1997 Asian financial crisis

From Wikipedia, the free encyclopedia

Countries most affected by the Asian Crisis.

The Asian financial crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and

raised fears of a worldwide economic meltdown due to financial contagion.

The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai

government to float the baht, cutting its peg to theUSD, after exhaustive efforts to support it in the face of a

severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden

of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis

spread, most of Southeast Asia andJapan saw slumping currencies, devalued stock markets and

other asset prices, and a precipitous rise in private debt.[1]

Though there has been general agreement on the existence of a crisis and its consequences, what is less clear
are the causes of the crisis, as well as its scope and resolution. Indonesia, South Korea and Thailand were the

countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippineswere also hurt by the slump.

The People's Republic of China, India, Taiwan, Singapore, Brunei and Vietnam were less affected, although all

suffered from a loss of demand and confidence throughout the region.

Foreign debt-to-GDP ratios rose from 100% to 167% in the four large ASEAN economies in 1993–96, then shot

up beyond 180% during the worst of the crisis. In South Korea, the ratios rose from 13 to 21% and then as high

as 40%, while the other northern newly industrialized countries fared much better. Only in Thailand and South

Korea did debt service-to-exports ratios rise.[2]

Although most of the governments of Asia had seemingly sound fiscal policies, the International Monetary

Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currencies of South Korea, Thailand,

and Indonesia, economies particularly hard hit by the crisis. The efforts to stem a global economic crisis did little

to stabilize the domestic situation in Indonesia, however. After 30 years in power, President Suharto was forced

to step down on 21 May 1998 in the wake of widespread riotingthat followed sharp price increases caused by a

drastic devaluation of the rupiah. The effects of the crisis lingered through 1998. In the Philippines growth
dropped to virtually zero in 1998. Only Singapore and Taiwan proved relatively insulated from the shock, but both

suffered serious hits in passing, the former more so due to its size and geographical location between Malaysia

and Indonesia. By 1999, however, analysts saw signs that the economies of Asia were beginning to recover.[3]

Contents

 [hide]

1 History

2 IMF Role

o 2.1 IMF and

high interest rates

3 Thailand

4 Indonesia

5 South Korea

6 Philippines

7 Hong Kong

8 Malaysia

9 Singapore

10 China

11 United States and Japan

12 Consequences

o 12.1 Asia

o 12.2 Outside

Asia

13 See also

14 References

15 External links

[edit]History

Until 1997, Asia attracted almost half of the total capital inflow into developing countries. The economies

of Southeast Asia in particular maintained high interest rates attractive to foreign investorslooking for a high rate

of return. As a result the region's economies received a large inflow of money and experienced a dramatic run-up

in asset prices. At the same time, the regional economies ofThailand, Malaysia, Indonesia, Singapore, and South

Korea experienced high growth rates, 8–12% GDP, in the late 1980s and early 1990s. This achievement was

widely acclaimed by financial institutions including the IMF and World Bank, and was known as part of the "Asian

economic miracle".

In 1994, noted economist Paul Krugman published an article attacking the idea of an "Asian economic miracle".
[4]
 He argued that East Asia's economic growth had historically been the result of increasing capital investment.
However, total factor productivity had increased only marginally or not at all. Krugman argued that only growth in

total factor productivity, and not capital investment, could lead to long-term prosperity. Krugman's views would be

seen by many as prescient after the financial crisis had become apparent, though he himself stated that he had

not predicted the crisis nor foreseen its depth.[citation needed]

The causes of the debacle are many and disputed. Thailand's economy developed into a bubble fueled by "hot

money". More and more was required as the size of the bubble grew. The same type of situation happened in

Malaysia, and Indonesia, which had the added complication of what was called "crony capitalism".[5] The short-

term capital flow was expensive and often highly conditioned for quick profit. Development money went in a

largely uncontrolled manner to certain people only, not particularly the best suited or most efficient, but those

closest to the centers of power.[6]

At the time of the mid-1990s, Thailand, Indonesia and South Korea had large private current account deficits and

the maintenance of fixed exchange rates encouraged external borrowing and led to excessive exposure

to foreign exchange risk in both the financial and corporate sectors. In the mid-1990s, two factors began to

change their economic environment. As the U.S. economy recovered from a recession in the early 1990s,

the U.S. Federal Reserve Bank under Alan Greenspan began to raise U.S. interest rates to head off inflation.

This made the U.S. a more attractive investment destination relative to Southeast Asia, which had been attracting

hot money flows through high short-term interest rates, and raised the value of the U.S. dollar. For the Southeast

Asian nations which had currencies pegged to the U.S. dollar, the higher U.S. dollar caused their own exports to

become more expensive and less competitive in the global markets. At the same time, Southeast Asia's export

growth slowed dramatically in the spring of 1996, deteriorating their current account position.

Some economists have advanced the growing exports of China as a contributing factor to ASEAN nations' export

growth slowdown, though these economists maintain the main cause of the crises was excessive real

estate speculation.[7] China had begun to compete effectively with other Asian exporters particularly in the 1990s

after the implementation of a number of export-oriented reforms. Other economists dispute China's impact, noting

that both ASEAN and China experienced simultaneous rapid export growth in the early 1990s.[8]

Many economists believe that the Asian crisis was created not by market psychology or technology, but by

policies that distorted incentives within the lender–borrower relationship. The resulting large quantities

of credit that became available generated a highly leveraged economic climate, and pushed up asset prices to an

unsustainable level.[9] These asset prices eventually began to collapse, causing individuals and companies

to default on debt obligations. 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.

Other economists, including Joseph Stiglitz and Jeffrey Sachs, have downplayed the role of the real economy in

the crisis compared to the financial markets. The rapidity with which the crisis happened has prompted Sachs

and others to compare it to a classic bank run prompted by a sudden risk shock. Sachs pointed to strict monetary

and contractory fiscal policies implemented by the governments on the advice of the IMF in the wake of the crisis,

while Frederic Mishkin points to the role of asymmetric information in the financial markets that led to a "herd

mentality" among investors that magnified a small risk in the real economy. The crisis has thus attracted interest

from behavioral economists interested in market psychology. Another possible cause of the sudden risk shock

may also be attributable to the handover of Hong Kong sovereignty on 1 July 1997. During the 1990s, hot money

flew into the Southeast Asia region but investors were often ignorant of the actual fundamentals or risk profiles of

the respective economies. The uncertainty regarding the future of Hong Kong led investors to shrink even further

away from Asia, exacerbating economic conditions in the area (subsequently leading to the depreciation of

the Thai baht on 2 July 1997).[10]

The foreign ministers of the 10 ASEAN countries believed that the well co-ordinated manipulation of their

currencies was a deliberate attempt to destabilize the ASEAN economies. Former Malaysian Prime

Minister Mahathir Mohamad accused George Soros of ruining Malaysia's economy with "massive currency

speculation." (Soros claims to have been a buyer of the ringgit during its fall, havingsold it short in 1997.)

Mahathir's claims were couched in antisemitic terms,[11] and in 2006 he apologized and withdrew the accusations.
[12]

At the 30th ASEAN Ministerial Meeting held in Subang Jaya, Malaysia, the foreign misisters issued a joint

declaration on 25 July 1997 expressing serious concern and called for further intensification of ASEAN's

cooperation to safeguard and promote ASEAN's interest in this regard.[13] Coincidentally, on that same day, the

central bankers of most of the affected countries were at the EMEAP (Executive Meeting of East Asia Pacific)

meeting in Shanghai, and they failed to make the 'New Arrangement to Borrow' operational. A year earlier, the

finance ministers of these same countries had attended the 3rd APEC finance ministers meeting in Kyoto, Japan

on 17 March 1996, and according to that joint declaration, they had been unable to double the amounts available

under the 'General Agreement to Borrow' and the 'Emergency Finance Mechanism'. As such, the crisis could be

seen as the failure to adequately build capacity in time to prevent Currency Manipulation. This hypothesis

enjoyed little support among economists, however, who argue that no single investor could have had enough

impact on the market to successfully manipulate the currencies' values. In addition, the level of organization

necessary to coordinate a massive exodus of investors from Southeast Asian currencies in order to manipulate

their values rendered this possibility remote.[citation needed]

[edit]IMF Role

Such was the scope and the severity of the collapses involved that outside intervention, considered by many as a

new kind of colonialism,[14] became urgently needed. Since the countries melting down were among not only the

richest in their region, but in the world, and since hundreds of billions of dollars were at stake, any response to

the crisis had to be cooperative and international, in this case through the International Monetary Fund (IMF).

The IMF created a series of bailouts ("rescue packages") for the most affected economies to enable affected

nations to avoid default, tying the packages to reforms that were intended to make the restored Asian currency,

banking, and financial systems as much like those of the United States and Europe as possible. In other words,

the IMF's support was conditional on a series of drastic economic reforms influenced by neoliberal economic

principles called a "structural adjustment package" (SAP). The SAPs called on crisis-struck nations to cut back on

government spending to reduce deficits, allow insolvent banks and financial institutions to fail, and aggressively

raise interest rates. The reasoning was that these steps would restore confidence in the nations' fiscal solvency,

penalize insolvent companies, and protect currency values. Above all, it was stipulated that IMF-funded capital

had to be administered rationally in the future, with no favored parties receiving funds by preference. In at least

one of the affected countries the restrictions on foreign ownership were greatly reduced.[15] There were to be

adequate government controls set up to supervise all financial activities, ones that were to be independent, in

theory, of private interest. Insolvent institutions had to be closed, and insolvency itself had to be clearly defined.

In short, exactly the same kinds of financial institutions found in the United States and Europe had to be created

in Asia, as a condition for IMF support. In addition, financial systems had to become "transparent", that is, provide

the kind of reliable financial information used in the West to make sound financial decisions.[16]

However, the greatest criticism of the IMF's role in the crisis was targeted towards its response.[17] As country

after country fell into crisis, many local businesses and governments that had taken out loans in US dollars,

which suddenly became much more expensive relative to the local currency which formed their earned income,

found themselves unable to pay their creditors. The dynamics of the situation were closely similar to that of

the Latin American debt crisis. The effects of the SAPs were mixed and their impact controversial. Critics,

however, noted the contractionary nature of these policies, arguing that in a recession, the

traditional Keynesian response was to increase government spending, prop up major companies, and lower

interest rates. The reasoning was that by stimulating the economy and staving off recession, governments could

restore confidence while preventing economic loss. They pointed out that the U.S. government had pursued

expansionary policies, such as lowering interest rates, increasing government spending, and cutting taxes, when

the United States itself entered a recession in 2001, and arguably the same in the fiscal and monetary policies

during the 2008–2009 Global Financial Crisis.

Although such reforms were, in most cases, long needed[citation needed]), the countries most involved ended up

undergoing an almost complete political and financial restructuring. They suffered permanent currency

devaluations, massive numbers of bankruptcies, collapses of whole sectors of once-booming economies, real

estate busts, high unemployment, and social unrest. For most of the countries involved, IMF intervention has

been roundly criticized. The role of the International Monetary Fund was so controversial during the crisis that
many locals called the financial crisis the "IMF crisis".[18] Many commentators in retrospect criticized the IMF for

encouraging the developing economies of Asia down the path of "fast track capitalism", meaning liberalization of

the financial sector (elimination of restrictions on capital flows); maintenance of high domestic interest rates to

attract portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure

foreign investors against currency risk.[17]

[edit]IMF and high interest rates

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.

In the Asian meltdown, highest IMF officials rationalized their prescribed high interest rates as follows:

From then IMF First Deputy Managing Director, Stanley Fischer (Stanley Fischer, "The IMF and the Asian Crisis,"

Forum Funds Lecture at UCLA, Los Angeles on March 20, 1998):

”When their governments "approached the IMF, the reserves of Thailand and South Korea were perilously low,

and the Indonesian Rupiah was excessively depreciated. Thus, the first order of business was... to restore

confidence in the currency. To achieve this, countries have to make it more attractive to hold domestic currency,

which in turn, requires increasing interest rates temporarily, even if higher interest costs complicate the situation

of weak banks and corporations...

"Why not operate with lower interest rates and a greater devaluation? This is a relevant tradeoff, but there can be

no question that the degree of devaluation in the Asian countries is excessive, both from the viewpoint of the

individual countries, and from the viewpoint of the international system. Looking first to the individual country,

companies with substantial foreign currency debts, as so many companies in these countries have, stood to

suffer far more from… currency (depreciation) than from a temporary rise in domestic interest rates…. Thus, on
macroeconomics… monetary policy has to be kept tight to restore confidence in the currency..."

From the then IMF Managing Director Michel Camdessus himself ("Doctor Knows Best?" Asiaweek, 17 July

1998, p. 46):

"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."

[edit]Thailand

Further information: Economy of Thailand

From 1985 to 1996, Thailand's economy grew at an average of over 9% per year, the highest economic growth

rate of any country at the time. Inflation was kept reasonably low within a range of 3.4–5.7%.[19] The baht was

pegged at 25 to the US dollar.

On 14 May and 15 May 1997, the Thai baht was hit by massive speculative attacks. On 30 June 1997, Prime

Minister Chavalit Yongchaiyudh said that he would not devalue the baht. This was the spark that ignited the
Asian financial crisis as the Thai government failed to defend the baht, which was pegged to the basket of

currencies, where U.S. dollar was the main component,[20] against international speculators. Thailand's booming

economy came to a halt amid massive layoffs in finance, real estate, and construction that resulted in huge

numbers of workers returning to their villages in the countryside and 600,000 foreign workers being sent back to

their home countries.[21] The baht devalued swiftly and lost more than half of its value. The baht reached its

lowest point of 56 units to the US dollar in January 1998. The Thai stock market dropped 75%. Finance One, the

largest Thai finance company until then, collapsed.[22]

The Thai government was eventually forced to float the Baht, on 2 July 1997. On 11 August 1997,

the IMF unveiled a rescue package for Thailand with more than $17 billion, subject to conditions such as passing

laws relating to bankruptcy (reorganizing and restructuring) procedures and establishing strong regulation

frameworks for banks and other financial institutions. The IMF approved on 20 August 1997, another bailout

package of $3.9 billion.

Thai opposition parties claimed that former Prime Minister Thaksin Shinawatra had profited from the devaluation,
[23]
 It has been investigated by the court of justice and despite comments from former Thaksin cabinet member

Sanoh that "There were four people who got involved in the Baht depreciation, i.e. Chavalit, Thaksin, Thanong

and Pokin," [24] no case has been filed against Thaksin for this or any other parties.

By 2001, Thailand's economy had recovered. The increasing tax revenues allowed the country to balance its

budget and repay its debts to the IMF in 2003, four years ahead of schedule. The Thai baht continued to

appreciate to 29 Baht to the Dollar in October 2010.

[edit]Indonesia

See also: Fall of Suharto and Economy of Indonesia

In June 1997, Indonesia seemed far from crisis. Unlike Thailand, Indonesia had low inflation, a trade surplus of

more than $900 million, huge foreign exchange reserves of more than $20 billion, and a good banking sector. But

a large number of Indonesian corporations had been borrowing in U.S. dollars. During the preceding years, as

the rupiah had strengthened respective to the dollar, this practice had worked well for these corporations; their

effective levels of debt and financing costs had decreased as the local currency's value rose.

In July 1997, when Thailand floated the baht, Indonesia's monetary authorities widened the rupiah trading

band from 8% to 12%. The rupiah suddenly came under severe attack in August. On 14 August 1997, the

managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The rupiah

dropped further. The IMF came forward with a rescue package of $23 billion, but the rupiah was sinking further

amid fears over corporate debts, massive selling of rupiah, and strong demand for dollars. The rupiah and

the Jakarta Stock Exchange touched a historic low in September.Moody's eventually downgraded Indonesia's

long-term debt to 'junk bond'.[25]

Although the rupiah crisis began in July and August 1997, it intensified in November when the effects of that

summer devaluation showed up on corporate balance sheets. Companies that had borrowed in dollars had to
face the higher costs imposed upon them by the rupiah's decline, and many reacted by buying dollars through

selling rupiah, undermining the value of the latter further. In February 1998, President Suharto sacked Bank

Indonesia Governor J. Soedradjad Djiwandono, but this proved insufficient. Suharto resigned under public

pressure in May 1998 and Vice President B. J. Habibiewas elevated in his place. Before the crisis, the exchange

rate between the rupiah and the dollar was roughly 2,600 rupiah to 1 USD.[26] The rate plunged to over 11,000

rupiah to 1 USD in January 1998, with spot rates over 14,000 during January 23–26 and trading again over

14,000 for about six weeks during June–July 1998. On 31 December 1998, the rate was almost exactly 8,000 to

1 USD.[27] Indonesia lost 13.5% of its GDP that year.

[edit]South Korea

Further information: Economy of South Korea

Economy of South Korea

    History

        Miracle on the Han River

        1997 financial crisis

    Companies

        List of companies

        Chaebol

        Samsung (Chaebol)

        Hyundai (Chaebol)

        LG (Chaebol)

        SK (Chaebol)

    Industry

        Currency

        Communications

        Tourism

        Transportation

        Real estate

        Financial services

        Nuclear power
     Rankings

        Regions by GDP per capita

        International rankings

    Related topics

        Science and technology

        Cities

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Macroeconomic fundamentals in South Korea were good but the banking sector was burdened with non-

performing loans as its large corporations were funding aggressive expansions. During that time, there was a

haste to build great conglomerates to compete on the world stage. Many businesses ultimately failed to ensure

returns and profitability. The South Korean conglomerates, more or less completely controlled by the

government, simply absorbed more and more capital investment. Eventually, excess debt led to major failures

and takeovers. For example, in July 1997, South Korea's third-largest car maker, Kia Motors, asked for

emergency loans. In the wake of the Asian market downturn, Moody's lowered the credit rating of South Korea

from A1 to A3, on 28 November 1997, and downgraded again to B2 on 11 December. That contributed to a

further decline in South Korean shares since stock markets were already bearish in November. TheSeoul stock

exchange fell by 4% on 7 November 1997. On 8 November, it plunged by 7%, its biggest one-day drop to that

date. And on 24 November, stocks fell a further 7.2% on fears that the IMF would demand tough reforms. In

1998, Hyundai Motors took over Kia Motors. Samsung Motors' $5 billion dollar venture was dissolved due to the

crisis, and eventually Daewoo Motors was sold to the American company General Motors (GM).

The South Korean won, meanwhile, weakened to more than 1,700 per dollar from around 800. Despite an initial

sharp economic slowdown and numerous corporate bankruptcies, South Korea has managed to triple its per

capita GDP in dollar terms since 1997. Indeed, it resumed its role as the world's fastest-growing economy—since

1960, per capita GDP has grown from $80 in nominal terms to more than $21,000 as of 2007. However, like

the chaebol, South Korea's government did not escape unscathed. Its national debt-to-GDP ratio more than

doubled (app. 13% to 30%) as a result of the crisis.

In South Korea, the crisis is also commonly referred to as the IMF crisis.

[edit]Philippines

Further information: Economy of the Philippines

The Philippine central bank raised interest rates by 1.75 percentage points in May 1997 and again by 2 points on

19 June. Thailand triggered the crisis on 2 July and on 3 July, the Philippine Central Bank was forced to

intervene heavily to defend the peso, raising the overnight rate from 15% to 32% right upon the onset of the
Asian crisis in mid-July 1997. The peso fell significantly, from 26 pesos per dollar at the start of the crisis, to 38

pesos as of mid-1999, and to 54 pesos as of first half August 2001.

The Philippine economy recovered from a contraction of 0.6% in GDP during the worst part of the crisis to GDP

growth of some 3% by 2001, despite scandals of the administration of Joseph Estrada in 2001, most notably the

"jueteng" scandal, causing the PSE Composite Index, the main index of the Philippine Stock Exchange, to fall to

some 1000 points from a high of some 3000 points in 1997. The peso fell even further, trading at levels of about

55 pesos to the US dollar. Later that year, Estrada was on the verge of impeachment but his allies in the senate

voted against the proceedings to continue further. This led to popular protests culminating in the "EDSA II

Revolution", which finally forced his resignation and elevated Gloria Macapagal-Arroyo to the presidency. Arroyo

managed to lessen the crisis in the country, which led to the recovery of the Philippine peso to about 50 pesos by

the year's end and traded at around 41 pesos to a dollar by end 2007. The stock market also reached an all time

high in 2007 and the economy is growing by at least more than 7 percent, its highest in nearly 2 decades.

[edit]Hong Kong

Further information: Economy of Hong Kong

Although the two events were unrelated, the collapse of the Thai baht on 2 July 1997, came only 24 hours after

the United Kingdom handed over sovereignty of Hong Kong to the People's Republic of China. In October 1997,

the Hong Kong dollar, which had been pegged at 7.8 to the U.S. dollar since 1983, came under speculative

pressure because Hong Kong's inflation rate had been significantly higher than the U.S.'s for years. Monetary

authorities spent more than US$1 billion to defend the local currency. Since Hong Kong had more than US$80

billion in foreign reserves, which is equivalent to 700% of its M1 money supply and 45% of its M3 money supply,
[citation needed]
 theHong Kong Monetary Authority (effectively the city's central bank) managed to maintain the peg.

Stock markets became more and more volatile; between 20 October and 23 October the Hang Seng

Index dropped 23%. The Hong Kong Monetary Authority then promised to protect the currency. On 15 August

1998, it raised overnight interest rates from 8% to 23%, and at one point to 500%.[citation needed] The HKMA had

recognized that speculators were taking advantage of the city's unique currency-board system, in which overnight

rates automatically increase in proportion to large net sales of the local currency. The rate hike, however,

increased downward pressure on the stock market, allowing speculators to profit by short selling shares. The

HKMA started buying component shares of the Hang Seng Index in mid-August.

The HKMA and Donald Tsang, then the Financial Secretary, declared war on speculators. The Government

ended up buying approximately HK$120 billion (US$15 billion) worth of shares in various companies,[28] and

became the largest shareholder of some of those companies (e.g. the government owned 10% of HSBC) at the

end of August, when hostilities ended with the closing of the August Hang Seng Index futures contract. In 1999,

the Government started selling those shares by launching the Tracker Fund of Hong Kong, making a profit of

about HK$30 billion (US$4 billion).

[edit]Malaysia
Further information: Economy of Malaysia

Before the crisis, Malaysia had a large current account deficit of 5% of its GDP. At the time, Malaysia was a

popular investment destination, and this was reflected in KLSE activity which was regularly the most active stock

exchange in the world (with turnover exceeding even markets with far higher capitalization like the NYSE).

Expectations at the time were that the growth rate would continue, propelling Malaysia to developed status by

2020, a government policy articulated in Wawasan 2020. At the start of 1997, the KLSE Composite index was

above 1,200, the ringgit was trading above 2.50 to the dollar, and the overnight rate was below 7%.

In July 1997, within days of the Thai baht devaluation, the Malaysian ringgit was "attacked" by speculators. The

overnight rate jumped from under 8% to over 40%. This led to rating downgrades and a general sell off on the

stock and currency markets. By end of 1997, ratings had fallen many notches from investment grade

to junk[disambiguation needed], the KLSE had lost more than 50% from above 1,200 to under 600, and the ringgit had lost

50% of its value, falling from above 2.50 to under 4.10 to the dollar. The then premier, Mahathir

Mohammad imposed strict capital controls and introduced a 3.80 peg against the US dollar

In 1998, the output of the real economy declined plunging the country into its first recession for many years.

The construction sector contracted 23.5%, manufacturing shrunk 9% and the agriculturesector 5.9%. Overall, the

country's gross domestic product plunged 6.2% in 1998. During that year, the ringgit plunged below 4.7 and the

KLSE fell below 270 points. In September that year, various defensive measures were announced to overcome

the crisis. The principal measure taken were to move the ringgit from a free float to a fixed exchange

rate regime. Bank Negara fixed the ringgit at 3.8 to the dollar. Capital controls were imposed while aid offered

from the IMF was refused. Various task force agencies were formed. The Corporate Debt Restructuring

Committee dealt with corporate loans. Danaharta discounted and bought bad loans from banks to facilitate

orderly asset realization. Danamodal recapitalized banks.

Growth then settled at a slower but more sustainable pace. The massive current account deficit became a fairly

substantial surplus. Banks were better capitalized and NPLs were realised in an orderly way. Small banks were

bought out by strong ones. A large number of PLCs were unable to regulate their financial affairs and were

delisted. Compared to the 1997 current account, by 2005, Malaysia was estimated to have a US$14.06 billion

surplus.[29] Asset values however, have not returned to their pre-crisis highs. In 2005 the last of the crisis

measures were removed as the ringgit was taken off the fixed exchange system. But unlike the pre-crisis days, it

did not appear to be a free float, but a managed float, like the Singapore dollar.

[edit]Singapore

Further information: Economy of Singapore

As the financial crisis spread the economy of Singapore dipped into a short recession. The short duration and

milder effect on its economy was credited to the active management by the government. For example,

the Monetary Authority of Singapore allowed for a gradual 20% depreciation of the Singapore dollar to cushion

and guide the economy to a soft landing. The timing of government programs such as the Interim Upgrading

Program and other construction related projects were brought forward. Instead of allowing the labor markets to
work, the National Wage Council pre-emptively agreed toCentral Provident Fund cuts to lower labor costs, with

limited impact on disposable income and local demand. Unlike in Hong Kong, no attempt was made to directly

intervene in the capital marketsand the Straits Times Index was allowed to drop 60%. In less than a year, the

Singaporean economy fully recovered and continued on its growth trajectory.[30]

[edit]China

Further information: Economy of the People's Republic of China

The Chinese currency, the renminbi (RMB), had been pegged to the US dollar at a ratio of 8.3 RMB to the dollar,

in 1994. Having largely kept itself above the fray throughout 1997–1998 there was heavy speculation in

the Western press that China would soon be forced to devalue its currency to protect the competitiveness of its

exports vis-a-vis those of the ASEAN nations, whose exports became cheaper relative to China's. However, the

RMB's non-convertibility protected its value from currency speculators, and the decision was made to maintain

the peg of the currency, thereby improving the country's standing within Asia. The currency peg was partly

scrapped in July 2005 rising 2.3% against the dollar, reflecting pressure from the United States.

Unlike investments of many of the Southeast Asian nations, almost all of China's foreign investment took the form

of factories on the ground rather than securities, which insulated the country from rapidcapital flight. While China

was unaffected by the crisis compared to Southeast Asia and South Korea, GDP growth slowed sharply in 1998

and 1999, calling attention to structural problems within its economy. In particular, the Asian financial crisis

convinced the Chinese government of the need to resolve the issues of its enormous financial weaknesses, such

as having too many non-performing loans within its banking system, and relying heavily on trade with the United

States.

[edit]United States and Japan

Further information: Economy of the United States  and  Economy of Japan

The "Asian flu" had also put pressure on the United States and Japan. Their markets did not collapse, but they

were severely hit. On 27 October 1997, the Dow Jones industrial plunged 554 points or 7.2%, amid ongoing

worries about the Asian economies. The New York Stock Exchange briefly suspended trading. The crisis led to a

drop in consumer and spending confidence (see 27 October 1997mini-crash). Indirect effects included the dot-

com bubble, and years later the housing bubble and the Subprime mortgage crisis. Japan was affected because

its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latter's

economy was more than twice the size of the rest of Asia together; about 40% of Japan's exports go to Asia.

The Japanese yen fell to 147 as mass selling began, but Japan was the world's largest holder of currency

reserves at the time, so it was easily defended, and quickly bounced back. GDP real growth rate slowed

dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998, due to intense competition from

cheapened rivals. The Asian financial crisis also led to more bankruptcies in Japan. In addition, with South

Korea's devalued currency, and China's steady gains, many companies complained outright that they could not

compete.[31]
Another longer-term result was the changing relationship between the U.S. and Japan, with the U.S. no longer

openly supporting the highly artificial trade environment and exchange rates that governed economic relations

between the two countries for almost five decades after World War II.[32]

[edit]Consequences

[edit]Asia

The crisis had significant macro-level effects, including sharp reductions in values of currencies, stock markets,

and other asset prices of several Asian countries.[33] The nominal US dollar GDP of ASEAN fell by US$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.[34] 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.

Exchange rate GNP (US$1 billion)[35]

(per US$1)[35]
Country Chang
Currency Change
June 1997 July 1998
June
July 1998
1997

 Thailand 170 102 – 40.0

 Thai baht 24.5 41 – 40.2%

 Indonesia 205 34 – 83.4

 Indonesian rupiah 2,380 14,150 – 83.2%

 Philippines 75 47 – 37.3

 Philippine peso 26.3 42 – 37.4%

 Malaysia 90 55 – 38.9

 Malaysian ringgit 2.5 4.1 – 39.0%

 South Korea 430 283 – 34.2

 South Korean won 850 1,290 – 34.1%

The above tabulation shows that despite the prompt raising of interest rates to 32% in the Philippines upon the

onset of crisis in mid-July 1997, and to 65% in Indonesia upon the intensification of crisis in 1998, their local

currencies depreciated just the same and did not perform better than those of South Korea, Thailand, and

Malaysia, which countries had their high interest rates set at generally lower than 20% during the Asian crisis.

This created grave doubts on the credibility of IMF and the validity of its high-interest-rate prescription to

economic 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 Europeaninvestment, though Japanese

investment was sustained.[citation needed] Islamic and other separatist movements intensified in Southeast Asia as

central authorities weakened.[36]

More long-term consequences included reversal of the relative gains made in the boom years just preceding the

crisis. Nominal US dollar GDP per capital fell 42.3% in Indonesia in 1997, 21.2% in Thailand, 19% in Malaysia,

18.5% in South Korea and 12.5% in the Philippines.[34] The CIA World Factbook reported that the per capita

income (measured by purchasing power parity) in Thailand declined from $8,800 to $8,300 between 1997 and

2005; in Indonesia it declined from $4,600 to $3,700; 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.[37] 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.[38]

The crisis has been intensively analyzed by economists for its breadth, speed, and dynamism; it affected dozens

of countries, had a direct impact on the livelihood of millions, happened within the course of a mere few months,

and at each stage of the crisis leading economists, in particular the international institutions, seemed a step

behind. Perhaps more interesting to economists was the speed with which it ended, leaving most of

the developed economies unharmed. These curiosities have prompted an explosion of literature about financial

economics and a litany of explanations why the crisis occurred. A number of critiques have been leveled against

the conduct of the IMF in the crisis, including one by former World Bank economist Joseph Stiglitz. 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.[39]

[edit]Outside Asia

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 $8 per barrel towards the end of 1998, causing a financial pinch

in OPEC nations and other oil exporters. This reduction in oil revenue contributed to the 1998 Russian financial

crisis, which in turn caused Long-Term Capital Management in the United States to collapse after losing $4.6

billion in 4 months. A wider collapse in the financial markets was avoided when Alan Greenspan and the Federal

Reserve Bank of New York organized a $3.625 billion bail-out. Major emerging

economies Brazil and Argentina also fell into crisis in the late 1990s (see Argentine debt crisis).[40]

The crisis in general was part of a global backlash against the Washington Consensus and institutions such as

the IMF and World Bank, which simultaneously became unpopular in developed countries following the rise of

the anti-globalization movement in 1999. Four major rounds of world trade talks since the crisis,

in Seattle, Doha, Cancún, and Hong Kong, have failed to produce a significant agreement as developing

countries have become more assertive, and nations are increasingly turning toward regional or bilateral free

trade agreements (FTAs) as an alternative to global institutions. 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, restructuring their economies so as to create a current account surplus to build large foreign currency

reserves. This has led to an ever increasing funding for US treasury bonds, allowing or aiding housing (in 2001–

2005) and stock asset bubbles (in 1996–2000) to develop in the United States.
[edit]

Good Look at the Thai Financial Crisis in 1997-98

1.Introduction

            An open economy is susceptible to a speculative attack; the smaller the

economy, the more severely it is likely to get hurt. Good balances in economic
components are the only immunity as well as medicine to such an attack. In 1992,
the European Monetary System had to be practically abolished as its member
economies had been consistently hit by speculators who had seen a way to exploit
economic imbalances that made possible a devaluation of the economies’ currency.
Two years later, Mexico had encountered  calamitous, speculative attacks that had
forced it to devalue the peso by more than 50%. Mexican banking and private
sectors all got hurt and the economy had stopped growing for more than half a
decade. On the other hand, only the central banks of the European economies had
forfeited currency in their foreign reserve in order to promptly stop the crisis.
Thailand was another open economy loudly hit by speculative attacks. It had
enjoyed too much and too recklessly wealth in its good days, the habit which had
given rise to  serious imbalances of a number of the economy’s components. The
overoptimistic characteristic of the economy had essentially led to the deterioration
of its health. With the weak body, not for a long time could it stand against outside
attacks from speculators. Being depleted  of its foreign currency reserve in
attempts to fight against the speculative forces, on July 2, 1997, Thailand decided
to switch to a flexible exchange rate regime. The Thai bath was depreciated by
more than 50% by the end of that year; the Thais had experienced a collapse of
their economy for the first time.

            This paper was aimed to give a clear picture of the Thai financial crisis and
insight thoughts on some of the issues related. The paper was divided as follow:
Section( 1) Introduction, Section( 2) An Anatomy of the Thai Financial Crisis,
Section (3) Did the Thais Ignore the Painful Lessons of the Mexico?, Section(4)
An Evaluation of the Thai Government Performance along Thailand’s Economic
Path and in Response to the Crisis, (5) Final Remarks on the Future of the Thai
Economy, Section (6) Conclusion.

2. An Anatomy of the Thai Financial Crisis

            Since early 1990s, Thai economy had attracted massive volumes of capital
inflow from aboard due to its accommodating economic policies, goal, healthy-
looking conditions, and some other outside factors such as the stagflation of
Japanese economy and the recession in European countries during 1990s. After a
long period of strict financial regulations that limited credit expansion of
commercial banks, starting from the beginning of 1990s, the Thai government had
decided to accommodate a policy of financial market deregulation and capital
account liberalization. Moreover,  with an exchange rate fixed to a basket of world
dominant currencies especially US dollars, the Thais had enjoyed a long period of
nominal exchange rate stability as the baht had fluctuated very narrowly between
24.91-25.59 baht per dollar (Table 1), stable price level  of 3.3-5.9%, and high
interest rate at around 13.25% before the crisis.

            The Thai government also had done a good job in keeping inflation rate
low between 3.36% and 5.7% (Table 2) as well as fiscal balances surpluses (Table
3). Plus the economy had possessed a characteristic of high saving rates situated at
around 33.5% of GDP while its GDP growth had stayed at an impressive level of
8.08-8.94 during 1991-95. As a result, the Thai economy had become very
attractive to international speculators, many of whom had channeled their large
sum of capital out of Japan which had undergone a lengthy period of stagflation
and low interest rate. And by 1995, Thailand had a net capital inflow  of US$
14.239 billion, more than one hundred percent increase from its net capital inflow
three years ago.

            As a consequence of the huge overflow of capital, domestic investment had

its prime years and the banking sector had expanded very rapidly. Thailand’s
investment rate between 1990-96 as shown in Table 4 came in the first place
compared to the other nations of the same region. Stock market prices rose by
175% in aggregate and by 395% in property sector. There emerged more than 50
banks and non-banks financial institutions which had been controlled and
monitored much leniently by the Thai central bank—the Bank of Thailand. These
financial institutions had made a large sum of money out of the economy as they
had had small constraints and difficulties in borrowing quite excessively  from
abroad and lending with a dear interest at home. By early 1990s, Thailand’s banks
were ranked among the world’s most profitable as the banks could charge up to 4
percentage points more interest for loans than they paid on deposits, a discrepancy
which was 4 times bigger than the spreads of less than 1 percentage point in the
banking system of many developed economies. And Thailand’s lending boom
measure calculated from  the growth of bank lending as a percentage of GDP ratio
was 58%, the highest in the East Asian group (Table 5). 

            However, the growth of the capital inflow and the lending practice of the
Thai financial institutions were not very healthy nor wise. A large part of the
capital had been put into non-productive sectors especially real estate. Those
sectors were non-productive because they produced non-tradable goods which
were sold only domestically, resulting in less national volume of exports and thus
weaken the economy’s balance of trade as well as the capital account. A statistic
showed that 10-35% of bank loans were committed to bricks and mortar. In
addition, only a small portion of the capital inflow could be categorized as foreign
direct investment (FDI)—a non-speculative, thus real, type of investment that went
to the build-ups of capital goods, factories, inventories and land. In table 6, the
percentage of contribution of inward FDI to current account financing was
calculated. The proportion of FDI to the Thai economy was low and had decreased
over time from 33.57% in 1990 to 15.90% in 1996, compared to that of Malaysia
who had a proportion of FDI above 90% throughout the time period. In addition,
the financial institutions tended to lend recklessly without a prudent procedure of
lending contraction and monitoring. This was an adverse selection problem
resulted from moral hazard on the side of the financial institutions as the
institutions had expected a safety net provided by the Thai government or the Bank
of Thailand if a bank run occurred. The same problem was also with the foreign
creditors and depositors sides as they credited money to the financial institutions
with little care, having in mind the government’s bailout policy.  As Jeffrey Sachs
had presented an early analysis of the role of excessive lending driven by ‘moral
hazard’ incentives:

“Banks and near-banks—such as Thailand’s now notorious financial trusts

—become intermediaries for channeling foreign capital into domestic
 economy. The trouble is that the newly liberalized banks and near-banks
often operate under highly distorted incentives. Under-capitalized banks
have incentive to borrow aboard and invest domestically with reckless
abandon. If the lending works out, the bankers make money. If the lending
fails, the depositors and the creditors stand to lose money, but the bank’s
owners bear little risk themselves because they have little capital tied up in
the bank. Even the depositors and the foreign creditors may be secure from
risk, if the government bails them out in the case of bank failure.”[1]

Furthermore, it was worth noted that the lending boom was significantly larger for
finance and securities companies than for banks (133% of the former as opposed to
51% of the latter). And the non-bank share of lending to the private sector was
quite significant (about 33% of bank lending). As a result, Thailand was the only
country, among the countries affected by the Asian crisis, where lending to private
sector was very different if we added the ‘other banking’ and ‘non-bank financial
institutions’ figures. Unfortunately, these non-bank institutions tended to have a
very bad lending practice. As later on, they were severely affected by the incident
of non-performing loans crisis, and 56 of them were forced to close their business
in a government’s attempt to remedy the crisis which had gone much worse after
the devaluation of the baht. Another imprudent lending practice of the financial
institutions was that they lent from foreigners  mostly in dollar denomination and
thus needed to pay back in the foreign-nominated currency, but they relent that
foreign-denominated currency in baht at home. A ratio of foreign liabilities to
assets is shown in table 8. Strikingly, the ratio is far higher in the case of Thailand
than that of the other countries: the ratio of Thailand before the crisis had been
increasing from 6.93 in 1993 to 11.03 in 1996 whereas that of the other countries
never exceeded 4.3 in the same time period. This suggested a serious mismatch
between the stock of foreign liabilities and assets. The Thais would get into a really
big trouble if they needed to repay those liabilities in all of a sudden.  This later on
would be shown to be a crucial cause of the deterioration of the nation’s balance of
payment and the collapse of the economy.

            Unfortunately, the golden years did not last long. Starting from the year
1995, Thailand’s economic growth became much slow down due to a number of
factors such as the contraction in the real estate sector, the emergence of China as
an intimidating competitor in international trade, the fall of world demand of
semiconductor which was one of the Thai major exports in 1996, and an
appreciation of the dollars after Spring 1995. As previously discussed, real estates
were non-tradable; thus, there was a constraint in market demand of them. Too
many houses and business buildings were built; by 1997, the commercial vacancy
rate had gone up to 15% (Table7). The real estate business had become
unprofitable., and the business owners, thus, had no capacity to pay back their
debts to financial institutions when the maturity came. The percentage of non-
performing loans had risen up to 13% in 1996. This soar of the non-performing
loans began the era of banking crisis as banks’ balance sheet had been deteriorated.
Besides, in international trade, Thailand had become less competitive in the
existence of an emerging trader like China together with a constantly increasing
trend of dollar currency (i.e. an appreciation of dollar) which had worsened
Thailand’s terms of trade since the Spring of 1995. (The exchange rate of yen for
dollar went from 80 in Spring 1995 to over 125 yen per dollar in Summer 1997).
Thailand’s terms of trade had been worsened because the Thai baht needed to
appreciate along with the dollar which was the major currency in the currencies
basket Thailand had fixed its exchange rate to. And as the world demand of
semiconductor had fallen in 1996, Thailand’s volume of exports decreased,
contributing to a balance of trade deficit.

            Another item should be looked at was the country’s current account

balance.  Thailand had had persistent current account deficit ranging from -5.08 to
-8.10 % of GDP lowest among the other nations for most of the time in the sample
(table9). This negative sum largely came from the country’s balance of trade
deficit. The value of its imports had widely exceeded its export value (table10).
This high volume of imports could be expected as the country had had a high GDP
growth rate (table11). However, the number could look better if Thai people had
been more prudent in spending and could be more competitive exporters. During
the boom period, the economy was in a bubble. Thai people had had an expectation
of a long run economic growth of their country; thus, their consumption had
become quite excessive especially in imported commodities and luxuries. 

            There came speculators who had seen Thailand’s slow growth rate, bank
run, and deteriorating balance of payments as signs of unprofitability for their
investment. They started selling domestic assets and claimed back their foreign
assets. As a result, bank balance sheets became increasingly deteriorated, and the
economy had faced a severe credit crunch problem. Even investors with productive
investment opportunities could not get loans to run their business. The country’s
economic growth, thus, had been even more deterred. On February 5, 1997,
“Somprasong” was the first Thai company to miss the repayment of its foreign
debt.  The situation had gone much severe that a large number of Thai financial
institutions were not anymore to pay back their debts; the government’s bailout
operation was expected. On March 10, 1997, the Thai government announced that
it would buy $3.9 billion in bad property debt from a number of; however, it
reneged the promise at the end. On May 23 the government made an attempt to
save “Finance One,” Thailand’s largest finance company, via a merger with
another financial institution. But again it could not fulfill its mission. As only one
month later, the new finance minister ‘discovered’ that the Bank of Thailand had
already used US$ 28 billion out of US$ 30 billion of its international reserves in
the course of forward market interventions to defend the value of the baht.

            Under a fixed exchange rate system, it was the responsibility of the

government or the central bank to conduct policies i.e. exchange-rate changing,
exchange-rate switching, and direct control, to keep its  exchange rate fixed as well
as to maintain a fine level of the overall condition of the economy. An exchange-
rate changing policy was the first approach, constituted of a fiscal and monetary
policy. As more and more capital flew out of the country or as the country had
faced a balance of payments deficit the central bank needed to forfeit its foreign
reserves, injecting the foreign currency into the economy to satisfy the currency’s
excess demand and bring the economy back to its exchange rate equilibrium. So as
speculators had kept taking dollars out of the system (i.e. Thai economy) , the
Bank of Thailand had a necessity to inject dollars into the system using its stock of
foreign reserves. Not for a long time, however, did the central bank could do that.
Its stock of foreign reserves was almost used up, and it realized that it could not, in
any way, be able to supply the foreign currency to the economy given the
enormous size of foreign liabilities. (This, you can look back in table 8.) An
exchange-rate switching policy, thus, soon would need to be committed. The
speculators knew the situation as well and had realized a mammoth gain from a
devalued baht as their foreign assets would worth much more. So there occurred
the first massive speculative attack in the Thai history on May 14-15, 1997. Only
in Spring of 1997, more than 90% of the country’s foreign reserve had been used
to defend the value of the baht, and the country was forced to finally switch its
exchange rate regime. On July 2, 1997, Thailand had become under a flexible
exchange rate system; the Thai baht was devalued by about 15-20 percent (28.80
baht per dollar) after the announcement. The value of the baht had continuously
gone down since then and reached the bottom at 48.80 baht per dollar in December
of the same year, the highest rate (lowest value of the Thai baht) ever since
Thailand started keeping record in 1969.

            In this world, open economies were interrelated basically through trade and
capital flow, and the health of an economy essentially depended upon how well the
economy had managed itself to be in a healthy  balance of trade and capital flow. If
the balances could  not be obtained, the economy  became unstable and, sooner or
later, it would fall down. It might get injured seriously or not seriously dependent
on its remaining strength and how and where it fell down. The Thai economy had
not well managed its balances. It was too reckless in capital flow management
which resulted in an imbalance of bank balance sheets of the nation’s financial
institutions. In trade, however, an imbalance was largely caused by outside factors
which were likely to be exogenous to the Thai economy, for instance, the
emergence of China in international trade, the appreciation of the dollars, and the
fall of world demand of semiconductor. The Thais might be able to do things such
as the abandonment of an exchange rate regime that caused the Thai baht to move
in the same direction as that of the dollars, and investment in research and
development to find other types of exports that Thailand could profitably produce
and export.

3. Do the Thais Ignore the Painful Lessons of Mexico?

            The Thai financial crisis appeared to be very similar to the Mexican

financial crisis of 1994-95. In both cases, an enormous amount of capital was
injected into the economies, of which a large part was speculative. The capital had
caused overlending syndrome of financial institutions that were loosely monitored
by the central bank. The central bank, on the other hand, promised to bailout
financial institutions that failed in operation, a policy which had created moral
hazard in the financial institutions as well as the creditors and depositors. Then,
good years had passed; the economies had experienced slow economic growth and
capital outflow. The outflow of capital had caused a bank run which
later  developed to be a banking crisis. And the necessity of the central bank to get
the economy going by supplying foreign currency out of its reserves had been
proved to be too huge a task that the central bank finally had to commit to an
exchange-rate switching policy, and the economies had to suffer a long period of
recession afterwards.

            (Points of argument which would follow were products of an attempt to

understand and explain some of  the behaviors of the economy. The points were
only suggestive, not necessarily true. Plus, the points were essentially based on
psychological aspects of the issue, and, thus, should be considered together with
tangible aspects which were believed to be more rational. For example, as the
reader realized that Thailand had believed that it would be after Japan not Mexico,
the reader should also have in mind the fact that the Thais had not felt carefree as
they must have seen their country’s statistics, for example, persistent current
account deficits, problematically mismatching ratio of foreign liabilities to foreign
assets, which indicated a fragile condition of the country.)

            So do the Thais forget the painful lessons of Mexico? I would say “yes, but
without many choices.” By the time that Mexico had entered into the financial
crisis (1994-95), the Thai economy had begun to get used to a new style of
economic liberalization. Thai people had earned more income and had become
more and more proud of the growth of their economy. A set of government who
came in and suddenly made the economy less appreciable would become
unpopular. Thus, the governments in power during that period had preferred not to
change the picture of the economy much. So, political concerns did have impacts
on the direction of the economic policies. Besides, the Thai economy had had one
characteristic much contributing to the rationale of the economy along its path. It
believed in a miracle, and that it could make things different. As commented by
Paul Krugman:

“Well, maybe the revelation that Asian nations do, in fact, live in the same
economic universe as the rest of us will provoke some much-needed
reflection on the realities of the Asian economic “miracle.””[2]

The Asian countries were believed to have Japan as a model for their economic
development. After World War II, Japan could quickly and profitably expand its
economy especially its manufacturing sector, and became the second largest
economy of the world in only less than four decades afterwards. It started from
exporting low-technical goods such as watches and electronic appliances. Only
shortly afterward, it shifted to produce merchandises which required  higher level
of technology, for example, automobiles, computers. Then, it moved on to cross-
border investment, and not long afterwards, it became the biggest creditor of the
world. The Asian countries had observed the success of Japanese economy and
believed that they, as well, could do the same thing. Thailand, for example, had
started with producing and exporting electronic and automobile parts, then moved
on to real estate investment, and planned to do good at capital investment. In less
than a  decade, the country had grown so much that it believed that it had been on a
right path, a path which would lead it to the prosperity that Japan had enjoyed.
Investment boom and the rise of cities were evident in the path of the growth. Ten
years ago, if you traveled along Chao-Pra-Ya river, a main river in Bangkok, you
would see only vast rice fields along both sides of the river. Today, however, the
rice fields had turned to be tall business buildings, hotels, and restaurants. This sort
of phenomenon also happened to some other provinces in Thailand which had
grown to be cities as the economy had expanded so much that Bangkok could not
alone accommodate all the businesses and industries. And in 1994-95, Thailand
must observe the economic crisis and collapse of the Mexican economy.
Unfortunately, it probably would have seen itself after Japan and not Mexico.
Miraculously successful as it had seen itself to be, it believed that it would not fall.

4. An Evaluation of the Thai Government Performance along Thailand’s

Economic Path and in  Response to the Crisis.

            The Thai governments had not done a very good job. They had not dared to
be far-sighted as they were still concerned much about politics. They had stuck to
the goal held since the first time of capital account liberalization, a goal which had
aimed at the expansion of the economy. The economy did expand, however, not
quite healthily. It was like a bubble, continuously inflated, but the bigger it
became, the more easily it would explode even with a soft touch of a rough
surface.

            The liberalization of the financial sector had been proved to be too reckless.
Statistics such as ratio of foreign liabilities to foreign assets, non-performing loans,
contribution of inward FDI to current account financing, had been evidences of the
recklessness. However, even a good statistics like high GDP growth could not have
made the economy joyful. Thailand’s GDP growth had been high at around 8.5%
during the first half of 1990s. Nevertheless, a large contribution of the growth had
come from production of non-tradable good and from pure speculative capital
inflow. The structure of the Thai economy was still not ready for that large amount
of capital not to be used in real investment. If Thailand had run current account
surplus and balance of trade surplus as high as  that of Taiwan or Singapore (table9
and table 10), it might have a reason and want to liberate itself that much in the
financial world.

            Politics seemed to be much influential in policy making of the government.

The majority of Thai people who walked on the street had been made to see only a
prosper side of the economy. It had only been shown to them the growing of the
cities and business sectors, and statistics such as high GDP growth, high saving
rate, government fiscal balance surpluses, high volume of exports, a claim that
Thailand had become one of the Asian Tigers. But it had not been shown to them
how serious the country had become indebted, and how recklessly capital had been
transferred and used in the economy. Thai people should be better informed and
made sophisticated. The Thai government had tried to maintain its popularity even
in the last minute when it decided not to ask IMF for a rescue package immediately
after the devaluation of the baht was announced, but waited until 26 days later to
eventually called in the IMF. This delay had a serious consequence as it
exacerbated the situation of bank run. According to Frederic S. Mishkin, it was
believed that  the faster the lending was done, the lower was the amount that
actually had to be lent.[3] The action of the government, thus, was highly
disadvantageous to the economy.  Whereas the US Federal Reserve Bank could
engage in a lender of last resort operation in a day in the event of stock market
crash of 1987, the Bank of Thailand had postponed for another 26 days before it
engaged in a lending operation.

            Another government conduct worth to be discussed was its loose monetary

policy during  the period right after the first devaluation of the baht. Committing to
that policy, the government showed its steadfast attempt to promote the production
and thus the growth of the economy, an objective which had never been set aside.
It had kept interest rate low so that the amount of money supply in the economy
would be high which would encourage domestic consumption and investment. This
conformed to the ‘Laffer curve’ condition saying that a fall not a rise of interest
rate would have strengthen the economy and restored confidence. Unfortunately,
the problem of bank panic was so serious that no matter how much money supply
the economy had, the creditors would attempt their best to take money out of the
system and did not invest. This resulted in a continuous spiral of currency
depreciation that dramatically increased the real burden of the foreign-currency
liabilities.  Seeing that a loose monetary did not work, the government later on had
switched to tighten its monetary policy.  It raised domestic interest rate, hoping to
retain money in the system. However, the policy turned out to be propelling a more
serious contraction of the Thai economy and credit crunch. 

5. Final Remarks on the Future of the Thai Economy.

The Thai financial crisis was built upon macroeconomic imbalances of the
country, and those imbalances were essentially attributable to the faulty structure
of the nation’s financial sector. A financial restructuring thus became the first
episode of its road to discovery.  Beside that it would be ensured that a similar type
of financial crisis would not happen again in the future, the financial restructuring
would have an immediate or short term benefit to the economy as it would beef up
the investors’ confidence to bring in credits or capital into the Thai economy in
order to make the economy move again.

The next step was that Thailand needed to try to have a reliable and capable
institution which could give it a safety net when such a crisis occurred. Unlike the
Fed, the Bank of Thailand had a constraint on its foreign-currency reserves which
were to be used to pay the nation’s debt. So the Bank of Thailand, at least in this
ten or fifteen years, would not be able to function as a lender-of-last-resort. This
job, therefore, needed to be given to a powerful international institution like IMF.
The Bank of Thailand, however, should be reconstructed so that it became
independent to the government in its policy making since politics was proved to be
a crucial source of the unhealthiness of the economy.

Beside a strong financial structure and a good supporting institution in case

of a future financial crisis, from this point on, Thailand needed to be careful in
keeping things in a well order. For instance,  current account deficit should not be
much in excess of 5% of GDP especially if the deficit was financed in a way that
could lead to rapid reversals according to the US Deputy Treasury Secretary
Lawrence Summers[4]; Banks should be restricted in how fast their borrowing
could grow (Mishkin)[5]. 

6. Conclusion
            To achieve Macroeconomic balances, great care and prudent policy
management are needed. To be prudent was to be far-sighted and realistic. In the
Thai financial crisis case, policies had not been prudently thought out. The collapse
of the economy was a very tough lesson for the Thais. It would take long for the
economy to recover. (It was predicted to be longer than that of Mexico concisely
because the other countries of the region were also hit. Thus, Thailand could not
gain much terms of trade after the devaluation of the baht to help improving its
economy. Plus, the slow down of Japanese economy had made it unable to give
much aid to Thailand unlike Mexico who had a huge support from the US for the
road to its recovery.) But hopefully, during that long road, the Thais would
maximally utilize the time to thought out wise policies and beef up a real strength
so that when the next storm came, it would not turn over again.