3.3 : Core Elements of the 2nd Generation Crisis Model. ..... 6. Chapter 2: Asia and the 1st Generation Model. Currency crises tend to have enormous political, economic, and social ...... complicating any effort to organize a voluntary rollover.
Currency and Financial Crises in East Asia
A critical assessment of the crisis in Thailand, Korea, Indonesia and Malaysia In light of the 1st & 2nd Generation Crisis Model.
Thesis Janine Wijenbergh Student nummer 836571994 Augustus 2002 Faculteit Managementwetenschappen Open Universiteit Nederland, Heerlen Begeleider: Dr. P. Ghijsen Examinator: Drs. C. Gelderman
“Theories without facts are empty: facts without theories are blind.” Immanuel Kant in the ”Critique of pure pure reason.”
I would like to thank Stanford University and the London School of Economics for making their facilities available to me.
A special thanks goes to Dr. Paul Ghijsen for his kind support, insight, knowledge, and his patience.
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Table of Content.
Chapter 1 : Introduction. __________________________________________________ 1 Chapter 2 : Asia and the 1st Generation Model. _______________________________ 6 2.1 : 1st Generation Model: Canonical Model. _________________________________ 6 2.2 : Asia’s Growth and Macro Economic Policies. _____________________________ 8 2.3 : Macro Economic Fundamentals. ______________________________________ 11 2.4 : Conclusion. _______________________________________________________ 16 Chapter 3 : Introduction of the 2nd Generation Model. ________________________ 18 3.1 : Example: Mexican Tequila Crisis 1994-1995. ____________________________ 18 3.2 : Sub-Models of the 2nd Generation Crisis Model.__________________________ 20 3.3 : Core Elements of the 2nd Generation Crisis Model. _______________________ 25 3.4 : Combining the Sub Models with Core Elements. __________________________ 28 Chapter 4 : The Crisis in Thailand. _________________________________________ 31 4.1 : A Crisis Develops. _________________________________________________ 31 4.2 : Recognizing Core Elements in the Crisis. _______________________________ 33 4.3 : 2nd Generation Model Applied. _______________________________________ 38 4.4 : Summary and Conclusion. ___________________________________________ 44 Chapter 5 : The Crisis in Korea. ___________________________________________ 45 5.1 : Spread of the Crisis to Korea. ________________________________________ 45 5.2 : Special Situation in Korea: Chaebols. __________________________________ 46 5.3 : Recognizing Core Elements in the Korean Crisis. _________________________ 48 5.4 : 2nd Generation Model Applied. _______________________________________ 51 5.5 : Summary and Conclusion. ___________________________________________ 56 Chapter 6 : The Crisis in Malaysia._________________________________________ 57 6.1 : Spread of the Crisis to Malaysia. ______________________________________ 57 6.2 : Recognizing Core Elements in the Malaysian Crisis._______________________ 58 6.3 : 2nd Generation Model Applied. _______________________________________ 60 6.4 : Summary and Conclusion. ___________________________________________ 64
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Chapter 7 : The Crisis in Indonesia. ________________________________________ 66 7.1 : Spread of the Crisis to Indonesia. _____________________________________ 66 7.2 : President Suharto & Family.__________________________________________ 68 7.3 : Recognizing Core Elements in the Indonesian Crisis. ______________________ 68 7.4 : 2nd Generation Model Applied. _______________________________________ 72 7.5 : Summary and Conclusion. ___________________________________________ 77 Chapter 8 : Summary and Conclusion. _____________________________________ 79 Literature. ______________________________________________________________ 84 Appendix I : Asian currencies 1985-1998. ___________________________________ 89
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Tables.
Table 1: Some Macro Economic Indicators ____________________________________ 11 Table 2: Current Account 1990-1997 _________________________________________ 12 Table 3: GDP Growth _____________________________________________________ 13 Table 4: Investment Rates _________________________________________________ 13 Table 5: Savings Rates ___________________________________________________ 14 Table 6: Fiscal Balance ___________________________________________________ 14 Table 7: Inflation_________________________________________________________ 15 Table 8: Openness of the Economy__________________________________________ 16 Table 9: Sub-Models combined with Core-Elements_____________________________ 29 Table 10: Liquidity and Currency Mismatches __________________________________ 34 Table 11: Incremental Capital Output Ratios, 1987-1996 _________________________ 40 Table 12: Top 30 Chaebols ________________________________________________ 47 Table 13: Bilateral Trade __________________________________________________ 51
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Figures. Figure 1: First Generation Model of Crises _____________________________________ 7 Figure 2: GDP During the Last 3 Decades______________________________________ 8 Figure 3: Capital Inflow into Mexico 1983-1997 _________________________________ 19 Figure 4: The Movement of the Thai Baht 1996-1998 ____________________________ 31 Figure 5: Thailand: Long term Debt versus Short term Debt _______________________ 34 Figure 6: Thailand: Capital Inflows; Reserves __________________________________ 39 Figure 7: Ratio of International Reserves to Short-term Debt ______________________ 41 Figure 8: Thailand: Property Sector: Stock Market Index _________________________ 43 Figure 9: Thailand: Stock Market Index, SET __________________________________ 43 Figure 10: The Movement of the Korean Won 1996-1998_________________________ 45 Figure 11: Korea: Long term Debt versus Short term Debt ________________________ 48 Figure 12: Korea: Capital Inflows; Reserves ___________________________________ 53 Figure 13: Korea: Stock Market Index, KOSPI _________________________________ 54 Figure 14: The Movement of the Malaysian Ringgit 1996-1998 ____________________ 57 Figure 15: Malaysia: Capital Inflows; Reserves _________________________________ 61 Figure 16: Malaysia: Property Sector: Stock Market Index ________________________ 63 Figure 17: Malaysia: Stock Market Index, KLSE________________________________ 63 Figure 18: The Movement of the Indonesian Rupiah 1996-1998 ___________________ 66 Figure 19: Indonesia: Long term Debt versus Short term Debt _____________________ 69 Figure 20: Indonesia: Property Sector: Stock Market Index _______________________ 75 Figure 21: Indonesia: Stock Market Index, JKSE _______________________________ 75 Figure I-a: Thai Baht 1985-1998 ___________________________________________ 89 Figure I-b: Korean Won 1985-1998 _________________________________________ 89 Figure I-c: Malaysian Ringgit 1985-1998 _____________________________________ 90 Figure I-d: Indonesian Rupiah 1985-1998 ____________________________________ 90
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”A few small glitches in the road” U.S. President Clinton, commenting on the Asian crisis. APEC forum in Vancouver, November 1997.
Chapter 1: Introduction. In 1997, four East Asian countries −Thailand, Malaysia, Korea and Indonesia − experienced 1
sharp currency and banking crises . All of a sudden, countries that had produced “miracles of growth”, saw their currencies plummet in value, became subject to an exodus of portfolio capital, and were faced with deep economic contraction that threw many of their citizens back into poverty. As much as the crisis seemed unexpected, the contagion and severity as a result of the turmoil was totally unanticipated. As may be clear from the quote on the top of this page, even at the highest level of the political arena of the world, the concerns about the depth of the crisis were not serious. This description quickly gave way to less rosy scenarios, as evidence of the effect of this crisis became clear. When the Asian crisis became apparent, the international economic community at first blamed the shortcomings of the Asian economies for the crisis. Asia had experienced an over-expected economic growth, and critics blamed Asia’s rapid success for the crisis. The consensus was that the crisis was bound to happen, and that the Asian countries had become victims of their own success. Some observers went even further in their assessment of the Asian crisis. They suggested in the aftermath of the crisis that Asia’s rapid development was somehow a mirage that did not really happen, or has been 2
completely wiped out by the crisis. This view is obviously mistaken . The enormous gains in income levels, health, education and general welfare in Asia during the last three decades were sound and will not be dissipated by an economic crisis or even an extended recession. 1
In the economic literature, different types of crises are defined as:
Currency Crises occur when a speculative attack on the exchange value of a currency results in a devaluation of the currency usually forcing authorities to defend the currency by using international reserves or by sharply raising interest rates. Banking crises refer to a situation in which actual or potential bank runs or failures induce banks to suspend internal convertibility of their liabilities or which compels the government to intervene to prevent this by extending assistance on a large scale. Systemic Financial Crises are potentially severe disruptions of financial markets that, by impairing markets’ ability to function effectively, can have large adverse effects on the real economy. A systemic financial crisis may involve a currency crisis. Foreign Debt Crises occurs when a country cannot service its foreign debt (Gibson, 1996). 2
The most striking example of this view is Paul Krugman (in a 1994 article) comparing the growth of
Asia to the growth of the former Soviet Union under communism. Krugman corrected his view at the start of the Asian crisis in the fall of 1997, stating that his provocative critique of East Asian growth suggested a slowdown in growth and not a collapse.
1
The Asian crisis is not the first financial crisis in history. In the past decades, other countries 3
and regions in the world have experienced similar problems . The effects of these crises are almost always severe: suddenly an economy that has been receiving large capital inflows stops receiving these flows. Instead, sudden demands are being made to repay the outstanding loans, pushing borrowers and ultimately the country into a potential situation of insolvency. This leads to deep economic contraction in the debtor countries, losses to foreign investors, and a rescheduling of debt payment or a rescue by a lender who provides temporary financing of the payments. Though the results of a financial crisis are similar in their devastation, the causes can be considered unique for each and every crisis situation. This paper will address the Asian crisis, specifically targeting the causes and the theories of the severe crisis in four countries, Thailand, Korea, Malaysia and Indonesia. Unlike previous crises in history, the Asian crisis has elements that have not been experienced in other crises in the world. The crisis spread from country to country, targeting not only currencies, but also local and international capital markets, and seemed not to be based on weak economic fundamentals. In light of the complexity of this crisis, and to be able to assess and understand the cause of the crisis, I have decided to follow the available economic literature, and to approach the 4
crisis in a qualitative manner . This will create a broad understanding of the mechanisms that set the crisis in motion, and ultimately caused the crisis to spread.
3
Some examples of crises in history are:
1929: The Wall Street Crash, leading to a severe banking crisis; 1982: The Mexican Debt crisis, when Mexico defaulted on its debt; 1992: The EMS crisis, when the European Exchange Rate Mechanism collapsed under pressure of a currency crisis; 1994: The Mexican Tequila crisis, when the Mexican peso collapsed (Krugman, 1998). 4
Qualitative research is used to determine the character and nature of causal relations, through
observation (participative); open interviews; or based on existing resources on the subject matter. In comparison, quantitative analysis usually has the purpose to determine correlation between occurrences using qualitative methods, such as regression analysis. For the purpose of this thesis, a qualitative analysis seems more suitable to determine the cause of the Asian crisis. The analysis in this paper follows the third research method, using existing economic sources. (http://globis.geog.uu.nl/gismt/staff/ritsmavaneck/kwalkwan/grijze.htm)
2
The cause of the crisis will be examined with an analysis of the actual situation in the four Asian countries, and each individual country will be examined in light of two existing crisis st
models, the 1 and 2
nd
5
generation model .
st
The 1 generation of crisis model can be briefly described as a crisis caused by excessive money-financed government borrowing, where the authorities are defending a fixed exchange rate with a limited stock of foreign exchange reserves. Monetary and fiscal policies of the country have become inconsistent, and a sharp depreciation of the currency is inevitable. In detail, the following questions will be answered in Chapter 2: st
1. Does the Asian crisis fit into the 1 generation model of crises? st
a)
How does the 1 generation crisis model work?
b)
What was the macroeconomic condition of the four Asian countries in the years leading up to the crisis? st
In the remainder of chapter 2, an assessment will be made about the relevance of the 1 generation crisis model for the situation in Asia. We will quickly learn that Asia’s rapid
economic development, and its high growth rate in the years before the crisis, was unique st
and made the countries less vulnerable to a crisis of the 1 generation model. In chapter 3, the 2
nd
generation crisis model will be introduced. The 2
nd
generation crisis
model is defined as a crisis caused by one, or more of the following scenario: 1. Panic or a self-fulfilling crisis, when individual investors act rational, but the market produces reversals in capital flows that seem to be unnecessary.
5
A “Theory” is defined as a set of statements or principles devised to explain a group of facts or
phenomena, especially one that has been repeatedly tested or is widely accepted and can be used to make predictions about natural phenomena. An economic theory indicates that it is accepted as such by economists. A “Model” is defined as a schematic description of a system, theory, or phenomenon that accounts for its known or inferred properties and may be used for further study of its characteristics. An economic model is usually an empirical, or simplified deduction from a theory. However, the literature on the subject of the Asian crisis does not always use the term “Theory” and “Model” in a consistent manner: the word “Model” is often used synonymously with “Theories”. In order to avoid confusion, I have decided to follow the definitions in their true form. In some instances however, the economic literature has named a specific model as a “Theory”. An example is “The bubble theory”, which is actually recognized as a sub-model from the 2nd generation crisis model. In these instances I have followed the general acceptance of the economic literature on the specific subject. (http://ruls01.fsw.leidenuniv.nl/www/w3_cuanmet/jaar1/Methodologie/lecture4.htm)
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2. Moral hazard, when extensive guarantees encourage risk-taking and too many resources are flowing into insured activities. 3. Disorderly workout, where an illiquid borrower is forced into insolvency due to a creditor’s grab race. 4. Bubble situation, where the value of an asset is inflated due to expectation of capital gain, and not on the expected income of the asset. This may create a bubble situation that, under certain conditions, can burst. 5. Contagion, where the crisis is submitted due to real or financial interdependencies. The sub-models are not necessarily mutually exclusive: it is very well possible that several sub-models are at work at the same time in one country, re-enforcing the crisis through their interactive relationship. For instance, a high level of government guarantees may have induced investors to extend their exposure in the real estate market, creating a bubble in this market. When financial markets realize that guarantees may not be honored, a bubble may burst, creating a panic situation where investors are exhibiting patterns of disorderly workout and are simply pulling their money out of this country. It should be clear from this example that there is a certain “chicken and the egg” syndrome at work in the 2
nd
generation model. To be able to differentiate between the different sub-
models, and their impact on the crisis in Asia, I have dissected the sub-models to find common elements, so-called core-elements, between the models. The elements are defined as: herd behavior; the existence of guarantees; liquidity/solvency problems; rational expectations by investors; and interdependencies between countries. These elements are important in at least one and in some cases in more than one submodel. For instance, we will see that herd behavior as a core-element can be at work as a driving force for a situation of panic, in a situation of disorderly workout, a possible bubble, and even a situation of contagion. The core elements will help in the qualitative analysis of the crisis to determine which sub-model is most relevant in describing the crisis situation in the four countries. In chapter 3 the following questions will be addressed: 2. Is the 2
nd
generation crisis model relevant to the Asian crisis? nd
a)
How does the 2
b)
How are possible sub-models of the 2 generation model defined, and what is their
generation model work in general? nd
content? c)
How are the core-elements defined, and how can they be used to determine the existence of each sub-model?
In chapter 4 through chapter 7 we will take a detailed look at the crisis countries. Chapter 4 will be dedicated to the crisis in Thailand, where the crisis originated. The situation in Korea will be discussed in chapter 5, followed by Malaysia’s crisis situation in chapter 6.
4
Finally, in chapter 7, we will focus on Indonesia, where the crisis struck harder than anywhere else due to the government’s mismanagement of the crisis. In each chapter, the following questions will be addressed: 3. Are any, more or all sub-models of the 2
nd
generation model relevant to the respective
country? a)
How did the crisis materialize?
b)
Can we recognize any of the core elements, as defined in chapter 2, in the crisis situation?
c)
With the help of the core-elements, can we determine the relevance of any of the sub-models?
The qualitative analysis will be concluded in chapter 8, with a summary of the findings of the analysis.
5
Chapter 2: Asia and the 1st Generation Model. Currency crises tend to have enormous political, economic, and social implications. This is one of the reasons that economists devote a lot of attention trying to determine the cause of crises. Several theories of currency crises exist in the economic literature. One of the st
theories is the 1 generation model. This model gives a straightforward answer: the macroeconomic policies of the government (monetary and fiscal) can directly be blamed for the start of this kind of crisis. st
In section 2.1, I will introduce and examine the 1 generation model. As we will see, the macroeconomic policies of a country are important factors in determining the relevance of st
the 1 generation crisis model. Therefore, in section 2.2 we will briefly address the monetary and fiscal policy in the four Asian crisis countries. The condition of some macroeconomic variables of the four crisis countries will be discussed in section 2.3. The chapter will be st
concluded with an assessment of the relevance of the 1 generation model in the case of the Asian crisis, in section 2.4. 2.1: 1st Generation Model: Canonical Model. st
The 1 generation crisis model was first described in a classic paper by Salent and Henderson (1978), and further developed into a canonical currency-crisis model by Krugman (1979). The model emphasizes the role of excessive money-financed government borrowing, where the authorities are defending a fixed, or pegged, exchange rate with a limited reserve of foreign exchange reserves. Fiscal and monetary policies are generally weak, and domestic inflation is high. The high inflation rate has an affect on the competitiveness of the domestic currency undermining the competitiveness of the country. As a result, the trade deficit will widen. The foreign exchange reserves will decline, as they are being used to buy domestic currency by the 6
central bank in an attempt to maintain the value of the exchange rate . If the government would drop its commitment to a fixed exchange rate, it would no longer have to sell foreign exchange reserves to support the currency, and the exchange rate could depreciate. Alternatively, it if reduced its fiscal deficit, interest rates could be higher, less capital would flow out, and the exchange rate would not be under pressure. If the 6
A country can use its reserves to defend its currency. When there is an apparent threat of
devaluation, the central bank can intervene, and buy back the currency, using its foreign reserves. In this way the central bank limits the supply, thereby trying to maintain or strengthen the value of the currency. In a situation of appreciation, the central bank can use its domestic currency reserve, and dump the currency on the market, in an attempt to weaken demand/price for its national currency.
6
government chooses not to change its policies, foreign exchange reserves will continue to fall. When reserves reach a critical level, they become too low to offset the sell order for the domestic currency. Eventually the central bank will run out of foreign exchange reserves, causing the currency to depreciate sharply. The financial markets will recognize that the authorities have insufficient reserves, and investors will try to anticipate the inevitable devaluation, generating a speculative attack in the form of capital outflows. Figure 1 shows what happens when the reserves reach a critical level, which is defined as point Rc in the chart. Note that the currency crash will occur before the central bank runs out of reserves. Why does this happen? Investors know that, eventually, reserves will be exhausted, and the currency will crash. They will not wait until the foreign exchange reserves are totally depleted. Investors will want to sell the domestic currency before the reserves run out. Figure 1: First Generation Model of Crises
Foreign Exchange Reserves
F ir s t G e n e r a t io n M o d e l
F is c a l D e fic its c a u s e fo r e ig n e x c h a n g e r e s e r v e s to fa ll; a tt a c k s o c c u r b e f o r e r e s e r v e s a r e d e p le te d .
Rc
S p e c u la t iv e A t t a c k o c c u rs
T im e
Source: Krugman, 1998. At point Rc in the chart, investors sell the domestic currency in large amounts, and the government either wastes what little reserves it has left, or immediately devaluates the currency. The effect is that the currency will depreciate sharply, and anyone holding it will loose money. st
The government will blame investors however, according to the 1 generation model, this is irrelevant. In this situation investors and even speculators act as messengers: their message is that the government has to change their policy. Domestic and external policies (monetary and fiscal policy) have become so inconsistent that a sharp depreciation of the currency is inevitable. By simultaneously pursuing two inconsistent policies, the government in effect and inadvertently caused the currency crisis.
7
st
An example of the 1 generation crisis model is the volatile exchange of Latin America in the 1970s when governments tried to target the exchange rate to stabilize high inflation rates while still running large fiscal deficits. st
Another example of the 1 generation crisis is the Mexican Debt crisis in 1982. It goes beyond the scope of this paper to examine this crisis in more depth. It suffices here to say st
that all the variables of a 1 generation model were present in this crisis: declining foreign exchange reserves, large fiscal deficits, capital outflows, and high rates of inflation. st
In order to make an assessment if the Asian crisis fits into the 1 generation model, the next two sections examine the macroeconomic condition of the four crisis countries. 7
2.2: Asia’s Growth and Macro Economic Policies . One reason that the crisis came as such a surprise was East Asia’s long track record of economic success. For three decades, Thailand, Korea, Indonesia and Malaysia had an impressive record of economic performances: fast growth, low inflation, macroeconomic stability and strong fiscal positions, high savings rates, open economies and thriving export sectors. Figure 2: GDP During the Last 3 Decades
Per Capita GDP in 5 Asian countries: 1965-1995 in PPP 1985 dollars
8500
6500
Indonesia korea malaysia thailand
4500
2500
500 1965 1970 1975 1980 1985 1990 1995
Source: IMFs International Financial Statistics.
7
This section is mainly based on Burda’s and Wyplosz’s book, “Macroeconomics, a European Text,
1997, Oxford University Press, pages 1-613.
8
Figure 2 expresses the successful performance of the countries in GDP growth. In Thailand, Malaysia and Indonesia, average income more than quadrupled between 1965 and 1995, and in Korea income rose seven-fold. Average incomes in the four countries climbed from 10% of the US average in 1965 to around 27% in 1998. 2.2.1: The Logic of Monetary Policy. Monetary policy is one of the tools used to improve the economic conditions of a country. It is a complex process of monetary control involving the relationship between the central bank and the commercial banks. All this must be done in an environment of economic openness with other countries that implement their own monetary policy. A central bank has two policy instruments to control, or otherwise influence, the money supply: money and the interest rate (Burda & Wyplosz, 1997, page 226). The central bank can influence the supply of money by controlling the availability of bank reserves. To equilibrate demand and supply of money, the interest rate at which these transactions occur is continuously adjusted. Foreign exchange markets also influence monetary policy. Central banks frequently use their foreign assets to intervene on the foreign exchange market to influence the exchange rate. A country can choose to fix, or peg its currency to other currencies. This has its effect on the flexibility of a country’s monetary policy, limiting the effect through: 1. The use of the interest rate as a monetary policy tool will be limited when a country is trying to keep its exchange rate stable, since this can interfere with keeping the currency stable. 2. Also, under fixed exchange rates, monetary authorities are limited in setting the money growth rate, since this also has an effect on the level of the exchange rate. In Asia, the crisis countries chose early on to “fix” their currencies. Basically, the value of their currencies was directly related to a basket of currencies. We can conclude that this is similar to directly pegging the exchange rate to the US dollar (Corsetti et.al., 1998). Thailand focused more closely on its exchange rate policy during the years leading up to the crisis. It faced a fairly large real appreciation during the early 90s, from 25.59 baht to the US Dollar to 24.91 baht in 1995. Korea had a more flexible exchange rate policy: the won depreciated in nominal terms between 1990 and 1993, from 700 to almost 800 won to the dollar. After 1993 until 1996, the won was quoted within a very narrow range of 800 to 770, depreciating again at the end of 1996, to 884 won per US dollar. In Malaysia, the ringgit moved in a 10% range to the US dollar for most of the period leading up to the crisis. The Indonesian policy can be described as real exchange targeting, with the nominal
9
rupiah/dollar rate falling from 1900 in 1990 to 2400 by the beginning of 1997 (Corsetti et.al., 1998). Appendix I present an overview of the movement of the Asian currencies against the US dollar in the years 1985-1998. 2.2.2: Fiscal Policy. Fiscal policy can be used to stabilize demand, either directly through government spending, or indirectly through taxation by reducing fluctuations in private sector incomes (Burda et. al., 1997). In many industrial countries, the public debts are very large: the debt process is explosive, and requires careful management. The ability to service the debt is related to the size of a country. Therefore data concerning debt is in term of ratios to GDP: the objective is to stabilize the ratio of debt to GDP rather than the debt level itself. Naturally, debt stabilization is an important part of fiscal policy. There are three ways to first achieve a stabilization of the public debt, and then to make sure that the debt is manageable within the debt-GDP ratio: 1. A government can cut the deficit, possible going to a surplus, either by reducing public spending or raising taxes. 2. A government can finance the deficit by monetazation: the government practices money creation. 8
3. A government can, under severe stress, resort to default on their debt . In Asia, overall public sectors budget in the region had exhibited deficits that were in line with other middle-income developing countries, moving steadily into surplus after the mid80s. As the economies of the Asian countries grew and fiscal policy was further tightened, public-sector debt-to-GDP ratios fell throughout the region, at times reversing the growth of the public-sector debt. By the mid-90s, several countries in East Asia had achieved sizable fiscal surpluses and ratios of debt to GDP substantially below those of many industrial countries. Summarizing, the macroeconomic strategy in East Asian countries had two characteristics: 1. An exchange rate regime oriented toward enhanced competitiveness, keeping the Asian currencies aligned with the US Dollar. 2. The adoption of a tight medium-term fiscal policy. The public sector deficits of the 60s and 70s slowly moved into surplus in the 80s. This fiscal policy also promoted the depreciation of the long-run equilibrium real exchange rate, preventing the emergence of exchange rate misalignment in the form of undervaluation of the domestic currency. 8
This actually happened in 1982 in the Mexican Debt crisis (World Economic Outlook, 1997).
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Table 1: Some Macro Economic Indicators Selected Economies 1991-1996. Country
Growth rate
Inflation rate
Debt Service
Savings/GDP
Current
Asia
91-95
96
91-95
96
Ratio** 91-95 96
91-95
96
Account/GDP 91-95 96
Thailand
8.44
5.5
4.8
5.9
10.9
11.4
34.5
33.7
-6.2
-7.9
Korea
7.5
7.1
6.2
4.9
Na
7.5
35.2
33.3
-1.5
-4.7
Indonesia
7.82
8.0
8.9
7.9
32.4
36.8
28.6
28.8
-2.4
-3.3
Malaysia
8.68
8.6
3.6
3.5
8.4
8.7
31.8
46.6
-7.0
-4.9
Other
91-95
96
91-95
96
91-95
96
91-95
96
95
96
US*
1.92
2.8
2.86
2.3
Na
Na
15.48
16.6
-1.8
-1.9
Japan*
1.44
3.9
0.92
-0.5
Na
Na
32.26
31.3
2.2
1.4
EU*
1.5
1.7
3.84
2.4
Na
Na
19.56
19.7
0.6
1.1
Source: World Economic Outlook, 1998 & 1999*; Berg, 1999**. Table 1 gives a general overview of the macroeconomic condition of the four crisis countries. For comparison, the levels of these indicators are also given for the US, Japan and the European Union to help put the economic condition of the Asian economies in an overall perspective. In the next section several macroeconomic indicators, as a result of the fiscal and monetary policies during the last three decades, will be discussed. 2.3: Macro Economic Fundamentals. 2.3.1: Current Account. On the anniversary of the Mexican financial crisis of 1995, Lawrence Summers, US Deputy Treasury Secretary, wrote in the Economist that ‘close attention should be paid to any current account deficit in excess of 5% of GDP, particularly if it is financed in a way that could lead to rapid reversals (Corsetti et. al., 1998). Table 2 shows the current account balances for the four countries during 1990-1997. As is clear from the numbers in this table, the Asian crisis countries had sizeable current account deficits in the 1990s. The current account in Thailand was over 6% of GDP virtually every year in the 90s. In Korea, the deficit was small in the early 90s, 1-3% of GDP, but after 1993 the deficit grew very fast, to 5% of GDP in 1996 (Corsetti et.al., 1998). In Malysia the deficit was above 10% of GDP in 1993, falling to 3.7% of GDP in 1996. Indonesia’s current account deficit appeared to be large in the early 90s, declining rapidly during 1992-1994. In 1995, however the deficit increased again.
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Table 2: Current Account 1990-1997 Current Account, % of GDP. Countries
1990
Thailand
-8.74
Korea
1991
1992
1993
1994
1995
1996
1997
-8.01
-6.23
-5.68
-6.38
-8.35
-8.51
-2.35
-1.24
-3.16
-1.7
-0.16
-1.45
-1.91
-4.82
-1.90
Malaysia
-2.27
-14.01
-3.39
-10.11
-6.6
-8.85
-3.7
-3.5
Indonesia
-4.4
-4.4
-2.46
-0.82
-1.54
-4.27
-3.3
-3.62
Source: Corsetti et. al., 1998. What is the meaning of deficits in the current account balance, and what is their implication 9
for the four crisis countries ? The standard theoretical criterion for assessing current account imbalances is the notion of solvency: a country is solvent when the discounted value of the expected stock of its foreign debt in the infinitely distant future is non-positive. In other words, a country that is accumulating foreign debt at a rate that is faster than the real cost of borrowing, cannot expect to be able to do so forever. A country can run very large and persistent current account deficits and still remain solvent, as long as it can generate trade surpluses (of appropriate size) at some time in the future. As we have seen in the previous section, a good test for debt servicing is the debt to GDP ratio. This ratio is also a plausible indicator for a country’s solvency. As long as a country is solvent, a large current account deficit is not a threat to the countries’ economy. We will answer the question of the sustainability of the large current account deficit in light of GDP growth, the inflation rate, the investment rates and the (public and private) savings rate, the inflation rate and the level of openness of the economies. 2.3.2: Output/GDP Growth. Earlier in this chapter we saw the GDP growth for the four countries in the past three decades, reflecting the healthy growth that the countries have experienced. This rapid, outward oriented growth was among several factors that attracted large amounts of foreign investment (Alba et. al., 1998). 9
The Balance of Payments records all transactions between a country and the rest of the world. The
most important item on the Balance of Payments is the current account. Current account items can be interpreted as transactions of sales and purchases of goods and services, including the services of foreign workers, capital and know-how, or the goodwill of countries receiving aid. Current account surpluses must be matched by net outflows of financial capital because the country is lending to the rest of the world or acquiring assets abroad. Current account deficits imply borrowing from abroad, so financial capital is flowing into the country (Burda & Wyplosz, 1997; page 33). .
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When current and expected economic growth is high, large current account deficits may be perceived sustainable. For a given deficit to GDP ratio, higher growth rates imply a slower dynamic of the foreign debt to GDP ratio, and enhance the country’s ability to service its external debt. Table 3 shows the GDP growth for the four countries during 1990-1997. Table 3: GDP Growth GDP Growth Countries
1991
1992
1993
1994
1995
1996
1997
Thailand
8.18
8.08
8.38
8.94
8.84
5.52
-0.43
Korea
9.13
5.06
5.75
8.58
8.94
7.1
5.47
Malaysia
8.48
7.8
8.35
9.24
9.46
8.58
7.81
Indonesia
6.95
6.46
6.50
15.93
8.22
7.98
4.65
Source: Corsetti et. al., 1998. It is clear that the Asian countries had large GDP growth ratios across the board, during the past three decades. We can conclude that the Asian economies did not have a problem with sustaining the large current account deficit, or with the debt service in light of their large GDP growth rates (Corsetti et. al., 1998). 2.3.3: Investment and Savings Rates. Following the structural reforms of the mid-to late 1980s, the Asian countries saw sharp increases in their investment rates. Table 4 shows a summary of the investment rates from 1990-1997. Table 4: Investment Rates Investment Rates, % of GDP Countries
1990
Thailand
41.08
Korea
1991
1992
1993
1994
1995
1996
1997
42.84
39.97
39.94
40.27
41.61
41.73
34.99
36.93
38.90
36.58
35.08
36.05
37.05
38.42
34.97
Malaysia
31.34
37.25
33.45
37.81
40.42
43.50
41.54
42.84
Indonesia
36.15
35.50
35.87
29.48
31.06
31.93
30.80
31.60
Source: Corsetti et. al., 1998. As is clear from the table Thailand reached investment rates of 42%, and Malaysia from 30% to 44% of GDP. In Korea, the investment rates reached a healthy 37% to 39% of GDP. In Indonesia, the investment/GDP ratio rose from an average of 25% during 1985-89 to 32% during 1990-96 (World Economic Outlook, 1998). Conventional wisdom holds that
13
borrowing from abroad is less dangerous for sustainability of the current account if it finances new investments (leading to increased productive capacity and to higher future 10
export receipts) rather than consumption (which implies lower savings) . For these reasons, a current account deficit that is accompanied by a fall in saving rates is regarded more problematic than a deficit that is acompanied by rising investment rates. As we can see in Table 5, while the investment rate grew significantly, the national savings rate in the four countries also increased in the years leading up to the crisis. Table 5: Savings Rates Savings Rates, % of GDP Countries
1990
Thailand
32.33
Korea
1991
1992
1993
1994
1995
1996
1997
34.83
33.73
34.26
33.89
33.25
33.22
32.64
35.6
35.74
34.88
34.91
34.60
35.14
33.60
33.06
Malaysia
29.07
23.24
30.06
27.70
33.81
34.65
37.81
39.34
Indonesia
31.75
31.10
33.41
28.66
29.52
27.65
27.5
27.98
Source: Corsetti et. al., 1998. The public savings rate (a higher budget deficit) is also significant for the sustainability of the current account. An increase in public sector deficits often represents a persistent change that results in an irreversible build-up of foreign debt. Government fiscal balances, as a % of GDP, are shown in Table 6. Table 6: Fiscal Balance Government Fiscal Balance, % of GDP Countries
1990
1991
1992
1993
1994
1995
1996
1997
Indonesia
0.43
0.45
-0.44
0.64
1.03
2.44
1.26
0.00
Malaysia
-3.10
-2.10
-0.89
0.23
2.44
0.89
0.76
2.52
Thailand
4.59
4.79
2.90
2.13
1.89
2.94
0.97
-0.32
Korea
-0.68
-1.63
-0.50
0.64
0.32
0.30
0.46
0.25
Source: Corsetti et. al., 1998. We can see that in the crisis countries the fiscal balance of the central government was either in surplus or featured a small deficit (Corsetti et. al., 1998; Alba et. al., 1998; Kochhar et. al., 1998).
10
The current account is the difference between national saving and investment; a deficit can emerge
from either a fall in saving or an increase in investment.
14
When we combine the large investments rates with the growth in savings, both domestic and public, we can conclude once more that the sustainability of the current account did not impose problems for the Asian countries. 2.3.4: Inflation. A country’s inflation rate is important in the analysis of current account deficits and the ability of a country to service its debt. When currency values are fixed or semi-fixed (as is the case with pegged exchange rates), and domestic inflation is above foreign inflation, a real currency appreciation can lead to decreasing cost-competitiveness. Eventually, this undermines the creditability of the peg and endangers its sustainability. High inflation rates may also signal poor macroeconomic policies (Burda et. al., 1997). Table 7 shows the inflation rate in the crisis countries during the 90s. Table 7: Inflation Inflation Rate Countries
1991
1992
1993
1994
1995
1996
1997
Thailand
5.70
4.07
3.36
5.19
5.69
5.85
5.61
Korea
9.30
6.22
4.82
6.24
4.41
4.96
4.45
Malaysia
4.40
4.69
3.57
3.71
5.28
3.56
2.66
Indonesia
9.40
7.59
9.60
12.56
8.95
6.64
11.62
Source: Corsetti et. al., 1998. As we can see in this table, the data on inflation is quite clear: in all four countries inflation rates were relatively low in the 1990s. Thailand’s inflation shows a similar decline: from 5.7% in 1991, to 5.69% in 1995. (with a very low inflation rate in the year 1993: 3.36%). In Korea, the inflation rate was higher in 1991, 9.3%, but steadily followed a path down, to a level of 4.41% in 1995. In Malaysia, the inflation rate has also been low in the years leading up to the crisis: from a rate of 4.4% in 1991, to a low of 3.56% in 1996. Indonesia’s inflation rate has been the highest of the four countries: starting at 9.4% in 1991, ballooning to 12.56% in 1994, and coming down to 6.64% over 1996 (Corsetti et.al., 1998). Again, we can conclude that in the four crisis countries the sustainability of the debtservicing was not threathened by outrageous inflation rates.
15
2.3.5: Openness of the Economies. The openness of an economy has an effect on the sustainability of the current account deficit. Economies that are relatively open are considered less likely to face sustainability problems, for two reasons (Corsetti et.al., 1998): 1. A large export sector (generating foreign export receipts) strengthens a countries’ ability to service its debt. When a country is heavily indebted with foreign debt, it can use the influx of foreign export receipts to service its debt. The Asian countries chose to peg their currencies to have the reliability of export receipts. This stabilized their ability to service their debt. 2. The economic and political costs of a crisis are relatively large, as the interdependence of the economy with the rest of the world is high. Since the costs of a cut-off from international capital markets and disrupted trade credit may be quite severe, a country that is characterized by openness is more likely to honor its liabilities. Table 8 gives an idea of the openness of the Asian economies.
Table 8: Openness of the Economy Openness (Exports + Imports)/2 as % of GDP Countries
1990
Thailand
37.76
Korea
1991
1992
1993
1994
1995
1996
1997
39.24
38.98
39.69
40.99
44.88
42.19
46.69
30.04
29.38
29.38
29.04
30.47
33.59
34.36
38.48
Malaysia
75.23
86.52
76.64
87.72
92.15
97.42
91.50
93.55
Indonesia
26.30
27.18
28.23
25.26
25.94
26.98
26.13
28.22
Source: Corsetti et. al., 1998. Openness is here defined as Exports + Imports as a % of GDP. 2 We can see that the four countries were considerably open. The degree of openness is above 80% in Malaysia and in the 30-40% range in Korea and Thailand. The degree of openness is the lowest in Indonesia: around 26% (Burda et. al., 1997). 2.4: Conclusion. As we have seen in this chapter, the macroeconomic situation in the four crisis countries can be called sound in the three decades leading up to the crisis. The Asian countries experienced unprecedented growth, expressed in high levels of GDP growth in the past three decades. The monetary and fiscal policies in the crisis countries were effective. In section 2.3 we have examined some macro economic fundamentals that were the result of
16
the monetary and fiscal policies. The current account deficit is important for any country: a large deficit has a direct impact on a country’s solvency. We have seen that the deficit was sustainable, in light of the large output and GDP growth. The investment rate in the four crisis countries was high, indicating that the large capital inflows were directed to increase productivity as opposed to larger consumption. The large investment rates, combined with large savings rates, both public and domestic, proved once more that the current account deficit did not impose problems for the Asian countries. The inflation rates were kept low in the 90s, a further indication that the large current account deficit was sustainable. Finally, the Asian countries have a healthy degree of openness, reducing the threat of large current account deficit. Summarizing, we can conclude that the current account deficits were large, but sustainable, and allowed the Asian countries to service their debts in a responsible manner. st
Since the 1 generation model is entirely based on weak macro economic fundamentals, we can safely reject this model as an explanation for the Asian crisis. In the next chapter we will expand our quest for the cause of the Asian crisis, and direct our attention to the 2
nd
generation crisis model.
17
“ All happy families resemble one another, but each each unhappy family is unhappy in its own way.” Leo Tolstoy (Anna Karenina)
Chapter 3: Introduction of the 2nd Generation Model. st
1 generation models of exchange rate crises, and the role of inconsistent government policies in triggering currency crashes, have considerable empirical support but do not nd
explain every crisis. As we will see in this chapter, the 2 generation offers another set of explanations that give a different perspective on possible causes of crises. st
nd
To clarify the difference between the 1 and 2 generation model, I start this chapter with an example of the 2
nd
generation model: the Tequila crisis of 1994. This crisis was not
brought on by unbalanced economic policies of the Mexican government, but was caused by other factors. Among those factors were the existence of a pegged exchange rate and large capital inflows in the years leading up to the crisis. After this example of a 2
nd
generation crisis model, I will then examine this model further,
and discuss the possible sub-models, in section 3.2. The sub-models are defined as: selffulfilling crisis and panic; crisis induced by moral hazard; disorderly workout; bursting of a bubble; and contagion. To achieve an understanding of the different sub-models, and to be able to diagnose the crisis situation in subsequent chapters, I have chosen a second angle to examine the 2
nd
generation model. There are five different core-elements that are apparent, in some way or another, in the sub-models. The core elements are defined as follows: herd behavior; implicit/explicit guarantees; liquidity/solvency; rational expectations of investors; and interdependence between countries. These core-elements will be discussed in section 3.3. I will conclude this chapter with a combination of the sub-models and the core-elements in a diagram, in section 3.4. This diagram will serve as a platform in the next four chapters, when the four crisis countries will be further examined, and their crisis situation diagnosed in light of the 2
nd
generation crisis model.
3.1: Example: Mexican Tequila Crisis 1994-1995. Capital inflows into Mexico had been building since the mid-80s, attracted by a favorable economic outlook after years of macroeconomic stabilization and intensive structural reform. After the first Mexican crisis, the Debt crisis in 1982, a period of sustained economic growth commenced. Figure 3 illustrates the large capital inflows, separated in portfolio and direct investment. The Mexican central bank pegged its exchange rate in the 80s. During this time, the central bank intervened numerous times in the currency market to maintain the peg. This resulted in a steady loss of reserves as the central bank used its reserves to defend to Mexican peso against devaluations.
18
In early December of 1994, after a change of government, rumors were started about an expected devaluation. Further defense of the peso depleted the reserves, and finally in December, the currency was devalued, and then allowed to float. Figure 3: Capital Inflow into Mexico 1983-1997 Capital Inflows in Mexico 10
Portfolio Investment Direct Investment
percent of GDP
5
0
83-88
89-90
91
92
93 year
94
95
96
97
-5
Source: Martinez (1998) The second stage of the Mexican crisis showed immediately after this devaluation. Suddenly it became apparent that the Mexican government owed around $28 billion in short term debt (dollar-denominated), but that the reserves, used to defend the peso, had shrunk to $6 billion (Radelet and Sachs, 1998). Foreign investors became nervous about their exposure, the capital inflows dried up and investors actually started withdrawing funds from Mexico, as is clear in Figure 3. The Mexican government quickly became illiquid, and was not able to borrow fresh funds. With this, the Mexican government was pushed to the end of default. Subsequently, emergency international loans were provided (IMF and US government), allowing Mexico to 11
recover . The effects of this crisis were severe: the Mexican GDP collapsed and portfolio and other private investments decreased (but quickly recovered in 1996 and 1997). The real exchange rate collapsed in 1995, but recovered in 1996 and 1997 (Radelet & Sachs, 1998). Summarizing, Mexico suffered a strong shock to its economy, but without long-term effects.
11
Mexico actually managed to repay these loans ahead of schedule in 1996.
19
The pattern of this crisis has all the signs of a crisis that suddenly erupts, was not justified by economic fundamentals and, in hindsight, did not need to happen. 3.2: Sub-Models of the 2nd Generation Crisis Model. The sub-models that fit into this model are diverse, complex, not necessarily mutually exclusive, and difficult to put into a general context. The economic literature is broad on this subject, and sometimes differs in opinions; different authors group the causes of this crisis model in various ways. Sometimes this is a matter of definition and vocabulary. For instance, where Radelet and Sachs (1998) define a self-fulfilling crisis as a 2
nd
generation
12
rd
crisis, Krugman (1998) defines a self-fulfilling crisis as a 3 generation model . Where Gibson (1996) defines a crisis as a “failure of banks to optimize”, Radelet and Sachs (1998) more or less define this as “ financial panic”. Since there is no clear agreement in the economic literature, I have decided to group the sub-models of the 2
nd
generation model as
follows: self-fulfilling crises and financial panic, moral hazard; disorderly workout; the bubble theory; and contagion. 3.2.1: Self-fulfilling Crises and Financial Panic. According to Gibson (1996), international loan markets are prone to self-fulfilling crises in which individual creditors may act rationally and yet market outcomes produce reversals in capital flows that seem to be fundamentally unnecessary. The self-fulfilling element can trigger a crisis due to dramatic swings in creditor expectations about other creditors, thereby creating a self-fulfilling, though possibly individually rational financial panic. This hypothesis depends on several underlying assumptions (Radelet & Sachs, 1998): 1. The fundamental conditions, though not perfect, were strong enough to sustain debt servicing on a reliable basis. 2. There could have been an adjustment of the exchange rates, ultimately preventing the market’s reaction, the crisis and financial collapse. 3. The financial markets exaggerated their initial reactions to the panic, creating a crisis with an unnecessary depth. It is debatable whether this phenomenon is really a cause for a crisis at all. It could also be seen as an underlying fundamental for the 2
nd
generation model. The sub-models of the 2
generation crisis model all have some element of a self-fulfilling crisis and panic.
12
rd
The 3 generation model, as introduced by Krugman, is generally denounced in the economic
literature. Corsetti et. al., (1998) state that the Asian crisis does not warrant the introduction of a 3 nd
generation crisis model, but that it can be grouped with the 2
20
generation model.
rd
nd
A country is more vulnerable to financial panic when the ratio of short-term debt to foreign exchange reserve is high. Essentially, this measure compares a country’s short-term foreign liabilities to its liquid foreign assets. A country uses its foreign assets to service its liabilities in the event of a creditor run. Once a crisis starts, each creditor knows that the liquid foreign exchange reserves are not sufficient to fully pay off each creditor. Under normal circumstances we can expect that short-term debts can easily be rolled over. But, once creditors believe that other creditors are no longer willing to roll over the debt, each of them will try to call in their loans ahead of other investors. In this way, investors do not want to be the one left without repayment from the limited supply of foreign reserves. Countries with relatively large foreign exchange reserves, relative to short-term debt, are much less vulnerable to a panic, since each creditor is certain that sufficient funds are available to meet his claims. 3.2.2: Moral Hazard. Moral Hazard can be defined as: “The problem that insurance or assistance from official sources encourages risk-taking and results in too many resources flowing into the insured activities in the future” (Chote, 1998). Moral hazard implies that banks are able to borrow funds on the basis of the bank’s liabilities, because of explicit or implicit guarantees. The underlying problem with guarantees is that banks, especially when they are under-regulated, may use the borrowed funds in overly risky ventures. In this sense, moral hazard can create over-investment, 13
while creditors belief that they will be bailed out if their investments go bad . The economic literature recognizes three levels of moral hazard (Corsetti et.al., 1998):
13
The workings and the logic of moral hazard can be illustrated with a brief example, drawn from
Milgrom and Roberts (1992). In this example the investor has received a guarantee for $100 million, and is not investing any personal funds. There are two investment alternatives: (A) a safe investment that will generate a return of $107 million, under any conditions, favorable or less-favorable; and (B) a more risky investment that will generate $120 million under favorable conditions, but only $80 million if the conditions are less than perfect. The owner of the intermediary knows that he can walk away from a loss, and generate the maximum return in the best of conditions. Let us assume he chooses the safer investment: ultimately, this will generate $7 million (return $107 – investment $100). If he chooses the second investment, he can gain $20 million return under good conditions and loose nothing under bad conditions. His expected gain will be: ½ (return good conditions) + ½ (loss bad conditions) = (½ *20) + (½ * 0) expected gain = 10. The second investment has a lower expected return, but no consequences for the investor when conditions are less favorable. The investor will thus choose the risky investment. If the conditions are less favorable, net return will drop to 0 and the cost will be a social loss to society.
21
1. Moral hazard induced internationally. Two different situations may occur: A. The history of large bailouts in the past. These bailouts are usually performed by large international institutions such as the IMF, the World Bank and/or a mutual effort by American banks. A large bailout in history for an emerging market in a crisis situation can create assurance for other investors in emerging markets. An example of a previous crisis where this situation occurred is the IMF/US treasury bailouts for Mexico in 1995. B. When international banks lend large amounts of funds to domestic intermediaries, without applying standards for sound risk assessment. This over-lending syndrome may have been based on the presumption that short-term liabilities are effectively guaranteed by either a government intervention in favor of the financial debtors, or by an indirect bailout through IMF support programs. 2. Moral hazard at the financial level. A large quantity of capital inflow does not necessarily mean that the quality of the investments is up to standard. There is a crucial factor of moral hazard underlying the sustained investment rate when national banks borrowed excessively abroad and lend excessively at home. Financial intermediation plays a key role in channeling funds towards projects that may be marginal, if not outright unprofitable from a social point of view. We will see later that this was an issue in the Asian countries. 3. Moral Hazard at the corporate level. At the corporate level, where political pressures may be used to maintain high rates of economic growth, this may lead to a tradition of public guarantees to private projects.
With
financial and industrial policy enmeshed within a widespread business sector network of personal and political favorites, and with governments that appear willing to intervene in favor of troubled firms, markets operate under the impression that the return on investment was somewhat insured against adverse shocks. Although bank debts start out in the private sector, it is not unthinkable that in a crisis environment, a large portion eventually ends up in the public sector (domestic or international), creating all the problems involved with rescheduling debt. Important to note is that the issue of moral hazard goes beyond the notion of some private lenders escaping their responsibility for the fair share of the debt burden. It can also again encourage risk taking in emerging markets, weakening market discipline overall.
22
3.2.3: Disordely workout Disorderly workout can be defined as: When an illiquid or insolvent borrower provokes a creditor grab race and a forced liquidation, even though the borrower is worth more as an ongoing enterprise. A disorderly workout occurs especially when markets operate without the benefit of creditor coordination via bankruptcy law. The problem is sometimes known as ‘debt overhang’. In essence, coordination problems among creditors prevent the efficient provision of worker capital to the financially distressed borrower, which will delay or prevent the eventual discharge of bad debts. The reluctance of lenders to rollover loans to the private sector can quickly develop into a parallel reluctance to roll over loans to the government on the grounds that the crisis in the private sector might weaken the government’s revenue position and, more importantly, that the government might end up assuming responsibility for many of the private sector obligations. Disorderly workout is especially a problem when a country’s financial system has not matured to the extent that laws are in place to prevent this from happening. After the Mexican crisis a discussion was started in the economic literature about “orderly workout” initiatives, where new institutions are build to support a more efficient marketbased resolution of debt crises. 3.2.4: Bubble Theory This theory seeks an explanation for the tendency of asset values to become misaligned for an extended period, i.e. to move away from their long-run fundamental equilibrium (Gibson, 1996). The bubble occurs when speculators buy at a price above its fundamental value with the expectation of capital gain, rather than on the basis of the income that the asset is expected to yield. The market price of the assets does no longer depend solely on market fundamentals, but also is a positive function of the expected rate of change in value of the asset. An important notion of the bubble theory is that there is no irrational behavior amongst investors. Investors exhibit rational expectations, and make no systematic prediction errors. Therefore, a price of an asset depends not only on its expected rate of change, but also on its actual rate of change. In each period, the bubble continues to grow, or may collapse with a positive probability. Market participants are aware of the bubble, and of the probability distribution regarding its collapse. Once the bubble continues to grow, the probability of collapse also grows. The timing of the collapse may not be foreseen, but is generally expected by investors. When the bubble bursts, market participants panic, and try to get out of the market. This has a downward
23
effect on the assets, creating more panic, and an overall undermining of the value of assets. Hence, a self-fulfilling crisis is born. For the sake of simplicity, and to be able to recognize a possible bubble in subsequent chapters, a bubble situation occurs when the following two conditions are met: 1. The market experienced a severe decrease in asset prices of at least 50%. 2. The decrease occurred within six months of the onset of the crisis. If both conditions are present, a possible bubble may be at work in the market. 3.2.5: Contagion, Domino Effects, and Sunspots. There is a large amount of economic literature devoted to the subject of contagion. Many economists believe that contagion, in combination with self-fulfilling behavior, have played a large role in recent emerging market crises. There are several definitions of contagion in the economic literature. The most common definition follows Fratzscher’s (1999): The transmission of a crisis to a particular country due to its real and financial interdependence with countries already experiencing a crisis. Past empirical work has established that contagion is characterized as follows (Goldstein, 1998): 1. Typically greater during periods of turbulence than during more tranquil times. 2. It operates more on a regional line than on a global line. 3. It usually runs from large countries to small countries. Contagion can occur through 3 different channels (Fratszcher, 1999): 1. Real/Financial Interdependence between countries. This will be discussed in section 3.3.5. 2. Competitive dynamics of devaluation. As one country after another undergoes depreciation of its currency, the countries that have not devalued will experience deterioration in its competitiveness and exports, making their currencies more susceptible to attacks, hence the term “domino theory of devaluations”. Eventually, this country will not be able to avoid devaluation of its currency. 14
3. The hypothesis of “Sunspots” is also defined as herd behavior in financial markets . This hypothesis implies that private creditors and rating agencies have a tendency to be “asleep at the wheel”, and do not asses risks in a responsible manner. Once a crisis starts, international investors re-assess the credit worthiness of other similar economies, and might find similar weaknesses, or assume similar weaknesses. The assumption is
14
Goldstein (1998) defines this as “the wake-up call hypothesis”.
24
that, in general, investor beliefs are not based on country specific economic fundamentals or on existing interdependencies between countries. It is not always easy to separate contagion from a self-fulfilling crisis. When a crisis in one particular country reveals similar weaknesses in another country, this can lead to a selffulfilling crisis. This weakness then becomes a signal that makes other countries, sharing the same weakness, suspicious in the eyes of financial markets. One country’s devaluation reduces the competitiveness of other countries and creates the need for an exchange rate adjustment elsewhere. 3.3: Core Elements of the 2nd Generation Crisis Model. As I mentioned in the introduction to this chapter, the sub-models are not necessarily mutually exclusive. It is very possible that a crisis is induced by a situation of moral hazard, but results in a self-fulfilling crisis created by panic. It is also feasible to explain a crisis with the bursting of a bubble: when there are countries that have a similar bubble-situation the crisis may spread, hence creating a situation of contagion. In this section, five core elements of the 2
nd
generation model will be introduced.
3.3.1: Herd Behavior. This behavior is used in many forms in the economic literature. context of the 2
nd
The herd behavior, in the
generation model, implies that the globalization of financial markets
reduces the incentive for investors to collect first hand information and encourages them to follow the most common investment strategies. Therefore, investors are acting like a herd, follow a general investment strategy, and do not base their investment strategy on their own research. Why do investors act as a herd? Investors in international capital markets are subject to 15
risks that are inherent to the nature of the market and transactions . These risks can be 15
Operating on the international capital market involves many risks for banks. Following are some of
the most important risks: Funding risk: Financial intermediaries are usually exposed to maturity mismatching; they borrow short and lend long. Credit risk: This involves the creditworthiness of the borrower. Banks have experience dealing with these risks, but on an international level, it may be more difficult to assess this risk. Country risk: Cross-border lending poses problems of political, social or economic nature. Sovereign risk: This is the risk that the debt servicing might be suspended because of government policies or events within the country. Foreign exchange risk: The risk that a country does not have the foreign exchange currency to repay its debt, if the debt is denominated in foreign currency. Currency risk: Cross-border lending exposes banks to the risks that their assets and liabilities are not denominated in the same currencies (Gibson, 1996).
25
diminished by gathering information on past and current events, so that a bank can calculate the objective probability of this event occurring in the future. However, a significant market failure is information deficiency. Available information may be limited or very costly to gather, especially at an international level. There is also a certain element of asymmetry in information: one party may have more knowledge about a transaction than another party. Investors realize these risks and adjust their behavior accordingly. This is reflected in there pricing strategies. Loans with a high degree of risk have high risk-premia attached, so that they will be compensated for the undertaken risk, and credit rationing is used to limit their risk. With this rational behavior of banks (reflecting risk in their pricing strategies, and practicing credit rationing), herd behavior should not occur. How can we then explain herd behavior? Not only do capital markets deal with the issue of risk, there is also the issue of uncertainty. Under uncertainty, it is not possible to calculate an objective probability of an occurring or expected event. To a certain extent, uncertainty can be transformed into risk by gathering 16
information. However, uncertainty can never be completely removed . We can recognize some herd behavior in the case of contagion. When investors experience problems in one country, they start to re-assess the creditworthiness of other, similar economies. When investors act, based on insufficient information, a self-fulfilling crisis might occur. The herd behavior, for instance following a competitors’ strategy, may then be used as a base to make investment decisions. 3.3.2: Implicit/Explicit Guarantees. When a government or official institution gives explicit or implicit guarantees, banks are allowed to borrow funds based on these guarantees. The funds may then be misused, either in risky or non-profitable ways. Guarantees can have an effect on the build-up of a bubble. In Thailand, we saw an extensive use of guarantees in the years leading up to the crisis. A large portion of the short-term capital flows in Thailand was directed to development of the real estate sector, supposedly creating a bubble in this sector. The guarantees implied that the loans were “covered”, and that there would be an official bailout in the case of occurring problems.
16
The reason for this is twofold. First, events may not be common enough to allow enough data.
Second, the structure of an experienced event may change every time, making it difficult to calculate objective probabilities (Gibson, 1996).
26
3.3.3: Liquidity/Solvency The differentiation between liquidity and solvency is an important factor in any crisis situation. The definitions are clear: Liquidity: a liquid borrower has the cash available to repay current debt obligations. Solvency: a solvent borrower has the net worth to repay debts out of future earnings. When creditors panic, and recall loans on a large scale, there is little consideration for the solvency of a borrower. Due to for instance a devaluation of an exchange rate, a borrower may have temporary problems to service the outstanding loans. This situation of temporary illiquidity may not necessarily imply that there is a situation of insolvency. A self-fulfilling prophecy is put in place when loans are being recalled, not restructured, or new credit is denied. A liquidity crisis is then inevitable when an illiquid but not insolvent borrower cannot pay his debts, but is also unable to borrow funds from the capital markets to service his debt. We see this element as a core characteristic in a self-fulfilling crisis and in the case of disorderly workout. Countries will be pushed into a situation of insolvency when loans are being abandoned, or refused to be rolled-over, whereas the country might still be reasonably liquid. A creditor grab race, as the result of a disorderly workout, has the tendency to make the situation worse for everyone involved: illiquidity can turn into insolvency, and borrowers can be forced into default because creditors en masse recall loans, or refuse to establish new credits. 3.3.4: Rational Expectations of Investors. Like the self-fulfilling crisis, this core-element may be called an underlying element of the 2
nd
generation model. The main ingredient of the behavior of investors can be described as rational. When individual investors act in a rational manner, maximizing their profits, the outcome of their behavior (as a group) can still be irrational. Kindleberger (1978)
17
explains this as follows:
I conclude that despite the general usefulness of the assumption of rationality, markets can on occasions – infrequent occasions, let me emphasize – act in destabilizing ways that are irrational overall, even when each participant in the market is acting rationally.
17
In: International Finance, Exchange rates and Financial Flows in the International System, Gibson
Heather D., 1996, page 273.
27
Kindleberger offers several distinct, but not mutually exclusive, explanations for these occasional departures from rationality: 1. Markets may exhibit a mob psychology, much like the herd behavior. 2. A speculative boom may begin with rational behavior on the part of individuals in the sense that they invest in an asset because they expect to receive a good income from it. Only later are assets traded on the basis of capital gains resulting from price rises. This may be rational from an individual investors’ point of view, but will drive the price of the asset further and further away from its fundamental value. This ultimately can be regarded as a case of “market irrationality” (generating a possible bubble). 3. The market may be composed of two groups of speculators: those who act in a stabilizing manner, buying when the price is low and selling when it is high, and those who act in a destabilizing manner. This first group can be regarded as insiders or professionals. The second group buys when the prices is high and sell when it is low, because they become infected by the euphoria associated with initial price movements which have been instigated by the professional insiders. 3.3.5: Real/Financial Interdependence between countries 1. Financial Interdependence: A crisis may be transmitted due to direct financial links between countries. For instance, financial institutions may have large cross-border holdings. There may also be indirect financial linkages, in particular the presence of a common lender and decisions by institutional investors. A crisis in one country may push a common lender to call in loans across the board and refuse new credit. This may include not only countries that already have experienced a crisis, but also other countries, thus spreading the crisis across countries. 2. Real interdependence: This can be explained through bilateral trade or through trade competition in third markets. A crisis in one country is more likely to spread to another economy if the two countries have a large amount of bilateral trade, or if the countries are strong competitors in third markets. 3.4: Combining the Sub Models with Core Elements. The diagram in Table 9 combines the core-elements and the sub-models. The diagram is self-explanatory, but I will briefly summarize the context, and give an explanation, where necessary.
28
Table 9: Sub-Models combined with Core-Elements Crises Models Core Elements
Self fulfilling crisis/Panic
Moral Hazard
Disorderly Workout
Bubble theory
+
-/less
+
+
-/less
+
-/less
+
+
-/less
+
Contagion
Herd Behavior
Implicit/Explicit Guarantees Liquidity/Solvency
Rational Expectations of Investors Real/Financial Interdependence between Countries
+
+
_
_
_
+
+
_
_
+ _
+/- debatable
+/-
+
Source: information gathered from Radelet & Sachs (1998). The herd behavior has importance in all the sub-models, but to a lesser extent with moral hazard. In general, the herd behavior has no bearing in the existence of guarantees. The guarantees are only applicable for the investors who base their investments on actual guarantees. It is feasible though, that there may exist a perception in the market that there will be an overall bailout, like a large bailout by the IMF. In that sense, herd behavior may become relevant. Implicit and explicit guarantees are, of course, more important in the case of moral hazard. In the bubble theory, guarantees can also be linked to the growth of the bubble, when the funds, borrowed based on guarantees, are used to invest in assets that are inflated. The issue of liquidity and solvency is applicable in most sub-models, but less relevant in the case of moral hazard and contagion. When investors react based on real or financial interdependence between countries, the issue of insolvency only becomes apparent as a result of contagion. In the case of contagion, the crisis spreads to other countries based on interdependences. The issue of solvency/liquidity appears only after the crisis has spread already. When there is a situation of moral hazard, investors are expecting insurance or assistance from official sources, and this can encourage excessive risk taking. When the 18
investors realize that their expectations may be too high , panic may occur and investors
18
For instance when it becomes clear that a government does not hold adequate reserves to even
accommodate a possible bailout.
29
may pull out of all loans, creating a self-fulfilling crisis. This may be what triggers the crisis, but the actual cause of this crisis is the existence of guarantees. Rational expectations act as an underlying characteristic for most sub-models, but in different gradation. As was discussed earlier, even though an individual investor makes rational investment decisions, the ultimate outcome for the market might be sub-standard, thus not rational. The interdependence between countries only has an impact on the sub-model of a selffulfilling crisis and the situation of contagion. When investors react to a crisis situation in one country it is clear that this can lead to a self-fulfilling crisis in other countries. In the next four chapters the crisis situations in the crisis countries will be examined in detail, in the context of the sub-models and the core elements of the models to determine the cause of the crisis and the relevance of any, or more of the sub-models for the crisis. First the core elements will be characterized, as they appeared in each individual crisis situation. The core elements are then applied to the sub-models of the 2nd generation model, to help determine the relevance of each sub-model in each crisis country. Since the crisis originated in Thailand, I will first examine the crisis in this country in more detail in Chapter 4. Chapter 5 will be devoted to the crisis situation in Korea. This country had unique weaknesses in its economy that probably made it more vulnerable to the crisis. Malaysia’s situation will be addressed in Chapter 6, and the crisis in Indonesia will be examined in Chapter 7.
30
Chapter 4: The Crisis in Thailand. The crisis started in Thailand on July 2
nd
1997, when the pegged exchange rate system was
abandoned, and the Thai baht was allowed to float. Rescue programs were put in place, and monetary and fiscal policies reviewed. Despite these efforts, the crisis deepened and eventually spread to other countries. In section 4.1 we will see how the crisis materialized. Section 4.2 will be dedicated to the core-elements of the sub-models. These core-elements will then be applied in section 4.3, to the sub-models of the 2
nd
generation model.
Section 4.4 will end this chapter with a brief summary and conclusion. 4.1: A Crisis Develops. The first currency in Asia to come under attack in 1997 was the Thai baht. Figure 4 shows the movement of the baht before and after the crisis.
National Currency to US $
Figure 4: The Movement of the Thai Baht 1996-1998
51.5 46 40.5
Baht
35 29.5 24 Date
Baht officially floated
Jun-96
Dec-96
Jun-97
Dec-97
Jun-98
Dec-98
Source: International Financial Statistics (IMF) By the end of July 1997, the baht had fallen 25% compared to its value at the beginning of the year. In August the baht fell even further, depreciating by 34% relative to its January value. By the end of September the baht had lost 42% of its value, compared to January 1997.
31
Following is a brief summary of the most important events in the months leading up to the crisis, and occurrences during the crisis: !
In the year before the July devaluation, the government took over the Bangkok Bank of 19
Commerce, several banks’ credit ratings were downgraded , and many finance companies experienced massive withdrawals. !
Speculative attacks on the baht started at the end of 1996. The Bank of Thailand was able to defend the currency through spot and forward sales on the international currency markets. The markets’ expectations of exchange rate devaluation had increased, however, both directly, as export growth was still minimal, and indirectly as it became less likely that 20
the Bank of Thailand would raise interest rates . The unwillingness of the central bank to correct the exchange rate led to a decline in official foreign reserves. !
Effectively on May 15, 1997, authorities tried to discourage capital outflows with the introduction of limited capital controls aimed at segmenting the on-shore and off-shore markets, while leaving the domestic monetary policy untouched. The measure failed to restore confidence.
!
The baht was attacked again in May of 1997. The authorities accelerated their forward sales of foreign exchange and, in June, suspended 16 finance companies that had received several times their equity in support. The Bank of Thailand lost another 4 billion US$ in foreign exchange reserves (making for a cumulative loss from January to July of 12 billion US$). None of these measures succeeded in defeating the pressure on the exchange rate.
!
However, the Bank of Thailand continued to support the currency, largely through a forward sale of baht, using 5 billion US$ of the foreign currency reserves. This led to a total amount 21
of outstanding forward sales of 30 billion US$ at the end of June 1997 . !
Loan portfolios of banks and other finance companies continued to deteriorate in quality and increase in risk. Asset liability maturity and currency mismatches grew further. Liquidity problems in many finance companies increased. The Bank of Thailand offered liquidity support to these companies, amounting to about 10% of GDP in early August 1997.
!
The government’s dedication to the baht, and its refusal to allow the baht to float, were to no avail. By late June, Thailand had sharply reduced its liquid foreign exchange reserves, and finally, the authorities allowed the exchange rate to float on July 2. The currency
19
Moody’s downgraded short-term sovereign ratings in September 1996 and long-term sovereign
ratings in March 1997 (Corsetti et.al, 1998). 20
A policy of low rates in the presence of strong speculative attacks on the currency in Thailand can
only be understood in light of the fragile condition of the financial sector. The central bank was held back by the concern that high interest rates would worsen and compromise the financial conditions of highly indebted banks, financial institutions and corporations. 21
This was roughly equal to the stock of reserves of Thailand at that time (IMF, 1998).
32
immediately depreciated by about 10% against the dollar relative to May levels, and fell by another 8% in the following two weeks. Short-term interest rates had been kept low, but they were finally increased to 20% in late June. !
The IMF was brought into the situation early on in the crisis, right after the floating of the 22
baht . On August 20, 1997, the IMF’s Executive Board approved financial support for 23
Thailand of about 4 billion US dollar , over a 34-month period. The total package of 24
bilateral and multilateral assistance to Thailand amounted to 17.2 billion US dollar . Thailand’s official support package was smaller than upcoming foreign currency obligations. This was partly because foreign banks based in Thailand accounted for more than half of Thailand’s private external debt maturing in 1998. These banks, largely Japanese institutions borrowing from their own headquarters, were willing to agree to maintain their exposure. !
The rapid spread of the Asian crisis in late 1997 brought on a larger-than-expected depreciation of the baht, a sharp economic downturn and adverse regional economic developments. These events warranted revisions to the IMF program in Thailand.
!
Monetary policy focused on both supporting exchange-rate stability and fostering an economic recovery. As the baht began to steady, the Thai authorities reduced interest rates. By mid-1998, money market interest rates began to approach pre-crisis levels, and first deposit rates, and then lending rates, started to drop as well. By September 1999, money market rates reached their lowest levels in over a decade. 4.2: Recognizing Core Elements in the Crisis. 4.2.1: Herd behavior. Determining herd behavior in international financial markets is a difficult task. What we are trying to assess is whether investors engaged into risky ventures without adequate information, while examining the risks and returns in an adequate manner. The herd behavior may be present when the investors enter and flee the market. For the sake of simplicity, I will limit the assessment of the herd behavior to occurrences in the Thai market. Though not proof, they may indicate herd behavior: 1. We know that the Asian countries were not very forthcoming with their information in the years leading up to the crisis. This lack of information may have induced investors to
22
The IMF warned the authorities in early 1997 of the impending foreign exchange crisis, but it was
difficult to convince them of the seriousness of the emerging problems. The warning was not made public, given the strong risk that such a move could precipitate the very crisis it was intended to avoid (Aghevli, 1999). 23 24
Which averages SDR 2.9 billion. The package was based on agreement by Thailand to an extensive economic reform program.
33
imitate other players in the market, rather than basing their strategies on their own research. 2. Figure 5 gives an overview of the build-up of capital inflows into Thailand. It shows the short-term and the long-term debt. Figure 5: Thailand: Long term Debt versus Short term Debt Thailand
Billions of US Dollars
60 50 40
long term debt
30
short term debt
20 10 0 1992
1993
1994
1995
1996
1997
Source: Lane et. al., 1999. It is indisputable that Thailand experienced a large influx of short-term capital in the years before the crisis. The short-term debt at the end of 1996 in Thailand was 65% of the GDP. It is likely that this was caused by some herd behavior. Information on the distribution of these capital inflows across international banks and institutions is not available. We do know that the exposure of Japanese banks in Asia was extensive, since the interest rates were very low in Japan. It is feasible that many Japanese banks got involved, because everyone else in the market was getting involved. 3. The liquidity and currency mismatching, shown in Table 10, was very large in Thailand. Table 10: Liquidity and Currency Mismatches Liquidity and Currency Mismatches as of June 97 Ratio of short-term
Short-term debt as a %
Ratio of broad
debt to international
of total debt
money to
reserves
International Reserves
Thailand
1.1
46
4.9
Korea
3.0
67
6.2
Malaysia
0.6
39
4.0
Indonesia
1.6
24
6.2
Source: Radelet & Sachs, 1998.
34
Most creditors were focusing on short-term debt, denominated in foreign currencies, and did not seem to have taken the obvious risks into account. When a debt is denominated in foreign currency, it also has to be serviced in this currency. Once the value of the baht started to decline, it became more expensive for creditors to acquire foreign currency, hence jeopardizing their position. 4. A large outflow of capital materialized in the months leading up to the crisis, as well as in the following months, indicating that this outflow was not an outflow of just one investor, but of multiple investors withdrawing from the market simultaneously. These examples are sufficient to accept that there was a definite appearance of herd behavior in the Thai market. 4.2.2: Implicit/Explicit Guarantees. A closer look at the government’s management allows us to assess the role of guarantees, both implicit and explicit. Although most of the evidence is anecdotal, the analysis of a few cases can shed light on more general behavioral patterns. Following are some striking examples of guarantees: 1. The liabilities of the financial intermediaries were perceived as an implicit government guarantee, reinforced by the political connections of the owners of the institutions. Most banks that provided the intermediaries with funds believed that they were protected from risk. 2. Somprasong, a major property developer, missed payments on its foreign debt in th
February ’97. On March 10 , the Thai government officially stated its intention to buy 3.9 billion US$ in bad property debt from Somprasong and other financial institutions with liquidity problems (Alba, et. al., 1998). 3. In the first quarter of 1997 the central bank’s Financial Institutions Development Fund (FIFD) had lent over 8 billion US$, 17.5% of which went directly to Finance One (at the time the largest finance company). A few months before its collapse, ING bank in Thailand had approved a loan to Finance One as part of a 160 million US$ syndication led by the World Bank’s International Finance Corporation. Concerns about the viability of Finance One were simply dismissed by the Bank of Thailand, which made explicit 25
reference to a promise of a bailout in case the company had financial problems . Finally, in June 1997 the public commitment to support Finance One, or any other troubled company, was officially abandoned (Corsetti, 1998). 25
Despite the government’s intentions to intervene in defense of Finance One, the task of saving this
company was clearly difficult and demanding. Finance One’s non-performing loans doubled in 1996, then doubled again in the first quarter of 1997. Meanwhile, the terms of Finance One’s assets and liabilities were the most mismatched of any of the top 10 finance companies.
35
4. The fixed exchange rate served as an important implicit guarantee. Investors know that this guarantee is limited by the availability of the international reserves and by a country’s capacity to borrow abroad. Consequently, when doubts arose about the sustainability of the exchange rate mechanism, Thailand attracted mainly short-term capital. This implicit guarantee created an incentive to borrow in foreign currencies and exposed the financial and business sector to take excessive exchange risks. Summarizing, guarantees can be recognized in the Asian economy that may have created a situation of investor’s expectations. Once it became clear to the financial market, both international and domestic, that these guarantees could not be honored, markets quickly lost confidence. 4.2.3: Liquidity/Solvency. We can recognize the issue of liquidity/solvency in many instances in the Thai crisis. Here are some examples: 1. The hallmark of the crisis was a sharp reversal of international capital flows. The reversal affected mainly short-term debt issued by the private sector, including financial institutions. As exchange rates depreciated and the domestic currency costs of debts rose, foreign creditors became more reluctant to extend new loans and roll over existing loans. Domestic debtors had to buy foreign exchange to service these debts, which put more pressure on exchange rates, which in turn reinforced the tendency for creditors to recall loans. 2. There was a serious mismatch between foreign liabilities and foreign assets, as is apparent in Table 10 (Liquidity and Currency Mismatches) on page 34. Domestic banks borrowed heavily from foreign banks but lent mostly to domestic investors. In normal times, a high ratio of foreign liabilities to foreign assets may not cause concern, as short-term foreign debt are easily rolled over. But in the presences of rapid currency depreciation this imbalance may cause serious financial problems (Goldstein, 1998). 3. The government in Thailand and the international community made several mistakes in handling the crisis. This mismanagement added fuel to the fire. For instance, the government’s public support of Somprasong and Finance One, among other companies, later had to be withdrawn, sending a message to the market that the government was not keeping its word. Another example is the official IMFs support package: it quickly became apparent that the package was insufficient to cover outstanding obligations. This, in combination with a further depreciation of the baht, called for a revision to the IMF program, sending the markets the signal that problems were more severe than first anticipated. Both incidents sent a message to the market: international confidence declined, creditors withdrew even more funds, intensifying the panic.
36
The problem of debtors being driven into a situation of insolvency was apparent in the Thai crisis. We will see in section 4.3.3 how this influenced the crisis. 4.2.4: Rational Expectations of Investors. Whether investors acted rational in the years leading up to the crisis, is a difficult question to answer. To help this assessment, we will concentrate on two questions, concerning the behavior of the foreign lenders: 1. Did foreign lenders believe that Asia’s financial situation was unsustainable, and that a crisis was to be expected? 2. Did investors expect to be bailed out, if a crisis occurred? The answer to the first question is easy to answer: It is clear from the economic literature that the crisis was totally unexpected. It is difficult to find any information to the contrary, either in the available data or in statements and reports made before the crisis. Furthermore, if foreign investors believed that a widespread crisis was credible (with only the timing uncertain), this sentiment would have been apparent in reports and newsletters of investment banking firms. Instead, these reports gave a mixed picture. They often pointed out weaknesses in the Asian economies (such as slower export growth and rapid loan growth), but they did not give any sense of a crisis waiting to happen. Most investment analysts displayed confidence in Southeast Asia’s prospects, in both the short and the long run, and there is little evidence to support the idea that the majority of investors expected a crisis in Asia any time soon (Radelet & Sachs, 1998). The answer to the second question is a bit more complicated. There is no doubt that many banks and firms across Asia had close government connections that supported their profitability (Berg, 1999). State-owned banks obviously could expect a bail-out if there were a crisis. But did foreign investors act on the presumption of an insurance against risk through the prospects of generous bailouts? A substantial share of funds went into the equity markets, where price fluctuations were indeed real and risky. Even bank loans went heavily to the non-financial corporate sector, where many loans had little prospect of a direct government bailout. Moreover, creditors have long complained that weak bankruptcy laws and ineffectual judicial systems in Asia reduce their ability to collect on collateral in the event of non-performing loans. This indicates that creditors were worried that they would not be compensated if loans went bad. It is probably fairer to say that foreign investors thought too little about risk because they expected rapid growth and high profitability to continue. Hence, creditors were not anticipating a crisis, or expecting a bailout in the case of a crisis (Radelet & Sachs, 1998).
37
For the sake of simplicity I am accepting the assumption that the international capital markets were working efficiently, and that we may therefore assume that the investors acted rationally. 4.3: 2nd Generation Model Applied. 4.3.1: Self-fulfilling Crises and Financial Panic. The most important core elements of a self-fulfilling crisis are: Herd Behavior, Liquidity/Solvency, and Rational Investors. We have recognized all three elements in the Thai crisis. Is there now proof that the crisis was of a self-fulfilling nature, and that there was panic involved? To find proof for a self-fulfilling crisis we will, for a moment, look back at the 3 factors, defined in the previous chapter that are important in determining a crisis of that nature: 1. Could Thailand sustain its debt servicing on a reliable basis? 2. Would an earlier adjustment of the baht been feasible, and could it have avoided the crisis and the financial collapse? 3. Did the financial markets exaggerate in their reactions, creating a crisis with unnecessary depth? First of all, the fundamental conditions of Thailand were not perfect: the current account deficit was large, but sustainable, as was concluded in chapter 2. It was possible for Thailand to service its outstanding (short-term) debt, and the country actually managed to do so for many years. Secondly, if the government had chosen early on not to keep the baht pegged much of the crisis could have been avoided. The reserves would not have been depleted, and markets would not have panicked when they realized the critical state of the reserves. Last of all, there was a clear element of panic in the crisis. Much of this panic was actually the result of the build-up of short-term debt. When a country exposes itself to a large amount of short-term debt, it exposes its economy to an array of possible problems (such as currency and maturity risks). If the structure of the debt would have been primarily longterm, creditors could not have recalled loans en masse, and the self-fulfilling element of the crisis could have been avoided. There is additional evidence that panic was indeed an issue with the Thai crisis. As defined earlier, a country is more vulnerable to financial panic when the ratio of short-term debt to foreign exchange reserve is high. Figure 6 on the next page shows the capital inflows into Thailand, compared with the buildup of reserves.
38
Figure 6: Thailand: Capital Inflows; Reserves Thailand reserve accumulation
percent of GDP
7
net private capital inflows
2
80
82
84
86
88 year 90
92
94
96
-3
Source: Goldstein & Hawkins, 1998. In Thailand, short-term debt in June of 1997, before the floating of the baht, was 46 billion US$. The reserves at that time were 31 billion US$. The short-term assets therefore could not cover all short-term liabilities, which is clear from the graph in Figure 6. When creditors became aware of this situation, each creditor wanted to have their loans repaid, before reserves ran out (Dennis & Kandel, 1999). The crisis eased up after about one year, even before any of the fundamental conditions, as required by the IMF, improved. It is hardly feasible that financial confidence, in the markets and the economy, returned in one year. As debts were repaid, rescheduled, or defaulted, the net capital outflows stopped, the intense pressure on the exchange rate ended, and the overshooting, caused by the financial panic, was reversed. Summarizing, we can conclude that there was definitely a clear element of panic involved, leading to a self-fulfilling crisis in Thailand. 4.3.2: Moral Hazard. The most important core element in moral hazard is the existence of guarantees. In section 4.2.2, we have seen that extensive guarantees existed in Thailand. In this section, we will examine whether these guarantees have led to a situation of moral hazard. It is very unlikely that the history of large bailouts in the past serves as a guarantee for a country for future bailouts, should a crisis occur. From a borrower’s perspective, it is hard to believe Thailand would deliberately risk a financial crisis simply because it counts on IMF assistance. The crisis in Thailand had huge economic, social, and political costs, making
39
any deliberate risk of crisis highly unlikely. We can therefore reject moral hazard, at an 26
international level, as a cause for the crisis in Thailand . However, there is still a possibility of moral hazard occurring at the financial and corporate level. In the years leading up to the crisis, international banks were loaning large amounts of funds to Thailand, without applying standards for sound risk assessment. How were these funds being used? A large quantity of capital inflow does not necessarily mean that the quality of the investments is up to standard. There is a crucial factor of moral hazard underlying the sustained investment rate when national banks borrow excessively abroad and lend excessively at home. Table 11 gives some background on the Incremental Capital Output Ratio in Thailand, among the other crisis countries. Table 11: Incremental Capital Output Ratios, 1987-1996
Capital-Output Ratio27 Country
1987-1989
1990-1992
1993-1995
4
3.9
4.4
Korea
3.5
5.1
5.1
Malaysia
3.6
4.4
5
Thailand
2.9
4.6
5.2
Indonesia
Source: Radelet & Sachs, 1998. It is clear from this table that the quality of investment in Thailand was not high, and not up to standard, indicating the existence of moral hazard at the financial level. Also, we have seen proof of guarantees by the government of Thailand, implicitly and explicitly. Especially the public support of finance companies, combined with the financial support at the onset of the crisis, created a general expectation in the market that the 26
For the same reason we can reject previous international bailouts as a cause for the crisis in Korea,
Malaysia and Indonesia. 27
The incremental capital-output ratio is a crude macroeconomic indicator of the quality of investment,
defined as the ratio of the value of new investment to the change in output in a given year. Generally speaking, when investment quality deteriorates, this ratio increases, as more investment spending is needed to support a given increase in GDP. Indeed, investment rates rose in Asia in the early 1990s, as the increased capital inflows added to already high savings to create a large pool of investment funds. Economic growth continued to be brisk, but did not rise with the increase of investment. As a result, the ratio rose in each country in the region. The numbers in the table above suggest a decline in investment quality, or diminishing returns to new investment as capital deepening was taking place (Radelet & Sachs, 1998).
40
government was willing to help companies with financial problems, and did not allow these companies to fail. This implied that the return on investments was insured, implying moral hazard. We can conclude that the issue of moral hazard, both at the financial and corporate level, was a clear cause for the crisis in Thailand. 4.3.3: Disorderly Workout. The core element of the sub-model of disorderly workout is obviously liquidity/solvency, in particularly the rapid disappearance of short-term capital flows. Herding can exacerbate the situation since every creditor wants to beat other creditors in recovering their loans. To determine if disorderly workout is applicable in the case of Thailand we will look at the following: 1. Is there proof of significant outflow of capital leading up to the crisis? 2. What was the maturity structure of the debt buildup? Figure 7 shows the ratio of international reserves combined with the level of short-term debt. Figure 7: Ratio of International Reserves to Short-term Debt
Billions of US Dollars
Ratio of International Reserves to short-term Debt. 1.5 1.4 1.3 1.2 1.1 1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0
q194
Indonesia Thailand Korea
q394
q195
q395
q196
q396
q197
q397
Source: Lane et. al., 1999. We can conclude the following: 1. Thailand’s short-term debt was extremely large; at the end of 1996 Thailand short-term liabilities (as % of total liabilities) were up to 50% (Lane et.al, 1999). (See also Figure 5 Thailand: Long Term Debt versus Short Term Debt, on page 34.) 2. At the end of the year 1996, short-term liabilities suddenly declined sharply. The decline was not totally met with an increase in the long-term debt, which indicates that shortterm loans were not being rolled-over, but re-called.
41
3. The ratio of international reserves to short-term debt went into a very sharp decline at the first quarter of 1997, most likely as a result of the Bank of Thailand using its reserves. This may very well have created a climate of massive short-term loan recall. 4. After the third quarter in 1997, the ratio improved significantly. We know that the reserves did not improve immediately after the IMF was called in. It took at least until the fourth quarter of ’97 to implement the program. It is therefore safe to assume that the improvement of the ratio was caused by a decline in short-term debt: many debtors had called in loans already. We can conclude that a situation of disorderly workout was apparent in Thailand, leading up to the crisis, and continuing well into the crisis. 4.3.4: Bubble Theory. The core elements that characterized the bubble theory are: herd behavior, guarantees and rational expectations of investors. We have seen in section 4.2 that all three elements were present in the Thai crisis. Large net private capital inflows provided an important component of the credit boom and a significant portion of the lending was directed to real estate and equities. In this section, we will examine the Thai property and stock market for the presence of a bubble. Real Estate Market. Exposure to the property market through loans to homebuyers is not particularly high in Asia. The exposure of banks to property developers is much higher and a much riskier form of exposure. It has been estimated that total exposure to the property sector accounted for between 30-40% of bank loans in Thailand (Berg, 1999). In late 1996, Somprasong Land, a major property developer, was unable to meet a foreign th
debt payment due on February 5 of 1997. This development provided the first clear indication that financing companies, heavily exposed to the Bangkok property market, were in trouble (Alba, et. al., 1998). One indicator of a bubble is growing pressure in asset prices. Considering the real estate market, pressures would have resulted in growing property prices. A bubble situation, and then a bursting of the bubble, indicates that property values should have been climbing steadily in the years leading up to the crisis, followed by a sharp decline at the onset of the crisis. There is limited information available about Thailand’s property market. As many Asian countries, disclosure of data is shielded, and has only become more available after the crisis. A useful indicator for the real estate market is the portion of the Stock Market Index
42
dedicated to real estate, as shown in Figure 8. This chart expresses the movement of the property market stock market index, in the years leading up to the crisis. Figure 8: Thailand: Property Sector: Stock Market Index Property Sector: Stock Market Index Thailand 400
Stock Market Index: property market
350 300 250 200 150 100 50 0 9 19
0
9 19
1
93 19
92 19
19
94
19
95
19
96
19
97
Source: International Financial Statistics, IMF. The Stock market index (property market) grew steadily until 1993, but started a firm decline after 1993. This decline continued into 1997. Stock Market. The Thai stock market fell by 51% from 1993 through 1996. Figure 9 gives a chart of the Thailand stock market index, the SET. Figure 9: Thailand: Stock Market Index, SET Stock Market Prices Thailand: SET 1900
Stock Market index: Actual
1700 1500 1300 1100 900 700 500 300 9 19
0
91 19
19
92
19
93
19
94
19
95
Source: International Financial Statistics, IMF.
43
19
96
19
97
When we examine this chart carefully we can detect the following: !
The SET index peaked in the first half of 1993, at about 1700.
!
After this, the index started to decline and in 1995 lost 25% of its value.
!
During the second half of 1995, the stock market dropped sharply; this led eventually to a total decline of 80%. Can we recognize a bubble, and what is more important the bursting of a bubble, in either market? The definition of a bursting of a bubble was defined in chapter 3 as 1) a decline of at least 50%; and 2) occurring within 6 months of the onset of the crisis. The decline in the property market was significant but started in 1993 clearly preceding the financial crisis. The decline in the stock market was also significant, but this decline occurred years before the crisis. If there was a bubble situation in either the property or stock market, this bubble burst long before the crisis ever started. Summarizing, the cause of the crisis in Thailand has not been caused by a bubble in the property or equity markets. The decline in the asset prices probably contributed to the onset of the crisis, creating doubts about the creditworthiness of borrowers, and gradually undermining confidence in the baht. 4.4: Summary and Conclusion. In this chapter we have determined that several of the core elements, as defined in the previous chapter, were present in the Thai crisis. The elements seemed to reinforce each other, ultimately setting the crisis in Thailand in motion. Moral hazard stands out as a clear cause for the crisis; the large guarantees brought a situation of large inflows and, combined with the pegged exchange rates, created an unsustainable situation. Herd behavior, combined with a situation of high levels of guarantees and liquidity/solvency problems, led to a self-fulfilling crisis with panic and a situation of disorderly workout. We found evidence for the rational expectations of investors, but this did not lead to a bubble situation in the stock and real estate markets. Contrary to the opinion of economic literature on the crisis, I did not find any proof for a bursting of a possible bubble. This submodel is therefore rejected.
44
Chapter 5: The Crisis in Korea. When the crisis started in Thailand, cracks appeared at almost the same time in Korea. In section 5.1 we will see how this materialized. Section 5.2 will be dedicated to a unique situation in Korea, the Chaebols. In section 5.3, core-elements of the 2
nd
generation model
will be discussed, and applied in section 5.4. Section 5.5 will end this chapter with a brief summary and conclusion. 5.1: Spread of the Crisis to Korea. The Korean won came under increased pressure shortly after the Thai baht was devalued in July of 1997. Figure 10 shows the movement of the Korean won during the period 1996 to 1998. Figure 10: The Movement of the Korean Won 1996-1998
National Currency per US $
South Korean Currency to USD 1700.00 1500.00 1300.00 Won 1100.00
Won officially floated
900.00 700.00 Date
Jun-96
Dec-96
Jun-97
Dec-97
Jun-98
Dec-98
Source: International Financial Statistics (IMF) The won depreciated 25% during November ’97, compared with a depreciation of 39% over the entire year. Following are highlights of the start and depth of the crisis: !
In January of 1997, Hanbo Steel collapsed under 6 billion US$ in debts. This was the first bankruptcy of a Korean Chaebol in a decade. In the months that followed, Sammi Steel and Kia Motors, two other major Chaebols, suffered a similar fate. The bankruptcies put several merchant banks under significant pressure: much of the foreign borrowing at the Chaebols had been channeled through (and in some cases had been guaranteed by) these banks.
!
The Korean banking system grew weaker in 1997. Non-performing loans tripled to 7.5% of GDP at the end of September 1997.
!
In response, the Korean authorities made a strong commitment to defend the won and address any financial sector problems. Korea made the same mistake as Thailand: they
45
defended the exchange rate until they had effectively exhausted their foreign exchange reserves. !
Usable reserves began to fall and short-term external debt accumulated in the first half of 1997. The Bank of Korea reported reserves of about 33 billion US$ at the end of 1996, 29 billion US$ at the end of March, and 13 billion US$ at the end of October 1997. The real state of the reserves became only apparent in 1998: many of the reserves in 1997 had 28
already been placed with foreign branches of Korean banks that had become illiquid . !
After substantial foreign exchange intervention, Korea abandoned the defense of the won on November 17, 1997. Foreign banks, which had heavily lent to Korean banks started to refuse to roll over their loans. The financial panic that ensued in December, led to a 40% currency collapse in just a week.
!
Korea began to negotiate an IMF package on November 21 and announced its agreement th
on December 4 . With help from the US government (led by the Federal reserve board and US treasury), the banks and the Korean government announced a standstill on debt servicing. 5.2: Special Situation in Korea: Chaebols. The Korean corporate world is characterized by the existence of Chaebols: state-favored conglomerates that dominate the Korean economy and focus primarily on grand investment (manufacturing) projects. Since the Chaebols created a unique situation in Korea, this section will give some more insight on their affect on the crisis. In early 1997, Korea was shaken by a series of bankruptcies of its large conglomerates, the Chaebols, which had heavily borrowed in previous years to finance their investment projects. In several cases, Chaebols effectively controlled several private banks, giving them privileged access to credit. The bankrupted Chaebols had severe financial problems in the previous years. Table 12 gives an overview of the financial state of the 30 largest Chaebols, at the end of 1996. This table outlines the assets, liabilities, sales, net profits and debt-equity ratios for the Chaebols.
28
When Korean banks used these dollars to satisfy demands for dollars from creditors who did not roll
over dollar obligations, the reserves were essentially used.
46
Table 12: Top 30 Chaebols
In hundred million won and % (1996). Chaebol Samsung Hyundai Daewoo LG Hanjin Kia Ssangyong Sunyong Hanhwa Daelim Kumho Doosan Halla Sammi Hyosung Hanil Donga Construction Kohap Jinro Dongguk Jaekank Lotte Kolon Haita Sinho Jaeji Anam Industrial Dongguk Muyok New Core Bongil Hansol Hansin Kongyong
Total Asset 508.6 531.8 342.1 370.7 139.0 141.6 158.1 227.3 109.7 57.9 74.0 64.0 66.3 25.2 41.2 26.3 62.9 36.5 39.4 37.0 77.5 38.0 34.0 21.3 26.4 16.2 28.0 20.3 47.9 13.3
Debt 370.4 433.2 263.8 287.7 117.9 118.9 127.0 180.4 97.2 45.9 61.2 55.9 63.2 25.9 32.5 22.3 49.1 31.2 39.0 25.4 51.0 28.9 29.5 17.7 21.8 13.6 25.9 18.3 37.1 11.5
Sales
Net Profit
Debt/Equity Ratio
601.1 680.1 382.5 466.7 87.0 121.0 194.5 266.1 96.9 48.3 44.4 40.5 52.9 14.9 54.8 13.0 38.9 25.2 14.8 30.7 71.9 41.3 27.2 12.2 19.8 10.7 18.3 8.7 25.5 10.6
1.8 1.8 3.6 3.6 -1.9 -1.3 -1.0 2.9 -1.8 0.1 -0.2 -1.1 0.2 -2.5 0.4 -1.2 0.4 0.3 -1.6 0.9 0.5 0.2 0.4 -0.1 0.1 -0.2 0.2 -0.9 -0.1 0.0
268.2 439.1 337.3 346.5 556.9 523.6 409.0 385.0 778.2 380.1 477.9 692.3 2067.6 3245.0 373.2 563.2 355.0 589.5 8598.7 210.4 191.2 316.5 658.3 489.5 478.1 587.9 1224.0 920.5 343.2 648.8
Source: Corsetti et. al., 1998. Overall, there was a significant problem with low profitability at the firm level. The average 29
debt-equity ratio for the listed 30 Chaebols was 33% . In the case of Sammi, bankrupt in January, the ratio was a staggering 3,245%, while in the case of the Jinro group the ratio was 8,598%. The table also shows that profitability, as measured by net profits, was very low, or outright negative in the case of 13 of the 30 companies.
29
The comparable figure for the US is close to 100% (Barro, 2001).
47
Korean companies’ profit margins had been shrinking for several years, as Korean Chaebols had been on an ambitious expansion and diversification path without regard for economic profitability. The large investments combined with low profitability forced Chaebols to borrow, both domestically and internationally, in order to maintain operations. As an example, debt obligations in the manufacturing sector accounted for 47% of total assets and the average debt equity ratio was more than 300% by the end of ’96 (Corsetti et. al., 1998). The high leverage ratios of the Chaebols and their low profitability made them very vulnerable to any shock to their cash flow. The health of the banking system, in turn, was extremely dependent on the viability of the Chaebols. Banks were highly connected to them, both directly through loans and discounts, and indirectly through guarantees. 5.3: Recognizing Core Elements in the Korean Crisis. 5.3.1: Herd behavior. Following are some occurrences in Korea that indicate the existence of herd behavior: 1. An important example of the herd behavior can be found in the competitive devaluation of the currencies in Asia, also known as the “Domino Effect”. This will be discussed in section 5.4.5. Herd behavior is also apparent in “Sunspots”, where investors see weaknesses in one country and recognize the same weaknesses in other countries. “Sunspots” will also be discussed in section 5.4.5. 2. Examining the build up of Korea’s debt in the years leading up to the crisis, can give us some insight on possible herd behavior. Figure 11 shows the Korea’s debt, divided in short term and long term debt. Figure 11: Korea: Long term Debt versus Short term Debt Korea 60 Billions of US Dollars
50 40
long term debt
30
short term debt
20 10 0 1992
1993
1994
1995
1996
Source: Lane et. al., 1999.
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1997
The flow of capital to Korea was smaller than we have seen in Thailand, but nonetheless significant, totaling 50% of GDP over 1996. A major difference with Thailand was that Korea’s short-term debt, as a % of total debt, was almost 70% in 1996, indicating some herd behavior. Table 10 (Liquidity and Currency Mismatches) on page 34, shows the mismatching in currencies and liquidities in Korea. The mismatching as a result of the short-term debt was extremely large in Korea. As we can see in this table, Korea had 3 times more debt outstanding than it had international reserves. Also, Korea’s short-term debt was denominated largely in foreign currency, which implies exposure to liquidity and currency mismatches. 3. The exposure of Japanese banks was high in Korea. This posed an extra problem for Korea: when the Thai crisis started and the IMF was called in, Japanese creditors saw little chance to recover the outstanding loans in Thailand. They immediately turned to other Asian countries, notably Korea, and started to call in the debts. The herd behavior in these examples is sufficient to assume that it was an issue in the Korean crisis. 5.3.2: Implicit/Explicit Guarantees. Following are some examples of situations of guarantees that can be recognized in the Korean situation: 1. In August of 1997, the authorities guaranteed the liabilities of all Korean financial institutions and overseas subsidiaries. The policy was to pay cash to meet maturing obligations, including those of a dozen merchant banks in receivership. 2. Korean authorities actually injected funds into financial institutions. This not only created an implicit guarantee but also limited their usable reserves, since part of the reserves became locked in. 3. The Chaebols owned many non-bank financial institutions, directly or indirectly. They were used to finance activities within the Chaebol group. 4. Korea’s exchange rate mechanism was not as fixed as that of the other crisis 30
countries , but can hardly be considered a floating currency. We have seen the same situation occur in Thailand: The dedication of the central bank to keep the value of the currency pegged, created an incentive to borrow in foreign currencies, and exposed the debtors to foreign currency risk.
30
The won varied more around the trend, particularly from early 1994 onwards, than either the Thai
baht or the Indonesian rupiah.
49
5.3.3: Liquidity/Solvency. External finance began drying up for Korea even prior to the Thai devaluation in July 1997, as investors became increasingly concerned about the looming domestic financial problems. This left many borrowers with solvency problems. Here are some examples: 1. During the 90s, Japan had been going through a crisis as well. Japanese banks, already in fragile conditions after the burst of the 1980s asset bubble and weakened by 31
a stagnant economy, had heavily lent to other Asian economies . As the Japanese crisis deepened in ‘97, many of these banks suffered capital losses and felt further pressure on their balance sheets. Undercapitalized, many Japanese banks chose to recall foreign loans and contain the magnitude of the domestic lending squeeze. 2. Once the trigger was pulled in Thailand, several powerful feedback mechanisms amplified the withdrawal into a panic. On top of the national liquidity crunch in Japan, Japanese banks, with exposure in Thailand, were taken aback by the early involvement of the IMF in the Thai crisis. The IMF required a standstill on debt recall, and forced rollover of outstanding short-term loans. As soon as this became apparent, Japanese banks tried to be one step ahead of a similar situation in Korea and called in outstanding loans. 3. More than half of Korea’s external debt was short-term, of which about 20 billion US$ fell due in the last two months of 1997. Korea faced an extraordinary liquidity crunch arising from the large level of short-term debt falling due and the difficulties in rolling over this debt. 4. Downward pressures on the Korean Won intensified in the last week of October, and equity prices fell sharply, reflecting diminished confidence about prospects for an orderly workout of the corporate debt overhang, and the growing difficulties encountered by the financial sector in rolling over external loans. It is apparent that the liquidity/solvency problem was a serious issue in Korea. We will see in section 5.4.3 how this induced a situation of disorderly workout. 5.3.4: Rational Expectations of Investors. The expectations of investors involved in the Korean crisis are similar to the Thai situation. Please see section 4.2.4 for an assessment on investor’s expectations.
31
Interest rates were very low in Japan during the 90s. Large scale lending to the fast growing East
Asian countries was stimulated by the higher returns available outside Japan. The bulk of the exposure was mainly in Korea and Malaysia (Chote, 1998).
50
5.3.5: Interdependence between Countries. Trade relationships between two countries give insight on existing interdependencies. Table 13 gives an overview of the bilateral trade between Thailand and Korea, among the other crisis countries. Table 13: Bilateral Trade Bilateral trade Relationships with Thailand, 1996 Exports to Thailand (as
Export Similarity (a
a % of total exports)
measure of similarity of product composition of exports)
Korea
1.8
0.44
Malaysia
4.6
0.40
Indonesia
2.2
