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Severe Impact of 1997 Asian Crisis on Indonesia, Thailand, and South KoreaResearch Paper

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Indonesia and the 1997 Asian Crisis:

A Comparison with South Korea and Thailand

Why and how was Indonesia greatly impacted by the 1997 Asian Crisis in comparison to South Korea and Thailand?

The global economic slowdown of 1998 originated in South East Asia; the Asian crisis, as it was known, began in the summer of 1997 and resulted in severe economic instability in the South East Asian economies. It occurred in two phases: the first phase began in July 1997 and lasted through to December, 1997; international assistance was given to the affected economies. The second phase began mid-1998; this time the economic turmoil spread further beyond the region to countries like Russia, Brazil, and China -- each showing signs of economic stagnation. The crisis was caused by financial speculation that resulted in the withdrawal of funds from the Korean and Thai stock markets and major shocks to their respective currencies. The Asian crisis eventually resulted in the stagnation of several South East Asian economies (Sutthirak and Gonjanar).

The first phase of the Asian crisis was caused by the decision of the Thai government to devaluate the country's currency, Thai Baht, on the 2nd of July 1997, a date many agree to be the starting point of the Asian crisis. It was also on the same date that the composite stock indices of the 5 countries (Thailand, Korea, Indonesia, the Philippines, and Malaysia) that were affected by the crisis began moving downwards in unison. The crisis ended in August 1998. It was also from this month that the affected stock indices began continuous upward trends (Mitton, as cited in Sutthirak and Gonjanar). During the onset of the Asian crisis, most of South East Asia was covered by clouds of smoke caused by forest fires in Indonesia. The environmental disaster was quite symbolic because not only did the smoke cloud the air, it also seemingly impeded the scrutiny of the causes of the Asian crisis. This failure by financial experts led to the sharp drop in output among the affected economies (Yap).

Other financial pundits assert that the crisis actually began on May 14, 1997, due to financial speculation on the Thai Baht and the collapse of the largest financial company in Thailand on 23rd of the same month. These two events caused the crash of the baht and the severing of its link to the American dollar. Other south East Asian currencies that were affected include the Indonesian rupiah, Singaporean dollar and Malaysian ringgit. Before February 1998 all these economies had devalued their currencies by not less than 30% (Hu as cited in Nematnejad).

Many financial experts agree that the 1980s, 1990s and the early 21st century could be referred to as the age of global capitalism. In fact nowadays it is rare to open a newspaper and not find a story on global capitalism (Park).

The extent of the Asian crisis surprised almost every pundit. The Thai, Korean, Indonesian and Malaysian economies had for quite a while been the economic success stories of the region. For instance the Indonesian economy grew by an average of 6.9% annually from 1970, while the Korean one grew by 8.4%. The transformation of these countries from poor and largely rural economies to vibrant middle income economies is one of the most extraordinary economic success stories in world history (Berg).

This paper delves into the causes of the Asian financial crisis and its impact on Indonesian, Thai and Korean economies. Particular attention is paid to Indonesia and why it was the most affected by the crisis. A comparison is done on the current financial situation in the three economies. A conclusion is also provided at the end of the paper.

2. What started the crisis?

The Asian financial crisis started when the Thai government decided to devalue the country's currency, the Thai Baht. This date also corresponds to the beginning of the downward trend of stock indices of the 5 countries that were affected by the crisis. The crisis ended in August 1998, the month when these stock indices began a sustained/continuous upward trend (Mitton, as cited in Berg). The global economic slowdown of 1998 is said to have originated in South East Asia due to this crisis.

The economies that were primarily affected by the Asian financial crisis include Indonesia, Thailand, South Korea, Philippines and Malaysia, although Singapore has also been mentioned. These countries experienced lower market values and reduced productivity (Friday et al., 2006). Thailand for instance, suffered decreased productivity, high rates of unemployment and many businesses went bankrupt, resulting in the worst recession in the Thai post war history.

The Thai and Indonesian financial systems collapsed and the rest of East Asia was also severely affected especially by the sudden reversal of capital flows that some analysts believe is the real cause of the crisis. The net private capital inflow into the Thai, Indonesian, Korean, Malaysian and Philippines economies increased to 97.1 billion dollars in 1996 from 37.9 billion dollars in 1994 (Radelet and Sachs, as cited in Yap). However in the last quarter of 1997 there was a sudden reversal of capital flow resulting in an 11.9 billion dollar net outflow. According to Radelet and Sachs the turnaround figure of 109 billion dollars in barely 6 months corresponds to 10% of the pre-crisis gross domestic product of the 5 countries (Yap).

The crises in these economies were perhaps further made worse fundamental financial deficiencies. In Thailand, for instance, macroeconomic problems such as large unsustainable current account deficits and an overvalued currency played a huge role in the country's crisis. The macroeconomic weaknesses in the affected countries were caused by the interaction of large capital inflows with weak financial structures (Berg). The theories on what may have caused the Asian crisis include:

Macroeconomic policy-induced crisis

When a central bank carries out a local credit expansion that is inconsistent with the set exchange rate, a balance of payments (BOP) crisis occurs. In a BOP crisis there is: collapse of the set exchange rate, currency depreciation and loss of foreign currency reserves. Generally the central banks carry out credit expansions to get funds for budget deficits. Foreign exchange reserves reduce gradually to such a level that a central bank is exposed to sudden runs, depleting the remaining reserves, and thrusting the economy to a floating rate (Yap).

Financial panic

Financial panic is a severe equilibrium result whereby there is a sudden withdrawal of loans from a borrower who is solvent by a short-term creditor. Generally, a financial panic is deemed to have occurred if these conditions hold: that the short-term assets are exceeded by the short-term debts; that no single private creditor has enough funds to settle the current short-term debts; and the central bank cannot act as the lender of last resort. In this particular situation it then becomes logical for each creditor to withdraw its loans if the other creditors are also doing the same, although each creditor would also be ready to lend if the others were willing to do the same (Yap).

Bubble collapse

A financial bubble is a situation wherein speculators buy a financial asset at an overpriced fundamental value anticipating a subsequent capital gain. A financial bubble is measured in terms of the deviation of the asset price away from its fundamental value. The further it deviates the more it is said to have grown, on the other hand it can also collapse with positive probability. The collapse is usually sudden but not totally unanticipated, given that most market players are often aware of the financial bubble and the probability spread/distribution of its collapse (Yap).

A study done by Krugman (1997) asserted that the Asian financial crises were mainly caused by the burst of a financial bubble in terms of the low and dwindling returns on investments. International "market failures" in terms of capital flow resulted in large capital inflows to South East Asia and the so-called crony capitalism in South East Asia resulted in increased local speculative investments in real estate, substandard infrastructure and flawed financial activities. Thus the burst of this Asian financial bubble appeared in the context of low and further declining capital returns on investments (Bustelo).

Moral-Hazard crisis

This occurs when banks are allowed to borrow funds against public guarantees of the bank liabilities. If these banks are not sufficiently regulated or if they are under-capitalized they may utilize these funds for excessively risky or even illegal activities (Yap).

Disorderly workout

A disorderly workout is a situation whereby an insolvent borrower prompts a grab race among creditors causing a forced liquidation even if the borrower is worth much more as a continuing business. It mostly occurs when financial markets are operating without the advantage of creditor coordination, usually guided by bankruptcy law. In this case the lack of coordination among the creditors blocks the effective provision of working capital to the financially troubled borrower and by extension the eventual settling of bad debts (Yap).

2. Impact on Indonesia, Korea, Thailand

2.1 Indonesia


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