The Asian financial crisis was another major currency crisis that happened during the 1990’s. The crisis assumed epic proportions. This is because it started in only one country i.e. Thailand whose currency faced an attack from speculators. However, in a very short span of time the crisis had gripped the entire South East Asian region. Countries like Vietnam, Malaysia and Indonesia all got involved in this crisis which almost appeared without any prior warnings.
This phenomenon of the crisis spreading quickly to multiple countries is called the “Asian contagion”. In this article, we will discuss these events in detail.
The dollar peg was the common feature amongst all currency crises that occurred during the 1990’s. However, unlike South American countries, the ones in Asia did not have excessively weak foundations. This meant that they were not inflating their currencies excessively while maintaining pegs thereby overvaluing it. In fact, prior to the crisis, these South Asian economies were considered to be growing extremely fast and were therefore high on the list of investment destinations which offered good returns!
However, the dollar peg caused severe damage to these economies in multiple ways. Firstly, it caused the value of these currencies to appreciate with the dollar appreciation. This caused the exports from these countries to become expensive as compared to exports from other countries like China, Hong Kong and Taiwan. Economies like Thailand and Indonesia lost a huge chunk of export business as a result of this dollar peg.
Also, a stable peg with the dollar led to excessive inflow of foreign capital in Thailand. This money was parked in the equity markets which were witnessing an unprecedented rise further giving credence to the theory that the economy of these Asian nations was undergoing a transformation. Without the peg, the rising inflows would have made the dollar more expensive and as a result would have discouraged an even greater flow of investments to the equity markets.
Lastly, the Asian economies had to hold a large amount of Forex reserves in order to maintain their currency pegs with the dollar. As and when speculative attacks increased, the Central Banks had to use these reserves to defend the value of their currency and maintain the pre-determined exchange rates.
During the 1990’s the economies in South East Asia were also facing one of the largest credit expansions of the century. Banks were rapidly making loans to private corporations despite the fact that these corporations were already extremely leveraged. The South East Asian banks had a very cozy relationship with the governments. As such, all of them assumed that in the event of a crisis, the government would have to intervene and continued to give out risky loans.
The money derived from the loans found its way to the overheated equity and real estate markets. Foreign investors had already driven the asset prices upwards. This was further aggravated by the domestic investors who invested their bank loans in such assets.
The higher asset prices created a self reinforcing loop in which the higher priced assets were used as collateral to issue more loans which in turn ended up driving asset prices even higher! To add to the woes, most of the Asian banks were largely funded with borrowed money. The equity that the banks held was extremely less and therefore when the loans went bad, banks started going bankrupt leading the crisis to spread across nations!
1990’s was the era of currency speculators. They figured out that Thailand’s central bank does not have enough reserves to defend its peg against the dollar. As a result, the Thai baht came under a speculative attack and within hours of extremely heavy selling the Thai baht had to be opened up to the markets. This is because the Thai central bank did not have enough reserves to protect the peg. In essence, the speculators had taken on the Thai central bank in the open market and won!
The loss of the Thai central bank was a turning point as speculators turned their attention on to other economies in the region. Speculative attacks were happening on several countries in the region who had pegged to the dollar. The Philippines was forced to float its currency. Similar cases happened with Malaysian ringgits and the Indonesian rupiah. The domino even spread to developed economies like South Korea, Hong Kong and Taiwan. However, they survived the crisis with a few minor bruises.
However, it needs to be noted that the Forex market was not the only market in crises in these countries. Most of these currencies lost more than one third of their value. As a result, the foreign hot money quickly pulled out of these countries. This led to a massive sell off as a result of which the local stock markets and property markets also faced historic crashes.
The 1997 Asian crisis made the world realize as to how quickly economies which were considered to be growing suddenly became bankrupt! The power of the Forex markets and that of currency speculators was once again established and currencies that were pegged to other currencies once again realized the necessity of holding huge quantities of foreign exchange reserves in order to fend off speculative attacks.