Analysis on Financial

Crisis
International Finance
(FIN 4010)

1997 ASIAN
FINANCIAL CRISIS

Lecture: Dr. Chathura Liyanage

Student: Irushi Wishwanee Minipura (6150)
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TABLE OF CONTENTS

ACKNOWLEDGMENT.................................................................................................................3

EXECUTIVE SUMMARY.............................................................................................................4

INTRODUCTION...........................................................................................................................5

History of The Crisis....................................................................................................................5

Evidence of the 1997-98 Financial Crisis in East Asia................................................................6

THE WARNING INDICATORS (SYMPTOMS) OF THE 1997 FINANCIAL CRISIS IN EAST

ASIA................................................................................................................................................8

1st Indicator: Current Account Deficit as a Percentage of GDP...................................................8

2nd Indicator: The Long-Term Debt as a Percentage of GDP......................................................8

3rd Indicator: The Short-Term Debt as a Percentage Of GDP.....................................................9

4th Indicator: The Current Account Minus Foreign Direct Investments as a Percentage of GDP
......................................................................................................................................................9

5th Indicator: The Debt Service in Relation to The Nation’s Exports.........................................9

6th Indicator: The Number of Months of Imports That the Nation Can Finance with Its
International Reserves................................................................................................................10

THE CAUSES OF THE CRISIS...................................................................................................12

EFFECTS OF THE ASIAN FINANCIAL CRISIS.......................................................................13

HOW ASIANS OVERCOME FROM THE CRISIS (SOLUTIONS)..........................................15

IMF’s Role in the Asian Financial Crisis...................................................................................15

CONCLUSION & LESSONS FROM THE CRISIS.....................................................................17

WORKS CITED............................................................................................................................18

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ACKNOWLEDGMENT

I am very grateful that I was able to complete my second task in International Finance
(FIN 4010) within the allotted time. The end result of this study, success, requires a lot of
advice and help from many people, and I feel honored to receive it at the end of the study.

My true appreciation and thankfulness go out to our Lecturer, Dr. Chathura Liyanage
for his nonstop help, exhortation, and consolation, which were all pivotal to the finishing of this
report. I express gratitude toward him for giving me this opportunity to do this analysis on
financial crisis. I might likewise want to thank every other person who helped me in the
fulfillment of this task.

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EXECUTIVE SUMMARY

The report below provides an analysis of a financial crisis called 1997 Asian financial
crisis. The countries hardest hit by the Asian currency crisis are Indonesia, Thailand, Malaysia,
South Korea, and the Philippines. 1st of all the report provide an introduction with the history of
the crisis and evidence for the crisis. Then it has given six warning indicators (symptoms) of the
1997 financial crisis in east Asia. They are, current account deficit as a percentage of GDP, long-
term debt as a percentage of GDP, short-term debt as a percentage of GDP, current account
minus foreign direct investments as a percentage of GDP, debt service in relation to the nation’s
exports and the number of months of imports that the nation can finance with its international
reserves. Next, report will explain causes for the crisis. Then, the report has forced on several
effects on the crisis. Further, report explain how Asians overcome from this crisis. Here, the
report mainly forces on role of the International Monetary Fund (IMF) during the crisis. Finally,
the report has given the conclusion by mentioning a lesson through this crisis.

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INTRODUCTION

History of The Crisis

The Asian financial crisis of 1997 affected many Asian countries in July 1997, this crisis
originated in Thailand. The 1997 East Asian financial crisis began with the devaluation of the
baht on July 2, 1997, where Thai Baht collapsed (declined) in July 1997. Thailand exchange rate
was a fixed exchange rate system. The value is determined (pegged) by the currency in US
dollars. However due to speculative attacks on the currency, in July, the government was forced
to fluctuate the Baht. As a result, the value of money goes down and the stock market has
diminished. The crisis had spread to other Asian countries. At that time, few believed that the
crisis was too deep, widespread, and long. Until the fall of 1997, the crisis spread to Korea,
Indonesia, Malaysia, and the Philippines.

Although Hong Kong, Taiwan, and Singapore did not collapse, but suffered and deeply affected.
China and India are less affected by the supervision of the financial and economic system. In the
summer of 1998, the crisis spread to Russia and suffered a complete political, financial, and
economic collapse. A company borrowed in foreign currency has gone bankrupt. It cannot be
repaid due to an increase in debt due to local currency depreciation. Incoming foreign currency
debt has also increased. They experienced capital outflows, their confidence in the economy
plummeted and GDP growth plummeted. This led to a decline in global stock markets and in

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1998 the International Monetary Fund (IMF) stepped in to control the crisis. [ CITATION cor \l
1033 ]

(Asian Financial Crisis - Overview, Causes, and Impact)

Evidence of the 1997-98 Financial Crisis in East Asia

Statistics of Table 1 describes the negative or sharp decline in real GDP growth. Table 2
describes the depreciation of the stock market and the currency in 1997-1998. These tables show
that in Thailand, South Korea, Indonesia, Malaysia and the Philippines, the crisis is the most
severe and the deepest. Also, as less affected countries we can see, Hong Kong SAR, Singapore,
and Taiwan PC (although Hong Kong's real GDP generally declined in 1998), and China and
India even less affected through the crisis. The crisis in these last five economies occur mainly
from contagion from the first five countries (formers) rather than from financial
mismanagement, internal economic and excesses (as was the case for Thailand, Indonesia,
Philippines, Korea, and the Malaysia).

Table 1: Growth of real GDP, 1995 to 1998

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Table 2: Percentage change in stock prices and currency depreciation in Asian economy,
1997 to 1998

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THE WARNING INDICATORS (SYMPTOMS) OF THE 1997
FINANCIAL CRISIS IN EAST ASIA

There were many inquiries were done in order to find some various financial and
macroeconomic indicators that might predict this financial crisis from 1996-1999. Many large
indicators have been tested, but only few fundamental key indicators were predicted. This report
will discuss them further.

1st Indicator: Current Account Deficit as a Percentage of GDP

This is the most basic warning indicator. It is generally believed that the current account deficit
exceeds 4-5% of GDP, which is unsustainable and may lead to turmoil in forex markets,
devaluation of currency, and leads to economic and financial crises. In 1996, the percentage of
current account deficit to GDP was 7.9 in Thailand, 4.9 in Malaysia, 4.8 in South Korea, 4.7 in
the Philippines, and 3.3 in Indonesia. Among the major Asian countries hardest hit by the 1997
crisis, Hong Kong and India had current account deficits of 3.9% and 1.6%, respectively, while
Singapore 13.9 %, Taiwan 10%, and China 9% had current account surpluses. For example, the
current account deficit in 1996 can be correctly represented by four of the five East Asian
countries (Thailand, South Korea, Malaysia, and the Philippines) that are actually in
crisis[ CITATION DOM10 \l 1033 ].

2nd Indicator: The Long-Term Debt as a Percentage of GDP

The second warning indicator is the country's total external (foreign) debt as a percentage of the
country's GDP. Experience has shown that if a country is unable to handle its debt and ultimately
repay it, a value of more than 30% can represent future problems. Indonesian prices are 59.7%,
Thailand 50.3%, Philippines 47.3%, Malaysia 42.1%, and South Korea 32.1%. In 1996, Hong
Kong and Singapore had no external debt. China's external debt accounts for only 15.8 of GDP,
while India's external debt is 22.5 where they had less effect from the crisis. [ CITATION DOM10 \l
1033 ]

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3rd Indicator: The Short-Term Debt as a Percentage Of GDP
The third indicator is the ratio of short-term debt to GDP. Experience has shown that when the
ratio exceeds 8-10%, these foreign investments can be withdrawn from the country easily and
quickly, making it more likely to encounter financial difficulties. The 1996 figures were 27.7 in
Malaysia, 20.8 in Thailand, 14.9 in Indonesia, 10.3 in South Korea and 9.1 in the Philippines, but
Hong Kong and Singapore and possibly Taiwan were zero and India was 7.5. Hence, this
indicator also signaled in 1996 potential troubles down the road for the five East Asian countries
that did fall into crisis in 1997. Only for China did this indicator predict a crisis that did not
come. [ CITATION DOM10 \l 1033 ]

4th Indicator: The Current Account Minus Foreign Direct Investments as a

Percentage of GDP
The fourth important indicator of a possible financial crisis is the current account minus FDI, as
a percentage of GDP. The negative value of the index measures the percentage of a country's
current account balance (as a % of GDP), which is covered by portfolio investments or hot
money inflows. They appear just as easily, quickly, and can plunge the country into economic
crisis. Experience has shown that the value of the index exceeds minus 2%or 3% of, which may
cause problems for the country in the future. In 1996, South Korea was -21.7, Thailand -5.6, the
Philippines -3.1, but Malaysia +0.7, Indonesia + 3.0, India +0.7, Singapore +23.6, and China
+51.1. This means that the 1996 index correctly predicted crises in three of the five East Asian
countries (South Korea, Thailand, and the Philippines) that faced the 1997 crisis. In addition, this
index correctly predicted no crisis for the other Asian countries[ CITATION DOM10 \l 1033 ]

5th Indicator: The Debt Service in Relation to The Nation’s Exports

The fifth indicator is the debt service on the foreign debt of the nation (as a percentage of export
earnings). The higher the share of export earnings a country needs to repay its external debt, the
more unstable is the position of the nation since there are many other growth claims on its
foreign earnings. For example, in the years leading up to the Asian crisis of 1997, Thai and
Malaysian banks made large dollar loans in the interbank market that could not be repaid during

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the crisis. There is no clear data on the value of this indicator, which indicates the possibility of
national budget problems. In 1994, the index value was 28.1%, while Mexico was struggling in
1995. Indonesia was the only country with the highest index value in 1996 (36.8%). The other
four East Asian countries had lower values in 1996 Therefore, this indicator alone is not seen as
a potential economic problem for these countries. The index value is zero in South Korea, Hong
Kong, and Singapore, 8.2 in Malaysia, 11.5 in Thailand, 13.7 in the Philippines, 23.7 in the
Philippines, 24.1 in India and 22.3 in China. There is no data for Taiwan. [ CITATION DOM10 \l
1033 ]

6th Indicator: The Number of Months of Imports That the Nation Can Finance with
Its International Reserves
The final warning indicator of a of potential financial crisis in an emerging market is the average
number of months of imports the nation could finance with the international reserves at its
disposal. At a fixed exchange rate, this indicator is particularly important. The risk of a score
below 3 or 4 is too low and can be taken as a clear warning of possible future financial problems.
Of the five East Asian countries that faced a crisis in 1997, only the Philippines posted the
lowest value in the 1996 index (2.8%). In 1996 Indonesia scored 4.4 points, Thailand 7.0 points,
Malaysia 7.2 points and South Korea 14.6.32 points. The index is 3.9 in Hong Kong, 4.4 in
India, 11.9 in Singapore and 12.8 in China. Therefore, this indicator only indicates that a crisis
may arise in Indonesia and even in Hong Kong. There is no data for Taiwan. [ CITATION DOM10 \l
1033 ]

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Bellow, Table 3 summarized all six factors that describe above, and it clearly mentioned about
the Warning indicators in 1996 that correctly predicted the 1997 Asian financial crisis and those
that correctly prediction no crisis

Table 3

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THE CAUSES OF THE CRISIS

1. Massive short-term foreign capital inflows: The inflow of foreign capital is short-term.

This income is also called "hot money". Because it can move out of the country quickly, it
creates instability. This is exactly what happened after the Thai baht collapsed. The
companies that invested in these companies went bankrupt and were unable to repay their
loans.
2. Fixed exchange rate: Due to the fixed exchange rate system in Asia, it makes their
currencies vulnerable to speculative attacks. When investors lost confidence in these
economies, they began to sell their currencies on the market. This forces the currency to
depreciate. In the end, Thailand had to float its currency, which led to a crisis. The fixed
exchange rate system also promotes foreign borrowing because the borrower has no
exchange rate risk. When a country switches to a floating exchange rate system, the currency
depreciates. The external debt of borrowers has increased. Another disadvantage of the fixed
exchange rate system is that these countries must raise interest rates to maintain this
exchange rate. It attracts short-term capital inflows and requires high interest rates.
3. Large current account deficit: Most affected countries (Thailand, Indonesia, South Korea)
had large current account deficits. This says that their imports were higher that exports.
Hence, pay for imports countries have to borrow money where it increases the foreign debt.
In these countries foreign debt ratio rose.
4. Inadequate banking regulations: Above factors led companies to take on more foreign
currency loans and banking regulations did not allow adequate supervision of borrowers.
5. The ratio of external debt to GDP increased in the big four ASEAN economies from
100% to 167% between 1993 and 1996. Foreign companies have attracted capital inflows
from developed countries. Western investors were looking for better returns, and the “Asian
economic miracle” seemed to offer better returns than low-growth Western economies.
6. Moral Hazard. With strong political and economic incentives for rapid growth,
governments often gave implicit guarantees to private sector projects. It creates strong
relationship between banks, firms, and government. This result in private sectors less
emphasis on the costs of projects

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EFFECTS OF THE ASIAN FINANCIAL CRISIS

 The Asian countries most affected by the economic crisis are Indonesia, Malaysia,
Thailand, South Korea, and the Philippines. Hence, they clearly saw that their stock
markets, currency exchange rates, and prices of other assets all plunge. As a result, the
GDP of the affected countries will fall by double digits.

 In 1997, Thailand’s nominal GDP per capita fell, from 19% in Malaysia 18.5% in the
Philippines. And South Korea 12.5%. Hong Kong, China, Japan, and Singapore suffered
smaller losses, but the losses were smaller.[ CITATION eco \l 1033 ]

 Severe depression- Companies that suffer from a loss of confidence and increased debt
repayment will reduce their investments, leading to a slowdown in growth. The sharp
depreciation has also affected consumer spending because the prices of imports and
imported raw materials have risen. This led to economic recession in countries such as

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 South Korea, Indonesia, Malaysia, and Thailand. In dollar terms, Indonesia’s GNP dropped
by 84% from June 1997 to July 1998.[ CITATION eco \l 1033 ]

 Inflation – Devaluation raises import prices.

 Global effects. The Asian crisis damaged the confidence of US investors, but low interest
rates helped stabilize the US economy. China was largely insulated by the crisis because it
attracted natural capital investment instead of relying on the flow of foreign capital. This
crisis has had a negative impact on the Japanese economy, and it has continued low growth
for 10 years.

• In addition, other than its economic impact this crisis also results in political
repercussions. Thai Prime Minister Yongchaiyudh and Indonesian President Suharto
resigned.

• The impact of the Asian financial crisis is not limited to Asia. International investors invest
and lend to developing countries, not just Asia and the rest of the world. After the crisis, oil
prices fell. As a result, there have been a large number of mergers and acquisitions in the
oil industry with the goal of achieving economies of scale.[ CITATION eco \l 1033 ]

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HOW ASIANS OVERCOME FROM THE CRISIS (SOLUTIONS)
IMF’s Role in the Asian Financial Crisis

The currency crisis was finally resolved by the International Monetary Fund (IMF). The
International Monetary Fund (IMF) is an international organization dedicated to promoting
global economic cooperation and trade, reducing poverty, and promoting financial stability. The
International Monetary Fund is required to provide financial assistance to the three countries
most severely affected by the crisis (Indonesia, South Korea, and Thailand). The crisis response
strategy has three key elements.

Financing- The International Monetary Fund (IMF) finally resolved the Asian financial crisis.
The fund provided the necessary tools to stabilize the Asian economy. At the end of 1997, the
agency pledged more than 110 billion US dollars in short-term loans for affected countries to
promote economic stability. This is more than twice the largest loan from the International
Monetary Fund in history. In return for funds, the International Monetary Fund urges countries
to comply with stricter conditions, such as taxes, cuts in public expenditures, privatization of
state-owned enterprises, and high interest rates to cool the overheated economy. Several other
restrictions have forced the state to close low-liquidity financial institutions without worrying
about unemployment.[ CITATION www1 \l 1033 ]

Macroeconomic policies-Tightening of monetary policy (at different stages between different

countries) prevents the collapse of the country’s exchange rate far beyond the core value and
prevents currency depreciation from turning into inflation and decline. The monetary tightening
policy is only temporary. once confidence began to recover and market conditions stabilized,
interest rates were lowered. [ CITATION www1 \l 1033 ]

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Structural reforms- Steps have been taken to mention weaknesses in the businesses sectors and
financial sectors. Other reforms aim to mitigate the social impact of the crisis and to lay the
foundations for a resumption of development. [ CITATION www1 \l 1033 ]

 In addition to financial support for the political reform programs in the three countries,
the IMF participated in cooperation with other countries in the crisis area:
 Example: Expanded the program currently supported by the International Monetary
Fund in the Philippines in 1997, and organized a backup plan in 1998
 Strengthen consultations with other affected countries and provide recommendations
on contagion control measures

In 1999, many disaster-stricken countries showed signs of recovery, and the growth of gross
domestic product (GDP) rebounded. Since 1997, stock markets and currency valuations in
many countries have fallen sharply, but the imposed solutions have paved the way for Asia's
revival as a powerful investment destination.[ CITATION www1 \l 1033 ]

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CONCLUSION & LESSONS FROM THE CRISIS

Facts have proved that financial crises are a common phenomenon, usually caused by
economic policies pursued by various countries. Countries belonging to a common economic
group or region are vulnerable to a country’s economic collapse. This was evident during the
East Asian financial crisis. Some countries have chosen external financial support from the
International Monetary Fund, while other countries such as Malaysia have chosen independent
economic policies to help them recover from the crisis immediately. Countries such as Indonesia
and Thailand that took a long time to apply for international funding, such as Indonesia and
Thailand, took a long time to recover. In particular, it cannot be said that the consequences of
this crisis have been completely eliminated. This is because there are still many gaps in regional
economic policies, which make countries suffer economic shocks.[ CITATION cor \l 1033 ]

Many countries have learned from the financial crisis how to build foreign exchange reserves to
offset external shocks. Most of the Asian countries have weakened their currencies and adjusted
their fiscal structures to achieve current account surpluses. Surplus can increase your foreign
exchange reserves. This crisis has concerned about the role of the government in the market.
Asians believe this is a crisis occurs due to government intervention. The conditions that IMF set
within their structural-adjustment packages also aimed to weaken the relationship between the
government and capital market in the affected countries, and thus to promote the neoliberal
model. In addition, through the package plan to adjust the conditions of the International
Monetary Fund, it makes weak relationship between capital market and government in the
affected countries.

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WORKS CITED

 (n.d.). Retrieved from

https://corporatefinanceinstitute.com/resources/knowledge/finance/asian-financial-
crisis/.

 (n.d.). Retrieved from economicshelp:

https://www.economicshelp.org/blog/glossary/financial-crisis-asia-1997/

 (n.d.). Retrieved from www.imf.org:

https://www.imf.org/external/np/exr/ib/2000/062300.htm

 CAMPANO, D. S. (2010). Retrieved from

https://scholarship.law.upenn.edu/cgi/viewcontent.cgi?article=1039&context=ealr

 institute, c. f. (n.d.). Retrieved from

https://corporatefinanceinstitute.com/resources/knowledge/finance/asian-financial-
crisis/

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