Asian Financial Crisis

What Is Asian Financial Crisis of 1997?

The Asian financial crisis occurred in 1997 due to continual currency devaluations, leading to stock market fluctuations and asset price changes. The market turmoil began in Thailand as it unpegged the Thai baht from the US dollar. And it quickly spread to many other East and Southeast Asian countries and global markets.

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The crisis, also known as the Asian Contagion, resulted in the failure of businesses, political turmoil, and lower import revenues. Corporate loans performed poorly, negatively impacting economies. Thus, it affected the economic status of the global population, particularly Asians. The Asian economies quickly recovered from the crisis in 1998-1999.

Asian Financial Crisis (1997-1998) Explained

The Asian financial crisis emerged due to the collapse of currency exchange rates Exchange Rates The exchange rate is defined as the rate at which two trading countries exchange marketable items or commodities. It is essentially the cost of exchanging one currency for another. As a result, the exchange rate can be calculated by dividing money in foreign currency by money in domestic currency.read morefollowing East Asia’s stellar economic performance. Given the booming financial structureFinancial StructureThe financial structure refers to the sources of capital and the proportion of financing that comes from short term liabilities, short term debt, long term debt, and equity to fund the company's long term and short term working capital requirements.read more of the East and Southeast Asian regions, this portion of the world became one of the most sought-after locations for investors to spend in.

The financial crisisFinancial CrisisThe term "financial crisis" refers to a situation in which the market's key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more began when Thailand sought to unpeg the Thai baht from the US dollar. The lack of foreign currency resulted in currency devaluationsCurrency DevaluationsCurrency devaluation is deliberately done in order to adjust the established exchange rates by the government and it is mostly done in the cases of fixed currencies. This mechanism is used by economies with a semi-fixed or fixed exchange rate, and it should not be confused with depreciation.read more of about 70% on July 2, 1997. As a result, the government found it difficult to maintain and sustain its exchange rate and floated the local currency, causing its exchange rate to plummet.

It led to an unexpected financial turmoil that impacted significant parts of Asia. The tiger economies (Thailand, South Korea, Indonesia, Malaysia, the Philippines, and Singapore) saw their domestic currencies depreciate to 38%. Furthermore, the stock marketsStock MarketsStock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price.read more in these countries declined.

Within a year, Asian economies suffered a sharp decline in capital inflows of over $100 billion and a 60% drop in the value of overseas stocks. While the Thai baht lost nearly 50% of its value in the first six months, the Indonesian rupiah lost 80% of its value, and the South Korean won and Malaysian ringgit lost around 50% and 45% of their value.

Asian stock markets hit multi-year lows in August 1997, and the crisis expanded throughout the world. The financial systemsFinancial SystemsA financial system is an economic arrangement wherein financial institutions facilitate the transfer of funds and assets between borrowers, lenders, and investors.read more of Europe, the United States, and Russia were all affected by the currency depreciationCurrency DepreciationCurrency depreciation is the fall in a country’s currency exchange value compared to other currencies in a floating rate system based on trade imports and exports. For example, an increase in demand for foreign products results in more imports, resulting in foreign currency investing, resulting in domestic currency depreciation.read more and sluggish stock market. In addition, many Asian countries experienced political turbulence due to this event. These economies, however, began to recover in 1998–1999.

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Causes and Effects

While the actual reasons for the Asian financial crisis of 1997-1998 are still unknown, numerous events contributed to its onset. The continuous devaluation of the local currencies, asset price changes, and stock market fluctuations led to the financial crisis, declining the GDPsGDPsGDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period.read more of these countries by double digits.

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Tiger economies became the regions that global investors hoped to invest in. Thus, massive foreign investmentsForeign InvestmentsForeign investment refers to domestic companies investing in foreign companies in order to gain a stake and actively participate in the day-to-day operations of the business, as well as for essential strategic expansion. For example, if an American company invests in an Indian company, it will be considered a foreign investment.read more were made, and the export market in East Asian countries grew. Interest ratesInterest RatesAn interest rate formula is used to calculate loan repayment amounts as well as interest earned on fixed deposits, mutual funds, and other investments. It is also used to calculate credit card interest.read more were kept high, and the currency exchange rate was fixed in favor of exporters to entice more investors. Unfortunately, it put the capital marketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets.read more and businesses at risk of foreign exchange volatility.

The major cause of the Asian Contagion was a huge foreign direct investment (FDI)Foreign Direct Investment (FDI)A foreign direct investment (FDI) is made by an individual or an organization, into a business located in a foreign country. The host nation receives job creation prospects, advanced technology, a higher standard of living, infrastructural development, and overall economic growth.read more and bad debtsBad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation.read more and real estate mortgage loans issued without verification following the export growth. As a result, the investment quality was reduced. In addition, the massive outflow of capital from Asian countries put downward pressure on local currencies, making it difficult to maintain their exchange rates.

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Each factor acted as one of the Asian financial crisis causes in one way or another, from the Federal Reserve’s attempt to deal with the Great Recession to the Chinese Yuan devaluation to 30% in 1994. To encourage capital flow into the U.S. market, the former cut the interest rate against inflationInterest Rate Against InflationThe inflation rate is the change in the price of goods and services, which represents the rising cost and demand for various goods. In contrast, interest rate are charged by lenders to borrowers or issuers of debt instruments, and an increase in interest rates reduces demand for borrowing while increasing demand for investments.read more. However, it strengthened the US dollar, which hampered export development and frightened international investors willing to invest in Asian countries.

On the other hand, the latter negatively affected the export growth of Southeast Asia. Moreover, due to the economic downturn, several firms shut down. In addition, multiple banks collapsed, and the unemployment rateUnemployment RateThe unemployment rate formula calculates the share of people who are not working or are jobless of the total employed or unemployed labour force and is depicted as a percentage. Unemployment Rate = Unemployed People / Labor Force * 100 read more increased.

How Did IMF Help Solve Asian Financial Crisis?

Because of the negative Asian financial crisis impact on the rest of the world, the International Monetary Fund (IMF) stepped in to help. It proposed multiple bailoutBailoutA bailout refers to the prolonged financial support offered by the government or other financially stable organization to a business in the form of equity, cash, or loan to help it overcome certain losses and stay afloat in the market.read more packages to aid countries affected by the crisis. The packages varied in value from $20 billion to Thailand, $59 billion for South Korea, and $40 billion for Indonesia. IMF also ensured that the countries did not default.

The agency gave a total of $118 billion in financial assistance with over $110 billion in short-term loans to the affected countries in return for them increasing interest rates and taxes, encouraging privatized state-owned businesses, and reducing public expenditure.

The IMF also got help from other financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more, such as the World Bank and the Asian Development Bank, and governments from the Asia-Pacific region, Europe, and the United States, to get these countries out of crisis and stabilize their economies.

Lessons Learnt 

The devaluation of currencies was the catalyst for the Asian contagion. Following the onset of the crisis, countries worldwide established various protective measures to ensure that their currencies remain stable and have a lenient currency value. Let us look at the lessons that not only Asian but also globe economies learned from this financial crisis:

• Avoiding asset bubbles
• Monitoring public infrastructurePublic InfrastructureThe constructions, facilities, systems, concrete, and other structures owned and maintained by the central or state government are referred to as public infrastructure. Such facilities and services, including roads, water, electricity, and telecommunications, are offered to the general public with or without charges.read more spending
• Having foreign exchange reserves to reduce risks
• Buying U.S. Treasuries
• Transforming economic structures to improve current account surplus and foreign exchange reserves

Frequently Asked Questions (FAQs)

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This has been a guide to Asian financial crisis of 1997-1998. We explain the causes & effects of Asian financial crisis along with how IMF solved it. You can learn more from the following articles –

• Currency Crisis
• Bank Run
• PIIGS