Critical Analysis of the 1997-1998 Asian Financial Crisis (Essay Sample)

CRITICAL ANALYSIS OF THE 1997 ASIAN FINANCIAL CRISIS
By (Author)
Name of the Class (Course)
Professor (Tutor)
Name of the School (University)
City
Date
Abstract
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 suffered from serious current account deficits between 1995 and 1996, other South East Asian economies looked safe from currency devaluation. The East Asian governments blamed the financial panic and contagion for 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.
THE 1997 ASIAN FINANCIAL CRISIS
Introduction
The 1997-98 Asian economic and financial crisis is one of the most horrible 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, these institutions and political authorities failed to respond in time. However, the cautionary marks of the Thais economy indicated that currency crisis was sustainable both in the long-run and medium term given that over 80% of the Thais current accounts drew 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.
Causes of the 1997-98 Asian Financial Crisis
A study by Sachs and Wing (2000, 66) identified investment boom as the primary source of the Asian crisis. During the first half of 1990s, the South East Asian economy posted impressive economic growth and development that was described as the ‘Asian Miracle’. The region 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, direct foreign investments, and abolition of exports and trade barriers in a number of South East Asian countries contributed to the region becoming an export powerhouse. 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 Asia fueled a massive investment boom particularly in residential and commercial property, infrastructure, and industrial assets. This led to inflationary pressure on residential and commercial property in major Asian cities. Consequently, the region witnessed investment boom in the real estate and housing sectors entirely financed by monetary borrowings and credits. According to Kaminsky, Saul, and Carmen (1998, 44), the South East Asian governments also contributed to the investment boom by heavily investing in infrastructural projects and providing incentives to encourage private investments. The investment boom resulted in excess capacity in the housing and real estate sectors, thus low returns than initially anticipated by the investors. This ballooned investment volume during the 1990s exceeded the demand capacity, thus a significant decline in the projected economic returns that further led to a rapid rate of defaults in loans repayments (Kaminsky, Saul, & Carmen, 1998, 45).
Economic and financial liberalizations also played a role in the Asian financial crisis. The South East Asian countries encouraged financial liberalization that allowed 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 uncontrolled capital inflows from international banks in the form of loans extended to local companies and banks. Such highly liberalized financial policies and regulations resulted in 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 in the 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 market, thus exerting depreciative pressure on the local exchange rates (Radelet, & Jeffrey, 1998, 67).
Socio-economic 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% in 1998 (see table 1 in the appendix), representing economic retrogression (Corsetti, Paolo, & Nouriel, 1998, 22). Thailand was the worst hit out of the five countries that were at the helm of the Asian crisis with its GDP posting 10.8% retrogression in 1998 (Corsetti, Paolo, & Nouriel, 1998, 23). Following the 1997-98 financial crisis, the South East Asian economic contraction 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 forceful lay-off of employees. Consequently, the rate of unemployment in Thailand, Indonesia, Malaysia, Hong Kong, and Philippines skyrocketed to a record high of 6.4% in 1999 (Sachs, & Wing, 2000, 38). As a result, the purchasing power of the Asians 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 real wages forced the consumers to cut their healthcare expenditures, thus deteriorating their social and health status. Besides, the crisis resulted in a significant decline in school enrolment as incidences of child labour rapidly increased in Thailand and Indonesia in order to supplement their family income.
Lessons Learnt from the 1997 Asian Financial Crisis
Although the 1997 Asian crisis came to an end, it raised a number of critical issues regarding the international financial and economic systems, with emphasis on the establishment of sound international financial architectural policies. As explained by 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 to govern the operations of financial institutions. Lane and Gian (2008, 330) backed Mishkin’s argument that although desirable, excessive financial and economic liberalizations are hurtful to the economy, some regulations are necessary. While drumming support for the role of financial liberalization, Moreno, Gloria, and Eli (1998, 81) explained that strengthening of international surveillance that complies with the international monetary standards and incorporating regional financial policies would be essential in averting future financial problems. They further argued that financial institutions should implement advanced risk management strategies, including improved financial regulation and supervision for both creditor and debtor countries. Had this been implemented, 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 international reserve position further exacerbated the financial market panic among investors and creditors. This led to the massive withdrawals witnessed in South East Asia.
Concl...