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Rashmin Sanghvi & Associates

Chartered Accountants

220, 2nd Floor, Arun Chambers,
Tardeo Road,
Mumbai - 400 034,
Maharashtra, India.

Tel. Nos.: (+91 22) 2351 1878, 2352 5694.

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South East Asian Crisis

South East Asian Currency Crisis

August, 1998

To appreciate the South East Asian currency crisis, we have to understand what happened in Russia in 1990 when the exchange parity between rouble and dollar stood at 4 Roubles to 1 US dollar. Rouble was considered strong, whilst USD was considered speculative. When Gorbachev introduced democracy in parts there was revolt and counter revolt. Then Yeltsin came to power. But he had no clue of market economics. In communist Russia, prices of all commodities were determined by the Government. There was no inflation for decades. In short there was no market economy in Russia. Yeltsin wanted to introduce capitalism and total democracy.

In Russia laws were changed by dictate of the President. He issued order and removed all regulations. Russia became more capitalist than USA. Market totally collapsed. Government had no money. Therefore Russia was forced to withdraw army from Afghanistan and Eastern Europe. Thousands of soldiers were retrenched as government had no money to pay. They became mafia who knew nothing else than to run guns. Then started massive depreciation of rouble. Four roubles to a dollar to eight roubles to a dollar, from eight to twenty and from twenty to hundred roubles to a dollar. Nobody knew what was happening. Yet no one was as concerned as about Southeast Asia because western countries wanted Russia to fall. The exchange parity so deteriorated that today it is almost 5000 roubles to one US dollar.

No economic theory can explain this, be it purchasing power parity, chart, fundamentals, technicals - nothing could justify depreciation of four roubles to a dollar to five thousand roubles to a dollar. Russian economy is totally in shambles. How to explain this !

I have a metaphor, a simile to explain this concept. Where there is jungle fire i.e. fire in the forest, what happens ? Fire starts from one corner and if you are successful to dowse it immediately, it is fine. But if you have limited supply of water, what do you do ? Fire will go on and on and it will spread in whole forest. That is what is happening in Indonesia for more than one year now. Indonesia has tremendous scarcity of water. The jungle fire of Indonesia is now harming Singapore, Malaysia and other neighbouring countries as well and it is still out of control.

The forest fire starts with dead leaves lying on the ground. It may be grass, fallen leaves, dead wood, dead trunks withered and fallen. When the fire catches dead wood and if not controlled, initially, then it catches everything including green wood, green trees, green leaves and everything. When the jungle fire starts there is no logic, while the dead wood burns green wood will also burn, birds, animals, children and everything till there is nothing to feed on. You cannot be sentimental about it. This is exactly what happened in Russia. Anybody who tried to save Russia, was at loss and unless and until Russian economy was not finished, the depreciation of the rouble did not stop.

Let us extend this simile to other countries. Countries which have dead wood, dead leaves in their economy are potential to catch jungle fire unless they take adequate steps. Russia had massive deadwood accumulated over the past 30/40 years. Russian economy was totally controlled for years, there was no inflation, no market economy. Such an economy was suddenly totally opened up, which resulted in chaos. Compare the amount of deadwood in Thailand, Indonesia and four-five other countries in the region which were victims of currency crisis. Each country has its own peculiar problems.

I will take up Thailand, the worst hit country, to explain it thoroughly. I will try and explain problems of Thailand which will help us to understand crisis experienced by other countries on more or less similar grounds. In Thailand, there is no political stability. In last six years, five governments have changed. No single party had majority. Coalition party, coalition groups formed government, fought with one another and collapsed. Thirty five to forty MPs in Thai Parliament are hard core criminals. Corruption, smuggling, murder, and so on, they are involved in almost all types of crimes. Politics in Thailand continues like this.

At every stage I am giving examples of deadwood. Try to compare with Indian scenario to find out whether we have similar deadwood present in our economy. Then you will know what is the potential for India to catch jungle fire.

Thailand accepted "Western advice" in full and lifted all controls. There was no foreign exchange control except that Thai Baht was linked to US dollar. So the value of the baht vis-a-vis dollar was fixed. There was no way of changing it. That encouraged people in Thailand and they felt that there was no exchange risk at all. Thailand, a developing country, had some scarcity of finance. Interest rates were around 20% p.a. If you borrow in Yen, interest rate was 1% p.a. Smart merchant bankers advised Thai businessmen to borrow in yen at interest rate of 1% p.a. There is no way you can convert yen into baht, so they converted yen into dollar and dollar into baht. The whole process would cost three to four per cent p.a. Borrowing at 4% p.a. and lending @ 20% p.a. in Thailand, there was a straight gain of 16% p.a. There was no exchange risk as dollar baht exchange rate was fixed and baht was considered as strong currency. Huge amount of foreign investments, FDI, FII, portfolio investments were freely flowing into Thailand. By the simple demand and supply rate baht used to go up. There being no perception for Baht to depreciate, nobody insured himself against exchange loss. So nobody did any hedging at all. Banks also went ahead, borrowed in Yen and lent in baht in Thailand.

What did borrowers do ?

Adventurous borrowers bought property, others invested in portfolio. Conservatives - green wood - invested in bank FDs. As investments were flowing in real estate and stock market, prices went up. FIIs too acted irrationally. Because prices were going up they invested in Thailand, and as they invested prices further went up. Everybody was investing, thus cause and effect cycle was built up. This was second reason / situation responsible for jungle fire.

The two main reasons for jungle fire are : firstly, Political Instability and secondly International borrowing without hedging. The only possibility of green wood would be somebody borrowed in yen, converted into dollar and form dollar to baht and hedged himself.

Let us go to the third situation,. Somebody asked Montek Singh Ahluwalia, why RBI is sitting on 20 billion dollar reserve without effective investment. Mr. Singh replied : we need to have liquid cash to support rupee under any unforeseen emergencies. The Central Bank of Thailand too had good reserves. Nut it invested these in Thai banks which had gone abroad. What happened to them ? For a short period of time Yen went up vis-a-vis dollar. People used to borrow at debt equity of 5 : 1 or even 10 : 1. Say you have borrowed abroad at debt equity of 10 : 1. On your one dollar capital you borrowed ten dollars and invested eleven dollars in stock market which is highly speculative investment done by borrowing. As if this was not enough, large part of the borrowing was on short term basis. You borrow on three months, bills of exchange. Central Bank, FII, Thai domestic investor everybody was running into one circle. There could be several other reasons for triggering jungle fire but the main reasons are as follows.

Somewhere around June, 1997 Yen appreciated, say from 120 Y to 115 Y to one US dollar. It meant that those who had lent to the Thai investor, wanted some increase in margin money, say by 10 per cent. How do you increase margin because all your money are invested in either share market to real estate !

The only way to raise money would be to sell share property. When they went to sell, they realised that the property could not be sold. So they sold shares. Fine, they realised some money and increased margin. Another development had already started before six - twelve months whereby Thai government was advised that the productivity of Thai industry is going down. Dollar had appreciated with vis-a-vis all other world currencies. Since baht was linked to dollar, it had automatically appreciated with vis-a-vis say, Indian Rupees, Chinese currency or for that matter any other currency of the world. This appreciation was not justified by the low productivity of Thai industry etc. So the Thai government was advised that you delink your currency from US dollar and depreciate it by about 20 per cent.

Thailand considered depreciation as insult or humiliation, so they did not yield to this advice. General domestic investors were probably unaware about this development. But FIIs knew about it. When they saw Japanese currency affecting Thailand economy and resulting in liquidation of investments, they started acting and this is, what I consider, triggered jungle fire from dead leaves to dead wood to kerosene. Most FII act moment to moment, day to day. They run on expectations especially hedge fund does totally opposite of what it is supposed to do hedge funds talk of providing hedge but they do speculation, gambling. Nick Leeson Barings bank, hedging, options, derivatives are all before you to see what they actually do.

Humans by nature ignore writings on the wall. When something happens so dramatically, we look at it as a drama and forget it. That is why, probably in India we are inviting more and more FIIs and going for hedging and derivatives. FIIs act as kerosene in a jungle fire. I will explain you how. In Thailand, there was some nervousness setting in. FIIs gauged it. FIIs said, let us get out first and far. That is why they want electronic system. Electronic bank transfer, electronic share transfer. Buying and selling on computer. You sell shares, money credited to your account and transfer out of Thailand in 3 minutes flat.

FIIs armed with knowledge that Thai currency needed depreciation, started selling. For any developing nation, sale or purchase by FII would be massive transaction. It runs the market, it makes the market. When FIIs started selling on large scale, market crashed. Thai investor also started selling. Investment of 11 dollars, instead of becoming 22, became ten, so to repay loan, they sold. In this nervousness, lot of people transferred their money abroad. Baht, initially fought but had to depreciate later on, because the Central Bank of Thailand had no money. Its reserves which were invested, were blocked, they could not be liquidated. Consequently Thai government could not use them to support baht from depreciating. The demand for dollar was increasing from all those who wanted to take their money out of Thailand, and the Central Bank was unable to meet this kind of exodus of money.

FIIs were selling shares, selling properties, converting baht into dollar and taking money outside. Similarly Thai investors started selling and they also took money outside Thailand. FIIs suffered double the loss when market depreciated by 20 per cent, and baht depreciated by 20 per cent. They suffered a loss of around 40 - 50 per cent. Now let us see how FIIS are managed. Generally a young merchant banker would be managing huge funds of FII. He would be interested in quarterly bonus. Nobody wanted to show losses. So the game started of who is getting out of Thailand first. This is called "Panic", just like jungle fire FIIs were selling and taking money out of Thailand which increased pressure on baht and it started depreciating. FIIs have regional funds. Say, Asia fund. A young merchant banker would be responsible for overall performance of the Asia fund. Ultimately Asia fund should make profit. Burnt by crash of Thailand stock market, they concentrated on Malaysia. Malaysia seemed to be the nice country with good fundamentals. When FIIs started booking profits in Malaysia, otherwise sound Malaysian stock market also crashed. Panic set in and higher outgoing money due to profit booking resulted in depreciation of Malaysian currency as well. This is how jungle fire - currency depreciation - spread to Indonesia and other countries on Southeast Asia.

Economies which had conservative planning and better financial management were less affected. A country like Indonesia, which had massive dead wood., massive corruption, was affected badly. Just 200 families are controlling entire country's economy. They are highly corrupt. President and his family are considered as "10 per cent family". To start any venture, 10 per cent bribe to somebody in President's family is the order of the day in Indonesia.

Compare this with the dead wood in Indian economy. Security scam of 1992 is the direct indication that what was there in Indonesia was already there in India. Market issues were bogus. It can ignite fire at any moment. Corrupt bureaucrats and those professional accountants who are turning a blind eye, adding and abet fraudulent results in corporate prospectus and balance sheet etc. are also dead wood. In India there is no system of punishing guilty, inefficient and fraudulent person. There is no exit system in India. Where is the exit system for management in India ? When IBM first time reported a loss of US $ 10 bn, the first person to go out was chairman and thereafter 10,000 workers were retrenched. Here in India when brothers split, even companies are split as if companies are their hereditary property. this is happening day in and day, out and we are just mute spectators. Large amount of dead wood, dead leaves and kerosene in the form if FIIs and hedge funds are being pumped in the economy. We have a potential volatile deadly combination lying before India. This is probably the implication of what has happened in Southeast Asia. If we can learn from Southeast Asian crisis it is fine, probably we can be saved. If we don't learn from it, God only save us.

Rashmin Sanghvi

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