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The Financial Crises In Russia And East Asia

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On July 2, 1997, the Government of Thailand abandoned its efforts to maintain a fixed- exchange rate - the Baht had been pegged to a basket of currencies dominated by the U.S. dollar - and allowed the Baht to float. This Baht quickly depreciated, falling 18% on the first day alone. The collapse of the Thai Baht was followed by speculative attacks on other countries' currencies (including the Indonesian Rupiah, the Malaysia Ringitt, the Philippine Peso, and the Korean Won) and to a further round of forced devaluations. The collapse of fixed exchange rates was accompanied by a series of more general financial sector crises in several of these countries. Although the precise details vary, the immediate cause appears to be a mismatch between assets and liabilities in the corporate and banking sectors (in both currency and term length) and a sharp decline in asset values. These immediate problems were exacerbated by general financial sector weakness due to inadequate supervision and rampant insider lending.

In many ways the crises in Asia were somewhat different than previously observed exchange rate crises. Corsetti, Pesenti and Roubini (1998) note that several of the usual indicators of a pending financial crisis - slow growth, large fiscal deficits, high rates of inflation and low savings and investment rates - were not observed in these countries prior to the crises. This led several observers to suggest that the crises were the result of self-fulfilling prophecies (i.e., the belief that the currency might be devalued led to speculative attacks on the currency which then forced the governments to devalue the currency even though fundamentals remained strong). However, many observers suggested, both before and (more often) after the crisis occurred, that there were visible problems with macroeconomic stability. The most noted weaknesses were: (i) large, and potentially unsustainable, current account deficits; (ii) rapid appreciation of currencies which were pegged to the dollar; and (iii) a slowdown in growth due to sectoral weakness (especially in semi-conductors) and stagnation in Japan. The large current account deficits made the countries vulnerable to shifts in investor confidence or to a slowdown in economic growth while the rapid appreciation of the U.S. dollar led the currencies to become overvalued. When Thailand had floated its currency, this increased pressure on other countries to do the same to maintain competitiveness in export markets.

The current account deficits were not the result of dis-saving by the government (i.e., fiscal deficits), but were caused by large inflows of private investment. Banks and enterprises in these countries would borrow abroad in foreign currencies and then use these funds to invest at home. This led to rapid stock market and real estate price increases (i.e., asset 'bubbles') and to ill-planned investment in projects with low real rates of returns. The problem was intensified by moral hazard due to implicit or explicit government guarantees and by poor supervision and regulation of the banking sector. As a result, when the exchange rate fell, banks found themselves with large portfolios of non-performing loans and that the currency mismatch between assets and liabilities meant that they were unable to service foreign currency loans. It must, of course, be recognized different factors played different roles in each individual crisis. As Caprio (1998) notes, excessive leveraging of corporate debt appears to have been the main problem in Korea, while in Indonesia, foreign exchange mismatches seem to have been a greater problem in the corporate sector (which indirectly led to banking sector problems).

The bank crises, especially the crisis in Thailand, were predictable. Models of banking crises (e.g., DemirguÐ*-Kunt and Detrgiache) note that high rates of credit growth and large amounts of credit to the private sector are correlated with the probability of future crises. All these countries had high rates of credit growth (between 10-25% in 1996) and large shares of private sector credit to GDP (>40% in all cases). In addition, the decline in foreign exchange reserves as the countries were forced to defend (or devalue) their currencies and over-valued exchange rates also increased the likelihood that a crisis would occur.


In summary, the main causes of the financial crises in Asia were:

* Large current account deficits that left the countries vulnerable to changes in investor confidence and macroeconomic conditions.

* Over-valued exchange rates that were often pegged to the U.S. dollar which was, at that time, appreciating quite rapidly.

* Rapid and unsustainable increases in asset prices, especially stock market and real estate prices.

* A currency mismatch between assets and liabilities that left banks and enterprises vulnerable to exchange rate devaluations.

* Inadequate bank regulation and supervision.

* Implicit and explicit government guarantees that made high-risk projects (including projects which relied upon continued appreciation in real estate prices) attractive to investors.


In East Asia, in addition to supporting the International Monetary Funds programs, the Bank provided Structural Adjustment Loans to prop up and recapitialize select banks by supporting bond issues. In addition, the World Bank set up credit lines to help finance imports.


The recent financial crisis in Russia has many of the symptoms of a classic crisis (e.g., large fiscal deficits, macroeconomic instability, and low savings), but is very different from the crises in Asia. For example, although poor data quality makes it hard to draw strong conclusions, Russia's current account appears to have been in surplus through the end of 1997. In addition, foreign investment was primarily directed towards the government sector rather than into risky private sector ventures or overvalued real estate. Oxford Analytic Briefs (November 13, 1997) reported that non-residents might have been holding as much as 40% of outstanding government paper at the end of 1997. As a result, the government's August 17th decision to suspend repayment of foreign debt and the subsequent decision to compulsorily convert short term Treasury bills and federal loan bonds to ruble-denominated government securities will undermine foreign investment. It will also have a significant effect on Russia's ability to continue



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