The 1997 Asian Financial Crisis: How the Baht Started a Currency Collapse

The Asian financial crisis began on 2 July 1997, when Thailand gave up defending the baht's peg to the US dollar and let it float. Its value fell sharply, and within weeks investors pulled money out of other economies in the region that looked similar.

By January 1998 the Indonesian rupiah had lost about 81% of its value against the dollar, the baht about 56%, the Malaysian ringgit about 46% and the Philippine peso about 41%. South Korea, then the world's 11th-largest economy, needed one of the biggest rescue packages the IMF had ever arranged.

The crisis is studied by currency traders because it shows how a peg can fail under speculative pressure, how contagion jumps from one country to another, and why borrowing in a foreign currency is so dangerous.

The boom before the bust

Through the early 1990s the "Asian tiger" economies grew at remarkable rates. Foreign money poured in, attracted by fast growth and by currencies that were pegged or tightly managed against the dollar, which made the exchange-rate risk look small. Local banks and companies borrowed heavily in dollars at low interest rates and lent or invested the money at home in property, shares and new factories.

Two weaknesses were building under the surface. Much of the borrowing was short-term and in dollars, while the assets it paid for were long-term and earned local currency, a double mismatch of maturity and currency. And the property and stock booms were partly fuelled by easy credit, so they were vulnerable to any change in sentiment.

The attack on the baht

By 1996 Thailand's exports were slowing, its current account deficit was large and its property market was showing signs of strain. Speculators began betting that the baht's peg could not hold. The Bank of Thailand defended it by selling dollars and committing large amounts of its reserves to forward contracts, but its usable reserves were running out.

On 2 July 1997 it gave up and let the baht float. The currency fell immediately, and kept falling. Companies that had borrowed in dollars suddenly owed far more in baht than they could repay, and many Thai finance companies collapsed. In August Thailand agreed an IMF-led rescue of about $17 billion.

How the crisis spread

Investors who had been burned in Thailand looked around for similar weaknesses and found them across the region. Money flowed out of Indonesia, Malaysia, the Philippines and, by the autumn, South Korea. Each falling currency raised the real cost of dollar debts, which caused more defaults, which caused more selling: a feedback loop that economists call contagion.

Indonesia was hit hardest. The rupiah's collapse wrecked companies with dollar debts, prices of food and fuel soared, and the economic crisis turned into a political one that ended President Suharto's 31-year rule in May 1998. South Korea's large conglomerates, the chaebol, were heavily indebted, and in December 1997 the country agreed an IMF-led package of close to $60 billion, the largest the fund had arranged up to that point.

The IMF, Malaysia and the speculator debate

The IMF's rescues came with tough conditions: higher interest rates to defend currencies, spending cuts, and the closure or restructuring of weak banks. Critics argued that some of these measures deepened the recessions, and the debate about whether the IMF got it right still continues.

Malaysia took a different path. Its prime minister, Mahathir Mohamad, blamed currency speculators, singling out George Soros, for attacking the region. In September 1998 Malaysia imposed controls on capital leaving the country and fixed the ringgit at 3.80 per dollar. Economists remain divided on whether the controls helped, but they showed that a government can still close the door on international money flows if it is willing to accept the costs.

Most studies conclude that speculators exposed weaknesses rather than creating them. The pegs, the dollar debts and the credit booms were domestic problems; traders bet against them once they became visible, which turned a slow problem into a fast crisis.

Living through it in the region

The numbers hide a human crisis. In Indonesia millions of people were pushed back into poverty as food prices soared and jobs disappeared. South Korea saw unemployment jump, and citizens donated gold jewellery in a national campaign to help repay foreign debt, an image that came to symbolise the crisis. Thailand's middle class saw savings and businesses wiped out, and many white-collar workers became street vendors.

Recovery came faster than many expected. South Korea repaid its IMF loans ahead of schedule, and by the early 2000s most of the region was growing again, now with cheaper currencies that helped exports. The lessons learned in those years shaped how Asian policymakers handled later shocks, including the global financial crisis of 2008.

What changed afterwards

• Bigger reserves. Asian central banks built up huge foreign currency reserves so they could defend themselves without asking the IMF for help.
• More flexible currencies. Many countries moved away from rigid pegs toward managed floats.
• Less foreign-currency borrowing. Regulators watched dollar debts more closely, and local bond markets grew.
• Regional safety nets. Asian governments created swap arrangements to lend reserves to each other in a crisis.

Lessons for currency traders

• Pegs plus big foreign debts are a warning sign. Watch reserves, current account deficits and short-term dollar borrowing.
• Contagion is real. A crisis in one country can move currencies that share the same weaknesses, even far away.
• Emerging-market currencies can gap. Spreads widen, liquidity disappears and moves of 10% or more in a day become possible.
• Governments can change the rules. Capital controls and fixed rates can appear overnight, trapping money that cannot leave.

Frequently asked

Related reading

• George Soros and Black Wednesday
• The history of forex
• The major currency pairs
• Forex risk management