Lessons From Asian Crisis

The virtuous cycle of strong economic growth continued so long as the exports and domestic stock markets remained buoyant, and high foreign exchange reserves and stable exchange rates supported each other in keeping the tap of foreign investment open. Under the pseudo floating exchange rate mechanism, the Tiger economies kept the exchange rate stable despite the pressure of inflation which was normal with supernormal real GDP growth. It was relatively easy for the Central Banks to support the exchange rate with strong stock market which attracted FII investment in stocks and moderate short term external borrowings. The speculative onslaught on the currency was kept at bay despite the annual inflation ranging between 4% to 9% by the Central Banks supporting the exchange rate and major operators in the forex market believing in their capacity to support the rate without any undue pressure on the forex reserves.

 

The Mexican and Latin American crisis of the late 1994 which had perhaps faded from the memory resurfaced with the similar sequence, causality and consequences in Asia in 1997. However, the Asian crisis is more pervasive and may emerge bigger in its magnitude and impact on the global economy since it has engulfed Hong Kong and Singapore, traditionally thought to be much sounder and stronger economies. It has also overcast Japan and is knocking the doors of China.

Depreciation of Asian currencies is not going to affect Hong Kong as much as it is to China since Hong Kong is mainly a trading centre, while China has huge manufacturing base for exports.

What are the lessons of the Asian crisis ? They are almost same as 1994 Mexican and Latin American crisis. But nobody paid any heed to the Mexican crisis because it was quickly resolved by the hefty American aid and bailout package, and this can not happen to us attitude among the other so called emerging market economies. Lessons from the crisis are: Number one, high economic growth generates moderate inflation requiring quick exchange rate adjustments which should not be delayed for indefinitely long period. Number two, exchange reserves which in absolute term appear large and comfortable may not be actually adequate when viewed in light of short term external debt and its servicing. Number three, prolonged use of short term financing of BoP deficit with stable exchange rates is an open invitation for currency attack. Number four, foreign portfolio investment has come to dominate the stock markets in the emerging economies and the FIIs can cause and precipitate both the currency as well as stock market

prices in the wake of long overvalued currency. Number five, because of the volatile nature of FII investment which seeks return in dollar terms emerging economies should tread steadily on the path of capital account convertibility.

(The author is chief executive officer, UTI Investment Advisory Services. The views expressed here are his own.)