What Caused the Asian Currency and Financial Crisis A Macroeconomic Overview

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What Caused the Asian Currency and Financial
CrisisA Macroeconomic Overview

• By
• Giancarlo Corsettty
• Paolo Pasenty
• Nouriel Roubini

• Presented by
• Amelia Rose
• Deddy Perwira

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Two main hypothesis and interpretation of the
causes.
1. Introduction

• Sudden shift in market expectations and
  confidence.
• The crisis reflected structural and policy
  distortions in the countries of the region.

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Central understanding of the roots of Asian
crisis.
2. At The Root of The Asian Crisis

• The multifaceted evidence on the structure of
  incentives under which the corporate and
  financial sectors operated in the region, in the
  context
• Regulatory in adequacies
• Close links between public and private
  institution

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The problem exhibited three different, yet
strictly interrelated at

• Corporate
• Long tradition of public guarantees to private
  projects, some of which were effectively under
  government control, directly subsidized, or
  supported by policies of directed credit to
  favored firms and/or industries
• Financial

• Investment rates and capital inflows in Asia
  remained high even after the negative signals
  sent by the indicators of profitability.
• Long list of structural distortion in the
  pre-crisis Asian financial and banking sectors
  lax supervision and weak regulation, low capital
  adequacy ratios, insufficient expertise in the
  regulatory institutions, etc.

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• International

• The moral hazard problem hinged upon the behavior
  of international banks, which over the period
  leading to the crisis had lent large amounts of
  funds to the regions domestic intermediaries,
  with apparent neglect of the standards for sounds
  risk assessment.
• A very large fraction of foreign debt
  accumulation was in the form of bank-related
  short term, unhedged, foreign currency
  denominated liabilities.
• The ratio of short term external liabilities to
  foreign reserves was above 100 in Korea,
  Indonesia, and Thailand.
• The sharp appreciation of the US dollar relative
  to the Japanese yen and the European currencies
  since the the second half of 1995 led to
  deteriorating cost-competitiveness in most Asian
  countries whose currencies were effectively
  pegged to the dollar.

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• 3 Current Account Imbalances and Macroeconomic
  Fundamentals

• 3.1 The evidence
• According to Lawrence Summers, close attention
  should be paid to any current account deficit in
  excess of 5 of GDP.
• Several Asian countries whose currencies
  collapses in 1997 had experienced somewhat
  sizable current account deficits in 1990s

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Current account, NIA definition ( of GDP)
 
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• 3.2 Solvency, Resource balance gaps, and
  Sustainability
• The standard theoretical criterion for assessing
  current account imbalance is the notion of
  solvency a country is solvent to the extend that
  the discounted value of the expected stock of its
  foreign debt in the infinitely distant future is
  non positive. In other words, a country that is
  accumulating foreign debt at a rate that is
  faster than the real cost of borrowing, cannot do
  expect to be able to do forever.
• A country could run very large and persistent
  current account deficits and remain solvent, as
  long as it can generate trade surplus.

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• Resource Balance Gaps
• A popular test of solvency in practical term is a
  non-increasing foreign debt to GDP ratio.
• Under the realistic assumption that in the long
  run the interest rate exceeds the growth rate of
  output, a stable debt to GDP ratio is a
  sufficient condition for solvency.
• Resource Balance GAP is the different between the
  current trade balance and the the trade surplus
  required to stabilize the debt to GDP ratio in
  the long run.
• Resource Balance GAP were quite large in 1996

• Korea 4.4
• Indonesia 3.3
• Malaysia 2.3
• Thailand 6.9

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3.3 Output Growth

• High growth rates may induce overly optimistic
  beliefs that the economic expansion will persist
  unabated in the future. Such expectation can then
  drive both a consumption and investment boom.
• In such circumstances, an eternal shock that
  leads to a sudden change in expectation can cause
  a rapid reversal of capital flows and trigger a
  currency crises.

GDP Growth
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3.4 Investment Rate, Efficiency, and Profitability

• Current account National Savings Investment,
  a deficit can emerge from either a fall in saving
  or increase in investment.
• Conventional wisdom holds that borrowing from
  abroad is less dangerous for sustainability if it
  finances new investment rather than consumption.
• The assumption of this conventional wisdom

• The return on investment is at least as high as
  the cost of the borrowed fund
• High investment rates contributes to the
  enhancement of productive capacity in the trade
  sector.

• Compare to the Latin America facing currency and
  financial crisis, Asian countries have very high
  investment rates, how ever the two assumption
  above did not held.

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Investment Rates ( of GDP)
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Incremental Capital Output Ratio (ICOR)

• The ratio between the investment rate and the
  rate of output growth.
• Measure of overall investment efficiency.
• In general, investment is efficient in the Asian
  region except Indonesia.

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3.5 Private and Public Savings

• A fall in national savings caused by lower public
  savings (a higher budget deficit) is typically
  seen as more disruptive than fall in private
  savings.
• The conventional underpinning of this view

• Fall in private savings is more likely to be a
  transitory phenomenon.
• An increase in public sector deficits often
  represents a persistent change which results in
  an irreversible build-up of foreign debt.

• The issue of understanding the role of public
  vs. private saving in current account crisis is
  far from settled.

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Saving Rates

• Asian countries were characterized by very high
  saving rates throughout the 1990s
• From the data before the crisis, there is little
  evidence of public dissaving, so the current
  imbalances do not appear to be the result of
  increased public sector deficits.

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Saving Rates ( of GDP)
Government Fiscal Balance ( of GDP)
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3.5 Inflation

• When currency values are fixed or semi fixed, and
  domestic inflation is above foreign inflation, a
  real currency appreciation leads to decreasing
  cost-competitiveness.
• High inflation rates may signals poor
  macroeconomic policy, and/or sizable fiscal
  imbalances, generating the need for segniorage
  revenue.
• High inflation signals that the fixed or semi
  fixed exchange rate regime is potentially exposed
  to speculative attacks.
• Inflation rates were relatively low in Asian
  countries in 1990s.

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Inflation Rate
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3.6 Openness

• Economies that are relatively open are considered
  less likely to face sustainability problems, for
  two reasons

• A large export sector (generating foreign
  currency receipt) strengthens the countrys
  ability to service its debt obligation.
• The economic and political cost of a crisis are
  relatively large, as the interdependence of the
  economy with the rest of the world is high.

• The degree of openness can be measured by the
  ratio of the average of exports and imports to
  GDP.
• Most Asian Countries were considerably open.

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Openness ((Exports Imports)/2 as a of GDP)