Asian Financial Crisis

The Asian financial crisis occurred in 1997 due to continual currency devaluations, leading to stock market fluctuations and asset price changes. The market turmoil began in Thailand as it unpegged the Thai baht from the US dollar. And it quickly spread to many other East and Southeast Asian countries and global markets.

The crisis, also known as the Asian Contagion, resulted in the failure of businesses, political turmoil, and lower import revenues. Corporate loans performed poorly, negatively impacting economies. Thus, it affected the economic status of the global population, particularly Asians. The Asian economies quickly recovered from the crisis in 1998-1999.

• The Asian financial crisis began in 1997 due to constant currency devaluations, which caused stock market and asset price volatility.
• It started in Thailand when it unpegged the Thai baht to the U.S. dollar. It swiftly spread to other East, Southeast Asian, and international countries, resulting in the failure of businesses, political turmoil, and lower import revenues.
• Currency depreciation and a sluggish stock market in Asian stock markets impacted the financial systems of Europe, the United States, and Russia.
• The International Monetary Fund announced numerous bailout packages worth $118 billion to assist the crisis-affected countries to stabilize their economies and support currency values.

The Asian financial crisis emerged due to the collapse of currency exchange rates following East Asia's stellar economic performance. Given the booming financial structure of the East and Southeast Asian regions, this portion of the world became one of the most sought-after locations for investors to spend in.

The financial crisis began when Thailand sought to unpeg the Thai baht from the US dollar. The lack of foreign currency resulted in currency devaluations of about 70% on July 2, 1997. As a result, the government found it difficult to maintain and sustain its exchange rate and floated the local currency, causing its exchange rate to plummet.

It led to an unexpected financial turmoil that impacted significant parts of Asia. The tiger economies (Thailand, South Korea, Indonesia, Malaysia, the Philippines, and Singapore) saw their domestic currencies depreciate to 38%. Furthermore, the stock markets in these countries declined.

Within a year, Asian economies suffered a sharp decline in capital inflows of over $100 billion and a 60% drop in the value of overseas stocks. While the Thai baht lost nearly 50% of its value in the first six months, the Indonesian rupiah lost 80% of its value, and the South Korean won and Malaysian ringgit lost around 50% and 45% of their value.

Asian stock markets hit multi-year lows in August 1997, and the crisis expanded throughout the world. The financial systems of Europe, the United States, and Russia were all affected by the currency depreciation and sluggish stock market. In addition, many Asian countries experienced political turbulence due to this event. These economies, however, began to recover in 1998–1999.

While the actual reasons for the Asian financial crisis of 1997-1998 are still unknown, numerous events contributed to its onset. The continuous devaluation of the local currencies, asset price changes, and stock market fluctuations led to the financial crisis, declining the GDPs of these countries by double digits.

Tiger economies became the regions that global investors hoped to invest in. Thus, massive foreign investments were made, and the export market in East Asian countries grew. Interest rates were kept high, and the currency exchange rate was fixed in favor of exporters to entice more investors. Unfortunately, it put the capital market and businesses at risk of foreign exchange volatility.

The major cause of the Asian Contagion was a huge foreign direct investment (FDI) and bad debts and real estate mortgage loans issued without verification following the export growth. As a result, the investment quality was reduced. In addition, the massive outflow of capital from Asian countries put downward pressure on local currencies, making it difficult to maintain their exchange rates.

Each factor acted as one of the Asian financial crisis causes in one way or another, from the Federal Reserve's attempt to deal with the Great Recession to the Chinese Yuan devaluation to 30% in 1994. To encourage capital flow into the U.S. market, the former cut the interest rate against inflation. However, it strengthened the US dollar, which hampered export development and frightened international investors willing to invest in Asian countries.

On the other hand, the latter negatively affected the export growth of Southeast Asia. Moreover, due to the economic downturn, several firms shut down. In addition, multiple banks collapsed, and the unemployment rate increased.

Because of the negative Asian financial crisis impact on the rest of the world, the International Monetary Fund (IMF) stepped in to help. It proposed multiple bailout packages to aid countries affected by the crisis. The packages varied in value from $20 billion to Thailand, $59 billion for South Korea, and $40 billion for Indonesia. IMF also ensured that the countries did not default.

The agency gave a total of $118 billion in financial assistance with over $110 billion in short-term loans to the affected countries in return for them increasing interest rates and taxes, encouraging privatized state-owned businesses, and reducing public expenditure.

The IMF also got help from other financial institutions, such as the World Bank and the Asian Development Bank, and governments from the Asia-Pacific region, Europe, and the United States, to get these countries out of crisis and stabilize their economies.

The devaluation of currencies was the catalyst for the Asian contagion. Following the onset of the crisis, countries worldwide established various protective measures to ensure that their currencies remain stable and have a lenient currency value. Let us look at the lessons that not only Asian but also globe economies learned from this financial crisis:

• Avoiding asset bubbles
• Monitoring public infrastructure spending
• Having foreign exchange reserves to reduce risks
• Buying U.S. Treasuries
• Transforming economic structures to improve current account surplus and foreign exchange reserves

This has been a guide to Asian financial crisis of 1997-1998. We explain the causes & effects of Asian financial crisis along with how IMF solved it. You can learn more from the following articles -

• Currency Crisis
• Bank Run
• PIIGS