Japan and the Asian Financial Crisis: The Role of Financial Supervision in Restoring Growth

Introduction

On July 2, 1997, the Bank of Thailand abandoned the currency peg to a basket (de facto U.S. dollar peg) and floated the baht. The baht immediately depreciated by 17 percent. This was the beginning of crises in the worldwide emerging market in the subsequent twelve months (and possibly more months). Thailand, Indonesia, and Korea asked International Monetary Fund (IMF) for a foreign exchange support by December 1997. At the height of the crises, the ASEAN currencies were depreciated by more than 50% in January 1998. The worst hit Indonesian rupiah was worth one-eighth of the level just before the baht depreciation. Contagion from Asian crises spread to Latin America (particularly, Brazil) and Russia. In August 1998, one year after the de facto baht devalution, the Russia essentially defaulted on its short-term government securities. It is not a direct spillover from Thailand to Russia, but it is not farfetched to argue that a chain of events led the crises from Thailand to Russia in thirteen months. There have been many studies on the Asian financial crises. Many point out the yen depreciation from 1995 (peaked at 80 yen in April 1995) to 1997 (about 140 yen in June 1997). As the yen depreciated, the Asian exports plummeted. The Japanese yen was depreciating partly as a correction of the excess appreciation and partly as a reflection of the weak Japanese fundamental. However, it was unfortunate to the Asian economies. The Japanese economy had been stagnant since 1992, before its short-lived recovery in 1996. The growth rate had been below 1.5% from 1992 to 1995. Although the growth rate became higher at 3.9% in 1996, it turned out to be a fragile recovery. A boom was felt in housing construction and consumer durables in the latter half of 1996, in anticipation of consumption tax rate increase to come. In April 1997, the consumption tax rate was raised from 3% to 5%, as scheduled, the temporary income tax cut was repealed, and the social security insurance premium was raised. The reaction of aggregate consumption was predictably negative. What was not expected was the duration of the negative reaction. Consumption and investment was still weak after six months since the tax increase. Then major financial crises shook Japan in November. The Sanyo Securities (a medium size securities firm), the Hokkaido Takushoku Bank (Takugin, for short), and the Yamaichi Securities (one of the Big Four) failed one after another. Since Takugin and Yamaichi were one of the largest financial institutions in Japan, which the government had indicated earlier to support, many people were shocked by the failure. Japanese consumer confidence was lost, and the Japan premium soared in the international interbank market download