Thailand's financial crisis: its causes, consequences, and implications

Journal of Economic Issues, March, 2007 by Jonathan E. Leightner

The Asian financial crisis began in Thailand in 1997 and then spread throughout Asia and around the world. Before the crisis passed, Thailand, South Korea, Indonesia, Brazil, and Russia accepted large loans from the International Monetary Fund (IMF). Some feared that the entire international financial system might collapse. On all corners of the globe, governments now fear facing a similar fate as evidenced by the European Union (EU) recently developing an emergency plan to deal with a possible European financial crisis. In the Financial Times article, "Ministers Plan Simulation of EU Financial Crisis" (May 16, 2005), George Parker explained, "[a]lthough there are no signs that such a problem is likely to appear in the foreseeable future, European regulators are haunted by the Asian financial crisis in 1997-98, which shook the whole region." In addition to producing systemic fear, the crisis set in motion profound shifts in Thai economic, political, and social systems.

This paper explains the causes and consequences of Thailand's financial crisis. It begins with a brief summary of the literature. Afterwards, this paper goes beyond the current literature on Thailand's crisis by extending the story to the current year and explicitly presenting some of the most important institutional consequences of the crisis.

A Brief Survey of the Literature: The Causes of the Crisis

The literature on Thailand's financial crisis includes Leighmer 1999, 2000, 2002, forthcoming; Alam and Leighmer 2001; and Leightner and Alam 2002. The story of the Thai crisis has parallels in the Japanese stories told by Ozawa (1999; 2003) and in the South Korean stories told by Zalewski (1999a; 1999b; 2002). The risks that Grabel (1999; 2000) warns of for Asia, the invidious distinction and conspicuous consumption that Elliott and Harvey (2000) warn of for Jamaica, and the problems with absentee ownership and the menace of competition that Atkinson (1999) warns of for globalization have counterparts in the Thai story. After summarizing the literature on the relationship between capital account liberalization and crises, Eichengreen (2004) argues that capital account liberalization is "unavoidable"; however, the pace of liberalization needs to be controlled and correctly sequenced to minimize the risks of future crises. Specifically, domestic financial markets need to be liberalized first and prudential supervision strengthened; foreign direct investment liberalized second; stock and bond markets third; and offshore banking last. The Thai case started with Thailand setting up an offshore banking center.

In the early 1990s, wages in Thailand increased much faster than wages increased in its neighbors--Cambodia, Laos, Malaysia, Burma (Mayamar), Vietnam, and Southern China. The Thai government was concerned that Thai manufacturers would move their production facilities to neighboring countries. In response to this concern, the Thai government decided to help those neighbors grow. The theory was that if Thailand could be the older brother (patron) that helped its younger siblings (clients), then when the siblings grew enough to threaten Thailand, they would be grateful for past help and be responsive to their older brother's needs. Therefore the Thai government established tax breaks and other incentives for Thai businesses to invest in Thailand's neighbors (Leightner 1999).

A good older brother also provides financing. Thus, Thailand decided to establish the Bangkok International Banking Facility (BIBF) which began operating in 1993. The intent of the BIBF was to attract money from the United States, Japan, and Europe to lend to Thailand's neighbors. However, the government's good intentions were subverted by business realities. (1) Since Thailand had much higher interest rates than its neighbors did, the foreign money was loaned to native Thais. Part of this foreign money fueled a speculative bubble in the Thai property market. Speculators purchased property because they expected the price of the property to rise in the near future. Their increased purchasing of the property caused the price of the property to rise, which caused even more speculative buying. When it became obvious that the current price greatly exceeded the real value of the property, speculators quickly sold, causing the price to collapse--the bubble burst (Leightner 1999).

In 1996, the Bangkok Bank of Commerce (BBC) experienced serious cash flow problems due to delinquent loans to the property sector. In an effort to solve its cash flow problems, the BBC asked politicians to whom it had made loans, to start paying on those loans for the first time. Apparently, some politicians saw BBC loans as bribes and had not intended to ever make payments on them. The Bank of Thailand (BOT), foreseeing a major political scandal, tried to cover up the BBC problems. When these problems were revealed to the public, the Bank of Thailand's reputation had been tarnished. Prior to 1996, the BOT had the reputation of being above corruption.