The Asian Financial Crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown due to financial contagion. The Asian Crisis has caused severe economic turbulence in the economies of South East Asia since the summer of 1997. There have been two distinct phases to the Asian Crisis: the first from July 1997 to December 1997, when the first international assistance was provided, and the second since mid-1998, when the turbulence has spread beyond the region as Russia, China and Brazil have shown signs of contagion. This crisis was initially a financial one as speculation caused funds to drain out of Thai and Korean currencies and stock markets. The crisis eventually caused economic growth rates to collapse in several South East Asian countries. Indonesia was one of the countries which was most affected by the crisis. The causes and effect of the Asian Crisis on Indonesia's economy is discussed below.
The causes of Thailand Financial Crisis
Before the South Asian financial crisis happened, Thailand's economy was a role model among other developing countries. The South Asian crisis started in Thailand and it shocked most economists when it burst. Therefore in the following paragraph, we are going to discuss about the Thailand financial crisis which happened in 1997.
Since early 1990s, the Thai economy had attracted massive volumes of capital inflow from aboard due to its accommodating economic policies, healthy-looking conditions, and the recession of the European Economy as well as stagflation of the Japanese economy. Although there were some problems behind these good situations, they were very difficult to be found. As we know the Thai Exchange Rate Regime before the crisis was the exchange rate fixed to basket currency, especially US dollar. The baht had fluctuated very narrowly between 24.91-25.59 baht per dollar. The Thai government also had done a good job in keeping inflation rate low as well as fiscal balances surpluses. Plus the economy possessed a characteristic of high saving rates while its GDP growth had stayed at an impressive level during 1991-1995. As a result, the Thai economy had become very attractive to international speculators. Many channeled their large sum of capital out of Japan which had undergone a lengthy period of stagflation and low interest rate. By 1995, there was more than one hundred percent increase in its net capital inflow from three years ago. Unfortunately, the golden years did not last long. 1995 onwards, Thailand's economic growth became much slower due to a number of factors such as contraction in the real estate sector, the fall of world demand for semiconductor which was one of the Thai major exports in 1996, and an appreciation of the dollars after spring 1995. Moreover, we must introduce George Soros who is a Hungarian-American currency speculator, stock investor, businessman, philanthropist, and political activist. He plays an important role in this financial crisis. When there were problems in Thailand's economy, such as weakness in domestic macro-economic fundamental and weakness of Financial System, Soros asked a lot of speculators to buy large amount of baht, and at same time reduce US dollar's interest rate. Thailand bought large amount of US Treasury Notes which Thailand got benefit from the foreign currency market, and Thailand government invested this amount into the real estate market which means it is difficult to take back (illiquid). Soros and his group attacked Thailand's foreign market, first they sell off all the baht they had, makes excess baht in the market, therefore the value of baht will decrease. Hence, Thailand government will need US dollar to buy baht. Then, Soros and his group asked Thailand to repay the US Treasury Notes but Thailand used up all their US dollars to invest in real estate market and buy the baht, hence there were not enough foreign currency reserve especially US dollar. Therefore, the exchange rate regime in Thailand was under a huge pressure.
Actions taken
The exchange rate regime is how government and central bank in each country manage its currency in respect to the foreign currencies in the foreign exchange market. There are two ways to determine the exchange rates: Fixed or pegged exchange rates and floating exchange rates.
For a country under the policy fixed exchange rate, the government sets the level of exchange rate which is not willing to float freely. In order to maintain the rate and prevent it from fluctuating, the central bank will trade its own currency with another world major currency such as dollar, euro or yen etc. Also the central banks have to keep large amount of foreign reserves in order to use to release extra funds into the market.
Thailand adopted a floating exchange rate regime before 1963. However, this regime was ended on 20 October 1963 and was linked to U.S. dollar at a rate B20.80 per U.S. dollar. In order to retain the pegged exchange rate, the gold content of Thai Baht had reduced for several times. To avoid the continuous reduction of gold reserves, the BOT introduced a 4.5% fluctuation range in May 1972 and up-valued the official rate to B20.00 per U.S. dollar in July 1973. In March 1978, the exchange rate regime was changed from one that was pegged to the U.S. Dollar to a system of pegging to a weighted basket currency of Thailand's major trading partners. The Effective Rate was established and the Baht's link to U.S. Dollar was broken. Afterwards, the Effective Rate was placed a controlled and was allowed to float within a limited range (Controlled Floating Rate). Between the years 1984 and 1990, the basket of currencies was revised for twice and composed of 10 currencies of Thailand's major trading partners. During the period of 1984-1997, the Exchange Equalization Fund (EEF) defended the Baht value against the U.S. Dollar by using some monetary and financial measures in line with the pegged exchange rate regime.
The exchange rate regime played a significant role in 1997 Thailand's financial crisis as it started with the Thai government decision of floating the baht. As we mentioned before, in order to run a healthy fixed exchange rate regime, the country has to keep large amount of foreign reserves. Under a fixed exchange rate system, it was the responsibility of the government or the central bank to conduct policies for instance, exchange-rate changing, exchange-rate switching, and direct control, to keep its exchange rate fixed as well as to maintain a fine level of the overall condition of the economy. As Thailand almost ran out of their foreign reserves at that time, an attempt to maintain a high value of their currency may result in an overvalued of the currency. This means that the governments could no longer meet the demand to convert the local currency into the foreign currency at the pegged rate. So in Thailand, the government eventually had to allow the currency to float.
An exchange-rate changing policy was an approach to recover the economy, constituted of a fiscal and monetary policy. As more and more capital flew out of the country or as the country had faced a balance of payments deficit the central bank needed to forfeit its foreign reserves, injecting the foreign currency into the economy to satisfy the currency's excess demand and bring the economy back to its exchange rate equilibrium. So as speculators kept taking dollars out of the system (i.e. Thai economy), the Bank of Thailand had to inject dollars into the system using its stock of foreign reserves. However, not for a long time did the central bank could do that. Its stock of foreign reserves was almost used up, and it realized that it could not, in any way, be able to supply the foreign currency to the economy given the enormous size of foreign liabilities. An exchange-rate switching policy, thus, soon would need to be committed. The speculators knew about it as well and had realized a mammoth gain from a devalued baht as their foreign assets would worth much more. So there occurred the first massive speculative attack in the Thai history on May 14-15, 1997. Only in spring of 1997, more than 90% of the country's foreign reserve had been used to defend the value of the baht, and the country was forced to finally switch its exchange rate regime. On July 2, 1997, Thailand had become under a flexible exchange rate system; the Thai baht was devalued by about 15-20 percent (28.80 baht per dollar) after the announcement. The value of the baht had continuously gone down since then and reached the bottom at 48.80 baht per dollar in December of the same year, the highest rate (lowest value of the Thai baht) ever since Thailand started keeping record in 1969.
Future prospects
The main problem for Thailand in recovering from its 1997 crisis will be doubts over macro-economic management thanks to its shaky political structure. Thailand suffered from chronic instability with the departure of numerous finance ministers and governments, and elected officials becoming involved in areas previously left to technocrats. Rural politics are also dominated by politicians who are elected on the basis of delivering local services. This patron-client relationship with vote-buying and strong loyalties means that macro-economic policies are not a priority for politicians. Despite this, the European and American economies continue to perform well and providing a good market for Thai exports. The main long term danger is if the Japanese economy collapses, since Japan has considerable investments in Thailand.
All in all, Thailand is back on its long-term growth path. Annual growth rates during the last five years, i.e. 2002 to 2006, average more than 4.5 percent and are thus somewhat above acceleration of the world economy with about three to four percent during the same period (calculated in real per capita terms). So Thailand has managed to overcome the depression caused by the Asian financial crisis and has regained its earlier position as a rapidly growing economy. This ambitious development process includes a continuing reform of Thailand's financial sector. We can, indeed, show that the phase where financial reforms were dictated by the needs of crisis resolution has gone and that the country is back to a "normal" situation. Normal, however, does not mean "no change" as Thailand's economy is evolving with high speed.
