Impact of Financial Crises on Economic Stability

The assignment discusses the major impact of the 1997 Asian financial crisis on stock markets and demand-supply dynamics. It highlights key reasons behind these changes, including increased interest rates and declining foreign exchange rates. The central bank's efforts to supervise weak financial institutions and develop policies to recover from economic crises are also emphasized.

1997 ASIAN
FINANCIAL CRISIS

Table of Contents
INTRODUCTION...........................................................................................................................1
1 Affect of Asian Financial Crisis on Exchange Rate.................................................................1
2 Impact of Crisis on other markets.............................................................................................3
3. Explaining how involved countries in crises recovered their economic conditions................4
CONCLUSION................................................................................................................................5
REFERENCES................................................................................................................................6

INTRODUCTION
The 1997 Financial crisis can be referred to period which destabilized the Asian economy
ultimately affecting the world economy in the last of 1990's. The report attempts to identify the
effects which has been brought by undertaken crisis on the exchange rate of the country. It also
provides information about effect which has been carried out by the crisis over the markets of
involved countries. Last section in this report will determine how impacted countries have been
able to improve their economic circumstances post crisis.
1 Effect of Asian Financial Crisis on Exchange Rate
There can be numerous reason which can be referred to as main cause of Asian Financial
crisis such as currency exchange rate, interest rate and soaring real estate values. Thus, this crisis
is also known as Currency Crisis and “Asian Contagion”. Countries like Thailand, South Korea,
Philippines, Malaysia, Indonesia and Singapore were the most badly affected nations due to the
economic instability occurred in the year 1997. This Crisis started in Thailand when government
of country formulated various policies to secure its currency from the US dollar due to this
undertaking the currency of country started declining. With the result of this decline there is a
decline in stock market of many Asian Countries which in turn affects overall economic
condition of these countries due to reduction in import.
Due to this crisis, Currency Market & Stock Market of East Asia devalued by 38% and
60% respectively. Further, assets prices and private debt raised resulting into decline in rates of
national currency. Therefore, the decline in currency of Thailand eventually evaluated currency
of neighbouring nation such as Indonesia, Malaysia and South Korea (Regnier, 2017).
Economy of Thailand was growing at faster rate but with the changes in economic
circumstance from 2 July 1997 Thailand baht started declining and reached to its lowest point
which is 56 points and as compared to US dollar. Reason behind this reduction is decrease in
foreign reserves of the country and which eventually influenced their import in a negative
manner. The decline in the imports reduced revenue and GDP of the economy of Thailand.
Change in exchange rate of a countries currency affects demand & supply. For Example- If
Thailand is purchasing goods from USA then the payment will be done in dollars, this will result
in paying more of national currency i.e. Baht due to depreciating value of the currency.
Further, Exchange Rate of Indonesia is dropped due to replacement of management
floating rate regime by fixed floating rate. Exchange rate of Rupiah was 11000 rupiah for 1 US
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during the Asian crisis which was very high. Banking Sector of South Korea was not
performing well and its non performing loans were increasing due to this reason exchange rate of
this country showed a decreasing trend during this phase. Currency of Philippines reduced to
46.50 pesos per dollar from 26 pesos per dollar and this happened due to an increase in interest
rate of country. Their is a rise in interest rate by 1.75% points and with the result of this GDP of
country is also declined by 0.6% (Ip, Lever-Tracy and Tracy, 2017).
From the above graph it can be evaluated that with the increase in interest rate demand
for currency of affected countries also increased and supply of the foreign currency decreased.
Thus, Reasons for drop down in exchange rate of all the Asian countries can be due to
increase in Interest Rate, Rate of Inflation, Private Debts and Decline in Foreign Reserves.
Change in exchange rate also gets affected with the changing purchasing power of
individuals of an economy and if a company is suffering from high rate of inflation than it can
which in turn reduces purchasing power of currency of that country. For Example there is a rise
in Inflation Rate of Philippines than purchasing power of Person gets reduced and with the result
of this demand of Peso is depreciated and supply is increased with the result of this exchange
will dropped.
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Further, difference in rate of return of countries is also a reason for reduction ion value of
the currency and depreciation in currencies value affects demand and supply
International Finance Theories
Exchange rate also affects purchasing power if a countries exchange rate is providing
goods at cheaper rate than other countries wants to make investment in that country which also
happened during the crisis. Due to increase in Interest Rate of Asian Countries citizens of those
countries are purchasing assets from foreign countries which reduces demand for the local assets
and investment and reduced supply of the foreign currency. This problem can be resolved with
theory of Purchasing Power Parity. According to prices of goods traded in international market is
equalized by calculating PPP Exchange Rate (Almeida Kim and Kim, 2015).
2 Impact of Crisis on other markets
Performance of Stock Market, Commodity Market and Property Market of all the
countries affected from financial crisis are having an adverse affect.
Impact on Stock Market
Operations & returns from stock market of Thailand reduced by 73% because of
reduction in income level of individuals and increase in rate of unemployment in the country.
Further, increasing burden of debts on private sector companies reduced their profitability with
the result of this share prices of all the companies operating in the Asian Region fell sharply.
Moreover, reduction in liquidity of many well known countries reduced interest of shareholder
which also affected prices of shares.
Rise in interest rate reduced purchasing power of citizens of the country which resulted
fall of Korea Stock Exchange and Seoul Stock Exchange is dropped down by 7% in the year
1997 and post that it kept falling which further weakened sustainability and growth of countries
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ranging in the Asian region. As big companies in the country such as Samsung and Hyundai
Motors sold dissolved their businesses and sole their businesses to American Companies.
Most popular Index of Philippines PSE Composite Index falls down by 2500 points
during the crisis. Thus, this crisis also has an impact on Stock Market.
Impact on Commodity & Real State Market
With this crisis many individuals were unemployed as there was substantial rate in
reduction of the investment. Investment in Commodity & Real Estate also reduced and
businesses were not interested in trading in these markets which in turn reduced profits of these
sectors. Further, prices of properties and commodities also fell down due to decrease in demand.
Impact on Micro Economic Factors
Interest Rate- Interest Rate of countries like Thailand, Indonesia, South Korea and other
Asian Countries increased with the Introduction of Financial Crisis of 1997. This is due to
increase in burden of Bank Loan and which is the reason for change in exchange rate of these
countries. Justification for the same is that with the increase in Interest Rate, demand of financial
assets of the other country in this case USA increased which in turn increased demand of local
currency. Increase in interest rate of affected Asian Countries influenced its citizens to invest in
countries which are having low interest rate and that also affected economy of the country as it
involved outflow of funds. This further reduced value of currency of these countries.
Higher Interest rates further slowed down spendings of individuals and which in turn
reduced growth of the economy. Further, it also affects Import of the countries affected by
Financial Crisis. For Example- If Thailand is making investment in market of US as interest rate
in the US market is low but it has to make payment in dollars with this imports gets costly as for
1 dollar Thailand is required to pay more baht. Which reduces imports and revenue of the
economy of Thailand(Sharma, 2018).
Inflation Rate- Inflation rate is an another factor which had increased due to emergence
of this crisis. As with the increase in rate of Inflation of countries like Thailand and Indonesia
purchasing power of individuals got decreased when compared to nations such as United States,
Japan or Germany. Thus, with the enhancement in Inflation rate value of the currency of that
country is depreciated.
Current Account Deficit- Current Account Deficit is an economic variable which shows
balance of trade of a country and all the countries it is trading with. Balance of trade gives
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detailed information of goods, services, interest and dividend. According to this variable a
country is making more investment in foreign trade by taking loans from foreign companies
which in turn creates more demand of foreign currency and an increase in demand of foreign
currency reduces exchange rate of the countries of Asia.
3. Explaining how countries involved in crises recovered their economic conditions
The financial crises of 1997 affected all the economies across the globe. Malaysia,
Thailand, Indonesia and other affected countries took help of International Monetary Fund
(IMF). Government made various policies for overcoming economic challenges (Recovery from
the Asian Crisis and the Role of the IMF, 2018) The policies made by IMF helped affected
countries in generating appropriate funds for the purpose of recovering their economical
conditions. In addition, the Government also amend its fiscal policies through which it reduced
its expenditure. These policies played an important role in getting recovered from the impact of
financial crises(Lim, 2017).
Further, after analysing the seriousness of financial crises over all the involved countries,
the central banks also made changes in foreign exchange policies of their respective countries. It
helped in gaining higher amount of foreign currencies in the country. It assisted in providing
economic stability to the countries who are involved in financial crises. In addition, the central
bank also started supervising the weak financial institutions of the country so they can enhance
their performance. The bank also developed policies and strategies of closing, merging or
supervising all the week financial institutions. These policies helped in generating a major
recovery in brining economic stability (The Malaysian Financial Crises: Economic Impact And
Recovery Prospects, 2019). With the help of these policies and procedures developed by
Government and central bank, all the affected countries started recovering from negative
economic conditions.
In this regard, it can be analysed that for the purpose of reducing the impact of financial
crises 1997, various major strategies and plans were made. These policies and strategies played a
vital role in improving economic condition and fixing damages caused by the financial crises
1997 (Wihantoro and et.al., 2015).
CONCLUSION
From the above study, it can be concluded that the financial crises had a major impact
over the stock market and other financial markets. It also affected the demand and supply of the
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country. There was some major reasons behind such changes such as increase in interest rate,
decline in foreign exchange rate, etc. Central banks and Government help these countries to
recover economic crises. Although, all the affected countries made their effective policies to
overcome from the negative impacts of these crises.
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REFERENCES
Books and Journals
Sharma, S.D., 2018. The Asian financial crisis: Crisis, reform and recovery.
Regnier, P., 2017. Small and Medium Enterprises in Distress: Thailand, the East Asian Crisis
and Beyond: Thailand, the East Asian Crisis and Beyond. Routledge.
Ip, D.F.K., Lever-Tracy, C. and Tracy, N., 2017. Chinese business and the Asian crisis.
Routledge.
Lim, L.Y., 2017. Southeast Asian Chinese business: Past success, recent crisis and future
evolution. Business, Government and Labor: Essays on Economic Development in
Singapore and Southeast Asia. p.313.
Almeida, H., Kim, C.S. and Kim, H.B., 2015. Internal capital markets in business groups:
Evidence from the Asian financial crisis. The Journal of Finance. 70(6). pp.2539-2586.
Wihantoro, Y. and et.al., 2015. Bureaucratic reform in post- Asian crisis Indonesia: The
directorate general of tax. Critical Perspectives on Accounting. 31. pp.44-63.
Online
Demand and Supply Shifts in Foreign Exchange Markets. 2016. [Online] Available through :
<https://opentextbc.ca/principlesofeconomics/chapter/29-2- demand-and-supply-shifts-in-
foreign-exchange-markets/>
Recovery from the Asian Crisis and the Role of the IMF. 2018. [Online] Available through :
<https://www.imf.org/external/np/exr/ib/2000/062300.htm>
The Malaysian Financial Crises: Economic Impact And Recovery Prospects. 2019. [Online]
Available through :
<http://www.ide.go.jp/library/English/Publish/Periodicals/De/pdf/99_04_03.pdf>
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