The Asian Currency Crisis
Recently, the Yuan weakened past the key 7.3 per US$ level which reminds us of the Asian currency crisis of 1997. Let’s recap what events led to such a big financial crisis.
No one could have taken seriously any analysts prediction that the economic cataclysm that would occur in the following months before July 1997. Just one month before the crisis, the average forecast for regional economic growth was around 7%, which was consistent with the performance of these economists in previous years.
Everything seemed to be in order at the start of 1997. South Korea and the Southeast Asian countries' public accounts were in order; they had maintained very high levels of economic growth for years; inflation was under control, and their savings and investment rates were very high.
Nothing hinted at what was to come; on the contrary, the prospects were promising; investment banks, funds, hedge funds, commercial banks, and other financial players all wanted a piece of this kind of economic miracle. The stock market was rising, the value of real estate assets was increasing, there was money for all kinds of projects, and best of all, with healthy public accounts and an insatiable appetite for investing, everything pointed to the prospect of continued prosperity for the foreseeable future.
While heading towards the causes of the crisis, let’s have a look at the impact of this crisis on the currencies and stock markets of countries such as Thailand, Malaysia, Indonesia, The Philippines, and South Korea.
As per the above chart, Indonesia's currency, the Rupiah, suffered the greatest drop of 83% when compared to other countries, while South Korea's currency suffered the least.
In terms of the stock market, Indonesia experienced the greatest impact (58%), while the Philippines experienced the least (36%). In other words, if one had invested $1,000 in Indonesia's stock market on June 30, 1997, the amount would have been reduced to $420.
But, now, as we all know, some flaws led to such a huge crisis, so let’s figure out these flaws:
One of them was the United States (US), which experienced a mid-economic crisis in the early 1990s, which resulted in a recession in 1991. This forced the US government to cut interest rates to levels lower than those in South Korea and other Southeast Asian countries. This attracted capital to these Asian countries. A lot of capital was being invested in projects whose profitability was more than questionable, and thus the bubble was created. However, as the United States began to recover, Alan Greenspan's federal government decided to increase interest rates. As a result of this, the attractiveness of these Asian markets began to wane.
This was not the only cause of the crisis; higher interest rates facilitated the appreciation of the US dollar. Because Asian countries had pegged their currencies to the US dollar at a fixed exchange rate, their exports were more expensive. To make it worse, China devalued its currency by more than 30% in 1994. As a result, exports to Southeast Asia and South Korea began to slow in 1996. The fact was that the accumulation of the current account deficit was financed by foreign debt. In 1996, the foreign debt of these countries exceeded 165% of their GDP.
In 1993, taking advantage of the influx of capital that was flooding Southeast Asia, the Thai government decided to create an entire international financial center in Bangkok to compete with Singapore and Hong Kong. Soon Bangkok specialized in foreign exchange lending operations. On July 2, 1997, the Thai government ran out of foreign currency, their economic activity slowed down and asset prices declined due to widespread capital outflows. Investors started attacking their currencies in the market, which ultimately led to the collapse of the Baht.
All of these were major causes of the Asian currency crisis in 1997. And now it will be very interesting to see how the economy reacts to the recent drop in the yuan, as well as how the yuan recovers from this drop.
Kautilya, IBS Mumbai.