The 1997 Asian Financial Crisis – Explained

The 1997 Asian Financial Crisis was the crisis that affected many Asian countries in July 1997.

The Asian countries affected were Thailand, South Korea, Malaysia, Indonesia, Singapore, and the Philippines.

The crisis originated in Thailand.

Thailand’s currency Baht collapsed in July 1997: Thailand had a fixed exchange rate system. It had pegged the value of their currency to the US Dollar. But, in July, the Government was forced to float Baht due to speculative attacks on the currency.

The value of its currency declined and the stock market tumbled. The crisis spread to other Asian countries.

The corporates who had borrowed in foreign currency went bankrupt. They could not repay their loans as the value of their debt increased due to the devaluation of their domestic currencies.

The countries that had borrowed in foreign currency also saw an increase in their debt.

They experienced capital outflows and the confidence in their economies declined

The GDP growth rates contracted.

It initiated stock market declines across the globe

The IMF stepped in to control this crisis in 1998.

Causes of the 1997 Asian Financial Crisis

Prior to the crisis, these countries showed impressive growth rates and foreign capital inflows and were known as ‘tiger economies.’ It led to a rise in foreign debt. Due to massive capital inflows, the asset prices in these countries inflated. There was a boom in the real estate, corporate sector, and the stock market. It was an ‘economic bubble’ that had to burst at some point.

The causes of the crisis were:

1. Massive short-term foreign capital inflows: The foreign capital inflows were short-term in nature. These inflows are also known as ‘hot money; as it can move out of the country quickly, leading to instability. This is exactly what happened after the collapse of Thailand’s currency Baht. The outflow of ‘hot money’ led to the burst of the economic bubble. The prices of assets came crashing down. The companies that had invested in these assets went bankrupt and could not repay their loans.
2. Fixed exchange rate: The Asian countries had a fixed exchange rate system. It made their currency susceptible to speculative attacks. When investors lost faith in these economies, they started selling their currencies in the market. It created devaluation pressures on currencies. Eventually, Thailand had to float their currency and it triggered a crisis. The fixed exchange rate also encouraged foreign borrowing as there was no exchange rate risk for borrowers. When the countries switched to floating exchange rate system, the currencies devalued. The borrowers saw an increase in their foreign debt. Another disadvantage of the fixed exchange rate system is that in order to maintain the peg, these countries had to increase their interest rates. This attracted short-term capital inflows looking for higher interest.
3. Large current account deficit:  Thailand, Indonesia, and South Korea had large current account deficits. It means that their imports were more than exports. This current account deficit was financed by a capital account surplus. In simple words, the countries had to borrow to pay for imports.  It led to a rise in foreign debt or borrowing. The foreign debt-GDP ratio in these countries rose. (You may read: Balance of payments (BOP), Current Account & Capital Account Explained)
4. Inadequate banking regulations: The above factors encouraged corporates to borrow more in foreign currency and the banking regulations were inadequate to do proper surveillance of the borrowers.

Triggering events of the 1997 Asian Financial Crisis:

• The US raised its interest rates to combat the recession that happened there in the early 1990s: This made ‘hot money’ to flow out of the Asian countries into the US to take advantage of higher interest rates.  This caused economic instability.
• The increase in capital inflows in the US caused the US dollar to appreciate. The Asian countries had their currencies pegged to the US Dollar. It appreciated their currencies as well and made their exports more expensive. Their exports slowed down and their current account deficit deteriorated further.
• Devaluation of Chinese Renminbi and Japanese Yen: This also made their exports more expensive.

Their economic activity slowed down and the asset prices declined due to wide-spread capital outflows. Investors started attacking their currencies in the market which ultimately led to the collapse of Baht.

You may also read: The Financial Crisis 2008 Explained and The Great Depression of 1930s

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