Excess Capacity

As the volume of investments ballooned during the 1990s, often at the bequest of national governments, the quality of many of these investments declined significantly. The investments often were made on the basis of unrealistic projections about future demand conditions. The result was significant excess capacity. For example, Korean chaebol's investments in semi-conductor factories surged in 1994 and 1995 when a temporary global shortage of dynamic random access memory chips (DRAMs) led to sharp price increases for this product. However, supply shortages had disappeared by 1996 and excess capacity was beginning to make itself felt, just as the South Koreans started to bring new DRAM factories on stream. The results were predictable; prices for DRAMs plunged through the floor, and the earnings of South Korean DRAM manufacturers fell by 90 percent, which meant it was difficult for them to make scheduled payments on the debt they had taken on to build the extra capacity.²⁵

In another example, a building boom in Thailand resulted in excess capacity in residential and commercial property. By early 1997, an estimated 365,000 apartment units were unoccupied in Bangkok. With another 100,000 units scheduled to be completed in 1997, years of excess demand in the Thai property market had been replaced by excess supply. By one estimate, by 1997 Bangkok's building boom had produced enough excess space to meet its residential and commercial needs for five years.²⁶

The Debt Bomb

By early 1997 what was happening in the South Korean semiconductor industry and the Bangkok property market was being played out elsewhere in the region. Massive investments in industrial assets and property had created excess capacity and plunging prices, while leaving the companies that had made the investments groaning under huge debt burdens that they were now finding it difficult to service.

To make matters worse, much of the borrowing had been in US dollars, as opposed to local currencies. This had originally seemed like a smart move. Throughout the region, local currencies were pegged to the dollar, and interest rates on dollar borrowings were generally lower than rates on borrowings in domestic currency. Thus, it often made economic sense to borrow in dollars if the option was available. However, if the governments could not maintain the dollar peg and their currencies started to depreciate against the dollar, this would increase the size of the debt burden, when measured in the local currency. Currency depreciation would raise borrowing costs and could result in companies defaulting on their debt obligations.

Expanding Imports

A final complicating factor was that by the mid-1990s, although exports were still expanding across the region, imports were too. The investments in infrastructure, industrial capacity, and commercial real estate were sucking in foreign goods at unprecedented rates. To build infrastructure, factories, and office buildings, Southeast Asian countries were purchasing capital equipment and materials from America, Europe, and Japan. Many Southeast Asian states saw the current accounts of their balance of payments shift strongly into the red during the mid-1990s. By 1995, Indonesia was running a current account deficit that was equivalent to 3.5 percent of its GDP, Malaysia's was 5.9 percent, and Thailand's was 8.1 percent.²⁷With deficits like these, it was increasingly difficult for the governments of these countries to maintain their currencies against the US dollar. If that peg could not be held, the local currency value of dollar-dominated debt would increase, raising the specter of large-scale default on debt service payments. The scene was now set for a potentially rapid economic meltdown.