The Asian financial crisis, which led to a wave of currency depreciations and economic recession among many east Asian economies, started in Thailand during the summer of 1997. Thailand, Indonesia, and Korea were the most affected, while Malaysia and the Philippines were affected at a lower, but nonetheless significant scale.
The fact that many of east Asia’s currencies were pegged to the U.S. dollar before 1997–98 significantly contributed to the crisis. With the dollar appreciating in the 1990s, most east Asian countries experienced huge balance of payments deficits. The countries’ governments used their foreign exchange reserves primarily to support the peg. In a short period of time, the reserves decreased to very low levels, leading to a currency crisis in the region.
Large international debts in the private sector also contributed to the crisis. A number of big corporations (mostly financial institutions) from the region borrowed expensive, short-term, foreign currency denominated, unhedged loans to finance rapid investments in real estate and the stock market. The worsening of economic conditions in 1997 led to a sharp rise in defaults among borrowers, causing a number of banks to become financially distressed. That led to a bank run.
In the early 1990s, Thailand’s bigger corporations (mostly financial institutions) borrowed heavily on the international market to finance investments, mostly in real estate and stocks. Following an economic recession in 1997, some of Thailand’s banks started missing loan repayments; investors feared the event would kick-start an imminent bank run. Thailand’s stock of foreign exchange reserves had been drawn down to such low levels that its government could not afford the dual costs of bailing out its banks and maintaining the foreign exchange rate of the Thai baht simultaneously. A depleted reserve forced the government to allow its currency to float in July 1997. The Thai baht depreciated heavily in the subsequent months. At the same time, the lack of governmental support and/or inability of the government to rescue them caused a number of Thai financial institutions to go bankrupt.
During that time period, the Bank of Indonesia was increasing reserve requirements, increasing interest rates, and making attempts to curb credit expansion. Fearing an appreciation of the rupiah, Indonesia repeatedly widened its currency’s trading band, hoping that the increased volatility would discourage speculators. That hope did not materialize, and investors did not put too much faith in Indonesia’s ability to reform.
In Malaysia, the current account deficit was widening at an alarming rate as well. The then prime minister Mahathir bin Mohamad’s “Vision 2020” led to an unrestrained expansion of credit, leaving the Malaysian central bank, Bank Negara, with few options but to take steps to do the exact opposite, i.e., tighten credit availability. Furthermore, Malaysian interest rates were too high to be ignored and that led to a large inflow of speculative capital.
Financing its ever-increasing current account deficit led to an accumulation of short-term foreign debt in Korea. Its large conglomerates, called chaebols, were heavily in debt; this led to a wave of corporate bankruptcies, causing consequential losses to Korean banks. International lenders did not roll over loans that would have been voluntarily restructured in normal circumstances.
In the Philippines, aggressive lending led to a speculative boom in its real estate market. Lenders were left with nonperforming loans when the boom cycle finally went full circle.
Low reserves and inflated currencies led to a wave of currency depreciations in the region. These depreciations dramatically increased the burden of foreign-currency liabilities. Hence, the costs of bailing out financial institutions were now beyond the fiscal means of these countries. The governments were powerless as their currency, financial institutions, and economic activity collapsed.
Although the International Monetary Fund (IMF) intervened at an early stage of the crisis, as the crisis kept its momentum and kept unfolding, adjustments were needed to some of the institutions’ policy recommendations that were already under way. The World Bank, the Asian Development Bank, and bilateral donors also assisted in reform efforts that eventually helped the region to recover. The IMF’s handling of the Asian financial crisis has been criticized by many. Nonetheless, it is also acknowledged that many of the affected countries had structural deficiencies (for example, weaknesses in financial systems, governance, and politics) that hampered the successful achievement of IMF recommendations.
- Iwan J. Azis, “Indonesia’s Slow Recovery after Meltdown,” Asian Economic Papers (v.7/1, 2008);
- Andrew Berg, “The Asia Crisis—Causes, Policy Responses, and Outcomes,” International Monetary Fund Working Paper (October 1999);
- Peter C. Y. Chow and Bates Gill, Weathering the Storm: Taiwan, Its Neighbors, and the Asian Financial Crisis (Brookings Institution Press, 2000);
- Dilip K. Das, Asian Economy and Finance: A Post-Crisis Perspective (Springer, 2005);
- Stephan Haggard, The Political Economy of the Asian Financial Crisis (Institute for International Economics, 2000);
- Karl D. Jackson, Asian Contagion: Causes and Consequences of a Crisis (Westview Press, 1999);
- David R. Meyer, “Structural Changes in the Economy of Hong Kong since 1997,” China Review—An Interdisciplinary Journal on Greater China (v.8/1, 2008);
- Dick Nanto, “CRS Report: The 1997–98 Asian Financial Crisis,” CRS Reports for Congress (1998);
- Wing Thye Woo, Jeffrey Sachs, and Klaus Schwab, eds., The Asian Financial Crisis: Lessons for a Resilient Asia (MIT Press, 2000).
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