CURRENCY CRISIS IN SOUTHEAST ASIA : MACROECONOMIC INCONSISTENCIES OR SELF-FULFILLING PROPHESY?

Abstract

The purpose of this research is to determine the causes of the currency crisis in Southeast Asia in 1997. There are basically two perspectives on how a currency crisis arises. The first argues that speculative currency attacks are due to the country's maintenance of economic fundamentals that are inconsistent with the fixed exchange rate. The second argues that even if a country maintains economic policies that appear to be consistent with the fixed rate, it could still be faced with a crisis as a result of a self-fulfilling speculative attack. This study examines the macroeconomic variables of the five Southeast Asian countries (namely Thailand, the Philippines, Malaysia, Singapore and Indonesia) that came under speculative attack in mid-1997 to determine to what extent the currency crisis was due to economic mismanagement of the countries in the region and to what extent it was the result of purely self-fulfilling events. By using a graphical analysis, followed by a regression analysis, it attempts to identify the likely causes of the crisis. The simple graphical analysis turned up some strong conclusions and its findings were supported somewhat by the empirical tests. In general, the findings of this research is that the currency crisis was the result of the regions over-dependence on highly mobile, short-term capital flows for its economic growth. This is attributed mainly to the inappropriate levels of supervision of financial institutions in these economies. Consequently, factors like consumer and asset price levels, current account deficits, export growth and foreign debt all deteriorated. The excessive domestic credit expansion through the banking system is particularly noted. The economies in the region were significantly weakened by these events, making them susceptible to currency crisis. However, this study also concludes that, even though the regional economies were weakened, it had yet to reach levels which warranted a currency crisis of the magnitude that they experienced. The cause of the crisis for the case of Thailand is quite obviously inconsistent fundamentals, but for the rest of Southeast Asia, the indications are that its could have been due to self-fulfilling events, like herding and contagion effects.