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The 1997 Asian Financial Crisis

What we know about the global financial crisis is that we don't know very much. ~Paul Samuelson

The floating of the Thai baht on 2 July 1997 signaled the incipience of the 'Asian Crisis', which had drastic repercussions for the 'miracle' economies of East Asia, along with the developing countries in general and global financial markets. The Asian Crisis also gave air to debates on the multiverse of fundamental economic, financial, and economic policy-making issues in general.

The 1997 Asian Financial Crisis was a momentous chapter in the archives of the financial realm. All principal economies of the South East Asian region including South Korea, Thailand, Malaysia, Indonesia, Singapore, and the Philippines, plummeted and took a deep dive. The erstwhile popular tiger economies were experiencing compound annual growth rates of 6%-9% before the crisis. These were some of the most substantial growth rates in the world at the time. The disaster aroused their stock markets and currencies to squander about a majestic 70% of their value.

Technically explained, a financial crisis is a situation or a circumstance where one or more vital financial assets – such as stocks, real estate, or oil – suddenly (and customarily unexpectedly) loses an abundant amount of their nominal value.

The 1997 crisis was a series of currency devaluations and subsequent events that further spread through multiple Asian markets. Thailand's currency markets were the first to fail, owing to the government's decision of no longer pegging the local currency to the U.S. dollar (USD). Currency slumps disseminated swiftly throughout East Asia, taking the stock markets down, combined with diminished import revenues and government upheaval.

Several strands of industrial, financial, and monetary aspects played a role in the abettment of the crisis. The economic approach of export-led growth was the unifying bond of the actors responsible. This strategy resonated all across the developing East Asian economies in the years leading up to the crisis. This strategy entails close government co-operation with export-oriented businesses, including granting subsidies, desirable financial deals, and a currency peg to the U.S. dollar to secure an exchange rate advantageous to exporters.

It did benefit the flourishing industries of East Asia, but on the other hand, it also presented certain risks. These included: explicit and implicit government guarantees to bail out struggling domestic industries and banks; cosy alliances linking East Asian conglomerates, financial institutions, and regulators; and a wash of foreign financial inflows with little attention to potential dangers all contributed to a massive moral hazard in East Asian economies, prompting significant investment in marginal, and conceivably unsound projects.

Since these economies were principally boosted by export growth and foreign investment, high-interest rates and fixed currency exchange rates (pegged to the U.S. dollar) were executed to attract hot money. Also, the exchange rate was pegged at a rate favorable to exporters. However, the foreign exchange risk arising from the fixed currency exchange rate policy imperiled both the corporates and the capital market. The breakdown of the hot money bubble created owing to this was a central element of the crisis.

In the mid-1990s, the U.S. recovered from a recession. Following this, the Federal Reserve hiked the interest rate against inflation. The higher interest rate lured hot money to rush into the U.S. market, thus ensuring the commencement of appreciation of the U.S. dollar.

Additionally, with the Plaza Accord's withdrawal in 1995, U.S., Germany, and Japan agreed to regulate to let the U.S. dollar appreciate corresponding to the Yen and the Deutsche Mark. It stimulated the appreciation of East Asian currencies pegged to the U.S. dollar. Extreme financial stresses started accumulating in these particular economies as export commodities from Japan and Germany turned more economical and competitive in contrast to other East Asian goods. Exports collapsed, and corporate profits dwindled. With a mixed collapse in foreign investment and export, asset prices, which were leveraged by massive volumes of credits, commenced falling. The foreign investors began to retreat in furor.

The East Asian governments and related financial institutions encountered increased difficulties in borrowing U.S. dollars to back their domestic industries and further sustain their currency pegs. These pressures came to a head in 1997 as these countries started running out of foreign currency. As they were no longer able to support the exchange rates, they had no other option but to float their currencies. The Thai government was the first to do so, and the value of the Baht thus collapsed immediately. Others followed suit and abandoned their pegs and devalued their currencies only to meet a similar fate.

To inhibit the economic devastation accompanied by the crisis, the affected countries introduced corrective measures. In late 1997 and early 1998, the IMF granted $36 billion to back reform programs in the three worst-hit countries—Indonesia, Korea, and Thailand. As part of international support packages, the IMF generated various bailout packages for the most distressed countries. It rendered packages of around $20 billion to Thailand, $40 billion to Indonesia, and $59 billion to South Korea to ensure that they did not default.

Since the bailout packages are structural adjustment packages, these countries had to comply with stringent provisions including, higher taxes and interest rates and a drop in public spending. The goal of the regulations was to stabilise currency rates. Consequently, several affected countries began exhibiting signs of recovery by 1999.

This financial crisis should serve as a lesson to all investors that they must remain observant of any kind of asset bubble formulation in the economy. History is a signatory to the fact that investors have been the most affected and left in the lurch once these end up bursting.

An essential responsibility for future policymakers is to recognise and address vulnerability before financial disasters erupt. Governments need to keep an eye on spending. While it may be extremely difficult to identify and precisely interpret warning flags for all types of crises early enough, preemptive steps have suggested that many possibly grave crises have been circumvented in the past.

Written by: Gaurav Chakraborty (

Edited by: Divij Gera


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