The South East Asian Currency Crisis


1.0 Introduction

This study will probe at the causes and likely effects of the ongoing Southeast Asian crisis that began in the second quarter of 1997.  Though the situation is still unfolding—and surely will continue to for many years to come—it can confidently be said that this is the worst economic crisis the world has experienced since the Great Depression of the 1930s. Until very recently, most analysts had confined the crisis to Indonesia, South Korea, Malaysia, and Thailand. Some obdurate analysts even continue to suggest that the Asian ‘miracle’ is still far from over! These, and many other predictions that the crisis would result in only a short, sharp downturn with almost no impact on the major capitalist countries, have all proved to be wrong. Severe economic crisis in Japan along with economic slowdown in China, currency lows in Canada, South Africa, Mexico and many other countries, and the finale of the stumbling American economy, do clearly suggest that the crisis is endemic to the entire global system. This is an ugly and painful realization, but it is indeed reality.   Not only does it seem that the Asian miracle is surely over, but that the burgeoning global economy is headed for a drastic slowdown.

            The evidence presented in this study will fortify these arguments through a synthesis of some of the available research in the area, along with some independent conjecture where appropriate.  As a crisis ‘in progress’, it is both unwise and impossible to provide any definitive conclusions.  There are evident themes and concrete examples, nevertheless, that do help shed light on this very perplexing dilemma.  Thailand, though it is obviously a South East Asian economy, will be used as a case study to highlight the nature of the crisis.

2.0 The Reckoning of the ‘Asian Miracle’

As we know, the past year and one half witnessed a spectacular transition in East, and particularly, Southeast Asia.   For many years previous, academics, policy makers, and most commentators alike had been anticipating the shift to the Pacific Century.  As a reminder, this was to be the epoch where the developing economies of Southeast Asia and the Pacific Rim at large would dominate the global economy and marshal in a new Pacific order.  Until the events of summer 1997, it truly did appear as though this was the stage that was being set.  GDP growth in most of the Southeast Asian economies throughout the 1980s and early 1990s was proceeding at most impressive levels. While many surely did anticipate that this level of growth was unsustainable into the longer term, there were few if any who predicted that the Asian machine would grind to a halt when, or as quickly, as it did.  Indeed, within a matter of weeks the widely exalted Asian Miracle was re-coined the ‘Asian Flu’, the ‘Asian Contagion’, and a host other unpleasantries.  Different strains of this malady continue to make the news on a daily basis.  In fact, things appear to be getting worse.  And there are few economists or other right minded people who see any end to the crisis in sight. Many commentators must now agree that times will surely get worse before they get any better.

            Most individuals already know that the effects of this crisis have been alarming and widespread.  The markets of countries around the world have experienced varied effects from the turmoil—most all of them negative—and in addition to spurring the questions of ‘what happened’? and what is going to happen?, distinct questions about the overall operation of the modern global economy have been raised. All of these questions are obviously important.  But they are also difficult, controversial, and have  so far puzzled all of the world’s greatest thinkers and policy makers. No definitive answers can be found.

            Despite the uncertainty, by now it is clear to most observers that the main factor responsible for both the growth and collapse of the Southeast Asian markets was liberalised and extensive international capital flows. The high degree of international capital mobility and the expanding speculative content of a long boom growth exposed flaws in the system of macroeconomic management, first of all in the exchange rate regimes.[1]  There was an enormous inflow of portfolio and direct investment into Southeast Asian markets during the late 1980s and early to mid 1990s.   These inflows helped ignite a stock market boom, a rapid expansion of the construction industry, an escalation of real estate prices and an acceleration in money supply growth and bank lending.  Important at the outset of the crisis was that during this phase of growth, all economies in the region had their currencies linked to the US dollar.  The Thai baht operated in a narrow band around 26 baht per dollar.  Somewhat more flexible, the Philippine peso operated within the range of 25 to 27 pesos per dollar.  The Indonesian rupiah steadily decreased in value, but with such consistency that it was considered to follow a ‘moving peg’.  The Malaysian ringgit, in contrast to these other three currencies, fluctuated somewhat more unpredictably and actually appreciated against the US dollar over the period of growth.

            On the eve of the crisis, the crux of the issue for investors and speculators was fixed vs. floating exchange rates. While it is true that both of these systems have their strengths and weaknesses, applied specifically to the emerging economies in Southeast Asia, floating rates could have helped them cope with sudden drops in the price of their exports to combat surges of foreign capital.[2]   It seems intuitive that most emerging countries would have easily accepted this logic.   Yet, most emerging economies did peg, or fix, their exchange rates directly or indirectly previous to the crisis.  One reason is that a commitment to a fixed rate, “or a close cousin or clone, can help to cut inflationary expectations.”[3]  Further, many Southeast Asian governments had volunteered to use fixed rates in their efforts to promote prudent macroeconomic policies.  With fixed rates, slack policies automatically led to a fall in foreign exchange reserves.  Eventually, policy had to be tightened or the exchange rate would have to be abandoned.[4]  As evidenced by the crisis, speculators preyed on inconsistencies or anticipated inconsistencies.  Driven by the enormous force of speculative pressure, most of the South East Asian economies in crisis were forced to un-peg their currencies, which in turn caused their markets to collapse and their currencies to devalue.  This is clearly one of the main factors, if not the main factor, that precipitated the crisis.

            James Riedel (1997) argues that the fundamental incompatibility between high capital mobility, a managed exchange rate, and monetary autonomy has been called the ‘triad of incompatibilities’.  For many years, there were many that believed this otherwise impossible combination was somehow possible in Southeast Asia, “where large inflows of foreign capital have generally been accompanied by stable nominal exchange rates and low inflation.”[5] On the surface, the crisis would tend to refute this evidence.  Looking deeper into the picture, however, it does seem that this old wisdom is in fact true, at least in an historical sense. For, the primary flows of capital to Southeast Asia have been planted in foreign direct investment. Because of this, argues Riedel, “concerns about destabilising speculation and imprudent public sector borrowing are not relevant.”[6] He further suggested that “deepening and strengthening the process of economic liberalisation ongoing in the Asian developing countries is essential for minimising the risks and maximising the benefits from increased capital market integration.”[7]

            It is believed here that this line of reasoning is fundamentally flawed. While it is true that the Southeast Asian countries had unilaterally liberalised their policies towards foreign direct investment through the abolition of restrictions on entry and establishment in the early 1990s, the absence of a credible financial framework led to the creation of growth bubbles and high investment risks.   Moreover, it left governments quite unable to enact monetary policy to combat the pressures from increases in foreign capital reserves.  “Portfolio managers and foreign investors, undertaking foreign direct investment with local partners, used large sums of foreign exchange to buy local stocks or purchase investment goods or equipment.  Higher demand for local currency raised its market price above the market rate.  At the prevailing exchange rate this resulted in an expansion of the domestic money supply in all of the Southeast Asian Countries.”[8]  At the same time, the demand for government securities in these countries was minimal, thus there was little opportunity for the government to ‘sterilize’ the capital flow.  In other words, monetary policy was quite ineffective in moderating the economic boom that was taking place in the region.  The growth of the stock markets in the Southeast Asian nations made it clear to many observers that high growth could simply not sustain itself, not only in the absence of effective monetary policy, but a well defined financial framework at large. The capital that entered Southeast Asia was volatile and poorly managed to begin with. As such, it might be said that crisis was inevitable and just a matter of time. 

            Governments in the region were also unwilling, probably even unable, to use fiscal policy to control capital flows.  Three of the central governments in these countries had small surpluses or deficits.  For example, in 1995 the Philippines and Malaysia had fiscal surpluses of 0.5 per cent of GDP and 0.3 per cent of GDP respectively while Indonesia had a small deficit of 0.2 per cent of GDP. Thailand was the only country that had a relatively large surplus of 2.8 per cent of GDP.[9]  “However, in a very real sense these surpluses had developed ex post and were unplanned.  Typically, economic growth during this period was even more buoyant than expected by the government authorities and as a result tax revenues were underestimated.”[10] Governments in the region appear to have been either unaware of or disinterested in the boom-and-bust cycle that was taking place.  To be fair, however, some of the inflationary boom that was taking place fell outside of traditionally measured inflation indicators, primarily in areas of  property values and stock market prices.  To a large degree, consumer prices were based on tradable commodities which were increasing at a far more benign rate. “Had the authorities recognised the importance of monitoring non-traded goods prices as an indicator of macroeconomic imbalances, they might have considered a more active fiscal stance.”[11]

            The current account deficits in all of the Southeast Asian nations had concerned analysts for years before the outbreak of crisis.  They represented a possible sign that demand expansion had been excessive in light of the exchange rate strategy adopted by the countries.  However, for the most part, in light of a long and strong history of growth, economists generally found some comfort from the fact that external deficits had long been associated with reasonably strong fiscal positions. Indeed, Southeast Asian current account deficits resulted from private investment exceeding private savings + private domestic savings were reasonably large.  Quite reasonably, the current account deficits could be viewed as responses to high levels of international investment, fuelled simply by perceptions of high prospective profits.  The problem, however, is that “the contributions to those perceptions of implicit guarantees of various kinds (including that of a steady relationship between the domestic currency and the dollar) were rarely acknowledged.  Nor was the potential for rapid change in perceptions about prospective returns.”[12]

            Now that the crisis has been well underway for more than a year, it is very clear to see that the allocation—or more appropriately misallocation—of financial capital led to a miscalculation of the of risks in Southeast Asia.  In Thailand, for example, many have estimated that the percentage of non-performing loans had already reached 20% of GDP by the end of 1996. “Compared to the 1994 Mexican currency crisis where the same ratio registered at only 18% at its worst, the Thailand scenario was evidently more severe. Notably, this peak actually came two-and-a-half years after the  Mexican crisis.”[13] Furthermore, the ratio of total loans to GDP for Thailand was 140% at end of 1996, compared with Mexico’s 45% during its crisis.[14] To add even more to risk concerns, the amount of foreign debt accompanied by the lack of hedging made many investors uneasy.[15] In general, the crisis in most of  the Southeast Asian countries has been a direct result of years of easy access to domestic and foreign credit.  This has kept the relatively less productive industries on a upward growth trend. Such a bubble had to burst.

            As regards foreign debt, pressure by speculators mounted on the Southeast Asian  abilities to fend off speculative attacks at the beginning of the crisis.  This was  related to investors’ concerns over the countries’ foreign debt, and their limited abilities to finance it. The level of foreign reserves was not the only parameter that speculators focused on, however.  Indeed, the amount of domestic credit available, the growth of domestic debt markets and the surge in foreign direct investment over the past years were equally important factors to consider. “The lack of confidence in how the authorities [had] been managing these variables triggered  pessimism in the markets and contagion effects took place.”[16]



At the time of this writing,  the South East Asian crisis continues to escalate beyond anyone’s wildest anticipations. Many experts and analysts have been completely dumbfounded. Most reasonable economists have long given up forecasting on currencies to avoid ruining their reputations.

            More than any other emerging economies, those in Southeast Asia had experienced an extremely rapid growth of cross-border capital flows along with the globalisation of capital flows.  By and large, this can be attributed to the rapid and generally concerted attempts at deregulating capital and financial accounts without adequate safeguards.  While this had provided an enormous volume of new funding opportunities for corporations and investors in Southeast Asia within a short time, the capital was unwieldy and highly mobile.  That is, financial capital has been readily available, but dependant on highly positive economic performance. With hardly any regulation,  the moment things slowed down and become questionable, this capital was removed and found itself in more promising and stable markets. Liberalisation, instant communication and a sea of electronic data surely created wealth and growth in Southeast Asia; but, they proved equally capable of destroying it.


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