Are we seeing early indicators of a financial crisis?

Cropped image of an unrecognizable businessman pulling out his empty pocket. [Getty Images]

In July 1997, the world began to witness what became the Asian financial crisis.

The crisis began in Thailand, with the collapse of the Baht, the country’s official currency.

The most affected countries were Thailand, Indonesia and South Korea. However, the regional contagion affected all the Asian countries including China and Japan.

Ironically, before the crisis, these countries reported sterling economic performance.

Following the fall of communism in 1989, the economic depression in the US in the early 90s, and the attractive interest rates in the Asian countries, most investors took their money to South East Asia.

In 1995, it was reported that half of all capital investment going into developing countries was going to these Asian countries. This was the Asian miracle that gave rise to the Asian tigers.

The economies of Thailand, Malaysia, Indonesia, Singapore and South Korea experienced high growth rates of between eight to 12 per cent Gross Domestic Product (GDP) in the late 1980s and early 1990s, thanks to the Asian miracle.

However, most of the private investment went into real estate development that did not yield desired returns in time. The government took hefty debts to build the corresponding infrastructure which equally underperformed.

Crony capitalism

The debt to GDP ratio went as high as 100 per cent to 130 per cent before the crisis.

Except in Singapore, graft was rife in the region, redefining crony capitalism as State officials colluded with the private sector to do business, often at the expense of the greater economic good of the country. These made the Asian tigers vulnerable to economic shocks. By Murphy’s law, nature always sides with the flaw – things did go wrong.

In 1997, the economic bubble burst. The US had recovered from its crisis and governor Greenspan increased the interest rate to attract investment homes.

Further, China and Japan devalued their currency making their exports cheaper, thereby outmanoeuvring their neighbours in the race for exports.

That’s when the borrowing went out of control, the forex reserves fell, stock markets crashed and real estate prices went to the dogs. In Cambodia, the high cost of living led to a regime fall. Financial crises are inked to economic cycles and are hard to predict. However, early warning indicators can predict financial crises.

The first indicator is solvency. Public external debt-to-GDP ratio increases in the run-up to a crisis

It is estimated that when the debt-to-GDP ratio goes beyond 85 per cent, the economy is headed to a crisis. The Kenyan ratio is 70 per cent, higher than the IMF recommended level and with ever-expanding budget deficits and a president encouraging more debt.

The second is liquidity. With most external debt being taken in dollars; the foreign exchange reserves make for a good indicator of a country headed to a crisis.

Our reserves have fallen to $7.8 billion, the equivalent of 4.66 months’ worth of exports by April 2022 down from the conventional six months.

With the closure of Pwani Oil, an edible oil manufacturer, however, one wonders if there’s a currency crisis brewing out of the public glare.

The third is production. Real GDP growth can attract investments and avert a crisis. If you plot a graph of Kenyan GDP between 2010 and 2020, you find an overall negative growth with the climax being 2020, when the country registered -0.3 per cent growth.

Finally, external shocks may push an economy into a financial crisis.

A strong dollar, war and the coronavirus have all colluded to make developing economies struggle with high inflation and currency shortages.

With these indicators, one can ask, are we headed to a crisis? More importantly, should we borrow more e debt for infrastructure development as recommended by the President in his Madaraka Day national address? You be the jury!

The writer is the CEO of Elim Capital