Asian Financial Crisis Explained

“It's a recession when your neighbour loses his job; it's a depression when you lose yours.”  

- US President Harry S. Truman (1884- 1972)

The remark above is rather illustrative of how we think of economic conditions of our society depending on how much we ourselves are getting impacted.

However, there wasn't much ambiguity in 1997 when several Asian economies witnessed a several financial crisis.

The Asian Financial Crisis, as it is called, began with Thailand and soon engulfed one country after another in the continent following a domino effect.

Though national and international monetary bodies intervened in the best manner possible, it took years for the affected economies to recover.

Let's dive in.

The Economic Bubble Earlier...

Asian economies saw an economic boom in 1980s and early 1990s as they saw a remarkable growth in their gross domestic products (GDPs), riding on the wave of foreign capital inflow and export-led growth.

Countries such as Thailand, Singapore, Malaysia, Indonesia and South Korea saw a growth of 8%-12% in their GPPs during those years.

The years were marked with national governments pursuing policies favourable to businesses, in particular, those engaged in manufacturing.

A lot of countries used to peg their national currencies to the US Dollar. It meant that they had to keep the exchange rates fixed which shouldn't be open to manipulation.

Though it led to an economic boom in these countries, it also meant that fluctuations in the US economy could impact these countries too.

There were other underlying concerns too.

There was a significant foreign investment, but it was a short-term inflow.

In these conditions, banks also used to lend huge loans without proper risk assessment. It was a classic case of crony capitalism where entities close to the political establishment could secure such huge loans even when they weren't really eligible.

It led to an economic bubble in these countries which was only waiting to burst.

External Shocks

In the mid-1990s, the Federal Reserve in the US began to raise its interest rates so that it could combat rising inflation.

Subsequent capital inflow in the US economy led to an appreciation in the value of the USD. Consequently, exports to the US from Asian countries became more expensive.

As a result, export-led growth in those Asian economies began to decline.

Then, we saw non-performing loans default and banks fail.

In July 1997, the foreign exchange in Thailand got depleted which forced the Thai government to float the exchange rate that used to be fixed.

Quickly, foreign investors queued up to withdraw their funds. The booming economy of Thailand came to a standstill.

The crisis spread from Thailand to other countries in the continent, thus leading to the Asian financial crisis.

Though Indonesia had sufficient reserves, its exchange rate recoiled following the devaluation of the Thai exchange rate. The sinking Rupiah led to the stock market hitting the ground.

President Suharto was forced to abdicate his position as widespread rioting took place in May 1998 due to the worsening economic crisis.

In South Korea, multiple companies and conglomerates filed for bankruptcy due to debt obligations. 

As money retreated from these countries, the exchange rates in these countries in Asia began to depreciate. 

Impact

Economic Recession

The crisis led to a severe economic recession in Thailand, Indonesia, South Korea and Malaysia. In other countries, it was relatively less severe.

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• Indonesia’s GDP growth declined from 4.7% in 1997 to –13.1% in 1998.
• In the Philippines, it declined from 5.2% in 1997 to -0.5% in 1998.
• In Malaysia, it fell from 7.3% in 1997 to -7.4% in 1998.
• In South Korea, it contracted from 6.2% in 1997 to -5.1% in 1998. 
   

Economic growth contracted and unemployment rates rose.

The period also saw a significant decline in the living standards of the populace. 

Devaluation of Exchange Rates

Let us look at the change in exchange rates as a result of the crisis. 

Asian Economies Collapse

In several countries, multiple banks and financial institutions faced insolvency. Banks failed and enterprises collapsed in the face of the crisis.

Thailand, South Korea and Indonesia were among the worst affected countries.

Hong Kong, Laos, Malaysia and Philippines were also hurt.

Brunei, China, Japan, Singapore, Taiwan and Vietnam were among the least affected countries. 
 

China and India were nearly insulated from these events as the economies in these countries weren't so closely tied to the US economy unlike the above-mentioned Asian countries.

Did Financial Assistance Help Contain the Crisis?

The International Monetary Fund (IMF) stepped in with a financial assistance worth $36 billion to three worst-affected countries, Indonesia, South Korea and Thailand. In turn, these countries revised their financial policies as per the IMF’s recommendations.

The IMF gave this financial support as part of international support packages totalling almost $100 billion.

China also provided a financial assistance worth $4 billion.

Other global organisations such as the World Bank also poured in assistance.

In total, the international financial community contributed to the tune of $118 billion to manage the Asian financial crisis. 

Reforms Introduced

The affected Asian countries began to undertake reforms as soon as the crisis unfolded and continued to implement them during the subsequent years.

Financial Sector Reforms

Weak financial institutions were closed or merged.

Stricter regulation of institutions and corporate governance laws were introduced, including disclosure requirements and independent auditing.

Insider trading and market manipulation were censured more severely in subsequent years.

Structural Reforms

The governments undertook several structural reforms such as promoting competition, liberalising markets, diversifying export base and attracting foreign investment capital inflow.

Exchange Rates Reforms

As the foreign exchange rates devalued, governments framed policies accordingly. The emphasis was on strengthening the local economies in such a way that external factors couldn't adversely affect the local conditions.

Fiscal Reforms

Several fiscal reforms were introduced such as improving tax systems and prioritising public investments.

Debt Restructuring

Debt restructuring measures were introduced so that failing institutions could manage their debt obligations and survive. 

A Quick Recap

Here is a quick timeline of the events that unfolded during the Asian financial crisis that began in July 1997 with the collapse of Thai Baht and continued into 1998. 

It wasn't before 1999 that the Asian financial crisis began to subside but the effects of it continued to linger.

It took years for the affected economies to completely recover from the crisis.

Next, we saw the Global Financial Crisis unfold in 2008.