Asian Financial Crisis

What Is The Asian Financial Crisis?

In 1997, the Asian financial crisis, famously dubbed the "Asian Contagion" occurred marked by a sequence of currency devaluations across Asia.

Thailand witnessed the initial stirrings of economic upheaval as the government opted not to peg its local currency, the Baht, to the U.S. Dollar (USD). This decision sent ripples of instability through the currency market.

The repercussions of currency devaluation rippled across East Asia, Latin America, and Eastern Europe, triggering stock market declines, diminished import revenues, and shifts in the political landscape.

Thailand's economy transformed into a financial bubble driven by substantial cash influxes known as "hot money." Similar circumstances unfolded in Malaysia, the Philippines, and Indonesia.

The influx of short-term capital was expensive and oriented towards quick profits. 

The circulation of money was largely unregulated and influenced by those in positions of authority, albeit not necessarily the most suitable or consistently productive individuals, but rather those closely linked to centers of power.

Brief History Of The Asian Financial Crisis

During the 1990s, Thailand, Indonesia, and South Korea had enormous private current record deficits. In addition, the support of fixed trade rates empowered external loans and prompted unreasonable exposure to foreign exchange risk in both the monetary and corporate areas.

The crisis was caused by several industrial, financial, political, and monetary reasons. Firstly, overheating pressure was built by large external deficits, inflated property, and stock market value.

To have a favorable exchange rate, governments in East Asia would be getting close to manufacturers of export products. 

This includes subsidies, favorable financial deals, and currency pegs to the U.S. dollar. This strategy was also adopted throughout the developing countries in East Asia.

The delayed support of fixed trade rates, at times at impractical levels, complicated the reaction of monetary policies, which came to be viewed as implied assurances of trade value, empowering outer getting and prompting excessive exposure to foreign exchange risk in both the monetary and corporate areas.

Causes Of The Asian Financial Crisis

The crisis has complex origins, arising from a blend of economic, financial, political, and monetary elements, such as: 

• Economic Overload: Various Asian countries, such as Thailand, Indonesia, and South Korea, dealt with heated economies characterized by substantial deficits in their current accounts.
• Currency Pegs And External Loans: Fixed exchange rates, coupled with extensive external borrowing, exposed these economies to foreign exchange risk.
• Property And Stock Market Bubbles: Inflated property and stock market values added to the pressure, creating vulnerabilities in the financial sector.
• Lack Of Transparency: Weak financial regulations, political instability, and opaque governance contributed to the crisis.

The pursuit of a favorable exchange rate led East Asian governments to forge closer ties with export-focused manufacturers. This encompassed subsidies, favorable financial arrangements, and currency pegs to the US dollar. This strategy was widely adopted across developing countries in East Asia.

Furthermore, the delayed adjustments to fixed exchange rates, occasionally set at impractical levels, complicated the effectiveness of monetary policies. 

These rates began to be perceived as implicit guarantees of trade value, encouraging excessive external borrowing and amplifying exposure to foreign exchange risk within the monetary and corporate sectors.

Effects Of The Asian Financial Crisis

The Asian financial crisis of 1997-1998 sent shockwaves through economies across the region. This section explores how several countries were affected, examining their unique circumstances and challenges during this tumultuous period. 

From the initial currency devaluation in Thailand to the ripple effects felt in neighboring nations, we will uncover the key factors contributing to one of Asia's most significant financial crises.

Now, let us dive into the details of how individual countries coped with the crisis.

Thailand: The Spark

Thailand was the epicenter of the Asian financial crisis, and its troubles began with a currency devaluation in July 1997. The key factors were:

• Currency Devaluation: The crisis started with a significant devaluation of the Thai Baht, depleting foreign exchange reserves.
• Balance Of Payments And Banking Crisis: Weakened currency, equity, and property markets led to a twin crisis.
• Private Sector Failure: Impetuous lending and nonperforming loans in the financial sector worsened the crisis.

The economy got trapped in the twin balance of payments and banking crisis due to weakening the currency, equity, and property markets.

Monetary advancement in an uncontrolled economic area brought about misallocation and jumbling. Furthermore, political instability, uncertainty, and botch at the political and authoritative levels added to Thailand's monetary implosion.

The crisis was attributed to private sector failure. It expanded current account problems, mainly through impetuous loaning and accumulating nonperforming loans in the financial sector. 

When the real economy indicated weakening with drowsy commodities and an expansion in the ongoing account deficit, “hot money” streamed in. It covered the deficit, yet additionally led to reckless investments. 

Financial advancement in an uncontrolled economic area brought about misallocation and mismatching. Furthermore, unstable politics, uncertainty, and mismanagement at the political and authoritative levels added to Thailand's financial meltdown

Indonesia

Foreign investors initially had confidence in Indonesian technocrats, but the crisis hit when the Rupiah was floated in August 1997. The key factors were:

• Rupiah Depreciation: A sharp depreciation of the Rupiah occurred due to high demand for the U.S. Dollar.
• IMF Intervention: Indonesia sought IMF assistance but struggled to implement necessary reforms, leading to further turmoil.

Despite the alarming signs in the Asian region, foreign investors initially remained confident in the ability of Indonesian technocrats to withstand the storm of the financial crisis as they did before in the 1970s and 1980s. 

When the pressure on the Indonesian rupiah was finally too strong, the rupiah was decided to float freely in August 1997. Since then, a very significant depreciation has occurred. 

Indonesia's currency decreased because private banks and companies wanted to buy an enormous amount of the U.S. dollar, which created a time bomb for greater inflation. 

In October 1997, Indonesia decided it needed help from the IMF. The IMF wanted to give a bailout of $43 Billion to restore market confidence in the Indonesian rupiah. 

In return, the IMF demanded some basic financial reform measures: the closure of 16 private banks, reduced food and energy subsidies, and suggested that Bank Indonesia raise the interest-rate climate. However, this reform package failed. 

Banks withdrew billions and demanded Bank Indonesia give higher loans to banks on the cliff's edge. 

Massive demonstrations complicated the situation even more, and criticism directed at the Suharto government intensified after he was re-elected president and formed a new cabinet in March 1998. 

This event led to the death of four students from the local university called Trisakti, which caused chaos in Indonesia’s city. Buildings were burned, thousands of people died, and some targeted Chinese ethnicity because they were labeled “too rich.” 

These events led to Soeharto’s resignation, and Bachrudin Jusuf Habibie replaced him. B.J. Habibie increased the rupiah’s value and strengthened the stock market.

South Korea

Government mismanagement in exchange rates and industry policies led to South Korea's crisis. The key factors were:

• False Reserves: South Korea claimed larger foreign exchange reserves than it had, causing instability.
• Default on Debts: They declared a default on debts to Japanese and Western banks and sought IMF aid.
• Chaebol Debt: Over-reliance on chaebols for loans caused failures and takeovers in the economy.

The Korean financial crisis arose because of government failure in two policy areas: exchange rate policy and industry policy.  

Stanley Fischer, a US economist who served as the First Deputy Managing Director of the IMF (International Monetary Fund), inspected the Bank of Korea then. After being inspected, it turned out that South Korea no longer had the reserves that the Central Bank of Korea had always promoted at that time. 

They also declared a default on their debts to Japanese and Western banks and asked the IMF for help. Thailand, Indonesia, and South Korea finally experienced a decline in confidence, and their currencies depreciated. 

The Korean government's bad management of Korea's bad loans was why the Korean Won exchange rate is terrible. Financial reforms in the mid-1990s opened banking activities in Korea and opened domestic banks' access to short-term international loans. 

Because these chaebols have been "close" to the government for a long time, they have never had difficulty getting loans from Korean and foreign banks to expand their business. 

However, the consciously nurtured debt burden led to major failures and takeovers in the South Korean economy. In mid-1997, Korean banking debt to foreign banks was recorded at 67.3 billion USD.

Philippines

The Philippines raised interest rates to protect its Peso, but the crisis still took a toll. The key factors were:

• Interest Rate Hikes: The national bank increased interest rates substantially.
• Peso Depreciation: Despite efforts, the Peso depreciated significantly, affecting the economy.

In May 1997, the national bank Bangko Sentral ng Pilipinas first raised the interest rates by 1.75% and imposed an additional increase of 2% on 19 June.

On 3 July, the national bank interfered to protect the Peso from failing like the Baht, and by mid-July 1997, it raised the short-term rate from 15% to 32%. 

The currency value dropped from 26 pesos per dollar to 46.50 in mid-1998 to 53 pesos in July 2001. It further fell to 55.75 pesos per dollar.

During the crisis, the country’s GDP shrunk by 0.6%. The PSE Composite Index also fell from 3,448 to 1,000 places in 1997.

The Philippines was stronger in the Asian emergency compared with its Asian neighbors since the loans were productive, their financial management was better, and available credit to businesses did not contract similarly to its neighbors. 

Its export growth is solid, as it has more ground-exchanging attachments with the United States. And finally, it has a huge overseas workforce remitting foreign currency that covers its current interest payment on public debt.

China

China managed to maintain its currency peg during the crisis. The key factors were:

• RMB Peg: China resisted devaluing its currency despite competitive pressures.
• Slow Growth: Economic growth slowed, revealing structural issues and non-performing loans.

In 1998, the Chinese renminbi (RMB) had been pegged to the U.S Dollar for 8.3 RMB to a dollar. Some speculate that because of China’s competitiveness in its exports across the ASEAN Nation, China would soon be forced to devalue its currency. 

The RMB successfully safeguarded its value amidst speculations by maintaining its currency peg. In July 2005, it appreciated by 2.3% against the US dollar, exerting pressure on the United States.

Unlike most Southeast Asian nations' investments, China's foreign investment took the form of lands instead of securities, which was isolated from rapid capital flight.

Even though China was unharmed by the crisis in 1998, its GDP growth was slow, drawing attention to its structural economic problems. 

To address its issue, China decided to have non-performing loans in its banking system and rely heavily on trade with the U.S.

A feature that separated the RMB from other Asian economies directly affected by the financial crisis is that the RMB is convertible for current account transactions and not for capital account transactions.

This feature made it difficult for speculators to take a short position against the RMB. Also, they could not place immense leveraged bets in favor or against the currency due to the absence of a forward market.

Hong Kong (China)

Hong Kong's currency peg faced challenges during the crisis. The key factors were:

• Inflation Concerns: Rising inflation affected the pegged Hong Kong Dollar.
• Speculation: Speculators targeted the currency board system, leading to interventions.

Since 1983, the Hong Kong dollar has been pegged at 7.8 HKD a dollar. In October 1997, the rising inflation rate adversely affected the currency compared to the US.

Financial authorities spent over $1 billion to defend its local currency as their foreign reserves account had more than $80 billion.

On 23 October 1997, it raised the interest rate from 8% to 23%, and at one highlight, '280%'.The HKMA had perceived speculators were exploiting the city's remarkable currency-board system, in which short-term rates(HIBOR) naturally expand about enormous net deals of the local currency. 

The rate climbed but pressured the stock market, allowing speculators to benefit by short-selling shares. The HKMA began purchasing part portions of the Hang Seng Index in mid-August 1998.

Hong Kong's position was relatively strong among other Asian countries during the crisis, but there were some problems 

1. There was a huge property bubble
2. Households were high in debt due to mortgage borrowing
3. Property developers were over-geared, including corporates. 
4. Hong Kong could only export and spend more than it could earn because trade deficits were around 3% of GDP. 

So Hong Kong’s LERS became a noticeable target because of the loss of competitiveness of the HKD concerning the USD, size and high liquidity of the market, and various funds development opportunities.

Malaysia

Malaysia imposed capital controls to combat the crisis. The key factors were:

• IMF Influence: The IMF and the U.S. contributed to the crisis through financial deregulation.
• Ringgit Crisis: Speculative attacks caused the Ringgit to plummet, leading to capital controls.

The International Monetary Fund and the US caused the crisis in the Malaysian economy by encouraging the discount adoption of financial deregulation in both capital records and the financial area. 

Unregulated capital streams combined with fixed trade rates flooded Southeast Asian economies, which were benefiting from arbitrage opportunities. 

In July 1997, not long after the Thai baht depreciation, the Malaysian ringgit was vigorously exchanged by speculators.

The short-term rate bounced from under 8% to more than 40%. This led to rating minimization and a general sell-off in the stock and currency markets.

By the end of 1997, ratings had fallen many scores from speculation grade to trash, and the KLSE and the ringgit lost more than 50% of their value. The former fell from 1,200 to less than 600 and later fell from 2.50 to under 4.57 (23 January 1998) regarding the dollar.

The then head of the state, Mahathir Mohamad, forced severe capital controls and presented a 3.80 stake against the U.S. dollar.

Mongolia

Mongolia's economy suffered due to external shocks from the Asian and Russian financial crises. The key factors were:

• Natural Disasters and Exports: Mongolia's exports collapsed in 1998 after natural disasters.
• Price Drops: A decline in commodity prices, including copper and cashmere, hurt the economy.

The cause of the Mongolian financial crisis was the Asian financial crisis of 1997 to 1998 and the Russian crisis in 1999. 

Mongolia's economy was on hold in 1996 because of a series of natural disasters and an increased price of copper and cashmere, then in 1997-1999, was improved. 

However, because of the Asian financial crisis, revenue streams and exports collapsed in 1998. In August and September 1999, the ban on oil exports from Russia also suffered.  

Mongolia was hit hard by the economic crisis, remarkably, a fall in item costs. Gross Domestic Product (GDP) shrunk by 1.6% in 2009 after a growth of 8.9 percent in 2008.

The nation is barely well-specialized in producing some essential goods, with minerals comprising 70% of total exports. 

Since mid-2008, the costs of main export goods, including copper, zinc, crude oil, brushed goat-down, and cashmere, dropped by near or above 50%; however, the costs of coal and gold remain stable. 

Furthermore, construction activities fell drastically in 2009 as public and private areas reduced investments, and bank loans became harder.

The primary effects of the crisis were:

1. Labor market effects (e.g., reduced wages, increased discrimination in the labor sector, higher competition for jobs, and a decreased profitability of small businesses of the poor)
2. Price shocks
3. Social changes (increased crime rates and liquor misuse). Poor people feel these effects

Singapore

Singapore's economy briefly entered a recession during the crisis but recovered. The key factors were:

• Government Measures: Active government management and fiscal policies helped cushion the impact.
• Devaluation: A gradual devaluation of the currency and infrastructure projects aided recovery.

As the financial crisis spread, Singapore’s economy went into a short recession. However, the brief span and milder impact on its economy were credited to the active management by the government. 

For instance, the financial authorities of Singapore considered a gradual 20% devaluation of their dollar to ease the landing. 

The plan for government projects such as the Interim Upgrading Program and other construction-related projects was brought forward. 

Instead of permitting the labor markets to work, the National Wage Council agreed to the Central Provident Fund, reducing labor costs with limited impact on disposable income and local demand. 

Unlike Hong Kong, no attempt was made to intervene in the capital market, and the Straits Time Index was permitted to drop by 60%. In less than a year, the Singaporean economy has recovered and continues on its growth trajectory. 

The Singapore government carried out a large group of measures in 1998 with two key targets: lower business costs and relief to people and families. A portion of these was set up until 1999 and others until 2000.

The 1998 budget did not include strong areas to counter the effects of the regional economic crisis, as the economy was still doing great when it was announced in February 1998. 

However, it did include measures to help with bringing down business costs, for example:

• A 15% local charge discount for business and industrial properties
• Property tax exemption of as long as five years for land under development 
• Removing stamp duty on all instruments besides those connected with stock, shares, and immovable properties.
• People and families also got help, such as a 5% individual tax refund, discounts on service and conservation charges, and rentals on Housing and Development Board flats

As Singapore came into recession at the end of 1998, the government reported one more package worth S$10.5 billion in November, focusing on reducing business costs by 15%.

A major component was a 10% cut in the employer's Central Provident Fund contribution rate. Another key component included a 10% corporate tax rebate, a decrease in wages of 5% to 8% decrease in wages, and cuts in a wide range of government rentals, rates, and costs.

Japan

Japan, a key player in Asia, faced pressure during the crisis. The key factors were:

• Yen Devaluation: The Yen devalued, but Japan's substantial currency reserves ensured stability.
• Global Concern: Japan's role in the global economy made its stability vital for the region.

The crisis put Japan under much pressure, and Japan’s economy was prominent in Southeast Asia. Asian countries usually run an import/export deficit with Japan. 

This is because Japan's wealth is twice the size of the rest of Asia combined. As a result, about 40% of Japan's exports go around Asia. 

The Japanese yen devalued to 147 as mass selling started, but Japan was the world’s biggest holder of currency reserves at the time, so it was secure and easily bounced back. 

Given the remarkable job of Japan in the worldwide economy, particularly in Asia, it is also an important matter of concern for Japan's neighbors and the global community.

On fiscal policy, another solution offered a package of 16 trillion yen, around 3% of GDP, which would be a good starting point. But, unlike previous events, the program is going near the starting point.

The well-known reservations about developments in inefficient public spending are true; that is why a large part of the package, around half of it, should appear as tax reductions. 

Anyone doubting the package must rethink the effectiveness of last year’s tax increase in curbing demand.

Governments require a comprehensive and transparent approach that could leverage public assets or funds to ensure those bad debt problems are behind them. Essential components of this approach are:

• Early identification and brief conclusion of unsolved establishments
• Aggressive efforts to discard problem loans
• Connecting future injections of public assets to solid restructuring plans, including a necessity to raise investments from the market

Such measures are being taken in different countries, some of which are in a crisis, to manage the banking sector problems. The delay has no benefits but contributes to Japan's slow development. 

Another thing is the requirement for transparency. In the banking and financial sectors, problems have continued to some degree because of a lack of transparency. The lack of transparency causes the problem to stay a bit longer.

IMF’s Role In The Asian Financial Crisis

The International Monetary Fund, commonly called the IMF, is an international organization dedicated to fostering financial cooperation and facilitating global trade while alleviating poverty and promoting financial stability within nations.

In instances where the impact of a crisis reaches significant proportions, nations severely affected often require external intervention. Given the immense financial stakes involved, assistance during such crises typically necessitates a collaborative and international approach.

Countries grappling with the repercussions of a crisis often seek the IMF's aid. Consequently, the IMF has extended multiple financial rescue packages exceeding $100 billion during previous financial crises.

Thailand received $17.2 billion, Indonesia $43 billion, and South Korea $59 billion as part of these bailout packages to bolster their financial stability.

These bailout packages consist of loans to ameliorate a nation's economic growth and governance. They are contingent upon countries' commitment to reduce government expenditures, address underperforming financial institutions, and raise interest rates.

The objective is to bolster the nation's currency value and enhance confidence in its financial solvency.

The IMF's intervention in crisis-affected nations involves providing loans to stabilize their economies. These loans come with the stipulation that countries adhere to the IMF's prescribed regulations.

With the conditions set by the IMF, most countries began to exhibit signs of recovery by 1999. However, despite the IMF's significant assistance during the Asian financial crisis, its strategies faced criticism.

Critics argue that the IMF's recommended policies often prioritize foreign investors over domestic ones, sometimes exacerbating a nation's economic challenges.

Despite the criticisms leveled against it, the IMF asserts that it played a constructive role in aiding the Asian economies' recovery following the 1997 financial crisis.

The IMF extended substantial financial support for the recovery efforts. Nonetheless, the IMF acknowledges that the measures it implemented did not yield immediate results due to concerns regarding transparency and openness.

The IMF Supported Programs That Solved The Crisis 

The strategies are tailored to restore the country's economies and help spot weaknesses in each country. The strategies were implemented in Thailand, Indonesia, and South Korea, and they involved: 

1. Monetary Policy

It must be strong enough to hold its position from currency devaluation, with its potential to damage domestic inflation and the balance sheets of domestic financial institutions and businesses with large foreign currency exposures. 

If the basic problems are fixed and confidence is restored, then interest rates, taxed, can be allowed to return to their standard rates. 

2. Financial Sector Rectification 

Weak spots are the leading cause of the Asian Crisis and require specific urgent attention. In many cases, weak but practical monetary institutions should be restructured and recapitalized. Those that have collapsed should be shut down or taken by a more prominent institution.

Some US$35 billion of IMF financial support was provided for change and reform programs in Thailand, Indonesia, and Korea, with the help of Indonesia being augmented further in 1998-1999.

Even though not all financing emerged, Some US$85 billion of financial support was committed from other multilateral and bilateral sources. In addition, collaborative action was initiated to stem private capital outflows. 

3. Governance

Should improve for the public and corporate areas, transparency and accountability. Weaknesses are spotted in the financial and corporate sectors. 

Many new troubles came from extensive government intervention in the economy, widespread political support, nepotism, and lax accounting practices. 

4. Fiscal Policies And Resource Reallocation

Should focus on the government's savings and take action for the cost of restructuring and recapitalizing the banking system. In addition, resources should be reallocated from unproductive activities for the public.

Researched and authored by Ilhaam Prayudi | LinkedIn

Rewritten by Kathy Azzi | LinkedIn

Reviewed and Edited by Shahrukh Azim Butt | LinkedIn

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