FINS5522 - Emerging Financial Markets
Week 4 (11th August 2010)
Essay Question: Why did the Asian Financial Crisis (AFC) take many by surprise? Explain the major contributing factors that caused the crisis (and their effects), and discuss the lessons that can be learned in relation to preventing and/or responding to future crises.
The Asian Financial Crisis (AFC) of 1997 was a period of financial turmoil and volatility that spread across Asia. Prior to July 1997, most of the South East Asian currencies were tied to the US dollar. The crisis began primarily in Thailand when the Thai baht came under pressure that its value would not hold. The pressure on the Thai baht ...view middle of the document...
There was a large CAD but strong capital inflows continued to enter the region leading to growing foreign exchange reserves. Along with scholars such as Radelet & Sachs (1998), Stein (2004) have also pointed out that many credit rating agencies such as Standard & Poors and Moody’s continued to give high credit ratings to the region. The truth may be that underneath what seemed to be strong, striving, growing economies lay fragile infrastructure. What simply happened as scholars such as Radelet & Sachs (1998) stated was that South East Asia had always been vulnerable to financial panic. As soon as a group of investors began to pull out, mass action began and like a stack of cards, South East Asia collapsed.
The question now comes to what factors contributed to the AFC. Scholars and experts alike have linked the AFC with various factors. The next section will attempt to address these issues in terms of structural factors, macroeconomic and financial market factors as well as the phenomenon of financial contagion.
Radelet & Sachs (1998) noted that inadequate prudential regulatory controls in the financial sector and corruption and mismanagement in the banking system lead to the fall of the South East Asian economies. The financial systems of South East Asia were largely inadequate to handle the strong influx of foreign capital inflows that entered the region. The weak regulatory and prudential supervision, along with ‘opaque relationships between the government and the banking sector’ (Parliament of Australia 1998) lead banks developing bad credit controls to make a series of non-performing loans, carry underperforming assets and develop bad debt.
Another factor that led to the financial crisis in South East Asia could be put down to the macroeconomic and financial factors such as the pegged currencies of the region, high CADs and the emphasis and reliance put on foreign capital. Speculation of the overvaluation of the Thai baht in June 1997 has lead to high interest rates, a widening of CAD and large inflation rate differentials. When the Thai government finally abandoned the baht peg in July 1997, much of its foreign reserves were depleted. As the Thai baht began and then continued to lose value in the following days, real asset prices dropped in Thailand as well as the rest of the South East Asian region. Due to the underdeveloped nature of equity markets...