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The Asian Financial Crisis of 1997-1998 Revisited: Causes, Recovery, and the
Path Going Forward
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Omid P. Panahi
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Omid P. Panahi
I
Table of Contents
1.0 Introduction ................................................................................................................................ 1
2.0 The 1997-1998 Asian Financial Crisis ...................................................................................... 1
3.0 The Major Causes of the 1997-1998 Asian Financial Crisis ..................................................... 2
3.1 Crony Capitalism ................................................................................................................... 2
3.2 Fixed Exchange Rates ........................................................................................................... 2
3.3 Moral Hazard ......................................................................................................................... 3
3.4 The Contagion Effect ............................................................................................................ 3
4.0 Recovery from the 1997-1998 Asian Financial Crisis............................................................... 3
5.0 How Future Financial Crises Could Be Prevented .................................................................... 4
6.0 Conclusion ................................................................................................................................. 6
7.0 References .................................................................................................................................. 7
II
1.0 Introduction
This assignment is conducted on the 1997-1998 Asian financial crisis, which adversely affected
a considerable number of Asian, Latin, and European economies. This paper aims to do the
following: (1) identifying the major causes of this financial crisis; (2) examining the recovery
of the affected economies by the early 2000s; and (3) determining the ways in which future
financial crises could be prevented. Subsequent to the main sections of the paper, concluding
remarks will be made.
Pang (2000) summarizes the Asian financial crisis in a series of events: (1) the collapse of the
regional economies mainly as a result of dysfunctional, overvalued currencies, which were
themselves caused by high rates of inflowing foreign direct investment (FDI) and foreign
portfolio investment (FPI); (2) the sudden and swift liberalization of the regional capital
markets to entice more FDI and FPI; (3) heavy corporate and private debt in Dollar and Yen;
(4) the public backlash to the excessive crony capitalism present in the region; (5) the
insufficiency of the remedial tools and state policies utilized in the region; (6) the rise and
global contagion of investor panic; and (7) the governments’ fake promises of bailout to local
corporations. The Asian financial crisis, according to Davidson (2005), came as an economic
crash with the end of what he calls the “Asian miracle,” which is the remarkable performance
of East Asian economies in the previous two decades.
Korean government to implement free market reforms and open its market to foreign
investment and ownership (Ardiansyah, 2002). These requests of reform were met with an
initial hesitation on the part of the authorities, which further exacerbated the crisis by causing
declines in the currencies and stock markets (IMF Staff, 1998). Eventually, however, the
necessary commitments were made and the proposed reforms were implemented.
Apart from the reform programs introduced by the IMF, additional measures were taken by
East Asian countries to manage the financial crisis. One of the most remarkable among them
is the reorganization of the financial sectors, where many of the ailing banks and financial
institutions in the region were shut down (Kim & Haque, 2002). Throughout 1997 and 1998,
Thailand liquidated 56 of its 91 financial institutions; Indonesia closed 16 of its commercial
banks; South Korea suspended 14 of its 30 merchant banks; and Malaysia restructured its 39
financial institutions (15 were restructured into six anchor groups, and 14 were absorbed by
their parent banks) (Radelet & Sachs, 1998; Chotigeat & Lin, 2001). These actions were taken,
according to Radelet and Sachs (1998), to minimize the losses that were being accumulated by
these financial institutions, as well as to send a strong message that the East Asian governments
were determined to implement reforms and restore confidence in their countries’ banking
systems. Overall, this strategy helped the East Asian economies recover from the 1997-1998
financial crisis.
Pang (2000) goes on to describe what the new East Asian economic model should look like.
The new economic model or developmental state, he writes, should entail the following: (1)
In the post-financial crisis era, according to Singh (1998), East Asian countries face a number
of policy challenges: (1) restoring the confidence of international investors to resume normal
capital flows into the region; (2) ensuring long-term economic growth; and (3) providing
immediate aid and assistance to the people who have, as a result of the financial crisis, become
unemployed or pushed back into poverty. In order to tackle these challenges, East Asian
countries would need to encourage cooperation not only between governments and
corporations, but also between labor and civil society organizations. A state of “political unity”
needs to be achieved, which would, in turn, ensure the implementation of credible economic
policies that are supported across the domestic political spectrums.
In a 1998 paper published by the International Monetary Fund, the IMF’s staff note, regarding
the Asian financial crisis, that “A key task for future policymakers is to identify and address
vulnerability before crises erupt” (IMF Staff, 1998). In some cases, they write, countries might
need to modify their exchange rate regimes, and adopt mechanisms such as currency pegs and
currency unions. These systems would help stabilize East Asian countries’ economies, given
the anchor currencies and the rate at which the pegs are set are appropriate, and certain policies
are implemented to maintain the rates. In other cases, countries might decide to shift toward
higher exchange rate flexibility, in order to avoid the risk of excessive foreign currency
exposure created by fixed exchange rates. Decisions of this sort have to be made with close
consideration of domestic economic circumstances.
In order to liberalize capital movements, the IMF staff (1998) argue, East Asian countries
would need to develop a robust financial system that accommodates the moderate regulation
and supervision of financial institutions. In addition, the liberalization of domestic financial
systems would need to be accompanied by the reception of foreign investors, since this will
stimulate the growth of domestic capital markets. Overall, the initiatives proposed by the
International Monetary Fund would help East Asian countries foresee, and ideally prevent,
future financial crises.
Furthermore, Kim (1998) points to the need for corporations to revise their internal objectives
and decision-making procedures. In order for East Asian countries to boost the productivity of
capital, he contends, domestic corporations must “realign managerial interests with the claims
of shareholders by linking managerial compensation to value creation.” Such a reform would
require the abandonment of the “growth at any cost” strategy, and the adoption of a merit-based
compensation system. Moreover, domestic corporations need to take the necessary steps to
protect foreign investors from the expropriation of their wealth. This will require higher
transparency in financial reporting, accountability on the part of managers, and additional legal
protections. This way, the likelihood of a future financial crisis could be significantly
diminished.
6.0 Conclusion
The 1997-1998 Asian financial crisis was the central topic of this assignment paper. Initially,
the financial crisis was briefly introduced and put in historical perspective. In the subsequent
section, the origins of the Asian financial crisis were thoroughly discussed, identifying its major
causes as (1) crony capitalism, (2) fixed exchange rates, (3) moral hazard, and (4) the contagion
effect. The following section described the manner in which East Asian countries recovered
from the 1997-1998 financial crisis. And the last section explored at length the measures that
could be taken by East Asian countries to predict, and ultimately prevent, future financial crises
of the sort that erupted in 1997. The developing countries in Asia have many lessons to learn
from the 1997-1998 financial crisis, and should harness this knowledge to better position
themselves in the 21st century world economy.
7.0 References
Kim, S. H. & Haque, M., 2002. The Asian Financial Crisis of 1997: Causes and Policy Responses.
Multinational Business Review, 10(1), pp. 37-44.
Ardiansyah, M., 2002. Impact of the 1997--1998 Asian Financial Crisis on the Indonesian and
Malaysian Palm Oil and Palm Kernel Oil Industries. Oklahoma State University.
Pang, E.-S., 2000. The Financial Crisis of 1997-98 and the End of the Asian Developmental State.
Contemporary Southeast Asia, 22(3), pp. 570-593.
Davidson, S., 2005. The 1997-98 Asian Crisis: A Property Rights Perspective. Cato Journal, 25(3),
pp. 567-582.
Lee, E., 1998. The Asian Financial Crisis: The Challenge for Social Policy. Geneva, Switzerland:
International Labour Organization.
Enderwick, P., 2005. What’s Bad About Crony Capitalism?. Asian Business & Management, 4(2), pp.
117-132.
Aligica, P. D. & Tarko, V., 2014. Crony Capitalism: Rent Seeking, Institutions and Ideology. Kyklos,
67(2), pp. 156-176.
Jackson, K. D., 1999. Asian Contagion: The Causes and Consequences of a Financial Crisis.
Boulder, Colorado, United States: Westview Press.
Garg, R., Kim, S. H. & Swinnerton, E., 1999. The Asian Financial Crisis of 1997 and Its
Consequences. Multinational Business Review, 7(2), pp. 32-36.
Glăvan, B., 2008. The Quantity Theory of Money and Financial Crises: Evidence from the 1997
Asian Crisis. Romanian Economic and Business Review, 3(2), pp. 103-108.
IMF Staff, 1998. The Asian Crisis: Causes and Cures. Finance and Development, 35(2), pp. 18-21.
Baig, T. & Goldfajn, I., 1999. Financial Market Contagion in the Asian Crisis. IMF Staff Papers,
46(2), pp. 167-195.
Radelet, S. & Sachs, J., 1998. The Onset of the East Asian Financial Crisis. National Bureau of
Economic Research, Issue w6680.
Chotigeat, T. & Lin, J. B., 2001. Coping with the 1997 Financial Crisis: Policy Issues in Southeast-
Asia. Multinational Business Review, 9(2), pp. 52-56.
Singh, A., 1998. “Asian Capitalism” and the Financial Crisis. CEPA Working Paper Series III.
Kim, E. H., 1998. Globalization of Capital Markets and the Asian Financial Crisis. Journal of Applied
Corporate Finance, 11(3), pp. 30-39.