Causes, Effects and Lessons of the Asian Crisis: The Case of Thailand (Essay Sample)

Causes, Effects and Lessons of the Asian Crisis: The Case of Thailand
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Introduction
The Asian Crisis which occurred in 1997-1998 was both an eye-opener and influential aspect of the economic outlook of the Asian block. The speed with which the crisis spread to the neighbouring nations indicated the effects of globalization and regionalization. Its effects on financial markets, international trade and GDP of the affected country provided empirical indications of outcomes of failures in the systems. Most economic theorists have indicated that the unexpected change in expectations across the market coupled with dwindling confidence in ability to recover led to the turmoil that generated and fueled the crisis. Corsetti. Over and above the worsening of the fundamental aspects of economic growth, the associated level of panic which affected the most central financial institutions was instrumental in the outcomes. Other views indicate that the dispersion in objectives and outcomes of the primary responses were attributable to the outcome. The distorted and imbalanced responses including massive hedging strategies and exaggeration of the situation set the exchange rates to a downward trajectory. As a result, the root of the crisis can be attributed to actions at the international, national, corporate and household level, which created a perfect environment for emergence and amplification of the meltdown.[Corsetti, Ginacarlo, Pesenti, Paolo and Roubini, Nouriel. 1998. What caused the Asian Currency and Financial Crisis? /research/economists/pesenti/whatjapwor.pdf] [Krishnamurty, Jayasankar. Learning from the 1997-1998 Asian Financial Crises: The ILO Experience in Thailand and Indonesia. 2009 /wcmsp5/groups/public/@ed_emp/documents/publication/wcms_107637.pdf]
Origin of the Crisis
The massive devaluation of the Baht in mid-1997was the primary step towards emergence of the momentous crisis affecting the entire financial sector in the country. On the same date, a downward movement of the stock indices from a number of countries established in 1995 started. At the same time, a reduction in the economic growth of the globe was experienced, creating turbulence with an epicentre in the Asian Block. Soon after, collapse in foreign exchange rates and collapse of the stock market propagated the closure of most financial entities, owing to the challenges in capitalization. In early 1998, the economy had shrunk 10%, implying that most banking institutions were not able to operate. The crisis was characterised by two distinct phases, starting with the global responses to the spillover to Russia and the Caribbean.[Sutthirak, Supwadee and Gonjanar, Patthanij. The Effects from Asian Financial Crisis: Factors Affecting on the Value Creation of Organizations. International Journal of Business and Social Science. 3 (16)] [Sutthirak and Gonjanar, 13]
The multiplicity of factors that propagated the crisis were closely monitored and extrapolated by the ILO, which was instrumental in establishment of solutions. The growth rates observed in Thailand between 1985 and 1995 were primarily driven by productivity capacities. The highly affordable low skilled labour created a suitable environment for foreign direct investment. Most of these MNEs created production units for processing exports from the country. As a result, the country was operating at a trade surplus, creating strong pull factors for capital influx. At the same time, the domestic currency was pegged on the dollar, providing a viable investment environment for a range of portfolio and securities investments based on the dollar.[Krishnamurty, 7] [Radelet, Steven & Sachs Jeffrey. The Onset of the East Asia Financial Crisis. 1998. http://core.kmi.open.ac.uk/download/pdf/6881692.pdf]
Since most of the recently instituted financial entities were built on debt capital, the increasing bad loans resulted to bankruptcies. The country had the option of lowering the interest rates in order to increase the demand for its currency, although this would have worsened the situation of the numerous creditors in the country. The assumption was that with a higher value of Baht would reduce the burden of the foreign debt, which represented a huge parentage of the debt in the country.[Li, Quan B. Currency Crisis in Thailand: The Leading Indicators. 2008. /economics/PPE08/quan.pdf]
The newly established companies presented a major challenge in the management of debt through lowering of interest rates. The fact that they were still in infant stages implied that they did not have strong systems and financial backing to survive the process of debt management. With liabilities exceeding the assets, the only approach was to dissolve them to avoid increase in the liabilities and compromises to the available assets. At the height of the speculative attacks, the Central bank of Thailand relied on huge supply of Bahts to fend off the demand, thus results to exhaustion of the reserves. The only source of assistance was Japan and IMF, who provided additional credit. With most of these companies closed and their assets frozen, the spillover effect resulted to the laying down of employees from different industries. The layoffs were propagated by the lack of credit to finance operations as well as the perceived melt down in the economy. Increasing unemployment rates led to a collapse of consumption and production chains.[Krishnamurty, 25] [Corsetti, Ginacarlo, Pesenti, Paolo and Roubini, Nouriel. 1998. What caused the Asian Currency and Financial Crisis? /research/economists/pesenti/whatjapwor.pdf] [Sutthirak and Gonjanar, 6]
Causes of the Crisis
Moral Hazard issues
The manner in which the financial and corporate sectors operated in the country created an elevated level of moral hazards in the country. The primary red flag exists in the slackened regulatory structures left the country vulnerable in case of macroeconomic and financial shocks from both the domestic and foreign markets. Corporations in the country were under significant pressure to sustain operations at high rates of growth, through guarantees which were not backed by sustainable resources. Certain firms received significant subsidies, without any form of control and favored industries received bailouts which nullified any form of risk aversion at the corporate level. The returns on investment in some instances were not measured in absolute terms, and the deficiencies in the current account were expanding at alarming rates. Although the options of foreign borrowing were available, most of the ventures were literary bankrupt months before the crisis. Since most of these bail outs and subsidies were based on a credit base, the undercapitalized economy eroded the ability of the financial industry accommodate shocks, especially considering that most of the assets were toxic and comprised of non-performing loans.[Li, 15] [Krishnamurty, 40]
At the international dimension, the highly liberalized economy was faced with the influx of foreign capital through borrowings which were not risk adjusted. The assumption was that the foreign borrowings would be guaranteed by the bank, just like the numerous subsidies in favour of the overseas borrowers, and failure to that, protection from IMF would accord returns regardless. Most of the loans were unhedged foreign-based instruments, which was the same currency that the Baht was pegged on. Increases in the dollar as experienced in 1995 created the primary impressions of a crisis, and the sentiments and confidence in the market switched significantly. The earliest casualties were the property markets, which resulted to defaults in the financial and corporate sectors. The onset of the default crisis led to reversal of the influx of capital from the foreign market and set the crisis in motion.[Sutthirak and Gonjanar, 10] [Wong, Kar-yiu. Housing market Bubbles and Currency Crisis: The case of Thailand. 2001. http://core.kmi.open.ac.uk/download/pdf/7363073.pdf]
Appreciation of exchange rates
The factors associated with loss of competitive advantage and changes in the balance of trade have a direct effect on the exchange rates during a financial crisis. The association of exchange rates with the current accentuates the outcomes, and it was worse for Thailand due to a number of factors. Most of its economic decisions were based on this growth, providing the impetus for excessive public expenditure, with bank lending expanding to accommodate the increased availability of financial resources. At the same time, the highly liberalized financial system encouraged borrowing from foreign partners. Even when the interest rates were pegged on the Baht, the real rates were hinged on the dollar, which was the basic currency. Most of the loans were however based on low interest rates in order to optimize benefits. The real value of the Baht was however masked by the value of the dollar. An appreciation of the dollar created a scenario where the competitiveness of the Baht dropped sharply, affecting it surplus economy. The declining external export dropped to year-on-year rate of 0.2% from 20% in the previous years. The country changed the system of pegging the value of the Baht on the collar which further spun the currency out of control and caused the debts to increase in monstrous rates. By the time the crisis was peaking, the external debt increased from to US$ 94.3 billion from US$ 28.8 billion. The perceptions of overvaluation of Baht resulted to disposal of the currency, resulting to halving of the value in a span of months. This is represented by an increase of the foreign debt to GDP rate from 32.8% in 1990 to 50.05% in 1996. Short term debt, which is highly costly and risks rose from 29.63% in 1990 to 41.41 % in 1996. At the same time, the short term debt, mostly from foreign sources changed from 62.55% in 1990 to 99.69% in 1996....