A Comparative Study of

East Asia and India

Avinash Chandiramani
Scott Dicks
Erin Fitzpatrik
Salil Jayakar
Ruhi Khan
Chad Simon

Disaster Strikes East Asia

Decades of impressive growth

Crisis
Financial Markets

Currency markets

The intensity and the duration of the crisis were inconceivable

The effects of the crisis spread through the Global economy
THE INDIAN ECONOMY ESCAPED THE CRISIS
VIRTUALLY UNHARMED

Agenda
INTRODUCTION TO THE CRISIS
Macroeconomic fundamentals
Theories
FINANCIAL AND TRADE LIBERALIZATION
Banking Sector
Capital flows
Debt / equity markets
Real Trade Linkages
EXCHANGE RATE REGIMES
Foreign reserves
Banking sector
Financial sector
Trade
CONCLUDING REMARKS

Introduction to the Crisis

1997: East Asia falls into crisis

Bankruptcy rates skyrocket

Stock markets crash
Growth rates tumble
Currency speculation forces Thai Baht
depreciation
THIS IS A TRIGGER FOR THE CRISIS

Introduction to the Crises

- Following this, Malaysia, Indonesia and Philippines

allow depreciation
-China, Hong Kong, Korea, Singapore and Taiwan
TIGERS

PAPER TIGERS

CREDIT CRUNCH

Macroeconomic Fundamentals

East Asia

India

Exceptional

Moderate

Inflation

Low

Low

Saving Rate

High

High

Over 5 % of GDP

Under 5 % of GDP

Pegged

Floating

Very Important

Less Important

GDP Growth

Current Account
Deficit

Exchange Regime
Trade

Bad Policy Theory

Intense Liberalization

Crisis

Inappropriate Policies
Dramatic increase in credit
Socially Risky behavior encouraged
Moral hazard by monetary authorities

Financial Panic Theory

Inherent Instability of Financial Markets
+
Loss of Investor Confidence

Crisis

Systemic Risk
Expectations of Instability
Coordination Failure

Downturn in Real Economic Variables (GDP)

Moral Hazard
A situation which creates incentives to engage in risky
behavior. Decreased personal liability acts as an incentive

Two Types:

Corporate Level

International Level

Contagion

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 comovement, commonly explained by herd behavior.

Liberalization Policy
Banking sector
Privatization

Capital Flows
Capital Account Convertibility (CAC)

Debt/Equity Markets
Introduction of financial institutions

Liberalization Policy
Liberalization Policy

An influx of capital
More efficient and competitive markets

but
Proper regulation is needed

Banking Sector
East Asia

India

High level of
privatization

Low levels of
privatization

Regulation was not enforced

&
Little diversity in investment

Increased supervision
&
Diversity in investments

Implicit
Guarantee
Morally hazardous behavior

Less moral hazard

Capital Flows
East Asia

India

Full Capital Account

Convertibility

Partial Capital Account

Convertibility

Increasing portfolio
investment

No change in
portfolio investment

Turnaround of short
term capital flows

Less dependence on
short term capital

Debt/ Equity Markets

Ineffective rating and

regulation agencies

Financial assets
as collateral for loans

Overvalued stock markets

Corporate bankruptcy in
East Asia

Real Trade Linkages

East Asia

India

Trade makes up
large % of GDP

Trade makes up
small % of GDP

Similar trading partners

Small amount of trade

with East Asia

Competitive exports to
similar countries.

Different exports than

East Asia

Investors group Asian

economies

India was not connected

with East Asia

Exchange Rate Regimes

Pegged 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 Regimes

Floating 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

Indias reserves
also grew

Short term debt rising

India discouraged
short term debt

Capital Outflows in 97
reserves decrease

Capital Inflows in 97
reserves increase

Pegs unsustainable
depreciation

Floating rate
No dramatic depreciation

Banking Sector
East Asia

India

Depreciation foreign
denominated debts
unsustainable

No depreciation
Foreign debts sustainable

1997: High levels of

non-performing assets

1997: Lower levels of

non-performing assets

Decreased credit by
banks

No decrease in credit by
banks

Financial Sector
East Asia

India

Switch to floating
exchange rate rapid
depreciation, uncertainty

Indias exchange rate

provided a greater
predictability

Further capital outflow

ensued

1997 experienced an
increase in capital
inflows of 24%

Trade
East Asia

India

Trade played an
influential role in East
Asian economies

Trade played less

influential role in Indian
economy

Crisis depreciations did not

competitiveness:
1. High levels of intraregional trade
2. Increased cost of
raw material imports

No dramatic swing in rates

to alter competitiveness

Conclusion
The financial crisis reflects three important
considerations

Liberalization

Exchange rate regimes

Combination of the above two

Conclusion
Liberalization

Partial capital account convertibility

Less dependence on short term flows

Diversified allocation of capital

Conclusion
Exchange Rate Regimes
East Asia

Pegged currency increased risk of speculative attack

India

Float allowed currency to reflect economic fundamentals

Conclusion
Combined Effect

FULL CAPITAL ACCOUNT

CONVERTIBILITY

+
PEGGED EXCHANGE RATE

=
SPECULATIVE ATTACK

Conclusion
Summing up:

The East Asian and the Indian economies

are fundamentally different and are at
different stages of growth and
liberalization.

Recommendations
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?

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In
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Trade as a % of GDP (1997)

200

150

100

50

East Asia Trading Partners (1997)

50%
40%
30%
20%
10%
0%
United States

East Asia
(Including Japan)

India

Portfolio Investment as a % of GNP

4.50%
4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
-0.50%

1990

1991

1992

1993

1994

1995

1996

India
EA Average

Credit Contraction

% Change in Credit from Deposit Money Banks

1994 1995 1996 1997 1998
Korea 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%

Currency Depreciation

International Reserves ($mill. SDRS)

30000

25000

$ mill. SDRS

20000
R2 = 0.998

15000

10000

Korea
Malaysia
Thailand
AVG
Indonesia
Poly. (AVG)

5000

0
1990

1991

1992

1993

Year

1994

1995

1996

1997

Indias International Reserves (USD$billions)

% of Non-Performing Bank Assets in 1997

Capital Outflows
% Change in Private Capital Flows
1994
1995
1996
1997
India
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%

Foreign Reserves
& Short Term Debt
End 1995

End 1996

Mid 1997

Foreign Res. ST Debt Foreign Res. ST Debt Foreign Res. ST Debt

Indonesia
Korea
Thailand
Average

14.7
32.7
37.0

27.6
54.3
43.6

19.3
34.1
38.7

34.2
67.5
45.7

20.3
34.1
34.1

34.7
70.2
67.5

28.1

41.8

30.7

49.1

29.5

57.5

1 to 1.49 Ratio

Values in billions of US$

1 to 1.60 Ratio

1 to 1.75 Ratio

Selected Macroeconomic Variables

(India)
1990 1991 1992 1993 1994 1995 1996 1997

Inflation

8.97

13.87

11.79 6.36

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

10.21 10.22 8.98

5.89

5.35

5.19

7.36

4.86