Thoughts on the origins of the Asia crisis: impulses and propagation mechanisms

The traditional fundamentals suggested by first and second-generation of crisis models did not provide much indication of an impending crisis in Asia. Growing current account deficits and somewhat overvalued real exchange rates suggested some need to curtail domestic demand and/or engineer nominal currency depreciation, but did not suggest a crisis of the magnitude that has occurred. ; Nevertheless, to a large extent, the Asian crisis can be explained in terms of impulses and propagation mechanisms related to fundamentals, specifically general weaknesses and distortions in the financial sector. These included relationship lending practices, excessive risk taking, and inadequate financial supervision and regulation. The effects of these factors was cumulative and increased the vulnerability of Asia to bad shocks. Once the crisis hit, various mechanisms magnified its initial impact. These included the effects of excessive leverage, collateralized lending, competitive devaluations, and exposure of unhedged foreign liabilities. Elements of illiquidity-based financial panic may also have played a role. It is important to emphasize, however, the difficulty in identifying whether the motivation for the panic was based in a spontaneous shift in creditor confidence or to changing fundamentals.