Revisiting the Asian crisis

Countries succumbed to pressure from IMF to liberalise their current account after growing rapidly

The balance of payments crisis in Asia began this month two decades ago in Thailand, and then rapidly spread to Indonesia and South Korea, by then a member of the Organisation for Economic Co-operation and Development (OECD), the advanced countries’ club, and later to Malaysia.

To recount the history of the crisis briefly, it began in July 1997 when the Bank of Thailand was forced to give up its pegged exchange rate with the dollar, after exhausting its reserves in defending the parity. (Many foreign speculators and banks had been shorting the baht for some time, including one bank simultaneously advising the Thai government on how to defend its currency, as Barry Eichengreen wrote recently in a Project Syndicate column — then, as now, western finance capital has no values other than making money, the end justifying the means.) The baht plummeted.

In the past few years, with a liberal capital account and faith in the exchange rate peg, the corporate sector had borrowed large foreign currency debt on an unhedged basis to benefit from the dollar’s lower interest rates. In most cases, Thai banks borrowed abroad in dollars and re-lent the money to their corporate clients. After the baht fell sharply, there were huge defaults on foreign currency debt; many Thai banks collapsed. While the crisis started in Thailand, it quickly spread to other fast growing Asian countries: Contagion is a standard phenomenon in financial markets. Three of the affected countries were forced to go to the International Monetary Fund (IMF) for rescue; Malaysia avoided doing so by imposing controls on outflow of capital.

The countries had been registering rapid growth for several years and South Korea’s admission to OECD membership was a recognition of its economic achievements. From the early 1990s, they came under pressure from the IMF to liberalise their capital account as part of the so-called “Washington Consensus” free market ideology, and they succumbed in varying degrees. Arguably, this was the root cause of the crisis. To that extent, it was different from the 1980s’ external debt defaults in several Latin American and African countries unable to service the external debts taken to finance deficits on current account. US banks were happy to lend them the money at attractive spreads in the belief that “companies can go bankrupt, countries cannot” (Walter Wriston, then chairman and chief executive of Citibank). 

To come back to the 1990s, the IMF ideology had completely overturned what its “founding fathers”, Harry Dexter White and John Maynard Keynes, believed: The former worried that capital flows “would become an independent and destructive force”, the latter that “control of capital movements, both inward and outward, should be a permanent feature of the system”. The Asian crisis of the 1990s illustrates their wisdom. To quote from Jagdish Bhagwati’s 2004 book In Defense of Globalization (of goods and services): “Starting in Thailand in the summer of 1997, the Asian financial crisis swept through Indonesia, Malaysia and South Korea, turning the region’s economic miracle into a debacle. Capital, which had been flowing in, flew out in huge amounts. Where these four economies and the Philippines had attracted inflows of over $65 billion in 1996, the annual outflows during 1997 and 1998 were almost $20 billion, amounting to an annual resource crunch of over $85 billion — a staggering amount indeed! This caused currencies to collapse, stock prices to crash, and economies to go into a tailspin… Per capita incomes tumbled to almost one-third their 1996 level in Indonesia, with the other crisis-stricken Asian countries showing declines ranging from a quarter to nearly half of the 1996 levels.” Millions lost their jobs thanks to corporate bankruptcies, and hundreds committed suicide. The material and human cost was enormous.

An external account crisis and going for an IMF rescue too often means financial/economic colonisation by the US-dominated institution, as it did for the Asian countries. To quote from Eswar Prasad’s book, The Dollar Trap: “One of the iconic images of the Asian crisis is that of a stern-looking Michel Camdessus, then the head of the IMF… glaring in schoolmarm fashion at President Suharto of Indonesia signing an agreement with the IMF in January 1998.” Most Asian countries learnt the lesson that you need self-insurance against the damage volatile capital flows can cause. China is a very good example, not hesitating to impose capital controls even when it has a huge current account surplus and trillions in reserves. But more on the lessons next week.

The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwade@gmail.com