In the early 1990s, the "Asian Tigers" were the envy of the developing world, with growth rates often near 10% a year. Then, in the summer of 1997, a currency crisis in Thailand spread across the region, toppling governments, bankrupting companies and pushing millions into poverty. In Part 12 of Great Financial Crises, we look at the Asian financial crisis.
The miracle years
Countries such as Thailand, Indonesia, Malaysia, South Korea and the Philippines had grown rapidly for years, helped by exports, high savings and foreign investment. According to the Federal Reserve's history essay, these economies had GDP growth above 5% a year before the crisis, often close to 10%.
Cracks beneath the surface
The Fed's essay identifies several weaknesses that built up:
- Rapid credit growth with weak bank supervision, leading to risky and doubtful loans.
- Property and stock booms fuelled by that credit.
- Large current account deficits, financed by foreign money.
- Heavy short-term foreign borrowing, often in US dollars, by banks and companies.
- Currency pegs to the US dollar that made foreign borrowing look safe, hiding the exchange-rate risk.
When the US dollar strengthened in the mid-1990s, pegged Asian currencies rose with it, hurting exports. Investors began to doubt the pegs could last.
2 July 1997: Thailand devalues
Thailand's central bank spent most of its reserves defending the baht against speculative attacks. On 2 July 1997, it gave up and let the currency float. The baht fell sharply. Thai companies and banks with dollar debts suddenly owed far more in local currency, and many became insolvent.
Contagion
Investors quickly pulled money from countries that looked similar:
- The Philippines, Malaysia and Indonesia let their currencies weaken substantially. Indonesia's rupiah collapsed, and the economic crisis turned into a political one, contributing to the fall of President Suharto in May 1998 after more than 30 years in power.
- South Korea, a major industrial economy, was pushed to the brink of default as foreign banks refused to roll over short-term loans. Several large conglomerates, known as chaebol, collapsed.
- Hong Kong faced several large speculative attacks on its currency peg, which it successfully defended.
In 1998, the crisis spread further, contributing to turmoil in Russia (Part 13) and Brazil.
The rescue and the controversy
According to the Fed's essay, the international community mobilised about $118 billion in loans for Thailand, Indonesia and South Korea, from the IMF, World Bank, Asian Development Bank and governments. In return, countries agreed to reforms: closing or recapitalising weak banks, reducing leverage and opening their economies.
The IMF's approach became highly controversial. Critics argued that demanding higher interest rates and tighter budgets in the early stages deepened recessions, and that some structural conditions went beyond what was needed to restore confidence. Supporters said high rates were necessary to stop currencies collapsing further. The Fed's essay notes that countries initially tightened policy, then loosened it as markets stabilised.
Malaysia took a different path, imposing capital controls in 1998 to limit money leaving the country, a move criticised at the time but later seen by some economists as partly effective.
A bank-to-bank rescue for Korea
A key moment came on 24 December 1997, when the Federal Reserve Bank of New York hosted a meeting at which major US banks agreed to voluntarily roll over short-term loans to South Korean banks. These were later restructured into medium-term loans, completed in April 1998, easing the immediate pressure.
The aftermath
Several of the hardest-hit economies suffered deep recessions in 1998, with sharp increases in unemployment and poverty. But most recovered within a few years, helped by cheaper currencies that boosted exports.
The crisis changed policy across Asia. Many countries:
- Moved to more flexible exchange rates.
- Built up very large foreign exchange reserves as insurance.
- Strengthened bank regulation and reduced reliance on short-term foreign debt.
- Created regional safety nets, such as the Chiang Mai Initiative for currency swaps.
Lessons for investors today
- Fast growth can hide fragility. Strong headline growth does not guarantee financial stability.
- Currency mismatches are dangerous. Borrowing in dollars while earning in local currency can be fatal when currencies fall.
- Short-term funding can vanish overnight. Rolling over loans depends on lender confidence.
- Contagion follows perceived similarity, not just actual fundamentals.
In Part 13, we look at how Russia's 1998 default nearly brought down a famous hedge fund, Long-Term Capital Management.
Sources
Great Financial Crises: the full series
- Part 1: Tulip Mania (1637)
- Part 2: The Mississippi and South Sea Bubbles (1720)
- Part 3: The Panic of 1907
- Part 4: The Wall Street Crash and Great Depression
- Part 5: Weimar Hyperinflation (1923)
- Part 6: The 1970s Oil Shocks and Stagflation
- Part 7: The Latin American Debt Crisis (1982)
- Part 8: Black Monday (1987)
- Part 9: Japan's Bubble and Lost Decades
- Part 10: The Savings and Loan Crisis
- Part 11: The Mexican Peso Crisis (1994)
- Part 12: The Asian Financial Crisis (1997) (you are here)
- Part 13: Russia's Default and LTCM (1998)
- Part 14: The Dot-Com Bubble (2000)
- Part 15: Argentina's Collapse (2001)
- Part 16: The Global Financial Crisis (2008)
- Part 17: Iceland's Banking Collapse (2008)
- Part 18: The Eurozone Debt Crisis
- Part 19: The Covid Crash (2020)
- Part 20: The 2023 Banking Turmoil
This series is for education only and is not investment advice. Figures are taken from the sources listed and other commonly cited historical records, and may vary slightly between sources.
