Are emerging markets in Asia heading towards another crisis?

Long considered the engine of global growth, emerging markets in Asia are finally running out of steam and experiencing alarming economic and financial market volatility. Leading financial institutions have been cited in the international media warning of an emerging market crisis and drawing similarities with the Asian financial crisis of 1997. This view is not without merit but requires revisiting the fundamentals which drove the crisis 18 years ago and understanding how they have evolved since then.
In the years leading up to the 1997 crisis, fast-growing Asian economies like Thailand, Malaysia, Indonesia, South Korea and Philippines were enjoying an investment boom. This was brought about by an inflow of "hot money" - mostly in the form of short-term U.S. Dollar-denominated debt with high interests. Domestic banks, however, lent out in local currencies for long-term projects. Asset prices boomed until external shocks - a China devaluation and a U.S. interest rate hike - triggered a reversal in market mood. As capital flooded out and foreign reserves depleted fast, central banks let go of exchange rate pegs to the U.S. Dollar. Inevitably, these currencies experienced massive depreciations. Asset prices collapsed while foreign debt soared above 180 per cent of GDP (gross domestic product) in the hardest-hit economies. A stronger dollar-amplified debt-servicing costs and subsequent balance sheet shocks rising from asset-liability mismatch (currency and maturity) drove banking sectors to insolvency. Inevitably, domestic income fell and several emerging economies in Asia entered recession.
Macro developments in Asia have unnerving resemblance with its experience of '97. Stocks, currencies and commodity prices have all tumbled. Massive amounts of capital have flown out from Asian emerging markets (EMs). Moody's Investors reported that total stock of sovereign debt in Asia has increased from around USD 900 billion in 2000 to above USD 5.5 trillion at the end of 2014. A series of external shocks, including China's historic devaluation on August 11, a catastrophic "Black Monday" and a looming U.S. interest rate increase are reviving memories that were thought dead and buried. But, this time emerging Asia has several lines of defence.
The first major one is in exchange rate policy. Back then, these financially-open economies with fixed exchange rate regimes had little monetary independence - the "Impossible Trinity" of international macroeconomics. Today these countries have significantly more flexible regimes. Their currencies have already been adjusting to market fundamentals for the past two years - especially since the start of "taper tantrum". This holds true for Thailand, Malaysia, Indonesia, and Philippines - the worst hit countries of the crisis. China's decision to allow the Yuan to be more flexible, and Vietnam's devaluation and widening of its currency-trading band, add to this adjustment momentum of Asian currencies. Allowing flexible regimes has two important implications for emerging Asia. First, central banks can use monetary policy as a tool to defend their economies from external volatility. Second, because these currencies were already adjusting, further episodes of depreciation should be more gradual and relatively less (in absolute terms) than that seen in 1997.
Closely related to this issue, is the growth in foreign reserves in Asian EMs. Back then, countries like Indonesia, Malaysia, Philippines, India and Thailand had around USD 30 billion in reserves. China had around USD 200-300 billion. On aggregate, foreign reserves were around 10 per cent of GDP for emerging Asia (Source: Wells Fargo).Today, their pockets run much deeper. A combination of export-led growth strategy and careful monetary management has increased level of reserves for these countries to around 25 per cent of their total GDP, covering 6-8 months of imports (even excluding China). China has the highest reserves in the world covering 20 months of imports. This means that these economies have much stronger buffers against external liabilities and balance of payments pressures. Unlike '97, central banks are also better armed to defend their currencies against speculative attacks.  
Despite higher foreign reserves, analysts and regulatory financial institutions are worried about the explosive growth in sovereign and private sector debt in emerging Asia. However, composition of debt has experienced marked transformations. Data from Moody's shows that, compared to 2000, share of foreign-currency debt in total sovereign debt has fallen dramatically across major EMs in Asia (China, India, Malaysia, Thailand, Philippines, Indonesia, Sri Lanka and Vietnam) at the end of 2014.These reductions range from 20 per cent to as high as 95 per cent for China and India. Development of domestic capital markets has shifted the focus to long-term local currency bonds. This means these countries are less vulnerable to the famous "double mismatch" that they suffered during the crisis. Analysts are also wary of rising foreign currency-denominated debt in EM corporate sectors. But, unlike '97, this debt is matched with risk-mitigating hard currency or currency-hedging instruments.
While financial fragilities have lessened, several Asian EMs (and some from other parts of the world) are highly vulnerable to terms-of-trade shocks. Commodity-exporters like Indonesia and Malaysia have already been battered as oil and metal prices have tumbled in recent months. These countries are resorting to devaluation to counter this challenge - whether that is a sustainable solution to persistently low commodity prices is debatable. This is one lesson emerging Asia will have to take away from the current episode of economic volatility. Heavy reliance on one commodity for economic growth is a perfect recipe for sharp slowdowns.
Although commodity-price related risk is still present, significant developments can be seen in exchange rate policy, foreign reserve level, debt composition and depth of domestic financial sector. It is true that 2015 has not been kind to these countries. But lessons gained from their own experience suggests that for emerging markets in Asia, it is hardly the end of the line.
The writer is a Macroeconomic Analyst based in Washington D.C.
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