Asian Currency Crisis – Causes and Effects

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One of the key characteristics of money is stability, however a currency crisis is said to occur when the value of a country’s currency becomes unstable and changes rapidly thereby undermining its ability to effectively serve as a medium of exchange.

The Asian currency crisis was a period of financial meltdown which began in July 1997 and gripped the major proportion of East Asia. It remains one of the most talked about region-wide crisis in the 1990’s, the sharpest to hit the developing countries, which resulted in a massive downward spiral of Asian economies hitherto seen as miracle economies and prompted the largest financial bailouts in history.(Radelet and Sachs 1998)

This paper will examine the origin of the crisis, its impact on the economies of the countries involved and the measures that have been adopted to avoid a recurrence of a similar crisis.


Upon mutual agreement, based on the plaza accord (1985) between the US, Germany and Japan, the US dollar was devalued by about 60% to the Yen in real terms in order to alleviate the increasing US current account deficit. Japanese firms facing export competitiveness due to the appreciation of the Yen began to move production to south East Asian countries whose currencies were pegged to the dollar. This provided an ideal location for the Japanese firms in terms of international price competiveness. This inflow of investment from Japan to the South East Asian countries accelerated a pattern that led to large inflow of capital from other Asian and foreign countries into the East Asian countries. The fixed exchange rate system gave the south East Asian economies strong exports, low import prices and expected financial stability.

For years, East Asian Countries were held up as economic icons. Their typical blend of high savings and investment rates, autocratic political systems, export-oriented businesses, restricted domestic markets, government capital allocation, and controlled financial systems were hailed as the ideal recipe for strong economic growth of developing countries (Shapiro 1999). Asian economies like Taiwan, Hong Kong, Korea, Singapore and Thailand enjoyed overall average growth rates of 5.6 percent, 6.6 percent, 7 percent, 6.9 percent and 4.6 percent respectively for several decades. Indonesia and Malaysia too enjoyed good economic performance during most of the 1970s and 1980s. (Rao, 1998)

However, these “miracle economies” were brought down in July 1997 when a brewing currency crisis started from Thailand. This seed of the Asian currency crisis of 1997 were actually sown during the previous decades when these countries were experiencing unprecedented economic growth. For long, exports had long been the engine of economic growth in these countries and as such many Asian states were regarded as “Export Power Houses”. The increased foreign capital inflow into these economies also propelled capital expenditure which led to an investment boom in commercial and residential properties, industrial assets and infrastructure. These capital expenditures were financed by heavy borrowings from banks which had excess liquidity but no strong regulatory frameworks. Thus, by the mid 1990s, South East Asia was experiencing an unprecedented investment boom, much of it financed with foreign investments and borrowings. The case was made worse as much of the foreign borrowings had been in US dollars as opposed to local currencies. At the time, this had seemed like a smart move (i.e. regional local currencies were pegged to the dollar and interest rates on dollar borrowings were generally lower than rates on borrowings in domestic currency, and it made economic sense to borrow in dollars if the option was available); but, many of the investments made with these funds were on the basis of projections about future demand conditions that were unrealistic.

Soon, there were indications of macroeconomic imbalances in the Thai economy; the real exchange rate had risen to an apparently unsustainable level and the current account was also in constant huge deficit. Rao (1998). Also, Asian Countries started to see their ballooned volume of investments during the 1990s declining significantly. Paul krugman (1999) stated the Asian countries attracted so much foreign capital that their economic growth was fuelled more by sheer volume of investment rather than by the productivity of those individual investments. Therefore the governments in the region could not maintain their dollar peg and their currencies started to depreciate against the dollar, this increased the size of the debt burden that needed to be serviced when measured in local currency. This started the debt boom.

A final complicating factor was that by 1996, there became a slackening of export growth which was much noticeable in Korea, Malaysia, Singapore and Taiwan, while in Thailand there became a decline in the dollar value of exports. This decline in export did not stop growing import and this disparity saw many south Asian countries shifting 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 U.S dollar.

Thus by 1997, the first obvious indication of the crisis started with the Thai economy. Thailand could no longer defend their currency and therefore floated the baht on the 2nd of July 1997. (Rao, 1998). Prompted by these developments in Thailand, investors saw basically the same issues facing Thailand surfacing in other neighbouring countries. As a result, investors panicked; their fears were not allayed especially because of lack of transparency regarding issues such as the extent of government and private debt, the health of the financial sectors and no trust in the government to take pre-emptive corrective actions. This led to massive capital flight. The withdrawal of foreign currency led to dramatic depreciation in exchange rate and higher interest rates. This led to an increase in the number of non-performing loans, causing an erosion of the market value capital of most of the countries. Thus, the scene was now set for a potential rapid economic breakdown.

There is no consensus on the exact origin of the currency crisis in East Asia; while some schools of thought believe that the crisis was caused by the initial financial turmoil in some Asian countries, followed by regional contagion (Radelet and Sachs, 1998; Marshall, 1998; and Chang and Velasco, 1999), others believe it occurred as a result of policy and structural distortions (Corsetti, Pensetti and Roubini; 1998). However, most of the East Asian economies were interdependent, hence it was only logical that a crisis in one would have a domino-effect and inadvertently cause a crisis in other East Asian Economies that were linked to it.

Warning Signals during the 24 Months prior to the 1997 Asian Financial Crisis, Months of Lead Time, and Performance Measures.

Number of Warning Signals and Months of Lead Time (in parenthesis)

Optimal threshold percentile







Noise to signal ratio

Conditional crisis probability


Share of crisis predicted


Overall Composite Index











Current Account











Capital Account











Financial Sector











Real Sector











Global Economy











Fiscal Sector











Source: ERD Working Paper No.26

Using a Signalling approach based EWS model, it shows that persistent warning signals prior to the 1997 crisis was not just in a few but all of the five countries most affected by the crisis. The findings of this model supports the fact weaknesses in economic and financial fundamentals in these countries triggered the crisis.

The Impact of the crisis on the Economics of the countries involved.

As Thailand floated the baht on July 2 and allowed the currency to fall, wave after wave of speculation hit other Asian currencies, a de-facto devaluation of the Philippine Peso followed on July 11. Korean Won too lost. Malaysia let its currency, the ringgit float on July 14th 1997, as foreign exchange reserves had gone down to $ 28 billion. Singapore followed on July 17th and the Singapore dollar (S $) quickly dropped in value from $1 = S $ 1.495 prior to the devaluation to $1 = 2.68 a few days later. A month later on August 14, Indonesia floated the rupiah. This was the beginning of a precipitous decline in the value of the Indonesian currency as a fall was seen from $1 = 2,400 Rupiah in August 1997 to $1 = 10,000 Rupiah on January 6th, 1998, a loss of 75% (Rao, 1998).

Source: DataStream

The Chart (above) shows the monthly evolution of the currencies of the eight South-East Asian countries during the crisis from July 1997 to April 1998. The Five countries where the crisis where particularly serious (Figure 1A) saw more decline in their currencies than countries in Figure 1B even though all countries shown were affected. 

The economy of Thailand where the crisis started from suffered a real sharp decline. Total export earnings declined and a trade deficit rose to $ 16 billion. With the deficit standing at over 8 percent of GDP and its financing largely coming from short term funds; the external debt of Thailand rose to $68.1 billion. The non-performing loans of banks and finance companies in Thailand were estimated to be around 12 percent of total loans in mid 1997. The Thailand economy was also plagued by a deteriorating external sector, a stock market decline (the stock market index fell from 1683 in 1993 to below 500 in1997) and most importantly dwindling forex reserves. A decline in investment saw the closure of investment houses which resulted in immediate unemployment rates of between 6 and 10 percent (Rao, 1998).

The Indonesian economy also suffered a set-back which included growing current account deficits due to lack-luster export growth and mounting debt service. Loss of confidence in Indonesia led to a series of attacks on the currency. In the second half of 1997, the rupiah fell by 72 percent against the dollar which had an adverse effect on the Japanese, European and US banks that lent billions of dollars to Indonesian companies. According to Witcher (1998), “the Indonesia’s financial system started to stagger under escalating bad loans”. Indonesia sought help from the IMF, they agreed to provide them with loans estimated at $40billion and in return demanded that Indonesia keeps interest rates high and immediately close 16 banks.

The news of bank closures led to panicked withdrawals by depositors and investors. As Stiglitz(1998) and Yellen(1998) discussed; due to limited information, investors were unable to distinguish which banks were healthy or not so they shied away from them all; this caused more havoc to the economy. The crisis quickly spread to the real sector. The real gross domestic product (GDP) contracted by 13% in 1998 and remained stagnant in 1999. Real output declined by approximately 14% in 1998. The Indonesian economy thus went into a recession with falling GDP in 1998. It also had a weak economy that was composed of falling domestic demand and company closures which meant rising poverty and unemployment. . Unemployment which was historically no more than 3 to 4 percent hit a 10 percent level in 1998 with around 8.7 million people jobless. The impact of the crisis on welfare and the economy as a whole was mostly reflected in the poverty rate which rose from 15% in 1997 to 33% in 1998.

The contagion effect soon caught up with South Korea, a country whose economic performance was spectacular compared to other Asian countries. However, the won began to depreciate from late August 1997 and gathered momentum by October. From about 900 won to the dollar in early August, the exchange rate plummeted to about 1200 by the end of November. The ratio of debt reserves rose during 1992 – 1997 (Rao, 1998). In January 1997, Hanbo Steel collapsed under a $6 billion debt. This was the first Korean ‘Chaebol’ to go bankrupt in 10 years (Chang,1998). In the wake of this, the Korean shares declined in value by 25.2% at the end of 1997. Balance in trade declined from a surplus of $7.6billion in 1987 to a deficit of $20.6billion in 1998. GDP per capita fell and Unemployment rate naturally rose to 5.9 percent in February 1998 and started to climb up from there (Rao, 1998).

The Philippines Economy faced a significant currency crisis, the peso fell significantly from 26/US $ to even 55/US $. The GDP growth rate dropped from 5.1% in 1997 to -0.5% in 1998. GNP hovered at 0.1% in 1998 compared to 7.2% in 1996 and by the fourth quarter of 1998, growth of investments had declined to -23.9%.

In Hong Kong, the economy saw the collapse of the Hong Kong’s stock market (with a 40 percent loss in October). On October 27 1997, the market rout on Wall Street was preceded by a 5.8 percent plunge in the Hong Kong stock market which snowballed through the world’s developed and emerging stock markets. Most markets in the Asia-Pacific region tumbled in sympathy, with Australia down 3.4 percent and Tokyo down 1.9 percent.

Below is a graph showing the evolution of the Asian stock markets during the financial crisis of 1997- 1998.

Source: Morgan Stanley International Capital (MSCI).

Figures 2A and 2B (above) show the monthly evolution of national stock price indices (expressed in US dollars) for these same eight countries and during the same period of time. The finding shows a consistent close relationship between exchange rate depreciations and stock returns during the crisis. (Bailey, Chan and Chung (2001).)

Japan was also affected because its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latter’s economy was more than twice the size of the rest of Asia together; about 40 percent of Japan’s export go to Asia. However, even with this, the Japanese was finally shaken as their yen fell to 147 when mass selling began; Also, with the collapse in the value of the Japanese stock market, the value of assets also plummeted, leaving the institutions with a diminished asset base and an increased portfolio of non-performing loans. The GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998.

In a relatively short period of time, the crisis currency crisis shock was spread even beyond Asia. The USA market (the Dow Jones industrial) plunged 554 points or 7.2%. The New York Stock Exchange briefly suspended trading; this was accompanied by plunges of 15 percent in Brazil, 13.7 percent in Argentina and 13.3 percent in Mexico.

Europe also had the impact of contagion effects, Markets like London fell 2.6 percent, while Germany, France and Italy all shed 2.8 percent. Smaller markets like Finland plunged 5.7 percent, while Spain skidded 4.1 percent.

Russia became the major non-Asian victim of the financial contagion. By mid 1998, investors began to perceive systematic weaknesses of the Russian economy which was similar to Asia; therefore they began a steady withdrawal of their capital from the economy. By midsummer 1998, it became apparent that Russia was struggling to maintain an exchange of roughly 6 rubles to 1 dollar at the time. Their central bank reserves began to dwindle. Despite the loan package and the pro-market administration, the international investment community lost faith in Russia and rushed for the exits. On August 15th 1998, the rubble was allowed to float and the Russian stock market lost 25% of its value.

The Measures that have since been adopted to avoid recurrence of a similar crisis.

After the slow down of the Asian Currency Crisis of 1997, the region’s former economic tigers had to mete out some conditions and policies towards a sustainable Asian economy that would be able to withstand any financial turmoil and consequently avoid the recurrence of a similar crisis. These regions’s heavy weight also had to accept the International Monetary Fund (IMF) conditions in order to stay afloat – although the IMF had never dealt with a crisis of this magnitude and was met with stiff hostilities; the IMF prescribed tough conditions and measures that contributed immensely to considerable long term gains for the Asian Economics (Lakhan, 2007)

One of these conditions were policies involving the Macro-economy. The tightening of monetary policy (at different stages in different countries) was necessary to stem exchange fluctuation, to prevent currency depreciation from leading into a spiral of inflation and into the eventual collapse of the exchange rate. Some countries like Thailand, South Korea, Philippines and Indonesia switched to improved credible policies that involved their exchange rate system. These countries adopted the “inflation targeting” policy which implied greater transparency and accountability instead of exchange rate as an anchor for monetary policy. Inflation targeting also allowed for the attainment of stable development of their economy through the establishment of credible and reputable central bank; as these central banks set inflation targets and implemented monetary policies committed to the achievement of targets. They also made monetary policy decisions based on overall judgement of the economy by keeping constant watch not only on immediate price movements but also on trends of demand and supply factors in the domestic economy, exchange rate movements and overall movement of the international economy. The effects from this policy adopted – inflation targeting – contributed largely to stabilizing the monetary and economic environment after the currency crisis (Tomoko, 2002). A typical example could be seen in South Korea.

After the Crisis, South Korea revised the Bank of Korea act to introduce inflation targeting in 1998. Since its introduction, South Korea’s inflation targeting has played an appreciable role in stabilizing the country’s economy. In particular, the introduction of inflation targeting has secured the independence of the Bank of Korea in monetary policy and drastically enhanced the transparency of monetary policy.

Affected countries of the crisis also embarked on their financial system stabilization to avoid any similar recurrence of the debilitating financial crisis. These measures ventured into the areas of liquidity support for troubled banks in question, deposit protection measures through a deposit insurance co-operation to prevent systemic risk arising from the spread of credit uneasiness, boosting capital base through capital injections from public funds and prompt disposal of non-performing loans by a third party organization – (Resolution and Collection Company in the case of Japan and asset management companies (AMC) in the case of Asian countries). The four countries where the financial crisis was particularly serious (Thailand, South Korea, Malaysia and Indonesia) injected public funds into financial institutions – often with government assistance. They also went into the act of promoting the consolidation of financial institutions by closing or suspending operations of banks with doubtful chances of survival, temporarily nationalizing them or merging them. They established an asset management company to purchase non-performing loans – Thai Asset Management Corporation (TAMC) in Thailand, Danaharta in Malaysia, Korea Asset Management Company (KAMCO) in South Korea, and Indonesian Bank Restructuring Agency (IBRA) in Indonesia (Lindgren et al, 2000)

Although the system of the companies or organizations varied from one country to another, they all similarly purchased non-performing loans at about market prices and disposed the assets selling by tender or by means of securitization. At present, they have disposed of about 50~70% of the assets. Thailand for example, had finance companies (non-banks) that had been suffering from business difficulties even before the currency crisis and the Thai government had been providing liquidity support to them. After the crisis, the government improved its classification standard for non-performing loans to conform to the international standard and strengthened write-off standards. It also nationalized commercial banks, injected capital and reorganized them. As a result, the number of commercial banks decreased. Thai commercial banks’ non-performing loan also later decreased dramatically due to agreements on debt restructuring as well as transfer of non-performing loans to the TAMC and write-offs. As a result, the non-performing loan ratio dropped to 19.2% as of the end of March 2001 and capital adequacy ratio stood at 12.01% as of December 2000 (A ratio higher than the BIS standard) (Montes, 1998).

Structural reforms were also adopted in the areas of banking supervision and regulation in order to forestall the kind of financial system instability caused by the crisis and to minimize the effect. These reforms were also necessary to address the weaknesses in the financial and corporate sector as these features had become impediments to growth such as monopolies, trade barriers and non – transparent corporate practices. Based on this recognition, the IMF and the World Bank jointly began monitoring the international standardization and observance of standards to maintain the soundness of financial systems by introducing the Financial Sector Assessment Program (FSAP) in 1999. Under FSAP, the IMF and the World Bank assess the observance of banking supervision and regulations implemented by each country’s financial supervisory authorities, promote observance of international standards, and recommend the best practices. These acts which have been entrenched in continue to globalize the Asian economy (Lindgren et al, 2000).

Rehabilitative measures were also extended to private corporations and financial institutions in the Asian countries as these institutions were also hit by the currency crisis largely because they had a superficial understanding of the need for exchange risk hedge, as their currencies were virtually pegged to the dollar. It was for this reason that the debt burdens caused by the mismatch of currencies increased during the crisis, bringing a serious impact on the economy as a whole. Thus after the currency crisis, there was a shift to a floating exchange rate system and this pushed private corporations into recognizing the importance of hedging against exchange risks. In South Korea, the government conducted a campaign appealing for the need for exchange risk hedges. Some other countries established a financial supervision system to check if foreign currency-denominated debts are hedged against exchange risks. Thanks to these policy efforts, the number of private corporations hedging against exchange risks increased drastically and the response capabilities of the economy as a whole to exchange fluctuations have been strengthened (Lindgren et al, 2000).

A stronger and unified Regional Financial and Multilateral Co-operation in East Asia was also adopted and this has proven to be an effective buffering against the occurrence of future crisis – Although regional financial cooperation in East Asia did exist even before the crisis, such as Executives’ Meeting of East-Asia Pacific Central Banks(EMEAP), a forum of central banks and monetary authorities in the East Asia and Pacific region established in 1991; the event of the Asian currency crisis proved more glaring that the countries in East Asia had a much more economic interdependency than was previously realized. This forced a fostering of a much stronger regional financial and multilateral cooperation. This co-operation in Asia was promoted in various forms, such as the “New Miyazawa Initiative” incorporating a comprehensive support measures, including a 30 billion dollar financial support scheme, announced in October 1998; the Chiang Mai Initiative (CMI), a swap arrangement mechanism to support those countries in potential danger of a currency crisis and the Asian Bond Market Initiative (ABMI) to avoid high dependence on the external financial market and use regional resources more efficiently (Naoyuki Yoshino et al, 2000)

In addition to the development of a regional crisis-prevention mechanism, Asian countries started to co-operate especially in trade relations. This inadvertently resulted in a much more stable policy for exchange rates between the Asian currencies. With the increased unification that came as a result of the push for a stronger and unified regional financial and multilateral co-operation in East Asia, there became a rising sense of Asian identity culminating into the speculation of an introduction of a regional common currency in the future (Naoyuki Yoshino et al, 2000).

The finance ministers of China, Japan, and Korea agreed at the ASEAN+3 Finance Ministers Meeting in 2006 to conduct joint research on monetary integration in East Asia. The motion put forward in 2006 helped to create grounds for the much talked about “China’s global strategy approach” which started making head way in 2010. Now, China is beginning to emerge as the new and dominant world power, buttressing this, is the recent widespread awareness and circulation of the Chinese currency (renminbi). These co-operation measures adopted in Asia also extended as a forum for economic co-operation (such economic co-operation was seen to be displayed in the widely acceptance of the Chinese currency “renminbi” by the other Asian countries). This economic co-operation by these Asian countries arguably challenges the American hegemony. It also proves a strong force towards the elimination of any future financial crisis that might occur as the initiatives and discussions on intensifying monetary and financial cooperation has reached a far – end spectrum (Naoyuki Yoshino et al, 2000).

From 1996 – 2000, there have been a resurgence of economic growth across the Asian region. Countries like Indonesia, Thailand, Malaysia, South Korea and the Philippines have averaged almost 5%.


From the chart above, it can been seen that after the rehabilitative measures were meted out, corporate balance sheets in Asia improved as debt-to-equity ratios have been reduced sharply and foreign currency borrowing is no longer a large component of the corporate sources of funding.

From the chart above, it can be seen that low loan-to-deposit ratios together with little off-balance-sheet financing, have helped banks avoid liquidity and funding stress in the current credit turmoil. Thus, Banks are stronger with current account surpluses and large foreign reserves.

Compared to United States and many European countries, Asian economies have relative modest property price appreciation (see Chart 5). Asian countries have taken measures to cool property markets in recent years whenever prices threatened to become a bubble. As a result, property price crashes in the wake of slowing economic growth and financial market turmoil have been less of a risk.


Although, the Asian currency crisis was fuelled by sheer weak economic and financial fundamentals including macro- economic imbalances, which created a contagion effect for the other countries involved.

However, with the measures now adopted, it is obvious that the Asian economies have now been strengthened and would continue on that path.

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