Slide 1

1Macroeconomic theory and policy: PresentationSection C : Group 6M V Jairaj| B14147Kiran Mettayil Chacko| B14151Manjot Singh Saini| B14152Monish Agrawal| B14156Divya Aggarwal| F14007South East Asian Currency Crisis

Introduction : Onset of a crises In the 1990s, South East Asian economies of Thailand, Malaysia, Singapore, Indonesia, Hong Kong, and South Korea had a GDP growth rate of 6%-9% per annum, but soon the dawn of crises was sethttp://www.powtoon.com/show/el30YCg4vyF/picto/#/2When miracle became a mirageBoonBaneReasonsBlame it on EconomicsWhat led to growth:Export orientationSoaring property prices due to export led growthBold investments in industrial capacity by exportersHuge infrastructure projects by governmentEncouragement for private businesses by government What led to crises:Financing of extraordinary growth with borrowed foreign money, major share was in form of short term debtExchange rate appreciated in real termsDomestic bank lending expanded rapidly throughout the region, companies defaulted on debt paymentsHeavy investments in infrastructure lead to surplus capacityCentral banks to absorb the risk of exchange rate movements due to lack of government interference High rate of government & private savingLow inflation rates and restrained domestic credit policiesConvertible currencies Unfavorable macro developments Capital inflows, real exchange rate appreciationUnfavorable micro developments credit expansion, financial regulation and supervision3Crises AftermathCommon CausesMovements in the yen-dollar rate and other terms of trade shocks Through trade and financial linkageSpillover Effect Crisis in one country served as a wake up call and forced market recognition of similar financial and institutional weaknesses in the crisis countriesContagion EffectMeasures by GovernmentSpread of CrisesInitial government responses failed to restore investor confidence and capital outflows, leading to seek support from IMF. The key initiatives of IMF were: - Strengthening the financial sector, and improving the efficiency of financial intermediation Improving the functioning of markets including by breaking the links between business, banks and governmentEnhancing transparency with regard to the disclosure of key economic, financial and corporate sector informationTightening the social safety net Why support was seeked from IMFGovernment adopted measures to defend the rate coupled with short lived hikes in interest rates and adopted floating exchange rates4IMF White knight or dark knightOriginal Role of IMFIMF would provide short term financial loans to troubled countries, giving them time to put their economies in orderAs a result of the Asian crisis, in late 1997 the IMF found itself committing over $110 billion in short term loans to three countries; South Korea, Indonesia, and Thailand. Conditions of IMFThe IMF is insisting on a combination of tight macro-economic policies, including cuts in public spending and higher interest rates, the deregulation of sectors formally protected from domestic and foreign competition, and better financial reporting from the banking sectorImpact on Asian TigersTight macro-economic policies are inappropriate for countries that are suffering not from excessive government spending and inflation, but from a private sector debt crisis with deflationary undertones; the tight policy increased the short term interest rates putting pressure on debt repayments IMF created a moral hazard, it arises when people behave recklessly because they know they will be saved if things go wrong. By providing support to these countries, the IMF is reduced the probabilities of debt default, and in effect bailed out the very banks whose loans gave rise to this situationContinued capital outflows and falling exchange rates, the countries experienced much deeper recessions than projected. This reflected mainly a collapse in domestic spending, especially private investment. The countries underwent enormous current account adjustments, associated mainly with sharp drops in import. 5Lessons learnt from the crisesPreventing CrisesAvoid large current account deficits financed through short-term, un-hedged capital inflows Aggressively regulate and supervise financial systems to ensure that financial institutions manage risks prudentlyErect an incentive structure for sound corporate finance to avoid high leverage and excessive reliance on foreign borrowing Managing CrisesMobilize timely external liquidity of sufficient magnitudeDo not adopt a one-size-fits-all prescription for monetary and fiscal policyBail-in private international investors Resolving the systematic consequences of crisesMove swiftly to establish resolution mechanisms for impaired assets and liabilities of banks and corporations Cushion the effects of crisis on low-income groups through social policies to ameliorate the inevitable social tensions6

THAILAND7Prior to the crisisThailand experienced rapid economic growth between 1985 and 1996 averaging 9.8% annuallyManufacturing, agriculture, and tourism were leading sectors of the economy

Many different factors contributed to this rapid growth Policy reforms Infrastructure developmentHigh domestic savingsLow inflationLow wages A stable (fixed) exchange rate

8Timeline of the crisisMay, 1997Foreign speculators attack the baht. Thailand spends 90% of foreign reserves to defend the baht against speculative attack.Thailand changes its exchange rate system from fixed exchange rate to managed-floated. At the same time, the Thai government also requests "technical assistance" from the IMF.July 2, 1997Thailand receives a $17 billion loan from the IMF and agrees to adopt tough economic measures in return.Aug 5, 199756 insolvent finance companies and one commercial bank are closed. The remaining financial institutions suffer from financial panic.Dec. 8, 1997The index of Thailands stock market (The SET), ultimately declines from 787 in January 1997 to a low of 337 in December of that year. Thai economy turns into recession.Dec 31, 1997Thai crisis spreads quickly from Thailand to other countries in the region1997-19989Reasons for the crisis10Reasons for the crisisIncremental Capital-Output (ICOR) RatiosCountry1987-1992 1993-1996China 3.1 2.9Hong Kong 3.7 6.1Indonesia 3.8 4.9Korea 4.0 4.9Malaysia 3.7 4.8Philippines 6.0 5.5Singapore 3.6 4.0Taiwan 2.4 3.9Thailand 3.4 5.1Source: Corsetti and Pesenti (1998)Excessive and Risky InvestmentCurrent Account Deficit (% of GDP) AverageCountry: 1990-1995 1996China 0.9 0.9Hong Kong 3.3 -1.2 Korea -1.2 -4.8Singapore 12.7 15.5Taiwan 4.0 4.0Indonesia -2.5 -3.7Malaysia -5.9 -4.9Philippines -3.8 -4.7Thailand -6.7 -7.911Impact of the crisis and the IMF BailoutHuge devaluation of Thai currency BahtContraction of the economy in the year 1997 by as much as 10%. The exports nose-dived and this created a huge current account deficit and the foreign exchange reserves of Thailand virtually evaporated. It hence necessitatedIMF-led bailoutsAugust 11, 1997, IMF unveiled $17 billion rescue packageAugust 20, 1997 IMF approved another $3.9 billion bailout packageRumors that former Prime Minister profited from the devaluationFinally recovered by 2001, paid off IMF debt in 2003

1996199719981999Real GDP Growth5.9-1.4-10.34.4GDP ($bn)182151112123Per capita GDP6741658058176094Unemployment3.53.27.36.2Export56.058.454.558.5Import72.263.342.449.9Current Acct. Balance-6.2-4.9+2.1+8.612RecoveryStructural Adjustment Package" (SAP) was introducedThe SAPs called on crisis-struck nations to reduce government spending and deficits, allow insolvent banks and financial institutions to failand aggressively raise interest rates.Increase in taxesFinancial restructuringLaws relating to bankruptcy (reorganizing and restructuring) procedures Establish strong regulation frameworks for banks and other financial institutions.

13Thailands: 1997 Crisis to presentThailand enjoyed solid growth from 2000 to 2008 - averaging more than 4% per year ReasonsWell-developed infrastructure, a free-enterprise economy, generally pro-investment policies, and strong export industries,.

The banking sector has also recovered well, with NPLs dropping to around 4-5% of total outstanding loans--a decade ago the ratio was close to 50%. Thai exports - mostly machinery and electronic components, agricultural commodities, and jewelry - continue to drive the economy, accounting for as much as three-quarters of GDP. A process of consolidation in the banking sector has also been under way since 2004, and regulatory standards and bank lending practices have improved markedly.The global financial crisis of 2008-09 severely cut Thailand's exports, with most sectors experiencing double-digit drops.

In 2009, the economy contracted about 2.8%.

The Thai government is focusing on financing domestic infrastructure projects and stimulus programs to revive the economy, as external trade is still recovering and persistent internal political tension and investment disputes threaten to damage the investment climateThere is hardly any growth this year at all.

Spending is weak, investment down, trade and tourism shrinking.

A drought is looming in the provinces and in Bangkok Easy money has pushed the bourse nearly to an all-time-high.

14IndonesiaPre-Crisis Macroeconomic indicatorsHigh GDP growth rate: 7.8%(1996)Inflation (CPI): 6.5%Export Growth: 9.7%Current account Deficit: 4%Gross Foreign reserves: 17.8 billionVulnerabilities to External shocksBank lending to private sector high at 55%(of GDP)Presence of a large number of large Nos of under capitalized banksHigh proportion of NPA at 13%( as a proportion of total lending)Ratio of Short term debts to foreign reserves at 176%Capital inflows were majorly in the form of short term debts which is vulnerable to investor willingness

15Indonesia-Build up of the crisisExport led growth in 1990 -1995Investment and consumption boomHuge inflow of foreign capitalHigher interest ratesSound macroeconomic policiesStable exchange rates

1. Excessive growth2. Overheating of economy3. Rise in inflation 4. Drop in trade surplusBI faces an awkward balancing act:Higher interest rates would curb inflation, but invite further capital inflows and appreciate the currency, which would make exports less competitive in world marketsExport Markets1. Emergence of China made exports competitive2. Slowdown of export growth due to stagnation in JapanDomestic Markets1. Slowdown in demand, plunged prices down2. Contagion effect from other countriesThe lost in investors confidence led to a sudden capital flight from the country dollars(Japan was the major lender: 35% which pulled off its investments in light of its economic recession)National Banking crisis: Debt burden increases as the debt was taken in foreign currencyDefault on the part of firms due to slow export growth and plunging pricesHigh proportion of short term debt obligations Local Currency came under speculative attack and significantly depreciated with respect to US dollars to the point that Indonesia had to freely float the rupiah16Indonesia-RecoveryRoad to RecoveryProvided a bailout package totaling USD $43 billionRequired he closure of 16 privately-owned banks, the winding down of food and energy subsidies, and advised the Indonesian Central Bank (Bank Indonesia) to raise interest ratesFailure: Closure of 16 banks triggered a run on the other banks as well creating a liquidity crunch : Patronage system of Suharto undermined IMF accords Arrival of IMFSecond and third AgreementsProvided provisions for a social safety net, a gradual phasing out of certain public subsidies and the tackling of Suharto's patronage system by ending monopolies large food subsidies for low-income households were granted and the budget deficit was allowed to widenCall privatization of state-owned companies, faster action on bank restructuring, a new bankruptcy law and a new court to handle bankruptcy cases Indonesian government was not fully committed to the reform agendaFourth Agreement and start of recoveryThe removal of Suharto from presidency and new political system catalysed a fourth agreement with the IMF in June 1998 allowed the budget deficit to widen further while new funds were pumped into the economy. Albeit fragile, the country's economy improved gradually through 1999, partly due to an improving international environment which caused a rise in export revenues.17

SOUTH KOREA18South Korea : What led to the crisis19South Korea: TriggerNot a traditional Balance of Payments problem, but a liquidity crisis20South Korea : Reform measures21

MALAYSIA22Malaysia

23Timeline of Malaysia's response to the 1997 Financial Crisis

DateChronicle of Events during the Asian Financial Crisis2nd July 1997-After exhausted of funds defending the Baht. Thailand decides to float it10th July-Bank Negara Malaysia intervene in the Forex market to defend the Ringgit13th August-Mahathir attack rouge speculators and point finger at Soros27th August-Malaysia designate the 100 Index linked counters and banned Short Selling 4th Sept-Malaysian Ringgit continue to plunge20th Sept-Mahathir called for currency trading immoral and be banned in HK 21st Sept 1997-Soros calling Mahathir 'a menace to his country'2nd Oct 1997-Meeting in Argentina. Mahathir and Nor Yaakop finalising the Capital Control5th Dec 1997-Malaysia impose tough market measures by Anwar Ibrahim7th Jan 1998-NEAC was formed16th Feb 1998-BNM reduce SRR from 13.5% to 10% in banks. Boosting liquidity in banks.20th May 1998-Asian currencies continue to plunge20th June 1998-Formation of Danaharta as an asset management company to handle NPLs10th August 1998-Danamodal was formed to recapitalise the Banking Sector16th August 1998-KLCI plunge to the lowest at 260 points1st Sept 1998-Imposition of Capital Control24NEAC (National Economic Action Council) - Objectives25Mahathirs counter strategyForeign exchange rate policiesStability of the currency is crucial external tradePrior to and during the crisis, the ringgit was traded offshoreMahathir banned offshore market trading of the ringgit in September 1998Selective capital controlsMahathir further introduced selective capital control measures For foreign institutions and persons, a 1 year moratorium from the purchase date of shares was imposedon repatriation of proceeds from the sale of those sharesMeasures were also introduced to control conversion of the ringgit to other currenciesExpansionary fiscal policiesTo resuscitate the economy, the government embarked on an expansionary fiscal policyIn July 1998, it unveiled a fiscal stimulus package of RM2 billion which turned the budget from a surplus of 2.5 percent of GDP in 1997 to a deficit of 1.8 percent in 1998 and 3.2 percent in 1999Debt restructuring agenciesthe government established a number of agencies to help restructure both financial and non-financial institutionsDanaharta (the debt restructuring agency) was set up in June 1998 to take over non-performing loans from banks, and to restructure and manage themDanamodal was set up in August of 1998 to recapitalise and restructure troubled financial institutions26Malaysia post crisis

Outward investments and FDI in Malaysia, 19992010 (RM millions)

Average annual growth on selected indicators in Malaysia, 200509 (%)

27THANK YOU!

28