The Asian crisis & financial liberalization: the case of Thailand

Publié le par Damien Gaudichon

In this paper, we examine a question raised at the beginning of the Southeast Asian crisis (notably in Thailand, Hong Kong, Indonesia, Malaysia, Philippines): Is the crisis “a hazard or a necessity?” (D.Cohen, 1999). Two opposing theories on the subject exist. The first states that the crisis revealed serious failures accumulated over a long period of time but which were masked by the strong economic growth of the 90's. The second states that it was a crisis with no economic basis, where financial liberalization (through the integration of international markets, and financial and economic deregulation) eventually led to the "panic" of international financial operators, which broke institutions otherwise solid.

In this paper, we do not consider that these two theories must necessarily compete with one another but rather that they can complement each other. Indeed, permissive conditions have led to financial liberalization. In this article we will focus on the Thai case. Thailand was the first country hit and  macroeconomic imbalances were already significant in thi scountry before the crisis.

Presentation of the level of financial liberalization and the unfolding of the crisis in Thailand

Comparison of four Asian countries in terms of financial liberalization
R (restrained) - PR (partially restrained) – L (liberalized) – LL (largely liberalized)




thai tab-copie-1

Source: Williamson  and Mahar, (1998), A survey of financial liberalization, coll. ''Princeton Essays in International Finance, n°211, Novembre", p. extracts of pages 5-6 (copied from Melchior web site).
Index calculated by Heritage Foundation (100=maximum freedom)


At the beginning of the crisis, Thailand had largely liberalized, with significant international flows;  over the same period the Baht was aligned with the dollar (since the mid 80's). Under the famous principle of Mundell’s Triangle, the Thai authorities could not have a monetary autonomy. The peg to the dollar was observed in the ‘90s until the crisis. The Mundell’s Triangle – also called the 'impossible trinity' tells us that it is impossible to have perfect capital mobility, autonomy of monetary policy and fixed exchange rates at the same time.


The collapse of half of the Thai baht and three quarters of the stock market between July and the end of 1997 upset the banking sector and foreign investments, which was the main obstacle to recovery. However, it is important to note that stock prices reached their peak in Thailand in 1993. It would thus be wrong to analyze the Thai crisis as just the explosion of a stocl market bubble. The main causes of this crisis are overinvestment and the external debt level.


The loss of confidence of foreign lenders caused a massive repatriation of capital to Europe and the United States. In Thailand, short-term capital outflows reached 12.6% of GDP in 1997. While FDI continued in the direction of Thailand, the private capital account showed a deficit of more than 10 percentage points of GDP. The baht could no longer remain attached to the dollar as it was in the past. Despite the efforts of the Bank of Thailand and assistance of other central banks in the region, the baht fell. This was the currency crisis in Thailand. Whenever the foreign lenders became convinced that the exchange rate of the baht is unsustainable, capital outflows accelerated and the crisis was inevitable.

thai.pngSource: SET index (MSCI) ; Exchange rate (perspective mondiale – Université de Sherbrooke)


We can wonder if the peg was useful and if the adjustments would have arisen earlier with a flexible exchange rate. As we will see, the economic imbalances acumulated since the mid 80's were too extreme to be sustainable. As a result, the authorities responded with financial liberalization.


Macroeconomic disequilibria: a response by the financial liberalization


Permissive factors to the crisis emerged in Thailand in the 90’s and financial liberalization increased macroeconomic imbalances further without stifling growth.

These economic dynamic created a bubble in land and real estate which allowed a wealth effect, the asset bubble was coupled with a bubble in short-term loans. These loans were, for the most part, used for speculative, and not productive, activities. The third feature was the strong link that existed between the real estate and the financial sector, and Thailand was extremely vulnerable during the downturn. In addition, there was strong growth in current account deficits due to the expansion of investment, despite a sustained rise in exports. Finally, this economic growth was based more on the increase of production factors, labour and capital, than on technological progress and productivity growth. Therefore long-term economic growth was not possible because labour and capital obey the law of decreasing marginal returns (Krugman 1994).

Financial liberalization initiated in the 80’s has also had important repercussions in the region. Foreign savings in the form of direct investment (FDI) and securities investment created deficits in the balance of payments. Indeed, there was an explosion of private sector debt, particularly overseas (foreign liabilities of commercial banks tripling between 1995 and 1997). In the case of these financial flows, macroeconomic imbalances were revealed and adjustments became difficult. Moreover, it was the international financial institutions which "made" the stock markets in the region.

When major western banks decided to leave the region, others followed suit and participated actively in the spread of the crisis at the regional level. In addition, there was an over-investment by  investment funds (mostly foreigners) in search of returns; they participated actively in rising asset prices (especially of real estate and shares), further exacerbating the current account deficit. This caused banks to lend to low-productive yet risky activities in view of expected returns.

Thus, even if financial liberalization may be accused of being a major source in the creation and transmission of the crisis, we must also keep in mind the macroeconomic imbalances that already existed and were then exacerbated in Thailand.


Conclusion: Thailand and Indonesia – A Comparison

The crisis was extreme for several countries including Thailand with a drop of more than 10% of GDP in 1998. As we have seen, many factors in addition to financial liberalization and structural factors come into play. We must remember that it is unsustainable imbalances that led to liberalization and allowed for a sustained growth of GDP per capita in the early 90's.






In both Thailand and Indonesia, the crisis led to a fall in GDP per capita, but economic growth increased again from 1999. The pace of growth was weaker than it was just before the crisis but was established on less artificial footing.

Both countries, heavily affected by the crisis, have successfully found a trend of positive economic growth despite troubled political situations. These countries, in order to avoid another currency crisis, maintain external surpluses and substantial foreign exchange reserves. However, credit growth is still sustained and the stock exchange has risen sharply (multiplied by 6 since 1996 for Thailand).
However, Thailand has had a deep economic advance (GDP per capita three times higher than that of Indonesia), which tends to be maintained. Its industrial production has almost doubled between 2000 and 2008 while the index of Indonesia increased by only thirty points. Concerning inflation, price volatility in Indonesia is very significant while the Thai CPI is relativey stable for an emerging country.

Although economic growth rates have been fairly close over the last decade, these two countries have diverged notably in their industrialization. Again, the role of structural factors and economic policies are often more important than considerations of financial openness.

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