Hong Kong’s Financial Crisis 1997-1998
The Asian miracle turned into a nightmare in 1997. Thailand triggered the region’s free-fall when the Thai baht was delinked from the US dollar in July. This sent other Asian currencies tumbling as speculators took advantage of profit-making opportunities. Hong Kong was not immune to the regional woes either. The first attack on the Hong Kong dollar began in earnest in October 1997 following the depreciation of the New Taiwan dollar. There were rumours that the Hong Kong dollar peg would soon be abandoned. In order to defend the local currency and demonstrate its resolve, the Hong Kong Monetary Authority raised interest rates. This, in turn, brought about painful economic consequences. As the crisis in Asia worsened, the impact on Hong Kong deepened. Hong Kong’s stock market took a pounding as speculators mounted three
more attacks in 1998. On 14 August of that year, the Government decided to take action and changed from being a passive regulator to an active market participant. Over the course of two weeks it became the largest shareholder in Hong Kong, owning 7.3 per cent of the 33 companies that made up the Hang Seng Index. Its decision was a controversial one. Was it appropriate? How did the move affect Hong Kong’s status as a global financial hub and a world trade centre?
The Asian Contagion
In the 20-30 years before 1997, Asia had been the subject of world attention as the centre for global growth. For much of the 1990s, double-digit growth was the norm for countries such as Thailand, South Korea, Malaysia, Indonesia and Hong Kong. However, underneath the impressive figures lay deep structural problems. As long as the economies were growing, these could be overlooked, but once things turned sour, they proved – as in Thailand’s case – to have disastrous consequences.
In the 1990s, Thailand started to deregulate its financial markets. It liberalised interest rates, capital flows and foreign exchange transactions. This, coupled with the baht’s effective peg to the US dollar, attracted large short-term capital inflows and significant external borrowing which, in turn, went to a variety of domestic institutions. In the words of one commentator, there was “too much liquidity chasing bad investments”.
This was exacerbated by negligent financial oversight, which resulted in strident speculation in the real estate and construction sectors as well as the general overheating of the economy. Thailand’s current account deficit ballooned.
The bubble began to burst in 1996 as exports slowed and competition from regional countries such as China and Vietnam increased. The Thai economy lost steam and the stock market began to collapse. Many Thai businesses faced financial difficulties and defaulted on their bank loans. Recognising the danger of the situation, many foreign and domestic investors began withdrawing their money. This only served to worsen an already dire situation. In order to support the baht, the Bank of Thailand spent US$7 billion on the spot market and
committed US$23 billion to the forward markets, but to no avail.
On 2 July, 1997, having used
up most of its reserves, Thailand succumbed to the problems that had been plaguing the country. The baht’s fixed exchange rate to the US dollar could no longer be maintained [see Exhibit 1]. The currency was forced to devalue, setting off a crisis that would send many Asian economies spiralling downwards.