Causes and Impact of the 1997 Asian Economic Crisis

Introduction: The Asian Economic Crisis of 1997

In the summer of 1997, an economic and currency crisis rocked the Asian markets. One by one, Southeast Asian countries such as Thailand, Indonesia, Korea, and Japan saw their economies crash in the wake of heavy foreign investment. An economic boom had made the region an attractive investment opportunity for much of the 1990s. By 1997, however, domestic production and development had stalled, and foreign investors grew nervous. A divestment run on the Thai baht triggered the crash. Large corporations, extremely dependent upon the confidence of foreign investors, failed to meet debt obligations and began to collapse throughout Southeast Asia. Currencies throughout the region faltered and nosedived from their mid-1990s positions of stability.

The causes of the Asian economic crisis are varied. Lax oversight of corporations had ramifications in economic downturns that had not been a concern during the mid-1990s boom. Macroeconomic policies of the Southeast Asian countries made their economies vulnerable to the uncertain confidence of foreign investors. Despite this, Corsetti, Pesenti, and Roubini (1998) make the point that "market overreaction and herding caused the plunge of exchange rates, asset prices, and economic activity to be more severe than warranted by the initial weak economic conditions." Much of the crisis that began in 1997 has roots that extend further back to the area's economic growth that started in the early 1990s.

Although many economists consider the Asian economic collapse to have begun in Thailand, conditions throughout the region meant that other countries' economies were destabilized to the extent that they quickly followed Thailand.

Thailand and the Collapse of the Baht

Throughout the early 1990s, growth in Southeast Asia attracted much foreign capital. However, by 1995 and 1996, Thailand's current account deficit had grown — from 5.7% in 1993 to 8.5% in 1996 (Pesenti et al., 1998). When domestic production slowed, this account imbalance represented an even greater percentage relative to GDP. Much of the instability in Thailand's economy was brought about by heavy short-term borrowing that required stringent debt maintenance. A boom in real estate and the Thai stock market attracted foreign speculation that could not be sustained in the face of investor doubts. The Thai government attempted to shore up shaky investor confidence by officially backing the financial institutions that were heavily indebted abroad.

For instance, in the first quarter of 1997, the central bank's Financial Institutions Development Fund (FIDF) had lent over USD $8 billion, 17.5% of which went to Finance One — at the time, the largest finance company in the country — alone (Pesenti et al., 1998). This support of the highly leveraged private sector by the Thai government lent the appearance of stability to an unstable system and attracted more foreign loans to Thai financial institutions.

In February 1997, the Thai company Somprasong was unable to make maintenance payments on its high level of foreign debt — the first large default in Southeast Asia's economic crash. By mid-May 1997, investor confidence in Thailand was so shaky that Singapore and Thailand had to intervene to prop up the baht in the face of "speculators who decided Thailand's slowing economy and political instability meant it was time to sell" (Chronology, n.d.). In the face of such instability, Finance One — the largest finance company in Thailand — failed at the end of May. Most of the company's lending was composed of risky loans for real estate and stock market margin investments.

Political instability resulting from the resignation of the Thai finance minister further shook foreign investor confidence. "The strong speculative attack on the baht that followed forced Thailand to let the currency float on July 2, a key date in the chronology of the Asian crisis" (Pesenti et al., 1998). Once the government was no longer backing the baht, currency depreciation further devastated the Thai economy, and the Thai government was forced to call upon the IMF for economic assistance. The Thai government had reneged on its guarantee of financial institutions in June 1997, further destabilizing the economy before this point was reached.

In South Korea, the economy was similarly compromised prior to the events of 1997. A boom in the mid-1990s had expanded the Korean economy and attracted much foreign investment. Many of the Korean chaebols, or large corporations, had high levels of foreign debt by 1997. In January 1997, the first sign of significant trouble for South Korea occurred with the failure of Hanbo Steel. Another Korean steel company, Sammi Steel, failed two months later. The string of collapses of Korean chaebols had serious consequences for many Korean banks. Lending to the Korean conglomerates had been financed with foreign borrowing that left much of the Korean banking sector beholden to the confidence of foreign investment. As this confidence began to wane, more corporations failed, and the South Korean currency and stock markets collapsed. Southeast Asian nations found themselves fighting a losing public relations battle, as negative media coverage further encouraged the international community's lack of confidence.

South Korea: Corporate Failures and Currency Decline

Lee (1998) points out that much of the crisis in South Korea was precipitated by political factors that influenced the governance of the Korean chaebols: "The behaviors of politicians, bureaucrats, and interest groups had been influential for resource allocation in the Korean economy."

The effect of the destabilization in South Korea was felt in the currency and stock markets. The South Korean won declined 15% against the dollar by November 1997, and the stock market fell 28% (Chronology, n.d.). By the end of 1997, South Korea was unable to meet its debt obligations to foreign investors. A consortium of German, Dutch, and U.S. lenders, in addition to the IMF, put together a $60 billion South Korean bailout package that involved rolling over short-term debt as well as an initial transfer of over $10 billion to stabilize the South Korean economy.

The economic crisis in South Korea was eased somewhat when credit-rating agencies boosted Korea's rating in February 1998, after having lowered it the year before. This had the psychological effect of restoring a measure of investor confidence in the country.