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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 India’s 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 India’s 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? Ko ia Th ai la nd M al ay s . ia ep ne s re a, R In do In di a Trade as a % of GDP (1997) 200 150 100 50 0 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 India’s 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