Asian Financial Crisis

The Asian financial crisis was a financial crisis that started in July 1997 in Thailand and affected currencies stock markets and other asset prices of several Asian countries many part of the East Asian Tigers . It is also commonly referred to as the Asian Currency Crisis.

Indonesia, South Korea and Thailand were the countries most affected by the crisis with Malaysia, Philippines and Hong Kong also hit by the slump. Mainland China and Taiwan were relatively unaffected. Japan was not affected much by this crisis but was going through its own ongoing long-term economic difficulties.

History

Until 1996 Asia attracted almost half of total capital inflow to developing countries. However Thailand Indonesia and South Korea had large current account deficits and the maintenance of pegged exchange rate encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors.

The Asian crisis started in mid-1997 and affected currencies stock markets and other asset prices of several South East Asian economies. Triggered by events in Latin America Western investors lost confidence in securities in East Asia and began to pull money out creating a snowball effect.

Thailand

From 1985 to 1995 Thailand's economy grew at an average of 9%. On May 14 and May 15 1997 the baht the local currency was hit by massive speculative attacks. On June 30 Prime Minister Chavalit Yonchaiyudh said that he would not devaluate the baht but Thailand's administration eventually floated the local currency on July 2.

In 1996 an American hedge fund had already sold $400 million of the Thai currency. From 1985 until July 2 1997 the baht was pegged at 25 to the dollar. The baht dropped very swiftly and lost half of its value. The baht reached its lowest point of 56 to the dollar in January 1998. Thai stock market dropped 75% in 1997. Finance One the largest Thai finance company collapsed. On August 11 the IMF unveiled a rescue package for Thailand with more 16 billion dollars. The IMF approved on August 20 another bailout package of 3.9 billion dollars.

Philippine

The Philippines central bank raised interest rates by 1.75 percentage points in May and again by 2 points on June 19. Thailand triggered the crisis on July 2. On July 3 the Philippines central bank was forced to intervene heavily to defend the peso raising the overnight rate from 15 percent to 24 percent.

Hong Kong

In October 1997 the Hong Kong dollar which was also pegged at 7.8 to the US dollar came under speculative pressure since Hong Kong's inflation rate was significiantly higher than that of the US for years. Monetary authorities spent more than US$1 billion to defend the local currency. Despite the speculative attacks Hong Kong managed to keep the currency pegged to the US dollar. Stock markets become more and more volatile between October 20 and October 23 Hang Seng Index dipped by 23%. Hong Kong Monetary Authority and the People's Republic of China promised to protect the currency. On August 15 1997 Hong Kong raised overnight rates from 8 percent to 23 percent.

South Korea

South Korea is the world's 11th largest economy. Macroeconomic fundamentals were good but the banking sector was burdened with non-performing loans. Excess debt will eventually lead to major failures and take-overs. For example in July South Korea's third largest car maker Kia Motors asked for emergency loans. In the wake of the Asian market downturn Moody's lowered the credit rating of South Korea from A1 to A3 on November 28 1997 and downgraded again to Baa2 on December 11 . That contributed to a further decline in Korean shares since stock markets were already bearish in November. Seoul stock exchange fell by 4 percent on November 7 1997. On November 8 it plunged by 7 percent the biggest one-day drop ever recorded there to date. And on November 24 stocks fell another 7.2 percent on fears that the IMF may demand tough reforms. In 1998 Hyundai Motor took over Kia Motors.

Malaysia

In 1997 Malaysia had a large current account deficit of over 6 percent of GDP. In July the Malaysian ringgit was attacked by speculators . Malaysia floated its currency on August 17 1997 and the ringgit fell sharply. Four days later Standard & Poor's downgraded the debt rating of Malaysia. A week later the rating agency downgraded the rating of Maybank the largest bank of Malaysia. The same day the Kuala Lumpur Stock Exchange's plunged at 856 points its lowest point since 1993. On October 2 the ringgit dropped again. Prime Minister Mahathir Mohamad introduced capital controls. However the currency collapsed again in late 1997 when Mahathir Mohamad announced that the government would spend 10 billion ringgit in a road rail and pipeline project.

In 1998 output of most sectors declined. The construction sector contracted 23.5 percent manufacturing shrunk 9 percent and the agriculture sector 5.9 percent. Malaysia's gross domestic product plunged 6.2 percent in 1998. Malaysia emerged as the fastest country to overcome the crisis after declining IMF assistance.

Indonesia

In June 1997 Indonesia seemed far from crisis. Unlike Thailand Indonesia had low inflation a trade surplus of more than 900 million dollars huge foreign exchange reserves of more than 20 billion dollar and a good banking sector.

But a large number of Indonesian corporations had been borrowing in U.S. dollars. During preceding years as the rupiah had strengthened respective to the dollar this practice had worked well for those corporations -- their effective levels of debt and financing costs had decreased as the local currency's value rose.

In July when Thailand floated the baht Indonesia's monetary authorities widened the rupiah trading band from 8 percent to 12 percent. The rupiah came under severe attack in August. On 14 August 1997 the managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The rupiah dropped further. The IMF came forward with a rescue package of 23 billion dollar but the rupiah was sinking further amid fears over corporate debts massive selling of rupiah strong demand for dollars. The rupiah and Jakarta Stock Exchange touched a new historic low in September. Moody's eventually downgraded Indonesia's long-term debt to junk bond.

Although the rupiah crisis began in July and August it intensified in November when the effects of that summer devaluation showed up on corporate balance sheets. Companies that had borrowed in dollars had to face the higher costs imposed upon them by the rupiah's decline and many reacted by buying dollars i.e. selling rupiah undermining the value of the latter further.

The inflation of the rupiah and the resulting steep hikes in the prices of food staples led to riots throughout the country. In February 1998 president Suharto sacked the governor of Bank Indonesia but this proved insufficient. Suharto was forced to resign in mid-1998 and B.J. Habibie became president.

Mainland China

The People's Republic of China was largely not affected by the crisis because of the non-convertibility of the renminbi (RMB) and the fact that almost all of its foreign investment took the form of factories on the ground rather than securities. While the PRC had and continues to have severe solvency problems in their banking system most of the deposits in PRC banks are domestic and there was not a run on the banks.

The United States and Japan

The "Asian flu" also put pressure on the United States and Japan. Their economies did not collapse but they were severely hit.

On October 27 1997 the Dow Jones industrial plunged 554-point or 7.2 percent amid ongoing worries about the Asian economies. New York Stock Exchange briefly suspended trading. The crisis led to a drop in consumer and spending confidence.

Japan was affected because its economy is prominent in the region. Asian countries usually runs a trade deficit with Japan because the latter's economy is more than twice the size of the rest of Asia together and seven times China's. About 40 percent of Japan's exports go to Asia. GDP real growth rate slowed dramatically in 1997 from 5 percent to 1 6 percent and even sank into recession in 1998. The Asian financial crisis also led to more bankruptcies in Japan.

Consequences

The Asian crisis affected currencies stock markets and other asset prices of several Asian countries. Indonesia South Korea and Thailand were the countries most affected by the crisis. The economic crisis also led to political upheaval most notably culminating in the resignations of Suharto in Indonesia and Chavalit Yongchaiyudh in Thailand. There was a general rise in anti-Western sentiment with George Soros and the International Monetary Fund in particular singled out as scapegoats.

Culturally the Asian financial crisis killed the idea of Asian values which presumed that East Asia had found a political and economic structure that was superior to the West. The Asian crisis also raised the economic prestige of the People's Republic of China considerably.

The Asian crisis contributed to the Russian and Brazilian crisis in 1998 because after the Asian crisis banks were reluctant to lend to emerging countries.