Discover It: East Asian Currency Crisis of 1997-98

Sreenadh: Hi Sir, Tell sth about The East Asian financial crisis and what caused it?

In the wake of the rising rupee and a weakening dollar, there appears to be renewed interest in the East Asian Financial crisis that happened nearly a decade ago and what lessons the world could have learned from it. Because the subject is quite complex, I prefer to write in a two parts. Here we go with the first part.

What I write below is heavily borrowed from, as usual, Wikipedia. To this I add, where appropriate some other material from other sources and at times my opinion. Those of you, who have got the patience and time, are strongly recommended to reading this:

http://en.wikipedia.org/wiki/East_Asian_Financial_Crisis

The East Asian Financial Crisis was a period of economic unrest that started in July 1997 in Thailand and South Korea with the financial collapse of Kia, a South Korean car manufacturer, and affected currencies, stock markets, and other asset prices in several Asian countries. It is also commonly referred to as the East Asian currency crisis. There is consensus on the existence of a crisis and its consequences, but what are less clear are the causes of the crisis, its scope and resolution.

What exactly was this economic unrest? And how did it affect the various markets? Thailand sparked off the crisis when in July 1997, it devalued its baht in an effort to shore up its faltering economy, abandoning costly policy of pegging the currency to the US dollar. That set off a chain reaction that turned Asia’s investment and real-estate boom into a bust, leading to a stampede by foreign investors rushing to pull money out. The crisis worsened as foreign-exchange reserves proved insufficient to prevent the region’s currencies from plummeting. As investors fled Asia after this devaluation, they set off a plunge in other currencies that had previously been propped up through fixed exchange-rate regimes. Indonesia’s rupiah fell 57% against the US dollar, causing companies to buckle under the $80 bn in foreign debt and leading to riots in Jakarta. Thailand’s baht fell 45%, and its stock market fell 75%. South Korea’s won lost half of its value, and its economy collapsed. Malaysian ringitt fell 35%. The crisis eventually spread to South America and to Russia, which defaulted on $40 bn of debt.

Effects

Indonesia, South Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hit by the slump. Mainland China, Taiwan, Singapore and Vietnam were relatively unaffected. Japan was not affected much by this crisis but was going through its own long-term economic difficulties. However, all nations mentioned above saw their currencies dip significantly relative to the US dollar, though the harder hit nations saw extended currency losses. Out of all the countries affected, South Korea was hit hardest.

Causes

As stated before, there is no real consensus on what caused the crisis. Economists differed on this variedly.

Until 1997, Asia attracted almost half of total capital inflow to developing countries. The economies of Southeast Asia in particular maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result the region's economies received a large inflow of hot money and experienced a dramatic run-up in asset prices. At the same time, the regional economies of Thailand, Malaysia, Indonesia, the Philippines, Singapore, and South Korea experienced high growth rates, 8-12% GDP, in the late 1980s and early 1990s. So when suddenly the western investors lost confidence in securities in East Asia and began to pull money out, creating a domino effect (the consequence of one event setting off a chain of similar events), the crisis resulted.