South Asia debt evokes fears of 1997-style crisis

Pakistan is scrambling for a bailout to avert a debt default as its currency plummets. Bangladesh has sought a preemptive loan from the International Monetary Fund (IMF). Sri Lanka has defaulted on its sovereign debt and its Government has collapsed. Even India has seen the rupee plunge to all-time lows as its trade deficit balloons.

Economic and political turbulence is rattling South Asia this summer, drawing chilling comparisons to the turmoil that engulfed neighbours to the east a quarter century ago in what became known as the ‘Asian Financial Crisis’.

Back then, what seemed like an isolated event – Thailand’s July 1997 baht devaluation to cope with currency speculation – spread like a virus to Indonesia, Malaysia, and South Korea. Panic-stricken lenders demanded early repayments and investors pulled out of stocks and bonds in emerging markets, including in Latin America and Russia, which defaulted on some of its debt in August 1998. 

A month later hedge fund Long-Term Capital Management, which had made highly-leveraged bets on Russian and Asian securities, buckled.

Can it happen again? Ammar Habib Khan, Chief Risk Officer at Karandaaz Pakistan, an Islamabad-based nonprofit that focuses on financial inclusion, thinks so. South Asian nations “had a big party on low-cost dollar debt, funding consumption, and vanity projects during the last 10 years,” he says. “South Asia has the same vibes as Southeast Asia in 1997.”

The fault lines started to show this spring, when the US Federal Reserve accelerated interest rate increases to combat inflation. That set dominoes falling in South Asia, where inflation has also been roaring. Easy money dried up, currencies depreciated, and foreign exchange reserves dissipated.

A prolonged crisis would sap dynamism in a region that’s home to a quarter of the world’s population and its fastest-growing major economy, India, threatening expansion plans for companies betting big on the area, such as Inc. and Walmart Inc.

So far, contagion seems contained. One reason is that in 1997, Asian countries’ so-called economic miracle masked vulnerabilities that are less prevalent today: too much public and private debt, weak banks, and highly-speculative foreign investment. South Asian countries also owe less to foreigners, having borrowed more in local currencies than in dollars to finance growth than neighbouring countries did in the 1990s.