The 1997-98 Asian financial crisis saw many leading South-east Asian economies collapse as a result of high levels of foreign debt and rapid capital outflows following a US Federal Reserve interest rate hike. Thailand was among one of the hardest hit, with negative GDP growth of 7.6% at the height of the crisis, pushing many Thai people below the poverty line.
Since then, the government and various regulatory authorities have made major progress in preventing a repeat of the crisis. As a result, the sector remains well capitalised and stable, and the state’s share of foreign debt has dropped substantially. However, the after-effects of the 1997-98 crisis can still be felt, with rapid currency appreciation, high levels of non-performing loans (NPLs) and the renewed risk of significant capital outflows.
Setting the Stage
The Asian financial crisis occurred between June 1997 and January 1998, when a number of rapidly expanding South-east Asian economies – including Thailand, Malaysia, Singapore, Indonesia, the Philippines, Hong Kong and South Korea – were affected by disruptions to currency, stock markets, banking systems and per capita incomes.
In October 2017 international media attributed the collapse to the billions of dollars of Western “hot money” – referring to currency moving quickly and regularly between financial markets to capitalise on high short-term interest rates – that was being poured into South-east Asia during the 1990s, creating a massive economic bubble. At the time, many Asian currencies, including the baht, were pegged to the US dollar, with fixed interest rates creating a large gap in borrowing costs, and many investors preferring to borrow abroad and bring the money home to invest.
As highlighted by a 1999 report published by Columbia University, Thailand attracted massive volumes of capital inflow during the early 1990s, owing to accommodative economic policies, robust macroeconomic fundamentals and persistent stagflation in Japan, as well as a recession that swept across Europe. Author of the report Narisa Laplamwanit argued that financial market deregulation, capital account liberalisation and a fixed exchange rate, coupled with low inflation and high interest rates, supported rapid capital inflows, with foreign debt rising extremely quickly as a result.
In a study of capital outflows from Thailand between 1988 and 2000, researchers at the University of Massachusetts found that Thailand’s total external debt rose from $8.3bn to $23.3bn during the 1980s, rising further to $28.1bn in 1990 and $100bn in 1995.
Macro Growth
Thailand’s fundamentals, however, were robust over that period. The economy expanded by an annual average of more than 9% between 1985 and 1996, peaking at 13.3% in 1988 and hitting 11.2% in 1990. Thailand recorded a net capital inflow of $14.2bn in 1995, more than a 100% uptick on 1992, making the country attractive to international speculators channelling capital out of Japan. Huge capital overflows drove Thailand’s financial services sector to equally rapid expansion, while the country’s investment rate became one of the highest in the region. Investment as a percentage of GDP hit 41.7% in 1996, against 41.5% in Malaysia, 38.7% in China, 38.4% in South Korea and 35.1% in Singapore.
Capital markets also grew, with stock market prices up by 175% and the real estate sector rising by 395% over the 1985-96 period. Thai banks were among the most profitable globally by the early 1990s, charging up to four percentage points more interest on loans than they paid on deposits. Lending growth reached 58% of GDP, the highest in East Asia at that time.
However, the rapid expansion was not considered healthy, as a substantial portion of capital was channelled into non-manufacturing industries, such as real estate, which produced no tradeable goods and had a significant impact on the country’s trade balance.
The current account deficit stood at 8% of GDP in 1996, with 10-35% of bank loans committed to brick-and-mortar property development. Only a small portion of inflows could be categorised as foreign direct investment (FDI), with most money remaining speculative. The ratio of FDI to GDP in Thailand fell from 33.6% in 1990 to 15.9% in 1996, according to Laplamwanit. Lending practices were characterised as reckless, lacking prudent procedures for contracts and monitoring, and creditors expected the central bank to provide a bailout in the event of a bank run.
Interest Rate Hikes
In April 1997 the US Federal Reserve began raising interest rates, leading many investors to pull money out of emerging markets and bring it back to the US, supporting US dollar appreciation. A series of speculative attacks on Asian currencies and increasingly expensive Asian exports exacerbated the situation during the summer of 1997.
High levels of non-bank lending, loan growth concentration in finance and securities companies, and significant foreign-denominated lending had left Thailand extremely vulnerable to capital outflows. Meanwhile, the real estate sector contracted, and rising trade competition from China, particularly in the arena of semiconductor exports, further impacted the current account deficit. Vacancy rates averaged 15% in 1997, and NPLs in the banking sector hit 13% in 1996 as property developers began to default.
Real capital flight (RCF) rose as a result, hitting $21.8bn in 1995 and $21.7bn in 1998, according to researchers at the University of Massachusetts. During the 1990s RCF averaged $9.8bn, four times higher than the previous decade. RCF amounted to $42bn in 1997 and 1998, totalling $118.1bn over the 1980s and 1990s. This had major consequences on the economy.
An ensuing credit crunch forced thousands of firms into bankruptcy, and government rate hikes did not prevent international investors from withdrawing money, leading many East Asian countries, including Thailand, to abandon their US dollar peg and float their currency. GDP growth in Thailand declined significantly from 8.1% in 1995 to 5.7% in 1996, -2.75% in 1997 and -7.6% in 1998, according to the World Bank. This pushed an estimated 1.1m Thais into poverty.
Crisis Management
A series of emergency meetings and IMF bailouts in the late 1990s brought about gradual economic recovery. GDP growth recovered to 4.6% in 1999, moderating to 4.5% in 2000 and 3.4% in 2001, before surging to 6.2% in 2002, 7.2% in 2003 and 6.3% in 2004. Between 2004 and 2014 GDP growth only slipped into the negative once, when it dropped to -0.7% in 2009 in the wake of the global financial crisis. In the years since, the authorities have undertaken a series of reforms aimed at preventing a similar crisis from occurring again, considerably reducing the country’s currency risks. The Thai Bond Market Association reported that the proportion of foreign currency debt to total government debt fell from 85.3% in 1997 to just 1.9% in January 2018. The current account balance has also seen improvement, reaching a surplus that equates to 11% of GDP in 2017.
Risks remain, however, with Moody’s reporting in March 2017 that the loan-to-deposit ratio of Thai banks was among the highest in South-east Asia at 96%, while the foreign currency loan-to-deposit ratio had reached 170% at the end of March 2017 – also among the highest regionally. Although foreign currency assets accounted for only 11% of the total, while the share of foreign currency loans stood at just 7%, Moody’s warned that currency shocks remain a risk to banks, as most foreign currency loans take the form of short-term trade financing for local corporates, hedged with domestic foreign exchange swaps.
Rise & Repeat
In the first nine months of 2017 alone the baht gained 8% against the US dollar. Writing in the South China Morning Post in September 2017, William Pesek, an Asia-based financial jounalist, said the baht’s rapid appreciation “has ‘hot money’ written all over it”, noting that the cost of insuring five-year Thai debt against default risk is lower than Spain’s, while Thai bond yields are below South Korea’s, despite both economies being more developed than Thailand’s.
Adding to capital flight pressures in emerging markets, the US Federal Reserve moved to hike rates by another 25 basis points in June 2018, its seventh such increase since the end of 2015, with plans to raise rates two more times later in the year.
The rate of NPLs among commercial banks hit 2.9% in the first quarter of 2017, its highest since 2011, while capital inflows accelerated. Media reported in June that government moves to relax restrictions on capital flows in April 2015 had failed to slow down the appreciation of the baht. Foreign assets in mutual funds rose from BT900bn ($26.1bn) in mid-2015 to BT1trn ($28.9bn) in mid-2017, and foreign investors purchased BT13.3bn ($385m) in equities and BT136.4bn ($3.9bn) in government debt in the first six months of 2017. Although resurgent GDP growth and improved banking liquidity and stability should help cushion future shocks, stakeholders will likely continue to be challenged in 2018 by currency appreciation, climbing US interest rates and rapid capital outflows.
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