Lessons from the Asian Financial Crisis of 1997

TWENTY years ago, Asia went through a very humbling financial crisis where jobs were lost, life savings were depleted and families broken up as people moved to other countries in search of employment. In Indonesia, approximately 11 per cent of the population lived below the poverty line just before the crisis but this rose to 40 per cent during the crisis. No society can withstand that sort of economic meltdown without civil unrest. The subsequent overnight transition to democracy without the right institutions and political culture resulted in serious ethnic tensions in Jakarta and its then colony, East Timor.

The crisis that started in Thailand did not just wreak havoc in Asia but spilled over to Latin America and Eastern Europe. Large-scale speculative attacks on the Hong Kong stock market led to massive sell-offs on the global equity markets with the Dow Jones Industrial Average suffering one of the biggest single-day declines in its history. Even countries with relatively healthy and strong fundamentals were not spared. Singapore and Hong Kong, two economies with current account surpluses, low debt levels and healthy growth rates, both experienced sharp recessions and asset price corrections in the ensuing years.

The Asian Financial Crisis was a classic case of financial contagion as financial markets are major avenues for contagion. Panic sales of assets in an afflicted country (in this case Thailand) led investors to take money out of erstwhile healthy financial markets to cover their losses. And a financial panic in one country may change some investors' beliefs about the financial health of a country with apparently similar characteristics, causing other investors to withdraw capital for fear of a run on the central bank.