The 1997 Asian Financial Crisis

Economics in History - The Asian Financial Crisis - 1997

The Asian financial crisis was a period of financial crisis that gripped much of East Asia and Southeast Asia, beginning in July 1997 and raised fears of a worldwide economic meltdown due to financial contagion. Although the causes of the debacle are many and often disputed, it is believed to be caused by the collapse of the currency exchange rate and the hot money bubble. It started in Thailand in July 1997 and swept over East and Southeast Asia. The financial crisis heavily damaged currency values, stock markets, and other asset prices in many East and Southeast Asian countries.

What Happened:

In July 1997, the Thai government ran out of foreign currency and was hence unable to support its exchange rate. The government was forced to “float” the Thai Baht which was fixed with respect to the USD, thus collapsing the currency exchange rate immediately. 

This event was followed by the devaluations of the Philippian Peso and Indonesian Rupiah and eventually the Korean Won. 

The Hot Money Bubble: 

Hot money signifies currency that quickly and regularly moves between financial markets, which ensures investors lock in the highest available short-term interest rates. Hot money continuously shifts from countries with low interest rates to those with higher rates.

The economic developments in Thailand, Singapore, Malaysia, Indonesia, and South Korea, were mainly boosted by export growth and foreign investment. Therefore, high interest rates and fixed currency exchange rates (pegged to the U.S. dollar) were implemented to attract hot money. Also, the exchange rate was pegged at a rate favourable to exporters. However, both the capital market and corporates were left exposed to foreign exchange risk due to the fixed currency exchange rate policy. Following the recovery of the U.S. from a recession in the 1990s, the Federal Reserve raised the interest rate against inflation. The higher interest rate attracted hot money to flow into the U.S. market, leading to an appreciation of the U.S. dollar and the currencies pegged to the US Dollar. This hurt export growth. With a shock in both export and foreign investment, asset prices, which were leveraged by large amounts of credits, began to collapse. The panicked foreign investors began to withdraw. The massive capital outflow caused a depreciation pressure on the currencies of the Asian countries resulting in the eventual collapse.

Macroeconomic Effects:

The crisis had significant macroeconomic effects include sharp productions in values of currencies, stock markets, and other asset prices of several Asian countries. The powerful negative shock also sharply reduced the price of oil which reached a low of about $11 per barrel towards the end of 1998 causing a financial pinch to OPEC Nations and other oil exporters. In response to the severe fall in oil prices, supermajors that emerged in the late 1990s underwent mergers and acquisitions in an effort to improve economies of scale, hedge against price volatility, and reduce large cash reserves through reinvestment. The reduction in oil revenue also contributed to the 1998 Russian financial crisis, which in turn caused Long-Term Capital Management in the United States to collapse. Major emerging economies Brazil and Argentina also fell into crisis in the late 1990s. 

The crisis, in general, was part of a global backlash against the Washington Consensus and institutions such as the IMF and World Bank, which simultaneously became unpopular in developed countries following the rise of the anti-globalization movement in 1999. 

Many nations learned from this and quickly built up foreign exchange reserves as a hedge against attacks, including Japan, China, South Korea. Pan Asian currency swaps were introduced in the event of another crisis. However, nations such as Brazil, Russia, and India as well as most of East Asia began copying the Japanese model of weakening their currencies, and restructuring their economies so as to create a current account surplus to build large foreign currency reserves. 

IMF and Economic Reforms:

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. Due to the IMF's involvement in the financial crisis, the term IMF became synonymous with the Asian Financial Crisis itself. Assistance from the IMF all came with conditions aimed at eliminating the close government-business relationships that had defined East Asian development and replacing Asian capitalism with what neoliberalists saw to be an apolitical and thus more efficient neoliberal model of development. The IMF's support was conditional on a series of economic reforms, the "structural adjustment package" (SAP). 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.

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.

Conclusion:

The significance of the Asian financial crisis is multifaceted. Though the crisis is generally characterized as a financial crisis or economic crisis, what happened in 1997 and 1998 can also be seen as a crisis of governance at all major levels of politics: national, global, and regional. In particular, the Asian financial crisis revealed the state to be most inadequate at performing its historical regulatory functions and unable to regulate the forces of globalization or the pressures from international actors.

Written by Zoyah Virani; edited by Alexey Dudarev