Kuala Lumpur: The next Asian contagion may be only a bad currency trade away.
Some 10 years after the collapse of Asian governments’ overvalued currencies in 1997, the remedies they embraced to prevent a recurrence may have only traded one set of risks for another. Their “never again” determination has led them to new extremes: artificially low currencies, a record $3.4 trillion (Rs139 trillion) in reserves and export-dependent economies.
“The currency and financial policies in Asia today risk planting the seeds of a new and different financial crisis,” says Nouriel Roubini, chairman of Roubini Global Economics and a professor at New York University’s Stern School of Business. “It’s a dangerous system both for these countries and for the global economy.”
In emerging markets, central banks and governments are grappling with risks including inflation, asset bubbles and vulnerability to a US slowdown. For investors, meanwhile, “risk has been underpriced,” Roubini says, with the result that “this can have negative effects on bonds, currencies and equity markets.”
Thailand sparked the Asian crisis in July 1997 when it devalued the baht in an effort to shore up its faltering economy, abandoning a costly policy of pegging the currency to the US dollar.
That set off a chain reaction that turned Asia’s investment and real estate boom into a bust, leading to a stampede among foreign investors to pull money out. The crisis worsened as foreign-exchange reserves proved insufficient to prevent the region’s currencies from plummeting.
Emerging markets have made some progress towards avoiding a similar catastrophe.
Central banks are more independent, government debt has declined, financial systems are stronger and current-account balances are generally in surplus. Economies from Russia to Brazil are booming while Indonesia, Thailand and Malaysia have earned higher credit ratings. South Korea, on the brink of default 10 years ago, recorded its 16th consecutive quarter of growth in the first three months of this year.
“A lot of lessons have been learned,” says the financier George Soros, whom Malaysia’s then-prime minister, Mahathir bin Mohamad, blamed for worsening the 1997 crisis through currency speculation.
Soros told reporters on 5 June in São Paulo that many economies “are incomparably better than they were 10 years ago.” Still, he said, some governments have learned “the wrong lesson”, citing price controls in Argentina and “very substantial reserves” in Brazil. Anwar Ibrahim, Malaysia’s finance minister during the crisis, says, “fundamental flaws have not been corrected.” Currencies are still inflexible, showing that “we are still in a state of denial”, he says.
As investors fled Asia after Thailand’s 1997 devaluation, they set off a plunge in other currencies that had previously been propped up through fixed exchange-rate regimes. The rupiah fell 57% against the US dollar, causing companies to buckle under $80 billion in foreign debt and leading to riots in Jakarta. The baht dropped 45%, and the Thai stock market fell 75%. The won lost half its value, and South Korea’s economy collapsed. The ringgit fell 35%. Hong Kong, China, Singapore, Taiwan and the Philippines also suffered. The crisis eventually spread to South America and to Russia, which defaulted on $40 billion of debt. Anwar says many governments still have not followed the International Monetary Fund’s advice to adopt flexible exchange rates that can help dissipate financial pressures.
“Fixed currencies are still a problem in the region, and they’re always politically motivated,” says Anwar, who was fired in 1998 when Mahathir imposed capital controls.
China, Hong Kong, Taiwan, Malaysia, Singapore, Thailand, India, Russia and Argentina still manage their currencies, generally maintaining artificially low levels. South Korea and Indonesia allow more flexibility.