Root Causes of Financial Crisis in the 1990s

IntroductionThe objective of this newsprint is to discuss the bow causes of pecuniary crisis in the 1990s. In this light, the paper has identified monetary easinesss that occurred in the late 1980s as a principal cause of crisis in the 1990s. The paper begins by presenting a discussion of monetary liberalisation in section 2 be pitiful and then focuses on how it resulted in pecuniary crisis in the 1990s. The paper employs the eastside Asian fiscal Crisis as a case study and provides a discussion of how financial liberalisation contributed to the crisis 1997/1998 in section 2 while section 3 provides general conclusions and recommendations of the paper.fiscal Liberalisation and the eastern Asian monetary CrisisOne of the master(prenominal) causes of financial crisis in the 1990s was financial liberalisation which facilitated the flow of superior a scrape borders. In the late 1980s and early 1990s, virtually developed and exploitation economies liberalised their financi al systems and removed a number of regulations regarding the movement of funds. In particular proposition numerous countries eliminated restrictions on unlike exchange movement thus change magnitude the flow of cross-border capital. One major crisis that occurred during the 1990s was the Asian financial Crisis. This crisis has been connect directly to an gain in cross-border capital flows which resulted to currency crisis across the eastern United States Asian Countries that were involved in the crisis. Most of the countries involved in the crisis witnessed dispraise in their currencies which in turn led to major crisis across only the countries involved. Tailand was facing competition for its trades which led to a decline in its export sales. One of the reasons for Thailands export declines was as a result of the devaluation of the Chinese Yuan in 1994 (Pathan et al., 2008). Rising export competition Thailand forced some(prenominal) businesses to shift from manufacturin g to the real estate. Banks began providing loans to home buyers to facilitate real estate enthronements. A banking companying facility The Bangkok International Banking Facility (BIBF) offered funds to both topical anaesthetic and foreign borrowers thus facilitating their real estate investments (Pathan et al., 2008 Bisgnano, 1999).In the early 1990s, the East Asian countries were witnessing significant sparing growth. As a result, these economies maintained broad trustworthy eyeshade deficits (Bird and Rajan, 2000). As a result, large inflows of capital and a depreciation of international reserves were inevitable to reduce finance the deficits (Bird and Rajan, 2000). During This block, many East Asian economies as well as made significant efforts to liberalise their interior(prenominal) financial systems as intimately as the capital tale chemical equilibrium of payments. The establishment of the BIBF in Bankgok is a typical example of how domestic liberalisation fac ilitated the attraction of foreign capital. It enabled domestic banks to accept foreign-currency-denominated loans and deposits from foreign investors. These loans were later employ to offer loans to the domestic market. This process led many local anesthetic firms to increase their leverage thus increasing their financial risk.Net capital inflows for alone countries in the region were confirmative and most of disco biscuit than not exceeded the real delineate deposit. In addition, international reserves were significantly high (The realness Bank, 2000). Capital inflows were significantly high in Malaysia and Thailand. These countries were classified among the top ten emerging market economies to received net private capital flows during the period under study (Lopez-Mejia, 1999).A significant portion of the loans were made in foreign currency. This st rollgy increased the gearing of many foreign and local borrowers. The colossal influx of capital combined with high presen t-day(prenominal) flyer and trade deficits in the first half of the 1990s resulted in the broad decline in the value of the currencies of the region, which eventually transformed into the financial and economic crisis of 1997 and 1998. More everywhere, most of the countries involved in the crisis were operating(a) a semi-pegged exchange rate regime, which also contributed to the currency crisis.Significant movements in the Thai Bhat meant that the currency could no drawn-out sustain its value. the currency was forced to crash in 1997. On the 2nd of July 1997, the Thai Bhat was allowed to float freely and its value fell hugely against other currencies (Joosten, 2004 Pathan et al., 2008). Despite the introduction of foreign exchange controls as well as large spot and forward interventions by the g everyplacenment and primal bank, the magnitude of the disaster on the currency was so high that these measures could not stop it. As a result, the devaluation of the Thai Bhat on the 2n d of July 1997 label the onset of the East Asian Financial Crisis (Joosten, 2004 Li and Kwok, 2008). The currency crisis in Thailand was transmitted to five other East Asian economies. As explained earlier, the main cause of the crisis was the liberalization of the financial system which led to large cross border movements in foreign currency. The large movement in the East Asian currencies led to their depreciation which eventually led to the crisis.Singapore has oftentimes tried to compare itself to London as a major financial Centre. Consequently, U.S financial institutions often used it as a safe harbour for depositing toxic assets. Given the liberalised nature of global financial markets, Singapore attracted a lot of toxic assets from the U.S which also helped in fuelling the crisis in Singapore (Lim and Maru, 2010).In Indonesia, the channel taken by the crisis was somewhat different from those of other countries standardized Korea and Thailand (Joosten, 2004). The primor dial Bank (Bank of Indonesia) increasing became concerned about an saving that was operating above full employment and decided to take measures that would slow bundle the economy to ensure that it return to full employment. The Central bank however, lacked the tools required to reduce aggregate demand. This is because it became concerned that if interest rates were increased, more foreign capital would flow into the economy a situation that would result to a currency crisis. Lack of an appropriate monetary policy tool meant that the Central Bank was unable to prevent an imminent crisis.Like Indonesia, Malaysias economy was operating beyond full employment. During the year 1995, the country witnessed an increase in public investment. The money was spent mainly on large root word projects (Joosten, 2004). By the end of 1996, the count, Malaysia witnessed a decline in its current chronicle deficit and the concerns over capacity overutilization were reduced. However, given increasin g concerns over the ability of other East Asian countries as good investment environments, investors began to perceive Malaysia as a safe haven. Consequently, the country witnessed a huge influx of foreign capital which resulted in an increase in bank lending that in turn fuelled an asset holloa. The influx in capital led to an increase in the countrys current account deficit over the period 1992-1995 as wel as declining exports. Huge current account deficits combined with trade deficits, the local currency could no longer sustain its value. This means that Malaysia could not escape the crisis either. The Philipines also had a just economy when compared to other East Asian economies. The country operated at low levels of foreign debt and showed no immediate risk of a crisis. However, an influx in foreign capital soon fuelled a rapid lending boom that was mainly used in the financing of risky investments and as such the country began facing difficulties (Joosten, 2004).Table 1 C urrent Account (% of GDP). YearIndonesiaMalaysiaPhilippinesRepublic of KoreaThailand 1992-2.0-3.7-1.6-1.3-5.5 1993-1.3-4.6-5.50.3-4.9 1994-1.6-7.6-4.6-1.0-5.4 1995-3.2-9.8-4.4-1.7-7.9 1996-3.4-4.4-4.8-4.4-7.9 book of facts (Joosten, 2004).Table 1 above illustrates the current account as a percentage of GDP for the East Asian Economies that were involved in the crisis over the period 1992 to 1995. It can be observed that all five countries exhibited a negative current account indicating that they operated current account deficits throughout the five year period leading up to the crisis. Korea however had a positive figure of 0.3% in the year 1993. Thailand showed the worst economic performance as evidenced by its largest current account deficit which kept increase with time.Conclusions and RecommendationsThe objective of this paper was to identify the root causes of financial crisis in the 1990s. utilise the East Asian Financial Crisis as a case study, the paper concludes that one of the major causes of financial crisis in the 1990s was financial liberalization. Financial liberalization facilitated the movement of capital across borders. The East Asian Economies liberalized their financial systems thereby allowing a huge influx of foreign capital. Given that most of these countries suffered trade deficits, the capital was spent mainly on infrastructural development which means that enough returns could not be realized to cover the current account deficits. As such the current account deficits had to be financed with international reserves. This resulted in a currency crisis across the region which eventually led to the financial crisis in 1997 and 1998. One of the main lessens that can be learnt from this crisis is that countries with huge current account deficits should not attract foreign capital if they are also operating trade deficits. This is because most of the foreign capital is used to finance unprofitable projects that cannot generate enough cash fl ows to offset the current account deficit. This increases the financial risks of both the private and public sector, which eventually result in a financial crisis.ReferencesBird, G. and Rajan, R. S. (2000) BANKS, FINANCIAL LIBERALISATION AND FINANCIAL CRISES IN acclivitous MARKETS, available online at http//www.freewebs.com/rrajan01/liberalfull.pdf , accessed 8th January, 2012.Bisgnano J. (1999). Precarious Credit Equilibria Reflections On The Asian Financial Crisis. BANK FOR INTERNATIONAL SETTLEMENTS Monetary and Economic Department Basle, Switzerland Working Papers.Joosten W. (2004). The Asian Financial Crisis in Retrospect. What HappenedWhat Can we concludeCPB Memorandum. CPB Netherlands Bureau for Economic form _or_ system of government Analysis.Li, K., Kwok m. (2008). end product volatility of five crisis-affected East Asia economies Japan and the World Economy, In Press, turn Proof, Available online 24 April 2008.Lopez-Mejia, A. (1999), Large Capital Flows A Survey of the Causes, Consequences, and Policy Responses, Working Paper 99/17, IMF.Mahui, M. N., Maru, J. (2010), Financial Liberalisation and the Impact of the Financial Crisis on Singapore, Third World Network 131 Jalan Macalister, 10400 Penang, Malaysia.Pathan, S., Skully, M. & Wickramanayake, J. (2008) Reforms in Thai bank governance the aftermath of the Asian financial crisis, International follow-up of Financial Analysis, 17 (2), 345-362.World Bank (2000), East Asia Recovery and Beyond, modernistic York Oxford University Press.