The Asian Financial Crisis and Its Aftermath: Do We Need a Regional Financial Arrangement?

Abstract

I. Introduction Following the collapse of the Thai baht's peg on 2 July 1997, the financial markets in East Asia were in turmoil until mid-1998. On 11 July, the Philippines and Indonesia widened the trading band of their currencies from 8 to 12 per cent. On 14 July, Malaysia abandoned the defence of the ringgit, and Prime Minister Mahathir Mohamad launched a bitter attack on rogue speculators.(1) Indonesia abandoned its managed floating system on 14 August. The Korean won also depreciated, following a futile currency defence that cost Korea most of its foreign reserves. This forced Korea, the world's 11th largest economy,(2) to seek financial assistance from the International Monetary Fund (IMF) on 21 November 1997. Korea widened its won trading band from 2.25 to 10 per cent on 19 November, and then allowed the won to float on 16 December. Many academic researchers and pundits have argued that these domino effects among the currencies were mainly attributable to regional structural weakness. The unpleasant term coined to describe this structural weakness is cronyism. The moral hazard problem in the corporate and financial sectors created by the incestuous relationship between the government and the private sector has been stressed in some more gentle articles.(3) Among the emerging economies, Thailand, the Philippines, Malaysia, Indonesia, and Korea have been the ones most severely affected. Prior to the crisis, the net flow of private capital to the five crisis-affected countries increased from US$24.9 billion in 1990 to US$102.3 billion in 1996. This massive capital inflow into the region became almost nil (US$0.2 billion) in 1997 and reversed to a massive capital outflow in 1998 (US$27.6 billion). Contrary to popular opinion in most creditor countries, however, the economic crisis in Asia is not an Asian crisis. The conditions that precipitate the crisis are by no means unique to the region. They have their roots in badly managed liberalization of the financial sector, excessive borrowing and lending by private agents, and the inability and unwillingness of key players -- including governments -- to accurately assess risks. The resulting collapse of domestic financial and currency markets is a phenomenon already observed in the 1990s in Europe, Latin America, and now Asia. Furthermore, continued spillover effects of the crisis hit Russia and reached Latin America and even the oil-exporting countries. More vividly, severe fallout from the and Russian crises landed on the U.S. shore and forced the U.S. Federal Reserve to bailout the Long-Term Capital Management (LTCM), a very large and highly leveraged hedge fund, to prevent further negative implosion from affecting the entire U.S. credit market. At that time, many serious economists expressed concerns about the possibility of global recession, or in the worst case, global depression. In retrospect, the financial crisis and its policy implications can be understood on the national, regional, and global dimensions. At the national level, both directly and indirectly affected countries have to strengthen their defensive countermeasures to prevent future financial crises. For this purpose, countries under the IMF programme, including Thailand, Indonesia, and Korea, have undertaken macroeconomic stabilization policies and bold structural reforms in financial and corporate sectors. As a result, usable foreign reserves have accumulated dramatically and the structure of external debts has much improved. In addition, policy-makers are very serious about structural reforms, although a sense of complacency can be observed among consumers, businesses, and trade unions. At the regional level, there were also many calls for financial co-operation just after the financial crisis broke out. However, the discussion on regional financial co-operation has largely remained within the realm of academia and has not been able to produce any tangible result. …