Ten Years After

The tenth anniversary of the Asian financial crisis is a cause for celebration. Aluminum is traditionally associated with ten-year anniversaries, and it seems to appropriately capture the essence of the changes that have transpired since the crisis.

Aluminum is a metal, which implies some rigidities, but is not as rigid as steel, which is associated with 11th anniversaries. Furthermore, aluminum is not as flexible as silk, which is associated with the 12th anniversary. Simply put, the macro-economic base in Asia (and many emerging market countries in general) have improved markedly, but by most accounts still could benefit from more reform.

In explaining the cause of the crisis, policy makers and economists tend to emphasize numerous mismatches in the private sector while institutional and currency rigidities prevented an orderly adjustment. The mismatches included maturities, as in borrowing short-term and investment long-term, in currencies, such as having dollar receivables and yen liabilities in a rising dollar environment, and in the capital structure by relying excessively on debt rather than equity.

At the same time, many developing countries in Asia were running sizeable current account deficits, had what economists regarded as over-valued currencies that were for all practical purposes fixed to the dollar, and were running low on reserves.

The mismatches have eased and many developing countries in Asia are recording current account surpluses. Most of the regional currencies have become more flexible, even though the floats are still managed. The region’s currencies are widely perceived to be under-valued. Countries have gone from a dearth of reserves to a surfeit.

Perhaps one of the most telling changes is that rather than worry about capital outflows, the bigger challenge for the region is managing capital inflows, which go well beyond the repatriation of export earnings. Foreign investors, especially from the US and Japan, have been featured buyers of East Asian equities and have helped lift regional bourses to record, or at least multi-year highs.

In many respects, the Asian financial crisis was, at its heart, a currency crisis. Rapidly growing and modern economies create various strains and pressures. The rigidity of the region’s currency regimes not only prevented a smooth and timely adjustment, but also contributed to the moral hazard problem, which allowed private sector operators (like corporations, investors and wealth individuals) to borrow low yielding currencies and bring the money home to earn a higher return with perceptions of little currency risk.

In the some ways, the Asian financial crisis was part of a wave of crises in emerging markets that began in Mexico in late 1994 and culminated back in Latin America with Argentina’s devaluation and default in early 2002. Even though the Latin American and Russian crises were more a function of government indebtedness and East Asia was more of a private sector phenomenon, the similarity resided with the toppling of largely fixed exchange rate regimes. It was as if dams were broken.

Some observers continue to complain that the Asian currencies remain largely fixed and pose risks of a new crisis. Evidence for the rigidity of the currency regimes, so the argument goes, is the persistent intervention and reserve accumulation.

But this criticism does not do justice to the flexibility that does exist now. Consider the currency movements over the past 12 months. The Thai baht, where the crisis ostensibly began, has appreciated by more than 21%, while the Philippines peso has risen almost 16% against the dollar. The Indian rupee has gained nearly 14% and the Malaysian ringgit, which was fixed against the dollar until July 2005, has appreciated by a little less than 7% over the past 12 months. The Singapore dollar, Korean won, and Indonesian rupiah have all appreciated by around 4% against the dollar.

In additional to the local political elite, most of whom were forced out of office, and investors, who took various sized hair-cuts, the other loser in the crisis was the International Monetary Fund. Their cookie-cutter formulaic response to the crisis and many of the concessions that were sought were not thought out sufficiently and were often perceived as doing the bidding of the US Treasury and the multinational banks.

Even if one believes in the Washington Consensus’s liberalization agenda, it is not clear that it carried the day. There are two practical challenges to the IMF’s agenda. The first is Malaysia. Whereas many other countries went hat in hand to the IMF and therefore were, to some extent, at the mercy of its demands as conditions for receiving assistance, Malaysia opted to go it alone. It imposed greater capital restrictions rather than opening the door wider as the IMF would have insisted. With the benefit of hindsight, it seems clear now that Malaysia’s economic performance has been just as good if not in some ways better than those that signed up for the IMF’s assistance programs.

The second challenge is China. The world’s fastest growing economy does not appear to listen much to the IMF’s unsolicited advice, and it is liberalizing slowly at its own pace. The bulk of the reduction of hard core poverty (people living on $1-$2 a day) has taken place not in those countries that have sought the IMF’s assistance, but in China. The PRC, sometimes in competition with Japan, has offered an alternative to the IMF’s assistance by arranging a network of bilateral swap lines in the region and beginning a process under which reserves or part of them can be pooled to ward off a speculative attack on one of more of the participating countries.

China’s aggressive foreign commercial expansion often includes loans to other developing countries without the kind of conditionality that the IMF insists on, in order to help secure supplies of raw materials. On a smaller scale, Venezuela’s Chavez is doing a similar thing in the Latin American region. As the IMF’s recent change in its surveillance of the foreign exchange market has shown, it appears to have done little to co-opt its critics.

During the Asian financial crisis, as other countries were being forced to devalue, China did not. Although it had devalued in the 1995-1996 period, and suffered what it considers a hard landing in 1998 (~4% GDP growth), the stability of the yuan was a constructive development.

Some observers, such as the widely respected Nouriel Roubini of New York University’s Stern School of Business, argue that China did not devalue because of the repeated urgings of the US government. Evidence for the claim is not provided, but the implication is foreign pressure on China worked and therefore could work again now in terms of getting China to appreciate the yuan at a faster rate. Instead, it is probably more realistic to believe that China pursues its national self-interest than to hope that it will capitulate under sufficient international pressure.

The Argentine crisis marked the end of the seven-year spasm in the emerging markets that resulted in more flexible currency regimes. This type of crisis is over. There are no more fixed exchange rate regimes that can be toppled. Hong Kong is still a peg, but more than a fortune has been lost trying to break it and the HKMA proved up to the task. Many Middle East countries still have pegged regimes, but they too have proved resilient to speculative attacks.

This is not to say the countries are no longer vulnerable to crises. On the contrary, it still seems, underscored by the US sub-prime woes, that booms will still be followed by busts. Crises and business down turns cannot be outlawed, but with proper policies, they can be mitigated and managed and the recovery can be quicker. Emerging Asia is so positioned.