Critical Analysis of the 1997 Asian Financial Crisis

Critical Analysis of the 1997 Asian Financial Crisis

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The 1997-1998 Asian financial crisis is one of the worst global financial and economic contagions that raised controversial debates among economic and financial analysts. This Asian Financial Crisis begun at the onset of the third quarter of the 1997 calendar year and it happened to be the third regional currency crisis since 1990, with the 1992-1993 European and the 1994-1995 Latin American currency collapses being the first and second respectively (Reinhart, & Kenneth, & Rogoff, 2009, 78). Although these earlier currency and economic crises flashed strong warnings to the leading financial institutions (International Monetary Fund) and governments on the possibility future regional financial and economic contagion, such institutions and political authorities failed to read the signs. The East Asian regional currency and financial crisis was not foreshadowed until mid-1997 when the lights flashed warnings of a possibility of a regional financial crisis. Other than Thailand that was it serious current account deficits between 1995 and 1996, other East Asian economies looked safe from currency devaluation (Rose, & Mark, 2009, 56-7). Notably, the cautionary marks of the Thais economy indicated that the possible currency crisis was sustainable both in the long-run and medium term given that over 80% of the Thais current accounts drawn financial support from the private capital inflows accounts (Radelet, & Jeffrey, 1998, 96-7). Therefore, there was no cause of alarm to the East Asian economy at large, including the most vulnerable country – Thailand. The East Asian governments blamed the financial panic and contagion for the of the 1997 exchange rate collapses and strongly believed that the currency crisis had nothing to do with the bad economic and political policies of the East Asian states. This research paper explores the possible causes and effects of this Asian Crisis-5 that mainly affected Indonesia, Philippines, Thailand, Malaysia, and South Korea. The paper will further discuss the lessons learnt from this East Asian crisis.

Cause of the 1997-98 Asian Financial Crisis

A study by Sachs, & Wing (2000, 66) identified investment boom as the primary source of the Asian crisis. During the first half of 1990s, the East Asian economy posted impressive economic growth and development that was described as the Asian miracle that was characterized by a 6-9% annual economic expansion, unprecedented Gross Domestic Product growth, and export boom (Radelet, & Jeffrey, 1998, 56). A combination of relatively educated and cheap labour, massive capital inflow and direct foreign investments, and abolition of international exports and trade barriers in a number of East Asian countries contributed to the region becoming export powerhouses. This was measured by the 18%, 16%, 15%, 14%, and 12% export growth in Malaysia, Thailand, Singapore, Hong Kong, and South Korea respectively (Radelet, & Sachs, 1998, 112). The increased returns generated by the unprecedented export led growth and expansion in Asian fueled a massive investment boom particularly in residential and commercial property, infrastructure, and industrial assets. This led to a soaring in the prices and value of residential and commercial property in major Asian cities such as Bangkok and Hong Kong. Consequently, the region witnessed investment boom in the real estate and housing sectors with heavy financial institutional borrowings to fund the booming property and real estate investments. According to Kaminsky, Saul, and Carmen, (1998, 44), the South East Asian governments of also contributed to the investment boom by heavy investing in infrastructural projects and providing incentives to encourage private investments. The investment boom resulted into excess capacity in the housing and real estate sector, thus low returns than anticipated by the investors. This ballooned investment volume during the 1990s exceeded the demand capacity, thus a significant decline in the economic returns that further led to a rapid rate of default repayment of the loans.

The second factor behind the Asian financial crisis was the regional financial and economic liberalizations. These South East Asian countries encouraged financial liberalization that allowed for easy conversion of foreign currencies into local currencies purposely to stimulate direct investments and foreign trade (Lane, & Gian, 2008, 77). Capital account transactions and capital flows were least regulated, leading to unregulated capital inflows from international banks in the form of loans extended to local companies and banks. Such highly liberalization financial policies and regulations resulted into excess foreign debts owed by the private sector. According to Dornbusch (2001, 823), the Asian financial crisis was attributed to panic and withdrawal by the lenders. The collapse of Thailand’s currency caused panic among foreign lenders and investors, resulting into credit crunch and bankruptcies. A significant proportion of foreign investors withdrew their financial resources. As a result, the troubled domestic currencies flooded the foreign exchange and capital market, thus exerting depreciative pressure on the local exchange rates (Radelet, & Jeffrey, 1998, 67).

Effects of the Asian Financial Crisis

The 1997-98 Asian financial crisis adversely affected the South East Asian macro and micro-economics performance. In general, the region that at one point boasted of the fastest growing economy in the world suffered a major economic and financial setback with a sharp drop in the GDP from over 8% in 1996 to negative 1.4% GDP (see table 1), representing economic retrogression (Corsetti, Paolo, & Nouriel 1998, 22). Thailand was the worst hit country out of the five countries that were at the helm of the Asian crisis with its GDP posting 10.8% retrogression in 1998. The South East Asian economic contraction following the 1997-98 financial crisis majorly impacted on the economic capacity to create employment opportunities. The collapsing of the leading financial institution and the decline in private investments in South East Asia led to forced laid-off of employees. Therefore, the rate of unemployment in Thailand, Indonesia, Malaysia, Hong Kong, and Philippines sky rocketed to reach a record high of 6.4% in 1999 (Sachs, & Wing, 2000, 38). As a result, the purchasing power of the employees significantly dropped, further hurting economic growth prospects. Following retrenchments, increased underemployment, and loss of employment opportunities, poverty index in Indonesia went up to 24.2% in 1998 but slightly dropped to 23.5% in the following year (Eichengreen, 1999, 18-9). Socially, the decline in the real wages forced the consumers to cut their healthcare expenditure, thus deterioration in their social and health status. Besides, the crisis led to a significant drop in school enrolment as incidences of child labour rapidly increased in Thailand and Indonesia in order to supplement on their family income.

Lessons Learnt from the 1997 Asian Financial Crisis

Although the 1997 Asian crisis came to end, it raised a number of critical issues regarding the international financial and economic systems, with particular emphasis on the development of sound international financial architectural policies. As explained Mishkin (1999, 715), the Asian crisis served as a strong lesson that prevention of such crises in future calls for designing of sound and sustainable macroeconomic policies and frameworks to govern the operations of the financial institutions. In support for Mishkin (1999), Lane and Gian (2008, 330) argued that although desirable, excessive financial and economic liberalizations are hurtful to the economy, therefore some regulations are necessary. While drumming support for the role of financial liberalization, Moreno, Gloria and Eli, (1998, 81) explained that strengthened international surveillance that focuses on complying with the international monetary standards and incorporation of regional financial policies would be essential in sounding alarm about any upcoming financial problems. He further argued that financial institutions should advance modern risk management strategies, including improved financial regulation and supervision for both creditor and debtor countries. Had this been done, then the Asian financial crisis would have been prevented. More importantly, Moreno, Gloria and Eli, (1998, 81) asserted that transparency is very fundamental in crisis prevention. According to Kaminsky, Saul, and Carmen, 1998, 43-4) lack of transparency by the central banks in the region with respect to the region’s international reserve position further exacerbated the financial market panic among investors and creditor, thus leading to the massive withdrawals witnessed in South East Asian.


In conclusion, although the financial panic and economic withdraws played a role in the spread of the Asian financial crisis, the contagion was primary attributed to investment boom that led to excess economic capacity than the effective market demand. In addition, weaken financial policies and liberations majorly contributed to this regional problem that adversely impacted on the economic, social, and political conditions in the South East Asian countries. The weaknesses of the financial sectors reflected the inability and ineffectiveness of the lenders and creditors to effectively allocate credit with least moral hazards involved. Therefore, the South East Asian economy recovery process calls for reforming and strengthening the financial institutions and systems to avoid a repeat of the same in future.

Reference List

Corsetti, G., Paolo P., & Nouriel R. 1998. “ Fundamental Determinants of the Asian Crisis: A Preliminary Empirical Assessment.” Federal Reserve Bank of New York Working Paper, pp.23-5.

Dornbusch, R. 2001. “A Primer on Emerging Market Crises.” NBER Working Paper, 8326.

Eichengreen, B. 1999. Toward a New International Financial Architecture: A Practical Post-Asia Agenda. Washington, DC: Institute for International Economics, pp.18-20.

Kaminsky, G., Saul, L. & Carmen, R. 1998. “Leading Indicators of Currency Crises,” IMF Staff Papers. Vol. 45 (March).

Lane, R., & Gian, M. 2008. “The Drivers of Financial Globalization.” American Economic Review 98(2, May), pp. 327–332.

Marshall, D., 1998. “Understanding the Asian Crisis: Systemic Risk as Coordination Failure.” Economic Perspective Third Quarter: 13-28. Federal Reserve Bank of Chicago.

Mishkin, F. 1999. “Lessons from the Asian Crisis.” Journal of International Money and Finance, 18, pp. 709–723.

Moreno, R., Gloria P., & Eli, R. 1998. “Asia’s Financial Crisis: Lessons and Policy Responses.” In Asia: Responding to Crisis. Tokyo, Asian Development Bank Institute, pp.78-85.

Radelet, S., & J. Sachs, 1998. The Onset of the East Asian Financial Crisis. NBER Working Series No. 6680, National Bureau of Economic Research, Massachusetts, pp.112-4.

Radelet, S., & Jeffrey, S. 1998. “The East Asian Financial Crisis: Diagnosis, Remedies, Prospects,” Brookings Papers on Economic Activity, Vol. 1, 56.

Reinhart, M., & Kenneth, & Rogoff, G. 2009. This Time Is Different: Eight Centuries of Financial Folly. Princeton, NJ: Princeton University Press, pp.65-7.

Rogoff, K. 1999. “International Institutions for Reducing Global Financial Instability.” Journal of Economic Perspectives 13(4), pp. 21–32.

Rose, K., & Mark, M. S. 2009. “Predicting Crises, Part II: Did Anything Matter (to Everybody)?” FRBSF Economic Letter 2009-30 (September 28).

Sachs, J., & Wing, T. W. 2000. “Understanding the Asian Financial Crisis,” in Wing Thye Woo, Jeffrey Sachs and Klaus Schwab (ed.), The Asian Financial Crisis: Lessons for a Resilient Asia, MIT Press.


Table 1 – GDP Growth 1994-1997 (%)

Country 1994 1995 1996 1997

South Korea 8.6 8.9 7.1 5.5

Indonesia 15.6 8.2 8.0 4.7

Malaysia 9.2 9.5 8.6 7.8

Philippines 4.4 4.8 5.8 9.7

Singapore 10.1 8.8 7.3 7.6

Thailand 8.9 8.8 5.5 -0.4

Hong Kong 5.5 3.9 5.0 5.3

China 12.7 10.6 9.5 8.8

Taiwan 6.5 6.0 5.7 6.8

Source: International Financial Statistics of the International Monetary Fund, Dec. 1997.