BW int'l cover story: Asia: Recovery without Reform (fwd)

[Robert Weissman <rob@essential.org>]

Business Week:
August 9, 1999
International -- Int'l Cover Story
Asia: Recovery without Reform (int'l edition)
Asia's markets are soaring--but the economies are shaky, and change is slow
The scent of fast money has returned to East Asia. From South Korea to
Malaysia, economies have pulled out of last year's death spiral, while
prices
on the stock market have rebounded to their pre-crisis levels. Global
investors ripping open their first-half Asian mutual fund statements gasped
at 40% returns on average for regional stocks, outside of Japan. And daring
souls who jumped into Japan's over-the-counter market saw their money
double
during the period.
   But before you read yet another Wall Street research report trumpeting
the
Great Asia Turnaround, it's worth asking exactly what sort of recovery is
under way. Given the recent headlines, you have to wonder. In South Korea,
a
government-arranged bailout in late July to keep the colossal Daewoo Group
from sinking under $57 billion in debts caused Seoul's KOSPI index to
tumble
11% in two days before bouncing back. In Tokyo, the government now hints
that
the economy, after expanding in the first quarter of 1999, may have
contracted again in the second. In China, rumors of a devaluation have
resurfaced (page 30), rattling stocks in Hong Kong. And in Thailand and
Singapore, monetary authorities are warning that their economies aren't out
of the woods.
   Why the sudden drizzle on Asia's parade? The reason is that, in one
country after another, euphoric investors and policymakers are coming to a
similar, sobering realization: The recovery is on shaky ground, and the
returning rush of global funds is blunting the drive for reform. Moreover,
the region still lacks the sophisticated institutions needed to handle the
cash without detonating another boom-and-bust cycle.
BIG SPENDERS. Almost all of the runups in stocks and growth can be
explained
by heavy government deficit spending, a natural bounce in output as
businesses replenish their inventories, and the return of easy money.
Firmer
global prices for products such as computer memory chips and a rebound in
spending on luxury goods have also helped. But nothing has worked better
than
old-fashioned Keynesian stimulus. Short-term interest rates have fallen an
average of 7.3 percentage points during the past year in the crisis
countries
of Indonesia, Malaysia, the Philippines, South Korea, and Thailand.
   At the same time, these countries--which ran balanced or surplus budgets
in the early 1990s--have become profligate spenders. Average budget
deficits
in the five crisis nations will clock 5%-to-6% of economic output in 2000,
estimates Asian research director Jean-Michel Paul of Rabobank
International.
He calculates that 80% of Asia's growth this year and the ``lion's share''
of
its stock rebound comes from government stimulus. When the costs of fixing
banks are factored in, Deutsche Bank says Thailand's public deficit could
soar to 8.5% of gross domestic product next year.
ENTHUSIASM. Signs of economic life, ranging from projected 1999 growth of
2%
in Thailand to a heady 8% in Korea, have caused the global investment herd
to
storm back. In 1997 and 1998, some $43 billion in capital from foreign
lenders and equity investors fled Asia's crisis countries. While foreign
bank
lending remains dismal, stock investors are returning. When Hong Kong,
Singapore, and Taiwan are included, figures Hongkong & Shanghai Banking
Corp., $30 billion could arrive in 1999. Japan is luring $10 billion a
month.
Former Japanese Finance Minister Eisuke Sakakibara is among many analysts
who
do not believe this gush of enthusiasm indicates long-term confidence.
``This
is cyber-capitalism,'' says Sakakibara. The inflows are ``very freewheeling
and volatile.''
   Unfortunately, the reforms needed to make Asia's recoveries sustainable
are starting to stall--or even slide into reverse. In Thailand, for
example,
dud loans account for 48% of total bank loans, up from last summer's
figure.
In Indonesia, the figure is more than 60%. Beijing's failure to clean up
the
bad loans of its banks and state enterprises, meanwhile, is one reason why
the campaign by Premier Zhu Rongji to expose industry to global competition
is meeting resistance. If these problems remain unresolved, the big stock
market gains will get harder to justify--and may well collapse.
   The rescue of bloated Daewoo was only the latest sign of what little has
been done to solve the problems that brought the region down in 1997. Under
heavy government pressure, Daewoo earlier this year had promised to sell
off
its shipyard, electronics businesses, hotels, and other weak operations.
But
it is setting unrealistic prices for the assets--and restructuring has been
minimal. As Daewoo neared the brink of default, the government strong-armed
banks to roll over more than $16 billion in debt.
   After getting off to a strong start in 1998, the reform drive by
President
Kim Dae Jung has stumbled in other areas. The government has not managed to
close either of two deals to sell insolvent banks to foreigners. At the
same
time, the chaebol have defied reformers' attempts to cut off their access
to
new money by exploiting a government program to promote mutual funds. By
appealing to Koreans' patriotism, groups such as Hyundai and Samsung have
raised more than $10 billion by setting up ``invest in Korea'' funds. The
injection of these funds into Korean equities goes a long way toward
explaining the stock market's 79% rise since March.
   Crony capitalism has also proved durable in Southeast Asia. Malaysian
Prime Minister Mahathir Mohamad has used the country's few sound companies,
as well as public funds earmarked for cleaning up banks, to prop up
ill-conceived industrial projects, such as national carmaker Proton.
Thailand's drive to sell off bad banks is running out of steam. ``With the
signs of recovery, people are not taking reform seriously,'' says Arporn
Chewakrengkai, an economic adviser to Thai Prime Minister Chuan Leekpai.
   Contrast Asia's cleanup with that of Latin America in the mid-1990s:
Argentina, Chile, and Peru let foreign investors acquire about half of
their
banking systems. More than two years after the crisis, there have been
relatively few foreign takeovers of banks in Asia. So bad habits such as
lending on the basis of personal relationships rather than rigorous risk
analysis persist.
   The bounce in Asian exports, up 4% in Thailand and Malaysia and by 8.5%
in
Korea, isn't particularly impressive, either. These numbers are far below
the
annual double-digit increases posted earlier this decade. And the pickup is
mainly due to such cyclical factors as a spurt in demand for computer
equipment and cheap currencies, rather than better efficiency. Instead of
being broadbased, ``the recovery has been in some senses too swift, too
dramatic, and too quick,'' warns Goldman Sachs Asia Chairman Mark Schwartz.
``There is still significant restructuring that needs to be done.''
LEERY. The reckoning could come in another year or two. At some point,
economists say, Asia's recovery must be fueled by strong domestic
consumption, local investment, and productivity. Otherwise, Asian
governments
will exhaust their ability to sustain growth with deficit spending. And
interest rates can be cut only so far before they no longer have any impact
on investment.
   Just ask the Japanese. Rates of just 0.25% ``are the lowest on the
planet,'' notes Nomura Research Institute Chief Economist Richard Koo. Yet
new lending is still contracting: Banks are leery of extending credit to
companies already in debt. Financial deregulation is now underway, but
Japan's service sector is still stifled by red tape while telecom and
transport rates remain exorbitant. Meanwhile, as Tokyo continues to pour
billions into wasteful construction projects and endless bank bailouts,
Japan's gross debt has hit $4.6 trillion, or 110% of GDP. Next year, Japan
should overtake Italy as the debt king of the industrialized world.
   So far, Japan's stock market has benefited most from the influx of
foreign
money. The 27% jump in the Nikkei stock average since January has been a
boon
to Japanese conglomerates, many of whose assets are in equity holdings of
sister companies. Ichizo Ohara, an economic adviser to Prime Minister Keizo
Obuchi, estimates that companies and financial institutions now have $200
billion in unrealized stock gains. This could vanish if foreign investors
lose faith and bolt, he warns.
   Japan knows all too well how fickle foreign money can be. In early 1994,
the Nikkei jumped about 3,000 points, as foreigners bet on a recovery.
Those
inflows pushed the yen up from 112 to 100 to the dollar. That, in turn,
helped throttle Japanese export growth. The economy swooned. So did the
Nikkei. ``We don't want to make that mistake again,'' says Sakakibara. So
since June 10, the Bank of Japan has spent $25 billion to keep the yen from
soaring against the greenback. That didn't keep the yen from reaching a
recent high of around 115 on July 27. Executives such as Toyota Motor Corp.
Chairman Hiroshi Okuda want to see the yen at more than 120. ``The Japanese
economy depends on external demand,'' warns Okuda. ``If the yen appreciates
further, the economy will suffer.''
   Foreign inflows could start creating new mischief elsewhere in Asia. To
date, the rallies in Malaysia, South Korea, and elsewhere have largely been
driven by local and small foreign investors. This has been enough to push
East Asian stock markets up by anywhere from 30% to 70%. But fund managers
say that the heavy hitters such as Western pension funds have only started
to
trickle in since March. ``Most of the big money has not yet come back to
Asia,'' says ABN-Amro Securities chief Asia economist Enzio von Pfeil.
   Even so, renewed investor interest has already harmed Asian corporate
restructuring. Able to raise money through equity issues again, companies
are
no longer desperate to shut or sell weak affiliates. Foreign investors, who
salivated at fire-sale prices on Asian assets last year, are finding
negotiations much tougher. That's one reason why South Korea's efforts to
sell off Korea First Bank and Seoul Bank have run into repeated snags. The
same thing is happening in Southeast Asia, says Hugh Young, managing
director
at Aberdeen Asset Management Asia Ltd. in Singapore. ``Deals are being put
on
hold because the stock market is so strong,'' he says. ``Companies are
holding out for better prices.''
   It isn't time to worry just yet about another 1997-scale blowout. There
are few signs of another surge in the short-term foreign lending that fed
the
bubble of the early 1990s. Foreign banks and bond investors are still
smarting from write-offs from corporate failures in Southeast Asia and
China.
   But it's a big worry for the future. Because banks and regulators still
lack risk-management skills, the money that does flow in could again be
lent
recklessly. Also, most Asian bond markets remain primitive. So central
banks
have limited abilities to use bond issuances to absorb excess capital that
could otherwise feed a bubble.
   This isn't stopping leaders from inviting hot money back. Politicians
facing elections in Korea and Thailand will be tempted to go for any way to
pump up growth. And bankers, though once burned, could well rush back in if
they sense another Asian takeoff. In a July talk to Asian central bankers,
Koh Yong Guan, managing director of the Singapore Monetary Authority,
warned
that the risk of another hot-money tsunami is real. ``We have
short-memories--or even no memories,'' he said. Market rallies fueled by
cheap money, half-baked optimism, and lackluster corporate restructuring
aren't the ticket for long-term prosperity in Asia.
By Brian Bremner in Tokyo, with Mark L. Clifford in Hong Kong, and Michael
Shari in Singapore