The 1997 Asian Financial Crisis 5 comments

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Nowadays Asia is seen as the growth driver of the global economy, and Asian equities are booming as foreign liquidity pours in. Yet it was not too long ago when the Asian financial crisis led to many predicting the end of the Asian economic miracle.

Various people have quoted different reasons for the currency crisis that engulfed Asia, in particular Southeast Asia, in the second half of 1997, including the unforgettable accusations by Dr Mahathir of Jewish plots to impoverish Asia. But what was undeniable was that the root cause was the high gearing of many companies in the worst affected countries (Indonesia, Thailand, South Korea), even the blue chip companies; this situation was further exacerbated by the fact that much of the debt was foreign dollar-denominated (primarily US dollars).

Where did all the borrowed money go to? Mainly investments in commercial and residential property, industrial assets, and infrastructure. By the mid-1990s Asia was in the middle of a building and investment boom, fuelled by surging business optimism due to the years of exhilarating export-led economic growth. The investment boom was encouraged by governments (by facilitating loans through state-controlled banks) eager to take advantage of the wave to build national capabilities and economic power in order to catch up with the West (and additionally, a few for their own private gains). As always, over-supply usually follows excessive investment, and this was no different.

The bomb struck first in Thailand in February 1997, as the debt default and subsequent collapse of a property developer revealed similar problems in other peers and by linkage, the banks that had lent them the money to invest in what was going to turn out to be "white elephants". Currency speculators realised that there was an opportunity for shorting the Thai baht when they looked at Thailand's growing current account deficit and high dollar-denominated debt burden accummulated through the years of excess; if there was a rush to call back loans by banks due to fear of default, it meant the borrowers would have to buy dollars on the forex market (using Thai baht) in order to repay their loans. In July 1997, the Thai government abandoned the peg (1 US$ = 25 baht) and in January 1998 the baht had collapsed to 1 US$ to 55 baht, which of course ballooned the debt burden even further.

Following the devaluation of the Thai baht, wave after wave of speculation hit other Asian currencies. One after another in a period of weeks the Malaysian ringgit, Indonesian rupiah and the Singapore dollar were all marked sharply lower, as they allowed their currencies to float under pressure from speculators: the ringgit collpased from $1=2.525 ringgit to $1=4.15 ringgit by early January 1998; the Singapore dollar dropped from $1=S$1.495 to $1=S$2.68; the Indonesian rupiah suffered the worst fate, falling from $1=2,400 Rupiah to $1=10,000 Rupiah by January 1998, a loss of 75%. This was quite amazing; normally currency rates do not fluctuate greatly, and 20% swings would be considered major moves. And these devaluations took place over a period of 6 months or less!

Indonesia were hit particularly hard. The crisis brought to prominence the crony capitalism practised by President Suharto, who showered his relatives and close associates with plum contracts. Over-investment and inefficient resource allocation was inevitable given the corruption right from the top. When the IMF provided loans to the country to tide over the crisis, one of its conditions was that such crony capitalism had to be unravelled. Ultimately, the racial riots and subsequent collapse of the Suharto regime in 1998 was a direct result of financial hardship due to the crisis and Suharto's unwillingness to forsake his brand of political corruption even after the Asian crisis.

One cannot fail to mention South Korea in this crisis. It was the Northeast Asian nation hardest hit by the crisis. State direction had long governed the direction of funds and loans to the various chaebol, a form of policy lending that was practised widely in Asia but especially so for Korea. By 1996-7 there was an excess of industrial capacity in several sectors; one of the chaebol, Hanbo, filed for bankruptcy under heavy debts, and Kia, a car manufacturer nearly did. The S&P downgrade of Korea's debt, in response to these corporate troubles, made matters worse, raising the cost of debt to Korean companies, and more importantly, causing a slide in the Korean won from 1 US$= <1,000 won to 1 US$= >2,000 won by December 1997. There was speculation that as many as half of the top 30 chaebol might have to file for bankruptcy. This eventually did not materialise, as the Korean government swallowed its pride and asked the IMF for loans, agreeing to the latter's condition of opening up its market for greater foreign access.

One can argue that the property and infrastructure investment boom was a bubble waiting to be pricked, and it was going to happen sooner or later. On the local front, it brought a decisive end to the property speculation that had reached absurd heights where people were queueing overnight to buy condominiums they had no intention of staying in, only hoping to sell at higher prices and cash in on the property boom they thought would never end. It has been nearly ten years, and these people are still sitting on negative equity. On a broader scale, companies have restructured their capital base and have now become less highly geared and more equity-based, in effect adopting a more sustainable and less risky growth approach. Governments are also pulling back from close cooperation with businesses, as they learn to let the market dictate the flow of funds, the so-called invisible hand in Western economies. Some of them probably had to do so, as preconditions for getting loans from the IMF. But things have worked out for the best for everyone in the end. What is most important is that the mistakes of over-investment and excessive borrowing should never be repeated again; one must be wary especially in periods of optimism such as now.

References:
(1) The Asian Financial Crisis