Asian Financial Crisis

A Bangkok, Thailand, shop offers 50% off in a desperate attempt to lure customers who have lost their spending power after the economic crash of 1997. (Photo: Peter Charlesworth/Light Rocket/Getty Images)

The unfolding crisis in Thailand illustrated how problems in the banking sector could lead to a pullback by foreign investors, setting off a spiral of depreciation, recession, and amplified banking sector weakness.  The result was contagion, with foreign creditors pulling back from other countries in the region seen as having similar vulnerabilities. Japan’s deteriorating economic and financial situation also played a role, with Japanese banks—formerly an important source of credit—pulling back from lending activity in the region. In the face of these pressures, foreign exchange intervention often proved counterproductive, with some countries depleting the bulk of their official reserves and suffering even larger subsequent depreciations.

In response to the spreading crisis, the international community mobilized large loans totaling $118 billion for Thailand, Indonesia, and South Korea, and took other actions to stabilize the most affected countries. Financial support came from the International Monetary Fund, the World Bank, the Asian Development Bank, and governments in the Asia-Pacific region, Europe, and the United States. The basic strategy was to help the crisis countries rebuild official reserve cushions, and buy time for policy adjustments to restore confidence and stabilize economies, while also minimizing lasting disruption to countries’ relations with their external creditors.

To address the structural weaknesses exposed by the crisis, aid was contingent on substantial domestic policy reforms. The mix of policies varied by country, but generally included measures to deleverage, clean up and strengthen weak financial systems, and to improve the competitiveness and flexibility of their economies. On the macro side, countries hiked interest rates to help stabilize currencies and tightened fiscal policy to speed external adjustment and cover the cost of bank clean-ups. However, over time, as markets began to stabilize, the macro policy mix evolved to include some loosening of fiscal and interest rate policy to support growth. 

The Federal Reserve played an active role in informing and supporting the U.S. and global policy responses. Behind the scenes, the Federal Reserve provided timely analysis of the underlying adjustment challenges and closely monitored the risks the crisis posed to U.S. banks, and the condition and funding profiles of Asian bank offices in the United States, coordinating policy with other bank supervisors in the United States and internationally. The Fed also acted as an agent for the U.S. Treasury, including by helping arrange a bridge loan for Thailand in the early stages of the crisis.

Perhaps most visibly, the Federal Reserve played a catalytic role in an official sector effort to encourage banks to act in their collective self interest in helping South Korea avoid a disorderly default.  Following a meeting on December 24, 1997, hosted by the Federal Reserve Bank of New York, U.S. banks with the largest exposures to South Korean banks voluntarily committed to roll over their short-term loans, and to work with South Korean authorities to restructure them into medium-term loans. Similar meetings and other forms of outreach took place in other G-10 countries. In the ensuing months, the Federal Reserve and other central banks oversaw banks’ cooperation with their rollover commitments, pending completion of the restructuring in April 1998.

The combination of strong policy measures by the affected countries and external support from the international community ultimately contained the crisis and set the stage for a subsequent strong recovery.

For the United States, the adverse direct trade impact resulting from the Asian crisis proved manageable, and was partly offset by some other more positive spillovers, including reduced inflation pressures (from cheaper Asian imports and weaker global commodity prices) and lower bond yields (from a flight to dollar assets). The adverse fallout for some other countries was more substantial. In particular, a number of emerging market economies in Latin America and Eastern Europe, including Brazil and Russia, faced significant balance-of-payments pressures in 1998, reflecting spillovers from the Asia crisis as well as home grown vulnerabilities, some of which were quite different from those at the heart of Asia’s crisis.