Business   

Valuable lessons from Asian currency crisis

Although ten years have gone by since the onset of the currency-led great Asian economic crisis, the lessons learnt from it are relevant to this day. During the first week of July 1997, the Thai monetary authorities watched helplessly as their foreign exchange reserves disappeared in the face of a speculative run on the baht. Indonesia, South Korea and Malaysia were to follow soon. Each affected country witnessed a massive flight of capital.

Exodus of capital and inability to restore the lines of overseas credit were the two defining characteristics of the crisis that was to last two years.

Obviously it is not the scale of devastation — immense as it was — but the reasons for a crisis of such a magnitude that are more relevant today. As the contagion spread quickly, it was clear that the nearly identical policies followed by them would lead to nearly identical results. That was why the problems of any of these countries could not be contained within its national boundary.

A year later, the Asian crisis had global ramifications that included the crash of the Russian and Brazilian currencies.

Till the mid-1990s, countries in Southeast Asia and East Asia had been witnessing rapid economic growth. International institutions such as the IMF had commended their policies for emulation by others. However, those very policies did not stand them in good stead when the crisis hit them. In fact they perhaps aggravated the crisis.

In general, these countries pursued what may be called ‘open’ economic policies, especially in relation to their external economies. Most of them ran large current account deficits, often in the region of 6 to 8 per cent of their GDP. They also allowed their companies to borrow short-term foreign currency loans from abroad. As was the experience of many Latin American countries a decade earlier, many banks were willing to lend money to companies in East and Southeast Asia, purely on the strength of the region’s potential.

Most loans were highly leveraged, meaning that the borrowers were able to raise disproportionately large loans on a small equity base. Corporate governance was not fashionable those days and, as was conspicuous in South Korea, there was government patronage to some companies that grew very big. The second biggest chaebol in South Korea, Daewoo, failed amidst serious allegations of fraud and misgovernance.

All these countries pursued a fixed exchange rate policy vis-À-vis the U.S. dollar. There were a number of proponents of such tight linkage with the American currency in those days. It was presumed that this would bring many advantages to their domestic economies. However, such a policy denied the authorities the flexibility to calibrate their monetary policies to meet contingencies. Most Asian currencies were overvalued in dollar terms.

Therefore, when investors lost interest in the region there was a flight of capital. A high current account deficit meant that outside savings and capital were used to supplement domestic savings and investment. At the first sign of trouble there was a reversal of capital flows. Banks refused to renew loans sending many companies into bankruptcy. It took two years for the economies to recover.

Ten years after the crisis the region is back in the forefront of global economic growth. The policies they are pursuing now are however very different from the ones they followed a decade ago. For instance, many of them have a surplus in their current account and, as an insurance against future contingencies, have built up substantial reserves. The preference for a fixed exchange rate with the dollar has been given up and nearly all of them are on a managed float.

It is interesting to see how India and China fared during the Asian crisis. By the standards of those in the region, both followed less ‘open’ policies. In India, the current account deficit was at a prudent level of 1.4 per cent (of the GDP). There was much better banking regulation and Indian companies were not allowed to borrow liberally from abroad. India’s system of managed exchange rates that evolved in the mid-1990s is now widely emulated.

The real issue now is that while both India and China were spared the worst of the economic crisis thanks to their prudent external account policies, they might have gone too far the other way. One area that illustrates the new mindset in a striking fashion is in exchange reserves.

Once meant to be an insurance, the large size of reserves in many countries has become something of an embarrassment. India has more than $212 billion of reserves and China $1.5 trillion.

There are major policy issues here which explain why the RBI and other central banks mop up the dollars (to prevent currency appreciation) and subsequently sterilise domestic liquidity. Such issues would not have arisen if the economy was not in a position of strength.

C. R. L. NARASIMHAN

Printer friendly page  
Send this article to Friends by E-Mail

Stories in this Section

Valuable lessons from Asian currency crisis
Towards bettering the digital life
Need for skills development authority
NSS 1987 and 1992 are different
Time limits for filing forms
Age for senior citizenship — how reckoned?
Minister welcomes investment in power sector
‘Kerala can be a hub for the defence-industry complex’

Copyright © 2007, The Hindu. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu