The Asian financial crisis started with devaluation in Thailand in 1997 and quickly spread to Korea, Malaysia, Indonesia and the Philippines. The result was a rapid decline in intra-regional trade and an explosion in financing costs for the Asian economies.
China is said to have avoided the crisis. 1 It held its currency stable and maintained a positive GDP growth rate, relying heavily on the strength of its fiscal stimulus even as domestic demand plummeted. The United States congratulated the Chinese for keeping their system working and maintaining their currency's value in US terms. The Chinese kept their official foreign currency reserves at a very high level, in the neighborhood of US$145 billion during the crisis and climbing higher since, and their trade balance has remained positive with a growing surplus.
But pressures on China remained very high over the two to three years following the crisis, and the Chinese made many adjustments to their system in response. Some of these adjustments had been previously planned, but because of the crisis were accelerated. Others the government implemented in the wake of the crisis in order to reinforce its central controls. Still others were forced upon the leadership.
In 1998 and 1999, Chairman Jiang Zemin and Premier Zhu Rongji both made speeches commenting on the difficulties China was facing in the midst of the Asian crisis. These included corruption in the Communist Party, smuggling, unemployment, social disorder, and the separation of government offices from commercial activities, to name a few. Others that could be added are deflation, softening exports, weakness in the banking system, and environmental damage. In all of these areas, the direct impact of the Asian financial crisis on China was to exacerbate the domestic pressures on the regime.
How was that impact felt? The answer lies primarily in the immediate economic sphere in the form of falling exports, increased international borrowing costs, declining availability of short-term liquidity, and downward pressure on the GDP growth rate. In 1999, China's international borrowing rates improved substantially vis-à-vis the height of the crisis in 1998, but the rates were still much higher than they had been immediately prior to the crisis.
The Asian financial crisis consisted of investor reaction - or more precisely, over-reaction. Investors used to take exposure in the region partly on faith. Too much