999: 401-419. Print.
Joelle, Leclaire, Tae-Hee, Jo. & Knodell, Jane. Heterodox Analysis of Financial Crisis and Reform: History, Politics and economics. Cheltenham: Edward Elgar Publishing Limited, 2011. Print.
Kindleberger, Charles. Manias, Panics, and Crashes: A History of Financial Crises, Third Edition. New York: John Wiley and Sons, 2005. Print.
Kline, William & Kevin, Barnes. “Spreads and Risks in Emerging Markets Lending.” Institute for International Finance Research Paper 1997: 97-110. Print.
Krugman, Paul. “The Myth of Asia’s Miracle.” Foreign Affairs, 1994: 73(6). Print.
Krugman, Paul. “What Happened to Asia?” Unpublished manuscript January 1998. 10-23. Print.
Radelet, Steven & Jeffrey, Sachs. “The East Asian Financial Crisis: Diagnosis, Remedies, Prospects.” Brookings Papers on Economic Activity, forthcoming. 1998: 201-230. Print.
Radelet, Steven (a). “Indonesian Foreign Debt: Headed for a Crisis or Financing Sustainable Growth?” Bulletin of Indonesian Economic Studies, vol. 31-39, 1995: 39-72. Print.
Radelet, Steven (b). “Measuring the Real Exchange Rate and its Relationship to Exports: an Application to Indonesia.” HIID Development Discussion Paper No. 1996: 23-56. Print.
Rakshit, Mihir. The Asian currency crisis. Oxford: Oxford University Press, 2002. Print.