If you think it feels like 1996, the eve of the Asian financial crisis, you're not alone. Take Avinash Persaud, chairman of Intelligence...

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If you think it feels like 1996, the eve of the Asian financial crisis, you’re not alone.

Take Avinash Persaud, chairman of Intelligence Capital of GAM London. “You’re seeing so much hot money rushing to Asia that it’s hard not to be reminded of the mid-1990s,” he says. “It will be interesting to see how Asia deals with it.”

It’s an important point that’s not getting enough consideration these days. The phenomenon may test how far Asia has come since its 1997-1998 crisis — or how much further it needs to go in repairing economies.

Breathless speculation that China will revalue its currency is drawing capital to Asia. China and Hong Kong are bearing the brunt of the trend, though markets in Malaysia, Singapore, South Korea and Taiwan are being influenced by the sudden arrival of speculative inflows.

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Hong Kong has even taken the unprecedented step of putting a ceiling on its currency. It was aimed at dissuading speculators from using Hong Kong as a Trojan horse of sorts to bet on a Chinese revaluation.

The trouble is this: An abrupt reversal of the inflows could be a major blow to Asian markets. That will be especially true if investors reckon the region’s financial systems still harbor some of the weaknesses seen in the mid-1990s.

There are a couple of reasons to wonder if money rushing to Asia today will leave just as quickly. One scenario would be a move by China to let the yuan rise slightly to convince markets another revaluation isn’t likely. Another is China doing nothing, frustrating investors hoping to profit from a currency change.

Other risks

Other risks also come to mind. What if rumors that large hedge funds are in trouble prove true? Or if global credit markets become even more volatile as central banks like the Federal Reserve raise interest rates? What if the U.S. dollar plunges under the weight of record current-account and budget deficits?

In each case, it’s possible investors will dump Asian assets in favor of ones in more-developed economies. After all, markets are being artificially buoyed by inflows of speculative hot money. While Asia is growing and China’s boom has been a godsend, short-term money that may exit at the slightest disappointment makes the region vulnerable.

“This kind of short-term investment is rarely a good sign in the long run,” says Diana Choyleva, director at Lombard Street Research in London.

A 1997-like crisis is highly unlikely. Since then, Asia has strengthened financial systems, reduced foreign-currency debt, improved transparency and made central banks more independent. Economies also have amassed record currency reserves to defend against the wrath of global markets.

Region’s growth

Efforts to wean Asia off exports have been far less impressive. The region’s growth rates still live and die by trends in the United States and, increasingly, China. Governments have been too slow to boost domestic growth and their economies will suffer if the world’s biggest ones slow.

Asian markets, meanwhile, aren’t getting as much long-term institutional investment as they deserve. Capital inflows related to yuan speculation are no substitute. There’s also a risk rising stocks and falling bond yields in the short run will give governments even less incentive to step up reforms.

Think of it as Asia’s own Alan Greenspanlike conundrum. The Fed chairman has been marveling aloud about how U.S. bond yields haven’t risen in step with increases in short-term interest rates, calling it a “conundrum.” Asia’s own puzzle is rising asset prices even though economic fundamentals haven’t kept pace.

The near-linear focus on a Chinese revaluation is having some intriguing side effects in Asian markets. Aside from rising stocks, speculators betting they soon may rise are affecting pegged currencies in Hong Kong and Malaysia. Hong Kong said it would prevent its currency from appreciating above 7.75 per U.S. dollar.

There’s little Asia can do to control the inflows, though. South Korea, meanwhile, has become less fixated on the strength of its currency. Officials in Seoul are realizing it’s futile to try to hold down the won.

Export reliance

While all’s well now, any surprises from China could send capital out of Asia. Then, governments may regret not doing more to retool their economies. It would be better if the region were less reliant on exports. It also would be better if nations weren’t using the crutch of weak exchange rates to boost growth — instead of boosting entrepreneurship.

Of course, China could do exactly the opposite and not satisfy markets with a revaluation. Amid signs its domestic economy is cooling, officials in Beijing may be less inclined to take a step that might damage export industries. Then again, disappointment over Chinese inaction could encourage capital to leave Asia.

If so, investors may finally be able to grade Asia’s postcrisis repair efforts. It’s likely to be a mixed report card.