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Asia Financial Crisis (AFC) in 1997 was started with devaluation of Thailand’s baht and followed by Ringgit Malaysia, Philippine Peso, and Indonesian Rupiah. There were some causes of the crisis such as South East Asia current account deficit, overvalued assets prices, corruption and macroeconomic policy mistake and excess lending.
Most of South East Asia Countries was facing current account deficit, some countries had 5% above GDP. They solved this deficit by attracting inflows of investment from overseas, regularly on short term investment. This is because financial deregulation and capital liberalization in the west countries, so it began to persuade developing countries to adopt free market as well. Then, foreign investment ostensibly good for economic but actually not, the problem is not from free movement of capital however that the country will be very dependent on foreign short term capital flow. Short-term borrowing (i.e. loans of less than a year’s duration) meant there should be had liquid assets in the banks’ account it will causes motivating a large part of their capital inflows were increasing the lending rate, which directly some of domestic banks actively seek foreign funds from the West to finance the lending with the consequences country will facing excess lending.
Secondly, the weakness of the South East Asian economies was not practically overvalued their assets make them weak to a quick depression. In Thailand property market become the weakness of financial sector, according to Robert Chote (1998) Thailand bank had lending funds to non bank financial institution, which is property market investors. It is approximation quarter of bank in Thailand, Indonesia and Malaysia was lending their funds through intermediaries for property related investment.
The third causes of AFC has been the internal factor of each developing country that is badly ill of corruption and does not handle capital market in a transparency, there was insufficient regulatory framework in business especially for the bank in South East Asia. For example in Indonesia, banks would never refuse to lend money to businesses have relation with the former president Suharto family, the lenders just think those borrowers would be able to repay the debt, even the investment failed.
Another factor was macroeconomic policies, which is pegging domestic currency to the US dollar had significant effects, by maintaining the fixed dollar rate between South East Asian economies in effect caused their currencies to appreciate. Then, when the crisis was develop the inflation of the US dollar give some trouble to those countries facing large deficit, but it would also make it harder to fund their deficit.
Therefore the effect of AFC will be affecting in Asia and to the global market.
In the Asia region, one of the distinct effects has been the devaluation in the value against US dollar and usually the economy performance can be seen in stock market, which is the country in crisis will experience quick drops in the stock market because stock market would be likely to fall reflect the lower anticipated profit. Another indication of the financial crisis was interest rate will rise rapidly to prevent further devaluation of the currencies, for example in Indonesia they raise overnight interest rate to 300% in 1997, but still failed to stop exchange rate from collapsing.
In Malaysia, the stock and the currency market nearly collapses and also GDP growth rate dropped from 7.3% to negative 7.4%, but the economy conditions recover in 1999.
The global impact of AFC economic turmoil is expected to give effect of some downturns in economic growth since the crisis began. The devaluation of South East Asian currencies will decrease the demand for western goods which are making the goods more expensive to obtain than usual. But, the positive consequence is the growth of export from major economies. Another impact in devaluation of currencies will give trade advantage to South East Asian companies, but the cost to acquiring assets will be increased as well, as a consequence, foreign direct investment will drop.
Compared with current Global Financial Crisis (GFC), the causes of GFC are linked to the turn down of financial markets. In US, banking industries has been affected by subprime mortgage trend which is more likely from real estate. According to Krugman (2009) the crisis growth from housing crisis to banking crisis are very fast.
The impact GFC in financial institution in developing countries in Asia, in fact the financial institution in developing country relatively unaffected as they have good track record on borrowing and lending process so, it will help to minimize the risk.
Then general recommendation, for financial institution would government should make clear regulation, then by funding market and supporting trouble assets market it will give liquidity to bank. Because this is a global issue, it may require cooperation other countries to make solution.
In case of GFC, Asian economies will move slowly, it is because most of the countries dependant to foreign demands, therefore when US and west countries struggle it relatively will give effect to Asian countries. But, since AFC most of Asia countries have good fundamental in their economy but policy adjustments for each country to adapt the situation are necessary.
The impacts of GFC in Malaysia are in foreign exchange rate, finance sector, banking system and trade.
Exchange rates in Malaysia since de-pegging in from US in 2005 have impact to capital flow to the Ringgit (Ooi, 2008), this depreciation in Ringgit value is related to the demand of portfolio flow and export sector. This will help Malaysia to improve their export for counter global recession.
In finance sector, Malaysia have suffered big impact on capital flow because US financial institution more concern to their domestic market, and in capital flow portfolio is the one most volatile. In Malaysia stock exchange, many foreign players involved then when the crisis, many foreign participants take their part back, and affecting to the stock market in KLCI.
According to Bank Negara Malaysia (2008), low debt repayment by private sector and official sector cause decreasing in direct investment.
The impact on banking system was quite under control as local banks had small correlation with US subprime loan, and also local bank have learned from AFC in 1997.
For trade, there has big impact in Malaysia because of very dependent in the world market, in 2009 Malaysia made biggest drop in export rate including in manufactured export, electronic, agricultural and natural resources export. Malaysia’s exports have a high relation with their import. So when exports decrease, imports also decrease.
In conclusion, AFC give good fundamental Asian countries when facing GFC. Then both of the crises always give global impact in economics to all countries in the world, and as financial crisis all financial market will be affected. The differences are just the volume of the impact and how they will find the solution to manage their problem.
Discuss in detail on the impact of Capital Control imposed by the Malaysian Government in 1998 on the economy in general, giving special consideration on the pegging of Malaysian Ringgit against USD.
In 1957, Malaysia adopt floating exchange rate that only volatile around RM 2.50. During the floating exchange rate in 1991 – 1997, the growth of GDP in Malaysia was higher and was calculated approximately at 9.2 percent a year. On the other hand, during the financial crisis, the economic growth became negative. Moreover, in 1999, the growth started to recover from -7.6 per a year to 6.1 percent a year. This condition can be happened due to the investors’ confidence has recovered and the business started the expansion movement (Talib, nd).
Financial crisis in 1998 caused catastrophe to countries in Asia, such as Indonesia, South Korea, Thailand, Philippines and Malaysia. In those years, every country in Asia was preventing itself from the crisis by defensive method. It is also followed by IMF term that every country has to tighten their capital and exchange control. This action is taken due to ensure the investor’s confidence and stem capital outflow. On the other hand, Malaysia challenged it by imposing restriction on capital repatriation by foreign investor and on offshore trading of ringgit-denominated assets (Sharma, 2003).
According to Sharma in The Malaysian Capital Control Regime of 1998, she stated that due to capital control, it downturn the economic in Malaysia. For example, export in electronic especially showed low demand and rises of lower cost producers. She added also that the price of the residential and commercial property increase. Moreover, subsidies are needed in industries, such as automobiles, cement, steel and others. But the troublesome is the falling in the assets quality of the bank because of the uncontrolled rapid credit expansion that made speculative price bubbles happened. Also there was difference in assets and liabilities that made the market vulnerable and seriously exposed. So, when financial crisis in Asia happened, Malaysian Ringgit became very volatile and the trading of Ringgit against USD at RM 4.22 per 1 USD. Thus government made decision to peg the Ringgit with USD at RM 3.82 per 1 USD.
The Malaysian government not only concern about the economy in Malaysia but also the virtual pegging of Malaysian Ringgit against USD. At that time Malaysian Ringgit weakened against USD, this is because the unlimited currency trading market. Many speculators that short or sell the Malaysian Ringgit in case of depreciated (Sharma, 2003). Malaysia also imposes restriction on exchange rate transaction to prevent speculator take position against ringgit and also to protect foreign exchange reserves and recover monetary. The process of recovery not only by pegging and controlling the currencies Bank Negara also take a part to support the process of recovery, they impose stretched limit on transfer of capital to foreign countries by residents, the central bank maintains its commitment to exchange rate stability and rules out revaluation, massive capital inflows translate into a massive increase in the domestic money supply, leading to suspected undervaluation and inflationary pressure this decision was to prevent potential escape or people try to cheating.
The Government’s declaration of a guarantee of bank deposit also carries positive effect in Malaysia. In conclusion, Malaysia was able to control the Asia Financial Crisis in 1998, with the collaboration all other sectors including Government and financial institution by designing effective capital control and effective enforcement which are showed political ability and outstanding institutional.
Based on your understanding of the Financial System in Malaysia, critically argue on how we could minimize the impact from another catastrophic economic crisis (if any).
The Malaysian financial system was insecure during the Asian financial crisis. This encouraged the government to take holistic approach towards financial restructuring.
It has been shown in paper4-emerging issues in Malaysian financial system: policy and challenges (2005) the government took approaches to restructure which includes the establishment of Danaharta, Danamodal and CDRC (Credit Debt Restructuring Committee) and promoted consolidation with merge exercise. Within 2 years, Malaysia managed to get out of the crisis with low usage of public funds (less than 5% of GNP) for the restructuring efforts and restoring economic stability. The government realized that the financial sector has to be transformed to address inherent weakness and set foundation for longer term development efforts amidst intense competitive pressures, globalization and liberalization of financial markets.
How to cope with the crisis can be in various ways. But the initial priorities in dealing with the crisis were to stabilize the financial system and to restore confidence in economic management. Strong actions were needed to stop bank runs, protect the payment system, limit central bank liquidity support, and minimize disruptions to credit flows, maintain monetary control, and stop capital outflows. According to the financial sector crisis and restructuring lesson from Asia, it suggests that the countries’ emergency measures, such as the introduction of blanket guarantees and bank closings, were accompanied by comprehensive bank restructuring programs and supported by macroeconomic stabilization policies. Blanket guarantees for depositors and creditors were used in Malaysia to restore confidence and to protect banks’ funding. Despite the huge contingent costs and moral hazard problems involved, the government opts to guarantee the deposit rather than risking the credibility of their banking systems. The guarantees were effective in stabilizing banks’ domestic funding–although in some cases it took some time to gain credibility–but were less effective in stabilizing banks’ foreign funding where Malaysia adopted capital controls. The developments within the domestic economy such as embarking on expansionary fiscal policies, easing monetary policy, implementing capital controls, and fixing the exchange rate can help to lead an improvement in the Malaysian economy.
A well-functioning and efficient financial system is vital in ensuring effective and efficient conduct of monetary policy. The need to hit information technology will increasingly be important to meet more difficult demand. Banking sector needs large amount of capital investments to remain competitive and be able to assume greater risks. The financial system must adapt to meet the changing requirements for financing new economic activities. In particular, new areas of growth have different characteristics, which may limit their access to the traditional form of the bank-based financing. The capital market will play an important role in financing the growth and businesses.
In order for Malaysia to remain internationally competitive, some of the important challenges will include such as continuing to Pursue Liberalization, Foreign Direct Investment, Building Good Governance and an Ethical Regulatory Framework, Restructuring and Upgrading the Industrial and Technological Base.
In terms of the foreign exchange, Malaysia can get advantage by pegged exchange rate during the crisis. This brings advantages such as Relative stability in the foreign exchange market, Avoiding the day-to-day management of the exchange rate, The fixed exchange rate provided more certainty for businesses to make business and pricing decisions, Fixing of the Ringgit against the US dollar resulted in some independence in setting the level of interest rate, Avoids a trade-off between an accommodative monetary policy to avoid a contraction of the economy, and the need to check further deterioration in the Ringgit exchange rate.
Comprehensive bank restructuring strategies in Malaysia sought to restore financial sector reliability as soon as possible, and at least cost to the government, while providing an appropriate incentive structure for the restructuring. The strategies included setting up appropriate institutional frameworks, removing nonviable institutions from the system, strengthening viable institutions, dealing with value-impaired assets, improving prudential regulations and banking supervision, and promoting transparency in financial market operations.
According to the IMF’s publication, more transparency in macro and microeconomic data and policies would have exposed vulnerabilities earlier and helped lessen the crisis. Better regulatory and supervisory frameworks would have helped, but supervisors would most likely not have been able to take necessary actions in the middle of the economic boom. No one foresaw the sudden massive erosion of loan values, once market sentiment changed and exchange rates collapsed. Broad-based reforms are under way to strengthen the institutional, administrative, and legal frameworks in the crisis countries, based on evolving international best practices, codes, core principles, and standards. The crisis has shown the need to tailor prudential policies so that resilience is built up in times of economic booms to deal more easily with inevitable economic downturns. International efforts have been undertaken to reduce the likelihood and intensity of future crises. Initiatives include work on the international financial architecture, the Financial Stability Forum, and financial sector stability assessments. The Basel Committee on Banking Supervision has formulated improvements to regulation and supervision of international lenders to address weaknesses that contributed to the Asian crisis.
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