1997-98 Asian Financial Crisis Liang Mengmeng

Brief Introduction The Asian Financial Crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown. The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai government to float the baht. As the crisis spread, in many Asian countries occurred slumping currencies, devalued stock markets and other asset prices, and a sharp rise in private debt. Thailand, Indonesia and South Korea were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump. Mainland of China, India, Taiwan, Singapore, Brunei and Vietnam were less affected.

Causes of the debacle Thailand’s economy developed into a bubble fueled by “hot money”. Besides “hot money” problem, Malaysia and Indonesia had “crony capitalism”. Thailand, Indonesia and South Korea had large private current account deficits and the maintenance of fixed exchange rates.

Causes of the debacle (Con’d) Policies that distorted incentives within the lender-borrower relationship. A dysfunctional relationship to capital: companies were able to borrow money without many questions being asked.

IMF’s role in this financial crisis IMF stepped in to initiate a $40 billion program to stabilize the currencies of South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis. Strategies: liberalization of the financial sector (i.e. elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; pegging of the national currency to the dollar to reassure foreign investors against currency risk.

Thailand The central bank of Thailand gave up trying to support its currency, and the baht collapsed. Half of corporate Thailand had taken to gambling on its currency. A vicious circle emerged: when investors saw that corporate Thailand was bankrupt, they sold their Thai shares, and the stock market crashed. When the stock market crashed, more money fled Thailand and the baht fell further.

Indonesia On 14 August 1997, the managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The rupiah dropped further fearing corporate debts, massive selling of rupiah and strong demand for dollars. Since a large number of Indonesian corporations had been borrowing in U.S. dollars, they had to face the higher costs imposed upon them by the rupiah’s decline, and many reacted by buying dollars through selling rupiah, undermining the value of the latter further.

South Korea Banking sector was burdened with non-performing loans as its large corporations were funding aggressive expansions. the biggest contributor to the Korean financial crisis of 1997 is its gross misallocation of capital and human resources, combined with a flagrant disregard for the bottom line.

Consequence Asia The crisis had significant macro-level effects, including sharp reductions in values of currencies, stock markets and other asset prices of several Asian countries. Out of Asia International investors were reluctant to lend to developing countries, reduced the price of oil, and many nations built up foreign exchange reserves as a hedge against attacks.

Question: What were the efforts had made to the Korea’s recovery from the Financial Crisis? Suggested answer: (From Recovery form a Financial Crisis: The Case of South Korea, by Jahyeong Koo and Sherry L. Kiser) Korea recovered from its currency market panic after only a year as a result of the IMF bailout, payment reprogramming, a tight monetary policy, and the collapse of import demand.