Quora Answer: Did Thailand Suffer the Hardest & Longest Fall after the Asian Financial Crisis of 1997?

The following is my answer to a Quora question: “Did Thailand suffer the hardest, and longest, fall after the Asian financial crisis of 1997?  Why did Thailand not bounce back as did Malaysia?” 

Thailand suffered the hardest from the Asian financial crisis of 1997 because Thailand was ground zero.  It spread from Thailand to the rest of Southeast and East Asia, and, for a while, raised fears that would lead to a global economic meltdown.  The Thai government of that time was complacent.  In a time of easy credit to fuel an economic boom, the Thai economy developed into an economic bubble fueled by hot money.  This was particularly so, in the property sector.  Similar conditions developed in Malaysia.  All of these countries had the added complication of crony capitalism and weak regulatory regimes, leading to artificial demand based on speculation.  This was exacerbated by the short-term flow of capital which was funneled to a few connected people.  The cost of the expensive source of capital was put on the economy.  Development funds were wasted. 

Another factor was that many of these nations had large private current account deficits, and fixed exchange rates.  This encouraged external borrowing, leading to excessive exposure to foreign exchange risk.  All this was conditioned on low interest rates from the Fed, which was untenable.  As the US economy recovered from recession in the early 1990s, the Federal Reserve slowly raised interest rates to control inflation in an economy that was heating up.  This put a crimp on cheap credit.  There was a knock-on effect, including the devaluation of the Chinese renminbi, the decline of semiconductor prices, and reactionary measures due to a strengthening US dollar. 

Since Thailand and Malaysia had their currency pegged to the US dollar, the higher value of the dollar caused their exports to become more expensive, and less competitive.  This lowered demand, slowing growth.  Due to a lack of savings, their foreign exchange reserves were low, they could not pay the interest rates on all that foreign currency borrowed.  This had a knock-on effect on the private sector, leading to corporate failure, lowering market sentiment, and creating a downward spiral. 

Since lenders were no longer confident they could recover their funds from creditors, they withdrew credit.  This caused a major liquidity crisis, a credit crunch, and asset prices collapsed once that artificial demand was no longer there.  This increased defaults, which lead to further collapse in asset values as the market panicked.  Foreign lenders, investors and speculators, who had flooded the market with cheap credit, tried to withdraw their funds.  This lead to a dearth of foreign exchange and a flooding of the market with local currency.  This lack of demand caused currency prices to collapse, causing these countries to default on their sovereign debt.  The central banks were forced to raise interest rates.  In their panic, they raised it too high, leading to further credit crunch.  Neither Thailand, nor Malaysia, had the foreign exchange reserves to support their own currencies.  Here, however, is where they took different paths.  Thailand accepted the IMF bailout, which was based on faulty assumptions of austerity.  IMF bailouts were conditional upon economic reforms.  The IMF prescribed reduced public spending, lower deficits, and aggressively raising interest rates. 

On hindsight, this is a mistake.  The IMF economic thought was based ceteris paribus.  An economy in crisis is no longer ceteris paribus, and old theories should have been thrown out the window.  One immediate way would be to defer payments for a year to raise the current account surplus.  Public sector projects should have been brought forward to create growth and cushion softening demand.  Singapore did something like that, and their economy recovered within months.  The IMF rescue package for Thailand was more than US$17 billion.  It was conditional on passing legislation regarding reduced bankruptcy protection, and strengthened regulatory framework.  There was a further bailout package of just under US$3 billion less than a month later.  Thailand’s economy recovered by 2001, four years ahead of schedule. 

The Malaysian ringgit was subject to attack by speculators within days of the baht’s devaluation.  The assumption was that the conditions that lead to the Thai economic crisis was also found in Malaysia.  This lead to a ratings downgrade on Malaysian bonds, from investment-grade, all the way to junk.  The KLSE lost more than 50% of its value, just like the ringgit.  The Malaysian government did not accept the terms of the IMF bailout. The prime minister and finance minister, Mahathir bin Mohamad, imposed strict currency controls that have never been fully repealed.  The ringgit was also pegged at 3.80 to the dollar.  This riled up the IMF, but curbed speculation.  Mahathir has many faults. He is a racist, Malay-exceptionalist, corrupt politician.  But in this, he proved to be correct. 

Mahathir stopped the overseas trade in ringgit and ringgit assets.  This made offshore use of the ringgit invalid.  He restricted the amount of currency and investments that Malaysians and foreign residents of Malaysian could repatriate, and imposed what eventually became an exit tax for foreign portfolio funds.  Another consequence of halting the trading of the ringgit offshore was the permanent suspension of CLOB counters.  This indefinitely froze approximately US$4.5 billion worth of shares.  Most of the affected investors were Singaporeans.  The Malaysian economy recovered by 2000. 

That being said, Thailand’s economy now is in a better position than Malaysia’s.  This is because Thailand made painful changes in the intervening years whereas Malaysia devolved into a kleptocracy.  The problem for Malaysia is that Mahathir is behaving as if the world was 20 years ago, when it is not.  Singapore’s economy in total is larger than Malaysia, which gives a sense of scale of the decline, and the daunting task facing the Pakatan Harapan government.  The same measures that saved Malaysia then, are an impediment to foreign investment in Malaysia now.  In summary, Malaysia recovered faster, but Thailand made the structural reforms necessary for long-term economic growth.