a comparative study of east asia and india avinash chandiramani scott dicks erin fitzpatrik salil...
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A Comparative Study of East Asia and India
Avinash ChandiramaniScott Dicks
Erin FitzpatrikSalil JayakarRuhi Khan
Chad Simon
Disaster Strikes East AsiaDisaster Strikes East Asia
Decades of impressive growth
The intensity and the duration of the crisis were inconceivableThe effects of the crisis spread through the Global economy
THE INDIAN ECONOMY ESCAPED THE CRISIS THE INDIAN ECONOMY ESCAPED THE CRISIS VIRTUALLY UNHARMEDVIRTUALLY UNHARMED
Crisis
Financial Markets Currency markets
AgendaAgenda
INTRODUCTION TO THE CRISISINTRODUCTION TO THE CRISIS Macroeconomic fundamentals Theories
FINANCIAL AND TRADE LIBERALIZATIONFINANCIAL AND TRADE LIBERALIZATION Banking Sector Capital flows Debt / equity markets Real Trade Linkages
EXCHANGE RATE REGIMESEXCHANGE RATE REGIMES Foreign reserves Banking sector Financial sector Trade
CONCLUDING REMARKS CONCLUDING REMARKS
– Bankruptcy rates skyrocket– Stock markets crash– Growth rates tumble– Currency speculation forces Thai Baht
depreciation
Introduction to the CrisisIntroduction to the Crisis
THIS IS A TRIGGER FOR THE CRISIS
1997: East Asia falls into crisis
- Following this, Malaysia, Indonesia and Philippines allow depreciation
-China, Hong Kong, Korea, Singapore and Taiwan
Introduction to the CrisesIntroduction to the Crises
TIGERS PAPER TIGERS
CREDIT CRUNCH
East Asia India
GDP Growth Exceptional Moderate
Inflation Low Low
Saving Rate High High
Current Account Deficit
Over 5 % of GDP Under 5 % of GDP
Exchange Regime Pegged Floating
Trade Very Important Less Important
Macroeconomic FundamentalsMacroeconomic Fundamentals
• Dramatic increase in credit
• Socially Risky behavior encouraged
• Moral hazard by monetary authorities
Bad Policy TheoryBad Policy Theory
Intense Liberalization
+
Inappropriate Policies
= Crisis
Financial Panic TheoryFinancial Panic Theory
Downturn in Real Economic Variables (GDP)
Systemic Risk
Expectations of Instability
Coordination Failure
Inherent Instability of Financial Markets
+
Loss of Investor Confidence= Crisis
Moral HazardMoral Hazard
Two Types:
“A situation which creates incentives to engage in risky
behavior. Decreased personal liability acts as an incentive”
Corporate Level
International Level
ContagionContagion
“The transmission of shocks to other countries or the cross-country correlation, beyond any fundamental link among the countries and beyond common shocks.”
This definition is usually referred to as excess co-movement, commonly explained by herd behavior.
Liberalization PolicyLiberalization Policy
• Banking sector• Privatization
• Capital Flows
• Debt/Equity Markets• Capital Account Convertibility (CAC)
• Introduction of financial institutions
Liberalization PolicyLiberalization Policy
Liberalization Policy
An influx of capital
More efficient and competitive markets
but…
Proper regulation is needed
Banking SectorBanking Sector
East AsiaEast Asia
High level of privatization
Regulation was not enforced&
Little diversity in investment
IndiaIndia
Low levels of privatization
Increased supervision&
Diversity in investments
Morally hazardous behavior Less moral hazard
ImplicitGuarantee
Capital FlowsCapital Flows
East AsiaEast Asia
Full Capital Account Convertibility
IndiaIndiaPartial Capital Account
Convertibility
Turnaround of short term capital flows
Less dependence on short term capital
Increasing portfolio investment
No change in portfolio investment
Debt/ Equity MarketsDebt/ Equity Markets
Financial assetsas collateral for loans
Corporate bankruptcy in East Asia
Ineffective rating and regulation agencies
Overvalued stock markets
Real Trade LinkagesReal Trade Linkages
Trade makes uplarge % of GDP
Trade makes up small % of GDP
East AsiaEast Asia IndiaIndia
Investors group Asian economies
India was not connected with East Asia
Competitive exports to similar countries.
Similar trading partners
Different exports than East Asia
Small amount of trade with East Asia
Exchange Rate RegimesExchange Rate Regimes
Pegged Exchange Rate RegimesPegged Exchange Rate Regimes
Advantages
• Associated with stability and low inflation
• Forces authorities to adhere to disciplined monetary and fiscal policies
Disadvantages
• Misalignments may occur when foreign and domestic countries face different economic conditions
• Maintaining pegs in the face of increased speculation can be costly
MOST EAST ASIAN COUNTRIES ADOPTED PEGGED RATES
Exchange Rate RegimesExchange Rate Regimes
Floating Exchange Rate RegimesFloating Exchange Rate Regimes
Advantages
• Currency moves with the relative performance of the economy
• Serves as an adjustment mechanism, insulating a currency from speculative attacks.
Disadvantages
• Fluctuations may reflect non-fundamental noise
INDIA ADOPTED A FLOATING EXCHANGE RATE IN 1994
Foreign Reserves
East Asia India
1990-96: foreign reserves grew
Short term debt rising
Capital Outflows in ‘97 reserves decrease
Pegs unsustainable depreciation
India’s reservesalso grew
India discouraged short term debt
Capital Inflows in ’97 reserves increase
Floating rate No dramatic depreciation
Banking Sector
East Asia India
Depreciation foreigndenominated debts
unsustainable
1997: High levels ofnon-performing assets
Decreased credit by banks
No depreciation Foreign debts sustainable
1997: Lower levels ofnon-performing assets
No decrease in credit by banks
Financial Sector
East Asia India
Switch to floating exchange rate rapid
depreciation, uncertainty
Further capital outflow ensued
India’s exchange rate provided a greater
predictability
1997 experienced an increase in capital inflows of 24%
Trade
East Asia India
Crisis depreciations did not competitiveness:
1. High levels of intra- regional trade
2. Increased cost of raw material imports
Trade played less influential role in Indian
economy
No dramatic swing in rates to alter competitiveness
Trade played an influential role in East
Asian economies
ConclusionConclusion
The financial crisis reflects three important The financial crisis reflects three important considerationsconsiderations
• Liberalization
• Exchange rate regimes
• Combination of the above two
Liberalization
• Partial capital account convertibility
• Less dependence on short term flows
• Diversified allocation of capital
ConclusionConclusion
ConclusionConclusion
Exchange Rate Regimes
East Asia
Pegged currency increased risk of speculative attack
India
Float allowed currency to reflect economic fundamentals
Combined EffectCombined Effect
FULL CAPITAL ACCOUNT CONVERTIBILITY
+
PEGGED EXCHANGE RATE
=
SPECULATIVE ATTACK
ConclusionConclusion
ConclusionConclusion
The East Asian and the Indian economies are fundamentally different and are at
different stages of growth and liberalization.
Summing up:
RecommendationsRecommendations
Considerations relevant for economic and financial policy:
• Controls on capital account convertibility or a
commitment to flexible exchange rates
• Less dependence on short term capital inflows
• Enforce regulation policies in financial and banking
sectors
• Increased transparency in all transactions
Any Questions?
Trade as a % of GDP (1997)Trade as a % of GDP (1997)
0
50
100
150
200
East Asia Trading Partners (1997)East Asia Trading Partners (1997)
0%
10%
20%
30%
40%
50%
United States East Asia (Including Japan)
India
Portfolio Investment as a % of GNPPortfolio Investment as a % of GNP
-0.50%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
1990 1991 1992 1993 1994 1995 1996
IndiaEA Average
1994 1995 1996 1997 1998Korea 7.00% 5.00% -3.00% -62.00% 13.00%Malaysia 90.00% 44.00% 67.00% 37.00% -49.00%Thailand 53.00% -38.00% -27.00% 19.00% -21.00%
% Change in Credit from Deposit Money Banks
Credit ContractionCredit Contraction
Currency Depreciation Currency Depreciation
R2 = 0.998
0
5000
10000
15000
20000
25000
30000
1990 1991 1992 1993 1994 1995 1996 1997Year
$ m
ill.
SD
RS
KoreaMalaysiaThailandAVGIndonesiaPoly. (AVG)
International Reserves International Reserves ($mill. SDRS)($mill. SDRS)
0
5
10
15
20
25
30
1990 1991 1992 1993 1994 1995 1996 1997
Year
India’s International Reserves India’s International Reserves (USD$billions)(USD$billions)
9
1716 16
19
0
2
4
6
8
10
12
14
16
18
20
1
India
Indonesia
Korea
Malaysia
Thailand
% of Non-Performing Bank Assets in 1997% of Non-Performing Bank Assets in 1997
1994 1995 1996 1997India 42.11% -30.97% 35.47% 24.40%Indonesia 631.57% 48.78% 40.29% -32.81%Korea, Rep. 102.25% -37.02% 89.00% -37.94%Malaysia -24.89% 19.44% 26.75% -27.28%Thailand -41.21% 126.29% 35.23% -74.61%Philippines 18.39% 11.41% 15.76% -16.53%
% Change in Private Capital Flows
Capital OutflowsCapital Outflows
Foreign Res. ST Debt Foreign Res. ST Debt Foreign Res. ST DebtIndonesia 14.7 27.6 19.3 34.2 20.3 34.7
Korea 32.7 54.3 34.1 67.5 34.1 70.2
Thailand 37.0 43.6 38.7 45.7 34.1 67.5
Average 28.1 41.8 30.7 49.1 29.5 57.51 to 1.49 Ratio 1 to 1.60 Ratio 1 to 1.75 Ratio
End 1995 End 1996 Mid 1997
Foreign Reserves & Short Term Debt
Values in billions of US$
1990 1991 1992 1993 1994 1995 1996 1997
Inflation 8.97 13.87 11.79 6.36 10.21 10.22 8.98 7.36
Gross National Savings
21.99 22.20 22.43 20.70 28.90 25.37 23.92 22.57
Overall Budget Surplus
8.12 5.81 5.65 7.47 5.89 5.35 5.19 4.86
Selected Macroeconomic VariablesSelected Macroeconomic Variables
(India)(India)