Desmond Wee
PSCI214 East Asia Political Economy
University of Pennsylvania
Background: Chain Reaction Thailand (early 1997): Exports decline →Loss of
investors’ confidence → Currency depreciation due to lack of foreign reserve → IMF’s aid package required currency devaluation & higher domestic interest rate → Increase in non-performing loans → Local stock market tumbles
Domino effect: spread from Indonesia to the Philippines, Malaysia and Korea.
Trade effect: Taiwan and China
Inflow of International Capital Most fundamental change in the majority of East
Asian economies is the 1990s
Private capital flows
Access to foreign funds
Increasing internationalization of the activities of East Asian firms
Most governments at least partially liberalized foreigncapital movement
Liberalization within a FlawedPolicy Framework Inadequate regulation to cope with foreign capital
inflows
Governments lacked the experience
Predominance of short-term debt
High short-term debt to reserves ratio → vulnerable to speculative attack
Newly-licensed banks
Risky lending practices
Unproductive, speculative investments
Liberalization within a FlawedPolicy Framework Fixed exchange rates worsened the vulnerability of
economies to crisis
Uncontrolled capital inflow → inflation
Domestic inflation harmed export competitiveness
Moral hazard problem: domestic borrower of foreign currencies with no risk of exchange rate
Distinguishing Crisis and Non-crisiseconomies China and Taiwan were not affected as much as
Thailand, Indonesia and Korea.
Heavily-affectedcountries
Less-affectedcountries
Capital accountliberalization
+Inflexible exchange rate
Prudential regulation
Sizeable foreignexchange reserves
Cause of the Financial Crisis?Fundamentalists Panic-stricken
Root causes of the crisislay in misguidedeconomic policies, & liberalization of theirfinancial system was not enough
Fundamentals of East Asian economies weresound and hastyliberalization of theirfinancial systems,followed by assetbubbles was root cause.
The Politics of Financial Policy: Behind the Fundamentals Influences on financial arrangements in Asia:
Relative strength of social coalitions & economic sectors.
Korea
The degree of concentration of the financial sector
Thailand
The particular links between individual financialinstitutions and state organs, ruling parties and leadingpoliticians.
The degree of foreign participation in the financialsector.
Supply-side approach
MOF and the central bank are powerful and insulatedfrom social and political forces?
Influence of parties and elections
The Politics of Financial Policy: Behind the Fundamentals
Domestic Responses Financial liberalization carries substantial risks as well
as benefits
Capital controls (exit controls & entry taxes)
Decrease speculative money
Opposition grew: e.g. IMF and the international community
Reintroduction difficult in its implementation
Discourage investment and growth
Domestic Responses Selective actions to limit trading currencies and
derivatives or limit repatriation of profits
Taiwan
The Philippines
Hong Kong
Domestic Responses Measures to improve prudential regulation
Increase in the ratio of banks’ capital relative to risk-adjusted assets to 8% or higher
Increase provisions for reserves agaisnt non-performingloans
Stricter assessment of non-performing loans
Increase in independence and unity of oversight agencies
The extent of financial and corporate restructuring in the most severely affected economies remained limited.
Reforming the Global Financial Architecture The crisis led to various proposals of global financial
reforms.
Panic-stricken:
restrictions on speculative capital
Additional disbursed assistance to governments whosecurrencies were speculative attack
Cooperation on monetary affairs at the regional level
Division between twin Washington-based institutions – IMF and World Bank was deepened.
Reforming the Global Financial Architecture Reforming the IMF
Calls for abolition of IMF IMF is internationalizing the moral hazard problem
Encouraged speculators to undertake dubious investments
Need for greater transparency of IMF
Criticism against conditionality by IMF
Worsened the recession by
Tight fsical policy
Increase interest rates
Ill-timed closure of financial institutions
Criticism agaisnt private sector actors for not bearingthe cost of the crisis
Regional Responses Proposal for establishing the Asian Monetary Fund
(AMF)
Killed by opposition from the US
Bilateral programs by Japan
The crisis has drawn East Asian economies together, realizing that they do not have an effective voice in the governance of the monetary system. This led to efforts to establish a representational organization or regime, the outcome remains to be seen.