The Legacy of the Catastrophe

To summarise the legacy of the catastrophe suffered in these economies: An open capital account, with quasi-IMF-forced higher interest rates, attracted a flurry of borrowings (on an average, almost 50% of total capital in- flows) from abroad, generating the lending boom and immediate asset price bubbles. For many banks in the East Asian economies, the growth rate of foreign exchange liabilities started outpacing their foreign asset increase rate by about 5% per annum. And to utter surprise, these foreign liabilities, instead of being backed by cash flows, were backed by collaterals like real estate and equity, which were already standing tall on top of a bubble. The absolutely unprepared banking systems of these economies soon faced the growing mismatch of borrowing short and lending long. Interestingly, it was the Mexican Peso crisis in 1995-96 that was the tipping point for panic among foreign investors in East Asia as the flow of capital reversed from these countries in the period around 1996-97, giving rise to a fear of massive devaluation.


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Source: Business&Economy, IIPM