Numerous theoretical and empirical papers have been published trying to understand how financial crises unfold. Some of the plausible theories that have emerged analyze business cycles and imperfections in the credit market, flaws in exchange rate regimes, and information asymmetries as possible root causes of these crises. On the other hand, empirical studies have analyzed the relationship between economic fundamentals and financial crises, the timing of speculative runs on currency, and the spread of contagion.

The existing literature has argued that in most crises, it is possible to find a set of fundamentals that could explain which countries would be most affected and to what extent. Kaminsky, Lizondo, and Reinhart (1998) construct an index of warning indicators consisting of exports, GDP, real exchange rate deviations, inflation and several other variables and analyze the extent to which the index predicts a currency crisis (1). Sachs, Tornell and Velasco (1996) present a model in which real exchange rate appreciation, lending booms and low reserves explain why some emerging markets were hit by crises following the peso devaluation in 1995 while others were not (2). Other literature has linked financial crises to fundamentals within the financial sector in particular. For examples of this, see Calvo (1995) and Velasco (1987) (3,4).

The literature on the East Asia Crisis in particular shows that the countries most severely affected ran larger current account deficits, showed greater exchange rate volatility and had higher indicators of financial and real instability. For example, see Corsetti, Pesenti, and Roubini (1998) (5). Other researchers have blamed the international organizations who pushed the East Asian economies towards rapid financial deregulation, leading to large capital inflows that quickly reversed upon the devaluation of the Thai baht. For examples, see Dissanaike and Markar (2009) and Austin (2009)(6,7). Finally, another explanation for the crisis is that trade linkages and in particular export policies are a determining factor in the magnitude of currency crises and played a key role in the East Asia Crisis. For example, see Khan (2018) (8).

The main contribution of this paper is to the literature that studies the role of fundamentals in financial crises. I provide a summary of the similarities and differences between 11 East Asian economies in several fundamental variables in order to differentiate which fundamentals may have been relevant in determining the severity of the East Asia Crisis. I also use a different methodological approach in which I compare countries that required IMF bailouts with those that did not, lending additional support to the literature arguing that large current account deficits and excessive credit levels make countries susceptible to crises. The second main contribution of this paper is to the literature analyzing the effect of exports and trade on the crisis. The data in this paper raise doubt on the relevance of export levels during the East Asia Crisis, despite the significant decrease in exports following the reversal of the Plaza Accord. The data shows that the countries requiring bailouts had lower reductions in their export revenues on average, suggesting that export levels alone likely did not cause this crisis. Rather, it may have been the interaction between debt and export levels that proved relevant, and future research should analyze the mechanism through which the two interact in order to guide more effective policy design.

The rest of the paper is organized as follows. Section 2 discusses the methodology. Section 3 lays out a brief overview of the build up to the crisis. Section 4 presents the data on fundamentals. I conclude in section 5.

The current account is a measure of a country’s trade balance plus its net income and transfer payments from abroad. The current account also measures net capital flows and reflects whether a country is a net borrower or net saver. A current account deficit means a country is a net borrower while a surplus indicates it is a net lender. Figure 3 shows the average current account balance of the TIKP and non-TIKP nations in the years leading up to the crisis.

The graph shows that, on average, the TIKP nations ran greater current account deficits compared with non-TIKP nations in the decade before the crisis, but the two groups converged as the crisis hit. Non-TIKP nations saw large inflows of capital beginning in 1992, and both groups experienced sudden stops when the capital flows reversed in 1996. As the graph indicates, the contraction was more severe for the TIKP countries (2%) compared with non-TIKP countries (~0.5%).

High GDP growth rates often accompany credit booms. Large expansions in credit facilitate spending and thereby increase GDP, especially if credit is used to finance investment in productive assets. However, credit may also lead to high debt levels and can adversely affect the economy if directed towards less productive resources. Credit booms generally accompany the expansionary phase of business cycles, with rising GDP, rising inflation and falling unemployment. Contractions in credit tend to accompany the contractionary phase of business cycles, with declining GDP and increasing unemployment. Figure 4 looks at domestic credit to the private sector as a share of GDP for the two groups. The TIKP countries saw their private sectors borrowing more, with a larger expansion in credit.

Some economists propose that the export-oriented policies mentioned earlier were to blame for the crisis (for example, see (12)). The US dollar depreciated after the reversal of the Plaza Accord in 1995, which suddenly made East Asian exports more expensive and less competitive in global markets. According to this view, the subsequent collapse in export revenues was one cause of the coming crisis.

As can be seen in figure 5, the TIKP and non-TIKP nations had similar trends in export growth. Both groups experienced a marked decline in their export growth in 1995, but the TIKP nations saw an increase in their export growth in the year leading up to the crisis while the non-TIKP nations saw their export growth fall further. Figure 6 plots exports as a share of GDP for the two groups and shows that exports in the non-TIKP group accounted for almost twice as much of GDP as in the TIKP group. Even though in the non-TIKP group export growth fell further and exports contributed more to GDP, it was the TIKP nations that required bailouts. Thus, the data suggest that export levels alone were not to blame for the crisis; an interesting follow-up question would be to analyze the interaction between a collapse in exports and existing debt levels – it is plausible that a collapse in exports has a more detrimental impact on economies with high debt burdens.

Inflation was relatively well managed in the ASEAN countries before the crisis. Laos was the only country with a hyperinflation episode, with an annual inflation rate of 61% in 1989. However by 1993, its inflation rate dropped to 6%, and the average inflation rate from 1990–1997 for the Asian economies excluding Laos was 7.5%. Overall, Figure 7 shows no significant difference in the average inflation levels between the two groups from 1990–1996, but the two groups diverged immediately before the crisis. A closer look at the data reveals that in 1997, Laos and Myanmar saw their inflation rates nearly double, while inflation in the other non-TIKP countries remained roughly constant.

Debt is an important aspect of any crisis episode because even if a financial crisis is not a debt crisis at its core, it may quickly develop into one. During a sudden stop episode, countries desperate to borrow have to face higher interest rates. Higher interest payments on short-term obligations may be hard to meet, and lenders may be unwilling to rollover the debt. Faced with liquidity issues, banks must turn to a lender of last resort – usually their central bank. As the crisis unfolds, the government often buys out the debts of private banks. This is the famous “doom loop”, and in this way, sudden stop crises may develop into debt crises (13).

Figure 8 looks at short-term debt in the East Asian economies in the period leading up to the crisis.

Since 1980, the debt stocks of the TIKP nations had much higher proportions of short-term debt on average than the non-TIKP nations. When the crisis hit in 1997, the TIKP group had six times more short-term debt relative to total debt than the other Asian economies had.

The data seems to lend support to the traditional view among policy circles that short-term debt makes countries particularly susceptible to financial crises. However, some of the academic literature has argued that this is a case of reverse causality – financial institutions that want to provide liquidity to borrowers with poor credit ratings must borrow short-term, and it is the decreasing credit worthiness of debtors rather than the short-term maturity structure of debt that causes susceptibility to crises (for example, see Diamond and Rajan (2000)). I refrain from offering a causal relationship between short-term debt and the trajectory of the TIKP nations, and merely document the empirical relationship.

As documented earlier, the Asian economies saw an explosion in FDI in the second half of the 20th century. Despite rapid FDI growth being common to the whole region, there were still notable differences in the composition of capital flows for the two groups. On average, the TIKP nations had much lower levels of net FDI inflows between 1990 and 1997 than the non-TIKP nations.

FDI is considered to be a longer-term, more stable form of capital flow as compared with other forms of capital. Since the TIKP nations had larger current account deficits but smaller inflows of FDI,capital flowing into the TIKP nations was likely more short-term and volatile in nature. The data also seems to be consistent with the view that short-term, volatile capital increases the fragility of a country’s financial sectors and makes them more susceptible to a crisis. As explained previously, I merely document the relationship between volatile capital flows and the TIKP group membership and refrain from making any causal statements.