“To this day I don't think anyone really understands the mechanism by which the Thai baht broke. I don't think we ever really understood what was happening. I guess we just sort of knew that the Bank of Thailand ran out of money and couldn't fix the currency the way it wanted to anymore.”
On 2 July 1997, Thailand’s Minister of Finance issued a notification determining that market forces would henceforth set the value of the baht, effectively floating the currency. The baht would plummet from 25 against the U.S. dollar to a low of 57 baht to the dollar in less then six months. This marked the start of the Asian Financial Crisis, which sent the newly industrialized economies of Asia – in particular Indonesia, Malaysia, South Korea and Thailand – into a tailspin over the next two years.
“There was no sense of panic. At the time, when you were in Thailand itself, you were sort of divorced from CNBC or other information outlets. It was very very quiet … what did surprise me was how low things could go. It was just amazing to look at the screens day after day and just see stocks keep falling. Everyday, day after day after day. ”
Stock markets crashed. Thailand’s stock market shed over three quarters of its value by end 1997, as did Malaysia and Indonesia. South Korea fared slightly better, losing 70% of its worth. Asian currencies came under pressure. One after another, like dominoes stacked in a row, currencies that had previously been pegged against the dollar (with the exception of the Malaysian ringgit) yielded to market forces. August saw the Indonesian rupiah’s managed float replaced by a free-floating rate. The South Korean won was floated on Christmas Eve that year. Malaysia went the opposite way, instituting capital controls in September 1998, fixing the ringgit at 3.8 to the dollar. These controls were only lifted in 2005.
For the hardest hit countries of Indonesia, South Korea and Thailand, it was a baptism by fire. The whole contagion spilled over from one country to another. And it did not stop in Asia but carried over to Russia, which had its own financial crisis in 2000. The crisis highlighted how countries are linked and how interdependent the international community has become. Who would have thought that a run on the Thai baht could have triggered this huge cataclysmic spasm that reverberated through the world?
“We really didn’t understand what was going on. I feel like almost probably nobody in Thailand did understand what was going on. So it was all very very big picture macro stuff and we were just little minions …”
Even with a decade’s worth of hindsight, experts are still at odds over the causes of the crisis. What we do know is this:
The years preceding the Asian Financial Crisis had seen regional economies experiencing rapid growth that attracted large amounts of foreign investment in the form of foreign debt financing. Marc Chandler, global head of currency strategy at Brown Brothers Harriman says that during this period of boom in the early 1990s, the system of fixed exchanges and managed floats gave people a false sense of comfort and encouraged poor investment decisions. The implicit guarantee against exchange rate risk very comfortably facilitated international trade and foreign debt financing, which in turn, supported high and sustained growth in many countries.
“I remember you could look out the window in Bangkok in the early 90s and you could count easily thirty cranes in the immediate horizon. Construction was huge and there was just no way that all that office space was going to be able to fill up.”
The high, sustained economic growth and subsequent wealth created led to a huge demand for property. This led to an oversupply in the property sector. The abundant foreign debt financing that flowed into Asian economies and into real estate development, was aggravated by very poor due diligence on the part of banks and financial institutions, loose private credit and the lack of corporate governance. In short, banks were not lending wisely to the private sector, which had turned a blind eye to corporate governance. Chandler likens it to a World Cup game without referees.
Countries, flushed with plentiful and easily available foreign capital, bought more and more. This resulted in the growing current account deficits seen the mid-1990s. David Cohen, director of Asian economic forecasting at Action Economics observes that the basic equilibrium was maintained for as long as foreign investment flows were smooth and currencies were strong. When that came to an abrupt end in July 1997, the pullout of foreign investment was inevitable. And with capital flight, currencies and current account deficits came under great pressure. The rest is history.
“People as a whole in Asia are a lot more cautious now in their investments. Generally, there's less of a sense of arrogance … jurisprudence is a lot better now, due diligence is a lot better.”
It has been ten years to date since the Thailand floated the baht. Asia has become the wiser for it. Among the key lessons of the financial crisis – the importance of liquidity and risk management; the need for enforceable regulations (the referees in a soccer match if you will); and that economic integration can make countries more resilient to crisis.
Indonesia, Malaysia, South Korea and Thailand are now all running current account surpluses. The consequence of these surpluses is a huge war chest of foreign reserves that act as an insurance policy against financial shocks. The external positions of these countries are in far better shape than a decade ago.
Measures to deal with immediate or sudden strains to the financial system are in place, as are mechanisms to facilitate financial restructuring. Regulatory frameworks have been upgraded and corporate governance has been strengthened. Through vigorous restructuring throughout all affected countries, nonperforming loans at banks have been brought down to more manageable levels. There is more to be done, but on the whole, the International Monetary Fund believes Asian countries have regained their footing.
The center of economic gravity is also slowly, but surely shifting away from the U.S. and other western industrialized countries, to China. The Chiang Mai network of bilateral swap lines among Asian central banks (including China) is now in the process of being converted into a reserve pooling arrangement. The Asian Bond Fund is yet another example of pan-Asian economic integration.
The irony is that today, a decade later, the very same countries affected by crisis a decade ago, are the ones funding a growing U.S. current account deficit. Nicholas Carn, a partner at Odey Asset Management notes, “Countries that have built up large foreign currency reserves and run chronic surpluses, create a different set of issues”. China for example is now in embroiled in trade disputes with the U.S. and is under great pressure to float the yuan.
Another irony – if another financial crisis were to emerge, the country most vulnerable would be the U.S. Marc Chandler of Brown Brothers Harriman adds that if, “at some point if the Chinese pullout, the U.S. dollar would come under attacked”.
“There’s a very old Thai expression – there is fish in the water, and rice in the fields. It’s a hard country to starve in. It was a crisis, but it didn’t have the kind of impact that the great depression had on America …where people really did starve and generations were set back.”
In a candid interview, Mark Matthews shared his personal thoughts and insights about living and working through the Asian Financial Crisis. Mr. Matthews was the head of sales at ING Barings Securities (Thailand), based in Bangkok from 1992 – 1998. He is currently a senior director and chief Asia strategist at Merrill Lynch in Singapore.