Essay on Economic Crisis

In 1998, the economic crisis affected greatly all Asian countries, their economic and social spheres unveiling political discrepancies and economic weaknesses. The reason is that different reformers in Malaysia, Indonesia and Thailand choose different approaches to recovery and liberalization. Whether economic liberalization precedes or succeeds a downturn in economic cycles, liberalization has profound political ramifications since it indicates the state’s willingness to ‘roll back’ some of its functions and transfer economic decision-making and power to market forces and social actors with the potential to empower civil society.

Help With Essay on Economic Crisis
Help With Essay on Economic Crisis

Until the outbreak of the crisis, Thailand was one of the best places to do business in Southeast Asia. After the crisis it was one of the worst hit by the economic turmoil. The devaluation of the baht in 1997 ensured that most Thai firms would lose most of their wealth. Hence, they need immediate cash injections to improve their balance sheets. Quite often, the only available and remaining source is inward foreign investment, given that most of the domestic investors were in severe trouble regarding their own cash-flow situation. Hence, many industries might become dominated by foreign firms or become local joint ventures with foreign firms. The main reform programs in Thailand include: capital control, banking reforms, the regulatory framework, bond markets (non-performing loans), NPLs (Glassman 2001).

Even though the government tightened the rule after the crisis by making the definition of NPL stricter (three months of unpaid debt service, instead of six or 12 months as earlier), all types of financial institutions seem to have upgraded their asset quality, as their NPL shares declined steadily between 1998 and 2001. And after those changes, the remaining NPLs seem to have stayed put. As regards the types of debtors, in the middle of 1999 when NPLs peaked, ordinary persons totaled 88 per cent of all NPL cases at Thai commercial banks. However, their suspended debt service amounted to only 24 per cent of all NPL value. The rest belonged to separate legal entities. “To reduce principal-agent problems, in particular for small and medium enterprises and individual major borrowers, the credit bureau can raise the lending efficiency of financial institutions in Thailand” (Drysdale 2000, 118).

The system adopted in Thailand since March 1998 also calls for quarterly, instead of annual, audits and credit reports to be submitted to the central bank. The measures also demand that financial institutions tighten their practices and credit analysis procedures, focusing more on borrowers’ cash flow and debt servicing ability, rather than on loan collateral (Dixon 2004). As for the status of commercial banks, the government made a major announcement on 14 August 1998, which was intended to support private banks’ recapitalization. “The development of bond markets can help large corporations to refinance their debts and provide cheap funds for their operations” (Drysdale 2000, 116). Furthermore, as a means to motivate debt restructuring or reconciliation with problem clients, the government proposed an option to financial institutions to increase their second-tier capital by exchanging non-tradable bonds with banks’ newly issued debentures, equaling the losses suffered by financial institutions in their debt restructuring (Enoch et al 2003).

The Bank of Thailand cannot change the movement of the baht, since to a certain degree it is determined by the yen-dollar exchange rate. The Bank can only intervene temporarily to prevent abrupt changes in the value of the baht. “Banks have been ordered to comply with higher capital adequacy ratios and to recapitalize after capital write-downs of bad debt” (Drysdale 2000, 109). In the long run, it cannot significantly influence the exchange rate, whose movements are dictated by market conditions. This contraction of imports in dollar terms occurred less because of the rise in import prices in baht terms and more because of output contraction. Since a large part of Thailand’s output, especially its exports, requires imported raw materials, it is not surprising that imports fell together with exports. Economic recovery must produce a rise in imports of raw materials. The ownership is being transferred from purely Thai to partially or wholly foreign; as a consequence, the management methods will change, and sometimes not subtly currency appreciation. Foreign investment took place mainly in the acquisition of finance institutions. In the finance sector, for example, foreigners can now hold majority shares in banks for up to ten years. So far, two banks—Thai Danu and the Bank of Asia—have deals allowing foreign banks to take majority positions.

It should be noted that changes in the prices of foreign currencies have a profound effect on all commodity prices. One has to look carefully into the impact of changes in foreign exchange rates on the rest of the economy before making hasty exchange rate policy recommendations. The flexible exchange rate has brought into the open the issue of distributive income between exporters and importers, tradable and non-tradable sectors, and creditors and debtors of foreign currencies After October 1998, the baht rebounded and depreciation turned into appreciation, eroding the competitiveness gained during the early period of the float. Nominal and real exchange rate movements converged as inflation differentials between Thailand and the United States became smaller.

Wage flexibility does indeed exist, and it can explain Thailand’s successful maintenance of the fixed exchange rate for so many years. Wage and price flexibility made it possible to adjust real wages during periods of macroeconomic imbalance without the necessity of a flexible exchange rate. Furthermore, conservative fiscal policies helped absorb large capital inflows through budget surpluses, while open capital accounts prevented the monetary base growth from becoming explosive and thus threatening price stability. Nonetheless, this insulating mechanism broke down when the monetary authorities attempted to bail out certain financial institutions to prevent system-wide financial instability. With so many new policy objectives, the fixed exchange rate system, previously so effective as a domestic anchor, had to be sacrificed.

In light of the above discussion, it could be said that efforts at financial reforms in Thailand were made more successful than in other two countries because of increased foreign ownership. Some ailing banks were integrated with state banks. Critics (Glassman 2001) suppose that over the next few years, Thailand will need a significant upgrading of a range of business-related institutions and processes.

Malaysia was another country affected by economic crisis. At the end of 1997, as the recession deepened, Mahathir favored government bailouts of ailing conglomerates. Unsurprisingly, nearly all of the proposed bailouts were for conglomerates with close links to the political elite. The political conditions and state of economic affairs in Malaysia were quite different from those in neighboring countries. They claimed that, compared to Indonesians (and Filipinos), Malaysians had a dislike for reforms emanating from outside the state and had a strong desire to maintain political stability. The Malaysian reform movement subsequently adopted this rallying cry to point to the same systemic problems under the Mahathir administration, which they alleged were the primary reasons for the economic crisis. Indonesia was presented by the opposition as a ‘positive’ example for the promotion of democracy.

Following “Malaysia’s approach to management of its financial crisis represented a significant departure from the orthodox, IMF-centered approach to crisis management” (Drysdale 2000, 169). Unable any longer to deal with the crisis, the government on 13 October 1997 turned to the IMF for financial assistance. In return for a standby loan of $43 billion, including a $12.3 billion standby loan from the IMF itself and additional standby loans from the World Bank, the ADB and contingency loans from individual countries such as Japan and Singapore, the Indonesian government pledged to implement a comprehensive program, including sound macroeconomic policies, financial sector restructuring and structural reforms (Woo et al 2000). “At the same time, Malaysia’s economy was made more vulnerable by trying to develop its equity markets and, as a result, became subject to a quick drop in equity prices when investors pulled out their funds” (Epstein 2001, 113).

The first step to implement the IMF reform program was in the field of financial restructuring. This step was considered necessary, as the weak banking system, saddled with large, non-performing loans, had been a major factor in causing the crisis. To this end the Indonesian government closed down 16 private insolvent banks, including some controlled by the President’s relatives and cronies. “Malaysia’s initial experiment with IMF-style policies of fiscal austerity appeared only to exacerbate adverse domestic economic conditions and, in any case, did little to the win the support and approbation of “the markets” (Beeson 2000, 335). Most transition theorists seem to agree that, regardless of the strength of civil society, the process of democratic transition requires a crisis of legitimacy for the existing regime. Also, it is important to note that “this contradictory position is explained by the intersection of politics and economics in Malaysia: much of the UMNO’s appeal has been derived from what Crouch calls its “patronage-dispensing function” (Beeson 2000, 335).

Unlike Thailand and South Korea, the other two worst-affected Asian countries, which had from the start vigorously implemented the reform programs in return for IMF assistance, the Indonesian government did not seem fully committed to implementing the reform program. According to Epstein (2001): “Malaysia fares much better than Indonesia, or Thailand. Compared to East Asian countries with IMF programs” (113).

In Malaysia, the formation of the BA indicated a resistance against another prevailing feature of the Malaysian state that had become quite obvious with the ousting of Anwar-unaccountable abuse of power to protect vested political and economic interests. “The need for lowering interest rates, to lower non-performing loans, to recapitalize the banking sector and to facilitate stock market recovery place can also be explained by the same motives” (Doraisami 2005, 249).

There are three main reasons for the limited reforms in the post-currency crisis period. First, the nature of the split in the political elite was of limited significance, failing as it did to result in any realignment of socio-economic forces. Second, that the government was able to increase repression to demobilize civil society. Third, the importance of the Internet in ‘catalyzing’ civil society was if not exaggerated at least misconstrued.

Indonesia was the third country affected by the crisis. The main changes in this country include: rennet generation (centralization of power, reliance on the military, technocrats, increasing role of Islam and education, etc.), Even the assumption of power in October 1999 of a new government under Abdurrachman Wahid, the first democratically elected president in Indonesia’s history, failed to achieve significant progress in economic recovery. Being a coalition of ministers from different political parties, President Wahid’s first cabinet was unable to provide strong and effective government (Green 2002). Like Habibie’s government, Wahid’s government during its first year failed to achieve steady progress in bank and corporate restructuring as agreed on in the government’s successive agreements with the IMF. The main economic reframes include: “Protection from imports, awarding contracts without bidding, providing access to cheap loans, granting rights to exploit natural resources, designation as mandatory partners in foreign joint ventures, rights to take over land Purchase of inputs at artificially low prices, favorable treatment by the tax office, rights to collect taxes (Drysdale 2000, 155-156). The socioeconomic effects of the Asian financial crisis in Indonesia were transmitted via two channels.

President Soeharto still hesitated to implement the second agreement faithfully, particularly the structural reforms aimed at reducing economic barriers to domestic competition. The President even seemed to backtrack on earlier commitments when he asserted that some of the IMF-mandated measures were ‘unconstitutional’. It was at this time that the President lost confidence in his supporters and started to see the IMF mandated reforms. Worsening economic conditions and greater flexibility on the part of the IMF led in early April 1998 to a third agreement. This allowed for large food subsidies for low-income groups and a budget deficit of 3.5% of GDP, instead of the 1% under the second agreement (Woo et al 2002). The effects through the second channel were caused by the changes in relative prices, as prices of tradeable goods (including manufactured goods) rose significantly vis-a-vis the non-tradeable goods and services as a result of the steep depreciation of the rupiah (Sjoholm 2002). With substantial financial and technical assistance from the IMF, the World Bank, the ADB, the United Nations Development Program and the CGI, the Indonesian government in 1998 took measures to protect the poor from the worst effects of the crisis, notably by providing emergency Social Safety Net (SSN) programs to the most vulnerable groups in society, including the distribution of subsidized rice to poor households, creation of short-term job opportunities through labor-intensive public works, and preservation of critical social services.

Indonesia, unlike Thailand, did not introduce rupiah exchange rate to the dollar. In contrast, it introduced ‘a quasi-fixed exchange rate’ which was guaranteed by the Indonesian government. Because of this implicit guarantee, few overseas loans were hedged. In 1999, however, macroeconomic stability was slowly being restored as the exchange rate, inflation and interest rates responded well to tight monetary policies. Positive growth was maintained during 2000, with GDP growing at 4.8%. Indonesia’s economic recovery and the resumption of rapid, equitable and environmentally sustainable economic growth depend not only on sound macro- and microeconomic policies but also on the evolution of strong, viable institutions which can establish and enforce basic rules on government, private corporations and the public at large.

In sum, the above analysis and facts show that even though the countries have succeeded in improving the culture of prudence and good governance in the financial sector, reforms in the real sector moved at a much slower pace. The most successful was the program developed by Thailand which helped the country to overcome economic crisis and recover. In Indonesian the financial situations was worsen by political regime while in Malaysia by social and political instability. Thailand has long regulated public borrowing by stipulating the maximum foreign debt the government is allowed to incur each year. When the IMF’s conditionality no longer holds, the same principle can be applied to stipulate the floor level of foreign international reserves and thus guard against future attempts to prop up the value of the baht. Many countries, however, seem to be happy with large amounts of international reserves. In three countries, since capital controls are costly to enforce and can reduce the welfare benefits arising from efficient adjustment of inter-temporal consumption, total capital control is out of the question. Nevertheless, to the extent that excessive short-term capital flows also increase the possibility of financial crisis, such hot money flows should be limited through the establishment of prudential regulations on private sector foreign borrowing.


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