Financial Crises In Emerging Market Countries

The East Asian Crisis

In the summer of 1997, an economic and currency crisis rocked the Asian markets. One by one, Southeast Asian countries such as Thailand, Indonesia, Korea, and Japan saw their economies crash in the wake of heavy foreign investment. An economic boom had made the region an attractive investment opportunity for much of the 1990s. By 1997, however, domestic production and development had stalled, and foreign investors grew nervous. A divestment run on the Thai baht triggered the crash. Large corporations, extremely dependent upon the confidence of foreign investors failed to meet debt obligations and began to fail throughout Southeast Asia. As a result, currencies throughout the region faltered and nosedived from their mid-1990s positions of stability (Mishkin, & Eakins, 2006).

The causes of the Asian economic crisis are varied. For example, lax oversight of corporations had ramifications in economic downturns that were not a concern in the mid-90s boom. Macroeconomic policies of the Southeast Asian countries made their economies vulnerable to the uncertain confidence of their foreign investors. Despite this, Corsetti, Pesenti and Roubini (1998) make the point that, "market overreaction and herding caused the plunge of exchange rates, asset prices and economic activity to be more severe than warranted by the initial weak economic conditions." Therefore, much of the crisis that began in 1997 had roots that went back further to the area's economic growth that had started in the early 1990s. In addition, many economists consider the Asian economic collapse to have begun in Thailand; conditions throughout the region meant that other countries' economies were destabilized to the extent that they quickly followed Thailand.

It is also worth examining the role that IMF played in helping or hindering the recovery from the 1997-1998 Asian economic crises. When countries of Southeast Asia found themselves over-leveraged and unable to meet foreign debt obligations, they turned to the IMF for help. In return for aid, countries had to agree to certain policy conditions set out by the Fund. Thailand was the first country to solicit help, and in August 1997, the IMF approved a loan for 3.9 billion US dollars. This agreement stipulated the maintenance of a level of government reserves, the increase of the VAT, government cuts, and a restructuring of the financial sector. A second bail-out was necessitated by the sharp decline of the baht, with subsequent aid packages through 1998 that put further conditions on the Thai government. Moreover, Indonesia also approached the IMF for assistance in 1997 and credit was approved with similar conditions that the Thai government had agreed to, including closer oversight for the banking sector. Although few of the strict loan conditions were adhered to, the Indonesian government also received billions in IMF aid. Korea also relied upon IMF support during the economic crisis of the late 1990s. Several aid packages introduced growth targets, and improvement of oversight for the banking industry. The Korean government was called upon to "dismantle the non-transparent and inefficient ties among government banks and business" (Corsetti et al., 1998).

There are many reasons frequently given for the wide reach and severity of the Asian economic crisis. An investment boom in the early- to mid-1990s saw the economies of Southeast Asian countries grow rapidly. However, much of this investment was in very speculative areas. Real estate and stock market margin investments constituted a high proportion of foreign investment and destabilized the Asian economies when investor confidence changed. In addition, the currencies of many of these Asian countries had appreciated to unsustainable levels. Many of the countries in question such as Thailand, Malaysia, and Indonesia operated a fixed exchange rate system that artificially maintained their currencies' value. The result of this policy was to create large current account deficits and set up these economies for monetary speculative attack (Peter G. Peterson, 1999).

A further problem that exacerbated the Asian currency and economic crisis was the tendency for governments and their central banks to promise bail-outs for foundering companies. The effect of these guarantees on the world market was to enable even more borrowing on the part of an already highly-leveraged society. Furthermore, the borrowing rate for domestic banks abroad was artificially low as a result of this government backing. Coupled with the currency depreciation that most countries were experiencing, this level of foreign debt proved to be too much of a burden

The 'domino effect' was also seen due to the extreme interconnectedness of the Asian countries' economies. When the currency of one country depreciated, this had a negative effect on the competitiveness of the other countries. So, when the Thai baht began to sink, this had a depreciating effect on other currencies such as the ringgit and the rupiah. For this reason, the spread of the crisis throughout Southeast