The Asian Financial Crisis: 20 years on

Mark Williams & Carolyn Chan

In the summer of 1997, the devaluation of the Thai Baht marked the beginning of the Asian Financial Crisis. Loss of investor confidence in the region led to further capital flight, with net private capital inflows drying up from US$110bn in 1996 to net outflows of US$11bn for the crisis-hit countries.

20 years on, we ask Mark Williams and Carolyn Chan – Liontrust Asia Income fund managers – to revisit these events, examine the subsequent development of the region, and highlight the future investment opportunities. Both Mark and Carolyn have been investing in Asian equities for over 20 years.

What were the main causes of the Asian Financial Crisis?

Carolyn Chan: Broadly speaking, a combination of macroeconomic imbalances, weaknesses in the corporate and financial sectors, pegged exchange rates and external developments led to the Asian Financial Crisis (AFC). Vulnerabilities differed in the crisis-hit countries: in Thailand, excessive unhedged foreign currency borrowing in the banking sector under the fixed exchange regime; in Indonesia, unhedged foreign currency in the corporate sector; and in Korea, foreign liabilities of non-bank financial institutions and the corporate sector. The most affected countries had a high ratio of short-term external debt to GDP with ratios ranging from 130% in Thailand to 340% in Korea (source: World Bank and IMF). In addition, corporate leverage was exceedingly high with debt to equity ratios of 200% in Indonesia, 640% in Korea, and 340% in Thailand in 1996 (source: World Bank). Contagion spread rapidly and panicked investors withdrew from the region. Rapid capital outflows exacerbated currency devaluations, the MSCI Asia ex-Japan index fell 60% in value in the year to August 1998, and unemployment soared.

Could it happen again? Should investors be worried given China’s debt levels?

Mark Williams: I think it’s very unlikely. In 1997, the region was overleveraged and much of this debt was owed overseas. Debt levels are still quite high today but the key distinction between then and now is that the debt profile has changed significantly.

Most importantly, the vast majority of China’s debt is funded domestically, which means that a sudden disappearance of funding sources (as was experienced in the AFC) is unlikely. In fact, across the region, companies are now less reliant on high levels of foreign debt and an assumption of fixed exchange rates. Corporate debt to equity ratios are now much lower at approximately 60% in Korea, 80% in Thailand, 70% in Indonesia and 55% in Malaysia (source: World Bank) . Also, while China’s gross debt is very high, it is primarily owed by the state (or state-owned enterprises) to the state (or state-owned banks). This makes it far easier for the debtors and creditors to reach agreement in the areas where debt is unsustainably large. It also means that the state’s assets can be an important offsetting factor. China has huge forex reserves (making a forced currency devaluation unlikely) and a centrally directed economy which can in our view withstand a lot of stress without any systemic problems developing.

CC: Asia is now far less reliant on foreign capital. After the AFC, Asian countries devalued their currencies and benefited from export-led recovery. But Asia was lucky in some respects that the US economy was strong at the time, driving export demand. This foreign reliance needed to be addressed as a resilient regional economy should be able to cope with downturns in its export markets and outflows of international capital. In this respect, the emergence of China has reduced reliance on the US, while the establishment of the Chiang Mai Initiative was another important step and established a network of bilateral currency swap agreements which provided liquidity support to the region.

What have been the other key changes in Asia over the last 20 years?

MW: Well, it may seem a bit trite, but the key event has obviously been the emergence of China, both as an economic force and an investment opportunity.

CC: The impact of the AFC on China was largely limited to a slowdown in trade to Asia with China’s GDP growth remaining resilient at 9% in 1998, down slightly from 10.3% in 1996 compared to Thailand’s GDP which contracted by 7.6% in 1998 having grown 5.7% in 1996 (source: World Bank). 

How was China viewed as an investment prospect in 1997? Did the Hong Kong handover change things?

CC: The Hong Kong handover was the same summer as the AFC – with sovereignty switching from Britain to China on 1 July 1997. My recollections of the handover are as a political milestone rather than an economic one. It was China’s accession to the World Trade Organisation which really marked a turning point in how investors viewed it, but that didn’t happen until 2001. Foreign investors were given direct access to China’s capital markets via the Qualified Foreign Institutional Investor Scheme which was introduced in 2002.

MW: Back in 1997 Hong Kong was a key investment market. Whereas China had yet to really emerge as an investment destination, Hong Kong was already an established developed market constituent of the MSCI All Country World Index. The constitution of the Hong Kong stockmarket very much reflected its Sino-British colonial history. The most obvious example that springs to mind is Jardine Matheson – one of the biggest companies on the market in 1997. It is an Asian conglomerate which was formed in Canton in 1832 as a trading house after the East India Company lost its monopoly in China.

CC: Hutchison Whampoa is another dominant Hong Kong player, owned by Li Ka-Shing – the ‘Superman of Hong Kong’ who has been associated with Hong Kong business for decades.

MW: Over the last 20 years, China’s economic transformation has overshadowed Hong Kong’s own strong economic growth.  Hong Kong is still a large economy – its GDP is around US$320bn. But while this represents a rough doubling in the last 20 years, China’s GDP has grown more than ten-fold over the same period to over US$11tn (source: IMF).

China’s 20 year transformation overshadows Hong Kong’s economic growth:

The Asian Financial Crisis: 20 years on - China’s 20 year transformation overshadows Hong Kong’s economic growth

And how do you view the relative investment opportunities in Hong Kong and China 20 years on?

CC: While the Hong Kong economy is still a big investment destination in its own right – albeit one in which we don’t see a lot of attractive value ourselves at the moment – it is dwarfed by the opportunity to invest in the Chinese economic growth story.

MW: Hong Kong plays a massive role as a portal or gateway to investment in mainland China. And this aspect has grown significant over the last 20 years, mirroring China’s economic emergence.

In the 1990s you could already buy ‘red chips’ – a play on the ‘blue chip’ term applied to Western large caps. These are HK-listed companies which are incorporated outside of mainland China but ultimately are Chinese state-owned entities. These are still available on the Hong Kong market. There are around 150 red chips listed on the Hong Kong Exchange.

Since 1993, there have also been H shares: Hong Kong-listed companies that are incorporated in mainland China. Tsingtao Brewery was the first, and now there are over 200.

Both red chips and H shares have grown hugely in the last 20 years. Between them, they now account for 40% of the market capitalisation of the Hong Kong stock exchange, up from 16% in 1997 (source: HKEX). So a large proportion of the value of Hong Kong’s stock exchange now relates to the mainland economy.

Often these H shares are a counterpart to the mainland-listed A shares to which international investors have only restricted access (via Stock Connect programs or QFII/RQFII status).      

Do you invest in H shares?

CC: Yes, just over 40% of the Liontrust Asia Income Fund is invested in Hong Kong and China and almost all of this is via H shares in Chinese companies.

This exposure is very selective – it is not broad Chinese equity market exposure – but we can still find plenty of companies where we think valuations look attractive, and which provide the combination of dividend yield and earnings growth that we are currently seeking.

These tend to be in areas of domestic consumption or those with government support, which are areas we have liked for some years now.

What is your outlook for Hong Kong and China for the next 20 years?

MW: In the short term, our base case for Asia is a further, desirable, economic slowdown. China itself needs to remove its reliance on inefficient, debt-driven investment and become more reliant on domestic consumption as a growth driver. This means that if Asia Pacific shares merely remain at their current fair valuations, there is the potential for about 10% expected earnings growth to be passed through in the form of share price appreciation. Growth rates will still be very high by Western standards.

China still by far the biggest contributor to global growth:

The Asian Financial Crisis: 20 years on - China still by far the biggest contributor to global growth

CC: In the longer-term, we expect to see further rebalancing from external to domestic demand. 

While US influence in Asia is on the wane, China is expanding its influence, making huge infrastructure investments which include the One Belt One Road project (US$900bn). It has also set up the Asian Infrastructure Investment Bank.

Huge infrastructure investment cements China’s position at Asia’s epicentre:

The Asian Financial Crisis: 20 years on - Huge infrastructure investment cements China’s position at Asia’s epicentre

MW: All will not be plain sailing in China’s growth story and economic and financial transitions will have negative effects in some areas of the economy – so you need to be very selective in terms of where you invest.

Looking specifically at Hong Kong’s economy and corporations, as mentioned already we do not see a lot of value at the current time. As with other markets in our region, however, such as India – we stand ready to reassess our stance as economic factors evolve and stock market valuations fluctuate.

Is it easy to find stocks with good yields in a region which is often lauded for its growth prospects?

MW: Yes, there is a deep pool of Asian companies offering an attractive combination of yield and growth potential. If we screen globally for companies forecast to yield more than 4% and grow EPS at over 10% (and with an appropriate minimum daily liquidity), we find that over a third of these companies are located in Asia Pacific ex-Japan (source: Liontrust, Bloomberg).

This pool of potential investments is likely to grow, partly due to the improving dividend culture in the Asian region. China is showing signs of a maturing approach to dividends and minority shareholders, both at the corporate and political levels, and South Korea is slowly making tentative steps in the same direction. This is important as it often forces capital discipline on companies which can ultimately be of benefit to shareholders. 

Asia has a large number of companies providing a combination of dividend yield and earnings growth:

The Asian Financial Crisis: 20 years on - Asia has a large number of companies providing a combination of dividend yield and earnings growth


• Past performance is not a guide to future performance. • Do remember that the value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.  • Investment in Funds managed by the Asia Team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. • The Funds' expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation.

• The information and opinions provided should not be construed as advice for investment in any product or security mentioned.  • Always research your own investments and consult with a regulated investment adviser before investing.

Wednesday, June 28, 2017, 11:24 AM