Debt Crisis – Asia 1997
Unlike the Debt crisis in Latin America, the debt crisis in East Asia stemmed from inappropriate borrowing by the private sector. Due to high rates of economic growth and a booming economy, private firms and corporations looked to finance speculative investment projects. However, firms overstretched themselves and a combination of factors caused a depreciation in the exchange rate as they struggled to meet the payments.
Unlike the experience of Latin America, Asia economies have been able to bounce back from their crisis more satisfactorily.
Causes of Asian Financial Crisis
- Foreign debt-to-GDP ratios rose from 100% to 167% in the four large ASEAN economies in 1993-96
- Countries like Thailand, Indonesia, South Korea had large current account deficits. Financed by hot money flows (on capital account). Hot money flows were accumulated because of higher interest rates in the East.
- Financial deregulation encouraged more loans and helped to create asset bubbles.
- Booming economy and booming property markets encouraged expansive borrowing by firms.
- In the late 1990s, the US increased interest rates to reduce inflationary pressures. Higher interest rates in the US, made the East less attractive as a place to move hot money flows. As hot money flows into the east dried up, currencies started to fall and governments struggled to keep exchange rates at their fixed level against the US Dollar.
- Thailand was the first to have to float the Thai Bhat, this caused a rapid devaluation, which triggered a loss of confidence throughout the Asian economies. Soon, other countries were forced to devalue as investors wanted to get out of Asian currencies.
- The devaluation caused debt to be even more difficult to repay and countries started to default.
- At this stage the IMF intervened to try and stabilise the crisis. However, their intervention has proved very controversial, with many arguing that their intervention made things worse.
- The IMF insisted on fiscal restraint – lower spending, higher taxes and privatisation. This contractionary fiscal policy caused the economic downturn to exacerbate and the economy plunged into recession. Bankruptcies increased and there was a flight of capital.
- Economists such as Stiglitz and Sachs emphasised the importance of market sentiment in increasing the magnitude of the problem. The initial problem was containable but because confidence evaporated there was a flight of investors – like a classic bank run causing an unstoppable downward momentum.