A financial crisis swept like a bush fire through the “tiger economies” of South East Asia between June 1997 and January 1998. One country after another, local stocks markets and currency imploded. When the dust started to settle, the stock markets in many of these countries had lost over 70% of their value. Leaders of some these nations had to approach the International Monetary Fund (IMF) to beg for massive financial assistance.
The crisis in Asia has occurred after several decades of outstanding economic performance and growth. Annual Gross Domestic Product (GDP) growth in the ASEAN- 5 (Thailand, Malaysia, Singapore, Indonesia and Philippines) averaged closed to 8% in the last decade. Per capital income levels also had increased tenfold in Korea, fivefold in Thailand and fourfold in Malaysia. Moreover, per capital income levels in Hong Kong and Singapore now exceed those in some industrial countries.
Although there were important differences between the individual countries, a number of elements were common to most. Export had long been the engine of economic growth in these countries. A combination of inexpensive and relatively well educated labour, export orientated economies, falling barriers to international trades, heavy investment by foreign companies, had combined during the previous quarter of the century to transform many Asian states into export powerhouses. The nature of these exports had also shifted in recent years from basic materials and products such as textiles to complex and increasingly high technology products, such as automobiles, semi-conductors and consumer electronics.
The wealth created by the export-led growth helped to fuel an investment boom in commercial and residential property, industrial assets and infrastructure. The value of commercial and residential real estate in cities such as Hong Kong and Bangkok started to soar. This started a building boom all around the region. Heavy borrowing from the banks financed much of this construction.
As for industrial assets, the continued success of Asian exporters encouraged them to make even bolder investments. This was exemplified most clearly by South Korea’s giant diversified conglomerates, or chaebol, many of which were encouraged by the government. But the chaebol always rely on heavy borrowings, built up a massive debts that were equivalent, on average, four times their equity.
As might be expected, as the volume of investments ballooned during the 1990s, often at the bequest of national governments, the quality of many of these investments declined significantly. All too often, the investment is based on unrealistic projection of the future demand conditions. The result was the emergence of significant excess capacity.
A good example was the investments made by Korean chaebol in semiconductor factories. Investments in such facilities surged in 1994 and 1995 when a temporary global shortage of Dynamic Random Access Memory chips (DRAMs) led to sharp price increases for this product. However, by 1996 supply shortages had disappeared and excess capacity was beginning to make itself felt, just as the Koreans started to bring new DRAM factories on stream. The results were predictable; prices for DRAMs plunged through the floor and the earnings of Korean DRAM manufacturers fell by 90%, which meant it was extremely difficult for them to make scheduled payments on the debt they had taken on to build the extra capacity in the first place.
In another example, a building boom in Thailand resulted in the emergence of excess capacity in residential and commercial property. By early 1997 it was estimated that there were 365,000 apartment units unoccupied in Bangkok. With another 100,000 units scheduled to be completed in 1997, it was clear that years of excess demand in the Thai property market had been replaced by excess supply. By one estimate, by 1997 Bangkok’s building boom had produced enough excess space to meet its residential and commercial need for at least five years.
By early 1997 what was happening in the Korean semiconductor industry and the Bangkok property market was being played out elsewhere in the region. Massive investments in industrial assets and property had created a situation of excess capacity and plunging prices, while leaving the companies that had made the investments groaning under huge debt burdens that they were now finding difficult to service.
The make matters worse, much of the borrowing to fund these investments had been in US dollars, as opposed to local currencies. At the time this had seemed like a smart move. Throughout the region local currencies were pegged to the dollar, and interest rates on dollar borrowings were generally lower than rates on borrowings in domestic currency. However, if the governments in the region could not maintain the dollar peg and their currencies started to depreciate against the dollar, this would increase the size of the debt burden that local companies would have to service, when measured in the local currency. Currency depreciation, in other words, would raise borrowing costs and could result in companies defaulting on their debt payments. At the same time, it makes the exports more expensive and less competitive on the world markets.
Reflecting growing imports, many SE Asian states saw the current account of their Balance of Payments shift strongly into the red during the mid 1990s. By 1995 Indonesia was running a current account deficit that was equivalent to 3.5% of its Gross Domestic Product (GDP), Malaysia’s was 5.9%, and Thailand’s was 8.1%. With deficits like these starting to pile up, it was becoming increasingly difficult for the governments of these countries to maintain the peg of their currencies against the US dollar. If that peg could not be held, the local currency value of dollar dominated debt would increase, arising the spectre of large-scale default on debt service payments. The scene was now set for a potentially rapid economic meltdown.
The Asian meltdown began on February 5th, 1997 in Thailand. That was the date that Somprasong land, a Thai property developer, announced that it had failed to make a scheduled $3.1 million interest payment on an $80 billion Eurobond loan, effectively entering into defaulting. Somprasong Land was the first victim of speculative overbuilding in the Bangkok property market. The stock market fell another 2.7% on the news, but it was only the beginning. Following Somprasong fate is Finance One, the country’s largest financial institution.
On July 2nd, 1997, the Thai government bowed to the inevitable and announced that they would allow the baht to float freely against the dollar. The baht immediately lost 18% of its value, and started a slide that would bring the exchange rate down to $1=Bt55 by January 1988. As the baht declined, so the Thai debt bomb exploded.
On July 28th the Thai government took the next logical step, and called in the International Monetary Fund (IMF). With its foreign exchange reserves depleted, Thailand lacked the foreign currency needed to finance its international trade and service debt commitments, and was in desperate need of the capital the IMF could provide.
Moreover, it desperately needed to restore international confidence in its currency, and needed the credibility associated with gaining access to IMF funds. Without IMF loans, it was likely that the baht would increase its free-fall against the US dollar, and the whole country might to into default.
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. With its foreign exchange reserves down to $28 billion, Malaysia let its currency, the ringgit, float on July 14th, 1997. Next up was Indonesia, whose currency, the Rupiah, was allowed to float on August 14th. For Indonesia, this was the beginning of a precipitous decline in the value of its currency, which was to fall from $1=2,4000 Rupiah in August 1997 to $1=10,000on 6th January 1998, a loss of 75%!
As the ringgit declined against the US dollar, the government deferred spending on several high profile infrastructure projects including its prestigious Bakun dam project. This was followed in December 1997 by the release of plans to cuts rate spending by 18%. The government also stated that it would not bail out any corporations that become insolvent as a result of excessive borrowing.
Indonesia has many weak points; two of the major problems are its weak and unstable economic infrastructure due to the overspending of the government of skyscraper projects, beach and holiday resorts instead of improving its basic infrastructure of the country. The other major problem is the rampant corruption and cronyism, which involves the president’s family and top government officials.
Singapore has not been hard-hit by the crisis and economic growth has only slowed down slightly. One of the reasons is that the Singapore government does not have much foreign debt. The government has sufficient foreign reserves to deal with crisis such as this one. Corruption is all but non-existent due to the strict enforcement of the laws. It also had a solid foundation formed through years of sound economic management and policies.
The presence of corrupt dictators, the last three presidents, is one of the reasons for the poor economic situation. The close relationship between the government and the chaebol is the other reason. The chaebol spent money recklessly by donating generously to politicians who then arranged for unsecured bank loans.
In order to prevent another economic crisis, reforms on certain areas has to be done:
To have a more level playing field for the private sector by dismantling monopolies and setting up simpler, more transparent regulatory system
To reduce unproductive government spending such as military build-up, prestige projects, subsidies and guarantees to favoured sectors and firms
To have a greater transparency and accountability in government and corporate affairs. Standard practices should include important areas such as disclosure, bankruptcy and corporate governance
The liberalisation of capital flow in a prudent and proper sequenced way that will maximise the benefits and minimise the risks of free capital movements
Strengthening the banking system that protects the saving of small depositors and at the same time, freed from government intervention in the allocation of credit.
Globalisation offers unprecedented opportunities: the chance to quicken the pace of investment, job creation and growth. Consumers from advanced countries will be able to benefit from the cheaper imports. At the same time, it carries with it risks: a greater vulnerability to shifts in market sentiments, which can trigger a massive shift in capital, and in turn, precipitate banking sector crisis with spill-over effects in other economies.
The Asian economies, especially those of Thailand, Indonesia, Korea were badly hurt by the crisis due to the wide spread corruption in the government, cronyism, unplanned and unstructured growth with poorly managed banking and financial systems. To have a recovery, various reforms and changes in the governance has to take place.
Finally, it is worth emphasising that despite its dramatic impact, the long run effects of the crisis may be good, not bad. To the extent that the crisis gives Asian countries an incentive to reform and restructure their economic systems, they may emerged the experience not weaker, but stronger institutions and a greater ability to attain sustainable long-term economic growth.
Goad, G.P., “The Region’s Brutal Economic Contraction Looks Set to Continue but a Distant Hope Still Beckons”, The Wall Street Journal, Oct 26, 1998.
Henderson, C. (1998), “Asia Falling – Making Sense of the Asian Currency Crisis and its Aftermath”, McGraw-Hill, Singapore.
Shameen, A. & Bacani, C., “No end in sight – Now, politics too drives Asia’s money woes”, Asiaweek, Jan 16, 1998.
Tsang, D. “The Asian Debt Market”, Asiaweek, Dec 19, 1997.
Woodael, P., “East Asian Economies”, The Economist, March 7, 1998.