In economic crises, history doesn’t repeat itself, but it sometimes rhymes. (American humorist Mark Twain may have said this.) In this case, it’s not rhyming. But it’s not a pretty song, either.
Until the 2008-2009 global economic crisis, the reference point for Asian stock market and economic collapses was the 1997 crisis. (Just like until World War II, the First World War was called the Great War.) But as the 2008-2009 crisis is the most recent crisis – and the only one many investors and traders in global markets have experienced – it’s easy to forget the context of 1997.
On the surface, what’s happening now – collapsing asset prices, declining currencies, and capital leaving the region – sounds a lot like what happened during the last major economic crisis in Asia, in 1997.
The immediate trigger of the 1997 crisis was the collapse of the Thai baht in the face of a severe loss of confidence on the part of investors. Equity markets around Asia hit multi-year lows as fears of financial contagion and a worldwide economic meltdown rose. The International Monetary Fund, a lender of last resort to governments, had to step in to stabilize some currencies.
The biggest economy in Asia at the time played a key role as well. In 1996 and 1997, a big banking scandal, and a misguided tax hike, shook the yen and hurt Japan’s economy – which had already been stuck in quicksand for years. But Japan was still the single largest source of foreign direct investment for the region’s economies, and a driver of growth in the region.
Japan’s struggles helped expose structural problems elsewhere in Asia. Large current account deficits, which meant that countries were borrowing more money from abroad than was being invested in the country, didn’t matter when growth was strong and investment from abroad was high. But as Japan’s economy slipped, so did those of a number of other countries in the region, so these deficits became a big problem for their economies – and their currencies.
Part of the problem was that many of the region’s currencies were pegged to – that is, were linked to – the U.S. dollar. The yen’s depreciation against a strong dollar led to currency devaluations around the region. Companies, banks and governments had all borrowed huge sums of U.S. dollars at a time when their revenue was still in local currency. So, devaluation meant that many companies and banks faced huge challenges to pay back debts.
For example, suppose a company had borrowed $100 when the baht was pegged at 25 units to the U.S. dollar. By the time the currency hit its lowest point of 56 units to the U.S. dollar in January 1998, the firm would effectively have had to pay back more than $220 on the original $100 debt. A lot of companies couldn’t do this.
Also, weak bank lending standards, cozy relationships between banks and borrowers, and poor regulatory oversight had for years let companies throughout Asia take on excessive risk. So when companies found it more difficult to pay back loans banks suffered. This drove so-called “hot” money away (mostly foreign portfolio investment that could be easily and quickly sold), which made the situation worse.
How do conditions compare now?
For starters, China’s economic slowdown now plays the role of Japan. And now it’s the sharp depreciation of the Chinese renminbi (rather than the yen) against the U.S. dollar that is spooking markets.
But that’s about where the similarities end. After years of financial prudence, improved risk management and stronger corporate governance, most Asian economies are in a much better position than they were in 1997. Also, governments provide a lot more data on the banking sector and the overall economy, so investors don’t have to guess and assume the worst. (Back in 1997, Thai authorities failed to disclose US$30 billion in bets the country had made in currency markets.)
Also, most governments in Asia have built up their foreign exchange reserves, which are a lot bigger than they were in 1997. By building up reserves, a country is better able to pay its debts without stretching, and without needing to borrow more from abroad. Compare this to 1997, when Hong Kong, India, Indonesia, South Korea, the Philippines, and Thailand all ran substantial deficits.
From a currency perspective, most Asian countries dropped their link to the U.S. dollar after the 1997 crisis. Today, the market plays the central role in determining exchange rates (China and Hong Kong are the big exceptions in the region). A more flexible exchange rate is an economic relief valve for countries in times of economic stress, because it makes them more competitive in the global market.
But every crisis has its own pedigree. The 2008-2009 global economic crisis was a U.S.-driven credit and liquidity story – rather than a problem created in Asia. And just because the current crisis doesn’t look much like what happened in 2008, or 1997, doesn’t mean that it couldn’t be just as bad.
Today, the region’s export dependency on China has increased. China is the largest or second-largest trade partner to much of Asia. An economic slowdown in China is like a boulder being dropped in a pond, with ripples that threaten growth throughout the region as demand slows.
Meanwhile, the volatility of China’s renminbi is alarming investors. Increasingly they’re turning to cash – the best hedge there is.
Besides scaring investors, weakness in the renminbi is also a big threat to the region’s economies. A more competitive China – due to a weaker currency making its exports cheaper, in local currency terms – could undercut other Asian producers. And currencies throughout Asia are coming under pressure as the renminbi weakens.
China’s stock market, or at least the Shanghai Composite Index, is down 10% already this year, and it could easily drop more. This gets headlines, but its impact on the rest of Asia is actually a lot less than what’s happening with the renminbi.
Healthier country balance sheets, lower debt levels, more flexible exchange rates and better regulatory oversight have put Asian economies in a stronger position. So what’s happening now in Asia doesn’t look like much like 1997. With China as the shaky foundation of Asia, the next crisis, whenever it happens, will be all new.