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Asian Financial Crisis and Lessons for AfricaTarun DasEconomic Adviser, Ministry of Finance, India andConsultant to UN-ECA, Addis Ababa.
1 Anatomy of the crisis
South East Asian economies - Indonesia, Malaysia, Philippines, South Korea andThailand recorded very high growth rates during 1980s and early 1990s. However, theseeconomies had also large current account deficits as a result of very large trade deficitsand interest payments on foreign debt. In fact, in most of these countries the currentaccount deficit was as high as or even higher than that in Latin American economies.These current account deficits were financed by short term capital inflows that led to asharp accumulation of foreign currency denominated and largely unhedged foreignliabilities. These imbalances reflected a demand boom driven by excessive investmentinto speculative and unproductive assets.In all of these affected economies, there was a boom bust cycle in the asset markets that preceded the currency crisis. Stock and property prices soared, then plunged leading tothe currency and financial crisis, and plunged even more after the crisis leading to deepand wide spread economic crisis. The financial intermediaries, both banks and non-bank,were the creators of this asset cycle.Liabilities of these financial intermediaries were perceived as having an implicitgovernment guarantee, but they were essentially unregulated. These institutions borrowedshort term money, often in dollars, then lent money to highly leveraged speculativeinvestors, largely in real estate. The excessive risky lending of these institutions createdinflation of asset prices. The overpricing of assets was sustained partly by a sort of circular process, in which proliferation of risky lending drove up the prices of riskyassets, making the financial condition of the intermediaries seem sounder than its real balance sheet position.Subsequently when the price bubble burst, the effects of the fall in the asset cycle beganto show by early 1997, the macroeconomic variables had already seriously deteriorated inmost of these economies. As the asset prices fell further, it became increasingly doubtfulwhether governments would really stand behind the deposits and loans that remained.Both the depositors and lenders rushed to withdraw their money. Foreign investorsstampeded to recover their loans and investments, forcing currency devaluation, whichworsened the crisis even further as banks and companies found themselves stuck withassets in devalued baht or rupiah, but with liabilities in US dollars.
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The crisis has led to dramatic depreciation of the nominal exchange rates (
Table-9.1).
Thesharp movement of the exchange rate has greatly complicated the macroeconomic policychoices by raising the cost of repaying foreign debt, weakening the financial andcorporate sectors. Remarkably, the CPI inflation rate since June 1997 has been in therange of 5-12 per cent with the exception of Indonesia. Mexico, by way of comparison,experienced a 40 per cent surge in inflation during first ten months of its crisis in 1995.Despite large increases in nominal interest rates in some countries, only Korea andThailand have been able to maintain real interest rates as a significantly higher levels thanthose before the crisis.
Table-1.1 Exchange rate changes and inflation rate in Asian crisis economiesIn June 1997 - May 1998 (in per cent)ItemsIndonesiaKoreaMalaysiaPhilippinesThailandMexico*
CPI inflation rate54.59.86.48.411.550.5Change in US dollar exchange rate-7.4-35.6-33.9-33.0-33.4-48.5Import share in CPI3018201630…Percent change in Realeffective exchange ratesince June 1997-57.1-30.9-29.0-25.3-28.5…Percent change in realeffective exchange ratesince Jan 199813.613.412.110.519.8…
 Source: Kalpana Kochhar, Prakask Loungani, and Mark R. Stone (August 1998).
Table-1.2: Annual growth rates of broad money supply, 1996-1998In Asian crisis countries (in per cent)CountryDecember1996January1997December1997January1998April1998
Indonesia303827206156Korea1617151410Malaysia21272016-1Philippines16361026-3Thailand1315021-1
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 Source: Kalpana Kochhar, Prakask Loungani, and Mark R. Stone (August 1998).
Economic activity has slowed more sharply than expected in all affected countries due tolack of both internal and external demand
(Tables-3.3 and 3.4)
. Crisis countries includingJapan account for 45 to 55 per cent of the exports to the region. Imports have declined by4 to 13 per cent in volume.Most countries have experienced sharp slowdowns in money and credit growth byvarying intensity and duration during the adjustment period (
Table-9.2).
These reductionsin monetary growth reflect the declines in demand and more cautious lending behaviour  by the banks. Banks attempt to strengthen their balance sheets in the context of droppingcollateral guarantees, more stringent credit rating of loans, stringent provisioningrequirements, improved credit risk assessment techniques and generally more riskyfinancial environment.
2 Origins of the crisis
The crisis unfolded against the backdrop of several decades of outstanding economic performance in Asia, and the difficulties that the East Asian countries face are not primarily the result of macroeconomic imbalances. Rather, they stem from weaknessesin financial systems and, to a lesser extent, governance. A combination of inadequatefinancial sector supervision, poor assessment and management of financial risk, and themaintenance of relatively fixed exchange rates led banks and corporations to borrowlarge amounts of international capital, much of fit short-term, denominated in foreigncurrency, and unhedged. As time went on, this inflow of foreign capital tended to be usedto finance poorer-quality investments.Although private sector expenditure and financing decisions led to the crisis, it wasexacerbated by governance issues, notably government involvement in the private sector and lack of transparency in corporate and fiscal accounting and the provision of financialand economic data. Developments in the advanced economies, such as weak growth inEurope and Japan that left a shortage of attractive investment opportunities and keptinterest rates low in those economies, also contributed to the build-up of the crisis.After the crisis erupted in Thailand with a series of speculative attacks on the Baht,contagion spread rapidly to other economies in the region that seemed vulnerable to anerosion of competitiveness after the devaluation of the Baht or were perceived buyinvestors to have similar financial or macroeconomic problems. As the contagion spreadto Korea, the world’s eleventh largest economy, the possibility of default by Korea raiseda potential threat to the international monetary system.The build-up to the difficulties in east Asia, which eventually lead to the presenteconomic and financial crisis in these economies and elsewhere can be traced in four major factors. They relate to:
•
high growth and commendable economic success resulted in underestimation of risk;
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