IMF retrospective on 1997 Asian Financial Crisis (23-05-07)
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
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Ten years ago (14-15 May 1997) the Thai baht was hit by massive speculative attacks.
The 10th anniversary of the Asian Financial Crisis of 1997 is a good time to reflect on what happened, why it happened, could it happen again, and how it could be prevented from happening again.
That's exactly what a forum held at IMF headquarters in Washington, D.C. did last week.
There are substantial differences between recent economic problems and the problems of 1997.
In 1997 Thailand faced exchange rate devaluation, whereas in 2006-07 Thailand faced exchange rate appreciation.
Exchange rate appreciation and capital inflows make life more difficult for exporters because the goods they are trying to sell on international markets become more expensive, making it more difficult for them to compete with companies in other countries (assuming the exchange rates in these other countries don't appreciate also).
Large capital inflows at least mean that liquidity and credit is being injected into the Thai economy which is a lot better than quickly losing loanable funds the way that banks did in 1997.
One major difference between 1997 and now is, perhaps, that people are anticipating problems and proactively changing policy so that the 1997 crisis won't happen again.
The Sufficiency Economy Philosophy and the economic focus of the current draft constitution (See previous article) are major examples of this.
For further reading, read other recent Bangkok Post articles on Thai monetary policy and our library for links for further study on capital controls.
Read about the impossible trinity in international economics which states that it is impossible for a country to have three desirable things at the same time:
1. A fixed exchange rate
2. Free capital movement
3. An independent monetary policy
Reading Questions
Here are some questions to guide your reading (See answers at end):1. What major destabilising change have Asian economies experienced recently in their currencies?
2. What problems might result from this change?
3. How do capital flows in 2006-07 differ from those in 1997?
4. What two negative effects stemmed from the 1997 crisis?
5. How volatile have exchange rate movements been recently? (Use inference)
6. How could volatile exchange rates and capital inflows create an asset bubble?
What is it about such an "asset bubble" that is bad for the Thai economy?
7. Were capital inflows into Thailand and Asia relatively higher or lower than their previous peak in the 1990s before the 1997 crisis?
8. Why does the IMF suggest that Thailand's use of capital controls might not have been be such a good idea?
9. What is best way to deal with surges in capital flows, according to the IMF?
Bangkok Post Article May 18, 2007
IMF: Capital surge in Asia triggers concern over bubbles
Washington — Asian nations are grappling with a surge in capital inflows that may lead to overvalued currencies or asset price bubbles in the rapidly-growing region, the IMF has warned.
"The one issue that countries have been wrestling with [is] coping with surges of inflows — this time not so much outflows but inflows," the IMF's Asia-Pacific director David Burton said at a Washington forum marking the 10th anniversary of the Asian financial crisis.
The 1997 crisis, triggered by a meltdown of regional currencies starting with the Thai baht, caused a severe recession and political upheaval in the region.
Displaying a chart depicting volatility of capital inflows in the region, Mr Burton said there had been some episodes where "these have exceeded two standard deviations from their normal behaviour."
"This could give rise to concerns in particular that surges in inflows could create problems — putting upward pressure on currencies, at times strongly, provide additional, sometimes unwarranted, loanable funds to the financial sector, also potentially force asset price bubbles, perhaps also create risk that these funds would flow out very suddenly as fast as they come in," he said.
Gross inflows in Asia reached nearly 8% of gross domestic product last year, higher than the peaks of the mid-1990s, and surges in inflows in some cases have been associated with strong pressures on exchange rates or asset prices.
Mr Burton said there could be temptations by governments to try to address these concerns by imposing some form of capital controls but cautioned that they could cause problems.
He cited as an example Thailand’s capital controls imposed late last year which were seen as as counter productive.
"What was thought to be surging capital inflow in the last quarter in Thailand was actually a surge in the current account surplus," he said.
Mr Burton said there was "no magic bullet" to dealing with surging capital inflows, "which are a feature of the global financial landscape and something countries probably have to live with".
A combination of exchange rate flexibility with limited intervention to smooth out volatile exchange rates could act as short term measures, he said.
Strong monetary policy frameworks that can help keep inflation expectations in check and policies to strengthen risk management are also recommended. AFP
Vocabulary (in discussion above)
a retrospective - when a show (or conference here) looks back on the past (to get an overall historical feel for what has happened, for example, the great painter De Kooning had a retrospective at the gallery of modern art in New York)
the IMF - oversees the global financial system, observing exchange rates and balance of payments, as well as offering financial and technical assistance in emergencies (See Wikipedia)
speculative - risking losses for the possibility of considerable gains (See glossary)
speculative attack on a currency - traders betting against a currency in large amounts because they believe that the currency is being held up in value above its market price by the government, that this cannot be sustained, and that the currency's value will eventually collapse and they will make a big profit
capital - money and assets put to use to make more money and assets (See The Economist)
a surge - sudden large increase
* surge in capital inflows
x triggers y, y triggered by x - x causes y
bubbles, asset price bubbles, speculative bubble - when asset prices rise far above their true value from excessive speculation, some event eventually triggers a massive sell-off, the price drops sharply, a lot of people lose their money and become insolvent or bankrupt which can cause problems for loans and the banking system (See glossary)
grappling with, wrestling with - trying to solve problem x
overvalued currencies, overvalued exchange rate - the currency has an unsustainable high value due to speculative capital inflows (or if the exchange rate is above the market clearing rate in a managed float or pegged exchange rate; Source)
coping with x - dealing with problem x successfully
the Asian financial crisis - a period of economic unrest that started in July 1997 in Thailand and South Korea and affected currencies, stock markets, and other asset prices in several Asian countries (See Wikipedia)
a meltdown - a sudden and complete failure
* a meltdown of regional currencies
recession - two quarters of negative real economic growth, decline in Gross Domestic Product (GDP) (See Wikipedia)
upheaval - a great change that causes many problems
* political upheaval
depicting - showing, describing
volatility - sudden and unpredictable changes, how much a value moves up and down (See The Economist)
an episode - an unusual event
standard deviations - (See Wikipedia)
currency appreciation, exchange rate appreciation - when a currency becomes more valuable, buys more of other currencies, so imports decrease in price but exports earn less money (for example, when the baht moves from 38 to 32, it appreciates, even though falling seems like losing money, the exchange rate is baht per dollar (baht / dollar))
putting upward pressure on currencies - causing currency appreciation
unwarranted - unnecessary
temptations - wanting to do things that are bad
imposing x on y - forcing y to do x
capital controls - government restrictions on moveing capital CAPITAL in and out of a country (See Wikipedia)
* imposing capital controls
counter productive - achieving the opposite of what you wanted
current account - a country's exports less imports of goods and services (plus some other things, See Wikipedia on current account and balance of accounts)
surplus - more than is needed, positive amount (opposite: deficit)
deficit - less than is needed, negative amount (opposite: surplus)
current account surplus - revenue from exporting is more than expense of imports (roughly)
there's no magic bullet - there's no easy solution
the global financial landscape - the global financial environment or world
exchange rate flexibility - (See Wikipedia on flexible exchange rates)
intervention, foreign exchange intervention - when a central bank buys and sells currencies in order to control the country's exchange rate, for example to reduce movement and volatility (See The Economist)
* limited intervention
smooth out volatile exchange rates - reduced sudden and unpredictable movements in exchanged rate
short term measures - solutions that work only for a short time
risk management - the study of identifying risk and strategies to deal with it once you find it (See Wikipedia)
Answer Key:
1. What major destabilising change have Asian economies experienced recently in their currencies?
Very large amounts of foreign capital have entered their economies recently (surge in capital inflows)
2. What problems might result from this change?
a. Overvalued currencies.
b. Asset price bubbles.
3. How do capital flows in 2006-07 differ from those in 1997?
In 2006-07 Thailand is experiencing inflows which cause exchange rate appreciation.
In 1997 Thailand experienced capital outflows which caused exchange rate depreciation.
4. What two negative effects stemmed from the 1997 crisis?
a. A severe recessions
b. Political upheaval (turmoil)
5. How volatile have exchange rate movements been recently? (Use inference)
Very volatile.
A "standard deviation" is a measure use in statistics of variance, variability, and volatility
So episodes that "have exceeded two standard deviations from their normal behaviour," implies that there has been a lot of volatility.
6. How could volatile exchange rates and capital inflows create an asset bubble?
What is it about such an "asset bubble" that is bad for the Thai economy?
An increase in capital inflows into Thailand leads to excess demand for assets in Thailand which leads to increased prices for Thai assets and increases in loanable funds (credit) in Thai banks.
A volatile Thai exchange rate means that the exchange rate has a tendency to change suddenly and unexpectedly.
Some event such as a higher level of Non-Performing Loans (NPLs) due to excess credit, let's say, might reverse the capital inflows and trigger a sudden surge of capital outflows and currency depreciation.
Volatility in exchange rates and the amount of capital and loanable funds is not good for an economy because it is difficult for businesses to make reliable business decisions for future in an unpredictable and volatile econmomioc environment like this.
When capital surges suddenly into an economy and then quickly flows out, capital flows seem to resemble a financial tsunami.
("'This could give rise to concerns in particular that surges in inflows could create problems — putting upward pressure on currencies, at times strongly, provide additional, sometimes unwarranted, loanable funds to the financial sector, also potentially force asset price bubbles, perhaps also create risk that these funds would flow out very suddenly as fast as they come in,' he said.")
7. Were capital inflows into Thailand and Asia relatively higher or lower than their previous peak in the 1990s before the 1997 crisis?
Since the question asks for a relative and not an absolute comparison it is important to use percentages.
For Asia 8% of GDP is greater than the previous peak in the 1990s.
For Thailand this data is not given.
8. Why does the IMF suggest that Thailand's use of capital controls might not have been be such a good idea?
An increase in the current account surplus (traded goods, export revenue greater that import expense) was responsible for the exchange rate appreciation, not an increase in the capital account (capital inflows greater than outflows).
Capital controls restrict flows on the capital account, not the current account.
This implies that the wrong medicine was used to treat the problem.
("What was thought to be surging capital inflow in the last quarter in Thailand was actually a surge in the current account surplus," he said.)
9. What is best way to deal with surges in capital flows, according to the IMF?
a. Exchange rate flexibility.
b. Limited intervention in foreign exchange markets by central banks.
c. Strong monetary policy frameworks to keep inflation expectations in check.
d. Policies to strengthen risk management
("'A combination of exchange rate flexibility with limited intervention to smooth out volatile exchange rates could act as short term measures,' he said. Strong monetary policy frameworks that can help keep inflation expectations in check and policies to strengthen risk management are also recommended.")
