The 1997 financial crisis

The East Asian Financial Crisis of 1997


The East Asian area suffered a significant economic setback as a result of the 1997 financial crisis. While most governments in this region have implemented policies to reduce the likelihood of such a catastrophe occurring, this article contends that another financial crisis is unavoidable. This, however, may take longer to manifest. The recent huge bank closures in East Asia are being viewed as a replay of the circumstances that contributed to the 1997 financial crisis. Flaws in East Asian economies' financial balance sheets as a result of recent drops in exports are viewed as a key signal of a financial crisis. Lastly, the paper criticizes the short sighted policies adopted by Singapore in managing its capital inflows as a factor that will stimulate another economic crisis in this region.


Introduction


The 1997 financial crisis that hit East Asia region is considered to be of great historical and economic significance in a number of ways. This crisis affected the world's economies which were experiencing the most rapid levels of economic growth leading to the emergence of the greatest financial bailouts in economic and financial histories. As a matter of fact, this crisis went to history as the most crucial attributed to the fact that it posed great adverse effects on the economies of developing countries after the debt crisis of 1982. Based on the economic conditions that prevailed at that time coupled with poor ways of managing national finances, a number of scholars in this field predicted that the Eastern Asia region was at the verge of its financial collapse. Based on the expensive adjustments different economies are forced to undertake in the event of a financial crisis, a number of economic variables considered as configurations to act as early warnings of financial crises have been identified (Benmelech and Eval, 2013). This paper aims at making a review of the strength of the East Asia region based on its macroeconomic and financial imbalances in the context of emerging markets, increase in real exchange rates, negative deviations in equity prices, declining exports, higher ratios of broad money to international reserves, recession and large current account deficit relative to investments and GDP as the key indicators to a financial crisis, with key considerations on balancer sheet flaws, closure of banks and increased capital inflows in selected economies.


Balance Sheet Flaws


Studies conducted to look into the causes of financial crises have indicated that most economies fall victims of pronounced balance sheet issues as a result of substantial short term debts. In this case, the ratios of broad money to international reserves of the region under consideration bubble with a slowed growth in then GDP of the regions under consideration. Models adopted to predict financial crises have indicated that appreciations in real exchange rates, expansion in domestic credits , increasing stock prices and deficits in current accounts as factors which would be used to indicate that a financial crisis is inevitable in a given economic block. According to Gliek and Michael (2013), the microeconomic basis of East Asia's financial crisis of 1997 could be attributed to the availability of imperfect information which led to financial market moral hazards. For instance, Indonesia and South Korea were victims of speculative bubbles in their bank lending rates. It is important to understand that speculative bubbles in financial lending go a long way in providing financial sectors with asset valuations which may be skewed.


A collapse of these bubbles leads to liquidity crises in which financial systems of an economic block may not be able to handle. Therefore, such economies are forced to undertake financial illiquidity measures such as curtailing the flow of loans which limits the abilities of these economies to sustain their rates of flow of goods and services particularly those with deep involvements in international exports. As the rates of financial illiquidity of these economies unravel, their credibility of equity and those of their currency markets are forced to undergo sharp drops. As a result, the domestic rates of inflation for these economies also increase leading to accelerated rates of unemployment. As a consequence economic growth of these countries also slows down at considerable rates.


Closure of Banks


In the past few years, the East Asia region has seen a massive increase in the number of banks undergoing closure. There is no doubt that financial institutions proving to be less viable need to undergo mergers and liquidation processes as a way of doing away with any possibilities of a financial crisis. However there is need to put into consideration the fact that most of these bank closures go a long way in heightening the levels of liquidity squeeze. This brings challenges to these banks since it is difficult to continue with the known normal operations of lending. For instance, the recent closure of a number of branches belonging to the Bank of Singapore and Hong Kong's largest bank, Bank of East Asia limited have led to an increase in the levels of reluctance among other banks in this region to roll over their loans. This has gone a long way in adding to the financial squeeze of this region. While these moves have been considered to be extremely abrupt, it is important to put into consideration the fact that such banks needed to embrace better approaches through the adoption of long term and highly comprehensive strategies of restructuring their operations as opposed to quick initiatives as a way of demonstrating resolve.


According to Krugman, (2014), the 1997 financial crisis of East Asia region resulted from hasty financial decisions leading to closure of banks rather than the adoption of healthier strategies like putting some of these institutions under receivership. This would have gone a long way in cushioning depositors while allowing clients considered being good borrowers to continue accessing financial credit services. In the same way banks were deprived of customers as a result of the IMF's intervention policy which led to the closure of multiple banks in East Asia region before the 1997 financial crisis, the current trend possess a lot of worries on the extents to which this region is cushioned against another crisis. The currencies of this region have continued to undergo depreciations. This has led to a slowed growth rate in selected countries of this region. For instance, Komail and Mehdi (2014) report that the surplus of this region is expected to worsen attributed to issues like closure of key financial institutions and poor performance of Viet Nam.as a matter of fact, Brunei Darussalam's CPI inflation has undergone massive deterioration over the past few years. This figure was recorded to be at -0.5% by the last quarter of 2016.


Capital Inflows


Capital inflows of a country play critical roles in determining the extents to which such economies would be vulnerable to financial crises. This is attributed to the fact that increase in inflows leads to an appreciation in real exchange rates and a speedy increase in the rates of lending by banks. The East Asia region saw a rapid increase on its capital inflows in the years that bled to the 1997 financial crisis. In this period, the average of capital inflows into East Asian countries was estimated to be over 6% of the GDP in seven years. To be specific, Eliamloueyan and Mahboubeh (2014) explain that the capital inflows into Thailand was estimated at over 10% of its GDP in the 1990's and rose to 13% in five years . The Malaysian economy saw this figure rising from 9% to 15% in the same period. However, the case of Malaysia was considered to be fruitful since most of its inflows were from direct foreign investments. Currently, Singapore is considered as a strong proponent of capital inflows. As opposed to other economies of East Asia, Singapore has been put to record as one of the countries in this region with an independent monetary policy. The Singaporean economy is known to take advantage of its independent monetary policies in increasing its reserves for foreign exchange . As a matter of fact, Ahmed and Andrie (2014) report that these reserves have been increased to levels which are above the economy's GDP.


While the policies adopted by the Singaporean government would be looked at as being economically viable, many researchers have criticized such policies as being short sighted. The long term effect of such a move is felt by central banks of the country. This is attributed to the fact that central banks will take the risk of absorbing the periodic changes in exchange rates on the behalf of investors as a way of encouraging capital inflows depicting short maturity structures. As a consequence, exchange rates will undergo appreciation in real times at the same way the capital inflows of this economy will increase its pressures on non-tradable prices. It should be noted that capital inflow policies adopted by most East Asian economies in the period that led to the financial crisis led to an increase in real exchange rates by over 25% between 1990 and 1997. The policies adopted by the Singaporean government may be effective to its short term requirement however, they may cause a lot of long term effects which may lead to a financial crisis.


Recommendations


Based on the factors discussed, this paper recommends that East Asia economies should focus on external investments as a way of increasing their economic viability. Further, there is need to initiate policies that will cushion banks in this region from bankruptcy as a way of preventing the current closures. To ensure viable balance sheets in these economies, exports must be encouraged through the implementation of broader structural initiatives in corporate governance, finance and trade. The Singaporean government needs to abandon its short sighted fiscal surplus targets.


Bibliography


Ahmed, Shaghil, and Andrei Zlate. "Capital flows to emerging market economies: a brave new world?." Journal of International Money and Finance 48 (2014): 221-248.


Benmelech, Efraim, and Eyal Dvir. "Does short-term debt increase vulnerability to crisis? Evidence from the East Asian financial crisis." Journal of International Economics 89, no. 2 (2013): 485-494.


Eslamloueyan, Karim, and Mahboubeh Jafari. "Financial crisis and saving–investment dynamics in the presence of cross-sectional dependence: The case of East Asia." China Economic Review 30 (2014): 209-220.


Glick, Reuven, and Michael Hutchison. "China's financial linkages with Asia and the global financial crisis." Journal of International Money and Finance 39 (2013): 186-206.


Komail Tayebi, Seyed, and Mehdi Yazdani. "Financial crisis, oil shock and trade in Asia." Journal of Economic Studies 41, no. 4 (2014): 601-614.


Krugman, Paul. "Currency regimes, capital flows, and crises." IMF Economic Review 62, no. 4 (2014): 470-493.

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