Introduction
The Asian crisis was one of the biggest liquidity crises that crippled the East Asian countries. July 2, 1997 is said to be the starting date of the Asian financial crisis. On this day the Bank of Thailand failed to sustain the value of its currency against the dollar and due to a contagion effect the crisis quickly spread to the neighbouring countries. The seriously affected countries were Thailand, Korea and Indonesia. Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump. The People's Republic of China, India, Taiwan, Singapore, Brunei and Vietnam were less affected, although all suffered from a loss of demand and confidence throughout the region. By February 1998, Thailand had lost 42% of its GDP, Indonesia 55% and Korea 34%. The foregone income growth opportunity for the respective countries was calculated at 26%, 25% and 17% of GDP for the duration of the crisis that varied from one to three years. The effects of the crisis lingered through 1998. By 1999, however, signs that the economies of Asia were beginning to recover were seen.
Causes
The Asian economies ran fairly prudent fiscal policies and had high savings and low inflation rates. But, they point out to one or several weaknesses, viz., inappropriate exchange rate policies, large current account deficits which had the potential of becoming unsustainable, weaknesses in the Asian banking system, non-transparency or poor governance or crony capitalism, highly leveraged corporate balance sheets, large credit growth, and/or inefficient investments, excessive dependence on short-term external debt, etc. There were excessive investments by the lenders without adequate attention to credit risks. There was an inherent vulnerability of the corporate sector as they held large un-hedged positions and had large nonbank private borrowings from abroad. Banks were not subject to effective prudential regulation and supervision or currency and maturity matching conditions for assets and liabilities. There was large domestic credit expansion resulting in unproductive investments financed by external funds, often of short term nature. The pegged exchange rate management is considered to be the most important reason by others. This regime encouraged large capital inflows, which resulted in excess liquidity and consequently, large credit expansion extending to non-tradables.
Impact on Indian Banking
The high growth period of the early 1990s show a reversal due to the Asian crisis. There was a sharp dip in the IIP index as well as the GDP growth rate. But the Indian financial system was relatively less affected by the South-East Asian crisis due to several reasons including their meagre exposure to real estate sector, short term external debt and the relatively transparent financial infrastructure.
The economic downturn during late 1990s which followed a rapid growth period of 1994-96 resulted in a stressed economic scenario, leading to deterioration in asset quality and capital adequacy levels across the banking sector.
Significant credit growth (23% in 1994-95) in absence of proportionate growth in deposits (12% in 1994-95) tightened the liquidity in the banking system.
The absolute gross NPAs in the banking system increased by 13.54%, 7.43% and 15.56% in 1996-96, 1997-98 and 1998-99 respectively. The tightness in liquidity also increased the cost of borrowing from 8% in 1995-96 to 8.44% in 1996-97. But the banks were able to pass on this burden to the customers thus maintaining their net profitability margins.
Measures taken
India was relatively less affected by the contagion. Management of the external sector was governed by parameters indicated by the High Level Committee on Balance of Payments (Rangarajan Committee) which recommended flexible exchange rate, sustainable current account deficit, preference to non-debt creating flows, limits on the quantum, use and costs of external debt, and highly restrictive approach to short-term debt. The importance of monitoring of external debt was also recognised and transparent disclosure system was mounted on the basis of the Report of a Policy Group on External Debt Statistics constituted by RBI Governor Shri S.Venkitaramanan
Cash Reserve Ratio - Taking into account the overall liquidity position and the developments in the financial markets, in particular, the possible spill-over effects on the foreign exchange markets, the envisaged reductions in CRR was deferred from the fortnight beginning December 20, 1997, and the phasing of CRR reductions was to be made effective from fortnights beginning January 31, 1998 up to April 11, 1998. However, in view of the situation prevailing in financial and foreign exchange markets, effective from the fortnight beginning December 6, 1997, the CRR to be maintained by SCBs (excluding RRBs) was increased by one half of one percentage point from 9.5 per cent to 10.0 per cent. The schedule of reductions in CRR announced on November 28, 1997 was kept in abeyance. On a review of the monetary and credit situation and in view of the then prevailing volatility in the foreign exchange market, as a part of the package of measures announced on January 16, 1998, the CRR to be maintained by SCBs (excluding RRBs) was increased by one-half of one percentage point from 10.0 per cent to 10.5 per cent of NDTL, effective from the fortnight beginning January 17, 1998. As a result, the resources of SCBs were impounded to the extent of Rs. 2,500 crore. This measure was rolled back subsequently. The CRR to be maintained by SCBs (excluding RRBs) was reduced by 0.5 percentage point from 10.5 per cent to 10.0 per cent in two phases of 0.25 percentage point each with effect from the fortnight beginning March 28, 1998 and April 11, 1998. In view of the re-emergence of volatile condition in the foreign exchange market, the Reserve Bank increased CRR from 10.0 per cent to 11.0 per cent, effective from August 29, 1998.
Foreign Currency Non-Resident Accounts (Banks) [FCNR (B)] Scheme
Freedom was given to banks to determine their own rates on deposits under the FCNR (B) Scheme subject to ceilings prescribed by the Reserve Bank from time to time, effective April 16, 1997. Effective October 22, 1997, the ceiling rates were prescribed at the relevant London Interbank Offered Rate (LIBOR) prevailing on the last working day of the previous week for relevant maturity and currency, in respect of deposits of six months and above but less than one year and floating rate deposits. In respect of deposits of maturity of one year and above, the interest would be within the ceiling of swap rates for the respective currencies/ maturities. Subject to the above, banks are free to offer either fixed or floating rate of interest on such deposits.
Taking into account the international developments which pointed to the problems relating to short-term external liabilities and large un-hedged positions of corporates in some of the South East Asian countries, banks were encouraged to mobilise longer-term, rather than short-term deposits. Accordingly, on April 29, 1998, the interest rate ceiling on FCNR (B) deposits of one year and above was increased by 50 basis points and that on such deposits below one year and floating rate deposits was reduced by 25 basis points. Further, banks were permitted to fix their own overdue interest rates in respect of FCNR (B) deposits remaining overdue for periods exceeding 14 days, subject to these deposits being renewed.
Public Borrowing
Although longer-term inflows have been adversely affected by the regional turmoil, as well as the sanctions that followed nuclear tests in May 1998, India’s limited dependence on foreign capital, as well as the $4.2 billion issue of Resurgent India Bonds to non-resident Indians in late 1998, have helped to cushion the impact. As a result, during the recent period, India’s foreign exchange reserves have remained at the equivalent of a comfortable 6.5 months of imports.
Monitoring and control
As part of risk management, banks were advised to monitor un-hedged exposures of their clients by building adequate risk evaluation procedures in their credit appraisal system. The RBI further strengthened the prudential regulations to cover all risks, keeping in view the international best practices and our country specific requirements. Also, it kept a close watch on liquidity conditions and exchange markets and ensured that sufficient credit was available to permit the growth potential to be realised. By implication, neither excessive credit expansion nor lending to unproductive purposes was allowed.
In order to monitor the channels of transmission of effects of monetary policy, the RBI adopted a multiple indicator approach wherein interest rates or rates of return in different markets along with such data on currency, credit extended by banks and financial institutions, fiscal position, trade, capital flows, inflation rate, exchange rate and transactions in foreign exchange are juxtaposed with output data for drawing policy perspectives.
