– V.Srinivas IAS –
A major economic crisis struck many East Asian economies in 1997. The East Asian economies, which were witnessing rapid growth and improvement in living standards, got embroiled in a severe financial crisis. Interrupting a decade of unparalleled economic growth, prosperity and promise, the crisis revealed the precariousness of the systems of economic governance in the region. No one had foreseen that these countries which were widely envisaged as economic models for many other countries could suddenly become embroiled in one of the worst financial crisis of the postwar period. The crisis was a result of large external deficits, inflated property and stock market values, poor prudential regulation, lack of supervision and exchange rate pegs to the US dollar resulting in wide swings to the exchange rates making international competitiveness unsustainable.
The Southeast Asian currency collapse began in Thailand. Thailand’s current account deficit and the interest on foreign obligations had exceeded 4 percent of Thailand’s GDP. Creditors believed that Thailand’s large current account deficit reflected high business investment, as it was backed by high savings rates and government budget surplus. Thailand maintained a fixed exchange rate relative to the dollar. Foreign funds kept coming to Thailand given the high interest rates on Thai baht deposits and the fixed exchange rate at 25 baht per dollar. But the Baht’s fixed value to the dollar could not be sustained. In 1996 and 1997 the Japanese Yen declined by 35 percent to the dollar. Wide swings in the dollar/ yen exchange rate contributed to the build-up in the crisis through shifts in the international competitiveness which proved unsustainable. As foreign investors began selling bahts, Government intervened to support its value. However, the currency could not be sustained and eventually the Thai currency collapsed.
Contagion beset Indonesia and Korea as financial investors became worried about large current account deficits. On July 2, 1997, the Thai baht was floated and depreciated by 15-20 percent. On July 24, 2017 East Asia witnessed a “Currency Meltdown” with severe pressure on the Indonesian rupiah, the Thai baht and the Malaysian ringgit. The 1997 Indonesian economic crisis brought an end to 30 years of uninterrupted economic growth, and was amongst the worst faced by any country in the world in the 20th century. The economic crisis was exacerbated by a political transition which played out with widespread riots and resulted in the election of a new President. The Indonesian rupiah depreciated from about 2500 rupiah per US dollar in May 1997 to around 14000 rupiah per US dollar by January 1998 with imminent hyperinflation and financial meltdown. The closure of 16 banks created panic. The Indonesian authorities responded with steps to provide blanket guarantee for all depositors and creditors, creation of an Indonesian Bank Restructuring Agency and assurances to carry forward corporate restructuring.
In 1997, Korea was the 11th largest economy in the world, with inflation rate less than 5 percent, unemployment rate less than 3 percent and GDP growth was 8 percent per annum. The Korean economic crisis emerged because its business and financial institutions had incurred short term foreign debts of nearly US$ 110 billion which were 3 times of its foreign exchange reserves. Massive financial bailouts were necessitated, as countries suspended debt payments to private creditors. The Korean won came under severe pressure and Korea opted for an IMF bail-out. Korea required a US$ 57 billion IMF program, Indonesia required a US$ 40 billion IMF program.
The social costs of the IMF programs in Indonesia, Thailand and Korea were severe. Sharp price rises were witnessed in all 3 countries as a result of large exchange rate depreciations and massive job losses were seen. Food prices went up by 35 percent. Unemployment levels reached 12 percent in Indonesia, 9 percent in Korea and 8 percent in Thailand. Of the 3 crisis countries, only Korea had formal unemployment insurance, the other countries did not offer social protection arrangements.
The IMF programs in East Asian countries addressed the challenges of prolonged maintenance of pegged exchange rates, lack of enforcement of prudential rules and inadequate supervision of the financial systems, lack of transparency due lack of availability of data, and problems of governance. Capital account liberalization became one of the core purposes of the IMF. There was a significant change in the thinking about the sustainability of fixed exchange rates. It was felt that monetary policy must be firm enough to resist excessive currency depreciation. The IMF programs promoted restructuring and recapitalization of financial institutions. Governance models for public and private sector were improved with transparency and accountability being strengthened. The IMF programs focused on fiscal policies which reduced the countries’ reliance on external savings and taking into account the cost of restructuring and recapitalizing banking systems.
World Economic History
Senior Bureaucrats and Author
V.Srinivas is an IAS officer of 1989 batch, presently posted as Chairman Board of Revenue for Rajasthan
He had previously served in the Ministry of Finance and as Advisor to Executive Director (India) IMF, Washington DC. Also worked as Planning and Finance Secretary of Rajasthan.
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