ALDERSGATE COLLEGE Espinoza, Daenielle Audrey M.

Solano, Nueva Vizcaya, Philippines, 3709 Bachelor of Science in Accountancy - 3

School of Business, Management and T72/AE18/ ECONOMIC DEVELOPMENT
Accountancy

LEARNING ACTIVITIES
Do the following:
1. The Asian financial crisis was a surprise to most economists, even those that
specialized on economic developments in the region. Why do you think this
happened?

The crisis was rooted in several threads of industrial, financial, and

monetary phenomena. In general, many of these relate to the economic
strategy of *export led growth that had been adopted across developing East
Asian economies in the years leading up to the crisis. This strategy involves
close government co-operation with manufacturers of export products,
including subsidies, favorable financial deals, and a currency peg to the U.S.
dollar to ensure an exchange rate favorable to exporters.
While this benefited the growing industries of East Asia, it also involved
some risks. Explicit and implicit government guarantees to bail out domestic
industries and banks; cozy relationships between East Asian conglomerates,
financial institutions, and regulators; and a wash of foreign financial inflows with
little attention to potential risks, all contributed to a massive moral hazard in
East Asian economies, encouraging major investment in marginal, and
potentially unsound projects.

*Export-led growth occurs when a country seeks economic development by engaging in international trade.

2. Can you generalize the results of your analysis in answering question 1 to the
question of predicting an economic shock?

As mentioned above, the International Monetary Fund (IMF) intervened,

providing loans to stabilize the Asian economies—also known as “tiger
economies”—that were affected. Roughly $110 billion in short-term loans were
advanced to Thailand, Indonesia, and South Korea to help them stabilize their
economies. In turn, they had to follow strict conditions including higher taxes
and interest rates, and a drop in public spending. Many of the countries affected
were beginning to show signs of recovery by 1999.

3. Can you think of a few other instances of economic crises that came as a
surprise to government, business, financial, and academic observers? What do
they have in common with the Asian financial crisis? What are the
dissimilarities?

The Asian crisis of 1997 to 1998, and the recent Global Financial crisis
of 2007 to 2008 have their similarities and their differences. Both stemmed from
weaknesses in the financial system. While the Asian crisis was related mostly
to real estate, stock price and currency inflations, the recent global crisis was
related to high-risk mortgages: institutions lending to those with poor credit. In
both cases, the bubble of overheated economies burst. The challenges of the
ALDERSGATE COLLEGE Espinoza, Daenielle Audrey M.
Solano, Nueva Vizcaya, Philippines, 3709 Bachelor of Science in Accountancy - 3
School of Business, Management and T72/AE18/ ECONOMIC DEVELOPMENT
Accountancy

Asian crisis were not easy to overcome, and the effects of the global crisis still
fester on.

4. Explain how the institutional and cultural setting of financial institutions in Asia
contributed to the crisis?

There are at least five different, but interrelated, accounts that explain
the institutional and cultural setting of financial institutions in Asian financial
crisis. These five accounts are weaknesses in the so-called “Asian
development model,” correction of macroeconomic weaknesses, weaknesses
of the banking sector and financial intermediaries, herd behavior and other
dynamic escalating activities, and contagion effect.
For “Banking Sector Inefficiency”, foreign banks would locate offshore
without paying taxes. Thai banks would then borrow from their offshore dollar
sources and invest mainly in ventures of high risk such as golf courses, hotels,
real estate, and the stock market.
The weaknesses of the banking sector and financial intermediaries had
promoted the expansion and diversification of domestic financial markets
through short-term borrowings. Firms that borrowed large amounts of money in
US dollars carelessly in the short-term became highly vulnerable to exchange
rate risks, thus requiring much more in local currency to cover loan payments.

5. Have these institutions changed since the crisis? If so, in what ways?

Financial institutions like banks were insolvent, with negative equity and
high non-performing loans.” They were also in the grips of a negative spread in
the banking system, with average net interest income in the banks at 15% and
cost of funds at 70%. Moreover, banks had lost all power they ever had over
their big clients.

6. Knowing what we know now about the crisis, do you think governments are
better able to predict the onset of another crisis? What kind of measures would
you put in place to monitor economic and financial activity as an early warning
system?

Many of the lessons learned from the Asian financial crisis can still be
applied to situations happening today and can also be used to help alleviate
problems in the future. First, investors should beware of asset bubbles—some
of them may end up bursting, leaving investors in the lurch once they do.
Another possible lesson is for governments to keep an eye on spending. Any
infrastructure spending dictated by the government could have contributed to
the asset bubbles that caused this crisis—and the same can also be true of any
future events.
ALDERSGATE COLLEGE Espinoza, Daenielle Audrey M.
Solano, Nueva Vizcaya, Philippines, 3709 Bachelor of Science in Accountancy - 3
School of Business, Management and T72/AE18/ ECONOMIC DEVELOPMENT
Accountancy

7. How did SARS and the Iraqi war affect the Asian region? Were these impacts
similar to those of the Asian crisis? How were they different?

The SARS crisis temporarily dampened consumer confidence in Asia,

costing Asian economies $11 billion to $18 billion and resulting in estimated
losses of 0.5 percent to 2 percent of total output, according to official and
academic estimates. SARS had significant, but temporary, negative impacts on
a variety of economic activities, especially travel and tourism. On the other
hand, during the Iraqi war, it appears that the debt overhang of Japanese
banks, which was worsened in the Asian financial crisis, is reducing the
available amount of credit for investment. The war in Iraq may hamper global
economic growth due to higher oil prices. It also resulted into disruptions of
international trade.

8. Some observers have suggested controls to cut down on the volatility of capital
movements. What are the advantages and disadvantages of such proposals?

If a country allows free movement of capital and wishes to target a stable

exchange rate, they loose independence of monetary and fiscal policy. In the
first age of globalisation 1900-39, countries were on the gold standard – which
meant fixed exchange rate, but with free movement of capital, it left countries
with limited independence over monetary and fiscal policy, e.g. the UK had to
pursue deflationary fiscal and monetary policies in the 1920s, which caused
mass unemployment. In the 2010s, some Eurozone economies lost
independent monetary and fiscal policy due to being in the Euro, with free
capital flows. Paul Krugman has argued for capital controls, especially during a
crisis. This is because during a crisis, the government may be forced to raise
interest rates to protect the currency, but this could be highly unpalatable to the
economy. In this case, Krugman argues capital controls are the least bad
response.
However, free market economists believe that capital controls prevent
the flow of capital to where it is most profitable and most efficient. It forces
domestic investors to gain a lower rate of return on investment and have a lower
income. Free movement of capital can lead to substantial inflows of foreign
direct investment in developing economies, enabling them to have a higher rate
of economic growth and ‘catch up’ with the developed world. Capital restrictions
it is argued, slow down this rate of catch up.

9. Governments have built up significant levels of foreign reserves since the

financial crisis. Discuss the policy issues relating to such a policy. What would
you say to the statement: “You can never have too much foreign reserve
cushion.”
ALDERSGATE COLLEGE Espinoza, Daenielle Audrey M.
Solano, Nueva Vizcaya, Philippines, 3709 Bachelor of Science in Accountancy - 3
School of Business, Management and T72/AE18/ ECONOMIC DEVELOPMENT
Accountancy

Because it’s implicit in the concept of maintaining a currency peg, which

represents a commitment by the government to buy and sell foreign exchange
(specifically, the peg currency) at a fixed price in terms of local currency. The
government can only fulfill that commitment if it actually has foreign exchange
on hand to sell. If the government runs out of foreign exchange or even comes
close that situation can easily provoke an economic crisis.

10. The Asian financial crisis has been characterized as a crisis of the private sector
in contrast to previous crises in Latin America that originated in the public
sector. Comment on this characterization using concrete examples from the
Asian crisis countries. Discuss the progress that has been made in dealing with
the aftermath of the Asian crisis in at least two countries. Be specific about the
measures undertaken.

The overflow impacts of the Asian crisis, transmitted to Latin America by

the channels of exchange and account, have influenced various nations in
various ways and have been met with approach measures in the fiscal,
budgetary and exchange circles. As the second quarter of 1998 starts, there is
an inclination of unassuming fulfillment in the locale about government
treatment of the crisis and the heartiness of economies. In purpose of fact,
speculative assaults on various monetary standards have been upset,
downturns on financial exchanges have been stopped and somewhat turned
around, and residential loan fees and outside credits are steadily retuning to
pre-emergency levels.
Regardless, the approaches put in spot to manage the Asian emergency
and the new worldwide setting it has produced involve costs for the area and
will antagonistically influence its development prospects. Obviously, they are
definitely not the main motivation behind why development figures for 1998
have been updated descending different elements incorporate surprisingly
terrible climate conditions expanded usage of limit up to this point underutilized,
in certain nations and, in others, the inconceivability of looking after
development rates at 1997 levels in perspective on the quick extension in outer
awkward nature. Diminished oil creation and a drop in oil costs are further
contributing variables, and are having a significant sway on the outside and
financial records of certain nations.

11. The recent financial crisis in the industrial countries is not expected to have as
big an impact on the Asian economies as the financial crisis of 1997. Explain
why this is so.

The Asian Financial Crisis of 1997 alludes to a macroeconomic stun

experienced by a few Asian economies including Thailand, Philippines,
Malaysia, South Korea and Indonesia. Regularly nations experienced quick
depreciation and capital outpourings as financial specialist certainty abandoned
over-extravagance to infectious cynicism as the basic irregular characteristics
ALDERSGATE COLLEGE Espinoza, Daenielle Audrey M.
Solano, Nueva Vizcaya, Philippines, 3709 Bachelor of Science in Accountancy - 3
School of Business, Management and T72/AE18/ ECONOMIC DEVELOPMENT
Accountancy

in the economy turned out to be progressively evident. The 1997 crisis pursued
quite a long while of fast financial development, capital inflows and develop of
obligation, which prompted an unequal economy. In the years going before the
emergency, government acquiring rose, and firms overstretched themselves in
a 'run for development' When market supposition changed outside financial
specialists looked to lessen their stake in these Asian economies causing
destabilizing capital surges, which caused quick depreciation and further loss
of certainty.