The Asian financial crisis was a financial crisis that started in July 1997 in Thailand, and affected currencies, stock markets, and other asset prices of several Asian countries, many part of the East Asian Tigers. It is also commonly referred to as the Asian currency crisis or locally, although inaccurately, as the IMF crisis.
Indonesia, South Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hit by the slump. Mainland China, Republic of China (Taiwan), and Singapore were relatively unaffected. Japan was not affected much by this crisis but was going through its own long-term economic difficulties.
Until 1996, Asia attracted almost half of total capital inflow to developing countries. However, Thailand, Indonesia and South Korea had large current account deficits and the maintenance of pegged exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors.
Economists have advanced the impact of Mainland China on the real economy as a contributing factor to the crisis. China had begun to compete effectively with other Asian exporters particularly in the 1990s after the implementation of a number of export-oriented reforms. Most importantly, the Thai and Indonesian currencies were closely tied to the dollar, which was appreciating in the 1990s. Western importers sought cheaper manufacturers and found them, indeed, in China whose currency was depreciated relative to the dollar.
The Asian crisis started in mid-1997 and affected currencies, stock markets, and other asset prices of several South East Asian economies. Triggered by events in Latin America, Western investors lost confidence in securities in East Asia and began to pull money out, creating a snowball effect.
Many economists, including Joseph Stiglitz and Jeffrey Sachs, have downplayed the role of the real economy in the crisis compared to the financial markets due to the speed of the crisis. 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 points to strict monetary and fiscal policies implemented by the governments 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 relatively small risk in the real economy. The crisis has thus attracted interest from behavioral economists interested in market psychology.
From 1985 to 1995, Thailand's economy grew at an average of 9%. On May 14 and May 15, 1997, the baht, the local currency, was hit by massive speculative attacks. On June 30, Prime Minister Chavalit Yonchaiyudh said that he would not devaluate the baht, but Thailand's administration eventually floated the local currency, on July 2.
In 1996, an American hedge fund had already sold $400 million of the Thai currency. From 1985 until July 2, 1997, the baht was pegged at 25 to the dollar. The baht dropped very swiftly and lost half of its value. The baht reached its lowest point of 56 to the dollar in January 1998. Thai stock market dropped 75% in 1997. Finance One , the largest Thai finance company collapsed. On August 11, the IMF unveiled a rescue package for Thailand with more than 16 billion dollars. The IMF approved on August 20, another bailout package of 3.9 billion dollars.
The Philippines central bank raised interest rates by 1.75 percentage points in May and again by 2 points on June 19. Thailand triggered the crisis on July 2. On July 3, the Philippines central bank was forced to intervene heavily to defend the peso, raising the overnight rate from 15 percent to 24 percent. The peso fell significantly, from 26 pesos per dollar at the start of the crisis, to 38 pesos in 2000, to 40 pesos by the end of the crisis.
During the tenure of former President Joseph Estrada, the Philippine economy recovered from a contraction of .6 percent in GDP during the worst part of the crisis to GDP growth of some 3 percent by 2001. Unfortunately, scandals rocked his administration in 2001, most notably the "jueteng" scandal, which caused significant falls in the share prices of companies listed on the Philippine Stock Exchange . The stock exchange itself fell to some 1000 points from a high of some 3000 points in 1997. The peso fell even further, trading from levels of about 35 pesos to 50 pesos. Later that year, he was impeached but was not voted out of office. Massive protests caused EDSA II, which led to his resignation and lifted Gloria Macapagal-Arroyo to the Philippine presidency. Arroyo did manage to end the crisis in the Philippines, which led to the recovery of the Philippine peso to some 40 pesos by the time Arroyo became president.
In October 1997, the Hong Kong dollar, which was pegged at 7.8 to the US dollar, came under speculative pressure since Hong Kong's inflation rate was significantly higher than that of the US for years. Monetary authorities spent more than US$1 billion to defend the local currency. Despite the speculative attacks, Hong Kong managed to keep the currency pegged to the US dollar. Stock markets become more and more volatile, between, October 20 and October 23, Hang Seng Index dipped by 23%. Hong Kong Monetary Authority promised to protect the currency. On August 15, 1997, Hong Kong raised rates overnight from 8 percent to 23 percent.
South Korea is the world's 11th largest economy. Macroeconomic fundamentals were good but the banking sector was burdened with non-performing loans. Excess debt would eventually lead to major failures and take-overs. For example, in July, South Korea's third largest car maker, Kia Motors asked for emergency loans. In the wake of the Asian market downturn, Moody's lowered the credit rating of South Korea from A1 to A3, on November 28, 1997, and downgraded again to Baa2 on December 11. That contributed to a further decline in Korean shares since stock markets were already bearish in November. The Seoul stock exchange fell by 4 percent on November 7, 1997. On November 8, it plunged by 7 percent, the biggest one-day drop recorded there to date. And on November 24, stocks fell another 7.2 percent on fears that the IMF would demand tough reforms. In 1998, Hyundai Motor took over Kia Motors.
In 1997, Malaysia had a large current account deficit of over 6 percent of GDP. In July, the Malaysian ringgit was attacked by speculators. Malaysia floated its currency on August 17, 1997 and the ringgit fell sharply. Four days later, Standard & Poor's downgraded the debt rating of Malaysia. A week later, the rating agency downgraded the rating of Maybank, the largest bank of Malaysia. The same day, the Kuala Lumpur Stock Exchange plunged at 856 points, its lowest point since 1993. On October 2, the ringgit dropped again. Prime Minister Mahathir bin Mohamad introduced capital controls. However, the currency collapsed again in late 1997 when Mahathir bin Mohamad announced that the government would spend 10 billion ringgit in a road, rail and pipeline project.
In 1998, the output of most sectors declined. The construction sector contracted 23.5 percent, manufacturing shrunk 9 percent and the agriculture sector 5.9 percent. Overall, the country's gross domestic product plunged 6.2 percent in 1998. Malaysia however emerged as the fastest country to overcome the crisis after declining IMF assistance.
In June 1997, Indonesia seemed far from crisis. Unlike Thailand, Indonesia had low inflation, a trade surplus of more than 900 million dollars, huge foreign exchange reserves of more than 20 billion dollars, and a good banking sector.
But a large number of Indonesian corporations had been borrowing in U.S. dollars. During preceding years, as the rupiah had strengthened respective to the dollar, this practice had worked well for those corporations -- their effective levels of debt and financing costs had decreased as the local currency's value rose.
In July, when Thailand floated the baht, Indonesia's monetary authorities widened the rupiah trading band from 8 percent to 12 percent. The rupiah came under severe attack in August. On 14 August 1997, the managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The rupiah dropped further. The IMF came forward with a rescue package of 23 billion dollars, but the rupiah was sinking further amid fears over corporate debts, massive selling of rupiah, strong demand for dollars. The rupiah and Jakarta Stock Exchange touched a new historic low in September. Moody's eventually downgraded Indonesia's long-term debt to junk bond.
Although the rupiah crisis began in July and August, it intensified in November when the effects of that summer devaluation showed up on corporate balance sheets. Companies that had borrowed in dollars had to face the higher costs imposed upon them by the rupiah's decline, and many reacted by buying dollars, i.e. selling rupiah, undermining the value of the latter further.
The inflation of the rupiah and the resulting steep hikes in the prices of food staples led to riots throughout the country. In February 1998, president Suharto sacked the governor of Bank Indonesia, but this proved insufficient. Suharto was forced to resign in mid-1998 and B. J. Habibie became president.
The Singaporean economy managed to turn in a relatively healthy performance in comparison to her Asian peers during and as a result of the financial crisis, although its strong linkages and dependency on her regional economies still entailed some negative effects on her economy. However, its overall ability to ride out the crisis was widely noticed, and led to increased study on the Singaporean fiscal policy as possible lessons for her Asian neighbours.
As an open economy, the Singapore Dollar is open to speculative pressures, as has occurred before in 1985. With the economy so vital to Singapore's standing as an independent nation, the Singapore government manages the exchange rate of her currency to ward off potential speculative attacks.
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The People's Republic of China was largely not affected by the crisis because of the non-convertibility of the renminbi (RMB) and the fact that almost all of its foreign investment took the form of factories on the ground rather than securities. While the PRC had and continues to have severe solvency problems in their banking system, most of the deposits in PRC banks are domestic and there was not a run on the banks.
The United States and Japan
The "Asian flu" also put pressure on the United States and Japan. Their economies did not collapse, but they were severely hit.
On October 27, 1997, the Dow Jones industrial plunged 554-points, or 7.2 percent, amid ongoing worries about the Asian economies. New York Stock Exchange briefly suspended trading. The crisis led to a drop in consumer and spending confidence.
Japan was affected because its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latter's economy was more than twice the size of the rest of Asia together, and seven times China's. About 40 percent of Japan's exports go to Asia. GDP real growth rate slowed dramatically in 1997, from 5 percent to 1,6 percent and even sank into recession in 1998. The Asian financial crisis also led to more bankruptcies in Japan.
Laos was mildly affected by the crisis going from about 4700 Kip for one dollar to about 6000 Kip for one dollar.
The Asian crisis affected currencies, stock markets, and other asset prices of several Asian countries. Indonesia, South Korea and Thailand were the countries most affected by the crisis. The economic crisis also led to political upheaval, most notably culminating in the resignations of Suharto in Indonesia and Chavalit Yongchaiyudh in Thailand. There was a general rise in anti-Western sentiment, with George Soros and the International Monetary Fund in particular singled out as scapegoats.
Culturally, the Asian financial crisis dealt a setback to the idea that there is a distinctive set of Asian values, i.e. that East Asia had found a political and economic structure that was superior to the West. The Asian crisis also raised the economic prestige of the People's Republic of China considerably.
The Asian crisis contributed to the Russian and Brazilian crises of 1998, because after the Asian crisis banks were reluctant to lend to emerging countries.
The crisis has been intensively analyzed by economists for its breadth, speed, and dynamism; it affected dozens of countries, had a direct impact on the livelihood of millions, happened within the course of a mere few months, and at each stage of the crisis leading economists, in particular the international institutions, seemed a step behind. Perhaps more interesting to economists is the speed with which it ended, leaving most of the developed economies unharmed. These curiosities have prompted an explosion of literature about financial economics and a litany of explanations why the crisis occurred. A number of critiques have been leveled against the conduct of the International Monetary Fund in the crisis, including one by former World Bank economist Joseph Stiglitz.
Michael Pettis , The Volatility Machine: Emerging Economies and the Threat of Financial Collapse Oxford University Press 2001 ISBN 0195143302
Last updated: 09-03-2005 18:37:12