The Asian financial crisis – back to the future?

A strong dollar has traditionally spelt bad news for emerging markets like those in Southeast Asia. Indeed, it was the principal cause of the Asian currency crisis that began on July 2, 1997, when Thailand devalued its currency relative to the greenback. The move followed months of speculative pressures that had substantially depleted Thailand’s official foreign exchange reserves. The devaluation triggered a deep financial crisis across much of East Asia with currencies, equity and property markets all weakening substantially. Some Asian countries entered deep recessions, that also sparked political crises. It led to the downfall of the Suharto regime and a second people power uprising in the Philippines; as well as a coup in Thailand.

Yet few analysts saw the financial tornado developing. Indeed, the years up to the crisis saw much talk of how other countries should emulate the so-called Asian values that had powered Southeast Asia’s economic miracle. So, 25 years later, as US interest rates and the dollar rise sharply, how likely is another crisis? Some countries are already encountering severe difficulties. Laos, admittedly a small and vulnerable economy, is certainly struggling. There are long queues outside the few petrol stations that are open, food prices are rising fast, and such is the cost of servicing the country’s dollar-denominated debt that talk of default is in the air. In April, petrol and diesel prices rose 72% and 96.6% year on year respectively, according to the Lao Statistics Bureau. Meanwhile, the price of food staples such as eggs and noodles have doubled leaving many Laos facing severe economic hardship.

In mid-June, Moody’s Investor Service downgraded Laos’ sovereign debt rating one notch further into non-investment grade, or “junk” territory, to Caa3 from Caa2. The rating agency said Laos’s default risk would “remain high given very weak governance, a very high debt burden and insufficient coverage of external debt maturities” by foreign exchange reserves. Laos’ problems follow hot on the heels of those seen in Sri Lanka, which in June became the first Asia-Pacific country in decades to default on its foreign debt.

The country’s problems began last September when the Lao currency, the kip, began to fall against the dollar, a process that accelerated sharply after Russia invaded Ukraine. That caused the price of key commodities -priced in dollars such as oil - to rise sharply, while the prospect of rising US interest rates to counter inflation turbocharged the greenback. The country has borrowed heavily in recent years, much of it in dollars, prompting warnings that it could fall into a Chinese debt trap, to pay for the likes of the high-speed railway that now connects the capital Vientiane with Luang Prabang in the north before heading onto Kunming in China. Public and publicly-guaranteed debt rose to $14.5bn, or 88 per cent of gross domestic product in 2021, up from $12.5bn, or 68 per cent of GDP in 2019, according to the World Bank, half of it owed to China.

Figure 1: The tumbling kip is raising the cost of servicing Laos’ dollar-denominated debt

Public anger is reportedly mounting with chatter on social media about possible street protests, although none have materialized so far. The police are likely to deal severely with any that do take place. However, given the failure of current policies, change could well come from within the government. There are rumours, for example, of divisions within the administration with younger technocrats arguing for greater liberalization and diversification of the economy.

Yen/dollar rate the key?

Meanwhile, in early June Jim O’Neill, the former Goldman Sachs economist most famous for coining the term “BRICs,” reportedly said that the U.S. dollar could spark a new Asian financial crisis if the Japanese yen sinks to 150 against the greenback — a level last seen in 1990. Those remarks were made before the Federal Reserve raised its key interest rate by three quarters of a percentage point to a range of 1.5% to 1.75%, the biggest hike in 30 years, a move which will only boost the appeal of the dollar. More hikes are expected with some indicators suggesting US borrowing costs could reach 3.4% by the end of the year.

O’Neill warned that if the yen depreciates further to 150 against the dollar, that could kick off a rerun of the 1997 Asian Financial Crisis. As of 16 June, the yen stood at 132 to the US dollar, having stood at just over 100 at the end of 2020.

With the Fed pressing the monetary tightening pedal, Asian central banks are likely to come under pressure to follow suit to prevent their currencies weakening and to prevent a large increase in destabilizing capital outflows. The rise in US interest rates will also present further challenges to Asia’s economic recovery. It increases the likelihood of a sharp slowdown in growth or even a recession in the US, a major export market. Meanwhile, higher borrowing costs in Asia are likely to slow investment and consumer spending. All that at a time when Asian economies, such as Thailand, Malaysia and the Philippines, have yet to recover fully from the economic hit of the COVID-19 pandemic. Industries that are particularly rate-sensitive, such as construction, are likely to be the hardest hit. Higher rates will also raise the costs of all types of borrowing, from mortgages to credit cards and car loans.

Lessons learned from the previous crisis

Overall though, most Southeast Asian economies seem in relatively good shape to weather any economic downturn and a repeat of the Asian Financial Crisis seems unlikely. The level of dollar-denominated debt throughout the region, as well as overall debt levels, are relatively low and most countries will have little problem servicing their debt even if the dollar does rise in value. Countries also learnt lessons from the Asian financial crisis. Take Indonesia, one of the worst-affected countries in 1997. Following the crisis, Jakarta introduced a cap of 3 percent of GDP on the size of the deficit in any one year. With almost $120 billion remaining in foreign currency reserves and a low debt-to-GDP ratio, Indonesia’s public finances are also in a sound position to continue defending the currency.

Figure 2: Dollar-denominated debt Asia

Worldbox Business Intelligence is a global solution provider of business intelligence and data analytics, headquartered in Zurich, Switzerland with research operations around the world.

Source: Worldbox