Lessons learnt from the Asian Financial Crisis
The 1997 Asian Financial Crisis or “TomYam Kung Crisis” occurred on 2 July 1997, which was the day that Thailand announced the float of the Baht and had to request financial assistance from the International Monetary Fund. The financial crisis significantly impacted and damaged the Thai economy and spread throughout the ASEAN region and other countries in Asia until it escalated into a financial crisis.
The Asian Financial Crisis began when the Baht was faced with significant speculative pressure resulting from imbalances within the Thai economy at the time. Prior to the crisis, there was significant inflow of private capital into Thailand, stemming from loans for investments, particularly investments in the real estate sector. This created an asset price bubble, which led to increased capital and debt. At that time, Thailand carried out monetary policy under a Fixed Exchange Rate Regime. Although such policy created stability for financial markets; however, it also led lenders and borrowers grossly under estimated the risks associated with capital inflow. This led to an imbalance between the banking sector’s financial instruments and debt and an imbalance between the amount of foreign currency in the private sector’s balance sheets. Such excessive borrowing turned into a vital weakness in the economic system. Importantly the imbalance in the banking sector’s financial instruments was “short term loans and long term investments”. In other words, short term borrowing of foreign funds but providing long term loans to domestic infrastructure projects. Such imbalance exacerbated the risk to the economy to capital outflows.
On the other hand, persistent high economic growth (i.e. the Golden Era) of the Thai economy contributed to the banking sector’s inability to adequately assessed risk and credit regulations lacked robust considerations of various risks. This included rules and regulations for Financial Institutions that were not restrictive enough. For example, easily providing approval license to establish financial institutions, which resulted in abundant bankruptcies or forced shut downs of such financial institutions once faced with liquidity issues from foreign outflows. This led to a financial crisis that impacted the economy and general public on a wide scale.
The TomYam Kung crisis was the worst crisis in Thailand’s modern economic history. Despite occurring 25 years ago, the Thai economy still has remaining “scars” from TomYam Kung. Therefore, deciphering and passing on the lessons learnt from the crisis will not only help the “new generation” learn to avoid and prevent a similar crisis to occur to the Thai economy, but will also alleviate current economic problems as well.
The cause of the economic crisis that led to the denouncement of the Fixed Exchange Rate and led to a float in the Baht in 1997 are as follows:
1. Persistent Current Account Deficit
1987-1996 was a period where the Thai economy expanded continuously and the Current Account deficit consistently increased and stood at 14,000 million USD prior to the crisis. This was a result of significant decrease in exports in 1996 (where exports only grew by 1.9%, compared to 24.82% the year prior, and was the first significant deterioration in exports since Thailand changed its economic development strategy in 1977 that emphasized production for exports).
2. Foreign debt
Between 1989-1994 Thailand went through financial liberalization which allowed the country access to foreign capital with ease, without any exchange rate risks since the Baht was pegged at 25 Baht/USD. Borrower could take out and return loans as a result of Thailand’s acceptance of Article 8 of the International Monetary Fund in 1990 to open Thailand’s financial system to the international community. Furthermore, in 1991 Thailand announced the relaxation of foreign exchange. Finally, in 1992 the government permitted commercial banks to establish the Bangkok International Banking Facilities (BIBF). After which, in 1993, 46 commercial banks were granted operating licenses, resulting in an expansion of the country’s financial system leading to an increase in Non-Performing Loans (NPLs) within financial institutions and an increase in loans from foreign financial institutions for domestic purposes.
Towards the end of 1997, Thailand’s international debt increased to 109,276 million USD, particularly short term international debt which comprised 65% of total international debt and the ratio of international reserves to short term debt stood at only 70.4%. Furthermore, the majority of financial institutions had not managed their exchange rate risks.
3. Excessive investments and Real Estate Bubble
Between 1987-1996, real estate business expanded significantly both in terms of land, residential, offices, and expensive condominium, because producers borrowed funds from abroad and raised capital in Thailand’s booming stock market to invest in real estate across the country with ease. Furthermore, continued increased in real estate prices led to speculation and incentivized significant investors into the sector, such as sales of housing reservations, land, condominium until an economic bubble was embedded into the economy.
4. Lack of efficiency in Financial Institutions’ operations
At the end of 1996, Thailand severely lacked confidence in domestic financial institutions, such that the government had to close down 18 finance companies and 3 commercial banks. Afterwards, in March 1997, the Ministry of Finance ordered 10 finance companies to raise capital and on 27 June 1997 closed down 16 finance companies and 42 more finance companies on 5 August, for a total of 58 finance companies. The government utilized the Financial Institution Development Fund (FIDF), under the purview of the Bank of Thailand (BOT) to provide support and financial assistance to commercial banks and finance companies once customers were unable to pay off their loans. This is particularly true for the real estate sector which faced excess investment relative to market demand and created liquidity problems for commercial banks, with NPLs as high as 52.3% of total real estate credit on May 1999
Excessive NPLs reflected the fact that prior to the crisis, financial institutions’ credit approval process was too loose and didn’t accurately consider project feasibilities or the ability to repay debt. Moreover, credit was also given out to friends or individuals with ties to politicians on a wide scale.
5. Policy Inefficiencies
In 1993, Thailand resolved to establish the BIBF and permitted the free flow of capital; however, preparations and regulations were inefficient. This is particularly true as the country was still under a Fixed Exchange Rate System regime, leading to financial system and economic instability. In other words, in order to maintain the exchange rate, the BOT kept absorbing excess liquidity in the market resulting from capital inflow by issuing bonds; however, this only increased interest rates, which were already high, and attracted further capital inflow leading to a vicious cycle.
Furthermore, financial institutions’ standards in regulation were not efficient enough, thereby making them unable to audit the laxed nature of loans in an accurate and timely manner. Regulations were not strict enough to foster a strong foundation for financial institutions.
6. Currency Attack on the Thai Baht
Prolonged economic problems created an opportunity for foreign investors to speculate and attach the Thai Baht. These were large institutional investors who raised capital to speculate against or attack a currency that founded Quantum Fund (a world renowned fund managed by George Soros). Other investors, including domestic and international commercial banks also speculated against the Baht as well.
In their attack on the Thai Baht, investors would focus on destroying the currency’s credibility, by focusing on fragile economic fundamentals (excessive Current Account deficit and high levels of short term debt relative to international reserves) to create rumors of a currency devaluation. Once the market believes these rumors, this led to significant sale of the Thai Baht in exchange for the USD. The BOT therefore, had to utilize $24,000 million worth of its international reserves (2/3s of the total international reserves) to intervene in the market and defend the value of the Baht. Eventually, only $2,850 million worth of international reserves were left, which was extremely low compared to $38,700 million in 1996.
Finally, on 2 July 1997, the BOT announced the float of the Thai Baht, marking the first day of the worst crisis in Thailand’s modern economy.
There were 2 main periods in resolving the crisis as follows:
1. During the crisis (2 July – November 1997)
1st Measure: Floating of the currency. On 2 July 1997, the BOT announced the cancellation of the Fixed Exchange Rate System with major trading partners and utilized a Floating Exchange Rate System.
2nd Measure: Loan negotiations with the IMF, whereby Thailand signed and accepted the loan conditions on 14 August 1997.
3rd Measure: Economic Recovery (the 13 October 1997 Measure) such as closing down 58 financial institutions, establishing the Financial Sector Restructuring Authority (FSRA), and Financial Institution Asset Management Corporation (FIAMC) to purchase NPLs from these 58 institutions.
4th Measure: State Owned Enterprise Reform
2. Post Crisis Measures (November 1997 – December 2000)
1st Measure: Increased interest rates to control inflation from escalating too high and prevent capital outflow as well as attract capital inflows to promote stability for the currency (if the Baht appreciates, then the amount of international debt decreases).
2nd Measure: Financial Institution restoration, whereby FSRA announced the restoration plan for the 58 financial institutions that were closed down. Only 2 institutions, Kiatnakin finance company and Bangkok Investment finance company (Public), were allowed to reopen for business. The other 56 finance companies were to enter into the process of selling their NPLs. Furthermore, in August 1998 (14th August 1998 Measure) the FSRA issued financial institutions restoration plan to raise capital in accordance with the Bank for International Settlement (BIS)’s standards. Capital was raised from public savings, selling shares to foreigners along with bond sales to the general public to raise funding capital for state owned commercial banks.
3rd Measure: Economic stimulus via fiscal policy (10th March 1999 Measure) whereby the government took out a 53,000 million Baht loan from Japan in accordance with the Miyazawa plan, economic injection, decreased Value Added Tax (VAT) from 10% to 7%, and decreased 23,800 million Baht worth of petroleum tax. Moreover, the government decreased import tax for production materials that were used as inputs for exports (10 August 1999 Measure). The government in cooperation with the International Finance Corporation, established a fund to restructure private sector debt to lower NPLs, increase capital for Small and Medium Enterprises (SMEs), and permitted the Government Housing Bank to issue housing loans worth 5,000 million Baht.
4th Measure: Other supportive measures to facilitate smooth operations of other policies, such as negotiations with the IMF and issuances of relevant laws.
After the TomYam Kung crisis, various studies, lessons, and structural reforms were made to protect and prevent such a crisis in the future. An important reform that helped foster resiliency and readiness to handle any impact in the country’s financial system was the establishment of the crisis prevention facility, both domestically and regionally as follows:
1. Chiang Mai Initiative : CMI
In 1999, ASEAN+ 3 governments (the 10 ASEAN member countries and China, Japan, and South Korea) agreed to create a self-help and support mechanism. Afterwards, the ASEAN + 3 Finance Ministers met in Chiang Mai and agreed to establish a project to provide regional financial assistance or the “Chiang Mai Initiative” (CMI), which was an agreement to set up a fund to lend international reserves within ASEAN economies to protect against possible currency attacks.
The creation of CMI was the result of lessons learnt during the economic crisis within the ASEAN region in 1997, particularly in East and South East Asia. Various countries had to request assistance from the IMF without any other alternatives. Therefore, members had developed strong and tangible economic and financial cooperation. Under the cooperation framework, ASEAN+ 3 Finance Ministers agreed to set up a fund worth 240,000 million USD. Originally, the cooperation framework was for bilateral swaps between member countries; however, it had evolved into a multilateral framework under the name “Chiang Mai Initiative Multilateralisation” (CMIM), with the aim of being a mechanism for regional financial cooperation. The framework elevated the provision of liquidity in case member countries are faced with Balance of Payment or short term liquidity problems, and acted as additional financial support to those received from the IMF.
2. ASEAN+3 Macroeconomic Research Office (AMRO)
On 19 February 2016, ASEAN+ 3 economies had officially established the ASEAN+3 Macroeconomic Research Office (AMRO) as an international organization in Singapore. AMRO is responsible for monitoring economic conditions, forecast the probability of economic and financial risks, provide policy recommendations to member countries, as well as supporting the CMIM operations, which was established as a mechanism to prevent a crisis when member countries are faced with Balance of Payment or short term liquidity problems.
By establishing itself as an international organization, AMRO is more efficient and flexible to analyze and provide macroeconomic warnings, fiscal sustainability, and regional financial sustainability. This will assist ASEAN+ 3 economies to better prevent and address economic crisis that may occur.
3. Asian Bond Markets Initiative (ABMI)
ASEAN+ 3 member countries foresaw that once a crisis occurs, member countries would need to rely on short term international currencies. Therefore, they focused on the development of a regional bond market to increase funding channels, which led to the creation of the Asian Bond Market Initiative (ABMI) on August 2003.
ABMI emphasizes the issuance of local currency bonds and development of the bond market infrastructure by promoting long term investment in the region. By developing regional bond markets to be resilient, credible, and a viable choice for investment and long term funding for both the government and private sectors, ABMI had promoted regional financial cooperation through tangible bond market development.
4. Utilizing Sufficiency Economy Philosophy
An important lesson from the TomYam Kung crisis is the implementation of economic policies in a non-careless manner in accordance with His Majesty King Rama 9th Bhumibol Adulyadej’s philosophy of sufficiency economy, which he had enlightened Thai people for over 25 years, before and after the crisis.
The key philosophy of sufficiency economy is economic development in a moderate and non-careless manner, while taking into account sufficiency, rationale, and building internal immunity. It also includes using your knowledge, awareness, morality, and adapting the impact of sufficiency economy philosophy to create sustainable development and being prepared and ready for all types of changes, whether economic, social, environmental, and technological.
The TomYam Kung crisis was a financial crisis that originated in Thailand and quickly spread to regional Asian countries. Despite having occurred over 25 years ago, the impact of the crisis are still deeply rooted in the Thai economy, both in terms of its “heritage” and “burden” for the younger generation (who were not born during the crisis).
An important “heritage” of the TomYam Kung crisis are the knowledge base, lessons, and risk prevention mechanisms that were created to prevent the Thai economy from having to endure another crisis again. This is particularly true in terms of enhanced regulation by the BOT and relevant authorities, in ensuring that domestic factors will not be the cause of the next crisis.
Nonetheless, an important “burden” that has fallen upon the new generation is the amount of debt that has been created from the FIDF which was used to repay depositors and creditors to foster confidence for depositors and financial institution debt owners, particularly financial institutions that were closed down post crisis.
Whether they like it or not, the new generation cannot deny these heritage and burden resulting from the TomYam Kung crisis. However, by understanding the causes and mistakes and deciphering these lessons, Thailand can live with these heritage and burdens.