Dr. Susmit Kumar

The 1997 Asian Financial Crisis was a financial crisis that engulfed most of Asia, barring countries like China and India, started from July 1997 in Thailand and raised fears of a world-wide economic meltdown. In this crisis, hedge funds and investment banks made tens of billions of dollars at the expense of tens of millions of Asians who lost their jobs.  Affected countries lost several years of economic progress. Countries like China and India whose currencies were not fully convertible, were not affected by this financial crisis.

Fifty years ago, East Asian countries were in very bad shape, but they reduced their poverty significantly by achieving universal literacy and improving their economies using domestic funds, something they were able to do because of saving rates close to 40 percent.

At the end of the Korean War, the South Korean economy was in worse shape than the Indian economy, but in the next 35 years it achieved phenomenal economic growth and joined the ranks of the developed countries. In the early years of its transformation, the South Korean government did not allow Korean industry to borrow from abroad; this policy was dropped after the U.S. applied pressure.

Following the 1985 Plaza Accord, the yen gained against the dollar and the Japanese started shifting their production units to low-cost East Asian countries. Between 1991 and 1995, annual Japanese manufacturing investment in East Asia almost tripled, from $2.9 billion to $8.1 billion. Japanese exporters supplied the region with vastly stepped-up quantities of capital and intermediate goods as they increased the share of Japanese exports going to East Asia by 40-50 percent in the same short period. [1]

In order to increase its exports, China devalued its currency, the yuan, by 35 percent in 1994. Japan then had to devalue the yen to maintain its export level. Other Asian countries delayed devaluation until 1997. This caused a sharp fall in their exports while China’s 1997 exports increased by 20 percent. Japan also had a trade surplus of $91 billion that year.

After years of large trade surpluses, South Korea’s imports began to exceed its exports. In 1996, its trade deficit was $23.7 billion. Its foreign exchange reserves at the end of 1997 were only $8.87 billion, compared to $29.4 billion at the end of 1996. Thailand’s 1997 trade deficit was about $10 billion. Taiwan’s trade surplus that year fell 44 percent to $7.6 billion—its lowest since 1984. In December, it had a trade deficit of $40 million, quite rare for that country.

China’s trade surplus with the U.S., in turn, had been increasing exponentially year by year, and in 1997 reached about $40 billion. Chinese exports in 1996 were valued at $150 billion, which was almost equal to the total value of the exports of Indonesia, Malaysia, Philippines, and Thailand combined. China’s foreign exchange reserves (FOREX) at the end of 1997 were about $142 billion, second highest after Japan’s.

At the same time, foreign investment had been flooding other Asian countries with dollars despite trade deficits. Thailand had the weakest economy in the region because of its high debts, which were about 38 percent of GDP. When currency traders, notably billionaire investor George Soros, saw the vulnerability of the Thai economy, they bought several forward contracts worth more than $15 billion and flooded the international market by selling bahts, the Thai currency, in May 1997. This was a speculative attack on the baht, believing that it would devalue Thailand at first tried to prop up its currency by selling dollars and buying bahts, but when its FOREX reserve dropped into the danger level, it had to unpeg the baht from the dollar on July 2, 1997, resulting in a free-fall for the Thai currency. Due to free convertibility, Thais also moved their money out of the country by converting it into dollars, depleting the nation’s foreign reserves further. According to Thailand’s central bank, it spent more than $16 billion in its failed attempt to prop up its currency. (Speculative currency traders sell a currency at a value they consider to be high on the expectation that it will depreciate so that they can buy the currency back for much less than they sold it. The difference in price is the trader’s profit.)

The crash of the baht created a domino effect and resulted in the crash of all other currencies and stock markets in the region one by one. Malaysian Prime Minister Dr. Mahathir Mohamad called Soros a moron and blamed him for the Asian crash. He also blasted Western economic powers for attempting to exploit and dominate the developing world. Indonesian president Suharto compared the currency traders to “gamblers.” He said, “We have 30 years’ experience building a strong foundation. Then, in six months it collapses, not because of an internal crisis, but because there is manipulation of our currency.”

To bail out the economies of Thailand, Indonesia, and South Korea, the International Monetary Fund arranged $17 billion, $43 billion and $57 billion, respectively, in loans. This money was used to repay loans to Western banks/creditors. These countries also had to swallow the bitter pills prescribed by the IMF or the U.S. Treasury Department—higher interest rates, privatization of state companies and services, devaluation of currencies, and slashed public expenditures for subsidies. Prior to the crisis, these countries had had modest budget surpluses and inflation was low; many of the draconian measures prescribed were entirely irrelevant to its causes.

In 1998, GDP in Indonesia fell by 13.1 percent, in South Korea by 6.7 percent, and in Thailand by 10.8 percent. The stock markets of these countries also dropped, by 50 to 84 percent. In a ripple effect, currencies and stock markets in Latin America, including Chile, Brazil, Argentina, and Venezuela, dropped 20 to 30 percent.

Due to the steep devaluation of Asian currencies, prices of essential items in these countries increased by significant amounts. For example, in Indonesia the price of rice increased by about 36 percent, electricity by 200 percent, milk by 50 percent, and cooking oil by 40 percent. It was poor people who suffered the most. They also faced layoffs due to the closure of massive infrastructure projects. A popular phrase came to be used to characterize the IMF at that time: For the average person, the real meaning of the IMF was not “International Monetary Fund,” but “I’M Finished.”

India and China escaped the crisis because of capital controls. Malaysia avoided the fate of Thailand, Indonesia, and South Korea because it went for tight money controls. Some Wall Street economists and the IMF as well as U.S. Treasury Secretary Robert Rubin criticized Malaysia for its money controls, predicting that it would scare off the investors, but they were proven wrong. In addition, while all other developing countries’ economies shrank, China and India saw sizable growth (about 8 and 5 percent, respectively), even with capital controls.

The crisis also exposed unfair lending practices by Western institutions. If a creditor loans a foreign firm at 7 percent and the firm thinks that it can make 15 percent yearly from this money, but the firm goes bankrupt, it should be a problem for the creditor and not the whole nation or the IMF. It needs to be considered as a bad loan. Before providing the loan, the creditor needs to check the lender’s creditworthiness. This is standard practice, and the possibility of bankruptcy is always considered a part of any loan. Contrary to standard practice, however, the IMF intervened in East Asia and issued loans there after the crash so that Western creditors could recover their money. In the case of Thailand, people invested a lot of money in real estate, but since there were not enough buyers, the real estate market crashed. It was due to Thailand’s real estate sector that most East Asian economies eventually suffered, but currency speculators made a lot of money.

After watching the IMF at work during the crisis, Joseph E. Stiglitz, 2001 winner of Nobel Prize in economics, wrote in April 2000:

“I was chief economist at the World Bank from 1996 until last November, during the gravest global economic crisis in a half-century. I saw how the IMF, in tandem with the U.S. Treasury Department, responded. And I was appalled.” [2]

“The IMF may not have become the bill collector of the G-7, but it clearly worked hard (though not always successfully) to make sure that the G-7 lenders got repaid.” [3]

It was he who described the crisis best:

“The IMF first told countries in Asia to open up their markets to hot short-term capital [It is worth noting that European countries avoided full convertibility until the 1970s.]. The countries did it and money flooded in, but just as suddenly flowed out. The IMF then said interest rates should be raised and there should be a fiscal contraction, and a deep recession was induced. As asset prices plummeted, the IMF urged affected countries to sell their assets even at bargain basement prices. It said the companies needed solid foreign management (conveniently ignoring that these companies had a most enviable record of growth over the preceding decades, hard to reconcile with bad management), and that this would happen only if the companies were sold to foreigners—not just managed by them. The sales were handled by the same foreign financial institutions that had pulled out their capital, precipitating the crisis. These banks then got large commissions from their work selling the troubled companies or splitting them up, just as they had got large commissions when they had originally guided the money into the countries in the first place. As the events unfolded, cynicism grew even greater: some of these American and other financial companies didn’t do much restructuring; they just held the assets until the economy recovered, making profits from buying at fire sale prices and selling at more normal prices.” [4]

In his book Globalization and Its Discontents, Stiglitz, who was also a member of the Council of Economic Advisers under President Clinton, described meetings where President Clinton was frustrated because an increase of one-quarter to one-half percentage point in the interest rate by Federal Reserve Bank chairman Alan Greenspan might destroy “his” nascent economic recovery.[5] A comparison here with the actions of the IMF during the East Asian debacle is instructive: There, the IMF forced interest rates to rise by 25 percentage points—50 times the interest rate Clinton complained about—for economies going into recession. The IMF argument for this enormous increase was that higher rates would make a country more attractive for investors. In reality, it made the situation even worse. Generally, a crisis starts due to Western creditors’ refusal to roll over short-term loans out of concern about foreign firms’ potential inability to repay their loans on account of high indebtedness. A large increase in interest rates, however, makes matters worse for these firms. An increase in interest rates increases the number of ailing firms, causing an increase in nonperforming loans. Therefore an increase of 25 points in interest rate is enormous and will thus have more catastrophic consequences.

The 1997 crisis in turn triggered an oil-price slump, causing Russia’s 1998 crisis owing to non-payment of taxes by its oil and energy sectors. The Clinton administration subsequently organized $22.6 billion in IMF and World Bank loans for Russia in July 1998 over concerns about destabilizing a country with nuclear capabilities, which could potentially cause political if not military problems for the U.S., but most of this money was siphoned out of the country. The Russian ruble collapsed within a couple of months. An increase in crude oil prices on international markets the next year helped Russia recover, however.

1 Brenner, Robert, The Boom and the Bubble, Verso, London, UK, 2002, p. 156.

2 Stiglitz, Joseph, “The Insider: What I Learned at the World Economic Crisis,” The New Republic, April 17, 2000.

3 Stiglitz, Joseph E., Globalization and Its Discontents, W.W. Norton Co., New York, 2003, p 208.

4 Ibid., pp. 129-130.

5 Ibid., p. 109.

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