The global financial crisis that began at the epicentre spread forcefully across the globe and affected nearly every economy, big or small. We now look at the impact on and challenges to Asia.

The Asian Financial Crisis of 1997 (“AFC”)

Not long after Asia recovered from the Asian Financial Crisis (AFC), it is hit with another crisis in 2007; this time the epicentre was the United States. While each crisis is different from another, they share enough common characteristics from which valuable lessons can be drawn.

It is generally accepted that what happened in Asia before the AFC was the influx of foreign capital that resulted in misallocation of capital, mismatch of short-term borrowings with long-term investments, aggravated by pegged exchange rates. In the early 1990s, interest rates in developed countries were low and investors were chasing for higher yields in the “emerging markets” starting in Latin America and culminating in Southeast Asia. In 1990 private capital flows in emerging markets were $42 billion and by 1997, they reached $256 billion (Krugman 2009a, p. 79). Most of these were short-term capital flows in the form of portfolio investments and other investments (loans and deposits) through the banking system.

Faced with huge capital inflows, it is almost inevitable that much went into speculative investments in the stock and property markets, or ended up in financially unviable projects. From the experience of one of the authors as a debt restructuring specialist in Southeast Asia during the AFC, it was commonly known among financial specialists that in the heyday of bank syndicated loans, both foreign and local banks were lending more than what was required or financially viable. Like the subprime saga of today, lenders and borrowers had over-optimistic financial projections at best, or engaged in fraud and financial mismanagement at worst. The results were asset bubbles and over-leveraged corporations with foreign currency loans that imploded when sudden massive reversal of capital flows caused huge depreciation in the borrowers’ currencies (Corden 2007).

The AFC was not the boom and bust of a normal business cycle but one associated with speculative and erratic financial flows. The current account deficits in many countries before the AFC were not the result of low savings rates.