What is the 1997 Asian financial crisis?
The 1997 Asian financial crisis refers to a macroeconomic shock that affected many Asian countries, including Thailand, the Philippines, Malaysia, South Korea, and Indonesia, where countries generally experienced rapid currency depreciation and capital outflows as investor confidence turned from excessive exuberance to contagious pessimism. Structural imbalances in the economy are becoming increasingly evident.
The crisis of 97-99 followed a series of rapid economic growth, capital inflows, and debt accumulation, resulting in an unbalanced economy.
As market sentiment shifted, foreign investors sought to reduce their holdings in these Asian countries, causing destabilizing capital flows that led to rapid currency depreciation and further loss of confidence.
Financial instability prompted the IMF to come to the rescue, providing $40 billion in financial assistance and initiating economic reforms to correct economic imbalances.
Unlike the Latin American debt crisis, the debt crisis in East Asia was caused by inappropriate private-sector lending, as high economic growth and a booming economy led private companies and corporations to seek to finance speculative investment projects, but the companies themselves ran out of money and caused a series of factors in the exchange rate to fall as they struggled to make payments.
Long-term causes of the Asian financial crisis
The ratio of external debt to GDP in the four major ASEAN countries rose from 100% to 167% between 1993 and 1996, as foreign companies attracted capital inflows from the developed world and Western investors sought better returns. The "Asian economies" offered better returns than the low-growth economies of the West.
Current account deficit: Countries such as Thailand, Indonesia, and South Korea have large current account deficits, meaning they import more goods and services than they export, reflecting their high growth and consumption.
The current account deficit was financed by hot money flows (at the expense of capital) accumulated due to rising interest rates in the East.
Fixed or partially fixed exchange rates: This made currencies vulnerable to speculation, also interest rates were used to maintain the value of the currency and this led to relatively high-interest rates in Southeast Asia, resulting in hot money flows.
Financial liberalization encouraged greater lending and contributed to asset bubbles: but the regulatory framework and structure of banks and corporates meant that loans were often made without adequate monitoring of profitability and rates of return.
Moral hazard: As governments seek rapid economic growth, they often provide implicit guarantees for private sector projects. This has been reinforced by the close relationship between large corporations, banks, and the government. This approach has encouraged private companies to focus less on project costs and to support the virtual expansion plans of the government.
Excessive glut: The boom in the economy and property markets has encouraged large-scale lending by multinationals and investors to channel capital into these fast-growing sectors of the economy. The idea that Asian economies were experiencing economic miracles because returns were guaranteed was to some extent irrational exuberance. High.
Causes of the 1997 Asian financial crisis
The rise in US interest rates
At the end of the 1990s, the United States started to raise interest rates to reduce inflationary pressures in the US. High US interest rates made Eastern Europe less attractive as a place for hot money inflows.
As the flow of hot money to the East declined, Asian currencies began to fall and governments sought to keep the exchange rate against the US dollar stable.
Speculative attacks
Speculative attacks forced Thailand to release its currency, the Thai baht, on 2 July 1997. This caused a rapid devaluation of the currency, which led to a loss of confidence in all Asian economies, and soon other countries were forced to devalue as investors sought to exit Asian currencies. Investors then realized that the earlier optimism was beginning to look false.
Defaulting on debts. In the run-up to the crisis, both governments and private companies had accumulated large foreign debts. However, currency devaluation increased the cost of debt repayment, and as a result companies and countries started defaulting on their obligations.
At this point, the IMF stepped in to try to stabilize the crisis, but its intervention proved highly controversial and many argued that its intervention made the situation worse.
The high-interest rates in Indonesia and the Philippines did not stop the devaluation of the currencies, which shows that investors were not convinced that these high-interest rates were sustainable.
The IMF's call for financial restrictions
Spending cuts, tax hikes, and privatizations in the context of austerity fiscal policy exacerbated the recession and the economy went into recession, bankruptcies increased and capital flight ensued.
Economists such as Joseph Stiglitz and Sachs stressed the importance of market sentiment in amplifying the problem. The initial problem was manageable, but as confidence faded, investors fled in a classic bank run, leading to an unstoppable decline.
Impact of the Asian financial crisis
Severe recession
Loss of confidence and rising debt payments led to companies cutting back on investment, leading to lower economic growth, and large currency devaluations affected consumer spending, pushing up the prices of imports and imported goods. This led to recessions in countries such as South Korea, Indonesia, Malaysia, and Thailand.
In dollar terms, Indonesia's GDP fell by a catastrophic 84% between June 1997 and July 1998.
Global effects
The Asian crisis affected investor confidence in the US. While low-interest rates helped stabilize the US economy, China was largely insulated from the crisis as it attracted physical capital investment and was not dependent on foreign capital inflows The crisis had a negative impact on the economy Japan has struggled with low growth for a decade.
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