The Asian financial crisis was a period of financial crisis that gripped much of East Asia and Southeast Asia beginning in July and raised fears of a worldwide economic meltdown due to financial contagion.
Capital flight ensued, beginning an international chain reaction. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency.
Indonesia , South Korea , and Thailand were the countries most affected by the crisis. Hong Kong , Laos , Malaysia and the Philippines were also hurt by the slump. Brunei , mainland China , Singapore , Taiwan , and Vietnam were less affected, although all suffered from a loss of demand and confidence throughout the region.
Japan was also affected, though less significantly. Only in Thailand and South Korea did debt service-to-exports ratios rise. The efforts to stem a global economic crisis did little to stabilize the domestic situation in Indonesia, however.
After 30 years in power, Indonesian President Suharto was forced to step down on 21 May in the wake of widespread rioting that followed sharp price increases caused by a drastic devaluation of the rupiah. The effects of the crisis lingered through In , growth in the Philippines dropped to virtually zero. Only Singapore and Taiwan proved relatively insulated from the shock, but both suffered serious hits in passing, the former due to its size and geographical location between Malaysia and Indonesia.
By , however, analysts saw signs that the economies of Asia were beginning to recover. Until , Asia attracted almost half of the total capital inflow into developing countries. The economies of Southeast Asia in particular maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result, the region's economies received a large inflow of money and experienced a dramatic run-up in asset prices.
This achievement was widely acclaimed by financial institutions including IMF and World Bank , and was known as part of the " Asian economic miracle ".
The cause of the debacle are many and disputed. Thailand's economy developed into an economic bubble fueled by hot money. More and more was required as the size of the bubble grew.
The same type of situation happened in Malaysia and Indonesia, which had the added complication of what was called " crony capitalism ". Development money went in a largely uncontrolled manner to certain people only - not necessarily the best suited or most efficient, but those closest to the centers of power. In the mids, Thailand, Indonesia and South Korea had large private current account deficits, and the maintenance of fixed exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors.
In the mids, a series of external shocks began to change the economic environment. The devaluation of the Chinese renminbi , and the Japanese yen due to the Plaza Accord of , the raising of U.
The Asian Financial Crisis in 1997 - Explanation
This made the United States a more attractive investment destination relative to Southeast Asia, which had been attracting hot money flows through high short-term interest rates, and raised the value of the U. For the Southeast Asian nations which had currencies pegged to the U. At the same time, Southeast Asia's export growth slowed dramatically in the spring of , deteriorating their current account position.
Some economists have advanced the growing exports of China as a factor contributing to ASEAN nations' export growth slowdown, though these economists maintain the main cause of their crises was excessive real estate speculation. Other economists dispute China's impact, noting that both ASEAN and China experienced simultaneous rapid export growth in the early s. Many economists believe that the Asian crisis was created not by market psychology or technology, but by policies that distorted incentives within the lender—borrower relationship.
The resulting large quantities of credit that became available generated a highly leveraged economic climate, and pushed up asset prices to an unsustainable level. The resulting panic among lenders led to a large withdrawal of credit from the crisis countries, causing a credit crunch and further bankruptcies.
Asian Financial Crisis
In addition, as foreign investors attempted to withdraw their money, the exchange market was flooded with the currencies of the crisis countries, putting depreciative pressure on their exchange rates. To prevent currency values collapsing, these countries' governments raised domestic interest rates to exceedingly high levels to help diminish flight of capital by making lending more attractive to investors and intervened in the exchange market, buying up any excess domestic currency at the fixed exchange rate with foreign reserves.
Neither of these policy responses could be sustained for long. Very high interest rates, which can be extremely damaging to a healthy economy, wreaked further havoc on economies in an already fragile state, while the central banks were hemorrhaging foreign reserves, of which they had finite amounts.
When it became clear that the tide of capital fleeing these countries was not to be stopped, the authorities ceased defending their fixed exchange rates and allowed their currencies to float. The resulting depreciated value of those currencies meant that foreign currency-denominated liabilities grew substantially in domestic currency terms, causing more bankruptcies and further deepening the crisis.
Other economists, including Joseph Stiglitz and Jeffrey Sachs , have downplayed the role of the real economy in the crisis compared to the financial markets. The rapidity with which the crisis happened has prompted Sachs and others to compare it to a classic bank run prompted by a sudden risk shock. Sachs pointed to strict monetary and contractionary fiscal policies implemented by the governments on the advice of the IMF in the wake of the crisis, while Frederic Mishkin points to the role of asymmetric information in the financial markets that led to a " herd mentality " among investors that magnified a small risk in the real economy.
The crisis has thus attracted interest from behavioral economists interested in market psychology. Another possible cause of the sudden risk shock may also be attributable to the handover of Hong Kong sovereignty on 1 July During the s, hot money flew into the Southeast Asia region through financial hubs , especially Hong Kong.
Causes, Solutions, and Lessons Learned
The investors were often ignorant of the actual fundamentals or risk profiles of the respective economies, and once the crisis gripped the region, the political uncertainty regarding the future of Hong Kong as an Asian financial centre led some investors to withdraw from Asia altogether. This shrink in investments only worsened the financial conditions in Asia  subsequently leading to the depreciation of the Thai baht on 2 July Several case studies on the topic of the application of network analysis of a financial system help to explain the interconnectivity of financial markets , as well as the significance of the robustness of hubs or main nodes.
Soros claims to have been a buyer of the ringgit during its fall, having sold it short in A year earlier, the finance ministers of these same countries had attended the 3rd APEC finance ministers meeting in Kyoto , Japan, on 17 March , and according to that joint declaration, they had been unable to double the amounts available under the "General Agreement to Borrow" and the "Emergency Finance Mechanism". The crisis could be seen as the failure to adequately build capacity in time to prevent currency manipulation.
1997 Asian financial crisis
However, this hypothesis enjoyed little support among economists, who argue that no single investor could have had enough impact on the market to successfully manipulate the currencies' values.
In addition, the level of organization necessary to coordinate a massive exodus of investors from Southeast Asian currencies in order to manipulate their values rendered this possibility remote.
The scope and the severity of the collapses led to an urgent need for outside intervention. Since the countries melting down were among the richest in their region, and in the world, and since hundreds of billions of dollars were at stake, any response to the crisis was likely to be cooperative and international.
The International Monetary Fund created a series of bailouts "rescue packages" for the most-affected economies to enable them to avoid default , tying the packages to currency, banking and financial system reforms.
The SAPs called on crisis-struck nations to reduce government spending and deficits, allow insolvent banks and financial institutions to fail, and aggressively raise interest rates.
The reasoning was that these steps would restore confidence in the nations' fiscal solvency , penalize insolvent companies, and protect currency values. Above all, it was stipulated that IMF-funded capital had to be administered rationally in the future, with no favored parties receiving funds by preference.
In at least one of the affected countries the restrictions on foreign ownership were greatly reduced. There were to be adequate government controls set up to supervise all financial activities, ones that were to be independent, in theory, of private interest.
Insolvent institutions had to be closed, and insolvency itself had to be clearly defined. In addition, financial systems were to become "transparent", that is, provide the kind of reliable financial information used in the West to make sound financial decisions. As countries fell into crisis, many local businesses and governments that had taken out loans in US dollars, which suddenly became much more expensive relative to the local currency which formed their earned income, found themselves unable to pay their creditors.
The dynamics of the situation were similar to that of the Latin American debt crisis. The effects of the SAPs were mixed and their impact controversial. Critics, however, noted the contractionary nature of these policies, arguing that in a recession , the traditional Keynesian response was to increase government spending, prop up major companies, and lower interest rates.
The reasoning was that by stimulating the economy and staving off recession, governments could restore confidence while preventing economic loss. They pointed out that the U. Many commentators in retrospect criticized the IMF for encouraging the developing economies of Asia down the path of "fast-track capitalism", meaning liberalization of the financial sector elimination of restrictions on capital flows , maintenance of high domestic interest rates to attract portfolio investment and bank capital, and pegging of the national currency to the dollar to reassure foreign investors against currency risk.
The conventional high-interest-rate economic wisdom is normally employed by monetary authorities to attain the chain objectives of tightened money supply , discouraged currency speculation , stabilized exchange rate, curbed currency depreciation, and ultimately contained inflation.
In the Asian meltdown, highest IMF officials rationalized their prescribed high interest rates as follows:. When their governments "approached the IMF, the reserves of Thailand and South Korea were perilously low, and the Indonesian Rupiah was excessively depreciated.
Thus, the first order of business was To achieve this, countries have to make it more attractive to hold domestic currency, which in turn, requires increasing interest rates temporarily, even if higher interest costs complicate the situation of weak banks and corporations Why not operate with lower interest rates and a greater devaluation?
This is a relevant tradeoff, but there can be no question that the degree of devaluation in the Asian countries is excessive, both from the viewpoint of the individual countries, and from the viewpoint of the international system. Looking first to the individual country, companies with substantial foreign currency debts, as so many companies in these countries have, stood to suffer far more from… currency depreciation than from a temporary rise in domestic interest rates….
Thus, on macroeconomics… monetary policy has to be kept tight to restore confidence in the currency To reverse currency depreciation , countries have to make it more attractive to hold domestic currency, and that means temporarily raising interest rates, even if this hurts weak banks and corporations. Inflation was kept reasonably low within a range of 3.
On 14 May and 15 May , the Thai baht was hit by massive speculative attacks. However, Thailand lacked the foreign reserves to support the USD—Baht currency peg, and the Thai government was eventually forced to float the Baht, on 2 July , allowing the value of the Baht to be set by the currency market. This caused a chain reaction of events, eventually culminating into a region-wide crisis.
Thailand's booming economy came to a halt amid massive layoffs in finance, real estate, and construction that resulted in huge numbers of workers returning to their villages in the countryside and , foreign workers being sent back to their home countries.
South east asian crisis 1997 pdf writer
The baht reached its lowest point of 56 units to the U. Finance One, the largest Thai finance company until then, collapsed. Right after the Asian financial crisis income in the northeast, the poorest part of the country, rose by 46 percent from to By , Thailand's economy had recovered.
The increasing tax revenues allowed the country to balance its budget and repay its debts to the IMF in , four years ahead of schedule. The Thai baht continued to appreciate to 29 Baht to the U. In June , Indonesia seemed far from crisis. But a large number of Indonesian corporations had been borrowing in U.
During the preceding years, as the rupiah had strengthened respective to the dollar, this practice had worked well for these corporations; their effective levels of debt and financing costs had decreased as the local currency's value rose.
The rupiah suddenly came under severe attack in August.
On 14 August , the managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The rupiah dropped further. The rupiah and the Jakarta Stock Exchange touched a historic low in September.