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.