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Asian economies are better equipped to weather external shocks and financial pressures owing to buffers built and reforms undertaken in the wake of the Asian Financial Crisis, which began twenty years ago this week, says Fitch Ratings.
The shift from fixed to more flexible exchange rates is one of the key differences from 1997. The four hardest-hit countries – Korea, Indonesia, Malaysia and Thailand – had fixed or heavily managed currencies at the time. This allowed exchange-rate misalignments to build and exposed the countries to speculative attacks, like the one that triggered the sharp devaluation of the Thai baht that set off the crisis.
Most Asian economies are also less reliant on net capital inflows, with current-account surpluses rather than deficits now the norm. Of the crisis-struck countries, only Indonesia runs a current-account deficit, which at 1.8% of GDP is smaller than the deficits in the lead-up to 1997. Thailand, for example, ran a deficit of 8.0% of GDP in 1996, Malaysia and Korea around 4.0% and Indonesia 2.8%.
Meanwhile, most central banks have built foreign-exchange reserves to levels allowing for significant scope to service external debts and, if they see a need, support currencies. In any case, exchange-rate depreciation is no longer the threat it once was to the health of Asian economies due to generally lower external-debt ratios and more widespread use of foreign-exchange hedging. The cost of servicing foreign-currency debt soared when currencies collapsed in 1997, causing a sharp rise in defaults with serious consequences for banking systems.
Banking sector supervision has also improved significantly. Lending standards and buffers against losses are stronger and balance sheets are more transparent. Moreover, Asian banks tend to fund their lending out of deposits – rather than relying on wholesale funding – making them more resilient to tighter market liquidity. Close relationships between banks and companies, which were at the core of the financial crisis, still exist to varying degrees, but in most countries they are not as cosy or pervasive as twenty years ago.
Regulators have become more active in other ways too. For example, macro-prudential tightening has cooled activity in several Asian housing markets during the last decade. A potential housing bubble appears to have been deflated in Singapore and while prices have continued rising in other markets – most notably Hong Kong – the tight regulatory stance has kept loan-to-valuation ratios low and protected banks against property-price shocks.
This is not to say the region is without risks. In addition to asset-price increases, a rapid build-up of household and corporate debt – mostly denominated in local currencies – during ten years of ultra-loose global monetary policy has created financial hazards. Private sector debt-to-GDP ratios are now close to, or above, levels seen during the Asian Financial Crisis in most economies. This makes financial systems sensitive to changes in economic conditions, particularly unemployment and real interest rates.
The region is also significantly more dependent on China, which has become one of the largest trading partners of most Asian economies. Financial fragility and leverage continue to increase in China and we expect slowing growth in coming years. The risks of an outright crisis are mitigated by several factors, including China’s relatively closed capital account and the significant proportion of banks and borrowers that are owned or heavily influenced by the state, which guards against the kind of collapse in creditor confidence that might trigger a financial crisis. Nevertheless, a sharp slowdown in China is one of the biggest risks to the rest of the region.