energy crisis of 1997-98

8/13/2019 Energy Crisis of 1997-98

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Energy Crisis of 1997-981/27/2014

Author:

Muhammad Asif

MBA(B&F) 6thSemester


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Econoics Report of Energy crisis in 2009


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Economics Report


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1.Introduction:Since the middle of 1997, East Asia has been gripped by an economic, and more latterly a political

crisis that shows few signs of abating. In the space of less than a year the international standing

and domestic situations of what were formerly taken to be miracle economies has been

dramatically transformed. Major companies have defaulted on their foreign debt repayments,

anxious domestic and international investors have relocated or withdrawn vast amounts of capital,

inflation and unemployment have soared, and political instability has risen to dangerous levels.

Within this context, the expectations of many observers that the East Asian miracle wouldcontinue indefinitely have been replaced by more sober predictions of recession and deflation.1

Even the most optimistic observers suggest that economic recovery for the region is at least three

years away. Pessimists suggest that the region could take decades to recover and that the present

crisis thus marks the end of the East Asian miracle.

2.HistoryFinancial history, it seems, When a financial crisis arises, it is the debtors who are called upon totake the blame. This is odd, since a loan agreement invariably has two parties. When a loan fails, it

usually represents miscalculations on both sides of the transaction, or distortions in the lending

process itself.


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The East Asian financial crisis has so far been true to form. As soon as the crisis hit in mid-1997, the

International Monetary Fund, which led the official international response, assigned primary

responsibility for the crisis to the shortcomings of East Asian capitalism, especially the East Asianfinancial markets. The IMFs primary strategy for the three hardest hit countries Indonesia, Korea

and Thailand was to overhaul the East Asian financial systems. The basic diagnosis was that East

Asia had exposed itself to financial chaos because its financial systems were riddled by insider

dealing, corruption, and weak corporate governance, which in turn had caused inefficient

investment spending and had weakened the stability of the banking system. There is some truth

in such claims.Andyet, such Asia centered accounts seem to be only a part of the explanation of

the crisis. The hypothesis that East Asias financial shortcomings alone caused the crisis and fully

explain the depth of the crisis fits uncomfortably with several important facts. First, the East Asianeconomies had been highly successful for a generation, belying the notion of fatally dysfunctional

economies. Second, the 1997 crisis was largely unanticipated, a point which also seems to be at

odds with explanations that rest on allegations of long-standing ills of the East Asian economies. A

few voices, notably Yung Chul Park (1996) in the Brookings Papers on Economic Activity, gave

warnings that East Asia could be subject to the same kind of crisis that had hit Mexico in 1994-95,

but such warnings were rare, and generally unheeded. Even the many observers who saw some

danger signs in late 1996 for example in the overvaluation of the Thai baht did not anticipate thekind of financial meltdown that has in fact occurred. Third, and related to the first two points,

foreign investors flooded the region with funds until the onset of the crisis. This behavior, too,


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does not comport easily with an explanation of the crisis that pins the blame on fundamental ills

of the East Asian economic systems.

In short, the East Asian economies were successful for nearly a generation; they received very largeinflows of funds in the years leading up to the crisis; there were few warning signs or

alarm bells. Why, then, in such circumstances have the East Asian economies temporarily

collapsed? Whatever the answer, the magnitude and suddenness of the financial reversal is made

clear in Table 1, which records the net capital flows to the five East Asian countries hardest hit by

the crisis: Indonesia, Korea, Malaysia, the Philippines, and Thailand. Private net inflows to these 2

five countries soared, rising from $40.5 billion in 1994 to $92.8 billion in 1996. Suddenly, in 1997,

the long period of inflow abruptly reversed, with a net outflow of around $12.1 billion. Theremarkable and unexpected swing of capital flows $105 billion (from $93 billion inflow to 12

billion outflow) represents around 11 percent of the pre-crisis dollar GDP of the five Asian

countries.

3.SummaryThe Asian financial crisis involves four basic problems or issues:

1. A shortage of foreign exchange that has caused the value of currencies and equities in

Thailand, Indonesia, South Korea and other Asian countries to fall dramatically.


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2. Iinadequately developed financial sectors and mechanisms for allocating capital in the troubled

Asian economies.

3. Effects of the crisis on both the United States and the world, and

4. The role operations and replenishment of funds of the International Monetary Fund.

The Asian financial crisis was initiated by two rounds of currency depreciation that have been

occurring since early summer 1997. The first round was a precipitous drop in the value of the Thai

baht, Malaysian ringgit, Philippine peso, and Indonesian rupiah. As these currencies stabilized, the

second round began with downward pressures hitting the Taiwan dollar, South Korean won,Brazilian real, Singaporean dollar, and Hong Kong dollar. Governments have countered the

weakness in their currencies by selling foreign exchange reserves and raising interest rates, which,

in turn, have slowed economic growth and have made interest-bearing securities more attractive

than equities. The currency crises also has revealed severe problems in the banking and financial

sectors of the troubled Asian economies.

The International Monetary Fund has arranged support packages for Thailand, Indonesia, and

South Korea. The packages include an initial infusion of funds with conditions that must be met foradditional loans to be made available.


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This financial crisis is of interest to the U.S. government for several reasons. First, attempts to

resolve the problems are led by the IMF with cooperation from the World Bank and Asian

Development Bank and pledges of standby credit from the Exchange Stabilization Fund of theUnited States. Second, financial markets are interlinked. What happens in Asian financial markets

also affects U.S. markets. Third, Americans are major investors in the region, both in the form of

subsidiaries of U.S. companies and investments in financial instruments. Fourth, the currency

turmoil affects U.S. imports and exports as well as capital flows and the value of the U.S. dollar; the

U.S. deficit on trade is now rising as these countries import less and export more. Fifth, the crisis is

causing economic turmoil that is exposing weaknesses in many financial institutions in Asia; some

have gone bankrupt. The economic problems of the troubled Asian economies are adversely

affecting the United States, Japan, and others.

The U. S. Congress is likely to consider the Asian financial crisis within three broad legislative

contexts. The first is in the financing and scope of the activities of the IMF. This includes legislation

to provide the IMF with an increase in its quotas or capital subscriptions, New Arrangements to

Borrow, an allocation of Special Drawing Rights, and an amendment to the IMF's Articles of

Agreement. The second legislative context is in the impact of the crisis on the U.S. economy and

American financial institutions. Forecasters foresee a decline in U. S. growth and an increase in the

U.S. trade deficit because of the crisis. The third context is in efforts to liberalize trade andinvestment in the world.


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4.Causes of Crisis 1997-984.1. The Korean industrial conglomerate (chaebol), Hanbo Steel collapses under $6 billion in

debts, raising questions about the sustainability of a rapid growth strategy dependent on

large, potentially unsustainable external borrowings.

4.2. The Thai baht comes under speculative attack from foreign currency traders. Doubtsemerge about the continuing competitiveness of the Thai economy given the bahts loose

pegging to the $US.4.3. Thai insurance and finance companies begin to collapse. At the same time the

contagion effect begins, initially affecting the Philippines and Indonesia. In July, Thailand

calls in the IMF for technical assistance. The IMF also offers the Philippines financial

assistance. Malaysia abandons the defense of the ringgit as the contagion spreads.

4.4. The rupiah falls dramatically following the governments decision to abandon itsmanaged float exchange rate policy. Mahathir blames Soros for initiating the crisis. The IMF

increases assistance to Thailand to over US$17 billion.

4.5. As the crisis deepens, Indonesia calls in the IMF. Late in the month the IMF offers theIndonesian government a $23 billion support package.

4.6. South Korean stock market prices collapse triggering debt and confidence crises. ByNovember 21, Korea is also forced to ask the IMF for assistance.


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4.7. The IMF puts together a multi-billion dollar rescue package for Korea. As the financialcrisis continues to intensify, Japan tries to stimulate its domestic economy, but its own

banking sector is downgraded by ratings agencies.4.8. In 1998 the Indonesian currency continues on a downward path, partly driven bySuhartos decisions to continue as President and appoint Habibie as Vice-Presidentthe

currency breaks Rp. 15,000 to US$1 barrier.

4.9. Stock markets in the region rebound during February, but remain characterized byextreme volatility. A standoff over a currency board proposal continues between Indonesia

and the IMF.

4.10. The Indonesian economy is on the brink of hyper-inflation. Unemployment escalates.Japanese proposals to stimulate its domestic economy are poorly received. The IMF adopts amore flexible position towards Indonesias reform program.

4.11. Japans Nikkei stock market index plunges at the start of the new financial year. MoodysInvestor Service lowers Japans sovereign debt rating. G7 leaders fail to give support the Yen

which continues its steady decline in value.

4.12. Massive student protest and riots erupt in Indonesia for Suharto to resign. Vice-PresidentB.J. Habibie takes over. The transition fails to bring stability to the Indonesian economy. The

yen continues to fall against the dollar, undercutting the competitive position of other Asiannations and sparking fears of a fresh round of currency collapses.

4.13. The crisis begins to affect Australia more directly steady decline in the value of theAustralia dollar despite Reserve Bank intervention sees interest rates begin to move up.


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Pauline Hansons One Nation Party has electoral success in Queensland. The Japanese

economy officially moved into recession following second successive quarter of negative

growth.

5.THE ECONOMIC IMPACT OF THE CRISIS5.1. Currency Rates

By far the most dramatic and destabilising consequence of the East Asian crisis has been a collapse

in the value of the currencies within the region (See Table 1). Of these, the Indonesian rupiah, theSouth Korean won, the Thai baht, the Philippine peso, and the Malaysian ringgit have been the

worst affected. The Hong Kong dollar has been the only currency not to record a fall over the past

12 months. Significantly, Hong Kong utilises a currency board system in which the Hong Kong

dollar is pegged to the US dollar. Unlike Indonesia, however, which also considered adopting a

currency board system until International Monetary Fund (IMF) pressure and declining investor

confidence persuaded it not to, Hong Kong has foreign reserves of its own and the implicit

support of mainland China which also has substantial reserves. Chinas currency has been similarlyunaffected as it is not fully convertible.


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5.2. Capital FlowsAlthough there are a number of interpretations about the ultimate causes of the crisis, there is little

doubt that flows of capital in and out of the region have been a major influence on both the

regions rapid development and its subsequent collapse. Huge inflows of private capital were

instrumental in causing both the appreciation of regional currencies and the value of domestic

assets, particularly in areas like real estate. Indeed, it is important to remember that it was the

bursting of Thailands speculative real estate bubble that was one of the first clear indicators and

triggers of the initial crisis. The other factor that needs to be borne in mind with regard to capital

flows is their sheer volume compared to what are still comparatively small Southeast Asian

economies. By some estimates, US$ 2 trillion passes through the worlds financial markets every

day. This compares with Indonesias entire annual GNP of US$ 136 billion.

The subsequent loss of investor confidence or outright panic caused significant withdrawals of

capital from the region. According to the Institute of International Finance, private capital flows to

the five countries worst affected by the crisis Indonesia, South Korea, the Philippines, Thailand, and


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Malaysia fell from +$US93 billion in 1996 to -$12.1 billion in 1997 and are forecast to be -$9.4

billion for 1998.

5.3. Interest RatesThe crisis has also led to a dramatic rise in prime lending rates within the region, especially in

Indonesia and the Philippines (See Figure 1). As the value of Asian currencies has fallen, banks

have increased interest rates in order to stem capital flight and maintain liquidity. At the same time,

governments have been forced to raise interest rates in order to contain the inflationary pressures

caused by the currency collapse. Two points are worth noting in connection with interest rates.

First, comparatively high interest rates were actually used by a number of governments to attract

capital prior to the crisisa strategy that was fraught with potential risk. Second, the current highinterest rate levels in the region make any rapid regeneration of domestic activity more

problematic.

5.4. Economic GrowthAnother important element of the crisis has been a substantial drop in economic growth rates within the region.

In May of last year, the IMF was forecasting continued strong growth for the region for 1997 and 1998. By

December, however, it had dramatically revised its growth forecasts, predicting a substantial drop in growth in

all countries with the partial exception of South Korea (See Table 3). This is an especially serious concern in a

region in which the legitimacy of government has often been directly bound up with its ability to deliver rising

living standards.


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5.5. Consumer DemandCompounding the impact of the crisis has been a substantial fall in consumer confidence and

spending. For instance, as Table 4 illustrates, automobile sales within the region are expected to

decline significantly during 1997-1998. The contraction of domestic markets is potentially

important for a number of reasons. First, economic recovery will be more dependent on

maintaining or increasing exports to key markets in North America and Europe. Given Europes

own modest economic performance and the possibility of further trade tensions over the United

States increasing deficits with the East Asian region, this is clearly a strategy that faces a number of

potential obstacles. Second, the regions deteriorating economic performance may make inflows of

foreign direct investment (FDI) in productive activities less likely in the short term, further

constraining local economic activity. Third, the IMFs influential policy prescriptions of fiscal

restraint make any government-led economic recovery less likely.

5.6. Default on Foreign Debts and Corporate CollapsesThe crisis has also increased many Asian countries foreign debt burdens. As Table 5 shows, Asiancompanies have borrowed heavily from international banks in recent years, especially short-term.

As the value of Asian currencies has fallen, these companies have found it difficult to meet their

debt repayments because their incomes are overwhelmingly in local currencies whilst their debts


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are largely denominated in foreign ones. In some cases this has led to defaults on debt

repayments. Perhaps the best known example of this was the Indonesian taxi company, PT Steady

Safe, whose inability to repay its debts resulted in the collapse of the Peregrine investment House

in Hong Kong last year. Many other companies, especially in Indonesia, Thailand and South Korea,

are having trouble repaying their foreign loans, something which makes any short-term resolution

of the crisis all the more problematic.

5.7. Non-Performing LoansIn addition to being unable to repay their foreign debts, many Asian companies have also haddifficulty servicing their local debts since the crisis began. The result of this, as Table 6 shows, has

been a substantial increase in the level of non-performing loans within the region. Not only does

this make the position of these companies more uncertain and the possibility of a domestic-led

recovery more remote, but it also acts as a continuing disincentive to further investment in the

region in the short-term.

6.ISSUES AND DEBATES6.1. What Caused the Crisis?

Broadly speaking, four alternative explanations for the crisis can be identified. The first, associated

most prominently with the IMF and liberal critics such as Charles Wolf Jnr., blames the crisis on the


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Asian development model.3 In this view, the crisis stemmed not from irrational behaviour by

currency markets (although many of those who subscribe to this view do concede that financial

markets may have over-reacted), but from the inefficiencies and distortions caused by excessive

government intervention in the economy. In particular, it is argued, excessive government

intervention encouraged the development of systems of crony capitalism and the mis-allocation of

resources.

A second, highly contentious explanation associated most prominently with Malaysias Prime

Minister Mahathir Mohammad, views the crisis in terms of a conspiracy on the part of foreign

currency tradersled by the well-known fund manager, George Sorosto undermine economic

development in Southeast Asia.4 According to Mahathir, traders such as Soros control such vast

amounts of capital that they can manipulate international currency and equity markets for their

own ends. At the same time, he says, these traders are guided by a beggar-thy-neighbour instinct.

For them, wealth must come from impoverishing others, from taking what others have in order to

enrich themselves.5 In his view, then, currency traders were not merely over-reacting when they

decided to sell Southeast Asian currencies, but were deliberately manipulating the market in order

to impoverish local economies and thereby enrich themselves.

A third explanation, advanced by scholars such as Steven Radelet and Jeffrey Sachs of the Harvard

Institute for International Development, explains the crisis in terms of a financial panic.6

According to this view, the crisis did not stem from poor policies in the region or from weak

fundamentals. Rather, it is argued, the main cause of the crisis was a sudden shift in market


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expectations and confidence that resulted in a massive withdrawal of capital from the region. In

this view, there was nothing rational about the crisis panic, not a reasoned consideration of the

fundamentals, drove the currency collapse.

A fourth explanation explains the crisis in terms of shifts in political and social power, both at a

global and a domestic level, which, firstly, led to the emergence of unregulated and volatile global

financial markets and, secondly, gave rise to the weakening fundamentals that characterised many

East Asian economies. The unregulated and volatile nature of global financial markets, it is argued,

needs to be understood in terms of the shift in power from states to mobile forms of capital that

has occurred as a result of globalisation.8 At the same time, the poor fundamentals of many

countries within the region need to be understood in terms of the emergence of powerful politico-

business coalitions within these countries during the 1980s and early 1990s. Richard Robison and

Andrew Rosser suggest that this business-government nexus exacerbated the moral hazard

problem by creating a false feeling of security amongst potential investors.9 At the same time, they

argue, the dominance of these coalitions prevented the adoption of the reform measures that

might have overcome the foreign debt, non-performing loan and other problems underlying the

crisis.

6.2.

Perspectives on the Management of the CrisisThe key institution involved in attempts to resolve the crisis has been the IMF. Its strategy initially

involved its standard recipe of reform for countries which have experienced rapid losses of investor

confidence and capital flightgeneral fiscal consolidation and belt-tightening. Such policies have


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been criticized as insufficiently discriminating and inappropriate for the East Asian situation, as

most of the economies of East Asia were in a comparatively sound position in terms of

government spending, foreign reserves, trade surpluses and their inflationary outlook prior to the

crisis.

The IMFs position was based largely on the assumption that the solution to the crisis lay in a shift

away from the sorts of interventionist economic policies that were associated with the so-called

developmental states of East Asia,10 towards policies that were centered on market mechanisms.

In particular, the IMF contended, overcoming the crisis required tighter fiscal policies, the closure of

insolvent financial institutions, the elimination of government and private monopolies, reductions

in tariffs and export subsidies, and the development of greater transparency in government.11

Critics maintain that these policies are both inappropriate for the sorts of problems the countries of

East Asia currently confront, and moreover, may be designed principally to break down state-

business structures of which the US and the IMF disapprove. Whatever the intrinsic merits of the

IMF packages, it is important to recognize that the US exercises direct veto power over its decision-

making processes and that IMF reforms are closely associated with US foreign policy goals, raising

important questions about the IMFs overall status and mission.

Two aspects of the IMFs crisis management have attracted particular criticism. First, Jeffrey Sachs

argues that the region does not need drastic budget cutting and credit tightening, but stable or

even slightly expansionary monetary and fiscal policies to counterbalance the decline in foreign

loans. Second, David Hale has criticized the IMF for failing to deal with the issue of foreign debt.


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He argues that the main cause of the crisis was not poor policies or crony capitalism, but the

enormous flows of short-term unhedged US dollar loans into the region. By leaving the resolution

of Indonesias debt problems up to the market, Hale contends, the IMF is adopting an approach

that would inevitably lead to widespread bankruptcies, sharply higher unemployment and

increasing ethnic conflict. The key to the successful resolution of the crisis in this view lies in the

IMF abandoning its commitment to a market-based solution in favour of negotiated debt

rescheduling.

Other critics have suggested that the most serious deficiency of the IMFs approach has been its

failure to appreciate the impact of the reform package on financial structures in East Asia. Focusing

on South Korea, Veneroso and Wade argue that one of the main reasons for the East Asian

miracle was the existence of cooperative, long-term, reciprocal relations between firms, banks and

governments in a system with high savings and high debt/equity ratios.15 By closing down

banks, allowing greater foreign investment in the financial sector, and requiring Asian countries to

liberalise their capital accounts, they contend, the IMF was effectively trying to dismantle the Asian

high debt financial system and replace it with a Western one. The dangers of this approach, they

argue, are twofold. Firstly, it would eliminate the developmental advantages of a high debt system

(i.e. greater access to capital for companies and closer cooperation between government and

business). And, secondly, insofar as it involved capital account liberalisation, it would leave Asiancountries even more vulnerable to financial panic than they had been before the crisis.


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7.Conclusion and Recommendation:The crisis is likely to prove something of a watershed in the region. Millions of people have

suddenly found themselves unemployed and thousands of companies have collapsed.Governments have not only found themselves unable to manage domestic economies and

international economic relations, but they have also lost a good deal of moral and political

authority. Resolving the crisis, therefore, will not simply be a question of applying optimal

economic strategies and techniques to specific technical problems. On the contrary, if the crisis

has one unequivocal lesson, it is that economic management and organisation is always a deeply

political affair. Whether it is the structure of domestic relations between political and economic

agents, or the management of transnational relations between government and external agencieslike the IMF, economics cannot be separated from an overarching political context.

8.References8.1. wwwarc.murdoch.edu.au/publications/wp/wp86.pdf8.2. www.frbsf.org/econrsrch/wklyltr/wklyltr98/el98-24.html8.3. wwwarc.murdoch.edu.au/publications/wp/wp86.pdf
http://www.frbsf.org/econrsrch/wklyltr/wklyltr98/el98-24.html

energy crisis of 1997-98

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