After sharp falls in emerging-market currencies and stocks over the past few weeks, some commentators have been drawing parallels to the 1997 Asian crisis: the rolling economic turmoil that gripped much of east Asia and southeast Asia almost two decades ago. Just like China’s recent decision to devalue the renminbi, the Asian crisis began with a largely unforeseen currency move: in early July 1997, Thailand was forced to abandon the fixed exchange rate between the baht and the US dollar after several weeks of attacks on the currency by traders who believed that it was overvalued.
Once the baht peg broke, traders turned their attention to the rest of the region and most other countries were also forced to abandon their pegs to the dollar. Over the course of the next year, the baht, the Malaysian ringgit, the Philippine peso and the South Korean won all fell by 35%-40%, while the Indonesian rupiah collapsed by more than 80%.
The effects on the region were severe. Investment dried up, inflation soared (due to the higher cost of imported goods), and companies that had borrowed in foreign currency to take advantage of lower interest rates were unable to repay their debts. Most economies went into recession, stockmarkets and property prices collapsed, and many countries saw political upheaval, including the ousting of Suharto, president of Indonesia, who had been in power since 1967.
So could we be heading for similar problems now? While the comparisons are understandable, today’s conditions look very different – and not least because the decline in Asian currencies so far has been much more modest than in 1997-1998. The ringgit, the worst affected, is down by around 18% so far this year – and that’s largely due to the 1MDB scandal (allegations of corruption surrounding a state investment fund) that have sent investors rushing for the exits. China’s headline-grabbing decision to weaken the renminbi barely registers: it’s down by little more than 3% so far this year.
But more importantly, Asia’s economic fundamentals look very different today. And that’s largely a direct consequence of what happened in 1997. In the aftermath of the crisis, Asian policymakers concluded that their greatest mistake was that they had been too dependent on fixed exchange rates and foreign capital inflows.
So they moved away from fixed exchange rates to floating exchange rates, while also trying to hold down their currencies against the dollar (in other words, deliberately made them weak). Weak exchange rates helped to improve the competitiveness of their exporters, allowing them to run trade surpluses and making them far less dependent on foreign investment.
The combination of trade surpluses and deliberate intervention to weaken their currencies meant that central banks have been able to build their foreign-exchange reserves, making them less vulnerable to attacks on their currencies. And the dangers of foreign currency debt seems to have been at least partly taken on board: Indonesia, which was the worst affected in this respect, has foreign-currency external debt equal to around 10% of GDP, compared with more than 50% on the eve of the crisis.
These changes mean that emerging Asia does not look vulnerable to a rerun of the crisis. This doesn’t mean that there are no risks in emerging markets: there are plenty of stress points in the gobal economy. But if the worst happens, it’s unlikely to look exactly like 1997 and Asia seems better placed than most to cope.
Why Asia learned to distrust the West
During the early 1990s, Asia was the world’s hottest investment destination, on the back of decades of rapid growth across much of the region. Foreign money flooded into the region, creating bubbles in stocks and property. Governments, businesses and investors came to believe the good times would last indefinitely and ignored the deteriorating fundamentals. The problems varied between countries, but broadly included rising debt, overvalued currencies, slim foreign currency reserves and a reliance on excess investment for growth.
When the crisis hit and capital inflows dried up, several countries were forced to turn to the International Monetary Fund (IMF) for support. The IMF provided billions of dollars in funding for Indonesia, South Korea and Thailand (Malaysia was offered aid but refused and chose to impose capital controls). But the bailouts came with tough conditions: the countries had to raise interest rates to support their currencies, which arguably helped to push them deeper into recession, cut government spending and allow insolvent banks to fail.
Some of these measures may ultimately have been beneficial – notably restructuring the banks. But they caused a great deal of pain and the IMF is still widely distrusted in the region today. The IMF’s actions fuelled the belief that it mostly acts in the interests of the West rather than developing countries – an idea more recently reinforced by the failure of Western countries to apply the same harsh measures to their economies in the aftermath of the global financial crisis. Asian economies concluded that they couldn’t rely on foreign investors and institutions, and attempted to insulate themselves from future crises by building up larger foreign exchange reserves through trade surpluses and export-led growth.