Hedge Funds and Asian Crisis: A Perspective of Hot Money and Structural Deficiencies

Abstract

The Asian financial crisis (1997) was one of the worst financial crises in Asia and has raised concerns not only for the future of region’s economy but also of the world economy as a whole. Though Asian crisis was centered only in South Asia but its impact was so deep that its reverberations were felt in the whole world. Asian financial crisis became a moot point and in recent subprime crisis policy makers tried to take lessons from it. In one of the articles recently published, it was quoted “The catchphrases may be different, but there are many similarities between the 1997 Asian financial crisis and today's.More than ten years have passed since the crisis but the real reasons for crisis are still debatable as different scholars have different views on it. One view suggests inherent weakness in the domestic structural factors of the economies was responsible for the crisis. This includes weak banking system, lack of adequate laws and regulations, and also the absence of strong supervision and enforcement of prudential regulation. Another view suggests that short term capital flows were more responsible for it. South Asian economies were the preferred destination for global investors because of high interest rates and therefore attractive to investors considering higher rates of return. There was a large influx of money and soaring asset prices. The South Asian economies were inflated with this short term capital which was expensive and conditioned on quick profits.As far as short term investments are concerned, investment funds and especially Hedge Funds were criticized during and after Asian crisis owing to their unregulated nature and near collapse of Long Term Capital Management. The idea that hedge funds were responsible for crisis was also supported by political figures. Dr Mahathir, the then Malaysian Prime Minister, in one of the statements published in the Wall Street Journal on September 23, 1997 remarked.“Whole region can be bankrupted by just a few people whose only objective is to enrich themselves and their rich clients....”The analysis of hedge funds with respect to the Asian financial crisis is important because some scholars still believe that hedge funds were primarily responsible for the crisis. After crisis two major international studies were conducted to ascertain the role of hedge funds in crisis. The first was the IMF study “Hedge Funds and the Financial Markets dynamics” led by Barry Eichengreen and Donald Methieson and published in May 1998. According to this, hedge funds were small entities of a very large system and it is misguided to blame them. Another major international report was written by FSF Working group on Highly Leveraged Institutions and published in 2000. According to this, hedge funds and proprietary trading desks have the potential to destabilize financial markets. Thereafter several studies were conducted by world bodies like IMF but there is no consensus on the real causes till date. According to IMF, South East Asian economies were experiencing a huge inflow of money and from 1990 to 1995, financial intermediaries invested somewhere around $20 billion in these economies and in 1996 this amount had dramatically increased to $45 billion per annum. Then with the collapse of Thai Baht and Malaysian Ringitt, there was a sudden outflow of $58 billion which created a chain reaction and currencies of other nations also started falling. But the question is that South East Asian economies which were experiencing high growth before 1997 faced economic crisis only because of outflow of money; or this outflow acted as catalyst in the already existing weak and fragile domestic structural factors.The paper will begin with an analysis of events leading to the Asian financial crisis. From there, it will discuss the presence of hedge funds and their activities in Asia. Based on this discussion, it will analyze whether there was significant presence of hedge funds to destabilize Asian markets.