On February 28, the US-led coalition of mostly Western countries cut Russia out of the SWIFT (Society for Worldwide Interbank Financial Telecommunications) international financial payment messaging system and froze the central bank’s access to much of its US$643 billion reserves. This was the first weaponization of the dollar-anchored global financial system on such scale against a major country’s central bank.
However justified by Russian leader Vladimir Putin’s aggression against Ukraine, this is likely to accelerate efforts, particularly by non-Western countries, to develop alternative payments systems. As the Times of India headline put it: “Question every country will ask – can US freeze my forex reserves too?”.
Asian countries are paying close attention, particularly China. Perceived Western triumphalism with respect to primarily Western sanctions brings back memories in the region of the Asian financial crisis of 1997. A deeper appreciation of that catastrophe and its aftermath, can help in understanding what Asia’s financial future may hold in the aftermath of the disruptions of the pandemic and the Ukraine war.
Revisiting the Asian financial crisis of 1997
In the region, the 1997-98 crisis and conditions imposed on bailout loans by the International Monetary Fund (IMF) devastated not only the financial systems of Indonesia, Korea and Thailand but also their economies and social conditions, upending domestic politics. Malaysia was also severely hit by the crisis, but chose to opt out of an IMF-led program. Despite doing so, in general, the pace of its recovery was similar to that of the other economies.
The Asian financial crisis was a new type of policy challenge – a capital account crisis. It differed fundamentally from traditional current account crises that characterized Latin American economies earlier in the 1990s (the result of inappropriate macroeconomic policies such as unsustainable budget deficits, leading to balance of payments problems). In Asia, rapid private capital inflows, mostly dollars, led to a high ratio of short-term foreign debt to foreign reserves. When short-term credit lines were not renewed, with sudden capital outflows currencies sharply depreciated, and reserves were exhausted in futile attempts at their defense.
It was the earlier experience with current account crises in Latin America, that provided much of the basis for policy responses, including by the IMF. Its programs were intended to restore the confidence of the financial markets, and generate the capital inflows needed to increase foreign reserves.
Perhaps partly because of that, conditions imposed by the IMF for essential loans were seen as “one size fits all”, as well as exceedingly harsh and intrusive, and with insufficient regard for wider economic, social and political consequences. Conditions were largely imposed by the IMF, with the US Treasury seen as pulling strings behind the scenes. There was limited appreciation of the complexity of the policy reform process.
The humiliation was captured in an iconic January 1998 photograph of Michel Camdessus, the IMF managing director, with arms folded watching as the Indonesian president Suharto, head bowed, hunched over a table to sign an emergency loan agreement. (Four months later, the strongman would resign after support for him collapsed.) This episode inspired quiet resolve among East Asian economies to lessen future reliance on external (Western-led) institutions.