Posted in Finance Articles, Total Reads: 7950
, Published on 30 October 2010
The Asian Financial crisis which affected the south East Asian countries in 1997 has lot of similarities with the subprime crisis which engulfed the entire world. During 90s many Asian nations were experiencing unprecedented growth fueled by easily availability of credit. Borrowing in dollars was much cheaper for the companies than in their own currencies.This was because of low interest rates offered by the United States central bank. Economies of South Asia maintained high interest rates attractive to foreign investors looking for high rate of return, as a result of which Asian economies received a large inflow of money. Asian real estate market experienced high rate of growth with government hardly taking note of them and put risk management practices in place. This led to increase in asset prices.
Everything was smoothly sailing until Thai Baht went into freefall after Bank of Thailand could not prevent currency speculators short selling its currency. Just before 1997, thai baht had been target of intense speculative attacks. Thai government was able to fight the speculators by pegging it to US dollars. But it collapsed dramatically caused by the decision of Thai government to float the baht cutting its peg to the USD. The currencies of many Asian economies started depreciating massively as the dollars which were pouring in the financial markets at the back of massive business expansions reversed its direction. Regional borrowers were caught in the quagmire as their debt servicing cost shot up tremendously. This led to increase in number of defaults. Many countries gripped in the Asian Financial crisis needed capital but found funds increasingly unavailable which further contributed to economic destabilization. The crisis saw market capitalization of many financial markets shrink by as much as 85% in US dollar terms. East Asian currencies also depreciated by as much as 50-80% against the US dollar by end of July 1998.
So what are the causes that led to this crisis?
Deregulation and liberalization of financial sector: The deregulation and capital account liberalization saw many countries exposed to risk arising from integration of international financial markets. Deregulation of banks saw them operating in more competitive environment with minimal risk management practices. Capital account liberalization allowed domestic institutions to access funds from international markets which resulted in excessive risk taking and accumulation of short term liabilities.
Underdeveloped debt markets: Lack of well developed debt markets resulted in banks acting as primary vehicle of financing. Banks which mostly had short term deposit had hedge their long term lending which was becoming increasingly difficult. They hedged this risk by providing loans at floating rate of interest to their long term borrowers which resulted in long term borrowers getting bankrupt in case of sudden and sharp interest rate increase which occurred during speculative attack on currencies. Regulation and Supervision of financial institutions: Easy credit norms set by financial institutions led to rapid leveraging of East Asian economies. In an environment which was termed as riskier by many of the financial pundits, there were only three jurisdictions which had ratios higher than minimum set by basel capital accord.
Disclosure and corporate governance issues: Weak financial disclosures and poor corporate governance by domestic financial institutions led to many international financial institutions not rolling over their short term debt and holding domestic currency denominated securities for fear of imminent correction
Currency market activity:East Asian faced rapid devaluation of their respective currencies. The volatility in the currency market spilled into equity markets which resulted in unsettling of real economies. Many portfolio investors moved their investments into safer place. This reallocation resulted in further downward spiral in the currencies.
OTC and off balance sheet activity: These instruments led to massive build up of short term foreign debt. Most of OTC instruments were difficult to monitor because of unregulated accounting processes and disclosures.
Capital flow surges and monetary policy: Low global interest rates around the world led to the start of private flows to developing economies. These capital flows brought along with them significant risks. Increased capital flows resulted in increased economic activity, inflationary expectations, real exchange rate appreciation. Excess liquidity channeled its way into asset markets fueling asset price bubble and also resulted in many countries to run significant current account deficits. In order to make their exports competitive, many countries followed fixed exchange rate system. Vulnerability to sudden reversal of capital flows increased with increased capital flows. With devaluation of thai baht, investors readjusted their portfolios with adverse shock to the macro economy.
Loss of competitiveness arising out from exchange rate policies: The exchange rate appreciation resulted into loss of competitiveness of Asian firms and resulted in decline in global demand of Asian exports.
Are there any similarities between subprime crisis and asian financial crisis? This is a question to ponder upon.
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