Asian crisis puts recovery in spotlight

China is now the world's fastest growing major economy, a nation so vast that it needs to create 25 million jobs a year - the equivalent of the entire British workforce. Its insatiable thirst for raw materials has sent commodity prices to all-time highs and its balance of trade surplus with America has seen the dollar plummet to quarter-century lows. Yet while the Chinese boom may not be an unalloyed economic good, fears about what might happen if it stumbles are much more acute. What, many in the markets worry, would happen if there was another East Asian crisis?

A new study by economists at the American Express Bank gives some cause for comfort, based on their analysis of the previous East Asian crisis, exactly a decade ago.

John Calverly, the chief economist and Strategist, and Kevin Grice, the senior economist, argue that the last Asia crisis was "very much a private sector boom-bust crisis, rather than a government fiscal crisis", but that "companies and banks have transformed themselves in the intervening years. Leverage has been reduced, especially short-term foreign borrowings, lending is much more cautious and business investment is at healthier levels, down from the boom conditions of the early 1990s."

Even so, as the study says, the previous bull market in Asian stocks turned to meltdown very rapidly, and from comparatively trivial origins.

Ten years ago today, on 2 July 1997, Thailand was forced to devalue the baht when the central bank ran out of foreign exchange reserves. It was the trigger for the greatest financial crisis and economic collapse to hit East Asia since the Second World War. It brought meltdown to Thailand, Indonesia, South Korea, Malaysia, the Philippines, Singapore, Hong Kong and Taiwan. Further crises in South America and Russia followed and the shock also sharply reduced the price of oil, which reached a low of $8 (£4) a barrel at the end of 1998.

Then, as now, there was a long regional economic boom powered by exports and investment. Thailand's GDP growth averaged 10 per cent from 1987-95 and real estate prices and stock markets rose strongly. But when the investment boom slowed in 1996-7, balance- sheet weaknesses in the private sector were exposed - especially excessive short-term foreign currency borrowing by banks and companies.

The weaknesses created a vulnerability to sudden investor sentiment changes, capital outflows, and devaluation. Within a few weeks, some of South Korea's largest corporations, names such as Samsung and Hyundai, were caught up in the crisis. It culminated in intervention by the IMF in several economies, with results that are still controversial - the "IMF Crisis" may have been a cure worse than the disease. Even now, with corporate and national recovery, South Korea's growth rate remains well below the level it achieved in the 1990s. Indeed, throughout the region GDP growth has settled on a lower trajectory - on average 2-3 percentage points lower per year in 2002-06 than was the case in 1990-1996.

Yet despite the superficial parallels, the American Express study points out the differences: "External deficits widened up to 1997 due to very strong private investment, rapid credit growth, and high capital inflows into equity and property markets. There was also a terms of trade deterioration given the policy of pegging exchange rates to a rising US dollar, whilst foreign exchange reserves were too low. In addition, bank and corporate sector balance sheets were weak".

Other economists, including Joseph Stiglitz and Jeffrey Sachs, have also downplayed the role of the real economy in the crisis: the rapidity of events suggested a "a classic bank run". In any case, in 2007, the American Express team argue: "Asia is much less vulnerable to a change in world conditions now because of its more flexible exchange rates, external surpluses and high foreign exchange reserves. Hence Asian stocks held up well in the market sell-offs in Spring 2006 and again in February-March this year. Nevertheless, the upside potential for stocks, while good for the next year or so, may be limited beyond that, and investors should be looking to reduce exposure in 2008. Beyond a stalling of the global upswing, which we do not expect, the biggest risk to investors in 2007-08 is that Asia "overheats", forcing central banks into aggressive rate hikes. But currency appreciation and flexible labour markets should hold inflation down".

source:news.independent.co.uk