Chapter 10 Asian Currency Crisis
- International Monetary Fund
- Published Date:
- January 2001
The Asian currency crisis that began in July 1997 with the devaluation of the Thai baht shows little sign of abating. Indeed, the very poor state of the domestic economies in the region, which as yet show no real signs of improving, would suggest that this crisis is likely to deepen in the period ahead and that it could spread further to countries that have so far not felt the full force of the crisis. This would make one think that we may very well only be at the end of the beginning of this crisis rather than at the beginning of its end. As such, in attempting to draw any definitive conclusions about this crisis, I find myself much in the position of Chou en Lai, the former Chinese premier who, when asked in 1979 about his opinion of the French Revolution some 200 years before, replied that it was too early to draw definitive conclusions.
The depth and global ramifications of the crisis will certainly make it a subject that will be long analyzed by scholars. As a market participant, I offer the lessons that I would draw from this crisis with some humility. In doing so, I would distinguish between (a) those lessons that relate more to the original causes of the crisis and (b) those lessons that relate more to the way in which this crisis is playing itself out and that pose a risk to the global system. I regard these latter lessons as the more pressing, since they might guide us in how to prevent the crisis from deepening.
2. LESSONS RELATED TO THE ORIGIN OF THE CRISIS
By now there seems to be common ground as to the main lessons that are to be drawn relating to what might have caused the crisis. These include the following:
An excessive reliance on short-term external borrowing by the banking system at the time that bank regulation was lax;
A excessive degree of corporate borrowing in foreign exchange that was not hedged;
An undue reliance on fixed exchange rate regimes and a pegging to the wrong currency given the countries’ trade and investment patterns;
A mode of corporate finance that relied too much on bank borrowing as opposed to equity financing or bond financing; and
An insufficiently regulated banking system that allowed over-investment in the property sector or in poor bank lending practices to large corporations.
The recognition of these weaknesses is likely to result in changes in the global financial architecture that might prevent the recurrence of future crises. Thus, one might find support for some form of inward capital controls, prudential limitations on bank borrowing from external banks, better bank supervision, etc. While all this is well and good for the long run, this would not seem to address the more immediate and pressing problems where more basic lessons have to be learned as to how can one set the basis for an early recovery from the present sharp downturn in these economies.
3. LESSONS IN THE PROCESS OF BEING LEARNT
Perhaps the more fundamental lessons from the Asian crisis are still in the process of being learned. These relate to the appropriate policy response to the massive economic and financial dislocation that is being experienced on a regional basis to a degree that has not been experienced in recent memory. In this respect, I would distinguish between:
a) The cyclical dimension of the crisis that is being marked by a collapse in domestic demand and by contractions in output ranging from some 7 percent in Korea, 8-10 percent in Thailand, and some 15-20 percent in Indonesia;
b) The absence of any sign of recovery in these economies in terms of real indicators of activity. Particularly striking in this regard is the continued sharp decline in the US dollar value of imports of the order of 45 percent on a twelve month basis and the absence of any sustained export growth in US dollar terms despite the sharp devaluations of the currencies;
c) The deflationary tendencies that these economies are beginning to display in a forward looking sense despite the very large depreciations in their currencies; and
d) The very large private sector debt overhangs that are crippling the corporate sectors of these economies and that are impeding the proper functioning of these economies’ banking sectors. The early resolution of this debt situation will be essential if there is to be any recovery in these economies.
These features would suggest that three lessons are yet to be learnt from this crisis:
a) How to set macroeconomic demand management policies for a more deflationary environment where output is in a downward spiral and where signs of inflation are all but non-existent. Specifically, we may yet be learning that when output is contracting and inflation is all but absent in a forward looking sense it might not make much sense to keep interest rates high in real terms in order to prevent a further depreciation of the currency. In this respect, one might wish to adopt a more Canadian style approach to policy that aims at ensuring that there is an adequate but not excessive degree of monetary stimulus to the system through an adequate combination of exchange rate and interest rate levels;
b) Likewise, one may question whether fiscal stringency is the most appropriate budgetary approach in countries whose budgets are being impacted by dwindling tax bases and whose economies are sorely lacking for want of aggregate demand. This is all the more so the case for countries which have had sound past records of fiscal policy management and whose public debt levels are presently relatively low; and
c) More fundamentally from the point of view of ever getting these economies to recover one may question whether more radical solutions need to be found to solving the corporate debt and banking sector problems of these countries. In this respect, at this stage one must wonder whether traditional bankruptcy workout procedures, even if properly implemented, can possibly be a swift enough approach to deal with countries where gearing ratios are often 500 percent and where corporate debt to GDP ratios are frequently over 200 percent. As the sad experience of Japan attests, failure to face these problems head on in a decisive manner could condemn Asia to the lost decade sort of experience that characterized Latin America in the 1980s.
I would venture to add that it is the rapid learning of these lessons that is more pertinent than pondering about how to avoid the next crisis, if we are not to have Asia continuing to pose a threat to the global economy in the period ahead.