The Asian financial crisis can seem remote to many people in markets today. A sizeable number were not around to witness the fallout, and it has been overshadowed by the global financial crisis among others.
Yet it was the Asian financial crisis – with rapid currency depreciation, defaults and the associated impact on growth – which really hurt the region’s economies.
It was the experience of this crisis that was partly behind the resilience of these economies 10 years later during the global financial crisis, where only Thailand suffered a marginal economic contraction. Many countries – China included – became determined to protect themselves against any future repeat.
The ongoing resilience of many Asian economies makes it difficult to see a similar crisis unfolding to that of 20 years ago. Foreign exchange reserves are now far higher across most Asian countries, and external vulnerabilities have also reduced, with stronger current account balances on the whole and less reliance on dollar-denominated debt.
There are still pockets of vulnerability, however. The Indonesian government, for example, depends heavily on foreign financing of its budget deficit, with investors holding around 40 per cent of its outstanding debt.
As developed market interest rates rise, there is likely to be less money flowing into emerging market assets. This could then have an impact on growth and exchange rates, and lead to poorer sentiment more generally.
Investors also need to be careful not to look for the same crisis occurring twice. Significant risk-off events rarely have the same causes, and there are several plausible risks within Asia which investors should focus on. Perhaps the most obvious of these is China’s addiction to debt, with the country now urgently needing to deleverage.
But neither do the obvious risks always lead to market volatility. The crisis in China’s bond markets last year, as the authorities allowed several issuers to default, passed largely unnoticed, with attention focusing on the US and Donald Trump instead.
While China was largely unaffected by the crisis, it nonetheless had a profound impact on the authorities who have maintained tight control of the capital account ever since.
As the country’s leaders try to fix an overdependence on credit-driven growth, that control is tightening further still. Increasing regulation and limiting market forces may help to maintain financial stability in the short term, but it will come at the expense of longer-term growth and perpetuate capital misallocation in the economy.
Indeed, the real concern around Asia today centres on how fast China can continue to grow. The country has become an important growth driver for the world, with the recent upsurge in the global economy helped by Beijing’s early 2016 policy stimulus.
As China looks to deleverage, its growth rate, and the rest of Asia’s, could slow significantly. The authorities have meaningfully tightened policy, with credit growth now running at around 15 per cent. That may sound like a lot, but it is approximately 40 per cent below the peak rate in 2016.
Tightening will now have an effect, most likely being felt across the second half of this year. How China handles its debt problem will clearly matter for markets and is likely to be an ongoing story for the next five years.
However, in the short term the implications for markets depend on a number of interconnected factors, in particular the US dollar. The currency has weakened over the course of 2017, easing the management of China’s capital account and generally making for a benign environment for emerging markets.
Stabilisation, or even continued weakness, would prolong this breathing space, helping to support risk appetite globally. But ultimately, the next big shock for global risk assets could emanate from China.
On the 20th anniversary of the Asian financial crisis, all roads lead to Beijing.
James Bateman is chief investment officer of multi-asset at Fidelity International
