Monday, June 28, 2010



The Asian Financial Crisis was beginning in July 1997. The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.

2. Even there has been general agreement on the existence of a crisis and its consequences, the causes of the crisis is not clear, as well as its scope and resolution. Indonesia, South Korea and Thailand were most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hurt. The People's Republic of China, India, Taiwan, Singapore, Brunei and Vietnam were less affected.

The Issues

3. The Asian financial crisis involves four basic problems or issues:
a) A shortage of foreign exchange that has caused the value of currencies and equities in Thailand, Indonesia, South Korea and other Asian countries to fall dramatically;
b) Inadequately developed financial sectors and mechanisms for allocating capital in the troubled Asian economies;
c) Effects of the crisis on both the United States and the world; and
d) The role, operations, and replenishment of funds of the International Monetary Fund.

4. The Asian financial crisis was initiated by two rounds of currency depreciation that have been occurring since early 1997. The first round was a precipitous drop in the value of the Thai baht, Malaysian ringgit, Philippine peso, and Indonesian rupiah. As these currencies stabilized, the second round began with downward pressures hitting the Taiwan dollar, South Korean won, Brazilian real, Singaporean dollar, and Hong Kong dollar. Governments have countered the weakness in their currencies by selling foreign exchange reserves and raising interest rates, which, have slowed economic growth and have made interest-bearing securities more attractive than equities. The currency crises also has revealed severe problems in the banking and financial sectors of the troubled Asian economies.

Financial Crisis In Malaysia

5. Before the crisis, Malaysia had a large current account deficit of 5% of its GDP. At the time, Malaysia was a popular investment destination, and this was reflected in KLSE activity which was regularly the most active stock exchange in the world (with turnover exceeding even markets with far higher capitalization like the NYSE). Expectations at the time were that the growth rate would continue, propelling Malaysia to developed status by 2020, a government policy articulated in Wawasan 2020. At the start of 1997, the KLSE Composite index was above 1,200, the ringgit was trading above 2.50 to the dollar, and the overnight rate was below 7%.

6. In July 1997, within days of the Thai baht devaluation, the Malaysian ringgit was "attacked" by speculators. The overnight rate jumped from under 8% to over 40%. This led to rating downgrades and a general sell off on the stock and currency markets. By end of 1997, ratings had fallen many notches from investment grade to junk, the KLSE had lost more than 50% from above 1,200 to under 600, and the ringgit had lost 50% of its value, falling from above 2.50 to under 4.10 to the dollar. Then the Prime Minister, Mahathir Mohammad imposed strict capital controls and introduced a 3.80 peg against the US dollar

7. In 1998, the output of the real economy declined plunging the country into its first recession for many years. The construction sector contracted 23.5%, manufacturing shrunk 9% and the agriculture sector 5.9%. Overall, the country's gross domestic product plunged 6.2% in 1998. During that year, the ringgit plunged below 4.7 and the KLSE fell below 270 points. In September that year, various defensive measures were announced to overcome the crisis. The principal measure taken were to move the ringgit from a free float to a fixed exchange rate regime. Bank Negara fixed the ringgit at 3.8 to the dollar. Capital controls were imposed while aid offered from the IMF was refused. Various task force agencies were formed. The Corporate Debt Restructuring Committee dealt with corporate loans. Danaharta discounted and bought bad loans from banks to facilitate orderly asset realization. Danamodal recapitalized banks.

8. Growth then settled at a slower but more sustainable pace. The massive current account deficit became a fairly substantial surplus. Banks were better capitalized and NPLs were realised in an orderly way. Small banks were bought out by strong ones. A large number of PLCs were unable to regulate their financial affairs and were delisted. Compared to the 1997 current account, by 2005, Malaysia was estimated to have a US$14.06 billion surplus. Asset values however, have not returned to their pre-crisis highs. In 2005 the last of the crisis measures were removed as the ringgit was taken off the fixed exchange system. But unlike the pre-crisis days, it did not appear to be a free float, but a managed float, like the Singapore dollar.

Overcome The Financial Crisis

9. Today, the Malaysian measures are widely praised for being innovative and effective. The same International Monetary Fund that heaped skepticism on them has acknowledged that useful lessons can be learnt from the Malaysian experience. History will recognize the Malaysian measures as a landmark as they posed a systematic challenge and a practical alternative to the orthodox policies or the group of powerful institutions like the IMF, the World Bank and the US Treasury.

10. Many people today point to the Malaysian measures to show that alternative ways of resolving financial and economic crises are possible, do exist and can work even better than the orthodox policies. Malaysia was more lucky than other countries affected by the crisis, like Thailand, Indonesia and South Korea. Malaysia was not in a debt default situation, and thus did not have to turn to the IMF for loans. Those countries had to obey the IMF, and lost their policy autonomy.

11. In 1998, a year after the start of the crisis, the Malaysian model was introduced. This package comprised:
a) The core macroeconomic measures of interest rates, monetary and fiscal policies. Interest rates were significantly reduced, allowing firms and consumers to breathe again and then to borrow, thus improving investment and consumption conditions. The statutory reserve requirement was reduced to increase liquidity, and banks were encouraged to increase lending. And government boosted its spending, to get the economy moving again when the private sector was in the doldrums;
b) Stabilising the exchange rate. The ringgit was fixed at 3.80 to the US dollar, thus ending the previous flexible exchange rate system. This put an end to currency fluctuations and speculation. It allowed the macroeconomic policies to be implemented, and prevented a possible debt servicing crisis, which could have occurred if the ringgit had depreciated to below a certain level, as happened for example in Indonesia;
c) Closing down the overseas trade of the ringgit, and the trade in Singapore of Malaysian shares. This put an end to speculative activities in the currency and in local shares;
d) Regulating capital flows, particularly short-term capital outflows by foreigners and local citizens. Measures included an initial one-year moratorium on outflow of foreign portfolio capital and foreign-owned financial assets denominated in ringgit. Restrictions were placed on capital transfers by local citizens and companies;
e) Maintaining financial stability by deciding on a policy of not closing down financial institutions facing difficulties, and announcing that the government would guarantee deposits placed in banks and finance companies. This prompted depositors to retain confidence in the banking system, unlike in other countries where bank closures (insisted on by the IMF) led to a run on the system and to capital flight;
f) Restructuring and recapitalizing the banking and corporate sectors to enable a recovery in the micro-economy. Among the measures were the establishment and work of Danaharta (an asset management company) to deal with the non-performing loans problem, Danamodal (a special agency) to recapitalize troubled financial institutions and the Corporate Debt Restructuring Committee to restructure corporate debt;
g) Revitalising the various economic sectors affected by the crisis; and
h) Maintaining certain key economic and social policies, in particular the regulation of foreign ownership of assets, subsidies and price controls, policies relating to distribution and balance among local ethnic communities.

12. If Malaysia had to turn to the IMF, it would have had to end many of these policies, and there might have been social chaos. There are thus some important lessons from the Malaysian policy response to the crisis.
a) There are alternatives to the IMF policies. The Malaysian case shows that such an alternative approach exists, and can be applied in a relatively successful manner with good results.
b) Having policy space and flexibility is important to a developing country. The Malaysian experience also shows that if a country is able to avoid turning to the IMF, it can be free of being in the straightjacket of the IMF’s mainly one-size-fits-all policies, and can choose its own policies and also change them if they are found to be unsuitable.
c) A coherent anti-crisis strategy should be seen as an integrated package of its elements and policies. Policy makers often face dilemmas as there are multiple goals and the same policy instrument meant to achieve one goal may impact negatively on other goals.

The Conclusion Of The Study

13. In a situation where there are many complex trade offs, it is useful to “think outside the box” and seek new or extra policy tools. In the Malaysian case, the various policy elements should be seen as parts of an integrated approach, or of a whole policy package. Thus, each element should be considered not only on its own merits or for its own role to achieve a particular goal, but also for its function of having an effect on another goal.

14. A particular element or policy may not have the same successful intended effect , unless done together with some other element of policy. Thus, the inter-relationship of the elements and the interaction with one another should be appreciated.


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