Asian FINANCIAL crisis
BACKGROUND OF THE CRISIS
The crisis indeed began on
CAUSES OF THE CRISIS
There have been a number of schools of thoughts behind the causes of this crisis. Some of the causes are as follows.
Interest rate crisis
In the early 1990s, the US Federal Reserve (US Central Bank) had been increasing its interest rate to tackle possible inflation as the economy began to experience a growth. As we have observed, inflation intensifies with the economic growth and the Central Bank is likely to hike interest rate to reduce overall spending and price hike.
Since money always looks for higher interest rate or return from financial and real investment, there had been a flow to US assets that caused the US dollar to appreciate. Since many Asian currencies maintained a fixed or close align to US dollar, their currencies had been appreciated with the appreciation of US dollar. With the appreciation, these Asian economies were loosing export competitiveness, hence continued to face current account balance deficit. Indeed, South East Asian exports were plummeting dramatically since the mid of 1990s just before the crisis.
Capital flow and hot money crisis
As mentioned before, since the
Hot money is an investment made by fund managers for short term return generally in stock and bond, currency markets.
Foreign reserve crisis
The amount of foreign reserve that Asian Central Banks had was not enough to defend their currencies especially when the currencies were under speculative attack at the end of 1997. With the plummeting the value of the local currencies, Central Banks intervened in the market to restore the value by selling foreign currency while buying local currency. After several attempts, the foreign reserve depleted without success. As a result, currency floating and IMF bailout were the outcomes.
We observe that all the Asian Central Banks of today are trying to pile up foreign reserve to defend their currencies to tackle future downturn.
Many economists commented that Asian currencies lost their values due to a deliberate attack of the currency speculators while others do not comply with this argument. They say that Asian economies were loosing confidence gradually since 1990s due to fragile and excessive liberalized system, which busted in the late of 1997. Native people and business rushed to banks to convert local currency to US dollar followed by speculators but central bank failed to supply required amount of dollar demanded and hence allowed to flow currency freely to tackle currency crisis. The currency crisis brought the East Asian financial crisis.
As soon as the currency floated, many local business and governments who borrowed in US dollar externally, they found it very expensive to pay the debt as the US dollar has become very expensive when we compare with local currency.
Liberalisation of financial system
East Asian governments liberalize the financial system very rapidly without much government regulation and control. The interest rate ceiling was lifted and the liberalization in the transaction of current and capital account and establishment of offshore banking. As a result, the control of Central Banks on financial system reduced considerably. On account of liberalisation policy, private sector borrowed in foreign denominated from external sources at a large amount and re-lends them to local investment at a higher interest rate. Sometime they borrowed for short term and but lent it in long term project domestically. With the floating of currency, it became huge expensive to pay the debt.
CONSEQUENCES OF THE CRISIS
A large portion of the debt by the government and especially private sector was in foreign denominated currency. With the plummeting of local currency, it became very expensive for the government and private sector to pay the debt.
The stock market plunged, employment cut and political unrest were the outcomes. Indonesian president Suharto had to leave power.
The national assets of these East Asian economies drastically dropped with the devaluation of currencies.
Trade deficits of the
Currency speculators found to be an important factor in the financial system and a new type financial system had been a search. Dr Mahathir commented that currency trading was immoral and should be stopped.
Investors, local and foreigners had to accept billions of dollars loss due to a plunging in security market.
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