Table of Contents
1.Synopsis
2.Introduction
Overview
Purpose for Research
3.Findings
4. Summary and Conclusions
5. Recommendations
6. Appendix
Synopsis
In 1997, several Asian countries were suffered by economic crisis. These
countries included Thailand,
Indonesia, Malaysia, Korea, and Singapore. Later the whole Asian economy
was suffered. It was
estimated that there was 1,000 billion US dollar’s economic loss in
the 1997 Asia Crisis, excluding the
damage to the whole society. Industrial production decreased by 25
percentage.(1)
Why Asian Crisis happened? First these countries have their own economic
drawbacks. In the early
1990s, these countries had a strong economic performance; they are
in denial when problems began to
surface. They believe that they were immune to the type of crisis that
erupted in Latin America in the
1980s, because they did not have the large fiscal deficits, heavy debt
burdens rapid monetary expansion,
and structural impediments that had made Latin America vulnerable.
So the Asian countries did not deal
in earnest with their emerging problems until too late.
At the same time, these Asian countries have problems in their monetary
policy and fiscal policy. Finally,
global market has influenced the Asian countries. For example, U.S.
dollar appreciated to Yen decreased
these Asian countries’ exports.
After the Asian crisis, how these countries deal with the problems to
remedy their countries? And how the
other countries had been influenced? In this research paper, I will
focus on China. What happened to
China in the 1997 Asian crisis? What are the problems, and how they
confronted with these challenges?
Will the Yuan devalue?
Introduction
Overview
After Second World War, especially after the separation of the Ex Soviet
Union, each country in the
world has transferred most of its sprit on developing economy. At the
same time, transportation and
communication, especially the internet, have a great development. Both
of these two points let the world
become a global market, and the whole global economy became an interdependent
and inter-influenced
economy.(2) Almost every country have transactions with the other countries,
the economic correlation
between different countries became tighter than ever. Under this condition,
Asian crisis wills inevitably
affect the whole globe. China, as the biggest country, how they dealt
with to the Asian Crisis.
Purpose for Research
Asian crisis is a disaster to the Asian economy, also to the global
economy. Under the new global
economic system, every country should pay attention not only to its
own economic development, but also
to the others’. Of course, China, which is eager to develop its economy
as soon as possible has to take
active action to the Asian crisis. Only having done these, China could
survive in the Asian crisis.
Findings
For the three decades before Asia's financial crisis, Indonesia, Korea,
Malaysia, and Thailand had an
impressive record of economic performance—fast growth, low inflation,
macroeconomic stability and
strong fiscal positions, high saving rates, open economies, and thriving
export sectors. It is therefore not
too surprising that no one predicted the Asian crisis. Now that the
crisis has unfolded, it is, of course,
much easier to identify the problems that led to it. In fact, there
is a consensus on the causes of the crisis,
in sharp contrast to the diversity of views on the remedies.
The underlying causes of the Asian crisis have been clearly identified.
First, substantial foreign funds
became available at relatively low interest rates, as investors in
search of new opportunities shifted
massive amounts of capital into Asia. As in all boom cycles, stock
and real estate prices in Asia shot up
initially, so the region attracted even more funds. However, domestic
allocation of these borrowed foreign
resources was inefficient because of weak banking systems, poor corporate
governance, and a lack of
transparency in the financial sector. These countries' limited absorptive
capacity also contributed to the
inefficient allocation of foreign funds.
Second, the countries' exchange rate regimes—exchange rates were effectively
fixed—gave borrowers a
false sense of security, encouraging them to take on dollar-denominated
debt. It is a mistake for a country
to have a fixed exchange rate unless its authorities are prepared to
do what it takes. That means, in
addition to pursuing sound macroeconomic policies, it needs to have
a healthy banking system and a
strong reserve position that can withstand a defensive rise in interest
rates to fend off speculators. But few
countries can maintain a fixed exchange rate when things go wrong.
Milton Friedman, Nobel economics
laureate and senior fellow at Stanford's Hoover Institution, the East
Asian crisis is entirely due to
governments playing around with exchange rates. There are only three
types of exchange rate regimes.
Really fixed, unified exchange rates-honking, Argentina, Panama versus
the U.S. dollar. Really flexible
exchange rates-New Zealand, Australia, Japan. Pegged exchange rates-Thailand,
Indonesia, Malaysia
before the East Asian breakdown. "It's not an accident, therefore,
that the IMF has tended to favor
pegged exchange rate regimes. And those pegged exchange rate regimes
cause the trouble. If there had
been no IMF, there'd have been no East Asian crisis." Said Milton Friedman.
(3)
Third, in the countries affected by the crisis, exports were weak in
the mid-1990s for a number of
reasons. It included the appreciation of the U.S. dollar against the
yen, China's devaluation of the Yuan in
1994, and the loss of some markets following the establishment of the
North American Free Trade
Agreement (NAFTA). This is external situation’ change. Finally, the
above monetary and fiscal policy’s
vulnerability let the speculators take the chance to attack.
The massive capital inflows and weakening exports were reflected in
widening current account deficits.
To make matters worse, a substantial portion of the capital inflows
was in the form of short-term
borrowing, leaving the countries vulnerable to external shocks. It
is clear, with the benefit of hindsight that
this situation was "just a big accident waiting to happen"; the only
question was what would trigger it. (4)
Once the crisis broke out in Thailand in July 1997, the Asian countries
were all vulnerable. And the
markets overreacted. The thinking was that if this could happen in
Thailand, it was bound to happen in
other Asian countries facing, to varying degrees, the same problems—weak
financial and corporate
sectors, a large current account deficit, and a heavy external debt
burden. Creditors withdrew funds from
the region, and the crisis spread. When these countries approached
the IMF for assistance, the most
pressing issue initially was to provide them with adequate financing
to deal with the liquidity crisis created
by the sudden flight of capital and the collapse of their currencies,
and to give confidence to the market.
The IMF provided the biggest loans in its history, while arranging
for additional financing from other
countries in the region as well as from the Group of Seven countries.
At the same time, these Asian countries have implemented two reform
programs to resolve the financial
distress. Currency depreciation during the crisis was dramatic—for
example, the Korean won dropped
from less than 1,000 to nearly 2,000 to the dollar in only one month.
In such extreme situations, the first
priority has to be the stabilization of the exchange rate before a
vicious inflationary cycle sets in. If
domestic prices are allowed to skyrocket, the monetary tightening required
to reestablish price stability is
extremely costly. So these Asian countries have to raise short-term
interest rates to arrest the deterioration
of their exchange rates and then to gradually reduce interest rates
as the exchange rates stabilized.
Structural reform is the other program. In Indonesia, the main source
of the problems in all of these
countries was structural—the weakness of the financial and corporate
sectors, inadequate governance,
and a lack of transparency. (5) And, as the crisis unfolded, markets
focused intensely on these problems;
it would have been very difficult to regain investor confidence if
the countries' programs had not included
initiatives to address them, even if they could not be solved overnight.
The governments needed to show
that they were aware of the size of the problems and were committed
to correcting them. (Korea has
somewhat same condition.) So Indonesia’s president has been fired,
the president’s family’s assets have
been frozen. A more transparent financial structure will be built,
because the Ex president’s family
controlled ¼ of Indonesia’s assets. Some Indonesian key departments,
such finance department, are
handled over by their family, which greatly hurt the county’s benefit.
Table 1 Forecast of the Country’s GDP’s Growth Rate (6)
1997 1998
1999 2000
Thailand -0.4% -8.0% 1.0% 3.0%
Indonesia
4.6% -13.7%
-4.0% 2.5%
Korea
5.5% -5.5%
2.0% 4.6%
China
8.8% 7.8%
Table 2 Forecast of the Country’s Inflation Rate (6)
1997 1998
1999 2000
Thailand
5.6% 8.1%
2.5% 4.0%
Indonesia 6.6%
60.7% 28.2%
10.0%
Korea
4.4% 7.5%
1.8% 2.0%
China
2.8% -0.8%
From the above two tables, we can see Asian countries’ GDP growth rates
have decreased while the
inflation rates have increased. In the next two years this deteriorated
financial distress will not improve in
some Asian countries. It is estimated that Asian countries were suffered
1,000 billion US dollar’s
economic loss in the 1997 Asia crisis, excluding the damage to the
whole society. Industrial production
decreased by 25 percentage.
In 1998, China would keep its goals of 8% GDP growth and below 3% inflation.
First quarter results
7.2% growth, with a 12.8% rise in exports, indicated that the economy
is on track, Chinese Vice Premier
Li claimed. He acknowledged that, with East Asia's products now much
cheaper after substantial currency
devaluation, China would find it tough to achieve its aims. Li Said:
"We will certainly pay a price for the
decision not to devalue our currency, but it is worthwhile to maintain
the healthy development of China's
economy and to ease the ongoing Asian financial crisis. The financial
crisis is eroding the competitiveness
of exporters and threatening the growth of exports, but it also forces
us to advance further with reforms."
However, China has met with great challenges. First, let us see what
happened to China in 1997. In July
1, 1997 HongKong Special Administrated Region (HKSAR) was built, which
is a part of China. From
August 1997, several groups of speculators entered the HKSAR security
market. In August 14 and 15,
they bought in large amounts of HK dollar through three month or six
month futures contracts and sold
off very quickly. This decreased the HK/US dollar exchange rate to
7.75/1, which is the
lowest-psychology-accepted point. HKSAR took active measure to stop
HK dollar’s depreciation five
days later. But the situation deteriorated in October. In Oct 21, HK
stock price decreased by10.41%. (7)
To fight this financial distress, to keep HKSAR’s stable economy, China
have put large quantities of U.S
dollar to stop HK dollar’s depreciation. At last HKSAR succeeded, but
it had a negative effect on 1998’s
GDP, which decreased 5.1% compared to 1997’s.
Secondly, China is the neighbor of the crisis countries, and inevitably
it is Asian financial crisis’ victim.
From Table 3, it tells us these crisis countries devalued their currency
a great lot. Owing to the Asian
financial crisis, the external climate has deteriorated sharply, dampening
China's export growth and
reducing inward FDI(Foreign Direct Investment). Taking into account
regional recessions and currency
devaluations, the projected export growth is no more than 5% and a
decline in FDI inflows is reduced by
25% in 1998. This raises questions regarding China's near-term growth
prospect. International investors
are understandably worried about a sharp economic slowdown ahead in
China. With signs of weakening
consumer spending and a benign inflationary outlook, the current macroeconomic
conditions in China call
for more expansionary monetary and fiscal policies.
Thirdly, in the wake of the turmoil surrounding Asian currency and financial
circles, a big pressure on
China's exchange rate policy. As world's seventh largest economy and
the tenth biggest trading nation,
China's currency policy has important repercussions far beyond its
borders. Those who see an imminent
devaluation in the Chinese Yuan mostly worry about the competitive
consequences of the Asian crisis on
Chinese exports. The currency devaluation in ASEAN 4 (Indonesia, Malaysia,
Philippines, and Thailand)
could have a potentially large impact on China's international competitiveness.
Indeed, China's
trade-weighted real effective exchange rate has appreciated sharply
since July 1997. In sectors such as
textiles and garments, where competition between China and Asian neighbors
such as the ASEAN 4 is
especially intense. The currency devaluation in ASEAN 4 will increase
their exporting ability.
Consequently the competition between China and these countries will
more intensified.
Table 3 Currency’s Depreciation Rate in Oct 1997(8)
Country Thailand
Indonesia Philippine
Malaysia Singapore
40%
50%
30%
30%
10%
At the same time, these countries will decrease their imports from China.
Both of the two things will
decrease China’s export. According Merrill Lynch Company’s forecast,
China’s export would only
increase 7.0% in 1998, while in 1997 the increase rate is 20.0%. (9)
On the other hand, Asian crisis will
increase the investing capital’s volatility, and impair the foreign
investors’ confidence. So foreign investors
felt riskier to invest in Asia than before, this of course included
China. It was estimated that foreign direct
investment (FDI) in China decrease by 14.2% compared to 1997’FDI. (10)
Finally China has its own following difficulties in the read world.
(1) GDP growth rate was only 7.7% in
1998, which was less than the target 8%. Inflation will be higher the
target 0.6%. (2) Export growth is
likely to be largely weakened, from 1997 ’s 22% decreasing to about
10%. Imports are however
anticipated accelerating as domestic demand strengthens. Consequently
trade surplus will shrink. (3) State
Owned Enterprises reform (SOE) will enter a critical stage. A high
tide of mergers & acquisitions of the
SOEs is expected to be observed. For the 1000 large SOEs to be managed
by the government, the
mergers and acquisitions are efficiency and competitiveness-oriented,
while for the remaining ones they
aim at wiping out losses and absorbing redundant workers. So unemployment
will inevitably arise in the
reform. (4) Foreign direct investment is however likely to be flat
or even to fall to some extent after
another respectable growth of about 8% this year. (5) It lacked a reasonable
commercialization of state
banks and a strengthening of the management over financial institutions.
(6) Although the RMB is not
likely to be devalued in the near term despite the devaluation of other
Asian currencies, the Chinese
government may have to review its RMB policy in due course depending
on further developments in the
region as well as in domestic markets. This will affect China’s financial
stability.
Table 4 will let us see China’s economic development in the recent years,
and it shows what the Asian
crisis’ effect is on China. (10)
1992 1993
1994 1995
1996 1997F
1998F
GDP
2663.8 3463.4
4662.2 5826.1
6859.4 7560.6
8403.0
(Billion RMB)
Real GDP
Growth Rate(%) 14.2
13.5 12.6
10.5
9.6
9.1
8.9
National Saving
/GDP(%)
38.3 41.5
42.2 41.9
41.4 41.4
40.5
Export Growth
Rate(%)
18.1 8.0
31.9
23.0
1.5
17.8
5.0
Import Growth
Rate(%)
38.5 31.4
13.8
28.6
14.7
4.7
12.1
FDI(Billion U.S
Dollar)
11.0 27.5
33.6 37.5
42.4 44.3
38.0
FDI Growth
Rate(%)
152.1 134.0
31.2
11.1
12.9
4.6
-14
Let us look closely facing with Asian crisis, how China dealt with the challenge.
(1) To maintain the healthy development of China's economy and to ease
the ongoing Asian financial
crisis, China has paid a price for the decision not to devalue RMB.
Beyond this, the government outlined
Beijing's post-crisis master plan, a strategy, which most people hailed
as "bold" and "responsible" and call
it a blueprint for a new China. It is an ambitious design to raise
the economy to the next level of
development and firmly integrate the country into the world community
by opening up markets and
forcing firms to become internationally competitive. The government
would speed up the entire range of
economic and social reforms and stimulate the domestic economy partly
by spending at least US$ 750
billion on infrastructure. Of course this will create new jobs and
keep China's growth up. Because, China
unlike those small, open economies in East Asia, which have been dependent
on export-led growth,
China's huge domestic market could support a different growth strategy.
Net exports typically account for
less than 4% of China's GDP. A pick-up in domestic demand could therefore
keep China on a high
growth track, offsetting the expected contraction in external demand.
This also let us see how important
huge infrastructure program it is to China.
(2) China has tried to channel its enormous savings, estimated at US$
480 billion, into its development.
The domestic mobilization of savings became more important because
of the Asian crisis, and China
would mobilize domestic savings - and not just rely on foreign direct
investment. Because the further
growth of high potential enterprises has been hampered by difficulties
in raising new capital and China's
banks too are badly in need of funds, while lumbering state enterprises
are seriously strapped for cash and
deep in debt. If China was to renovate the SOEs, create a housing market
from scratch, develop a stable
financial system and launch a new enterprise culture, it will need
money. So government has reduced the
interest rate for six times to stimulate consumption and investment.
(11) This would help to offset FDI ’s
decrease. So government has reduced the interest rate for six times
to stimulate consumption and
investment. This would help to offset FDI ’s decrease. In fact, China
would try to find a way to tap
domestic financial resources and mobilize them to meet domestic investment
needs.
(3) Chinese government has implement finance reform. In pursuing its
broad agenda, prodded on by the
Asian economic crisis, the Chinese leadership must promote substantial
change, yet maintain stability. In
many cases, such as in the financial sector, the need for restructuring
is urgent. In others - the
implementation of full capital account convertibility, for example
- the government has to tread slowly and
carefully. As China approaches the whole range of tasks it faces, the
trick will be to decide what to do
first and where to move quickly, while heading off any brewing social
unrest.
(4) Chin has restructured its banking system, and a more perfect commercial
banking will form. It has
already abolished a long-standing system of credit quotas and lowered
bank reserves requirement.
Large-scale mergers and acquisitions among banks are permitted, because
China's banks were in worse
shape than those were in Asia’s battered economies. This will not only
call for increased competition in
the industry, as well as a massive recapitalization of the system,
but also recommend the rapid
development of China's bond markets. Bank of China Senior Adviser Zhu
Min said that Chinese banks
were adapting to the new, more open environment, gradually restructuring
operations to improve
efficiency and competitiveness. At the same time, Asia's Financial
Services Practice in China, was equally
positive, and the pace of change in the banking sector had accelerated
recently. While even the best banks
in the country were still way behind their Western counterparts, in
five to ten years, China would begin to
see the emergence of a modern, competitive banking system.
(5) China's state owned enterprises has been reformed. The government
has clarified the principles and
guidelines for asset valuation and enterprise consolidation, opening
the way for increased participation by
foreign multinational companies. The first stage of reform doubtless
has taken the form of intra-Chinese
mergers, many inefficient SOEs has been merged and acquired by the
other efficient SOEs or private
enterprise. Some foreign investment has taken part in SOEs’ reforming.
The scope and diversity in SOEs’
reforming of China are gradually enlarged.
Lin Yifu, Director of the China Center for Economic Research at Peking
University, noted that in China's
socialist economy, the government-owned businesses shoulder enormous
"non-economic policy burdens",
especially that of providing workers' housing, education, retirement
and healthcare. In addition, he noted
that artificial suppression of prices, as well as the government's
low wage policy, foster uncompetitive
business structures.
In fact, Chinese government has began another SOEs’ reforming, called
"Debt to Stock", which means
transform some high-debt SOEs’ large debt into stock. For these SOEs,
heavy debt is a heavy burden,
and it push SOEs have to survive for the debt’s interest. Of course,
this has exacerbated the SOEs’ cash
flow 's deficits and hindered the enterprises’ development. After the
"Debt into Stock" reforming, the
SOEs need not pay out the dividend instead of interest. This will not
only increase the SOEs’ cash flow,
but also invite the bank to take part in the management of the SOEs,
which can benefit the bank’s credit
management and reduce the bank’s investment risk. (12)
(6) China has also been seeking to introduce more fiscal stimulus. The
government hopes that investment
in public infrastructure, residential housing and high-tech industries
could serve as the engine to propel the
economy. With a high domestic savings rate, even an expected fall in
foreign direct investment may not
dash the hope for an expansion in fixed investment. The bottom line
is that China can shield itself from
the negative effect of the ongoing Asian crisis, provided it shifts
macroeconomic policies designed for soft
landing to those for modest reflation.
Finally, in comparison with ASEAN 4, China's exports are more diversified,
ranging from simple
consumer electronics to more sophisticated machinery and equipment.
More importantly, China's labor
costs are below the average of most ASEAN 4 nations. Furthermore, China
has struck the right balance
between continuity and long-term stability on the one hand, and the
capacity for change, renewal, and
adaptation to the evolving environment on the other. It has twenties
years’ experience in the economic
system’s reform. Especially in middle term of 1990s, China has successfully
soft-land to modest reflation,
so the government are more confident the transition. Chines Vice premier
Li said: "The imperative of
stability may best be achieved by some form of protection of existing
structures, whereas the imperative
of change appears to best be attained by the nations adhering to the
precepts of the market economy. Our
government will challenge to achieve the balance between social-political
stability and economic flexibility,
no matter how many difficulties we will confronted with, and we are
sure to succeed.
Summary and Conclusions
From the above, we know that 1997’s East Asian crisis took an adverse
effect on the global economy. As
their neighbor, China has confronted with many difficulties. The Asian
financial crisis has clearly exerted
external pressure on China to develop its economy. The key challenges
are over the medium term, that is,
whether China can make a breakthrough in structural reforms over the
next several years. SOEs
restructuring and turning around the ailing banking sector are both
daunting tasks. If China fails to make
substantial progress in these structural reforms, the country's economy
may explode at some point
resulting in a spectacular financial crash. The current Chinese leadership
recognizes the country's
structural as well as short-term problems and has shown willingness
and resolve to overcome them. Fiscal
stimulus and monetary easing have been implemented since the new cabinet
was formed in March 1998,
and they started to impact domestic demand in the second half of 1998.
More importantly, China is
wasting no time in tackling deep-rooted structural problems from SOEs
to banks. The process is bound to
be wrought with risks, but once substantial progress is made in these
reforms, the economy should be on
a much stronger footing. For long-term investors, China offers many
exciting opportunities. Obviously, to
keep a stable economy environment, Yuan will not devalue in the short-term.
Recommendations
In the 1990s, a more globalized economy has formed. This kind of interdependent
and inter-influenced
economic relation, so each country will inevitably influence each other.
For the developing countries, they
should pay more attention to their international finance, such as international
debt, exchange rate system.
1997’s Asian crisis is a lesson, but China has achieved excellent performance.
Of course, it is too early to
conclude that China has succeeded. Definitely, China will try their
best to get out of Asian crisis’
influence, to development it economy better.
Appendix
1.China Xinhua News, July 30, 1999
2. Arvind K. Jain, International financial Markets and Institutions, Kolb Publishing Company, 1994
3.Beware the funny money, Brimelow. Peter, Forbes, 163(9): 138-141, May 3, 1999
4.The Asian crisis: causes and remedies, Aghevli.
Bijian B., Finance and Development, 36(2):
28-31, Jun, 1999
5.Developing country debt and world economy,
Jeffery D. Sachs, The University of Chicago Press,
1989
6.http://www.stats.gov.cn/gitj/b.htm
7.http://www.sinc.sunysb.edu/Stu/yihe/politics/fengbao.html
8.http://202.194.9.72
9.The Asian Wall Street Journal, November 4, 1997
10.Citibank N.A., Global Corporate Banking,
Economic Research Department, The Asian Wall
Street Journal, December 16, 1997
11.East China News, pp 1, August 9, 1999
12 http://www.peoplesdaily.com.cn/zdxw/4/19990809/1999080946.html