CFA, Finance, FRM

Asian Financial Crisis : Currency Battle

Asian Financial Crisis: A brief overview

The Asian Crisis started with the devaluation of currency “Baht” in Thailand and other events that affected other Asian countries like South Korea, Malaysia, Indonesia, Singapore, and the Philippines. The stock markets tumbled drastically and the value of the currency declined nearly by 60%. Heavy buying of US Treasuries to ensure the stability of currencies led to an increase in foreign debts and were the reason for spreading the crisis to other Asian countries.

The crisis was controlled by the intervention of the IMF and the World Bank. The Asian crisis in countries such as Thailand, South Korea, Japan, and Indonesia led to some much-needed changes in financial and government reforms.

Causes of the 1997 Asian Financial Crisis

All these countries showed majestic growth rates and foreign capital inflows and were known as ‘tiger economies’, prior to this crisis.  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 called ‘hot money; because it can move out of the country quickly, causing instability. This is similar to what happened after the collapse of Thailand’s currency Baht. The burst of the economic bubble was due to the outflow of ‘hot money’. The prices of assets came crashing down. The companies that had invested in these assets went bankrupt and were unable to repay their loans.
  2. Fixed exchange rate: The Asian countries had a fixed exchange rate system that made their currency susceptible to speculative attacks. The investors started to sell their currencies in the market when they lost the faith in these economies creating devaluation pressures on the currencies. Gradually, Thailand had to float their currency and it triggered a crisis. Foreign borrowing was encouraged foreign as there was no exchange rate risk for borrowers. The currencies devalued when the countries switched to floating exchange rate system and an increased their foreign debt. These countries had to increase their interest rates in order to maintain the peg and thus attracted short term capital inflows.
  3. Large current account deficit:  Thailand, Indonesia, and South Korea had large current account deficits meaning that their imports were more than exports. Capital account surplus financed this current account deficit meaning that the countries had to borrow to pay for imports. The foreign debt-GDP ratio rose to 167% in 1993-96 and went beyond 180% during the crisis.
  4. Inadequate banking regulations: The above-mentioned factors encouraged corporates to borrow more in foreign currency and also the banking regulations were insufficient to do proper surveillance of the borrowers.

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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 led ‘hot money’ to flow out of the Asian countries into the US to take advantage of higher interest rates which caused economic instability.
  • US dollar appreciated due to capital inflows in the US. Exports were more expensive as Asian countries had their currencies pegged to the US Dollar. Thus, exports slowed down and their current account deficit deteriorated further.
  • Devaluation of the Chinese Renminbi and Japanese Yen made their exports more expensive.

Response to the Asian Financial Crisis

The IMF intervened and initiated $40 billion to stabilize the currencies of Thailand, South Korea, Indonesia, and the economies that were hit hard by the crisis. The IMF funded capital was administered and the government spending and deficits were reduced. By 1999 the Asian economies started to recover and started to attract the capital inflows and the GDP of the economies started to experience a high growth rate i.e. around 8-12%.

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Lessons Learned from the Asian Financial Crisis

Many of the lessons learned from the Asian financial crisis can still be applied to situations happening today and will also help to resolve the problems that may be caused in the future.

  1. Investors should beware of asset bubbles some of them may end up bursting, leaving investors to stumble losing all the investments.
  2. Governments should keep an eye on spending. The asset bubbles could have been contributed to any infrastructure spending ordered by the government causing the crisis.
  3. Good governance plays a major in maintaining economic stability in the country.

Author: Trushali Hindocha

About the Author:

Trushali completed her graduation in Computer science and engineering, she has worked as Associate Consultant in Atos Syntel for 18 months. She is currently pursuing MMS in Finance from KJ Somaiya Institute of Management Studies and Research, Mumbai. She is also well acquainted with Tableau and programming languages like Python and R for Data Analytics.

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