One of the key characteristics of money is stability, however a currency crisis is said to occur when the value of a country's currency becomes unstable and changes rapidly thereby undermining its ability to effectively serve as a medium of exchange.
The Asian currency crisis was a period of financial meltdown which began in July 1997 and gripped the major proportion of East Asia. It remains one of the most talked about region-wide crisis in the 1990's, the sharpest to hit the developing countries, which resulted in a massive downward spiral of Asian economies hitherto seen as miracle economies and prompted the largest financial bailouts in history.(Radelet and Sachs 1998)
This paper will examine the origin of the crisis, its impact on the economies of the countries involved and the measures that have been adopted to avoid a recurrence of a similar crisis.
ORIGIN OF THE CRISIS 危机根源
Upon mutual agreement, based on the plaza accord (1985) between the US, Germany and Japan, the US dollar was devalued by about 60% to the Yen in real terms in order to alleviate the increasing US current account deficit. Japanese firms facing export competitiveness due to the appreciation of the Yen began to move production to south East Asian countries whose currencies were pegged to the dollar. This provided an ideal location for the Japanese firms in terms of international price competiveness. This inflow of investment from Japan to the South East Asian countries accelerated a pattern that led to large inflow of capital from other Asian and foreign countries into the East Asian countries. The fixed exchange rate system gave the south East Asian economies strong exports, low import prices and expected financial stability.
For years, East Asian Countries were held up as economic icons. Their typical blend of high savings and investment rates, autocratic political systems, export-oriented businesses, restricted domestic markets, government capital allocation, and controlled financial systems were hailed as the ideal recipe for strong economic growth of developing countries (Shapiro 1999). Asian economies like Taiwan, Hong Kong, Korea, Singapore and Thailand enjoyed overall average growth rates of 5.6 percent, 6.6 percent, 7 percent, 6.9 percent and 4.6 percent respectively for several decades. Indonesia and Malaysia too enjoyed good economic performance during most of the 1970s and 1980s. (Rao, 1998)
However, these "miracle economies" were brought down in July 1997 when a brewing currency crisis started from Thailand. This seed of the Asian currency crisis of 1997 were actually sown during the previous decades when these countries were experiencing unprecedented economic growth. For long, exports had long been the engine of economic growth in these countries and as such many Asian states were regarded as "Export Power Houses". The increased foreign capital inflow into these economies also propelled capital expenditure which led to an investment boom in commercial and residential properties, industrial assets and infrastructure. These capital expenditures were financed by heavy borrowings from banks which had excess liquidity but no strong regulatory frameworks. Thus, by the mid 1990s, South East Asia was experiencing an unprecedented investment boom, much of it financed with foreign investments and borrowings. The case was made worse as much of the foreign borrowings had been in US dollars as opposed to local currencies. At the time, this had seemed like a smart move (i.e. regional local currencies were pegged to the dollar and interest rates on dollar borrowings were generally lower than rates on borrowings in domestic currency, and it made economic sense to borrow in dollars if the option was available); but, many of the investments made with these funds were on the basis of projections about future demand conditions that were unrealistic.
Soon, there were indications of macroeconomic imbalances in the Thai economy; the real exchange rate had risen to an apparently unsustainable level and the current account was also in constant huge deficit. Rao (1998). Also, Asian Countries started to see their ballooned volume of investments during the 1990s declining significantly. Paul krugman (1999) stated the Asian countries attracted so much foreign capital that their economic growth was fuelled more by sheer volume of investment rather than by the productivity of those individual investments. Therefore the governments in the region could not maintain their dollar peg and their currencies started to depreciate against the dollar, this increased the size of the debt burden that needed to be serviced when measured in local currency. This started the debt boom.
A final complicating factor was that by 1996, there became a slackening of export growth which was much noticeable in Korea, Malaysia, Singapore and Taiwan, while in Thailand there became a decline in the dollar value of exports. This decline in export did not stop growing import and this disparity saw many south Asian countries shifting strongly into the "red" during the mid 1990s. By 1995, Indonesia was running a current account deficit that was equivalent to 3.5% of its Gross Domestic Product (GDP), Malaysia's was 5.9% and Thailand's was 8.1%. With deficits like these starting to pile up, it was becoming increasingly difficult for the governments of these countries to maintain the peg of their currencies against the U.S dollar.
Thus by 1997, the first obvious indication of the crisis started with the Thai economy. Thailand could no longer defend their currency and therefore floated the baht on the 2nd of July 1997. (Rao, 1998). Prompted by these developments in Thailand, investors saw basically the same issues facing Thailand surfacing in other neighbouring countries. As a result, investors panicked; their fears were not allayed especially because of lack of transparency regarding issues such as the extent of government and private debt, the health of the financial sectors and no trust in the government to take pre-emptive corrective actions. This led to massive capital flight. The withdrawal of foreign currency led to dramatic depreciation in exchange rate and higher interest rates. This led to an increase in the number of non-performing loans, causing an erosion of the market value capital of most of the countries. Thus, the scene was now set for a potential rapid economic breakdown.
There is no consensus on the exact origin of the currency crisis in East Asia; while some schools of thought believe that the crisis was caused by the initial financial turmoil in some Asian countries, followed by regional contagion (Radelet and Sachs, 1998; Marshall, 1998; and Chang and Velasco, 1999), others believe it occurred as a result of policy and structural distortions (Corsetti, Pensetti and Roubini; 1998). However, most of the East Asian economies were interdependent, hence it was only logical that a crisis in one would have a domino-effect and inadvertently cause a crisis in other East Asian Economies that were linked to it.
Using a Signalling approach based EWS model, it shows that persistent warning signals prior to the 1997 crisis was not just in a few but all of the five countries most affected by the crisis. The findings of this model supports the fact weaknesses in economic and financial fundamentals in these countries triggered the crisis.
The Impact of the crisis on the Economics of the countries involved.
As Thailand floated the baht on July 2 and allowed the currency to fall, wave after wave of speculation hit other Asian currencies, a de-facto devaluation of the Philippine Peso followed on July 11. Korean Won too lost. Malaysia let its currency, the ringgit float on July 14th 1997, as foreign exchange reserves had gone down to $ 28 billion. Singapore followed on July 17th and the Singapore dollar (S $) quickly dropped in value from $1 = S $ 1.495 prior to the devaluation to $1 = 2.68 a few days later. A month later on August 14, Indonesia floated the rupiah. This was the beginning of a precipitous decline in the value of the Indonesian currency as a fall was seen from $1 = 2,400 Rupiah in August 1997 to $1 = 10,000 Rupiah on January 6th, 1998, a loss of 75% (Rao, 1998).
The Chart (above) shows the monthly evolution of the currencies of the eight South-East Asian countries during the crisis from July 1997 to April 1998. The Five countries where the crisis where particularly serious (Figure 1A) saw more decline in their currencies than countries in Figure 1B even though all countries shown were affected.Â
The economy of Thailand where the crisis started from suffered a real sharp decline. Total export earnings declined and a trade deficit rose to $ 16 billion. With the deficit standing at over 8 percent of GDP and its financing largely coming from short term funds; the external debt of Thailand rose to $68.1 billion. The non-performing loans of banks and finance companies in Thailand were estimated to be around 12 percent of total loans in mid 1997. The Thailand economy was also plagued by a deteriorating external sector, a stock market decline (the stock market index fell from 1683 in 1993 to below 500 in1997) and most importantly dwindling forex reserves. A decline in investment saw the closure of investment houses which resulted in immediate unemployment rates of between 6 and 10 percent (Rao, 1998).