East Asian Financial Crisis

Topics Covered

  • What Was the East Asian Financial Crisis?
  • Causes
  • Solutions to handel the situation
  • Lessons Learned From the Asian Financial Crisis

What Was the East Asian Financial Crisis?

  • The Asian financial crisis, also called the “Asian Contagion,” was a sequence of currency devaluations and other events that began in the summer of 1997 and spread through many Asian markets.
  • The Asian Financial Crisis of 1997 affected many Asian countries, including South Korea, Thailand, Malaysia, Indonesia, Singapore, and the Philippines.
  • The currency markets first failed in Thailand as the result of the government’s decision to no longer peg the local currency to the U.S. dollar (USD).
  • Currency declines spread rapidly throughout East Asia, in turn causing stock market declines, reduced import revenues, and government upheaval.

Causes

  • The Asian financial crisis, like many other financial crises before and after it, began with a series of asset bubbles.
  • Growth in the region’s export economies led to high levels of foreign direct investment, which in turn led to soaring real estate values, bolder corporate spending, and even large public infrastructure projects. Heavy borrowing from banks provided most of the funding.
  • Ready investors and easy lending often lead to reduced investment quality, and excess capacity soon began to show in these economies.
  • The U.S. Federal Reserve also began to raise its interest rates around this time to counteract inflation, which led to less attractive exports (for those with currencies pegged to the dollar) and less foreign investment.
  • The tipping point was the realization by Thailand’s investors that the rate of appreciation in that country’s property market values had stalled, and its price levels were unsustainable. This was confirmed by property developer Somprasong Land’s default and the 1997 bankruptcy of Finance One, Thailand’s largest finance company.
  • After that, currency traders began attacking the Thai baht’s peg to the U.S. dollar. This proved successful and the currency was eventually floated and devalued.
  • Following this devaluation, other Asian currencies including the Malaysian ringgit, Indonesian rupiah, and Singapore dollar all moved sharply lower.
  • These devaluations led to high inflation and a host of problems that spread as wide as South Korea and Japan.

Solutions To Handel The Situation

  • The Asian financial crisis was ultimately solved by the International Monetary Fund (IMF), which provided the loans necessary to stabilize the troubled Asian economies. In late 1997, the organization had committed more than $110 billion in short-term loans to Thailand, Indonesia, and South Korea to help stabilize the economies. This was more than double IMF’s largest loan ever.
  • In exchange for the funding, the IMF required the countries to adhere to strict conditions, including higher taxes, reduced public spending, privatization of state-owned businesses, and higher interest rates designed to cool the overheated economies. Some other restrictions required countries to close illiquid financial institutions without concern for jobs lost.
  • By 1999, many of the countries the crisis affected showed signs of recovery and resumed gross domestic product (GDP) growth. Many of the countries saw their stock markets and currency valuations dramatically reduced from pre-1997 levels, but the solutions imposed set the stage for the re-emergence of Asia as a strong investment destination.

Lessons Learned From the Asian Financial Crisis

  • ALWAYS BEWARE OF ASSET BUBBLES:Carefully watch for asset bubbles in the latest/hottest economies around the world. All too often, these bubbles pop, catching investors off-guard.
  • WATCH GOVERNMENT SPENDING:Government-dictated spending on public infrastructure projects and guidance of private capital into certain industries contributed to asset bubbles that may have been responsible for the crisis.
  • RE-EVALUATE FIXED EXCHANGE RATES:Fixed exchange rates have largely disappeared, except when they use a basket of currencies, since flexibility may be needed in many cases to avert a future crisis.