RDP 9805: The Origin of the Asian Financial Turmoil 1. Introduction

As recently as November 1997, the events in Asian financial markets were described as ‘a few little glitches in the road’.[1] Now they are recognised as the third major financial crisis of the 1990s.[2] The main features of the turmoil have some similarities to earlier episodes:

  • private capital markets withdrew their support from a group of countries that in the previous several years had been recipients of large capital inflows;
  • the defensive package of foreign exchange market intervention, sharp rises in interest rates and selective controls proved inadequate to avert the (downward) floating of some formerly fixed exchange rates;
  • large unhedged foreign exchange positions and weak banking and financial systems contributed to vulnerability and sharply constrained the authorities' room for manoeuvre;
  • the trauma quickly spread out from its original locus to affect exchange rates and other asset prices in the region (and for a short while, in major industrial countries as well);
  • large, multilateral official rescue packages had to be mobilised; and
  • the events have generated calls (both within the region and beyond) for stronger preventative arrangements to reduce the likelihood and severity of future outbreaks.

While some of these factors are common to earlier crises, one of the unusual features of the Asian turmoil is that it was centred in emerging economies which had a record of strong economic growth, generally moderate inflation, and disciplined fiscal policy for at least a decade. As is shown, however, mounting weaknesses in other areas eventually took their toll. The most significant of these weaknesses were in the financial sector, where strong capital inflows, extended periods of rapid economic growth, rising property prices and perceptions of implicit government guarantees led in some economies to a degree of complacency by banks in their credit standards, which supervisory systems proved inadequate in disciplining. This was compounded by some loss of confidence by markets in the longer term export potential of some Asian economies. Once these factors started currency depreciations within the region, contagion effects exacerbated and spread them.

This paper presents an interpretation of the origins of the Asian financial turmoil. Section 2 of the paper provides a capsule summary of developments in exchange rates, exchange market intervention and reserves, interest rates and credit controls, equity prices, real economic activity and trade flows, and international rescue packages. Section 3 then turns to an analysis of the factors generating the crisis, including the likely transmission channels for contagion. Section 4 provides some conclusions.


President Clinton at the meeting of APEC heads of government in Vancouver. [1]

The others being the crisis in the European Monetary System in 1992–93 and the Mexican ‘tequila crisis’ of 1994–95. [2]