Financial turbulence led to lower growth prospects in several jurisdictions as well as the prospect of currency devaluation. But in contrast to the experience of most industrial countries, the sharp devaluation in East Asian currencies did not result in an initial worsening of trade deficits-the so called "J-curve- effect"-but instead prompted an immediate reversal. South Korea experienced a sharp contraction in its current account deficit from US$23.7b in 1996 to US$8.9b in 1997. A sharp decline in the purchase of capital goods led to a contraction of the trade deficit from US$15.3b in 1996 to US$2.3b in 1997. Thailand, Indonesia and Malaysia shared similar experiences (see figure below).

>

Figure 14: The effect of the nominal devaluations on the visible trade balance
Indonesia	Thailand
Source: Indonesian Central Bureau of Statistics and Datastream/ICV	Source: Bank of Thailand and Datastream/ICV
South Korea	Malaysia
Source: Korean Customs Administration and Datastream/ICV	Source: Malaysian Department of Statistics and Datastream/ICV
Philippines
Source: Central Bank of Philippines And Datastream/ICV

Policy responses by some of these countries are thought to be partly responsible for this phenomenon. In light of the change in economic conditions, some jurisdictions suspended selected infrastructure projects which had been contributing to their significant trade deficits. Others imposed higher taxes on luxury items which contributed to a reduction of imports.

Monetary conditions tightened in several countries with the onset of financial turbulence. During the initial stages of the crisis, monetary authorities in several jurisdictions mounted a vigorous defence of their respective currencies. Although this was ultimately short-lived, interest rates rose sharply during the campaign and remained high throughout the rest of the year. For example, in Thailand, average daily repurchase (repo) and interbank rates nearly doubled in the second half of 1997 to 19.5% and 19.8% respectively.

In these economies, the subsequent contraction in liquidity placed a strain on the financial system and the corporate sector. The threat of corporate and financial insolvency arising from the economic slowdown became more acute with asset-price deflation while domestic banks saw non-performing loans swell as the value of their collateral rapidly-deteriorated. Higher non-performing loans and rising interest rates are believed to have also led to an adverse selection problem in the credit market, in that banks could not effectively distinguish between good and bad borrowers. This resulted in a significant credit crunch in Thailand, Indonesia, South Korea and Malaysia.