In the summer of 1997, the seeds of the Asian financial crisis were sown by the devaluation of the Thai baht but 20 years later is the region at risk of fresh turmoil?
Following the baht’s devaluation – which was caused by the Thai government being forced to float the currency due to lack of foreign currency to support its peg to the US dollar – investor confidence in the region tumbled and capital flew out of Asia at an alarming pace: net private capital inflows went from $110bn in 1996 to net outflows of $11bn for the crisis-hit countries.
Most of south-east Asia and Japan was hit by slumping currencies, devalued stock markets and a jump in private debt as the crisis spread. The chart below shows how the FTSE Asia Pacific index fell by more than 40 per cent before starting to recover in the third quarter of 1998.
Performance of index in 1997 and 1998
Source: FE Analytics
The countries most affected by the crisis were Thailand, Indonesia and South Korea, but Hong Kong, Laos, Malaysia and the Philippines were caught up in the slump. Brunei, China, Singapore, Taiwan, and Vietnam were suffered less, although by no means escaped its fallout, while Japan was affected less significantly.
Some 20 years later and some investors are now concerned that a fresh financial crisis could be sparked in Asia, this time by the growing debt of China. China's debt is now more than 250 per cent of GDP and credit rating agency Moody's recently downgraded the country for the first time in three decades, citing this issue as one of the reasons.
However, those believing that this could lead to a new financial crisis are likely to be mistaken, according to Liontrust Asia Income managers Mark Williams and Carolyn Chan.
Asked if the Asian financial crisis could happen again, Williams said: “I think it’s very unlikely. In 1997, the region was overleveraged and much of this debt was owed overseas. Debt levels are still quite high today but the key distinction between then and now is that the debt profile has changed significantly.”
Chan added: “Asia is now far less reliant on foreign capital. After the Asian financial crisis, Asian countries devalued their currencies and benefited from export-led recovery. But Asia was lucky in some respects that the US economy was strong at the time, driving export demand.
“This foreign reliance needed to be addressed as a resilient regional economy should be able to cope with downturns in its export markets and outflows of international capital. In this respect, the emergence of China has reduced reliance on the US, while the establishment of the Chiang Mai Initiative was another important step and established a network of bilateral currency swap agreements which provided liquidity support to the region.”
Williams pointed out that the “vast majority” of China’s debt is funded domestically, which means that a sudden disappearance of funding sources – as was experienced in the Asian financial crisis – is unlikely to be seen again. Indeed, across Asia companies are now less reliant on high levels of foreign debt and an assumption of fixed exchange rates than they were two decades ago.
Performance of fund vs sector since launch
Source: FE Analytics
Furthermore, China’s debt is primarily owed by the state or state-owned enterprises to the state or state-owned banks, making it easier for debtors and creditors to reach agreement in the areas where debt is unsustainably large. Another positive is the fact that China has huge forex reserves and a centrally directed economy, which can in Williams and Chan’s view can withstand a lot of stress without any systemic problems developing.
David Jane, manager of Miton’s multi-asset fund range, agreed that the potential for China’s debts to be at the centre of another financial crisis appears to have eased more recently.
“Not so long ago, China was feared as the potential cause of the next great financial crisis, yet headlines regarding a debt crisis in China are now rarely seen, at least in the West. In the background, the Chinese authorities have been quietly cleaning up the secondary banking system, sorting out the state-owned enterprises and working on its One Belt One Road policy,” Jane said.
“Western commentators’ problem with the Chinese economic development model is the system’s structure, driven by central planning and control, rather than markets forces, often leading to capital misallocation. While there is fair criticism in the capital misallocation argument, this is also a feature of Western systems. In our view, the main problem is a substantial excess of savings and a lack of opportunities to invest.
“While China’s financial system is far from squeaky clean, its risk of unravelling in a dramatic fashion is much reduced. Unlike Western banking systems, the Chinese authorities have a high degree of control over the main actors in the system. However, the problem of excess savings remains.”
That’s not to say that China’s debt mountain is of no cause for concern. Freya Beamish, chief Asia economist at Pantheon Macroeconomics, said that more worrying than the size of China’s debt is the rapid pace at which it has grown.
“China's total debt stock is high for a country at its stage of development, relative to GDP, but it is sustainable for country with excess savings. China was never going to be a typical emerging market, where external debtors can trigger a crisis by demanding payment. The external debt problem has been enough to give the authorities difficulties in their endeavours to cede control of the RMB [renminbi], but China has FX reserves of 28 per cent of GDP with which to appease angry foreigners,” she said.
Chinese debt levels
Source: Pantheon Macroeconomics
“We don't worry much, then, about the level of Chinese debt. But we do worry about the rate at which it has grown. China's debt growth has more in common with Japan in the early 1990s than with other, crisis-prone emerging markets. Historically, the rate of change of debt has been a better predictor of systemic banking crisis than any magical level over which countries cross only at their peril.
“The explanation for this is straightforward: The rate of increase of debt is a good predictor of future bad debts because it is just infeasible for lenders to find viable projects at a rate that vastly exceeds the potential growth of the economy. Bad debt, therefore, is rife in China. But we think Armageddon is unlikely.”