Asian Financial Crisis: Causes and Recovery

Pre-crisis economic performance in Asia

Prior to the financial crisis, the East Asian economies demonstrated high economic growth. In the 1980s and 1990s, these countries recorded high GDP growth rates of 8-10%. In the 1990s, the financial sector of ASEAN-4 countries experienced a credit boom. Banks provided both banking and non-banking credit to private borrowers. By the end of 1997, the share of bank lending to private investors in the real estate sector reached 30-40%. During this era, Asian countries attracted huge foreign direct investments. In particular, FDIs went into the real estate markets and equities. Moreover, these countries offered high-interest rates on bank deposits in order to attract foreign direct investment. Before the financial crisis, the East Asian countries had low levels of food inflation.

Asian financial crisis

The Asian financial crisis originated from the floatation of the Thai Baht in July 1997. The Thai government was forced to float its currency as it lacked support from the US Dollar, and it was no longer possible to continue with a fixed exchange rate regime. Prior to the crisis, the US also raised its interest rates, which attracted investors and caused billions of dollars of outflow from the Asian markets. The credit crunch and bankruptcies created a wave of panic throughout the East Asian countries. The financial crisis swiftly reached other East Asian countries, including Malaysia, South Korea, Indonesia, and the Philippines.

Reasons for the Asian financial crisis

The Asian financial crisis was mainly caused by weaknesses in the Asian credit market. The East Asian countries offered high-interest rates to investors supported by a fixed exchange rate regime that eventually failed. Although high-interest rates attracted foreign direct investments, they just created the economic bubble in the long term. The overextension of credit by banks in these countries made them insolvent. The fixed exchange rate regime allowed borrowers to acquire credit from external lenders that increased their country’s exposure to the foreign exchange risk.

IMFs role in the Asian financial crisis

The IMG played a vital role to bring stability to the countries that were affected by the financial crisis. It rolled out a $40 billion support package for achieving stability in the currencies of three countries, including Thailand, Indonesia, and South Korea, that was hard hit by the crisis. However, the IMF support was conditional as it enforced certain economics reforms. These reforms were referred to as Structural Adjustment Package (SAP) that required stricter fiscal and monetary policies. These reforms also forced insolvent financial institutions to shut down. However, the role of the IMF was criticised as its policy was based on the capitalist approach. Moreover, its high-interest rates approach was claimed to be contradicting the US approach for bringing stability in its economy after the recession of 2001.

The recovery process of Thailand, South Korea and Malaysia

Thailand received $3.9 billion as the IMF’s bailout package. The country increased its tax collection, and it was able to control its deficits. By 2003, it paid off its debts to the IMF, and its currency appreciated. South Korea made to the recovery stage faster than other countries because of its strict regulatory framework and close ties with the US. In Malaysia, the government implemented tightening controls over capital flow and also pegged its currency against the US Dollar. The government made the offshore use of the Malaysian Ringgit invalid, which prevented speculators from trading in the Malaysian Ringgit. The central bank also eased off the credit crunch by injecting fresh liquidity into the banking sector.