FINS5522 - Emerging Financial Markets
Essay Assignment|
Week 4 (11th August 2010)

Essay Question: Why did the Asian Financial Crisis (AFC) take many by surprise? Explain the major contributing factors that caused the crisis (and their effects), and discuss the lessons that can be learned in relation to preventing and/or responding to future crises.

The Asian Financial Crisis (AFC) of 1997 was a period of financial turmoil and volatility that spread across Asia. Prior to July 1997, most of the South East Asian currencies were tied to the US dollar. The crisis began primarily in Thailand when the Thai baht came under pressure that its value would not hold. The pressure on the Thai baht caused a widening of the Thailand’s Current Account Balance (CAD) and the using up of Thailand’s foreign reserves. This forced the Thai government to float its currency and lead to its devaluation. Real estate and real asset value began to fall and foreign investors began pulling out of South East Asia, triggering the financial crisis that would spread across Asia. The next section of this paper will attempt to answer questions of why the AFC was unanticipated by so many economists and experts. It will also attempt to address the major contributing factors that lead to the AFC and in turn its effects. Lastly this paper will conclude with the lessons that could be learnt from one of the most shocking currency crises of recent times.

Upon careful reflection, many experts (Krugman 1998; Radelet & Sachs 1998; Stein 2004) have asked how such a crisis came as such a surprise to these Asian economies. Stein (2004) has pointed out that the traditional warning signs that signaled such currency crises such as that of Latin America in the 1980s were missing in South East Asia. High growth continued throughout most of South East Asia, there was a lack of uncertainty in equity markets