1997 Asian Financial Crisis
The most dramatic event in the second half of 1997 and 1998 was the financial crisis in East Asia. Initially, it arouse mainly in Thailand and Malaysia, but then spread to Hong Kong, Singapore, Indonesia, South Korea and Japan. In this regard, there was a danger of its expansion to the entire industrialized world. Many works considering the series of financial crises have occurred in South-East Asia in 1997-1998 Thus, two points of view exist on the causes of the Asian crisis. According to the first one, the sudden change in investors’ expectations and reducing the degree of confidence in the Asian market have become the main impetus for the development of a crisis situation. Another perspective indicates that imbalance of key macroeconomic aspects is the primary cause of this condition. The paper investigates the factors that contributed to the financial crisis in Korea and implementation of reforms to address it. It is presumed that there is a strong link between investors’ expectations, reducing the degree of confidence in the Asian market and imbalance of macroeconomic factors. The following eight literature reviews attempt to demonstrate and support the hypothesis.
Practitioners, who are directly related to financial transactions in the Asian market in the pre-crisis period, adhere to the first point of view. According to Lee and McKibbin (2007), one of the main causes of the Asian financial crisis was the fall in private and public savings in the United States. Therefore, this contributed to the imbalances of global current account. The collapse of stock and real estate market seriously weakened Japanese banks. Being the biggest lenders and creditors, the latter provoked modifications in other external commercial banks that eliminated their loans. On the eve of the Asian financial crisis, the stock markets of the countries were on the rise. Moreover, they were the object of active investment of foreign capital. Nevertheless, investors dramatically changed their behavior, refusing to trust the governments of these countries, which led to panic and massive outflow of capital. Additionally, they plunged the national financial systems in the deep Asian financial crisis and threatened economic stability. The authors underlined the need to pay attention to the incentives of institutional investors and the structure of domestic institutions.
Kanaoka (2012) provided a discussion of the causes of the Asian financial crisis from two aspects, trade and financial ones. Financial issue referred to external factors. Thus, the crisis was triggered by Thailand illiquidity. The latter indicated the linkage of reserves and short-term debts. The ground of the enlarged short-term debt was seen in major capital inflows that originated in capital flows’ liberalization between foreign and domestic markets. The rising account deficits occurred in the background of the massive external capital inflows. In the internal economies, inflows of capital were attracted by large interest rates. The capital inflows compensated current account deficits. According to Kanaoka (2012), the excess capital inflows induced lending boom, which meant rapid growth of nonperforming loans. From the trade aspect, the trade channel was considered to be consistently important for contagion. As Kanaoka stated (2012), commerce links were the propagation mechanism for the chain reaction. However, they were not so crucial in controlling the neighborhood effect.
Nevertheless, theoretical economists believed that the root causes were caused by structural abnormalities in the development of the economies of the Asian region. In a research article by Kihwan (2006), four specific questions were addressed for guiding the study. The author examined the reasons of the crisis, the role of the IMF (International Monetary Fund) in tackling the problems, preventive measures, and lessons that could be taken from this condition. Among the grounds, Kihwan (2006) asserted that Korea’s account balance deteriorated due to the rise of inflation, estimation of the Korean yen, and decline of the world economy. Instability of the American dollar also served as a trigger of the financial crisis in Korea. Another factor was a number of internal events in 1997. As a result of financial difficulties, many companies and groups encountered bankruptcy. Another determinant was the currency crisis in regional countries.
Kihwan (2006) argued that capital account liberalization was one of the lessons that should be got from this experience. Other ideas are related to supremacy of a pure floating exchange rate system over a regulable floating system, foreign investigation, and prudential supervision. Against the background of the financial sector in the Asian region, liberalization of the financial system backfired. One of its goals was to increase the supply of cheap credit in the domestic market. As a consequence of the reform of the financial sector (opening of the market to foreign capital), the credit supply in the market increased. However, liberalization of unformed system, in which there was no clear regulation, led to the fact that an unstable market of rapidly developing countries was filled with short-term loans, which made it more assailable to minor changes in the global capital market. Therefore, this course of events was natural for the region, where the capital markets were relatively underdeveloped, and reshaping of short-term investments to long-term ones further enhanced the vulnerability of banks.
Another article supported the hypothesis of the linkage between internal and external factors of crisis causes. According to Sutthirak and Gonjanar (2012), the Asian financial crisis involved four fundamental issues. They included the deficit of foreign exchanges, which influenced the value of equities and currencies in the Asian region. Sutthirak and Gonjanar (2012) emphasized the role of improper development of financial sector and mechanisms that allocated capital in the troublesome Asian economies. A crucial responsibility was delegated to such external aspects as the consequences of the financial crisis that appeared in the United States as well as around the globe. Furthermore, the authors underlined the significance of operations and accession of the IMF.
Muchhala (2007) considered the Asian financial crisis one of the most important events in the recent world economy history. He argued that financial liberalization in the Asian region caused the raises in capital flows to domestic firms and banks, which, in turn, enlarged bank loans. Thus, this ultimately resulted in the prompt accumulation of external debt, which exceeded the cost of exchange reserves. The effects of the financial crisis not only contributed to the correction of structural deficiencies of the economy, but also led to modification of academic analysis of imperfections of the Asian financial system. The crisis has shown particular institutional ineffectiveness in the Asian economy. Underdevelopment of the financial sector implied the absence of strict banking supervision, poor legislative regulation, the low level of capital adequacy, the lack of contributions from a balanced incentive structure of the insurance system, deficiency of expertise of projects, reducing stimuli for high-quality selection of projects, non-market credit allocation criteria and corruption in the banking sector. All these factors induced the weakness of the financial system and consequently, the high percentage of grants. Politically motivated and extreme lending, banking supervision, and inadequate model of handling bankruptcy are the internal features, which highlight the problems of Asian economies. Muchhala (2007) stated that the main source of financing of the corporate sector included bank loans. The equity market in these countries was not sufficiently developed, and the private bond market was practically absent. Hence, this important factor increased instability of the financial system. In addition, vulnerability of the Asian economies intensified the lack of transparency of financial markets and widespread non-market methods of conducting business transactions. The lack of such elements as ensuring financial stability as a national deposit insurance, central allocation of troubled financial institutions and their supervision had adverse effects.
Zakaria, Hussin, Nordin, and Sawal (2010) argued that the cause of the financial crisis in Asia was a speculative attack. Asian countries heavily suffered from the consequences of the financial slump. The latter gave a rise to a number of economic problems, namely the bankruptcy of multinational enterprises and companies. In turn, this led to the increase of the unemployment rate. Asian states strived to overcome the issue by involving external and internal resources that were aimed at bringing the economy to the normal value. However, the crisis was deteriorated by anti-market rhetoric, wrong policy response, panic, and extreme risk-taking that affected the balance of corporate sectors and banks. As a result, the Asian financial crisis negatively influenced the society, politics, and industrial sector. According to Zakaria, Hussin, Nordin, and Sawal (2010), imports and exports played a crucial role in commercial progress of the Asian trading countries. Therefore, the economy was opened and receptive to external disturbances.
Among other factors of the financial crisis, the authors discussed deficiencies in risk management, speculative attacks, equity markets, corporate governance forms, and legal infrastructure. Commercial vulnerability was prompted by unsustainable economic growth and overvalued exchange rates. The emergence of interrelated problems on the corporate and governmental levels was caused by excessive state support for large private projects, i.e. considerable flows of governmental grants and direct budget crediting. The direct government funding of private business was typical of Malaysia, while in other countries it was performed through bank loans, either at the expense of corporate lending. In fact, in both cases, foreign short-term loans became the main source of financing. That excessive government and bank lending to the corporate sector at the cost of short-term credits made Asian countries experience current account deficit.
Concluding the analysis of institutional and structural factors that induced the Asian financial crisis, the lessons, which it presented to the world, should be emphasized. Firstly, financial deregulation and liberalization of international capital transactions all over the world made monetary and credit sphere in many countries unable to protect the national economy from the destabilizing impact of financial market volatility. The crisis has shown the need for such socio-economic institutions, which would allow private economic agents to operate effectively in opportunistic and price instability. In other words, the he crisis taught people that under the new circumstances, the role of the state is not in the protection of economic agents, but in promotion of a more rapid adaptation to changes in them. Another important responsibility of the government is a timely correction of the aspects that can lead to macroeconomic destabilization in the future. The Asian crisis showed the necessity of the corporate governance reform, the separation of private enterprise and governmental regulation, as well as restructuring conglomerates in accordance with market principles.