Asian Financial Crisis 1997-1998

Asian Financial Crisis 1997-1998

Introduction

During almost two centuries of the formation and development of the world industrial society, the economies of many countries have been undergoing crises. During the crises there was a decline in production, falling prices, collapse of banking systems, bankruptcy of industrial and trading firms, and a sharp rise in unemployment. In the second half of the 20th century, a significant number of global financial crises occurred. One of them was the Asian financial crisis of 1997-1998. Until the early 1960s the countries of East and Southeast Asia did not particularly stand out on the economic map of the world. Korea and Taiwan, Malaysia and Thailand were perceived in the West as typical developing countries: exotic, impoverished, corrupt. The changes that occurred in East Asia in 1960-1990 really deserve the name of a “miracle.” The average annual GDP growth in this period was from 6.3% in Hong Kong to 7.0% in Singapore. As a result, per capita GDP, which in 1960 was somewhere at the level of Nigeria and Ethiopia, approached the European level, and in some cases even surpassed it. Accelerated industrialization demanded more and more resources, which were limited, and domestic savings began to exhaust. In this regard, local financial systems started to take on increased currency risks, borrowing the majority of short-term loans through local banks in US dollars.

Causes of the crisis in Malaysia

The main cause of the crisis was not the change in expectations in the market, but the fact that fundamental macroeconomic factors that were not up to standard in the late 1990s. These factors include debt and profitability of commercial banks, foreign exchange reserves, balance of payments deficit, monetary policy, investments in the corporate sector, capital inflows and outflows, the real exchange rate, indices of trust and financial fragility, the ratio of savings and investments, debt service, budget deficit, political instability. The Asian financial crisis has demonstrated the presence of interrelated problems in various sectors of the country's economy (Corsetti, Persenti, & Roubini, 1998).

Excessive government support for high-priced and large-scale private sector projects with a long payback cycle, accompanied by direct budget lending and large subsidies, caused problems in the corporate and public sectors. Unlike other countries where funding was provided through bank loans or company loans, Malaysia was characterized by direct financing of private business by the government. In both cases, foreign short-term loans have become the main source of financing. Such excessive lending to the corporate sector by banks and the government caused the government budget deficit in Malaysia by the early 1990s. At the same time, the number of short-term loans continued to increase, as companies had to repay existing loans invested in long-term projects.

The poor level of development of the financial sector, as well as the problems of banks with the choice of projects for investment were the main problems of Malaysia and other countries in the region. Despite the low return on investment, the amount of investments and the volume of capital inflows in Malaysia were high even before the crisis. Another reason for the emergence of a large amount of bad loans was the decision of banks to reinvest short-term loans provided in non-profitable long-term projects. Unlike Malaysia, where the number of non-performing loans in 1996 reached 10% of the total volume of loans issued, in the least affected regions, such as Singapore, the share of “bad” loans was much lower (Goldstein, 1998).

Other condition for the beginning of the crisis in Malaysia were numerous barriers to foreign capital access to direct control of local banks and organizations, as well as the lack of deposit insurance and supervision of troubled financial institutions that could ensure the stability of the financial system. To address these problems, the financial sector was reformed in the 1990s, aimed at liberalizing the market for foreign capital participation, which consequently led to an increase in the supply of cheap loans in the domestic market. However, this reform led to a oversaturation of the market with short-term loans, which, in conditions of market instability and lack of clear regulation, caused its vulnerability to the slightest changes in the global capital market.

Government responses to the crisis

At first, like other countries in Southeast Asia, Malaysia tried to deal with the crisis, following the recommendations of the IMF. They focused on the floating rate of the national currency; exchange rate liberalization; no restrictions on capital transactions; raising interest rates to fight inflation and increase investors’ confidence; minimum state assistance to banks and companies; lifting restrictions on the right of foreigners to own property; privatization of state property; reduction or abolition of government subsidies (HIEBS, 2000).

As Malaysian economist Martin Khor notes, "the application of these principles led to the escalation of the financial crisis into an economic crisis and recession." The crisis spread to the real economy: in 1997, GDP growth was 7.7%, and in 1998 there was a drop of 6.7% (Khor, 1998).

The specific feature of the crisis in Malaysia was that economic growth was closely interrelated with social stability in the society. Therefore, the Malaysian government refused to follow the recommendations of the IMF, considering them too harsh. The example of Indonesia, where the financial crisis led to a change in the leadership, confirmed the validity of Mahathir Mohamad’s concerns about the IMF's advice. Rejecting the policies suggested by the IMF, the government spent a solid amount of money to revive the economy and established control over the capital flow to prevent currency speculation by hedge funds.

The Central Bank introduced a fixed exchange rate of ringgit, which lost 40% during the year of the Asian crisis and banned the use of the national currency outside of the country. The circulation of ringgit abroad, equivalent to almost $6 billion, was necessary to transfer to the country within a month, and the possibilities for converting it into hard currency were significantly limited. The Central Bank of Malaysia also set a limit on the import-export of ringgit, which amounted to one thousand per person, and the export of foreign currency for a resident in the amount of 10 thousand ringgit. Government did not set restrictions on the import of foreign currency. These measures had a positive effect on the increase in the exchange rate of ringgit from 4.18 to 3.98 per US dollar (Ranta, 2017).