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Deepening market-driven economic integration in East Asia makes intraregional exchange rate stability across the region increasingly desirable and necessary. This paper suggests that East Asia's emerging economies begin with a currency basket system based on the G3 (US, Euro area and Japanese) or G3-plus (including emerging East Asian) currencies as a monetary policy anchor. This arrangement will enable all East Asian currencies to collectively appreciate vis-à-vis the US dollar, while maintaining intraregional rate stability, in the event of continuous surges of capital inflows to East Asia or a rapid unwinding of global payments imbalances. Such a system would contribute as an initial step to an East Asian monetary zone. After sufficient convergence and with stronger political commitment, East Asia may agree on more rigid intraregional exchange rate stabilization schemes through, for example, an Asian Snake or an Asian Exchange Rate Mechanism.

The East Asian crisis was the result of interactions between massive capital flows and weak domestic institutions. This paper examines the weaknesses in the financial and corporate sectors that were at the heart of the crisis, reviews the economic consequences of these weaknesses and outlines the progress in financial and corporate sector restructuring. Significant progress has been made in reforming East Asian financial sectors. Governments have committed themselves to improving the regulation and supervision of banks and non-bank financial institutions, raising competition in the financial sector, strengthening corporate governance, and developing local capital markets and equity financing. East Asia's experience has shown that if a systemic crisis in the financial and corporate sectors develops, governments need to put in place coherent frameworks for resolving banking and corporate distress. Governments will also need to segment the crisis and prioritise their responses.

Financial deregulation and capital‐account liberalization preceded speculative currency attacks in Thailand. A combination of de facto fixed exchange rates and high rates of interest generated excessive capital inflows, which led to too much liquidity chasing bad investments. The under‐supervised and over‐guaranteed financial sector extended loans excessively, particularly for non‐productive, speculative purposes. Non‐transparent practices, in the form of weak disclosure of institutions' true balance sheets and insider relations, masked these poor investments. The buildup of short‐term, unhedged debt left East Asian economies vulnerable to a sudden collapse of confidence. Currency attacks ran down official foreign exchange reserves. Rapid capital outflows and the consequent depreciation of currencies exacerbated the strains on private sector balance sheets. The policy lessons are to (i) use macroeconomic policy to avoid excessive capital inflows and currency overvaluation, (ii) strengthen the financial system, with proper disclosure and accounting requirements, stringent loan classification and provisioning rules, and capital adequacy requirements, prior to capital‐account liberalization, (iii) stabilize exchange rates based on currency baskets that reflect trade and investment linkages, and (iv) develop regional. financial cooperation with regional surveillance and peer pressure to maintain policy discipline.