MULTINATIONAL FINANCE MANAGEMENT

ASSIGNMENT

ON

ASIAN CRISIS AND ITS EFFECT ON THE WORLD

There was no clear indicator which says that the Asian Crisis was a result of domestic policies and practices or to the fundamental and unpredictable nature of the global financial system.

Initially it spread from Thailand to Malaysia, Indonesia, the Philippines, then to South Korea and the blame game was pointed towards domestic ills in the East Asian countries. The overspeculation in real estate and the share market, the collusion between governments and businesses, the bad policy of having fixed exchange rates and the rather high current account deficits. IMF studiously avoided blaming the financial markets, or currency speculation, and the behavior of huge institutional investors.

There was another view that the pace of development in these countries which lead the crisis emerged and spread. This view put the blame on the developments of the global financial system: the combination of financial deregulation and liberalization across the world, the increasing interconnection of markets and speed of transactions through computer technology and the development of large institutional financial players.

This combination has led to the rapid shifting of large blocks of short-term capital flowing across borders in search of quick and high returns, to the tune of US$2 trillion a day. Only one to two percent is accounted for by foreign exchange transactions relating to trade and foreign direct investment. The remainder is for speculation or short-term investments that can move very quickly when the speculators' or investors' perceptions change.

BEFORE CRISIS SITUATION Why was world looking towards East Asian countries?
Until 1997 the countries of East Asia were having very high growth rates. What are the factor for the success of the East Asian Miracle 1. High saving and investment rates 2. Strong emphasis on education 3. Stable macroeconomic environment 4. Free from high inflation or major economic slumps 5. High share of trade in GDP

6. Thailand, Indonesia and South Korea had large private current account deficit. 7. It led to excessive exposure to foreign exchange risk in both the financial corporate sectors. 8. In 1990s the U.S.Economy recovered from recession.

Growth rate of country region wise during 1960 to 1992

A total of US$184 billion entered developing Asian countries as net private capital flows are 1994-96, according to the Bank of International Settlements. In 1996, US$94 billion entered and in the first half of 1997 $70 billion poured in.

SITUATION IN EAST ASIAN COUNTRIES DURING 1997

These countries began to raise U.S.interest rates to head off inflation. At the same time, South Asias export growth slowed dramatically in the spring of 1996, deteriorating their current account position. At the end of 1996, the proportion of loans with maturity of one year or less was o 62% for Indonesia, o 68% for South Korea, o 50% for the Philippines, o 65% for Thailand and o 84% for Taiwan.

The sequence of events leading to and worsening the crisis included the following. 1. Financial liberalization. 2. Currency depreciation and debt crisis. 3. Liberalization and debt: the Malaysian case. 4. Local Asset Boom and Bust, and Liquidity Squeeze. 5. The fall in output. 6. Easing of fiscal and monetary policy.

With the onset of the crisis, $102 billion went out in the second half of 1997. The massive outflow has continued since. These figures help to show: How huge the flows (in and out) can be. How volatile and sudden the shifts can be, when inflow turns to outflow. How the huge capital flows can be subjected to the tremendous effect of "herd instinct," in which a market opinion or operational leader starts to pull out, and triggers or catalyses a panic withdrawal by large institutional investors and players.

It is believed that financial speculators, led by some hedge funds, were responsible for the original "trigger action" in Thailand. The Thai government used up over US$20 billion of foreign reserves to ward off speculative attacks. Speculators are believed to have borrowed and sold Thai baht, receiving US dollars in exchange. When the baht fell, they needed much less dollars to repay the baht loans, thus making large profits.

In an article titled "The Rich Get a Little Richer," the business weekly reported on the recent profit levels of US-based "hedge funds", or investment funds that make their money from leveraged bets on currencies, stocks, bonds, commodities. The magazine says that a key contributing factor for the hedge funds' excellent July performance was "the funds' speculative plays on the Thai baht and other struggling Asian currencies, such as the Malaysian ringgit and the Philippine peso." As a whole, the hedge funds made only 10.3 percent net profits (after fees) on average for the period January to June 1997. But their average profit rate jumped to 19.1 percent for January-July 1997. Thus, the inclusion of a single month (July) was enough to cause the profit rate so far this year to almost double. This clearly indicates a tremendous profit windfall in July.

What happened in Thailand

1. Mid may 97: Thai Baht was hit by massive speculative attack 2. Spark: End-June 97, Thai prime minister declared that he would not devaluate the baht 3. Thai government failed to defend the baht against international speculative 4. Financial crisis hits 5. Booming Thai economy ground to halt, contacted by 1.9% 6. Massive layoffs in finance , real estate & construction: unemployment rate all time high 7. Huge number of worker returning to their villages in the countryside and 600,000 foreign workers sent back 8. Stock market dropped 75%, finance one collapsed 9. Baht reached 56 us$ in Jan 98

What happened in Indonesia

1. Drastic devaluation of the rupiah: from 2,000 to 18000 for 1 us$ 2. Sharp price increase 3. Wake of widespread rioting: 500 deaths in Jakarta alone 4. Governor, bank Indonesia was sacked 5. President Suharto was forced to stop down in may 1998 after 30 year in power

What happened in S. Korea

1. Drastic devaluation of the won: from 1,000 to 1,700 for1 us$ 2. Credit rating of the country (Moodys): A1 to B2 3. National debt to GDP ratio more than doubled 4. Major setback in automobile industry

What happened in Philippines

1. Growth dropped to virtually in 1998 2. Peso fall significantly, from 26/us$ to even 55/us$ 3. President Joseph Estrada was forced to resign

What happened in Japan

1. 40% of Japans export go to Asia, so it was affected even if the economy was strong 2. Japanese Yen fall to 147 as mass selling began 3. GDP real growth rate slowed from 5% to 1.6% 4. Some companies went bankrupt 5. Being worlds largest currency holder, Japan could bounce back quickly

What happened in US
1. Markets did not collapse, but were severely hit 2. NYSE briefly suspended trading, for the first time 3. Dow Jones industrial average suffered as 3rd biggest point losses ever
4. Relationship with JAPAN changed forever: US stopped supporting the highly artificial

trade environment and exchange rate.

EFFECT ON INDIA
The effect of SEA crisis on India intrinsically is mild for the following reasons: 1. Full capital convertibility is not allowed. 2. Lock in period for foreign investment in real estate. 3. Floating exchange rate with some influence by RBI during period of crisis. 4. Strong fundamental growth with services sector being the prime reason. 5. External debt to GDP has been declining for the past few years.

There were two kinds of effects to the Indian Economy. The indirect effect would be the effect of the crisis on the world economy and then the effect of the word on the Indian Economy. IMF had forecasted a growth rate of 4% for the world economy for the period of 1997-98. Later this forecast was downgraded to 3.5 percent. Slower rate of growth had effected the world economy would certainly effect the Indian economy and more specifically Indian Exports in a negative way. Looking at the direct implications of the South East Asian crisis, ie, look at the direct trade links between some of the South East Asian economies and the Indian Economy and examine how they are likely to be affected due to crisis. Thus they had essentially concentrated on the real economy as against the financial economy.

The lessons from developing country crises are summarized as: 1. Choosing the right exchange rate regime 2. The central importance of Banking 3. The proper sequence of reform measure 4. The importance of contagion

The Asian Economic Crisis

Eshan Karunatilleka

ECONOMIC POLICY AND STATISTICS SECTION HOUSE OF COMMONS LIBRARY http://www.parliament.uk/documents/commons/lib/research/rp99/rp99-014.pdf

THE ECONOMIC CRISIS IN EAST ASIA: CAUSES, EFFECTS, LESSONS

By Martin Khor Director Third World Network
http://siteresources.worldbank.org/INTPOVERTY/Resources/WDR/malaysia/khor.pdf