Why US efforts to curb inflation won’t lead to another Asian financial crisis

Banks, balance sheets and local-currency bond markets are more robust than in 1997, there are no destabilising capital flows, and most currencies are no longer tightly pegged to the dollar
There could be pockets of weakness but China’s projected economic rebound later this year will help regional recovery

Hoe Ee KhorandKimi Xu Jiang

Published: 11:30am, 7 Aug 2022

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Hawkish shifts in the US Federal Reserve’s monetary policy have often led to heightened financial and economic stress in emerging economies.

In the early 1990s, the Fed raised interest rates preemptively to curb inflation, precipitating the Mexican “tequila” crisis. In 2013, the Fed signalled its intention to tighten monetary policy, resulting in the major emerging-markets sell-off known as the “taper tantrum”.

Given the region’s history, one might expect policymakers in the Asean+3 countries – the 10 members of the Association of Southeast Asian Nations, together with China (including Hong Kong), Japan and South Korea – to be particularly anxious about the Fed’s increasing hawkishness.

Indeed, recent Fed efforts to curb inflation have prompted fears of a regional financial crisis, similar to the 1997 Asian financial crisis.

But the Fed’s actions will not have as much impact on the region as they did in the late 1990s. Today, the Asean+3 economies are stronger and more durable, making a 1997-style meltdown improbable.

The 1997 crisis was mainly caused by macroeconomic imbalances and sharp capital flow reversals, triggered by speculative attacks on the Thai baht and other regional currencies.

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East Asian economies had enjoyed rapid growth before the crisis – funded by surging capital inflows and excessive foreign lending – but without sound regulation and policy. Most Asian currencies were pegged to the US dollar, bank regulatory frameworks were simpler, and capital buffers were low.

Painful structural reforms since have helped Asean+3 economies rebuild balance sheets, strengthen economic fundamentals and establish robust regulatory frameworks. Policymakers have also assembled a formidable, multilayered US$8.8 trillion financial safety net.

In addition to foreign reserves of US$7 trillion, the Asean+3 economies can now rely on multilateral swap arrangements such as the Chiang Mai Initiative Multilateralisation agreement, and the International Monetary Fund.

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Most emerging Asean+3 economies have run current account surpluses in recent years. In contrast, crisis-hit economies ran persistent current account deficits and relied on external funding in the years before 1997.

The Asean-4 (Malaysia, the Philippines, Indonesia and Thailand) have run current account surpluses for most of the past two decades, except for Indonesia, which ran a small deficit.

Bank Indonesia headquarters in Jakarta on June 21. Asean banks are in a healthier state than they were before 1997. Photographer: Bloomberg

Moreover, banks in the region are much sounder and more resilient. They are generally well capitalised, with sufficient liquidity buffers since adopting the Basel regulations after the 2008 global financial crisis.

As a result, banks were generally on a sound footing going into the Covid-19 pandemic, allowing them to dip into their regulatory and countercyclical capital buffers.

Furthermore, the local-currency bond market in Asean+3 has increased to 123 per cent of gross domestic product this year, compared to 74 per cent of GDP in 2000. With the ability to borrow in local currency, debts are no longer as exposed to currency mismatch.

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Likewise, capital flows have not been surging into the region as they did in the run-up to the last two financial crises. In Asean-4 markets, net capital outflows have been relatively mild, and capital inflows consist mainly of relatively stable direct investments. In South Korea, portfolio inflows increased during the pandemic as investors saw Korean bonds as safe assets.

Lastly, East Asia’s economies – especially the crisis-affected Asean-4 economies and South Korea – no longer operate tightly pegged exchange rate regimes, allowing their currencies to adjust to market forces as a buffer against shocks.

The few economies that still peg their currencies to the US dollar or a currency basket have managed to fend off speculative attacks through strong foreign exchange buffers and prudent fiscal policies.

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Admittedly, there could be pockets of weakness. The pandemic is not over, and each economy’s recovery trajectory will depend on its ability to adapt and seize new opportunities. US monetary tightening could adversely and unevenly affect financial markets in Asean+3, and might trigger portfolio outflows similar to the 2013 taper tantrum.

In recent months, investors sold stocks in South Korea and the Philippines, and reduced their positions in Indonesian and Malaysian bonds. However, these outflows have been relatively insignificant and do not threaten financial stability.

China’s rebound will also contribute to the region’s recovery, with the economy forecast to bottom out and regain momentum during the second half of the year, with full-year growth expected at around 4.8 per cent.

Rising US interest rates will probably lead to some capital outflows and higher borrowing costs for Asean+3. But a full-blown 1997-style financial crisis remains unlikely. The region has moved on.

Hoe Ee Khor is chief economist at the Asean+3 Macroeconomic Research Office. Kimi Xu Jiang is an economist at the Asean+3 Macroeconomic Research Office. Copyright: Project Syndicate

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