Financial Crisis in Asia 1997

On the 2nd of July 1997, Asia was hit by one of the most devastating financial crises it has ever seen. Of all the financial crisis that have taken place, this was one of the most distressing in that it was totally unexpected. The purpose of this paper is to show that particular developmental strategies employed by these economies eventually led to their downfall. It will attempt to find out where the origins of the crisis lie, and what events started the cycle that eventuated with this disaster. In order to trace the events that led to the eventual collapse of the Asian economies, one must venture across the ocean to the United States. The issue of liberalisation first gained attention in the US during the Regan Administration. However, it was during the Clinton era that liberalisation became a top priority. Whereas previous governments had pushed for the liberalisation of Japan, one of Clinton’s main foreign policy objectives was the liberalisation of the Asian economies. This process was pushed forth in Asia with such vehemence because the region held a lot of investment opportunities for American Banks, Brokerages, and other financial sector businesses. Unfortunately, Asia’s economies were not structurally ready to deal with the influx of capital that was headed their way. They had weak banking and legal systems that were unable, or unwilling, to regulate the flow of foreign capital in the country. The Americans eventually persuaded Korea to relax its capital flow regulations by giving it the option of joining the Organisation for Economic Co-operation and Development. Even then, Korea was concerned that its financial institutions may not be able to deal with an influx of foreign capital. One fatal mistake that Korea, as well as other Southeast Asian countries made, was that they opened their capital markets in the wrong way. They did not allow long term investments in Korean companies, but rather, only short-term investments that could be removed easily. One example of the sort of quick investments that were being made in Asia can be seen in the Japanese. In Japan the interest rates were very low, so investors would borrow at 2 percent and then convert their currency into Thai baht. Due to the interest rate differential, they were able to make a lot of money off simple currency conversion. Other Asian economies were quick to follow suit, and soon there was a movement of huge amounts of capital into the region. In just one year, more then $93 billion was invested in five Asian countries. One must, however, concede that Southeast Asia became very receptive to the changes being imposed on them by the United States. Eventually, foreign investment came to be seen as a miracle cure for underdevelopment. It was seen as a quick fix that could, in a short period of time, bring countries to the same level of development as the West. The trouble started in 1995, when the United States inflated the dollar, and hence also inflated the Thai baht and other Asian currencies that were pegged to the dollar. This caused their exports to become expensive compared to Chinese exports. The Thai deficit rose to such an extent that all their foreign currency reserves started to drain in order to pay it. This is the first time that investors got to see the weakness in the Thai financial market. It is not possible to place the entire blame for the crisis on the United States. As was mentioned before, Asian countries were more than happy to accept the capital coming there way. It is important to evaluate the different internal weaknesses in these economies that led to the eventual crisis. Enough stress can not be placed on how the internal weaknesses of the Asian region led to this crisis. The remainder of this essay with deal with these weaknesses, and of the events that eventually led to the collapse of the East Asian miracle. Liberalisation in Southeast Asia took place primarily in two steps. In Thailand, and in much of Asia, this liberalisation consisted of the removal of foreign exchange controls, interest rate restrictions, encouragement of nonbank (private) capital markets, and the adoption of the capital adequacy standard for bank supervision. This liberalisation led to intense competition in the Thai market. Banks competed on the size of their portfolios, and this led to some of the frivolous, short term, investment that became synonymous with the region. They also competed to generate off-balance sheet transactions and quasi-banking operations, all of which added to the vulnerability of the region. In Indonesia, as well, there was a removal of banking regulations. With the removal of these regulations, the number of banks in the country more than doubled in a period of six years. Many of these banks were owned by large industrial groups, which used them to manage their own financial affairs. Banks also created Offsure accounts in order to conduct illegal activity. This first liberalisation actually went a long way