"...emerging markets will grow faster than the
developed world for decades to come."

Gideon Rachman, The Financial Times

Asia set to play an important role in the global economy

Ten years later, certain countries’ economies are now more sophisticated, flexible, innovative and open

Ten years after the Asian financial crisis sent shock waves rippling through global financial markets, the region has emerged stronger than ever and is set to play an even more important role in the global economy.

And although the effects of the crisis still linger, the consensus opinion is that the region is now “overprepared” for a similar debacle in the future.

“There is not much scope for another crisis of this nature,” says Richard Kelly, senior economist with TD Bank Financial Group in Toronto. Rather, there has been a great deal of care taken to avoid a recurrence, he adds. There is no question of renewed stability in Asia, which today “represents a more reasonable risk.”

Chuck Bastyr, chief investment officer with Meadowbank Asset Management Inc. in Toronto, agrees: “Investors now have much more comfort investing in the region.”

The Asian crisis that emanated from Thailand in July 1997 was precipitated by massive speculative currency trading activity, leading to a dramatic decline in the value of several east Asian currencies, primarily the Thai baht, the Indonesian rupiah, the Malaysian ringgit, the South Korean won and the Philippine peso. These currencies, on average, lost more than half of their value by November 1998. The crisis spread rapidly across the region, reverberating through the global financial system and triggering fallouts in Russia and Brazil a year later.

As the crisis unfolded, business confidence in the banking systems of the affected countries deteriorated and a large number of businesses and financial institutions either became insolvent or reached the brink of bankruptcy. Investors suffered huge capital-market losses, while foreign investors abandoned the region in droves. Private demand collapsed and output contracted sharply, leading to massive unemployment.

Analysing the crisis in retrospect, the International Monetary Fund, in a May 2007 report, states that the Asian financial crisis proved to be a temporary setback in spite of its enormous economic and social costs: “Its hallmark was the sudden reversal of investor sentiment and abrupt withdrawal of international capital. Doubts about the soundness of financial institutions and corporations spread quickly across national borders, creating a vicious circle of capital outflows, plummeting exchange rates and crippling balance-sheet effects in the crisis-struck countries.”

The roots of the crisis lie in the fact that emerging Asian countries were benefiting from large capital inflows that spurred rapid economic growth. The region’s GDP growth averaged more than 7% annually during the 1990-96 pre-crisis period, with the most affected countries’ growth averaging as follows: Malaysia, 8.8%; Thailand, 8.6%; South Korea, 7.7%; and Indonesia, 7.2%.

Comparatively, the global economy, excluding Asia, was growing at an average annual rate of less than 4% in the same period. As a result, Asian businesses flourished, Bastyr argues, benefiting from high capital spending, buoyant exports, high consumption levels and the positive wealth effect created by the region’s surging economies and capital markets.

However, an estimated 50% of the capital inflows were in short-term funds rather than in direct long-term investments, thereby increasing the vulnerability of the region to sudden capital outflows. In addition, benign monetary conditions provided easy access to capital for the region’s economies, allowing them to run up huge current-account deficits, which further exacerbated their problems.

The allocation of the huge capital inflows led to booming asset prices, especially in real estate and equity investments. Faced with the prospect of “too much money,” the region’s central banks were reluctant to initiate a slowdown in economic activity by raising interest rates for fear of attracting still greater capital inflows. In addition, the fiscal authorities did not tighten fiscal policies enough to offset the expansionary effects of the capital flows. In essence, Asian central banks were caught in a catch-22 — too much capital and limited ability to respond without triggering a negative economic reaction.

Amid the crisis, the affected countries’ central banks adopted a range of measures to defend their currencies, including intervention in the currency markets, liquidity restrictions and capital controls. However, these measures were largely unsuccessful, forcing the central banks to unpeg their respective currencies from the U.S. dollar and to float them freely on the open market. Their actions eventually led to the value of their currencies free-falling as the governments lost the ability to defend them.

As the crisis unfolded, the region’s former economic tigers succumbed to acceptance of IMF conditions in order to stay afloat — even though the IMF had never dealt with a crisis of this magnitude. The IMF came to Thailand’s, Indonesia’s and South Korea’s rescue with loans totalling US$112 billion. However, the IMF prescribed tough medicine that caused considerable short-term pain with the hope of long-term gain under its restructuring plans.

Ten years later, certain countries’ economies are now more sophisticated, flexible, innovative and open

Among the conditions of assistance, which contributed to the region’s recovery in one way or another, were a tightening of monetary policy to stem exchange rate depreciation; structural reforms to remove features of the economy that had become impediments to growth, such as monopolies, trade barriers and non-transparent corporate practices; maintenance of sound fiscal policy, including the provision for rising budgetary costs of financial-sector restructuring, while protecting social spending; closure of unviable financial institutions, with the associated write-down of shareholders’ capital; and the recapitalization of undercapitalized institutions.

Since then, , says Ian Ainsworth, interim chief investment officer of Mackenzie Financial Corp. in Toronto, there have arguably been improvements in financial regulation and infrastructure; discipline has been imposed in the banking systems; governments have learned to channel underlying resources for expansion more effectively; and direct investing is more focused.

There have also been improvements in transparency, accounting standards, shareholder rights and corporate responsibility, Bastyr adds.

There has also been a resurgence of economic growth across the region, albeit somewhat slower in the five affected countries. In 1998, Indonesia’s GDP growth contracted by 13.2%, followed by Thailand’s by 10.8%, Malaysia’s by 7.5%, South Korea’s by 6.7% and the Philippines’ by 0.6%. Between 1999 and 2006, growth in these economies averaged almost 5%; and it’s forecasted to be about the same in 2007.

From an investor’s standpoint, emerging Asian markets have been experiencing a secular bull market over the past five to six years, Bastyr says. For the one-year period ended July 31, the MSCI Philippines index was up 68.4% in US$, followed by Indonesia, 61.6%; Malaysia, 57.9%; Korea, 46.8%; and Thailand, 40.8%. These markets have also produced impressive three- and five-year returns, ranging from 20.9% in Thailand over three years to 46.7% in Indonesia; and 16% in Malaysia over five years to 39.6% in Indonesia.

More important, Kelly says, the region has accumulated record-high foreign currency reserves, external debts are significantly lower and borrowing/lending activities are subject to a lot more controls. In addition, while export growth has averaged almost 20% annually over the past five years, more than half of all exports are intraregional, reducing dependence on U.S. and European markets. The emergence of China as an economic powerhouse has helped to solidify regional trade and growth.

The exchange rate regimes are also now much more flexible, providing greater scope to deal more efficiently with external shocks; most corporations that were heavily indebted are now in net cash; and Asia is beginning to develop its own bond market to access local cash, thereby reducing the “foreign funding element,” Bastyr says.

In a June report, the Washington, D.C.-based Brookings Institution summed up the current state of the east Asian economies: they are more sophisticated, flexible, innovative and open; tariffs have been cut by half; there has been a shift from diversification to specialization in production; local currency markets are more diversified, reducing risk; growth is smarter, with innovation playing a larger role relative to investment; and social and political landscapes across the region have been transformed by urbanization, demographic shifts and far greater transparency and political dialogue.

Asia has learned valuable lessons from the 1997 crisis and has taken appropriate steps to avoid a recurrence. Bastyr believes that the equity markets still have a far way to go, as the local population remains risk-averse, preferring bank deposits: “There is tremendous potential for growth once the shift from safety to the stock market occurs.”

Kelly argues that excess foreign reserves can be counterproductive and the excess can be used for more productive purposes.

However, with the rebirth of the so-called “Asian miracle” — now accentuated by a booming China — the region is certainly well positioned to lead global growth.

Dwarka Lakhan

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.


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