What was the causes of the Asian Financial Crisis? (Part1)


In the early 1990s, Asian countries were enjoying an immense growth on its Economics and Financial markets expansion. There were even a nickname for the Asian countries with remarkable growth as the five Asian tigers; including Hongkong, Singapore, Taiwan, South Korea, and Thailand. They experienced a tremendous boost in their growth rates that transformed their economies from a low income to middle income or became even more progressive and were known to be extraordinary miracles. Indonesia, South Korea, Thailand, and Malaysia’s growth rates stood high at a range from 7.5 to 8.7 percent. The Philippines’ growth rate was only 2.2 percent from 1991 to 1995 but jumped up to 5.8 percent in 1996.

Unfortunately, the situation turned upside down as the devaluation of the Thai baht from unavailability to pegged their currency against the US dollars in the mid of 1997. The event led to an economic recession that was the worst ever after world war II and were known as the Asian contagion. It occurred from the spread of the crisis throughout the region through different channels from countries to countries. The crisis became a crucial lesson for economists and policy-makers to study and understand the cause of the crisis and how it affected the economy.

In this article, I would like to share my research on the Asian Financial crisis or so-called, Tom-Yum-Koong crisis. As this is my first medium post, I hope this would benefit anyone who reads, and if there is any comments feel free to share it with me.

Let’s get started!

First of all, I would like to share Andrew Berg’s point on the three main causes of the Asian Financial crisis.

  1. Macroeconomics Weaknesses
  2. Domestic Financial Vulnerabilities
  3. External vulnerability

To better understand the causes, an addition of framework from Mishkin to Berg’s provides an excellent guide to understanding the crisis in detail. The framework is categorized into three stages; however, only the first and second is focusing on the causes.

Stage 1 (Mishkin framework)
Stage2 (Mishkin framework)

Stage 1:

Path A: Domestic Financial Vulnerabilities

The stems of the domestic financial vulnerabilities in Thailand embed from the mismanagement of the policies in Financial liberalization that were not well regulated and supervised. There was a controversial view about Financial liberalization that it could lead to a higher risk of the country facing a financial crisis.

To adopt a liberalization policy, the IMF suggested that the country should have a significant amount of financial personnel that understands the function of monetary policies; more importantly, strong corporate governance is required to prevent the country from the external risk that increases the vulnerabilities toward Thailand.

The decisions in adopting inadequate policies lead to the insolvency of the banks and running out of reserves. During the 1990s, Thailand had violated the impossible trinity, a concept that three policies cannot use at the same time; fixed exchange rate, free flow of capital, and independent monetary policy.

For the reason that the free flow of capital is crucial to promoting economic growth and improving the financial system, most countries in the early 1990s have already liberalized their financial system. Thailand sees the policy as an opportunity and has the vision to become a Financial hub in Asia. As a result, they established BIBF which facilitated the influx of foreign currency. BIBF, Bangkok’s international banking facility, borrowed US dollars from abroad and lent them to investors and corporations in Thailand.

To allow free flow of capital, Thailand fixed the exchange rate against the US dollars at around 25THB/US dollars to ensure that there was no fluctuation in the currency and were not influenced by the market conditions. The problem arose when Thailand also had an independent monetary policy, meaning that the government had independence in the control of interest rates in the country. The Thai government set the interest rate higher than in the US, Europe, and Japan that was having a low-interest rate, so investors from abroad see Thailand as a favorable country to invest in, and a large amount of capital surged into Thailand. Typically, if Thailand had a low current account deficit, that would be no problem; however, in 1997, the US dollars appreciated after a long period of recession, causing the Thai baht also to be appreciated and becoming less competitive in the trading markets.

The Impossible trinity

Meanwhile, in China, the Yuan depreciated and attracted investors causing Thailand to face a massive problem of increasing current account deficits that leads to a decision from investors to deprive their money out, financially this is called a financial panic.

Having the three policies used altogether increases the vulnerabilities of speculators. It attracts them to speculate on the Thai markets when there is a sign that the Thai economy is facing difficulties, and that will eventually lead to a massive attack against the Thai economy.

As Thailand had large current account deficits, speculators detected an opportunity to buy Thai baht and sell it in foreign countries as they speculated that the Thai economy is going to depreciate from the financial panic. Since a lot of Thai baht have been deprived, the central bank needs to pull out reserves to buy back the Thai baht to maintain its fixed currency. Unfortunately, the attack on currency was substantial that the central bank reserves were exhausted, forcing them to abandon one of the three policies, which is a fixed exchange rate converted into a float exchange rate.


Berg, A. (1999). The Asia Crisis; Causes, Policy Responses, and Outcomes. International Monetary Fund. Retrieved from https://www.imf.org/external/pubs/ft/wp/1999/wp99138.pdf

Grenville, S. (2011). The Impossible Trinity and Capital Flows in East Asia. ABD Institute. Retrieved from https://www.adb.org/sites/default/files/publication/156174/adbi-wp319.pdf

Mishkin, F. S. (2016). The economics of money, banking, and financial markets. Harlow, England: Pearson.