8 – 1997: Asia financial crisis

Problem: The collapse of the Thai baht in 1997 sparked a crisis that spread across East Asia. The International Monetary Fund stepped in to help, but its draconian terms brought widespread criticism.

Outcome: A still-unresolved debate abouthow currency crises should be managed.

It was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown (financial contagion). It is also commonly referred to as the IMF crisis.

The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.[1]

Interestingly, Although the two events were unrelated, the collapse of the Thai baht on July 2, 1997, came only 24 hours after the United Kingdom handed over sovereignty of Hong Kong to the People's Republic of China. In October 1997, the Hong Kong dollar, which had been pegged at 7.8 to the U.S. dollar since 1983, came under speculative pressure because Hong Kong's inflation rate had been significantly higher than the U.S.'s for years. Monetary authorities spent more than US$1 billion to defend the local currency.

Stock markets became more and more volatile; between 20 October and 23 October the Hang Seng Index dropped 23%. The Hong Kong Monetary Authority then promised to protect the currency. On 15 August 1998, it raised overnight interest rates from 8% to 23%, and at one point to 500%. The HKMA had recognized that speculators were taking advantage of the city's unique currency-board system, in which overnight rates automatically increase in proportion to large net sales of the local currency. The rate hike, however, increased downward pressure on the stock market, allowing speculators to profit by short selling shares. The HKMA started buying component shares of the Hang Seng Index in mid-August.

The HKMA and Donald Tsang, then the Financial Secretary, declared war on speculators. The Government ended up buying approximately HK$120 billion (US$15 billion) worth of shares in various companies,[20] and became the largest shareholder of some of those companies (e.g. the government owned 10% of HSBC) at the end of August, when hostilities ended with the closing of the August Hang Seng Index futures contract. The Government started selling those shares in 2001, making a profit of about HK$30 billion (US$4 billion).

The IMF created a series of bailouts ("rescue") packages for the most affected economies to enable affected nations to avoid default, tying the packages to reforms that were intended to make the restored Asian currency, banking, and financial systems as much like those of the United States and Europe as possible.

IMF intervention has been roundly criticized. The role of the International Monetary Fund was so controversial during the crisis that many locals called the financial crisis the "IMF crisis".[15] To begin with, many commentators in retrospect criticized the IMF for encouraging the developing economies of Asia down the path of "fast track capitalism", meaning liberalization of the financial sector (elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure foreign investors against currency risk.[14]

IMF's Role in the Asian Financial Crisisby Walden Bello

The swift evaporation of the Asian economic "miracle" probably ranks second only to the unraveling of Soviet socialism as the greatest surprise of the last half-century. All at once, convention has been turned on its head as South Korea, Thailand and Indonesia line up for multibillion-dollar bailouts from the International Monetary Fund (IMF). Many of the same institutions and people who recently celebrated the Asian "tigers" as the engine of world growth into the 21st century now speak of them as a source of financial contagion, or, as the trigger for global deflation.
With strong encouragement of the IMF and World Bank, many Asian countries followed a three-pronged strategy for attracting foreign capital: liberalization of the financial sector (i.e. elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure foreign investors against currency risk.

In retrospect, these countries exemplified the perils of "fast-track capitalism." Foreign capital entered in the form of short-term loans to banks and enterprises, but this speculative investment capital never found its way into the real economy of domestic manufacturing or agriculture—low-yield sectors that would provide a decent rate of return only after a long gestation period. Instead, the capital was invested into high-yield sectors with a quick turnaround time, such as the stock market, consumer financing and, in particular, real estate.