1997 Asian Financial Crisis

1997 Asian Financial Crisis Asian Crisis Background Ed Vallorani December 14, 2009 Page 1,2,3 Nine Asian
n countries, South Korea, Japan, China, Hong Kong, Taiwan, Singapore, Malaysia, Indonesia and the Philippines were considered as Asian Tigers in the early 1990s. These economies were rapidly growing due to the inflow of investments, improvements in technology, increases in education, a ready supply of labor as people moved from the countryside to the cities to work in factories, and reduced restrictions on trade and commerce leading to freemarket economies. In the buildup to the 1997 crisis there was excessive borrowing. This borrowing tended to be for speculative purposes in projects such as retail space, office buildings, hotels, other real estate and other assets. The great inflows of money into these assets caused their prices to rise dramatically, creating a bubble. This speculation was fueled by national banks borrowing excessively from abroad Deregulation in the and lending excessively in their home countries.
financial sector led to easy money, which caused many speculative and bad loans to be made. It also led to large debt burdens. Since hot money tends to follow hot money, a feeling of euphoria, an I cant lose mentality, pumped money into already overvalued sectors, leading to valuations that could not be sustained. It also led to a misunderstanding of the risks involved with these investments.
As long as asset prices continued to rise, the speculation continued. In the case of these Asian countries, rapidly growing GDP and stable exchange rates kept the speculation going. In the boom years, speculative loans were made to businesses whose credit worthiness did not warrant the loans. As the crisis began, these businesses could not repay their loans. As the realization started to spread that loans could not be repaid, currency speculation began. The Thai baht was the first currency to experience problems. Expecting the currency to devalue because macroeconomic conditions dictated that the exchange rate could not be maintained at current levels, speculators sold the baht. In an almost selffulfilling prophecy the baht devalued rapidly. This only exacerbated that situation. Since Thailands debt was denominated in U.S. dollars, in just a few months it required twice as many baht to repay the dollar denominated debt. In effect, the currency devaluation doubled the debt of Thai organizations, catching more organizations in the debt crisis. At this time another phenomenon occurred. All of a sudden, investors began to reassess their investment risk, not only in Thailand, but in the entire region as well. As risk was reassessed, the events in Thailand spread like a virus to the other countries of the region. The I cant lose mentality quickly turned into an I am going to lose big unless I get out mentality. Money flows turned around quickly. Regional currencies devalued repeating the same stress for many of the countries that Thailand was suffering. As the crisis continued, the financial
problems were worse than originally expected. The crisis also exposed the varying levels of political risk inherent in each country. The crisis cascaded through the region like a row of strategically placed dominos being knocked down when the first domino falls. One way to fight the crisis would be through monetary policy; however, this was not an option for these economies. Pumping more money into their economies would only put pressure on their currencies to devalue further, making the debt crisis worse. These economies needed help from the IMF. When the IMF gets involved, it has stringent rules. One is its insistence on the raising of interest rates. Unfortunately, in the shortterm, this only deepens the recession.
Several aspects of the buildup to the crisis are worth highlighting:

1. Capital inflows into Thailand averaged over 10% of GDP during the 1990s, and reached a remarkable 13% of GDP in 1995 alone. Thailands inflows were predominately borrowing by banks and financial institutions. 2. Governments maintained exchange rates 3. Exchange rates appreciated in real terms as the capital inflows put upward pressure on
nontradeables prices.

1997 Asian Financial Crisis

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1997 Asian Financial Crisis Asian Crisis Background Ed Vallorani December 14, 2009 Page 1,2,3 Nine Asian

Several aspects of the buildup to the crisis are worth highlighting:

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