Not guaranteed to protect against financial contagion. Photographer: Nicolas Asfouri/AFP/Getty Images
Not guaranteed to protect against financial contagion. Photographer: Nicolas Asfouri/AFP/Getty Images

Asia is still traumatized by the great financial crisis of 1997, when Thailand's devaluation of the baht set off a region-wide collapse in markets. Could it happen here again?

The mere question will strike many as odd, given Asia's rapid growth and progress in strengthening financial systems, improving transparency and amassing trillions of dollars of currency reserves. But Asia now faces three risks that could quickly undo those gains: Federal Reserve tapering, a Chinese crash and an explosion of household debt.

The danger of the Fed pulling too much liquidity out of markets has been well documented. So have China's rising vulnerabilities. Debt, though, deserves far more scrutiny. As economists survey the scene, Thailand once again tops the worry list. Debt there has risen rapidly, underwriting standards appear loose and nonperforming loans are rising.

Thailand has plenty of company in Asia, Oxford Economics warns in a new report. Financially conservative Singapore has seen credit growth in the last six years exceed that of the U.S. in the run-up to its 2008 subprime meltdown. Several nations now have private-debt ratios of between 150 percent and 200 percent of gross domestic product. They include the higher-income set -- Australia, Hong Kong, South Korea and Taiwan -- as well as China, Malaysia, Thailand and Vietnam. Even where debt levels are lower, Indonesia and the Philippines, the trajectory is troublesome.

"Debt surges of this kind often end badly," says Oxford economist Adam Slater.

Even more worrisome than the absolute levels of debt, says Frederic Neumann, Hong Kong-based co-head of Asian economic research at HSBC Holdings Plc, is the pace of increase. For all its rapid growth and buoyant markets, Asia isn't as healthy as it appears on the surface, and might take on even more debt to support growth. As leverage exceeds the peak before the 1997 crash, is a sharp correction on the way?

"The optimists argue that's unlikely to occur in Asia, where people tend to be more prudent and save more of their monthly income," Neumann says. "Well, not necessarily."

All this fresh debt leaves Asia highly exposed to financial shocks and economic shifts. Any destabilizing event -- Fed Chairman Janet Yellen over-tightening, renewed turmoil in Europe, a Chinese credit crunch, surging oil prices, troubles in Japan's bond market -- could push Asia back to the brink. And it's not as though export markets are booming to provide a cushion.

What should governments be doing to avoid disaster? "It's all about productivity growth," Neumann says. "If it slows, profits come under pressure and there's a tendency to leverage up to maintain returns on equity, so anything that boosts productivity growth, really. For example, state-owned enterprise reform, infrastructure, less labor market rigidity and trade liberalization."

Few of these upgrades are afoot. Certainly not in Thailand, where the generals who seized power on May 22 are too busy consolidating power to restructure the economy. Ambitious talk of change in Hong Kong, Korea, Malaysia and elsewhere hasn't been met with noticeable action. And the real worry, of course, is China. On Aug. 1, the central bank warned that credit and money supply are increasing too rapidly, months after Premier Li Keqiang pledged to tackle China's lending bubble.

China's unprecedented stimulus binge after Wall Street's 2008 reckoning supported growth throughout Asia. Beijing's epic largess could come back to haunt the region if growth slows sharply or giant debt defaults slam world markets. The same goes for the Fed's quantitative easing program. Ultra-low U.S. rates pulled tidal waves of capital Asia's way, helping to facilitate a surge in private-debt ratios. But now Fed policies and China's growth engine risk shifting into reverse.

Thailand's implosion was only the most spectacular example of Asia's propensity for boom-and-bust cycles since the late 1990s. Others include Hong Kong's property slump in the early 2000s, mini-crises in unsecured debt in Korea and Taiwan in the mid-2000s and Vietnam's real-estate blowup that began in 2010. This track record is a warning against downplaying the damage unsustainably high debt could inflict.

Granted, Asia is still among the world's least-ugly economic regions, with Greece and Portugal back in the news and Argentina defaulting anew. Also, stricter loan-to-income ratios and robust "macroprudential" policies such as taxes and regulations that limit money flows could save Asia from revisiting the depths of 1997. But, Oxford's Slater warns, "the risks from the debt build-up look sufficient to call into question the much-touted trend of the rise of the Asian consumer." That would be bad news for everyone.

To contact the writer of this article: William Pesek at wpesek@bloomberg.net

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net.