San Ignacio University

International Economics
Prof. Ulises Urdaneta

South East Crisis of 1997

AnaKarina Casado
Valentina Fernandez
Jorge Yeshayahu Gonzales-Lara
Maria Carolina Landaeta
Table of Contents

I. Introduction ............................................................................................................................ 3
II. Background ........................................................................................................................... 4
III. Description of the Crisis ...................................................................................................... 4
IV. Causes: ................................................................................................................................. 5
V. Consequences: ....................................................................................................................... 6
VI. Impact on the Financial Markets ......................................................................................... 8
VII. Effects on the Global Economy.......................................................................................... 9
VIII. Government responses .................................................................................................... 10
IX. Conclusion ......................................................................................................................... 11
X. References ........................................................................................................................... 12

2
I. Introduction

Between June 1997 and January 1998, a financial crisis swept through the "tiger
economies" of South East Asian. Over the previous decade the SE Asian states of Thailand,
Malaysia, Singapore, Indonesia, Hong Kong, and South Korea, had registered some of the most
impressive economic growth rates in the world. Their economies had expanded by 6% to 9%
per annum compounded, as measured by Gross Domestic Product. This Asian miracle,
however, appeared to come to an abrupt end in late 1997 when in one country after another,
the currencies faced enormous pressure as they depreciated against the U.S. dollar. They had
maintained their currency fixed against the dollar and experienced a deteriorating current
account position as well as an increasing foreign debt burden in the process.
In less than a year, both the international and domestic situation of the Southeast Asian
economies dramatically transformed. Major companies defaulted on their foreign debt
repayments, domestic and international investors relocated or withdrawn vast amounts of
capital, inflation and unemployment soared, and political instability rose to dangerous levels.
Moreover, the crisis had a significance that extended beyond the region's boundaries to the
world at large, particularly to other emerging market economies.
In this paper, we will discuss the background and description of this crisis, the causes
the lead to its development, and the consequences it brought to the countries involved. We will
also take a look at the effects the South East Asian financial crisis had on the financial market
and the overall global economy. Finally, we will look into the measures and economic issues
authorities and economic decision makers took to solve the crisis.

3
II. Background

The South East Crisis or Asian Financial Crisis was a period of financial hardship that
gripped much of Asia beginning in July 1997. The crisis raised fears of a worldwide economic
meltdown due to financial contagion.
The crisis involved four basic problems or issues for the countries it affected:
(1) A shortage of foreign exchange which caused the value of currencies and equities in
Thailand, Indonesia, South Korea and other Asian countries to fall dramatically.
(2) Inadequately developed financial sectors and mechanisms for allocating capital in the
troubled Asian economies.
(3) Effects of the crisis on both the United States and the world, and
(4) The role, operations, and replenishment of funds of the International Monetary Fund.

III. Description of the Crisis

The Asian Financial Crisis of 1997 affected many Asian countries, including South
Korea, Thailand, Malaysia, Indonesia, Singapore and the Philippines. After posting some of
the most impressive growth rates in the world at the time, the so-called "tiger economies" saw
their stock markets and currencies lost about 70% of their value.

It began with a series of asset bubbles that were financed with foreign direct investment.
When the Federal Reserve began to hike interest rates, foreign investment dried up and high
asset valuations were difficult to sustain. Equity markets moved significantly lower and the
International Monetary Fund eventually stepped in with billions of dollars’ worth of loans to
stabilize the market. The economies eventually recovered, but many experts have been critical
of the IMF for its strict policies that may have exacerbated the problems.

4
IV. Causes:

● These economies experienced a surge in capital inflows to finance productive

investments that made them vulnerable to a financial panic. That panic and inadequate
policy responses triggered a region wide financial crisis and the economic disruption
that followed.
● Weaknesses in Asian financial systems. These weaknesses were caused largely by the
lack of incentives for effective risk management created by implicit or explicit
government guarantees against failure. The weaknesses of the financial sector were
masked by rapid growth and accentuated by large capital inflows, which were partly
encouraged by pegged exchange rates.
● Financial intermediaries were not always free to use business criteria in allocating
credit. In some cases, well-connected borrowers could not be refused credit; in others,
poorly managed firms could obtain loans to meet some government policy objective.
Hindsight reveals that the cumulative effect of this type of credit allocation can produce
massive losses.
● Financial intermediaries or their owners were not expected to bear the full costs of
failure, reducing the incentive to manage risk effectively. In particular, financial
intermediaries were protected by implicit or explicit government guarantees against
losses, because governments could not bear the costs of large shocks to the payments
system or because the intermediaries were owned by “Ministers’ nephews”. That such
guarantees can trigger asset price inflation, reduce economic welfare, and ultimately
make the financial system vulnerable to collapse.
● The importance of implicit government guarantees in the most affected economies is
highlighted by the generous support given to financial institutions experiencing
difficulties. The very high overall debt ratios of corporate conglomerates (400% or
higher) suggest that these borrowers were ultimately counting on government support
in case of adverse outcomes. This was confirmed by events in 1997, when the
government encouraged banks to extend emergency loans to some troubled
conglomerates which were having difficulties servicing their debts and supplied special
loans to weak banks. These responses further weakened the financial position of lenders
and contributed to the uncertainty that triggered the financial crisis towards the end of
1997.

5
V. Consequences:

● The consequences of the crisis are discussed in terms of the impact on unemployment
and poverty, growth and trade. The crisis had significant macroeconomic-level effects,
including sharp reductions in values of currencies, stock markets, and other asset prices
of several Asian countries. The nominal U.S. dollar GDP of ASEAN fell by $9.2 billion
in 1997 and $218.2 billion (31.7%) in 1998. In South Korea, the $170.9 billion fall in
1998 was equal to 33.1% of the 1997 GDP. Many businesses collapsed, and as a
consequence, millions of people fell below the poverty line in 1997–1998. Indonesia,
South Korea and Thailand were the countries most affected by the crisis.

● The economic crisis also led to a political upheaval, most notably culminating in the
resignations of President Suharto in Indonesia and Prime Minister General Chavalit
Yongchaiyudh in Thailand. There was a general rise in anti-Western sentiment, with
George Soros and the IMF in particular singled out as targets of criticisms. Heavy U.S.
investment in Thailand ended, replaced by mostly European investment, though
Japanese investment was sustained. Islamic and other separatist movements intensified
in Southeast Asia as central authorities weakened.
● More long-term consequences included reversal of the relative gains made in the boom
years just preceding the crisis. Nominal U.S. dollar GDP per capital fell 43.2% in
Indonesia in 1997, 21.2% in Thailand, 19% in Malaysia, 18.5% in South Korea and
12.5% in the Philippines. The CIA World Factbook reported that the per capital in
Thailand declined from $8,800 to $8,300 between 1997 and 2005; in Indonesia it
increased from $2,628 to $3,185; in Malaysia it declined from $11,100 to $10,400. Over
the same period, world per capita income rose from $6,500 to $9,300. Indeed, the CIA's
analysis asserted that the economy of Indonesia was still smaller in 2005 than it had
been in 1997, suggesting an impact on that country similar to that of the Great
Depression. Within East Asia, the bulk of investment and a significant amount of
economic weight shifted from Japan and ASEAN to China and India.

6
● The crisis affected dozens of countries, had a direct impact on the livelihood of millions,
happened within the course of a mere few months. Politically there were some benefits.
In several countries, particularly South Korea and Indonesia, there was renewed push
for improved corporate governance. Rampaging inflation weakened the authority of the
Suharto regime and led to its toppling in 1998, as well as accelerating East Timor's
independence. It is believed that 10,400 people committed suicide in Hong Kong, Japan
and South Korea as a result of the crisis.
● After the Asian crisis, international investors were reluctant to lend to developing
countries, leading to economic slowdowns in developing countries in many parts of the
world. The powerful negative shock also sharply reduced the price of oil, which reached
a low of about $11 per barrel towards the end of 1998, causing a financial pinch in
OPEC nations and other oil exporters. In response to a severe fall in oil prices, the
supermajors that emerged in the late-1990s, undertook some major mergers and
acquisitions between 1998 and 2002 – often in an effort to improve economies of scale,
hedge against oil price volatility, and reduce large cash reserves through reinvestment.
● Many nations learned from this, and quickly built up foreign exchange reserves as a
hedge against attacks, including Japan, China, South Korea. Pan Asian currency swaps
were introduced in the event of another crisis. However, interestingly enough, such
nations as Brazil, Russia, and India as well as most of East Asia began copying the
Japanese model of weakening their currencies, and restructuring their economies so as
to create a current account surplus to build large foreign currency reserves. This has led
to ever-increasing funding for U.S. treasury bonds, allowing or aiding housing (in
2001–2005) and stock asset bubbles (in 1996–2000) to develop in the United States.

7
VI. Impact on the Financial Markets

The resulting panic among lenders led to a large withdrawal of credit from the crisis
countries, causing a credit crunch and further bankruptcies. In addition, as foreign investors
attempted to withdraw their money, the exchange market was flooded with the currencies of
the crisis countries, putting depreciative pressure on their exchange rates. To prevent currency
values collapsing, these countries' governments raised domestic interest rates to exceedingly
high levels (to help diminish flight of capital by making lending more attractive to investors),
and to intervene in the exchange market - buying up any excess domestic currency at the fixed
exchange rate with foreign reserves. Neither of these policy responses could be sustained for
long.
Very high interest rates, which can be extremely damaging to an economy that is
healthy, wreaked further havoc on economies in an already fragile state, while the central banks
were hemorrhaging foreign reserves, of which they had finite amounts. When it became clear
that the tide of capital fleeing these countries was not to be stopped, the authorities ceased
defending their fixed exchange rates and allowed their currencies to float. The resulting
depreciated value of those currencies meant that foreign currency-denominated liabilities grew
substantially in domestic currency terms, causing more bankruptcies and further deepening the
crisis.
The conventional high-interest-rate economic wisdom is normally employed by
monetary authorities to attain the chain objectives of tightened money supply, discouraged
currency speculation, stabilized exchange rate, curbed currency depreciation, and ultimately
contained inflation. To reverse (currency depreciation), countries have to make it more
attractive to hold domestic currency, and that means temporarily raising interest rates, even if
this (hurts) weak banks and corporations.
When it became clear that the tide of capital fleeing these countries was not to be
stopped, the authorities ceased defending their fixed exchange rates and allowed their
currencies to float. The resulting depreciated value of those currencies meant that foreign
currency-denominated liabilities grew substantially in domestic currency terms, causing more
bankruptcies and further deepening the crisis.

8
VII. Effects on the Global Economy

Although it could be thought that what was a regional crisis had little effect on a global
perspective, the truth is that the world economy was far from being unaffected by South East
Asian crisis. Not only did growth in the crisis-affected countries slowed down drastically, but
other emerging markets were also touched quite significantly.
The first influences were especially noticed in the financial markets. Because of their
nature, projections and expectations profoundly influence exchange rates on this sphere, so the
transmission of the crisis was almost immediate. For example, in August of 1997, only a
fortnight after the devaluation of Thailand’s Baht, the economic press began to cite Brazil as a
candidate country to follow in the footsteps of Thailand, arguing that their exchange rate was
appreciated. From that moment on, Brazil suffered constant pressures until January of 1999,
when the Brazilian Real was devalued.
The influence of the events of Asia on the economies of emerging markets such as Latin
America and other regions also materialized in the generalized falls in the stock markets. Here,
as well, the volatile and speculative nature of the market played an important role on the
transmission. For example, the Argentine stock market fell by 33% between October and
November of 1997. The Brazilian stock exchange accumulated a loss of 65% in approximately
one year. As a result of the baht crisis, after a stage of stability, the Mexican stock market fell
by 42%; and the recovery didn’t begin until the fall of 1998. Finally, the behavior of the
Venezuelan stock market was very similar to that of Mexico, with a 47% drop in one year.
Global commerce and trade was also affected with the South East Asian Crisis. The fall
in prices of raw materials and basic goods, caused by the economic recession, generated a
contraction of imports with an impact on world trade. Given the commercial and financial
connections these Asian countries had with the U.S, where 30% of the net exportations and a
40% of agricultural exportations at the time went to Asia, these more established market was
also touched.
The Asian region represented around 15% of the world's imports of raw materials and
basic goods, and the relative price structure was drastically modified with the plummet of
international prices. The Goldman Sachs commodity index fell by 30% by October 1997; 17
of the 22 products that make up this index recorded significant declines for that date, in
particular petroleum (35%), copper (31%), wheat (17%), maize (14%) and soybeans (7 %).
This, of course, affected other producing countries, were the currency weakened, cuts in their
public budgets occurred and import capacity decreased, accelerating, in this way, the
inflationary tendencies in the world economy.

9
VIII. Government responses

The strategy used in the face of the crisis had three main components:

• Financing. The IMF provided financing of some US $35,000 million to support

adjustment and reform programs in Korea, Indonesia and Thailand; the assistance granted to
Indonesia increased further in 1998-99. Other multilateral and bilateral entities undertook to
provide financing for the balance of payments imbalances. (IMF World Economic Outlook:
Interim Assessment, December 1997, analyzes in more detail the origins of the crisis.)
• Macroeconomic policy. A more restrictive economic policy was adopted (at different
stages depending on the country) to stop the collapse of countries' exchange rates and prevent
the depreciation of the currency that would lead to an inflationary spiral. The restriction of
monetary policy was temporary: once confidence began to recover and market conditions
stabilized, interest rates were reduced. In essence, it was necessary to apply a firm fiscal policy
in Korea and Indonesia, while in Thailand the adoption of fiscal restriction measures was
foreseen to reverse the process of increasing the deficit that had taken place the year before the
crisis.
• Structural reforms. Measures were taken to correct the flaws in the financial sector and
the business sector. Through other reforms, efforts were made to mitigate the social
consequences of the crisis and lay the foundations for the resumption of economic growth.
The details of these reforms were formulated in collaboration with the authorities of each
country, and with the World Bank and the Asian Development Bank. The need for reform of
the financial sector was especially pressing, given the causes of the crisis. In all three countries,
the programs had the following common components:
● Closing of insolvent financial institutions, to prevent additional losses.
● Recapitalization of potentially viable financial institutions, in many cases with
government assistance.
● Close supervision, by the central bank, of financial institutions in difficulties.
● Strict financial supervision and regulation to prevent the repetition of the difficulties
that led to the crisis.
● Protection programs for poor and vulnerable segments of society in the face of the most
damaging aspects of the crisis, deepening and expanding security networks and
(especially in Indonesia) devoting considerable budgetary resources to the increase of
commodity subsidies, such as the rice.
● Measures aimed at greater transparency in the financial, business and public sectors.
● Measures aimed at making markets more efficient and increasing competition.

Financial markets stabilized in the first months of 1998 in Korea and Thailand, and much
later in Indonesia. The currency began to recover and in mid-1998 interest rates were reduced
to levels lower than before the crisis. Then the economic activity began to recover: in mid-1998
in Korea and later in the other countries.
Once started, the recovery process was unexpectedly solid, especially in Korea, whose
economic growth was 10.75% in the whole of 1999. The recovery was due to the resurgence
of domestic private demand, whose collapse had caused the recession. The experience of the
Asian crisis and the results of the applied economic policy strategy gave rise to new ideas
regarding the international financial system and the appropriate economic policy response to
financial crises.

10
IX. Conclusion

The South East Asian Financial crisis was a devastating economic occurrence that
originally affected this geographical regional but quickly spread all over the world.
As presented in the previous sections, macroeconomic imbalances and weak financial
institutions created the perfect landscape for the crisis to develop. This, joined with the
openness of the financial and capital account from previous year and an inadequate legal
foundation, magnified the crisis significantly.
Likewise, our research showed that the reforms set by officials under the support of the
World Bank and the International Monetary were essentially aimed at refinancing the balance
of payments imbalances, establishing fiscal restriction and policies to stabilize the exchange
markets and alleviate the consequences of the crisis on the population’s wellbeing.
In the end, probably the biggest lessons we can take from studying the South East Asian
Crisis is how the speculative nature of both the exchange and stock markets can intensify an
economic crisis that could’ve been contained; when panic scenarios arose, the same flood of
capital that made this region grow exponentially in previous years ended up causing a crisis so
big that the effects could be felt all around the globe.

11
X. References

Griffith-Jones, S & Pfaffenzeller, S. (1999). The East Asian Financial Crisis: A Reflection on
Its Causes, Consequences and Policy Implications (Master's thesis). Retrieved from
https://www.ids.ac.uk/ids/global/Finance/pdfs/sgj1.pdf

Guillen, A. (2000). Crisis Asiática y Restructuración de la Economía Mundial. Comercio

Exterior, 50(7), 16-23.

Pettinger, T. (2017). Asian Financial Crisis 1997. In Economics Help. Retrieved from
https://www.economicshelp.org/blog/glossary/financial-crisis-asia-1997/

Vilarino, A. (2001). Turbulencias financieras y riesgos de mercado. Capítulo 11: Crisis

financiera asiática. Pearson Educación.

12