Signs of a new Asian financial crisis 

IT’S been 20 years since the Asian financial crisis struck in July 1997. Since then, there has been an even bigger global financial crisis, starting in 2008. Will there be another crisis?
The Asian crisis began in Thailand when speculators brought down the baht. Within months, the currencies of Indonesia, South Korea and Malaysia were also bleeding badly. The East Asian Miracle had turned into an Asian Financial Nightmare.
The countries had been lavished with praise before the crisis, but beneath the success story weaknesses had built up, including current account deficits, low foreign reserves and high external debt.
In particular, the countries liberalised their financial system in line with international advice, enabling their private companies to freely borrow from abroad – mainly in US dollars. Companies and banks in South Korea, Indonesia and Thailand rapidly accumulated over 100 billion dollars of external loans. This was the Achilles heel that was to bring down economies.
The weaknesses made the countries ripe for speculators to bet against their currencies. When governments ransacked their reserves in a desperate bid to stem the currency fall, three of the countries ran out of foreign exchange, forcing them to go cap in hand to the International Monetary Fund (IMF) for bailout loans. These carried draconian conditions that worsened their economic situation.
Malaysia was fortunate: it halted the ringgit’s plunge and retained just enough in foreign reserves to avoid a humiliating plea for IMF loans.
After a year of self-imposed austerity measures, Malaysia dramatically switched course and introduced a set of unorthodox policies.
These included pegging the ringgit to the dollar, capital controls to prevent short-term funds from exiting, lowering interest rates, increasing government spending and rescuing failing companies and banks.
This was the opposite of orthodoxy and of IMF policies. The global establishment predicted the sure collapse of the Malaysian economy, but instead it recovered faster and with fewer losses than its neighbours. Today, the Malaysian measures are often cited as a successful anti-crisis strategy.
The IMF itself has changed a little, though it now includes capital controls in its policy.
The Asian countries, vowing never to go to the IMF again, built up strong current account surpluses and foreign reserves to protect against bad years and keep off speculators. The economies recovered, but never back to the spectacular 7 to 10 per cent pre-crisis growth rates.
Then in 2008, the global financial crisis erupted with the United States and its non-performing housing loans at the epicentre.
The underlying cause was deregulation of US finance that had given financial institutions freedom to devise all kinds of “financial products” to draw in unsuspecting customers. They made billions of dollars but the house of cards came tumbling down.
To fight the crisis, President Barack Obama embarked first on expanding government spending and then on financial policies of near-zero interest rates and “quantitative easing”, whereby the Federal Reserve pumped trillions of dollars into US banks.
The idea was that cheap credit would get consumers and businesses to spend and lift the economy. But instead, a significant portion of the trillions went via investors into speculative activities, including abroad to emerging economies.
Europe, on the verge of recession, followed the US with near-zero interest rates and quantitative easing, with limited results.
The financial crisis affected Asian countries in a limited way through declines in export growth and commodity prices. The large foreign reserves built up since the Asian crisis, plus the current account surplus situation, acted as buffers against external debt problems and kept speculators at bay.
Just as important, hundreds of billions of funds from the US and Europe poured into Asia yearly in search of higher yields. These massive capital inflows helped to boost Asian countries’ growth, but could cause their own problems.
First, they led to asset bubbles or rapid price increases of houses and the stock markets.
Second, many of the portfolio investors are short-term funds looking for quick profit, and they can be expected to leave when conditions change.
Third, the countries receiving capital inflows become vulnerable to financial volatility and economic instability.
If and when investors pull some or a lot of their money out, there may be price declines, inadequate replenishment of bonds, and a fall in the levels of currency and foreign reserves.
A few countries may face a new financial crisis.
A new vulnerability in many emerging economies is the rapid build-up of external debt in the form of bonds denominated in the local currency.
The Asian crisis two decades ago taught that over-borrowing in foreign currency can create difficulties in debt repayment should the local currency level fall.
To avoid this, many countries sold bonds denominated in the local currency to foreign investors.
However, if the bond value held by foreigners is high, the country will still be vulnerable to the effects of a withdrawal.
Almost half of Malaysian government securities, denominated in ringgit, are held by foreigners.
Though the country does not face the risk of having to pay more in ringgit if there is a fall in the local currency, it may have other difficulties if foreigners withdraw their bonds. – The Star/ANN

Martin Khor is executive director of the South Centre, an inter-governmental organisation of developing countries based in Geneva, Switzerland.