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ASIAN CRISIS: Introduction

This paper develops a model of financial and currency crises led by moral hazard, with special reference to the recent Asian events, and presents a preliminary empirical analysis of the extent to which the 1997/98 crisis was related to regional macroeconomic and structural weaknesses.

Our interpretation of the origins and causes of the Asian meltdown focuses on moral hazard as the common source of overinvestment, excessive external borrowing, and current account deficits in a poorly supervised and regulated economy. In our model, private agents act under the presumption that there exists public guarantees on corporate and financial investment, so that the return on domestic assets is perceived as implicitly insured against adverse circumstances. To the extent that foreign creditors are willing to lend against future bail-out revenue, unprofitable projects and cash shortfalls are re-financed through external borrowing. Such a process — referred to as ‘evergreening’ — translates into an unsustainable path of current account deficits.

While public deficits need not be high before a crisis, the eventual refusal of foreign creditors to refinance the country’s cumulative losses forces the government to step in and guarantee the outstanding stock of external liabilities. To satisfy solvency, the government must then undertake appropriate domestic fiscal reforms, possibly involving recourse to seigniorage revenues through money creation. Speculation in the foreign exchange market, driven by expectations of inflationary financing, causes a collapse of the currency and anticipates the event of a financial crisis. This is because a speculative attack depletes international reserves that the public sector could otherwise use to bail-out insolvent private firms. source

Financial and currency crises thus become indissolubly interwoven in an emerging economy characterized by weak cyclical performances, low foreign exchange reserves, and financial deficiencies resulting into high shares of nonperforming loans: the empirical section of the paper presents evidence in support of the thesis that the combination of these structural factors was at the core of the Asian collapse.

The paper is organized as follows. Section 2 presents a synthetic overview of the structural imbalances in Southeast Asia on the eve of the crisis. The micro-founded model of twin currency and financial crises in the presence of moral hazard, introduced in Section 3, provides a conceptual and analytical apparatus to interpret the econometric results of Section 4. Section 5 concludes.