South East Asian Economic Crisis

An economic crisis, which erupted in Thailand in mid-1997 and which soon spread to neighbouring countries—Malaysia, Indonesia, Philippines and South Korea — came to be popularly referred to as South-East Asian economic crisis (although South Korea is in East Asia and only the other countries are in South East Asia). Although experts do not fully agree on the reasons behind the crisis, it is generally held that the crisis was caused mainly by the following factors.

1. Persistence of large current account deficit.
2. Large foreign debt and particularly, a high proportion of short-term debt.
3. Large inflow of foreign capital, particularly the sensitive short-term capital.
4. Indiscriminate lending by banks and other financial institutions, arising from lack of adherence of financial intermediaries to prudent norms concerning capital adequacy, asset classification, provisioning, and absence of disclosure requirements.
5. Lack of transparency in the economic system that made proper judgment  by investors and others, for decision-making difficult.
6. Over-investment in several sectors.
7. Imprudent lending by international lenders.
8. Large real effective exchange rate appreciation.

As the crisis first occurred in Thailand, a look at the factors which led to the Thai crisis would help understand reasons for the emergence of the crisis.  Because of the appreciation of the Yen against the US dollar after the Plaza Accord of 1985, Japanese exports were becoming costlier and hence Japanese firms were on the lockout for cheap manufacturing locations. The cheap Thai labour attracted lot of FDI from Japan (and also from other countries. The high returns on short term investments attracted large portfolio investments and short-term funds to Thailand. The pegged exchange rate system followed by the SE Asian countries encouraged such investments because of the absence of exchange rate risk under that system. The high interest rate differential between the developed markets and Thailand (also other SE Asian countries) tempted banks to channel funds from developed economies to Thailand. The indiscriminate lending by banks (and other financial institutions) resulted in the over-expansion of several industries. The speculative investments in real estate created such a situation that that the occupancy rates in new buildings were only about 20 per cent. The inability of the borrowers to repay resulted in 58 of the 91 finance companies downing the shutters. The investment spurt and increase in the demand for labour made Thai labour very costly—reported to be 3 to 5 times than the labour in neighbouring countries including China. The Thai exports suffered a setback due to increasing cost and increasing competition from cheap Chinese goods. The increased spending and high cost in Thailand encouraged imports, causing alarming current account deficit. All the above developments created an all around panic and the feeling that the Thai currency, Baht, would have to be devalued became stronger. There was a run on the Baht—people wanted to convert Baht into dollar so that they could re-exchange dollar for more units of Baht when it would be devalued. The Thai Central bank sold more than $ 23 billions forward in a desperate attempt to defend Baht. This only encouraged speculation. Finally, from July 2, the Baht was allowed to float. It immediately depreciated by 20 per cent and further later. As the crisis, emerged, short-term foreign investors began to withdraw their money. The crisis soon spread to other SE Asian countries where the conditions, in several respects, were similar to those in Thailand. Between end of June 1997 and end of March 1998, depreciation of these currencies against the US ranged between 11 per cent and 74 per cent. Between end of June 1997 and end of January 1998, stock prices declined in the range of 32 to 53 per cent. As these SE Asian economies were highly integrated with the rest of the world, the crises have had its impact on the world economy as a whole. The high foreign trade to GDP ratio of these nations (varying between 50 and 120 per cent) is one indication of their global integration. Equally important are the inward and outward capital flows. 

See Table

Table Case 1.1                   Current Account Deficit (Per cent of GDP)

                                1995                1996                 1997
Indonesia                   -3.3                   NA                  -2.9
South Korea              -2.0                  -4.9                   -2.8
Malaysia                    -10.0                -4.9                   -5.8
Philippines                 -4.4                  -4.7                   -4.5
Thailand                     -6.0                 -7.9                    -3.9
India                          -1.1                 -1.8                    -1.0

Table Case 1.2                      External Debt Ratios (1996)
                         Total debt as % of               Short-term debt as % of total              Debt service
Indonesia                  67                                            25                                              37
Malaysia                   49                                             28                                             8
Philippines                54                                            19                                             14
Thailand                   56                                             41                                             12
India                        28                                              7                                              24

QUESTIONS:-

1. Discuss the possible impact of the South East Asian economic crisis on:
i. Exports of India to South East Asia.
ii. Exports of India to the rest of the world.
iii. Imports of South East Asia to India.