25th Anniversary of East Asian Economic Crisis


Twenty-Five years ago, during July 1997, a severe economic crises rattled South East Asian countries, which later led to social unrest, followed by a political crisis which lead to forced resignation former Indonesian president Suharto, and other incidents like jailing of Malaysian Deputy Prime Minister Anwar Ibrahim.

The crises started in Thailand. During the 1980s and early 1990s, South East Asian countries enjoyed high levels of growth with high exports. The currencies of East Asian countries currencies were stable and mostly pegged to the USD. During that time period, interest rates in Thailand were around 5-10%, higher than in the USA. Investors used to borrow in USD and invest in South East Asian countries. In 1995, according to the Plaza Accord, the USD was left to appreciate against the Japanese yen. This development put a lot of stress on South East Asian economies as their exports were facing stiff competition from Japan due to depreciation of the yen against the USD.

During these periods, despite the high levels of growth, something which the governments of South East Asian countries failed to notice, many borrowings in USD were invested in speculative real estate markets.  By mid 1990s, USA started to raise interest rates to control inflation, which caused funds to move away from South East Asian countries to be invested US treasuries. The bubble started to burst in South East Asia. The real estate market collapsed. Thailand tried to maintain the fixed exchange rate by selling dollars in the market using its foreign reserves, however the attempt failed and Thai Baht lost 50% of its value.

After few months, the crises started to hit other East Asian countries mainly Indonesia, Malaysia and South Korea.

Malaysia enjoyed 8-9% GDP growth with 1988-96, with an inflation around 3-4%. During the crises, the Ringit dropped by 50% against US Dollars. 

For over 30 years, Indonesia was ruled by Suharto. Like the Rajapaksa family in Sri Lanka, Suharto’s family influenced the politics and commerce of Indonesia. Suharto was criticised by international agencies as dictatorial and as one of the most corrupt ruler. However, Suharto is known to have brought in stability to Indonesia by defeating the communist. Suharto was also initially supported by the West for controlling communism in Indonesia.

During the 1997 economic crises, Indonesian companies with US dollar-denominated borrowings struggled to service debts with their rupiah earnings, and many went bankrupt. Efforts by Bank Indonesia to defend its managed float regime by selling US dollars not only had little effect on the currency’s decline, but also drained Indonesia’s foreign exchange reserves.  By January 1998 Indonesia’s rupiah fell by over 80 per cent against the USD.

Indonesian president Suharto’s attempts to re-instil confidence with “I Love the Rupiah” campaigns had little effect. Economists Steve Hanke who is currently famous in Sri Lanka for his inflation figures, which are higher than Central Bank of Sri Lanka (CBSL) data, at that time recommended that Indonesia to set up a currency board. When the news of Indonesia setting up a currency board came up, the rupiah went up by 28% against the US dollar on both the spot and one year forward market.

However, the US Government, headed by Bill Clinton and the International Monetary Fund (IMF) were against such moves and threatened Suharto to drop the currency board idea or forego USD 43 billion IMF bailout package. 

By May 1998, protests intensified against Suharto to step down. Amidst pressure from opposition, religious clerics and his own loyalists, Suharto resigned on 21 May 1998.

The IMF came up with a bailout package of USD 110 billion to Indonesia, South Korea and Thailand. Meanwhile Malaysian Prime Minister Mahathir Mohammed rejected the IMF package.  “IMF would take control of Malaysia’s economy; it would only care about loans and not the growth of Malaysia,” claimed Mahathir Mohammed.

The former Malaysian PM blamed currency traders, in particularly Hungary born American businessman George Soros, for the crises. ”I am saying that currency trading is unnecessary, unproductive and totally immoral, ‘It should be stopped. It should be made illegal. We don’t need currency trading.”

In September 1997’s combined annual meetings of the International Monetary Fund and World Bank held in Hongkong, Mahathir Mohammed and George Soros verbally attacked each other. At one instance Mahathir called Soros a moron. Mahathir also blamed Jews including Soros for the crises. Soros responded by stating that Mahathir is a menace to his country and is finding scapegoats for his own failures.

Before the crises started, Mahathir was expected to step down by late 1998 and hand over the post of PM to Deputy Prime Minister Anwar Ibrahim. However, the economic crises created fissures in the ruling party. Ibrahim favored an IMF bailout package as a solution to the crises. Ibrahim was stripped of his post and later sent to jail. Till date Anwar Ibrahim’s dream of becoming a PM hasn’t materialised. Mahathir continued in his post till 2003.

Instead of an IMF bailout package, Mahathir imposed strict capital controls, pegged its currency at 3.8 ringgit to USD and incentivised exports.

By Mid April 1999, all four major countries hugely impacted by the crises, started showing signs of growth.

In Sri Lanka’s case, by the time Gotabaya Rajapaksa’s Government came to power in November 2019, it had foreign reserves of USD 8.5 billion. We cannot say that Rajapaksa inherited a strong economy, as the foreign reserves were not a result of current account surplus, as Sri Lanka had huge foreign debt of USD 33 billion, another USD 20 billion foreign debt by State-owned enterprises. However, at that time, the government was in a situation to at least borrow further from bilateral or from international capital markets.

What triggered the current crises are the tax cuts by Rajapaksa’s government with a view to increase business activity in the post Easter Sunday attack periods. The consequence was credit rating agencies downgrading Sri Lanka, to the point where Sri Lanka lost access to international capital markets.

The nature of Sri Lankan economic crises is different from South East Asian economic crisis. The 1997 crisis is a recession, liquidity crises and happened suddenly, and unpredicted. Also the South East Asian countries had a strong export even before the crisis started, something which Sri Lanka lacks. Whether the Sri Lankan crises is a solvency crises or not is still been debated, but definitely it’s much more than a liquidity crisis. By late 2020, a serious economic crisis in Sri Lanka was clearly evident. Unlike an unpredicted sudden recession, Sri Lankan crises were well predicted at least two years in advance. It was an economic tsunami, but the tsunami warning was given two years ago. Only the bureaucrats and ruling party politicians were denying of any economic crisis.

Economists were divided in their opinion in how to find solutions to the crisis. Most economists were of the opinion that Sri Lanka should reverse tax cuts, restructure SOE’s and seek IMF bailout package for bridge financing. However, the government, certain economists with leftist ideologies, former Central Bank Governor’s Prof W. D. Lakshman and Ajith Nivard Cabraal rejected seeking IMF package. Minister Vasudeva Nanayakara went to the extent of saying, “We would not go to IMF, even if we die.” Currently, by July 2022, it is clearly evident that the government policies and theories on how to solve the economic crisis is a total failure. The all powerful Rajapaksas had to escape from their official residencies to save their lives from their very own die hard supporters who voted for them.

Now the question arises, why did the bureaucrats, Central Bank Governors and economists advising the Rajapaksas make all these poor decisions? There could be two possibilities in their decision making. One could be that they thought it in the best interest of the country, but ultimately their decisions went wrong. For example, the decision of not going to the IMF at least a year ago. Even in the 1997 East Asian crisis, there were different approaches by countries to get out of the crisis. While IMF bailed out Thailand, Indonesia, South Korea, the Malaysian PM rejected an IMF bailout.  Even recently, former Malaysian PM Mahathir Mohammed, in an interview to Asia Nikkei, criticised the IMF. “Sri Lanka’s current debt crisis is a warning to other governments in Asia to pursue responsible financial policies or be prepared to be a toy in the hands of the ruthless IMF,” stated Mahathir Mohammed.

Human beings make mistake. Economists, politicians, bureaucrats are human beings too. Great noble prize winning economists have made mistakes too.

Let us take the example of US based hedge fund Long Term Capital Management Ltd (LTCM).  LTCM was one of the leading hedge fund companies in the world during 1990s, having two Nobel Prize winners on its board. LTCM board members Myron Scholes and Robert C. Merton received the Nobel prize for economics in the year 1997. Despite having nobel prize winning economists on it board, and some of the best brains in the field of mathematics and economics in its workforce, LTCM started to collapse during the 1997 Asian Financial crises.

The other thing to be noted here is, in the post late 2019 tax cuts periods in Sri Lanka, credit rating agencies were downgrading Sri Lanka. Instead of taking counter actions, Central Bank of Sri Lanka criticised the rating agencies. And of course, credit rating agencies too have made mistakes in the past.  During the 2008 subprime crisis, ratings agencies gave favourable ratings to many products which turned out to be toxic.

While revisiting the decisions taken during the period 2020 till April 2022, some concerns expressed are why Sri Lanka delayed an orderly default till April 2022. Why was Sri Lanka continuously servicing international market debts, when there were massive shortages of basic essential commodities? During 2021, Sri Lankan companies were allowed to buy back Sri Lankan dollar denominated bonds at discounted rates. Were the decision makers of Sri Lanka in any way connected to companies which bought back those bonds? Is that why the government kept servicing the debt?

Hamilton Reserve Bank (HRB), a St Kitts and Nevis based bank, has filed suit in the Federal Court of New York against Sri Lanka to pay the full amount of USD 250 million, part of the USD 1 billion bond issue maturing on 25 July. There are suspicions on whether any one assured HRB that Sri Lanka wouldn’t default on payments till July, as it is reported that HRB’s only investment in Sri Lankan bond is the one maturing in July. These are some of the questions which have arisen among many Sri Lankans.

A free and unbiased investigation can only reveal whether the decisions taken by the Sri Lankan Government from 2020 till April 2022 was in the best interest of Sri Lanka which went wrong or it was taken in the self interest of bureaucrats and politicians. Even if it was taken in the best interest of the country, one cannot deny the fact that it was all blunders, for which the Gotabaya Rajapaksa government and other bureaucrats including Central Bank Governor Ajith Nivard Cabraal has to take responsibility.

By Rajiesh Seetharam