3.2 The underlying cause of all the above-mentioned problems is how foreign capital was (mis) used. Instead of funding export projects or foreign exchange earning/saving activities, a sizable portion of those capital inflows rushed into short-term and speculative sectors such as real estate and stock markets. That is true even in the case of foreign direct investment. The data from Thailand reveal that during the period of capital glut (1993-96) 37% or roughly a third of net foreign direct investment clustered in the real estate sector (see Table 5).
3.3 After 1995 two external factors aggravated the strains on the current account of ASEAN-4: downturn f export markets and upswing of the U.S. dollar exchange rate. The trade-weighted average growth of trading partners’ imports weakened from 11-12% in 1994-95 to 8% in 1996. This slackening was attributed to the following: a widespread deceleration of imports by industrial countries stemming from sluggish economic activity in Europe and a decumulation of inventories, a glut in the global electronics market that resulted in a sharp fall in prices, and a slowdown of growth in much of the Asian region itself–including China, India, Malaysia, and Thailand– partly in response to measures undertaken in some countries to contain the emerging overheating pressures. As regards exchange rates, after 1995 the U.S. dollar recovered at a very quick pace (Chart 1). For example, it rose from 94.06 yen in 1995 to 108.78 yen in 1996 and 121.06 yen in 1997. Because ASEAN-4 pegged their exchange rates closely to the U.S. dollar, their substantial currency appreciation meant that the degree of competitiveness in international arena dwindled to a large extent.
3.4 On top of capital account liberalization, the financial deregulation undertaken by ASEAN-4 in consonance with the global pressure raised the degree of risks and vulnerability to deterioration of financial institutions’ asset quality. Such adverse impact was due to three primary causes. First, amid stronger competition due to foreign capital, limited experience among local financial institutions in the pricing and management of risks in new areas of business practice led to imprudent lending or credit commitments. Second, inadequacies in the regulations and supervision of financial institutions served as loopholes to modern practices in banking and finance. Third, inefficiency on the part of central authorities’ regulatory personnel, due to their lack of experience, further worsened structural weaknesses of the Asian financial sector. In short, the management of, and the supervision plus regulations of, financial institutions paid too little attention to prudent analysis and containment of risks. Consequently, asset quality declined to an alarming degree while the number/amount of non-performing loans as well as bankruptcies grew unprecedented. It should be noted as well that negative effects of initial imprudence were exacerbated by subsequent events, i.e. economic slowdown, tighter financial policies, decline in domestic real estate and equity markets, and eventual currency depreciation that placed in difficulty customers with uncovered foreign currency liabilities. Overall, in addition to threatening deficits on the external account, weak financial sector further undermined confidence of both debtors and investors, leading to Asian financial crisis.
