Asian economy in trouble, but not likely to revive 97 crisis, analysts say

A quarter of a century ago, a major financial crisis hit Asia, shaking its economies. Now, the ghost from 1997 is haunting the region again.

Currencies and equity markets in Asia’s biggest economies have fallen to lows not seen in decades, with the mighty US dollar, a rapid interest rate hike by the US Federal Reserve and a slowdown in China prompting capital outflows from the region.

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

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

Despite interventions by China’s central bank, the yuan – also known as the renminbi – continues to hover 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, fared even worse. The Japanese yen is down 26% this year, falling the most among all Asian currencies. In South Asia, the Indian rupee also fell to a record low, down 9% against the dollar on the year.

Japan’s gross domestic product grew at an annualized pace of 2.2% in the second quarter of this year as consumer spending picked up following the end of coronavirus restrictions on businesses.

“The Fed’s rapid monetary tightening is having repercussions far and wide,” said Frederic Neumann, HSBC’s chief Asia economist. “Even Asia, despite its robust macroeconomic fundamentals, is now facing increased financial market volatility,” he added.

As the intense pressure on major Asian currencies continues, some financial analysts are concerned that if the situation is left unchecked, it could lead to a financial crisis in the region.

“The strong dollar environment has raised questions about how Asia will be impacted and whether this will precipitate another financial crisis,” Morgan Stanley Chief Asia Economist Chetan Ahya wrote in a research report on Monday.

In the summer of 1997, a massive crisis was triggered in the region by the devaluation of Thailand’s currency, the baht. It sent shockwaves across Asia, leading to massive capital flight and stock market turmoil. The chaos led to a deep recession in the region, pushing companies into bankruptcy and bringing down governments.

But even if investors worry about a possible repeat, they are not in full panic, particularly as Asian economies are in a much better position to defend their currencies than they were back then.

ran to intervene

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

Japan’s finance ministry said last week it spent nearly $20 billion in September to slow the yen’s decline in its first intervention to support the currency since 1998.

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

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

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

In addition, these nations had huge foreign debt, weak corporate governance, and fixed exchange rates.

When the Fed began raising rates in the mid-1990s to counteract US inflation, the dollar began to rise, hurting exports from Asian countries that pegged their currencies to the dollar.

As growth slowed sharply in these economies, bubbles began to burst, triggering massive debt defaults and causing investors to flee.

The pressure on currencies was so intense that Thailand finally depleted its reserves defending its parity with the dollar. Thailand gave up its fixed exchange rate and devalued the baht against the dollar, triggering a series of currency devaluations in the region.

Today, as the world heads into a global recession, some of those same factors are emerging again, including an aggressive tightening by the Fed to contain inflation.

“The external environment [para a Ásia] has become more challenging in the context of the broad challenge of inflation and the near-synchronous and sharp pace of monetary tightening,” said analysts at Morgan Stanley.

Asia is “better placed” now

This time Asia has a war chest to fight back.

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

“Underlying macro fundamentals in Asia are better now compared to the mid-1990s,” he said, adding that currency buffers are sufficient to support capital outflows and smooth out market volatility.

“It is important to note that there is not the same accumulation of foreign currency debt in recent years, which was one of the triggers of the Asian financial crisis,” added Goh.

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

“Exchange rates have become more flexible, which helps to absorb most of the external pressure,” he said. “We don’t expect international reserves to drop to dangerously low levels anytime soon in key Asian emerging markets,” he added.

China and Japan have the two largest foreign exchange reserves in the world, with $3 trillion and $1.3 trillion, respectively. Combined, that’s a third of the world’s entire foreign exchange stack.

“There is $1.3 trillion in foreign exchange reserves. And you spend just under $20 billion. So, I mean, there’s a long way to go,” said Jesper Koll, CEO of Monex Group Japan. “The Bank of Japan will not run out of money.”

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

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

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

More pain ahead

But there is still pessimism ahead for the region’s economies. As US interest rates are set to rise further, the dollar is likely to rise further, slowing growth.

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

The outlook should improve in 2023, according to analysts.

“Asia’s resilience in the face of the current global storm is in part a result of the reform that the Asian financial crisis has brought about,” said HSBC’s Neumann.

“In the end, the region’s robust fundamentals will pass through these rough seas,” he said.

— Diksha Madhok in New Delhi contributed to this article.