Asian economies are in trouble, but a 1997-style crisis is unlikely

Hong Kong/Tokyo
CNN business

A quarter of a century ago, a major financial crisis swept through Asia, shaking its economies to the core. Now, the ghost of 1997 is haunting the region again.

Currencies and stock markets in Asia’s biggest economies have plunged to their lowest levels in decades as a strong US dollar, rapid interest rate hikes by the US Federal Reserve and a slowdown in China fuel capital outflows in the region.

In a new report, the United Nations warned that the actions of the Fed, along with other central banks, risk pushing the global economy into recession.

China, the world’s second-largest economy, depreciated its currency, the yuan, to a record low of nearly 7.27 in international trade last week.

Despite the Chinese central bank’s intervention, the yuan—also known as the renminbi—remains near record lows in the offshore market. So far this year, it has fallen 11% against the dollar, on track for its worst year since 1994, according to Refinitiv data.

Japan, the world’s third largest economy, has fared even worse. The Japanese yen has fallen a whopping 26% this year, the biggest decline of any Asian currency. In South Asia, the Indian rupee has also hit a record high, falling 9% on the greenback for the year.

“The Fed’s rapid monetary tightening is sending ripples far and wide,” said HSBC chief Asia economist Frederic Neumann. “Even Asia, despite its strong macroeconomic fundamentals, is currently facing increased volatility in financial markets,” he added.

As the intense pressure on Asia’s major currencies continues, some financial analysts worry that if the situation is not controlled, it could lead to a financial crisis in the region.

“It has raised questions about how the strong dollar environment will affect Asia and whether this will trigger another financial crisis,” Morgan Stanley’s chief Asia economist Chetan Ahya wrote in a research report on Monday.

In the summer of 1997, a huge crisis arose in the region due to the devaluation of the Thai currency, the baht. It sent shock waves across Asia, causing massive capital flight and stock market turbulence. The chaos led to a deep recession in the region, companies went bankrupt and governments were overthrown.

But while investors are worried about a possible repeat, they are not in an outright panic, especially as Asian economies are in a much better position to defend their currencies than they were then.

Governments are already stepping in to stop the bleeding and prevent a repeat of the 1997-1998 breakdown.

Japan’s Finance Ministry announced last week that it spent nearly $20 trillion in September to slow the yen’s slide in its first intervention to boost the currency since 1998.

India’s central bank has so far used nearly $75 trillion to ease the rupee’s dollar volatility, Indian Finance Minister Nirmala Sitharaman said at an event last week.

Although China has not released any figures, the People’s Bank of China warned yuan traders last week that they could lose money if they bet against the currency in the long term.

One of the main causes of the crisis 25 years ago was an asset price bubble in the early 1990s created by a huge influx of investment in some Southeast Asian countries in search of quick returns, otherwise known as “hot money”.

In addition, these nations had high external debt, weak corporate governance and fixed exchange rates.

When the Fed began raising rates in the mid-1990s to combat inflation in the year In the United States, the dollar began to rise, hurting the exports of Asian countries that pegged their currency to the green card.

As growth slowed significantly in these economies, bubbles began to burst, leading to debt defaults. and sending investors fleeing.

The pressure on currencies was so intense that Thailand eventually exhausted its reserves defending the dollar’s parity. Thailand abandoned its fixed exchange rate and devalued the baht against the dollar, triggering a series of regional currency devaluations.

Today, as the world moves into a global recession, some of these factors are re-emerging, including the Fed’s aggressive tightening to contain inflation.

“The external environment [for Asia] has become more challenging in the context of the widespread inflationary challenge and the near-synchronous and sharp pace of monetary tightening,” Morgan Stanley analysts said.

This time, Asia has a war chest to fall back on.

“I don’t expect a repeat [1997] Asian financial crisis this time,” said Khoon Goh, head of Asia research at ANZ Research.

“The fundamental macro fundamentals in Asia are better now compared to the mid-1990s,” he said, adding that foreign exchange is sufficient to soften capital outflows and market volatility.

“Importantly, there is not the same amount of foreign debt in recent years, which was one of the drivers of the Asian Financial Crisis,” added Goh.

Policymaking has also improved in important ways to make future crises less likely, said Louis Kuijs, chief Asia economist at S&P Global Ratings.

“Exchange rates have become flexible, which helps absorb most of the external pressure,” he said. “We do not expect foreign reserves to fall to dangerously low levels anytime soon in key emerging markets in Asia,” he added.

China and Japan hold the world’s two largest foreign exchange reserves, with $3 trillion and $1.3 trillion respectively. Combined, they make up a third of the world’s total stockpile of foreign exchange reserves.

“There are 1.3 trillion dollars in foreign exchange reserves. And you spend 20,000 billion dollars for little. So, I mean, there’s a long way to go,” said Jesper Koll, chief executive of Monex Group Japan. “The Bank of Japan will not run out of money.”

Unlike in the mid-1990s, Asia’s external debt and private sector debt have remained stable.

“I think Asian countries in general have learned a lesson,” said Takuji Okubo, managing director and chief economist at Macro Advisors in Japan.

“I can’t think of any … stupid countries in Asia,” he said, adding that countries are now more cautious and have realized that “having a lot of dollar debt can cause significant problems when the money starts to come out in a downturn.”

But, there is still darkness for the economies of the region. With US interest rates expected to rise further, the dollar is likely to rise, slowing growth.

The World Bank recently cut its GDP forecast for the region to 3.2% from 5% this year. China in particular has cut its GDP forecast to 2.8% from 5%.

The outlook is expected to improve in 2023, according to analysts.

“Asia’s resilience in the face of the current global storm is partly the result of reform spurred by the Asian Financial Crisis,” HSBC’s Neumann said.

“Finally, the region’s strong foundations will see it through these rough seas,” he said.

– Diksha Madhok in New Delhi contributed to this article.