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The reasons for the recent meltdown in the economy of indonesia

Asian Contagion Between June 1997 and January 1998 a financial crisis swept like a brush fire through the "tiger economies" of SE Asian.

This Asian miracle, however, appeared to come to an abrupt end in late 1997 when in one country after another, local stock markets and currency markets imploded. This section explains why this happen, and explores the possible consequences, both for the world economy, and for international businesses?

Background The seeds of the 1997-98 Asian financial crisis were sown during the previous decade when these countries were experiencing unprecedented economic growth. Although there were and remain important differences between the individual countries, a number of elements were common too most. Exports had long been the engine of economic growth in these countries. A combination of inexpensive and relatively well educated labor, export oriented economies, falling barriers to international trade, and in some cases such as Malaysia, heavy inward investment by foreign companies, had combined during the previous quarter of a century to transform many Asian states into export powerhouses.

The nature of these exports had also shifted in recent years from basic materials and products such as textiles to complex and increasingly high technology products, such as automobiles, semi-conductors, and consumer electronics. The wealth created by export led growth helped to fuel an investment boom in commercial and residential property, industrial assets, and infra-structure. The value of commercial and residential real estate in cities such as Hong Kong and Bangkok started to soar.

In turn, this fed a building boom the likes of which had never been seen before in Asia. Office and apartment building were going the reasons for the recent meltdown in the economy of indonesia all over the region. Heavy borrowing from banks financed much of this construction, but so long as the value of property continued to rise, the banks were more than happy to lend.

As for industrial assets, the continued success of Asian exporters encouraged them to make ever bolder investments in industrial capacity. An added factor behind the investment boom in most SE Asian economies was the government. In many cases the government had embarked upon huge infra-structure projects. Throughout the region governments also encouraged private businesses to invest in certain sectors of the economy in accordance with "national goals" and "industrialization strategy".

In South Korea, long a country where the government played a pro-active role in private sector investments, President Kim Young-Sam urged the chaebol to invest in new factories. Kim, a populist politician, took office in 1993 during a mild recession, and promised to boost economic growth by encouraging investment in export oriented industries.

Korea did enjoyed an investment led economic boom in the 1994-95 period, but at a cost. The chaebol, always reliant on heavy borrowings, built up massive debts that were equivalent, on average, to four times their equity.

In Malaysia, the government had encouraged strategic investments in the semi-conductor and automobile industries, "in accordance with the Korean model".

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One result of this was the national automobile manufacturer, Perusahaan Otomobil Nasional Bhd, which was established in 1984. By 1989 Perusahaan Otomobil Nasional Bhd was selling 72,000 cars out of a total market of 117,000.

Whether this company could succeed in a competitive marketplace, however, was another question. Skeptical analysis note that in 1987 an average 1,600cc Proton cost about three times per capita income in Malaysia; by 1996 a 1,6000cc Proton costs 5. In Indonesia, President Suharato has long supported investments in a network of an estimated 300 businesses that are owned by his family and friends in a system known as "crony capitalism".

Many of these businesses have been granted lucrative monopolies by the President. In another example, in 1995 Suharato announced that he had decided to build a national car, and that the car would be built by a company owned by Mr Hutomo, in association with Kia motors of South Korea. In sum, by the mid 1990s SE Asia was in the grips of an unprecedented investment boom, much of it financed with borrowed money. Between 1990 and 1995 gross domestic investment grew by 16.

By comparison, investment grew by 4. Moreover, the rate of investment accelerated in 1996. As might be expected, as the volume of investments ballooned during the 1990s, often at the bequest of national governments, so the quality of many of these investments declined significantly. All too often, the investments were made on the basis of projections about future demand conditions that were unrealistic. The result was the emergence of significant excess capacity.

  • Defending the peg was clearly now impossible;
  • The external imbalances were a reflection both of strong private capital inflows and of high domestic private investment rates, and were exacerbated, prior to the crisis, by appreciation of the U;
  • In addition, the longer-term weaknesses that make so many emerging markets vulnerable to higher U;
  • Contagion spread rapidly in the region after the devaluation of the baht, as other countries were perceived by investors as facing similar weaknesses that cast doubt on their credit-worthiness;
  • Although there were and remain important differences between the individual countries, a number of elements were common too most.

A case in point were investments made by Korean chaebol in semi-conductor factories. Investments in such facilities surged in 1994 and 1995 when a temporary global shortage of Dynamic Random Access Memory chips DRAMs led to sharp price increases for this product.

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However, by 1996 supply shortages had disappeared and excess capacity was beginning to make itself felt, just as the Koreans started to bring new DRAM factories on stream. In another example, a building boom in Thailand resulted in the emergence of excess capacity in residential and commercial property. By early 1997 it was estimated that there were 365,000 apartment units unoccupied in Bangkok.

  1. In the early stages of the program, the Thai authorities adapted monetary policy to a managed float of the baht; fostered the restructuring of distressed financial institutions, including the closure of 56 bankrupt finance companies; enacted budget cuts to free up resources to help finance the restructuring and to support improvement in the current-account position; deepened the role of the private sector in the Thai economy; and sought to attract foreign capital through other reform measures.
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  3. Regional initiatives can also be helpful in supporting sustained economic growth and stable financial relations among participating countries.
  4. The scene was now set for a potentially rapid economic meltdown. It would be wrong to conclude, however, that the impact upon companies doing business in the region will be purely negative.

With another 100,000 units scheduled to be completed in 1997, it was clear that years of excess demand in the Thai property market had been replaced by excess supply. By early 1997 what was happening in the Korean semi-conductor industry and the Bangkok property market was being played out elsewhere in the region. Massive investments in industrial assets and property had created a situation of excess capacity and plunging prices, while leaving the companies that had made the investments groaning under huge debt burdens that they were now finding difficult to service.

To make matters worse, much of the borrowing to fund these investments had been in US dollars, as opposed to local currencies. At the time this had seemed like a smart move. Throughout the region local currencies were pegged to the dollar, and interest rates on dollar borrowings were generally lower than rates on borrowings in domestic currency.

Thus, it often made economic sense to borrow in dollars if the option was available. However, if the governments in the region could not maintain the dollar peg and their currencies started to depreciate against the dollar, this would increase the size of the debt burden that local companies would have to service, when measured in the local currency.

Currency depreciation, in other words, would raise borrowing costs and could result in companies defaulting on their debt payments. In this regard, a final complicating factor was that by the mid 1990s although exports were still expanding across the region, so were imports. The investments in infrastructure, industrial capacity, and commercial real estate were sucking in foreign goods at unprecedented rates. To build infra-structure, factories, and office buildings, SE Asian countries were purchasing capital equipment and materials from America, Europe, and Japan.

Boeing and Airbus were crowing about the number of commercial jet aircraft they were selling to Asian airlines. Semi-conductor equipment companies such as Applied Materials and Lam Materials were boasting about the huge orders they were receiving from Asia. Motorola, Nokia, and Ericsson were falling over themselves to sell wireless telecommunications equipment to Asian nations.

And companies selling electric power generation equipment such as ABB and General Electric were booking record orders across the region. Reflecting growing imports, many SE Asian states saw the current account of their Balance of Payments shift strongly into the red during the mid 1990s. By 1995 Indonesia was running a current account deficit that was equivalent to 3. With deficits like these starting to pile up, it was becoming increasingly difficult for the governments of these countries to maintain the peg of their currencies against the US dollar.

If that peg could not be held, the local currency value of dollar dominated debt would increase, raising the specter of large scale default on debt service payments. The scene was now set for a potentially rapid economic meltdown. Somprasong Land was the first victim of speculative overbuilding in the Bangkok property market. Now one had been. The stock market fell another 2. In theory, this practice made sense because Finance One was able to exploit the interest rate differential between dollar denominated debt and Thai debt i.

Finance One borrowed in US dollars at a low interest rate, and leant in Thai Bhat at high interest rates. The only problem with this financing strategy was that when the Thai property market began to unravel in 1996 and 1997, the property developers could no longer payback the cash that they had borrowed from Finance One.

In turn, this made it difficult for Finance One to pay back its creditors. In February 1997, trading in the shares of Finance One was suspended while the government tried to arrange for the troubled company to be acquired by a small The reasons for the recent meltdown in the economy of indonesia bank, in a deal sponsored by the Thai central bank.

Finance One was bankrupt and it was feared that others would follow. It was at this point that currency traders began a concerted attack on the Thai currency, the baht. This peg, however, had become increasingly difficult to defend.

Businesses and financial institutions would be exchanging baht for dollars to service their debt payments and purchase imports. There were several attempts to force a devaluation of the baht in late 1996 and early 1997. These speculative attacks typical involved traders selling Baht short in order to profit from a future decline in the value of the baht against the dollar.

In this context, short selling involves a currency trader borrowing baht from a financial institution and immediately reselling those baht in the foreign exchange market for dollars. The theory here is that if the value of the baht subsequently falls against the dollar, then when the trader has to buy the baht back to repay the financial institution it will cost her less dollars than she received from the initial sale of baht.

For example, a trader might borrow Bt100 from a bank for a period of six months. Of course, since short selling involves selling Baht for dollars, if enough traders engage in this practice, it can become a self-fulfilling prophecy! In May 1997 short sellers were swarming over the Thai baht. In an attempt to defend the peg, the Thai government used its foreign exchange reserves which were denominated in US dollars to purchase Thai baht.

Defending the peg was clearly now impossible. On July 2nd, 1997, the Thai government bowed to the inevitable and announced that they would allow the baht to float freely against the dollar. As the baht declined, so the Thai debt bomb exploded. This made more bankruptcies such as Finance One all further pushed down the battered Thai stock market.

With its foreign exchange reserves depleted, Thailand lacked the foreign currency needed to finance its international trade and service debt commitments, and was in desperate need of the capital the IMF could provide.

Moreover, it desperately needed to restore international confidence in its currency, and needed the credibility associated with gaining access to IMF funds. Without IMF loans, it was likely that the baht would increase its free-fall against the US dollar, and the whole country might go into default. IMF loans, however, come with tight strings attached.

Furthermore, the IMF required Thailand to close illiquid financial institutions. In the event, in December 1997 the government shut some 56 financial institutions, laying off 16,000 people in the process, and further deepening the recession that now gripped the country.

The Domino Effect Following the devaluation of the Thai baht, wave after wave of speculation hit other Asian currencies. One after another in a period of weeks the Malaysian ringgit, Indonesian rupiah and the Singapore dollar were all marked sharply lower.

Next up was Indonesia, whose currency, the Rupiah, was allowed to float on August 14th. With the exception of Singapore, whose economy is probably the most stable in the region, these devaluations were driven by similar factors to those that underlay the earlier devaluation of the Thai baht.

A combination of excess investment, high borrowings, much of it in dollar denominated debt, and a deteriorating balance of payments position. The leaders of these countries, however, were not always quick to acknowledge the home grown nature of their problems.

Mahathir Mohammed, gave speeches asserting that the international financier, George Soros, was the arch villain in a conspiracy to impoverish Southeast Asian nations by attacking their currencies.