Iran oil shock stirs memories of 1997 Asian Financial Crisis — but here’s why history may not repeat itself

A month into the worst oil supply disruption since the 1970s Arab embargo, the economic pain spreading across Asia is reviving an uncomfortable question: Could this be 1997 all over again? The parallels are hard to ignore. Asian currencies are under pressure, fuelling the risk of capital outflows. Spiking energy costs have pushed governments to roll out emergency measures, while central banks are drawing down foreign exchange reserves. In Thailand, policymakers have moved to ration gasoline. Meanwhile, surging pump prices in the Philippines prompted the government to declare a national emergency. Across the region, the widening trade deficits and rising inflation expectations feel reminiscent of the Asian financial crisis that began in 1997. But economists say the similarities may be largely superficial, thanks to more flexible exchange-rate regimes and deeper foreign exchange reserves, which provide a buffer that helps absorb some of the shock. “Crises can take many shapes, and the shape of this [Iran] crisis is entirely different,” said David Lubin, a senior research fellow at Chatham House. The 1997 episode, he noted, was driven by “a toxic mixture of fixed exchange rates, high levels of short-term foreign debt, low levels of foreign exchange reserves, and elevated current account deficits”. “These days, Asian economies — precisely because of the legacy of the late-1990s crisis — are much better protected”. The region’s financial architecture has also “evolved substantially over the past three decades”, with deeper local markets, broader domestic investor bases and far less reliance on short-term foreign funding, said Fesa Wibawa, an investment manager of fixed income at Aberdeen Investments. That, he said, reduces the risk of sudden capital flight and forced deleveraging that defined the 1997 crisis. Financial shock versus physical shock The 1997 crisis was a shock to the financial account, where bank inflows dried up. But the ongoing crisis is a shock to the current account, as oil and product inflows have drained, said Brad Setser, senior fellow at the Council on Foreign Relations, a think tank. “One was a financial shock, the other is a physical or supply shock. And for the worst-affected Asian economies, the 97/98 [crisis] was a much bigger shock,” he said. In 1997, Southeast Asian economies had built large amounts of short-term dollar-denominated debt, supported by quasi-fixed exchange rates and dangerously thin reserve cushions. When speculative trades piled in, Thailand, Indonesia, the Philippines and Malaysia were forced to abandon their currency pegs, triggering cascading defaults and deep economic contractions that were worsened by International Monetary Fund austerity programs. The main challenge for Asia in the current crisis is the effective blockade of the Strait of Hormuz, which has choked about one-third of the oil supplies needed for the regional economy. About 10 million barrels a day of the 30 million barrels needed are not going through the artery. Diesel and jet fuel prices have also soared in recent days, with supply shortages rippling across Asia. The reserve buffer South Korea’s foreign exchange reserves stood at more than $US400 billion ($568b) as of end-January, according to the US Federal Reserve, a sharp increase from roughly $US30b to $US40b during the 1997-1998 crisis. South Korea’s local-currency bond market has also grown to about 3500 trillion Korean Won ($3.3 trillion), with foreign investors holding around 21 per cent of outstanding bonds, a cushion that did not exist in the late 1990s. India’s foreign exchange reserves sit at around $US688b after a series of interventions by the Reserve Bank of India since the war began to shore up the rupee. Countries such as Indonesia, the Philippines and Thailand also hold significantly larger reserves than they did three decades ago. Unlike the late 1990s, when many Asian economies held large amounts of dollar-denominated debt — meaning a weaker currency increased financial pain — most countries in the region now have built up their dollar reserves. Weaker currencies, while uncomfortable, can provide some trade benefits rather than amplifying financial losses. Dan Wang, China director at Eurasia Group, said exchange rate reforms have also strengthened the region’s resilience. The most affected economies in 1997 had quasi-fixed exchange rates, forcing central banks to spend reserves to defend their currencies. When reserves ran out, currencies collapsed. Today, most Asian currencies are allowed to move more freely, which means they can absorb pressure by gradually weakening, reducing the risk of collapse under the strain of a defended peg. Larger foreign exchange reserves also added a layer of safeguard for central banks to defend their currency. “During the oil shock, ample reserves, especially in Thailand and the Philippines, have avoided the need for aggressive rate hikes to defend a peg,” Wang said. “The problem those countries face [now] is possible stagflation, but the financial system remains intact.” Stagflation risks Still, Asia’s economies are bearing the brunt of the prolonged Middle East conflict, as the oil-dependent region faces a physical shortage of its primary energy input, potentially raising the risk of stagflation, economists warn. Alicia García-Herrero, chief economist for Asia Pacific at Natixis Bank, said that while the crisis is not self-inflicted, fiscal space is far more constrained than in 1997 due to higher public-debt levels and limited room for aggressive stimulus. Indonesia and the Philippines appear the most vulnerable, she said, with risks centered on capital outflows, currency pressure on the rupiah and peso, and tighter fiscal buffers for subsidies. However, investors positioning across the region have remained cautious rather than panicking, said García-Herrero, with selective outflows from Indonesian bonds offset by modest net inflows into regional equities. “No broad capital flight is evident yet,” she said. Indonesia’s 2026 energy subsidies budget of 381.3 trillion rupiah ($5.84t) assumed crude oil prices at $US70 a barrel, while officials have flagged a worst-case scenario of $US92. Brent crude futures for June delivery stood at around $US97 a barrel on Thursday after the US and Iran reached a two-week ceasefire agreement. The Philippines, one of the region’s most oil-exposed economies, has also seen fuel prices rise quickly, with the government having limited room to increase subsidies. Headline inflation in the country surged to a 20-month high of 4.1 per cent in March, up from 2.4 per cent in February. The oil shock will not hit every country equally. Malaysia, Singapore and China appear less vulnerable to the energy supply shock, thanks to their current-account surplus, robust strategic reserves and more diversified energy sources, said industry veterans. Singapore stands out as one of the most resilient economies due to its diversified growth model and strong institutions, García-Herrero said, while Malaysia also benefits from its status as an energy exporter and continued inflows into semiconductor and AI-related investment. The oil shock could spill beyond Asia, said Robin Brooks, a senior fellow at the Brookings Institution, adding that if Iran were to strike an oil tanker in the Strait of Hormuz, “we will see oil spike, we will see emerging market currencies get hit massively”. Emerging market currencies could come under heavy pressure, Brooks said, forcing central banks to sell US Treasurys to raise dollars in a bid to defend their currencies. The selling pressure could push US yields higher and ripple through global bond markets. Capital flows today appear “more volatile and market-driven, even if they are generally less destabilising than in the past,” Wibawa said. He described the recent currency moves as part of a market adjustment rather than signs of a brewing systemic stress. Wibawa also pointed to the absence of extensive currency mismatches, unhedged foreign-currency exposures, and a lack of transparency that defined the 1997 crisis. The lesson of 1997 The Asian financial crisis — one of the worst emerging-market shocks of the 20th century — pushed policymakers in the region to spend the subsequent decades building financial and fiscal buffers that are now being tested. The question now is how long the shock lasts and whether the physical energy shortage can be resolved before the economic damage spirals out of control. “Time is running out for de-escalation to avoid major costs to the world economy,” said Rob Subbaraman, chief economist at Nomura Bank, adding that the surge in energy prices has lasted long enough to inflict a significant impact on the global economy. “If the US escalates further and/or puts U.S. boots on the ground, the initial inflation spike could quickly morph into a growth shock,” he said. CNBC