Mark Anthony A. Vida Alejandro L. Jimenez, Ph.D.

Columban College – Graduate School Global Business Management

Master in Business Administration

CASE STUDY: The Asian Currency Crisis

1. Do you think pegging the value of the Thai Baht to the Dollar by the government was a good move?
Defend your answer.

Under a fixed exchange rate system, it was the responsibility of the government or the central bank
to conduct policies i.e. exchange-rate changing, exchange-rate switching, and direct control, to keep
its exchange rate fixed as well as to maintain a fine level of the overall condition of the economy. The Bank
of Thailand had a necessity to inject dollars into the system using its stock of foreign reserves. Not for a
long time, however, did the central bank could do that. Its stock of foreign reserves was almost used up,
and it realized that it could not, in any way, be able to supply the foreign currency to the economy given the
enormous size of foreign liabilities. Only in Spring of 1997, more than 90% of the country’s foreign reserve
had been used to defend the value of the baht, and the country was forced to finally switch its exchange
rate regime.

Was it a good move? I would say “yes, but without many choices.” The Thai economy had begun to
get used to a new style of economic liberalization. Thai people had earned more income and had become
more and more proud of the growth of their economy. A set of government who came in and suddenly
made the economy less appreciable would become unpopular. Thus, the governments in power during that
period had preferred not to change the picture of the economy much. So, political concerns did have
impacts on the direction of the economic policies. Besides, the Thai economy had had one characteristic
much contributing to the rationale of the economy along its path. It believed in a miracle, and that it could
make things different.

The Thai governments had not done a very good job. They had not dared to be far-sighted as they
were still concerned much about politics. They had stuck to the goal held since the first time of capital
account liberalization, a goal which had aimed at the expansion of the economy. The economy did expand,
however, not quite healthily. It was like a bubble, continuously inflated, but the bigger it became, the more
easily it would explode even with a soft touch of a rough surface.

2. The trouble started in Thailand and developed to an Asian Financial Crisis. Why is that so?

Asia is a region that is home to 60% of the world’s people, and where many economies were
growing by nearly 10% a year in real terms. By late 1997, the economic outlook for many of the Asian
Tigers had changed drastically.

The first reason results from an excess supply of domestic money. If a country with a pegged
exchange rate prints money to finance government spending and to cover a budget deficit, investors will
prefer to hold a less inflation-prone foreign currency, and the supply of that country's currency will rise in
foreign exchange markets. Speculators may assume that the country will no longer be able to defend its
exchange rate and will attack the currency.

Another explanation is the use of monetary policy to maintain a pegged exchange rate. The
government may be required to support the value of the currency with high domestic interest rates (offer
foreign savers a currency premium) and by using its foreign reserves to buy the domestic currency. But
high interest rates slow down domestic economic growth and make things uncomfortable for the nation's
ruling party. If currency traders doubt the government's commitment to maintaining high interest rates and
foreign currency reserves are nearly depleted, then they might attack the currency.

Throughout the region banks and finance companies operated with government guarantees that
resulted in their lending on overly risky projects. Poor regulation encouraging bankers to finance risky
projects in the expectation that they would enjoy the profits, if any, while the government would cover any
significant losses. Banks based lending decisions not on a project’s expected return but on its return in
ideal circumstances. The result was too much investment and an inflated property bubble from
overdevelopment of scarce land. Access to relatively inexpensive foreign capital injects additional funds
into the system, resulting in even higher property prices.

Japan has encouraged banks to carry as good assets old mortgages on real estate now worth
perhaps a quarter of face value. Korean multinationals have been permitted to conceal their subsidiaries'
losses by shifting loans from one set of books to another. In Thailand, banks were allowed to carry loans at
full value until the borrowers hadn't paid interest on them for more than a year. The Asian governments and
central banks created a system of "zombie" banks - brain dead but still moving - similar to those found in
the U.S. during the 1980s savings-and-loan crisis. Many Asian financial institutions continue to operate
although they are insolvent when using accepted accounting practices. With governments and central
banks vouching for the zombie banks, they were able to keep borrowing dollars from banks in other
countries.

The dollar-denominated loans are devastating the Asian markets. Debtors have to sell the local
currency to acquire dollars so they can pay their debts. As the local currency declines in value, debtors and
local banks must find ever-increasing quantities of it to service their debts. The collapse of asset prices will
lead to widespread loan defaults combined with corporate bankruptcy and insolvency for many domestic
banks.