These grew more serious in the 1990s, but they continued to be masked by generally sound macroeconomic conditions and investor confidence in a sustained Asian boom. However, the sudden onset of the crisis cannot be explained without appreciating the panic-prone and panic-inducing behaviour of international financial markets. Fortunately for most of Asia, the crisis, though severe, was short. The Russian default and LTCM debacle in the fall of 1998 were a turning point. The G7 countries, led by the US Federal Reserve, lowered interest rates promptly and decisively. While this lowering was motivated by domestic considerations, there was also a collective sense of concern over the weak state of the global economy. In the event, it helped restore liquidity and confidence to global financial markets. Now nearly all the Asian countries are recovering, though in different ways and to varying degrees. Post-crisis caution After this near-death experience, it is not surprising that countries are re-examining their belief in the global economic system. What lessons have countries learnt? 1  IMF News Brief 97/19, 8 October 1997. BIS Review 76/2000  2  Firstly, unlike previous crises, the crisis was due mainly to a run on the capital accounts. Thus, there was no reason to rethink the merits of free international trade and investments. These fuelled the last Asian boom, and are crucial if countries are to get their economies growing again. The most open of the Asian economies – Hong Kong and Singapore – were among the least badly affected by the crisis.
Companies borrowed excessively, especially in foreign currencies without hedging their exposures, encouraged by implicitly pegged exchange rates. But lenders in the developed economies could not escape blame either. They were only too eager to extend credit, based on the political connections of the borrowers, or on faith in an Asian miracle. Banks stampeded into the region. When sentiments turned, they stampeded out again, equally indiscriminately. The sudden massive outflow of funds, especially through banking lines, left countries in a severe liquidity crunch, and was an immediate cause of the crisis. The punishment meted out by the markets was out of proportion to the crime. The damage was not just the 9% shrinkage in the GDP of the crisis countries, but the social dislocation and political turbulence that followed. Indonesia suffered the worst, even though the IMF made a pre-emptive house call early in the crisis, and pronounced Indonesia’s fundamentals to be basically sound.1 The Indonesian government had pursued prudent macro policies and maintained steady economic growth. But companies had borrowed large sums from abroad, and the banking sector was afflicted by related party lending, poor credits, and weak provisioning. This, together with concerns about KKN – corruption, collusion and nepotism – was enough to turn an initial loss of confidence into a full-blown crisis of the body politic, forcing President Suharto to resign and pushing the country to the brink of chaos. The origins of the Asian crisis thus lay in institutional weaknesses and inefficiencies.