Increased business risk means that the proba- bility of default—situations when the assets are worth less than the debt they secure—has in- creased. Thus, increased business risk means that the put option underwritten by bondholders has become more valuable and consequently the value of the bonds has fallen. This implies that corpo- rate bond yield spreads rise, as they did during the Asiancrisis. Together, these option-theoretic inter- pretations of corporate securities can explain why high stock-market volatility, rising equity prices, and falling corporate bond prices—all while ex- pected earnings have not changed—are perfectly consistent. The underlying shock was an increase in the riskiness of the corporate sector and the stock and bond price movements simply reflected a redistribution of firm value among claimholders. 5
This paper combines both approaches. The determinants of debt rescheduling for 34 developing countries over the period from 1986 to 1998 is examined by utilizing the two-limit Tobit model. After determining the macroeconomic variables and fundamental debt ratios affecting the debt repayment capacities and debt rescheduling of the sample developing countries, the estimated debt rescheduling ratios are used to determine the country grades similar to rating agencies. The model is tested for its predictability of the external debt crises a-year in advance with special emphasis given to the recent Asiancrisis. In the model, contrary to the previous studies, the ratio of the amount of debt rescheduled to the total debt, rescheduling ratio, is used as a dependent variable in order to pay attention to the relative amount of debt reschedulings over total debt.
this strategy can be for an emerging market country with a large amount of foreign-denominated debt. Under a pegged exchange-rate regime, when a successful speculative attack occurs, the decline in the value of the domestic currency is usually much larger, more rapid and more unanticipated than when a depreciation occurs under a floating exchange-rate regime. For example, in the recent Asiancrisis, the worst-hit country Indonesia saw seen its currency decline to less than one-quarter of its pre-crisis value, in a very short period of time. The damage to balance sheets after these devaluations has thus been extremely severe. In Indonesia the over four-fold increase in the value of foreign debt arising from the currency collapse made it very difficult for Indonesian firms with appreciable foreign debt to remain solvent. The deterioration of nonfinancial firms' balance sheets led to a deterioration in bank balance sheets because borrowers from the banks were now less likely to be able to pay off their loans. The result of this collapse in balance sheets were thus sharp economic contractions as we have seen.
Sachs (1998) radicalized yet the financial analysis of the Asiancrisis. He certainly recognizes that emerging Asia had exposed itself to financial chaos because its financial systems were riddled by insider dealing, corruption, and weak corporate governance, which in turn had caused inefficient investment spending and had weakened the stability of the banking system. He argued that the banking sectors in all of the crisis countries remain illiquid and heavily undercapitalized. Since the banks are net borrowers from abroad, the sharp real depreciation of the national currencies almost surely have meant that a large proportion of net worth has been wiped out. He added also that the 1997 crisis was largely unanticipated, although the concerns were more pressing on Thailand in the first half of 1997.
We use cross-market correlations to test for stock market contagion during the 1997 Asiancrisis, but we propose a different approach to eliminate the bias in the conventional correlation coefficient. We compute the correlation matrix using time-varying estimates. This conditional correlation coefficient is measured at each point in time so it is automatically adjusted for the bias introduced by the change in market volatility. To compute the time- varying conditional variance we use an asymmetric Generalized Autoregressive Conditional Heteroscedasticity (GARCH) process where volatility responds more to negative shocks than to positive ones. 4 The standard GARCH model allows for the variance to change over time as a function of past errors and the past conditional variance but assumes that volatility responds symmetrically to positive and negative shocks. Several papers (for example, Erb, Harvey, and Viskanta, 1995; Kroner and Ng, 1999; and De Santis and Gerard, 1999) argue that volatility processes increase more following negative shocks than following positive shocks. This is crucial, because during the crisis, when most shocks are negative, the symmetry restriction in GARCH leads to a downward bias in the volatility processes – hence, we use an asymmetric GARCH.
Speculative attacks then spread to other countries in the region (Indonesia, Malaysia, Philippines), which also had to appeal to the IMF (Indonesia in October 1997 and Korea in November). The sources of contagion are many and different in different countries: the similarity of macroeconomic imbalances (notably the widening of the current account deficit) partly explains the spreading into neighbouring countries, however, in the case of Malaysia and to a lesser extent Indonesia, it is probably the effect of competitiveness that has been the main vector of contagion. As the different economies of the region compete on common external markets, since one of them, in this case Thailand, renounced the dollar peg, the temptation became strong, even irresistible, for the others to do the same so as to not lose competitiveness and not to see their market shares decrease compared to those of competitors. Speculators, perceiving the weight of this temptation, attacked the currencies of neighbouring countries of Thailand. Weaknesses in the banking sector, which is another point common to all these economies, certainly also contributed to making currencies more vulnerable. This characteristic was also found in South Korea, the last economy to have been hit by and yet did not practice a policy of pegging its national currency to the dollar. In the latter case, the close relationship between the state, banks and large industrial groups explains the accumulation of risky loans, which dealt a fatal blow to the entire financial system and undermined the confidence of foreign lenders. 3 Regarding the IMF, the essential lesson that can be drawn from the Asiancrisis is the partial failure of the ambitious programme that had been put in place in the aftermath of the Mexican crisis: in particular, the role of the information was clearly insufficient to avoid the financial crisis in Thailand, then its spreading to the rest of the region.
1. Other parts of the world have not been immune from contagion from the Asiancrisis, the Russian economy was performing poorly in any case. But, Latin-American economies, including Brazil, arguably may have avoided their woes in the absence of contagion from the Asiancrisis. This crisis has clearly exacerbated economic problems in many parts of the world. For example, the following economies (in addition to the five affected countries) have experienced recession (fall in output for two consecutive quarters) since the Asiancrisis: Singapore, Hong Kong, Japan, Germany, Argentina, Brazil, Chile, Colombia, Venezuela, South Africa, Romania, Ukraine, Turkey, and the Czech Republic. See, the World Bank (1999) and International Financial Statistics, various monthly issues. This crisis and its aftermath placed the global real economy to one of its greatest perils since the Great Depression.
This paper presents another analysis to the on-going retrospections on the 1997 AsianCrisis (henceforth, crisis). 1 It raises three items that seem to be overlooked in the discussions, the first being that recent economic performances of Indonesia, Malaysia, Philippines, South Korea, and Thailand (henceforth, crisis-affected economies) are actually inferior when compared to pre-crisis performances. The second point is that the crisis-affected economies have not recouped the losses i n 1997. Stronger economic performances are needed to reclaim the lost opportunities. The last point is that unless economic policies in the crisis affected economies move in a positive direction – taking up the useful strategies in the past but also putting in new components for the current challenges – economic progress is limited and punctuated by crises. A related point is the attitude of complacency with a seemingly stable economic environment. In fact, this view is misplaced if the international financial system is characterized by massive and volatile financial flows, while economies are ill equipped to deal with the challenges produced by massive and volatile financial
Since what we are interested in explaining is how turbulence is transmitted across countries which are connected by trade or finance and in assessing which of these links are most important, it matters greatly how we define “elsewhere.” As in Kaminsky and Reinhart (1998), we define “elsewhere” by grouping the countries in our sample into various clusters. As noted in Section II, an important source of “fundamentals-based contagion” in the Asiancrisis was countries’ exposure to a common bank lender. We identify two distinct bank clusters in our sample; one of these clusters is made up of countries that borrow primarily from U.S. banks, while a second bank cluster consists of countries where an important share of their borrowing is concentrated among Japanese banks.
In the wake of the collapse of the Bretton Woods system in early 1970s, currency crises were often associated to banking crises. Chile in 1982, Sweden and Finland in 1992, Mexico in 1994 and, more recently, in 1997-98, South-East Asia countries were hit by a crisis taking place at the height of a capital inflow period, mainly intermediated through the domestic banking sector. These episodes were preceded by excessive credit to the private sector in presence of institutional distortions created by public explicit and implicit safety nets. They all involved fixed exchange rates as additional guarantee on the private sector liabilities and were all preceded by an abrupt rise in domestic interest rates. Nevertheless, up to the Asiancrisis, the link between rapid credit expansion and currency crises had been emphasized only empirically (IMF (1997), Kaminsky and Reinhart (1999)). What was different then about the Asiancrisis ? to justify the regained interest in international crisis models and the need for a new international financial architecture for emerging markets.
inconsistent macroeconomic policies. A model explaining this type of crisis can be found in Krugman (1979); models of this kind are known as ‘first-generation’ models of currency crises. In the 1990s, thanks to capital account liberalizations, private flows of capital came to dominate public flows. In addition, the developments in information technology and new financial instruments exacerbated the role of private investors. A turning point came with the speculative attack on various European currencies in 1994, which broke the European exchange rate mechanism based on fluctuation bands. This experience opened the door to models such as Obstfeld (1996) and subsequent ‘second-generation’ models which explained private speculation and self-fulfilling crises. However, in 1997 the Asiancrisis brought even more complex micro- level problems and market failures, such as currency and maturity mismatches, balance-sheet problems and financial regulations. The models dealing with these issues are known as ‘third-generation’ models. We believe that the problems involved in the Asiancrisis can be better understood by organizing these ideas around a multiple equilibria, self-fulfilling expectation model. It is worth noting that a currency crisis is generally linked to a fixed, or somehow controlled, exchange rate which eventually breaks down in a sudden move. When the exchange rate is not allowed to move freely, the macroeconomic adjustments and expectations are transmitted through the interest rate. Table 1 shows how during the 1997 Asiancrisis were tightly-controlled if not fixed 2 .
The Asian crises were marked by periods of market mayhem when currencies and stock markets in the region tumbled in waves, with declining markets pushing each-other in a circular and mutually reinforcing manner. It is very difficult to isolate the magnitude of shocks that transmitted from one market to the other. In order to discern the patterns of currency and stock market pressure, we take advantage of the Vector Auto-regression (VAR) methodology. The methodology is useful in this context as it recognizes the endogeneity of all the variables in the system. It also moves away from our earlier focus on contemporaneous correlations, and allows for the impact of lagged values of the variables. To keep the analysis simple, we do not estimate VARs that include overlapping markets (i.e. incorporating both exchange rates and stock market returns on the right hand side), but rather look at the interactions between the five countries one market at a time. For a given country, the sample starts from the day that country’s currency peg unraveled 8 and ends on May 18, 1998. 9 We then run a five variable VAR for the exchange rates, obtain the estimated impulse response function for the shocks originating from the given country, and then do the same for the stock market data. We choose a lag length of one day, and do not find improvement in our model by including more lags. This exercise was repeated for all five countries, giving us a total of 10 impulse response graphs. By virtue of this, we make use of the data that spans a country’s financial turmoil phase, and follow the impact of one standard deviation innovation in its currency and stock market on the rest of the markets under study. The issue of ordering the variables for generating the impulse response functions turned out to be inconsequential, as changing the ordering did not have any significant impact in the results.
probably not an appropriate measure of leverage monitored by depositors. There is little variation in this ratio between banks or over time. This ratio also rises in the last year before the crisis, whereas and the franchise value and the market capital-to-asset ratio fall. When included in our estimates of deposit supply, the leverage ratio often yields a wrong sign or is insignificant. This is a typical result in the literature (see e.g., Mondschean and Opiela 1999). We used the franchise value in the reported regression estimates. Coefficients on the market capital-to-asset ratio are of similar sign and significance. The ratio of provisions for loan losses to total loans is more than likely not a good measure of loan quality. As Table 1 indicates, this ratio was extremely small and varied little over time and across banks. Provisioning standards forced banks to set aside loan loss reserves only after a loan had not been repaid for 1 year. Provisioning regulations were changed to meet international standards only in the last year before the crisis. Initial attempts to use this ratio yielded the wrong sign or an insignificant coefficient. Interacting a dummy variable for the last year when provisioning laws changed yields the correct sign. As an alternative proxy for loan quality we use the ratio of foreclosures to assets. This ratio represents actual foreclosures on properties. As Table 1 indicates, this ratio is much larger than provisioning to loans and its standard deviation among banks changes substantially in the last year before the crisis. The correlation between the loan-loss provisions ratio and foreclosures ratio is near zero.
overvaluation, unemployment, etc.) that are neither "too good" nor "too bad," where crises can occur if and only if contagion sets in or expectations turn pessimistic.Our emphasis on illiquidity complements this perspective, and underscores the fact that financial factors are at least as important as real ones in trying to determine where that middle region lies in which self-fulfilling crashes can take place. While the behavior of real macroeconomic fundamentals was quite varied accross Asian countries, illiquidity was a common feature to all of the ones that eventually found themselves in a crisis. In this the troubled Asiancrisis differed from 1990s Latin America, which also suffered from large real appreciation and current account deficits, but where financial systems were a great deal more liquid, and banking sectors more solid. Paradoxically, this incipient solidity was the result of the cleanup following earlier debt and/or banking crises in Argentina, Brazil, Chile, Mexico and Venezuela.
According to the other view — advanced in this paper — the crisis re À ected structural and policy distortions in the countries of the region. Fundamental imbalances triggered the currency and ¿ nancial crisis in 1997, even if, once the crisis started, market overreaction and herding caused the plunge of exchange rates, asset prices and economic activity to be more severe than warranted by the initial weak economic conditions. A synthetic overview of our interpretation is provided in section 2, while sections 3-5 present a systematic assessment of the sources of economic tension at the root of the Asiancrisis. This is based on the analysis of the available empirical evidence for the following countries: South Korea, Indonesia, Malaysia, Philippines, Thailand, Singapore, Hong Kong, China and Taiwan. Macroeconomic imbalances in these countries are assessed within a broad overview of structural factors: current account de ¿ cits and foreign indebtedness, growth and in À ation rates, savings and investment ratios, budget de ¿ cits, real exchange rates, foreign reserves, corporate sector investment, measures of debt and pro ¿ tability, indexes of excessive bank lending, indicators of credit growth and ¿ nancial fragility, monetary stances, debt-service ratios, dynamics and composition of capital in À ows and out À ows, and political instability.
crises. Prior to the Asiancrisis, EA-5 exchange rates tended to be overvalued and their movements were limited. In 1997–98, the currencies went through a massive correction in all these countries. Indonesia and Thailand abandoned their heavily managed exchange rate regime and moved to a more ﬂ exible regime. Overvalued currencies had made imports cheaper to the EA-5 econo- mies in the pre–Asiancrisis years. Expectations of continuous appreciation of the exchange rate also lowered the cost of borrowing overseas, which further fueled a boom in investment that relied on external debt and imported capital goods. External debts grew rapidly, reaching their peak in 1998 (ﬁ gure 4.5), mainly due to private and short-term external borrowing. As a result of very high investment rates, the current account balance turned negative despite healthy export performance.
Although the 1997 Japanese proposal for an Asian Monetary Fund was rejected, under pressure from the IMF and Washington, a good case can be made for placing responsibility for the functions of macroeconomic surveillance and regional resource pooling within a permanent institution which could evolve over time into a fully-fledged Asian Monetary Fund with its own Asia-specific rules on conditionality. The resources available under the Chiang Mai Initiative are clearly inadequate and there would be significant economies of scale from more extensive resource pooling. Support for an Asian Monetary Fund is increasing, not least as a reaction to the problems thrown up by the Asiancrisis itself: the difficulties of implementing unilateral exchange rate policy in a world of increasing trade interdependence and capital mobility; the inadequacy of existing global institutions in dealing with regional crises; and the need for regional, if not international, institutions to internalize the spillover effects arising from globalization. If political problems can be overcome, an AMF would be a crucial, affordable, and relatively painless, first step towards developing distinctly EA institutions and beginning the long path towards monetary and exchange rate integration.