It seems like 1997 all over again

This follows the US Federal Reserve’s signal that it might taper off its money printing and assets purchase programme under “quantitative easing” (QE). All the emerging markets have been hard hit by the reversal of capital since May 22 when Ben Bernanke, the Fed chairman, indicated that the Fed would slow down its QE if the US economy improved. Brazil, India, Turkey and Indonesia have been acutely affected by the dollar outflow.

After the collapse of the US financial system in 2008, the zero interest-rate policy and QE helped drive the dollar to seek higher returns in the emerging markets. For almost five years, the dollar flow into the emerging markets created asset bubbles. Now the dollar is about to head to the exit. This abrupt reversal of dollar funds is wreaking havoc in the emerging markets.

According to Kasikorn Research Centre, Thailand did not take in much foreign capital in 2009. But in 2010 the dollar funds started to flow into Thailand en masse, driving up equity prices and boosting the bond market. Thai investors enjoyed the dollar-fund party, making profits from higher asset prices. The real estate sector surged with a boom. The cheap dollar took advantage of Thailand’s higher interest rate, relatively stable currency and economic growth potential. They all had a good time. It was as if the party would never end.

In 2010 alone, foreign funds were net buyers of Thai bonds to the tune of Bt241.6 billion, compared with Bt81.70 billion for equities. In 2011, the foreign funds continued to buy up the Thai bonds, becoming net buyers of Bt140.20 billion. But they took profits out of the stock market by becoming net sellers of Bt5.10 billion in Thai equities. In 2012, the foreign funds chipped in another Bt289.80 billion in net buy into the Thai bond market, and also Bt76.40 billion in net buy in the Thai stock market.

These three years were the high tide in the Thai financial markets, with the foreign investors providing the dollar to finance the party. Thai investors and policy-makers took it for granted that the dollar would be here to stay due to the sluggish recovery in Europe and the doubtful economic prospects in the US.

The money party continued in the first quarter of this year. Then on May 22, Bernanke came out to say that the party was over. The Fed might taper its QE. Since then the dollar funds have gone into reverse. It was a normal exit in the beginning, but now it looks more disorderly, and is disrupting the financial stability of the emerging markets.

In the early part of this year, foreign funds were still net buyers of Thai bonds, at Bt16 billion, but they took profits from the stock market with a net sell of Bt113.40 billion. Since May, the Thai stock market has lost more than 20 per cent of its value. The market capitalisation, which peaked at Bt13.5 billion, has fallen to less than Bt11.5 billion. More than Bt2 trillion in wealth effects has been wiped out in a hurry.

And this is just the beginning of the crisis, which is now reminiscent of the 1997 crisis. Brazil has just raised its interest rate by a 0.50 percentage point to 9 per cent to combat inflation. It has set up $60 billion in a foreign exchange fund to stop the real from plummeting. India has introduced a series of capital control measures to protect the rupee from a free fall. Indonesia has also introduced drastic measures to revive its sagging rupiah and deteriorating macro-economic conditions.

Now is not the time to sit back. The authorities must focus on economic stabilisation rather than trying to boost growth as in the past. The fiscal programme must be considered and the budget spent very efficiently to save bullets for future needs. All efforts must be made to protect the baht, which broke Bt32 against the dollar last week, from sliding downhill. It is time to stay tight and hold on for a rough ride ahead.