25 years on — are we facing another Asian financial crisis?

Malaysia must take the looming recession forecast seriously and be ready for any eventuality that may arise


MALAYSIA and its neighbouring countries have in the past 30 years been hit by a series of economic crisis, with some of the spillovers still felt till today.

One crisis that shook the regional economies to the core was the Asian financial crisis of 1997/1998, which resulted in banks and other companies collapsing or had to be rescued, and many others were forced to downsize, resulting in massive unemployment.

To recap, the 1997/1998 Asian financial crisis began in Thailand and then quickly spread to neighbouring economies. It began as a currency crisis when Bangkok unpegged the Thai baht from the US dollar, setting off a series of currency devaluations and massive flights of capital.

In the first six months, the value of the ringgit slumped by 45% while the Indonesian rupiah plunged by 80% and the Thai baht by more than 50%. Collectively, the economies most affected saw a drop in capital inflows of more than US$100 billion (RM473 billion) in the first year of the crisis. Significant in terms of both its magnitude and its scope, the Asian financial crisis became a global crisis when it spread to the Russian and Brazilian economies.

The significance of the Asian financial crisis is multifaceted. Though the crisis is generally characterised as a financial crisis or economic crisis, what happened in 1997 and 1998 can also be seen as a crisis of governance at all major levels of politics — national, global and regional.

In particular, the Asian financial crisis revealed the state to be most inadequate at performing its historical regulatory functions and unable to regulate the forces of globalisation or the pressures from international actors.

Although Malaysia’s controls on short-term capital were relatively effective at stemming the crisis in the country and attracted much attention for its ability to resist International Monetary Fund (IMF)-style reforms, most states’ inability to resist IMF pressures and reforms drew attention to the loss of government control and general erosion of state authority.

Most illustrative was the case of Indonesia, where the failures of the state helped to transform an economic crisis into a political one, resulting in the downfall of Suharto, who had dominated Indonesian politics for more than 30 years.

Fast forward to the present day, 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 increases by the US Federal Reserve (Fed) and a slowdown in China spark capital outflows from the region.

The ringgit has also dropped nearly 14% this year, in line with a slide in other emerging market currencies, as the US dollar has strengthened.

A United Nations (UN) agency recently warned that the Fed’s actions, along with those of other central banks, risk pushing the global economy into recession.

Will the Ghost of 1997/1998 Haunt the Region Again?

Not so, according to Universiti Kuala Lumpur (UniKL) Business School economic analyst Assoc Prof Dr Aimi Zulhazmi Abdul Rashid.

While examining the difference between the crisis a quarter of a century ago and the present, he said the current state of the economy is different in many areas compared to the previous crisis.

He noted that the 1997/1998 financial crisis was a combination of economic, financial and corporate underlying issues that triggered a sharp loss of confidence and capital outflows or “hot money” from Asia’s emerging market economies.

Marked by that recession, he said, the crisis also led to a surge in unemployment and a sharp drop in living standards, especially among the poor.

“On the other hand, the current economic situation is attributed to a sudden rise in inflation owing to strong demand amid the reopening of the country’s economy following two years of lockdown, as well as supply constraints that further added cost pressure,” Aimi Zulhazmi told The Malaysian Reserve (TMR) recently.

He pointed out that in 1998, Malaysia’s GDP contracted 6.7% from a growth of 7.7% a year before. Similarly, the ringgit fell from an average of 2.42 to the US dollar in April 1997 to an all-time low of 4.88 to the US dollar in January 1998.

“At that time, the ringgit as well as other currencies took a big and sudden dive against the US dollar; the currency dropped without any control, overnight,” he said.

To revive the economy, in July 1998, the government announced a RM2 billion fiscal stimulus package, which worked out to about 1.5% of GDP at the time.

In comparison, he said, whilst the ringgit is presently declining, it is at a more gradual rate.

However, Aimi Zulhazmi admitted that if the high interest rate continues, then it will certainly be a big challenge to the global economy and Malaysia will not be spared.

“A continuously increasing rate by the US may put the country and influence the global economy to recession next year,” he said.

Learning from the Pain

One lesson that many countries learned from the financial crisis was to build up their foreign exchange reserves to hedge against external shocks.

Socio-Economic Research Centre (SERC) ED Lee Heng Guie said that the regional economies have learned from the aftermath of the painful experiences of the crisis, and in return most of them have built ample reserves resilience to buttress their currency and economy.

As at end-August 2022, Malaysia foreign reserves stood at US$108.2 billion compared to US$15.2 billion in 1997. Likewise, Thailand’s reserves stood at US$220 billion at end-July 2022 against US$26.9 billion in 1997; Indonesia US$133.2 billion at end-July 2022 from US$17.5 billion in 1997 and South Korea up to US$415 billion at end-July 2022 from US$20.5 billion in 1997.

However, Lee cautioned that economies with higher macro-economic vulnerabilities tend to be more disruptive and sensitive to capital outflows and that will cause sharp depreciation of their currencies, a surge in borrowing cost due to tightening liquidity conditions and rising US interest rate.

“For these emerging economies to withstand the capital outflows pressure, some of their central banks have raised interest rates and use foreign reserves to defend their sinking currencies, but raising rates also means higher borrowing cost and this can lead to a slow economic growth in demand for the domestic products.

“It is unfair to describe the situation as a recession now. We also reckon that the central banks in the region will continue to monitor the spillovers and put in safeguard measures to intermediate the impact of capital reversals and currencies depreciation, and hence, a full-blown financial crisis in the region is unlikely,” he added.

However, Lee and Aimi Zulhazmi said Malaysia should take the recession prediction seriously and must be ready for any consequences that may arise in the future.

“We have to work on reviewing policies and regulations, and implement structural reforms to reduce regulatory barriers to enhance market efficiency, ensuring policy transparency and certainty, as well as sustaining better growth prospects,” Lee said.

He said that the government also should move to alleviate the structural fiscal deficit and reduce debt and liabilities to rebuild the fiscal buffer against future shocks.

AMRO chief economist Hoe Ee Khor stressed that a simultaneous economic slowdown in the US and Europe, in conjunction with tightening global financial conditions, would have negative spillover effects for the region through trade and financial channels.

“In Asean+3 countries, the inflation is accelerating. Food and fuel prices remain elevated despite recent easing in key global commodity benchmarks. Subsidy cuts in some economies and depreciating currencies have also pushed prices higher,” he told TMR.

South-East Asia a Bright Spot

Asia, especially South-East Asia (SEA), remains a bright spot, even as the global economy looks set to head into recession next year, the IMF said recently.

Asia is facing three “formidable headwinds”, namely rising interest rates, the war in Ukraine and the impact of China’s subdued economic activities.

“Despite this, Asia remains a relatively bright spot in an increasingly dimming global economy,” the IMF said in its latest outlook report “Asia Sails into Headwinds from Rate Hikes, War and China Slowdown”.

The IMF projected growth for Asia and the Pacific at 4% this year and 4.3% in 2023, with both below the 5.5% average over the last two decades.

“SEA is likely to enjoy a strong recovery. In Vietnam, which is benefitting from its growing importance in global supply chains, we expect 7% growth and a slight moderation next year. The Philippines is forecasted to see a 6.5% expansion this year, while growth will top 5% in Indonesia and Malaysia,” it said.

IMF noted that inflation now exceeds central banks’ targets in most Asian economies, driven by a mix of rising global food and energy prices, currencies falling against the US dollar and shrinking output gaps.

“Core inflation, which excludes volatile food and energy prices, has also risen and its persistence — driven by inflation expectations and wages — must be closely monitored,” it said.

Policy for Challenging Times

Amid lower growth, IMF said, policymakers face complex challenges that will require strong responses.

“Central banks will need to persevere with their policy tightening until inflation durably falls back to target. Exchange rates should be allowed to adjust to reflect fundamentals, including the terms of trade — a measure of prices for a country’s exports relative to its imports — and foreign monetary policy decisions,” it said.

However, IMF said that if global shocks lead to a spike in borrowing rates unrelated to domestic policy changes and threaten financial stability or undermine the central bank’s ability to stabilise inflation expectations, foreign exchange interventions may become a useful part of the policy mix for countries with adequate reserves, alongside macroprudential policies.

“Countries should urgently consider improving their liquidity buffers, including by requesting access to precautionary instruments from the Fund for those eligible,” it said.

IMF pointed out that public debt has risen substantially in Asia over the past 15 years — particularly in the advanced economies and China — and rose further during the pandemic.

“Fiscal policy should continue its gradual consolidation to moderate demand alongside monetary policy, focused on the medium-term goal of stabilising public debt,” it said.

Accordingly, IMF said, measures to shield vulnerable populations from the rising cost of living will need to be well-targeted and temporary. In countries with high debt levels, support will need to be budget-neutral to maintain the path of fiscal consolidation. “Credible medium-term fiscal frameworks remain an imperative,” it said.

Beyond the short term, it stated that policies must focus on healing the damage inflicted by the pandemic and war.

“Scarring from the pandemic and current headwinds are likely to be sizeable in Asia, in parts because of elevated leverage among companies that will weigh on private investment and education losses from school closures that could erode human capital if remedial measures aren’t taken today,” it said.

IMF noted that strong international cooperation is needed to prevent greater geo-economic fragmentation and to ensure that trade aids growth. “There is an urgent need for ambitious structural changes to boost the region’s productive potential and address the climate crisis,” it concluded.

  • This article first appeared in The Malaysian Reserve weekly print edition