The world's emerging economies are under pressure. Their currencies are depreciating as investors send their money to dollar markets ahead of the U.S. Federal Reserve's announcement to taper quantitative easing. Indeed, the values of the Brazilian real, the Indian rupee and the Indonesian rupiah have fallen by about 10 percent over the past three months, reminding many of the currency crises in Mexico (1994) and Asia (1997). These crises left once promising economies stagnant, leading to social unrest and even regime change.
Concerns are particularly prevalent in Southeast Asia, where the continued reliance on foreign capital and the slowed growth of China — the driving force of the region's economy — have conjured memories of the 1997 Asian crisis. Regional governments fear that reduced global liquidity and more constraints among emerging markets could again hurt Southeast Asian economies.
After 1997, members of the Association of Southeast Asian Nations enacted several measures meant to make their economies less vulnerable to potential crises. Each country accumulated foreign reserves individually and, to a lesser extent, through regional liquidity crisis funds, such as the one created by the Chiang Mai Initiative. From 1997 to 2012, the foreign reserves for the 10 ASEAN members rose from about $200 billion to around $800 billion. For most of these countries, the reserves would cover about seven or eight months of imports — in 1997, reserves only covered three or four months.
Moreover, most ASEAN countries have adopted a flexible currency exchange regime, putting them less at risk than they were in 1997, when most countries had either pegged (or fixed) rates or a crawling peg. When speculative pressure become too strong, these countries were forced to float and let the market determine how much their currencies were worth. And when the currencies depreciated, reserves were drained in countries that had been experiencing years of rapid foreign investment. The more recent currency depreciations come amid improved financial operations, banking reforms and enhanced fiscal strength in many countries, making the possibility for another full-scale currency crisis low.
Nonetheless, sliding currencies and capital outflows are symptomatic of these countries' economic vulnerabilities, which have not changed much since 1997. Despite efforts to reduce dependency on trade in some countries, growth is still largely export driven. For example, exports accounted for roughly 31 percent of the Philippines' gross domestic product and about 80 percent of Malaysia's. Thus, any reduction in foreign demand would hurt their economies, and the damage cannot be offset by domestic populations too poor to buy the products.
In some sense, most of these export-oriented economies were built two or three decades ago. Initially they were successful, sustained by Japan's manufacturing model until that model ended in the 1990s. And over the past decade, China helped keep Southeast Asia's export-driven economies relatively prosperous with its strong growth and its endless appetite for commodities and raw materials. But now that China is undergoing its own economic correction, most of these countries are having a hard time finding alternative export markets.
Meanwhile, most emerging Asian economies have continued to rely heavily on foreign direct investment and portfolio investment to compensate for account imbalances and to fuel their economy. They attracted foreign investment by lending excessively through foreign credit, though many of these funds were misallocated or used ineffectively in the 1990s. While some corrections have been made, these countries still expect higher growth and higher global liquidities to maintain investment flows — which only adds to the economic volatility of these countries.
Even if a crisis in not forthcoming, reduced liquidity could inevitably lead to another structural correction for Southeast Asian economies. Each country would feel its effects differently.
Among the countries most vulnerable to currency pressures are those with deteriorating current account balances and those that rely on the investment inflow to balance out deficits in trades and services. Indonesia's account deficit saw a reversal since late 2011 as a result of falling commodity prices and shrinking external demand (particularly from China) of coal, palm oil and copper. Energy subsidies meanwhile weighed down the state budget. Commodity exports accounted for approximately 50 percent of the country's total exports and 40 percent of government revenue. The current account deficit reached nearly 4.4 percent of GDP in the second quarter of 2013 — the highest in a decade. This prompted the government to raise interest rates Aug. 29, while the reference lending rate has been raised twice since June. It also imposed higher import tax and favorable tax incentives for investment in late August.
This coincides with rising inflationary pressure. Currently, inflation is at 8.6 percent as of July, compared to 4.3 at the end of 2012. Currency depreciation will undermine the government's efforts to curb inflation, thereby raising the risk of stability and calling into question the ruling party's ability to win the presidential election next year. Still, the country remains attractive to foreign investors in mining, manufacturing and transportation construction, and such investment could help deter downward market pressures and sustain growth, which is projected to reach 5 percent in 2013.
Last quarter, Malaysia's account surplus fell to 1 percent of GDP. Thailand went from having an account surplus to having an account deficit of negative 5.1 percent of GDP. Because of their high export dependencies, particularly on commodities exports, which account for 30 percent of Malaysia's total exports and 15 percent of Thailand's total exports, falling external demand has hurt both countries, and they have revised their growth forecasts accordingly. Malaysia estimates its economy will grow by 4.5 percent to 5 percent (down from 5 percent to 6 percent), and Thailand estimates its economy will grow by 3.8 percent to 4.3 percent (down from 4.2 percent to 5.3 percent).
This comes as external debt rises for both countries. Malaysia's debt is 53 percent of GDP, while Thailand's is 40 percent of GDP. This does not mean a crisis is imminent, though it does lower investor confidence, making the countries vulnerable to investment flights.
The concern may be higher in Thailand, where falling domestic demand and a constrained state budget are threatening to slow down the economy. While Malaysia and Thailand are much more economically stable now than they were in 1997, they are still concerned about their exposure to foreign markets and their need to move up the value chain.
Vietnam is similarly worried. Despite its capital control, the country is still recovering from the financial turmoil of 2009, when the global slowdown exposed the country's structural deficiencies. Sharp currency depreciation, fleeing capital, soaring inflationary pressure and a banking crisis were among its many problems. Over the past two years, Hanoi's efforts to rein in credit, increase productivity and restructure financial markets have helped stabilize the economy. However, with the country's persisting trade deficit and high exposure to speculative investment, the redirecting of global liquidity could put additional pressure on Vietnam as it corrects its economy and restructures state corporations and financial markets.
Notably, the Philippines may actually benefit from a weaker currency, which would help exports. Remittances amounted to more than 40 percent of total exports — critical for a country that maintains a fairly consistent trade deficit and relies on intermittent financial inflows. However, in the long term, these dependencies may further expose the Philippines to global economic maladies — recessions could cause remittances to decline. Should the global economy slow down again, it would add more pressure to the already tight domestic market
It is unclear what will happen if the global economy continues to recover, but a reduction in global liquidity could lead to a structural shift in Southeast Asian economies. Regional contagion is unlikely, and so in the coming years these countries will have to manage a deft response to the paradox that continued U.S. growth boosts trade but simultaneously compels U.S. authorities to wind down the stimulus that has boosted capital flows into Asia.