THE ASIAN FINANCIAL CRISIS

1. THE ASIAN FINANCIAL CRISIS

2. SCENARIO • the last decade of millennium witnessed a world in which currency crises occurred at an average of 19 months. • i.e. EMS breakdown in 1992, followed by Mexican crisis in 1994, and the latest 1997 financial crisis engulfed countries of SEA. • characterized by • currency collapse as a result of a drastic depreciation in exchange rate, • depletion of the foreign reserves • a sharp increase of short term interest rate • domestic GDP contracted by huge percentage

3. The causes of Financial Crisis • the question is what causes the problem? • How we can look into it. • There are many competing views in explaining the cause of crisis

4. 4 Views • VIEW 1 - First Generation Model proposed by Eichengree et al 1994 & Second Generation Model proposed by Obstfeld (1994) • VIEW 2 - known as the “fundamentalist” led by Corsetti, Persenti and Roubini [1998a, 1998b] • VIEW 3 - led by Radelet and Sachs (1998), known as “self-fulfillers”. • VIEW 4 - purely a contagion issue or unwarranted contagion.

5. View 1: First Generation Model • First Generation Model – explain crises as a product of budget deficit. • The central bank attempt to maintain a fixed exchange rate with limited reserves. • This leads to a high monetary growth through credit expansionary policy and then trigger inflationary pressure on economy-wide. • Anticipation of future devaluation leads to an accelerated draw down of reserves as speculators attack the currency.

6. View 1: First Generation Model • This view probably fit the experience of Latin American crises. • In Asian countries, hard to accept because they were generally in surplus and as a result, inflation was low. • Above all, Asian countries demonstrate prudent and strong international reserves.

7. View 1: First Generation Model • Face lift to the FGM – some view that implicit guarantees by the government have led banks to engage in moral hazard lending. • The argument is that implicit guarantee in itself represented a hidden government debt. • So the soundness of macropolicy was an illusion and misleading. • Basically to say many governments in ASIAN countries engaged in reckless and unsustainable spending.

8. View 1: Second Generation Model • While the Second Generation Model proposed by Obstfeld (1994) explain crises as the result of conflict between a fixed exchange rate and the desire to pursue a more expansionary monetary policy. • The model can be explained along the line of multiple equilibria. What does it mean?

9. View 1: SGM: Multiple equilibria • The first equilibria – features no attack, therefore no change in fundamental, and indefinite maintenance of the peg. • The second equilibria – is when a speculative attack is followed by a change in fundamental which validate ex- post, the exchange rate change that speculators expected to take place.

10. View 1: Conclusion • Raw conclusion, the two models did not capture well to the Asian financial crises [Krugman 1999, Jomo 1998 Chang et al 1999].

11. VIEW 2 • known as the “fundamentalist” • led by Corsetti, Persenti and Roubini [1998a, 1998b] • basically based from FGM which postulated that the crises reflected structural and policy distortions in the countries of the region which triggered the crises.

12. VIEW 2 • According to the view, the crisis reflected structural and policy distortions in the countries of the region. • Fundamental imbalances triggered the currency and financial crisis in 1997, even if, once the crisis started, market overreaction and herding caused the plunge of exchange rates, asset prices and economic activity to be more severe than warranted by the initial weak economic conditions.

13. VIEW 2: Evidences • As shown in Tables 1 and 2, several Asian countries whose currencies collapsed in 1997 had experienced somewhat sizable current account deficits in the 1990s. • The countries that came under attack in 1997 appear to have been those with large current account deficits throughout the 1990s [refer Corsetti, Persenti and Roubini (1998a, 1998b)]

16. VIEW 3 • led by Radelet and Sachs (1998) • known as “self-fulfillers”. • is an extension from SGM which explain the cause of the crises due to sudden shifts in market expectations and confidence and then initiate the chaos/turmoil.

17. VIEW 3 • sudden shifts in market expectations and confidence were the key sources of the initial financial turmoil, its propagation over time and regional contagion. • While the macroeconomic performance of some countries had worsened in the mid 1990s, the extent and depth of the 1997-1998 crisis should not be attributed to a deterioration in fundamentals, but rather to panic on the part of domestic and international investors, somewhat reinforced by the faulty policy response of the International Monetary Fund (IMF) and the international financial community.

18. VIEW 4 • purely a contagion issue or unwarranted contagion. • Transmitted through • strong similarities across countries in macroeconomic policies and conditions (openness, weak banking system, thin equity market etc.). • relying on similar hard currency/currencies • similar output/production for export

19. REFERENCES • ASEAN ECONOMIC BULLETIN, 1998, VOL.15(2) DAN VOL. 15(3). • Corsetti, G., Pesenti, P. and Roubini, N. (1998). What Caused the Asian Currency and Financial Crises? A Macroeconomic Overview. NBER Working Paper No. 6833. • Radelet, S. and Sachs, J. (1998). The Onset of the East Asian Financial Crisis. NBER Working Paper No. 6680.