Introduction

One of the key characteristics of money is stability, however a currency crisis is said to occur when the value of a country’s currency becomes unstable and changes rapidly thereby undermining its ability to effectively serve as a medium of exchange.

The Asian currency crisis was a period of financial meltdown which began in July 1997 and gripped the major proportion of East Asia. It remains one of the most talked about region-wide crisis in the 1990’s, the sharpest to hit the developing countries, which resulted in a massive downward spiral of Asian economies hitherto seen as miracle economies and prompted the largest financial bailouts in history.(Radelet and Sachs 1998)

This paper will examine the origin of the crisis, its impact on the economies of the countries involved and the measures that have been adopted to avoid a recurrence of a similar crisis.

ORIGIN OF THE CRISIS

Upon mutual agreement, based on the plaza accord (1985) between the US, Germany and Japan, the US dollar was devalued by about 60% to the Yen in real terms in order to alleviate the increasing US current account deficit. Japanese firms facing export competitiveness due to the appreciation of the Yen began to move production to south East Asian countries whose currencies were pegged to the dollar. This provided an ideal location for the Japanese firms in terms of international price competiveness. This inflow of investment from Japan to the South East Asian countries accelerated a pattern that led to large inflow of capital from other Asian and foreign countries into the East Asian countries. The fixed exchange rate system gave the south East Asian economies strong exports, low import prices and expected financial stability.

For years, East Asian Countries were held up as economic icons. Their typical blend of high savings and investment rates, autocratic political systems, export-oriented businesses, restricted domestic markets, government capital allocation, and controlled financial systems were hailed as the ideal recipe for strong economic growth of developing countries (Shapiro 1999). Asian economies like Taiwan, Hong Kong, Korea, Singapore and Thailand enjoyed overall average growth rates of 5.6 percent, 6.6 percent, 7 percent, 6.9 percent and 4.6 percent respectively for several decades. Indonesia and Malaysia too enjoyed good economic performance during most of the 1970s and 1980s. (Rao, 1998)

However, these “miracle economies” were brought down in July 1997 when a brewing currency crisis started from Thailand. This seed of the Asian currency crisis of 1997 were actually sown during the previous decades when these countries were experiencing unprecedented economic growth. For long, exports had long been the engine of economic growth in these countries and as such many Asian states were regarded as “Export Power Houses”. The increased foreign capital inflow into these economies also propelled capital expenditure which led to an investment boom in commercial and residential properties, industrial assets and infrastructure. These capital expenditures were financed by heavy borrowings from banks which had excess liquidity but no strong regulatory frameworks. Thus, by the mid 1990s, South East Asia was experiencing an unprecedented investment boom, much of it financed with foreign investments and borrowings. The case was made worse as much of the foreign borrowings had been in US dollars as opposed to local currencies. At the time, this had seemed like a smart move (i.e. regional local currencies were pegged to the dollar and interest rates on dollar borrowings were generally lower than rates on borrowings in domestic currency, and it made economic sense to borrow in dollars if the option was available); but, many of the investments made with these funds were on the basis of projections about future demand conditions that were unrealistic.