Twenty years after the East Asian crisis

The Asian financial crisis commenced in July 1997, twenty years ago. One after another, many East Asian tiger economies were toppled by financial market contagion and capital flight, plunging their economies into protracted recession, banking crises, corporate failures and bursting of stock market and property market bubbles.

Over the next two decades, Asean economies that were at the centre of the financial crisis, including Thailand, Malaysia and Indonesia, have made tremendous progress in addressing the macroeconomic and financial vulnerabilities that contributed to the financial crisis.

Among the major achievements, there have been significant progress in the sophistication of macroeconomic management, as well as far-reaching banking sector reforms that have

resulted in stronger prudential regulation of banks, much improved capital adequacy ratios in the banking system, better risk management systems and adoption of macro-prudential measures to manage risks related to real estate lending.

In Malaysia, Tan Sri Dr Zeti Akhtar Aziz took the helm as governor of Bank Negara Malaysia in 2000 and held that office until 2016, driving far-reaching reforms to the banking system that resulted in banking sector consolidation and substantial strengthening of financial regulation that has made Malaysia a regional leader in commercial banking, with Malaysian banks having to become international players with a strong regional footprint to the rest of Asean.

Indonesia, Thailand and the Philippines have also implemented substantial banking sector reforms, undertaking banking sector consolidation, improving capital adequacy ratios and strengthening prudential regulation and supervision of their banking systems.

Asean countries have also built up their foreign-exchange reserves to improve their resilience against volatile international capital flows as well as strengthening their financial resilience by adopting macro-prudential measures when required.

The Chiang Mai Initiative, agreed in 2000 in the aftermath of the Asian financial crisis, has also created a

regional mechanism for cooperation among the Asean countries plus China, Japan and South Korea for financial crisis prevention and resolution, initially built around a network of bilateral currency swaps.

Indonesia and the Philippines have also substantially improved their fiscal positions with very substantial reductions in government debt as a share of gross domestic product (GDP). Since 2004, the Philippines’ general government debt-to-GDP ratio has more than halved to a new record low of 34.6% in 2016.

In Indonesia, one of the major macroeconomic successes during the two terms of office of President Susilo Bambang Yudhoyono was that government debt as a share of GDP was reduced from 56% in 2004 to just 26% when he stepped down from office in 2014.

Malaysia, Indonesia, Thailand and the Philippines have also taken steps to deepen their equity and bond markets, improving the diversity and liquidity of their capital markets.

Despite these tremendous achievements, the ghosts of the East Asian crisis continue to haunt the regional grouping with fears that the region could still be vulnerable to another financial crisis.

While Asean governments have made great progress in improving financial resilience, the triggers for the next crisis could be very different to the East Asian crisis.

The greatest change in the East Asian economic landscape since 1997 has been the rapid rise of China as a global economic power, with its share of world GDP having risen from just 3% in 1997 to 15% by 2016.

The Asean region’s bilateral trade with China has increased from US$24 billion in 1998 to US$452 billion (RM1.94 trillion) by 2016. The rapid growth in Asean exports to China has been an important growth engine for the grouping over the past decade, notably helping Asean through the global financial crisis in 2008-09 when the US and European Union slumped into recessions.

However, the risk of a severe Chinese economic slowdown or hard landing remains a potential key downside risk scenario for the Asean region due to the significant increase in the importance of China as a key export market over the past decade.

While the risk of a China hard landing remains a relatively low probability scenario with a likelihood of around 20% to 25% of occurring over the next two or three years, China does face significant economic and financial imbalances.

Among these are the high levels of non-performing loans in the banking system, the rapid growth of the shadow banking sector which has been lightly regulated until very recently, and the rapid growth in Chinese corporate debt as a share of GDP since 2009. Macroeconomic modelling of a

China hard landing scenario using the IHS Markit Global Link Model of the world economy indicate that Asean countries are among the most vulnerable in the world to a China hard landing shock, with Singapore, Malaysia, Thailand and the Philippines among the most vulnerable to the shock waves of a China economic slowdown.

The channels of transmission would be through weakening trade and investment flows, as well as financial market linkages such as bank balance sheet exposures.

Such a risk scenario could also trigger other macroeconomic vulnerabilities, notably the relatively high levels of household debt to GDP in Malaysia and Thailand.

Therefore, despite the tremendous progress made by Asean countries since the East Asian crisis in improving macroeconomic management and financial systems, there are still significant economic and financial vulnerabilities. Building a stronger regional cooperation for crisis prevention and resolution is an important task ahead for Asean, in partnership with other major East Asian economies.

  • Rajiv Biswas is the Asia-Pacific chief economist for IHS Markit.