This article first appeared in The Edge Malaysia Weekly on July 11, 2022 - July 17, 2022

THE recent rout among Asian currencies has brought back memories of the Asian financial crisis (AFC) in 1997. The nightmares had given policymakers then sleepless nights, as the currencies were massively devalued, which led to aggressive rate hikes, a stream of defaults among corporates that were highly leveraged in foreign currency-denominated loans and the meltdown of asset prices.

The recent currency rout was made even more unnerving because, in May, Sri Lanka fell into an unprecedented economic collapse that has left the country in turmoil and unrest until today.

There is no doubt, then, that many would wonder whether the current economic headwinds seen could be an indication that economies in Asia might be heading that way once more.

OCBC Bank chief economist Selena Ling does not think there will be a repeat of the AFC despite the unfavourable events that have lined up recently.

“When you look at the AFC in 1997, the exchange rate mechanism came under attack, but we don’t have that today. The ringgit is not pegged to the US dollar either.

“So, when you have all the markets moving relatively sharply compared with the US dollar, it is more of a reflection of the US Federal Reserve hiking rates sharply rather than the country-specific weakness,” she explains during an interview with The Edge.

She reiterates that what the Asian currencies are experiencing now is because of the broad US dollar strength rather than a fundamental weakness in specific Asian currencies.

During the AFC days, debt leverage in terms of gross national debt and corporate debt was a big issue whereas, today, debt ratios are more controlled, Ling says.

“There are pockets of weakness in different economies, but compared with the last two crises, you don’t hear of any particular Asian sovereign being very dependent on US dollar debt per se. Most have developed a fairly healthy debt market where they can borrow and have no issues getting financing.

“The systemic weaknesses have been addressed to a certain extent,” she explains.

While it can be quite unnerving to watch one’s currency depreciating against the US dollar, Ling says central banks today have learnt from the AFC crisis and will not repeat the intervention efforts they undertook then to try to defend their currency at “all costs”.

Recall the case of the Thai baht (THB) in 1997, where the Bank of Thailand tried to defend its currency against speculators who were driving down the currency. It purchased THB with US dollars in the foreign exchange market, raised interest rates and restricted foreigners’ access to the local currency.

Unsurprisingly, foreign exchange reserves fell sharply from US$37.1 billion at end-1996 to US$30.9 billion in June 1997.

Not long after that, the central bank ran out of money and tools to fend off the speculators it had attracted with its moves.

“Typically, most central banks prefer to have some stability [in currency]; they can allow the currency to move in line with the market, but not sharp fluctuations because it’s disruptive for businesses and individuals.

Many central banks have been trying to smoothen out the foreign exchange volatility. If you look at the foreign exchange reserves, [they have] been coming off but not as sharply as in the past crises,” she says.

Notably, Malaysia’s international reserves have also been declining, amounting to US$109 billion (RM482 billion) as at June 30 compared with US$116.9 billion as at Dec 31, 2021.

Ling also allays fears that other emerging economies may also follow Sri Lanka’s economic collapse. She emphasises that the situation in the country was different and its predicament could have been largely due to the issue of financial mismanagement by the government over the years.

“If you look at the rest of Asia, they are in a much better position. For example, looking at the current account position and foreign exchange reserves, most of them are not in a situation where they have their backs against the wall,” she adds.

She also does not think the current situation could lead to the kind of systemic risk seen during the global financial crisis in 2008/09, which saw major financial institutions failing, causing panic across the financial system in the US that quickly spread across the world.

“The current situation is a different animal from what it was during the GFC. The financial system still has liquidity, borrowing is happening, credit is not an issue and we don’t see entire sectors being shunned. It’s basically a functioning market now,” she says.

The chief economist sees Asian economies being more resilient than those in other parts of the world, based on healthy foreign exchange reserves that Asian countries possess and the fact that there has not been widespread capital outflows.

She points out that an indicator often tracked to judge capital outflows is the foreign bond holdings. So far, such as in the case of Malaysian government bonds, it shows that foreign bond holdings are still high at 38% to 39%, indicating that there is no sign of panic.

In Asia, many countries have also seen good momentum in trade this year, indicating a strong momentum in manufacturing sectors while consumer demand continues to hold up. A large part of this, says Ling, is because there has been no big spikes in unemployment that were apparent during the last two crises.

“So, as long as household income is relatively resilient, that provides one level of support. I would say Asia is in a much better space. We haven’t seen big swings to current account deficits just because of this current slowdown and higher interest rates,” she adds.

There has been mounting concern that the world is on the brink of a recession, given the anticipated aggressive rate hikes started by the Fed to tame inflation.

Also in the equation is the Russia-Ukraine war — an unexpected variable that has dampened the recovery from the Covid-19 pandemic. The war has put Europe in a pickle because of its reliance on Russia’s energy resources, and is pushing inflation to multi-year highs, prompting the European Central Bank (ECB) to be resolute on raising rates as well.

Furthermore, China — one of the economic growth locomotives — is determined to adopt a zero-Covid strategy and this is expected to slow down its economic activities.

Against this backdrop, Ling sees a high possibility of a synchronised slowdown in the three major economies — the US, China and Europe — taking place but is not calling for a global recession.

“It is likely that, in certain economies, we could see pockets of technical recession because of the slowdown, but we will probably not see a global recession across the board this year. We are now in July, with five to six months of data under the belt, [so] unless we see a hard stop in 2H2022, it won’t be enough to wipe out the growth in 1H2022,” she says.

Nevertheless, she is quick to add that one must “never say never”.

“For a global recession to take place, it would require an extra trigger on top of what is being thrown at the global economies currently. It will have to be a curveball that will sink the ship,” she elaborates.

Having said that, a synchronised slowdown among major economies is more than likely to put stress on global economic growth.

Asean, which has just reopened its borders this year, is benefiting from the recovery from the pandemic. There have been signs, however, that US policy decisions are starting to affect this region in terms of financial market volatility.

While the US is expected to continue to raise rates by another 175 basis points by year-end, on top of its quantitative tightening of US$47.5 billion a month, which will increase to US$95 billion by September, there are fears that the US will fall into a recession like it did in the 1970s during Paul Volcker’s time as Fed chairman.

Ling believes, however, that the US could fall into a shallow recession, not a deep recession like that of the 1970s.

“The view is that the faster they frontload the rate hikes, the earlier the pause and the rate cuts will come. If you look at the futures market, it is starting to price in the possibility of a Fed rate cut in 2023 itself. That may be one saving grace for the economy,” she says.

Just last week, Bank Negara Malaysia raised the overnight policy rate (OPR) by 25bps to 2.25%, in line with market expectation.

In his report, OCBC economist Wellian Wiranto says Bank Negara’s move to raise rates by 25bps instead of a more aggressive 50bps is prudent, given the increasingly uncertain global economic outlook.

“We see at least one more 25bps hike from the central bank this year, with a high likelihood that it will take place in the next immediate meeting on Sept 8. It might then pause in the last meeting of the year in November to assess the balance between inflation and recession risks before undertaking any action thereafter,” he says.

A big concern for Malaysians has been the expensive subsidy bill that is likely to soar to RM80 billion this year — a measure to contain headline inflation. While Malaysia is a commodity exporter and stands to benefit from higher prices, the pace of the rise in prices has not kept up with the subsidy bill increases. This is likely to strain the government’s coffers.

On the other hand, the subsidies have managed to help keep inflation under control, around 2.8% in May, compared with Singapore, at 5%.

Ling says: “When you look at the fiscal space to stimulate the [domestic] economy, if global growth deteriorates for the worse, Malaysia has not much room for that. However, if you look at what has happened over the last two years, the debt ceiling has been raised from 50% to now at 60%. Maybe that’s the new normal?

“If the subsidy bill is not cut back, there is a high chance that the country will overshoot the 6% deficit. At this juncture, I don’t think the rating agencies are perturbed. If they were, S&P [Global Ratings] would have kept the negative instead of shifting back to neutral.”

The important thing, she says, is for a government to have a plan to address the fiscal deficit in the near future. She believes many would still be gracious if the deficit is overshot again, given that the government has spent the last two years fighting the pandemic.

The absence of a plan will be a cause of concern for many, though.

OCBC forecasts Malaysia’s economic growth to come in at 5.7% this year, a result of the low base effect, and sees growth coming off in 2023, projecting GDP to come in at 4.6% in 2023, as it sees a much sharper slowdown in the US next year.

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