Painful adjustment cycle – but a systemic crisis à la 1997-98 is unlikely
Over the last few days, we had several questions from investors asking if this is going to be another Asian crisis. We think that a downward adjustment cycle in Asia began in 2013 – this cycle has been and will remain painful, in our view. The adjustment process is likely to continue for long, but the authorities have the tools to control the pace of adjustment and mitigate downside risk.
We believe a 1997-98 scenario is unlikely – i.e., an abrupt, systemic downdraft in Asia, translating into a deep banking system crisis, with adjustment forced on the region at a rapid pace. At that time, the region’s currencies excluding China and Hong Kong depreciated sharply – 41% from June 1997 to January 1998. We believe that a more domestic debt profile, presence of persistent disinflationary pressures, current account surpluses, flexible exchange rates, and adequate FX reserves give policy makers in the region better control over liquidity conditions. Moreover, rate hikes in the US are likely to be slower than and not as deep as they were in previous cycles. With the ECB and BoJ still implementing their QE programs, DM monetary policies should not turn adverse at a quick pace. In addition, the tighter links in the global economy and Asia’s significantly higher share in global GDP do mean that economic developments in Asia will have a more sizable impact on the US as compared to previous cycles. As our US economics team has argued, it could delay the pace of tightening. Though an abrupt systemic downdraft is unlikely to materialise, that does not necessarily mean that Asia’s macro outlook is in good shape. The persistent disinflationary pressures and the slow response from policymakers in addressing these pressures remain our topmost concerns.
Accelerated pace of currency depreciation raising questions from investors:
Since August 11, after the PBOC announced a change in its exchange rate management approach, the pace of currency depreciation has quickened in the region. Considering the starting point of PPI deflation in the region, that might actually go some way in helping AxJ economies address the deflation problem. Though the growth slowdown in the region had accelerated since the start of the year with a contraction in the region’s exports, the accelerated trend in currency depreciation in the last few days has raised the debate among investors as to whether there could be another Asian financial crisis type of outcome.
From our conversations with investors, we sense that there are four key questions:
1) What is wrong with the Asian macro story today?
2) Which economies are most exposed to slowdown in China and rise in US real rates?
3) What triggered the Asian Financial Crisis and are there similarities today?
4) What are the differences with the 1990s cycle?
