Danger lurks even as the good times roll

Published July 2, 2007

COMMENTARY

Danger lurks even as the good times roll

The Asian crisis seems like a long time ago but it's still worth remembering

By VIKRAM KHANNA
ASSOCIATE EDITOR


ON this day 10 years ago, after relentless pressure from speculators and with its foreign exchange reserves wiped out, Thailand floated the baht, which had, until then, been fixed to the US dollar.

The baht flotation is widely reckoned as one of the triggers of the 'Asian crisis' that was to sweep the region's economies for the next eighteen months.

The crisis seemed to come out of a clear blue sky. For several years preceding, in report after report, Asia's torridly growing economies had been held up for their dynamism, openness, and macroeconomic stability. In 1993, the World Bank had published a study entitled The East Asian Miracle, extolling the region's economic virtues.

By July 1997, economists were telling a different story. Countless sins that had, for the most part, been overlooked or forgiven, were dredged up: mismanaged exchange rates and capital flows, lax supervision of banks and companies, weak legal systems, cronyism run rampant.

The crisis spread from country to country like an epidemic. After Thailand floated the baht, the currency promptly took a dive. At the end of June '97, it was at around 24 to the US dollar. On Jan 12, 1998, it was close to 56.

The Indonesian rupiah dived deeper, going from 2,400 to the dollar to 16,500 by June 1998. The Malaysian ringgit and South Korean won also went into a tailspin.

As it spread, the crisis morphed. What seemed to start as a currency crisis became a financial and banking crisis and then a wider economic and political crisis. Thousands of Asia's companies went bust under the weight of plummeting currencies and rising interest rates, sending banking systems reeling.

Stock and property prices crashed. In 1998, the most affected countries - Indonesia, Malaysia, Korea and Thailand - saw their real income per head shrink by an average of 11 per cent. Millions were thrown out of work.

In Indonesia, the 32 year-old Suharto regime collapsed. In Thailand, tycoon Thaksin Shinawatra capitalised on the crisis to ride to power on a populist platform.

Distant memory

Today, Asia is booming again and the 1997 crisis seems a distant memory. Across the region, economic growth has bounced back - although it remains less heady than in the pre-crisis years, except in China and India. Construction cranes are once again dotting the skylines of Asian cities. The ranks of the super rich are swelling faster in Asia than anywhere else.

The fixed exchange rate regimes that were billed as a key cause of the crisis have also largely gone (and with them, the implicit guarantees of continued fixity) - although many economists, including those at the International Monetary Fund, note that Asian currencies are still not flexible enough.

Banking systems around the region have, by and large, been cleaned up. A lot of dud assets have been sold off. Once heavily-indebted companies have recovered and corporate governance has improved, even if it remains wanting. Stock and property markets have come back in most countries.

And after a decade of current account surpluses and generous infusions of foreign investment, Asian central banks have amassed huge war-chests. Total reserves of Asia ex-Japan have soared to more than US$2.5 trillion, a roughly ten-fold increase from 1997. Surely, it is thought, Asian countries are no longer crisis-prone - or at least they have large-enough resources to cope.

Perhaps. But the next crisis, if there is one, is unlikely to be like the last. Nor are large resources necessarily insurance enough - for example, they could not prevent Japan from suffering a crisis in the 1990s. Moreover, for all their apparent health, Asian economies are far from invulnerable.

Take Korea's banking system. It had recovered by 2002, thanks to public capital injections, bank closures, consolidations, foreign investment in the banking sector and successful asset sales, as well as better governance.

But this did not stop a credit card crisis from erupting in 2003. Liberalised rules on credit card issuance led to the emergence of millions of over-leveraged borrowers and delinquencies.

From time to time, experts have also drawn at tention to the fragility of China's banking system, which has made loans at a breakneck pace - often without adequate credit checks - amid a long investment boom.

A May 2006 report by Ernst & Young (later withdrawn after protests from Beijing) claimed China's bad loans to be more than US$900 billion, more than five times official estimates.

Many countries in Asia - particularly Indonesia, Thailand, China and Vietnam - have yet to move away from relationship-based banking systems to rules-based ones. Legal frameworks, including bankruptcy and foreclosure procedures in these countries are also less than robust - all of which increases their vulnerability to crises.

Some economists, like Nouriel Roubini of New York University, also warn that the reluctance of Asian countries to sufficiently let their currencies rise has helped create Asia's reserve build-up. The reserves may be too much of a good thing: the incomplete sterilisation of the capital inflows that add to them has led to explosive domestic liquidity growth and less-than-judicious lending to the household sector. And that, in turn, has fed asset bubbles in stock and property markets - many of which have run up far in excess of what economic fundamentals can justify.

Nor is there any shortage of potential threats or shocks that could bring these latent economic weaknesses to the surface. One is a possible 'hard landing' of the US economy, which would lead to a serious slowdown in China and other export-dependent Asian countries, and trigger a new wave of non-performing loans.

Another nasty surprise could come from the currency markets. A US dollar sell-off - for whatever reason - could mean a sharp appreciation of Asian currencies, an exchange-rate shock that would feed through to exports and growth.

Other uncertainties

There are other uncertainties in a world where financial markets are even more globalised now than in 1997: to what extent are Asian entities exposed to the so-called 'collateralised debt obligations' or CDOs, which are primarily backed by dubious US 'sub-prime mortgage' assets? How well would Asian markets cope with a rapid reversal of the yen carry-trades, under which investors have borrowed cheaply in yen to invest in higher-yielding assets, including in Asia?

These are only the known unknowns. As the 1997 Asian crisis taught us, there are also 'unknown' and 'partially known' unknowns. This is why, although it seems like a long time ago and Asia has changed beyond recognition, the Asian crisis is still worth remembering.