Solvency and the currency crisis in Asia: Evidence for the four Asian countries.

The study deals with the Asian currency crises, in which the causes and consequences of the crisis are analysed. The two hypotheses which, are often viewed as competing, fundamental and panic and herd behaviour, are also examined. The first hypothesis states that fundamental imbalances triggered the Asian currency and financial crisis in 1997. The crisis occurred because the economies had deteriorating current accounts, a slowdown in growth rates and short-term debt approaching a dangerous level, while the second hypothesis states that sudden shifts in market expectations and confidence were the cause of the initial financial turmoil. When the crisis erupted it caused panic in domestic and foreign investors. A major focus of the study is to evaluate these two approaches and to examine whether there was evidence of insolvency prior to the crisis. A solvency index as originally popularised by Cohen (1991) is then calculated for each country. An econometric analysis of the trade sector is undertaken in which the Engle-Granger two-step procedure is employed, and the short-run dynamics are described by the Error Correction Mechanism (ECM). The Johansen Maximum Likelihood test is also employed as a comparison to the Engle-Granger Two-Step model. Subsequently the price elasticities obtained from the export demand model together with the GDP supply elasticity are used to calculate the index. From the results, it appeal's that all countries were solvent prior to the crisis in which the percentage of actual debt service paid (in 1997) was greater than the percentage that needs to be paid to be solvent. This suggests that a further external credit could have solved the problem, as it was a matter of short-term liquidity difficulties and panic, rather than insolvency