1997 Financial Crisis ( Cause and Effects) on current Malaysia Economy

Causes of Crisis


Actually many signs can be found before crisis, and many economists have contributions on it. After collecting all the information, I have the following conclusion of the causes of Crisis:

1. Strong demand pressures

The pressure which is from increased investment and consumption have raised external current account deficits and put pressure on domestic prices. In Malaysia, the strain has been felt most sharply in the current account, where the deficit has risen quickly from 4% of GDP in 1992-93 to over 8% of GDP in the past years.

2. Economic Growth above Potential Output.

Since 1991, the economy has been consistently growing above what is treated as its potential growth path. When actual and potential GDP are equal Zero, the output gap is zero. The output gap increased during 1994-96, as actual GDP grew faster than potential GDP. This has generated price pressures. It is a greater cause of concern when a significant proportion of these inputs (both capital and labor) was imported.

3. Raising current account deficit.

The deficit in the current account corresponds to the saving-investment gap. Despite having one of the highest savings rate in the world, Malaysia ran into current account deficit problems because of its high investment rate.

The current account deficit was only partially financed by net long-term capital inflows for some of the years. At the same time, reserve investments have steadily increased from RM 4.0 billion in 1993 to RM 11.4 billion in 1996, and increase of 2.8 times. Malaysian investment overseas in 1997 was estimated at RM 9.9 billion.



Effects of Crisis

The economic crisis has affected the economy of Malaysia a lot. The following I will present the effects of the crisis:

1. Enhance Malaysia's competitiveness.

Because of ringgit depreciation, Malaysia's competitiveness has been enhanced after taking into account the combination of the currencies of Malaysia's trading partners and correcting for inflation among the countries.

Malaysia's real effective exchange rate has declined starting from July 1997. This means that Malaysian goods are relatively cheaper and more competitive than its trading partners. With cheaper ringgit, exports grow faster than imports, which help to reduce the size of the current account deficit.

2. Increase in domestic prices.

It is the result of rising costs of imported intermediate goods. Rising consumer prices will also cause real household income and real wages to fall.

3. Proportionate increase in the value of external debt exposure for foreign debts denominated in foreign currencies.

4. Deceleration in the growth of domestic private investments.

5. Economic growth rate will continue to worsen if the exchange rates worsen or continue to remain unstable.