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A short note on Asian Financial Crisis 1997-98

 The miraculous rise of Japanese economy in 1970-80s inspired many Asian countries to adopt state driven growth model. East and Southeast Asian countries mirrored the Japanese economies policies and registered an impressive growth during 1980s. These countries were nicknamed “Asian Tigers”. However, the growth bubble burst in July 1997 in Asia and soon it became a global crisis.

Asian Tigers’ economic growth were based upon the two important pillars provided by people and government, respectively. Asian countries faced low inflation and high employment rates as people were willing to work long hours at lower wages. And governments worked as catalyst providing capital and tax benefits to domestic industries. They selected industries which could successfully compete with foreign firms. Banks provided credit to businesses as per the government policies.

Banks’s Overseas Borrowings: Lower Interest Rates in the US

The US interest rates were much lower than Asian rates. Thus, Asian banks found it cheaper to borrow in dollars from US than domestic sources. These banks then investments much of their borrowings into high-risk bond markets. Banks gambled on the expectation that local currencies wouldn’t devalue against dollars. But by this way, they were exposed to foreign financial markets. On the other hand, higher interest rates in Asian countries attracted foreign capital which kept the Asian stock exchanges to northward direction. Many of these investors also bought real estate as collateral in exchange of providing loans.

The Asian Bubble Bursts in 1997

In the month of July (1997), Thailand first shown some signs of weakness in the economy. Speculators started to sell their Thai currency holdings in volumes, as they expected that its value would decline. Once the currency sell off started, investors started to dump local currencies in exchange for American dollars. Soon the panic spread to other Asian countries, and foreign investors sold off their holdings. Before it was over, many Asian stock markets collapsed, businesses filed for bankruptcy and unemployment soared. For instance, Hong Kong stock market plummeted by 40% in 197-98.

South Korea tried to curb the capital flight by paying foreign debts in dollars. But this caused further appreciation of dollars and devaluation of local currencies. The panic didn’t stop at Asian borders, it spread to Latin American countries. Foreign investors started to sell off in Brazil, Argentina and Mexico. They started to see all emerging economies from the same narrow lenses.

Factors Responsible for Crisis

  • The most important factors was integrated global financial markets.

  • Second, economic interdependence among trading partners. Thus, devaluation of one currency diminished the importing capabilities from other trading partners. So the trade volume was significantly reduced.

  • Third, internet, enables financial transactions in seconds. It reduces the government’s ability to respond quickly. Even a small rumor can be spread quickly through ICT technologies and negative sentiments can run through the market.

  • Fourth, the investors started to see all emerging markets through the same lenses. They thought problem in one meant problem in all emerging economies.

  • Lastly, the local banks were unsupervised. And often loans were made with political considerations and hid the information from public.

Asian economic crisis showed that when financial instability strikes to one country, it can spread to other countries like an outward ripples in a pond.

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