Question

Outline the causes and impact of the Asian crisis of 1997/1998

Answer 1

Causes and impact of the Asian crisis of 1997/1998:

                The Asian crisis of 1997/98 is considered one of the international financial crisis in the modern history. The crisis first started in Thailand which later spread to Malaysia, Indonesia, Philippine and Singapore; not forgetting Hong Kong, Taiwan, Korea, Japan and China. In 1997, what had started as a currency crisis in Thailand quickly developed into a financial and economic crisis and spread to other countries in the region. We will discuss the causes & impact of this crisis in detail below.

1) Excessive monetary growth & international capital flow: The fast growth of the Asian economies in 1990-97 & rapid expansion of global capital markets increased flow of capital to Asian countries. The volume of private capital flows to these economies rose nearly 30% annually. Since most of the Asian countries had pegged their currencies they were not able to absorb the inflow. They opted to create domestic liquidity rather than letting their exchange rate flow. This large inflow created structural weakness in the economy.

2) The contagion effect: The Thai currency “Thai baht” collapsed after Thai government was forced to float the baht due to lack of foreign currency to support its currency peg to the U.S. dollar. This collapse of currency prompted international short term creditors to withdraw their loans from the entire East Asian region.

3) Crony capitalism: Crony capitalism refers to a form of capitalism that restricts the allocation of resources & opportunities to few elites. This system results in corruption & lower incentives for wealth creation. Most of the Asian economies did not practice free market capitalism.

4) High corporate leverage & protectionism: Asian corporations in many countries experienced high level of leverage compared to corporations in developed countries. Between 1991 & 1996 leveraged doubled in Thailand and Malaysia and increased by one-third in Korea. Korean companies had very high leverage levels. These high leverage ratios were mainly a result of protectionist government policies. This protectionism in the form of import tariffs & crony capitalism shielded the domestic economies from market competition and international best practices and standards, and ultimately created weaknesses and resource misallocation within the corporate sector.

Impacts:

Due to the currency devaluations Asian countries witnessed one of the biggest stock market plunge. It led to a negative wealth effect which led to a general contraction of domestic demand. Consequently, domestic-oriented industries, such as the construction and services sectors, were severely hit by the crisis. The foreign direct investment (FDI) levels displayed a declining trend. The financial crisis resulted in higher rates of unemployment.