Reasons Prof. Dr. John JA Burke

Reasons Prof. Dr.
John JA Burke
Thai Baht Crisis [1997] is part of larger East Asian Financial Crisis There is no one accepted definition or statement of causes Reasons for crisis are matters of debate Common themes emerge among various assessments
Preceding the 1997 crisis

Baht had traded at around 24 Baht per $1 Overnight the value fell 25% Baht eventually reached Baht 40 per $1
Event spread across region

Malaysia, Philippines, Korea, Indonesia
Event then had contagion effect

Russia and Latin America
1988-1995
Period of Thai economic boom Chronic Current Account Deficits Weak Financial System Overvalued domestic currency
May 1997
Foreign speculators attach the Baht Thailand spends 90% of foreign reserves to defend the value of Baht Thailand changes its exchange rate system Fixed exchange rate to managed float Thai government also request IMF technical Assistance Thailand receives $17 billion loan from IMF Agrees to adopt economic measures in return
2 July 1997
5 August 1997
8 December 1997
56 Insolvent Finance Companies and 1 Commercial Bank closed Remaining Financial Institutions are object of financial panic
31 December 1997 Index of Thailands stock market [SET] declines from 787 in January 1997 to 337 in December 1997 Economy enters recession 1997-1998 Thai crisis spreads to Malaysia, Indonesia, Philippines, South Korea, Japan Full Asian Crisis
Conventional View
Since early 1990s Thai Economy Attractive

Massive volumes of capital inflow from abroad
Why Accommodating economic policies [meaning] Healthy looking conditions [what conditions] Recession of European economy Stagflation of Japanese economy
Exchange rate of Baht fixed to basket of currencies, particularly the US Dollar Baht fluctuated narrowly between 24.9125.59 Baht per dollar
Weaknesses in domestic macro-economic fundamentals Weakness in the Financial System Financial liberalisation and volatile international capital flows Speculative attacks and floatation of the Baht Unstable political and social institutions
Current Account Deficit

Persistent current account deficit ranging from (5.08%) to (8.10%) of GDP Lowest among other nations in region
Reasons for current account deficit

Real appreciation of the Baht Large increase in real wage
Structure of the Financial System

Intermediaries for channeling foreign capital into domestic economy
Asymmetric Information: Adverse Selection and Moral Hazard

Adverse Selection: Tendency of lending money to investors who are high risk seekers Moral Hazard: Lending money recklessly without prudent procedure of lending contraction and monitoring
Questions:
Why Thailand became attractive to magnitude of capital inflows Why financial liberalisation and capital inflows were key implications in crisis
Defend Loss of 4 billion dollars of foreign reserves
Switch Fixed exchange rate regime to floating exchange rate regime
Misconduct of financial institutions Delay in policy implementation Unstable political regime
Thai Financial Crisis
Year 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
THB/USD 21.82 23.01 22.99 23.66 27.2 26.32 25.76 25.31 25.72 25.61 25.53 25.42 25.33 25.16 24.93 25.36 31.07 41.32 37.88 40.22 44.51
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
25 31 45 43 31 39 37 42 60 90 68 49
End 1990
9.7 7.7 13 22.6 35.9 46
End 1995
End 1996 End 1997 June 1998 October 1998 September 1999 February 2000
47 38.1
1996 Real GDP Growth (%) GDP ($bln) Per Capita GDP [%PPP] Unemployment [%] Export [$bln] Import [$bln] CA Balance [$bln] 5.9 182 6741 3.5 56 77.2 -6.2
1997 -1.4 151 6580 3.2 58.4 63.3 -4.9
1998 -10.3 112 5817 7.3 54.5 42.4 +2.1
1999 4.4 123 6094 6.2 58.5 49.9 +8.6
Depreciation of Exchange Rates Financial Institution Crises Stock Market Collapses Economic Recessions Political Instability
International investors perceive that similar problems afflict other countries in Asia
Chronic current account deficit Weak financial system
Peripheral countries suffer

Japan Hong Kong Singapore
Chronic CA Deficit and Weak Financial System
Foreign Exchange Crisis Property Market Crash Banking Crisis
Stock Market Crash
Economic Crisis
Political Crisis
Causes
Russia
Russian crisis of 1998
Default on External Debt Ruble lost 70% of value
Triggered by Asian Crisis

Russian economy depended on export of raw materials Fall in commodity prices confronted Russia with lack of revenue to pay off its external debt and to support its currency
Decline in productivity Fiscal deficit Artificially high exchange rates Decline of wages Decline of tax receipts Stock and Bond markets collapsed Bank closures Price level increases
Two economies intertwined Russia is a major export market for Kazakhstan Cheap Russian goods negatively affected domestic production Downward pressure on KZT and balance of payments NBK used $1bln to try to hold the KXT/$ rate
In 1999, Kazakhstan was country in transition

Economy was small and vulnerable Lack of diversification [still persists] Ratio of total trade to GDP was 70%
Most going to Russia
Peg could not be sustained

Devaluation to make exports more competitive and reduce speculative currency attacks
Devalue KZT by 33%

Tenge settled at 133/$1
Tight monetary policy [same thing in Thailand] Regulations on exports, imports and banking were stiffened
Commodity prices recovered Actions of government and NBK not impressive in terms of real effects Had the commodities markets not recovered, the Kazakhstan economy would not have recovered post 1999
Kazakhstan banks made the same mistakes that Thai Banks made in 1997 Aggregate liabilities were estimated in November 2008 at $87.3bln About $40bln was sourced from foreign loans to be repaid in currency of lender In 2009, $10,6 bln was due to be rolled over or repaid in full Simply put, banks are at risk of refinancing risks
Four largest banks in Kazakhstan failed and required bailouts and re-organisation Like Thailand, credit creation led to asset inflation of real property and other assets In 2009, NBK decided on another devaluation
KZT125/$1 to KZT150/$1
Asset inflation reverses
Nobel Prize Winner in Economics 2001
Reasons
High Savings Rate Government investment in education State directed industrial policy Capital controls
Result
Decades of phenomenal economic growth
Loosen capital controls

Borrow fro foreign banks
Speculation against currencies Borrowing abroad

Banks/financial institutions in host country expose themselves top vagaries of international market A rumour is enough to alter foreign bank policy
Eager to lend turns to refusal to roll over If international lenders collectively refuse to roll over loans, economic collapse is self-fulfilling prophesy
Speculators who believe a currency will devalue, move out of the currency into dollars [or an alternative currency] What allows this
Free convertibility The ability to exchange the local currency for a major trading currency
Collectively, as traders move out of local currency, that is, they sell it, the value of the local currency is weakened
Central bank engages in purchasing with foreign reserves its own currency
Eventually this tactic is unsustainable The currency falls in value
Result
Speculators now can take their profits
Example based on Baht Crisis

Assume a speculator borrowed 24bln Baht
Cost was $1,000,000,000 If Baht falls to 40/$1, speculator takes 600,000 and converts it to 24 billion Baht Profit 400,000,000 [perhaps in one week for doing nothing]
Stiglitz raises question

Who is getting bailed out
Answer
Foreign lender International banks not required to face consequences of risk decision to lend
Death Strangling Interest Rates

IMF often insists on increases in interest rates that exceed 25% Result: leveraged firms go into bankruptcy unable to refinance or to pay off debt
Thai Baht Crisis is Over But recently we have witnessed the most significant meltdown of the global financial system International banks constitute a significant segment of the global financial system Que Faire?

Reasons Prof. Dr. John JA Burke

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Reasons Prof. Dr.

Preceding the 1997 crisis

Event spread across region

Event then had contagion effect

Since early 1990s Thai Economy Attractive

Current Account Deficit

Reasons for current account deficit

Structure of the Financial System

Asymmetric Information: Adverse Selection and Moral Hazard

Defend Loss of 4 billion dollars of foreign reserves

Switch Fixed exchange rate regime to floating exchange rate regime

Misconduct of financial institutions Delay in policy implementation Unstable political regime

Thai Financial Crisis

9.7 7.7 13 22.6 35.9 46

1997 -1.4 151 6580 3.2 58.4 63.3 -4.9

1998 -10.3 112 5817 7.3 54.5 42.4 +2.1

1999 4.4 123 6094 6.2 58.5 49.9 +8.6

Peripheral countries suffer

Chronic CA Deficit and Weak Financial System

Foreign Exchange Crisis Property Market Crash Banking Crisis

Stock Market Crash

Triggered by Asian Crisis

In 1999, Kazakhstan was country in transition

Peg could not be sustained

Devalue KZT by 33%

Asset inflation reverses

Nobel Prize Winner in Economics 2001

Loosen capital controls

Speculation against currencies Borrowing abroad

Example based on Baht Crisis

Stiglitz raises question

Death Strangling Interest Rates

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