A quarter of a century ago, a major financial crisis ripped through Asia, shaking its economies to the core. Now, the ghost of 1997 is haunting the region again.
Currencies and stock markets in Asia’s biggest economies have plunged to lows not seen in decades, as a mighty US dollar, rapid interest rate increase by the US Federal Reserve and a slowdown in China spark capital outflows from the region.
In a new report, a United Nations agency warned that the Fed’s actions, along with those of other central banks, risk pushing the global economy into recession.
China, the world’s second biggest economy, saw its currency, the yuan, fall to a record low of nearly 7.27 against the dollar last week in international trading.
Despite interventions by China’s central bank, the yuan— also known as the renminbi —continues to hover near record lows in the offshore market. So far this year, it has fallen 11% against the dollar, on track for its worst year since 1994, according to data from Refinitiv.
Japan, the world’s third biggest economy, has fared even worse. The Japanese yen has tumbled a whopping 26% this year, declining the most among all Asian currencies. In South Asia, the Indian rupee has also slumped to a record low, down 9% versus the greenback for the year.
“The Fed’s rapid monetary tightening is sending ripples far and wide,” said Frederic Neumann, chief Asia economist at HSBC. “Even Asia, despite its robust macroeconomic fundamentals, is now facing heightened financial market volatility,” he added.
As the intense pressure on major Asian currencies continues, some financial analysts are concerned that if the situation is not controlled, it may lead to a financial crisis in the region.
“The strong dollar environment has raised questions about how Asia will be impacted and whether this will precipitate another financial crisis,” wrote Morgan Stanley’s chief Asia economist Chetan Ahya in research report on Monday.
In the summer of 1997, a massive crisis was triggered in the region by the devaluation of Thailand’s currency, the baht. It sent shockwaves throughout Asia, leading to massive capital flight and stock market turbulence. The chaos led to a deep recession in the region, bankrupting companies and toppling governments.
But even as investors worry about a possible repetition, they’re not in a full-fledged panic, mainly because Asian economies are in a much better position to defend their currencies than they were back then.
Scrambled to intervene
Governments are already stepping in to stem the bleeding and prevent a rerun of the 1997-1998 meltdown.
Japan’s Ministry of Finance disclosed last week that it spent nearly $20 billion in September to slow the yen’s decline in its first intervention to prop up the currency since 1998.
India’s central bank has used nearly $75 billion so far to ease rupee-dollar volatility, Indian finance Minister Nirmala Sitharaman said at an event last week.
While China hasn’t disclosed any figures, the People’s Bank of China warned yuan traders last week that they will lose money in the long term if they bet against the currency.
One of the main causes for the crisis 25 years ago was the asset price bubble created by a huge inflow of investment into some Southeast Asian countries in the early 1990s in search of quick returns, otherwise known as “hot money.”
On top of that, these nations had huge foreign debt, weak corporate governance, and fixed exchange rates.
When the Fed started raising rates in the mid-1990s to counteract inflation in the United States, the dollar began to rise, hurting exports of Asian countries that had pegged their currencies to the greenback.
As growth slowed sharply in these economies, the bubbles started to burst, triggering huge debt defaults and sending investors fleeing.
The pressure on currencies was so intense that Thailand finally exhausted its reserves defending its dollar peg. Thailand gave up its fixed exchange rate and devalued the baht relative to the dollar, setting off a series of currency devaluations in the region.
Today, as the world heads towards a global recession, some of those same factors are again emerging, including aggressive Fed tightening to contain inflation.
“The external environment [for Asia] has become more challenging in the context of the widespread inflation challenge and the near synchronous and sharp pace of monetary tightening,” said Morgan Stanley analysts.
Asia is “better placed” now
This time, Asia has a war chest to fight back.
“I do not expect a repeat of the  Asian Financial Crisis this time,” said Khoon Goh, head of Asia research at ANZ Research.
“The underlying macro fundamentals in Asia are better now compared to the mid-1990s,” he said, adding that foreign exchange buffers are sufficient to withstand capital outflows and smooth market volatility.
“Importantly, there is not the same build up of foreign denominated debt in recent years, which was one of the triggers of the Asian Financial Crisis,” Goh added.
Policymaking has also improved in important ways, making future crises less likely, said Louis Kuijs, chief Asia economist at S&P Global Ratings.
“Exchange rates have become more flexible, which helps absorbing most of the external pressure,” he said. “We don’t expect foreign reserves to decline to dangerously low levels any time soon in the major Asian emerging markets,” he added.
China and Japan have the world’s two biggest foreign exchange reserves, holding $3 trillion and $1.3 trillion respectively. Combined, that is a third of the world’s entire foreign exchange reserves pile.
“There’s $1.3 trillion of foreign exchange reserves. And you spend just shy of $20 billion. So, I mean, there’s a long way to go,” said Jesper Koll, executive director of Monex Group Japan. “The Bank of Japan is not going to run out of money.”
Unlike in the mid-1990s, the external debt and private sector debt in Asia have remained stable.
“I think Asian countries in general have learned a lesson,” said Takuji Okubo, managing director and chief economist at Japan Macro Advisors.
“I can’t really think of any … stupid Asian country,” he said, adding that countries are more cautious now and have realized that borrowing a “lot in dollar can cause significant problem in a downturn when money start flowing out.”
More pain ahead
But, there is still gloom ahead for economies in the region. As US interest rates are forecast to rise further, the dollar is likely to climb higher, slowing growth.
The World Bank recently cut its GDP forecast for the region to 3.2% from 5% for this year. China, in particular, has seen its GDP outlook slashed to 2.8% from 5%.
The outlook is expected to improve in 2023, according to analysts.
“Asia’s resilience in the face of the current global storm is partly the result of reform that the Asian Financial Crisis prompted,” Neumann from HSBC said.
“In the end, the region’s robust fundamentals will see it through these rough seas,” he said.
— Diksha Madhok in New Delhi contributed to this article.