May 3, 1999
International -- Asian Cover Story

Asia: How Real Is Its Recovery?

Bourses are booming and, in some cities, consumers are splurging again. But overcapacity is endemic, and banks remain a black hole

Like many Asian industrialists during the boom years, Kim Woo Choong's business strategy could be summarized in two words: borrow and build. For three decades, his sprawling Daewoo Group piled up debt as it evolved from a tiny trading company into a powerhouse in autos, shipbuilding, consumer electronics, construction equipment, and hundreds of other businesses. Even after South Korea's economy crashed in 1997, forcing many other chaebol to downsize, the Daewoo chairman defiantly insisted on boosting capacity in everything from cars to color televisions.

At long last, reality seems to have set in. The Daewoo chairman announced on April 20 that the $52 billion conglomerate would sell many of its most cherished assets, including one of the world's biggest shipyards, two Hilton hotels, telecom companies, and units making trucks and engines. Kim would use the $7.5 billion he hopes to raise toward paying down Daewoo's staggering $49 billion in debts. The news sent Korean shares soaring: Investors saw it as another sign among many that Asian companies are ready to restructure their way to recovery.

Daewoo is not the only source of optimism about Asia. In Seoul, consumers are splurging on everything from handbags at designer boutiques to flowers at the shop of Ku Ja Dong, where business is up 30% in the past two months. In Hong Kong, banks are writing new home mortgages, and it's once again tough to land a table at the chic Joyce Cafe. Passenger traffic is back up to pre-crisis levels at Singapore's Changi Airport, personal computer sales are booming in Japan. Plunging interest rates and successful Asian sovereign debt issues show that foreign lenders are more confident as well. "The crisis is not fully over, but I think we have seen the worst," says Philippine central bank Governor Gabriel C. Singson, who expects 2% growth in 1999.

There's no doubt green shoots are sprouting in the rubble. Many investors seem satisfied that the Asia crisis is history. Since mid-February, bourses in Indonesia, Thailand, and Hong Kong have been among the world's top performers. The Korean stock index has more than doubled since October.

The question now is whether Asia's recovery is sustainable. On this count, the jury is still out. True, private economists now forecast 1% to 3% growth this year for South Korea and Malaysia after severe contractions in 1998. But much of that growth will stem from heavy deficit spending, bank bailouts, and more than $100 billion in emergency credits by foreign institutions.

IMPORTS DOWN. And the real economies of Asia remain shaky. Joblessness is still rising, consumer spending is flaccid, and commercial banks aren't lending to the private sector. Strong balance-of-payment numbers are due mostly to falling imports, rather than resurgent exports. While exports are up 18% so far this year in the Philippines, they are up only modestly in Japan and still dropping in Korea, China, and Indonesia.

The chief danger is that the capital-market recovery will lull Asian politicians and companies into believing that they can relax on reform. In truth, the task has barely begun. Despite a few major acquisitions by multinationals, little of the excess capacity facing manufacturers and property developers from Bangkok to Jakarta has been cleared by the market. The foreign debt overhang of emerging Asian markets has been reduced only slightly, with some $227 billion in interest and principal coming due this year and next, according to Deutsche Bank. While there has been real progress on reform in South Korea and Thailand, says Citigroup Vice-Chairman William R. Rhodes, "there still is work to do."

Considerable risks still loom over the region. Indonesia, the giant of Southeast Asia, remains a political tinderbox, riven by poverty and ethnic strife. Asia's two biggest economies--Japan and China--are in no shape to drive a regionwide recovery. If government pump-priming and bank reform don't put these economies on solid footing over the next year, they could well trigger another crisis.

You wouldn't know it by the 30% runup in the Nikkei average since October, but Japan is sliding into its third year of recession. The $60 billion that Tokyo has pumped into its overstretched banks, meanwhile, hasn't cleaned up the mess. Another injection of that size is expected next April. Meanwhile, these banks are too frightened to lend. "Japan's banks have imposed a suffocating credit squeeze across the region," notes Deutsche Bank economist Kenneth S. Courtis. Another bout of yen depreciation, which many expect, would be just as damaging.

Some $200 billion in tax cuts and public-works spending may generate a positive quarter or two in Japan. But the money will start to run out later this year. Merrill Lynch & Co. senior economist Ronald Bevacqua figures that excess capacity worth $450 billion in output--about 10% of GDP--needs to be "rationalized out of existence" in wholesaling, construction, and retailing.

Add it all up, and the Asia that is likely to emerge from the crisis will be far less economically vibrant than it was before. Instead of roaring back to the 7% to 9% annual growth they posted in previous decades, Asia's emerging markets could slog along with 1% to 2% growth--or even stay flat--for several years. "Some people think that now that we have hit bottom we will be moving upward," says Thai economist Pasuk Phongpaichit. "But it's like driving uphill on a very wet and muddy road. I don't see us moving up for some time."

Asia's longer-term prospects may not be as exuberant as before the crisis either. The World Bank predicts 5% annual growth for the next two decades, strong by world standards but a "big step down" from old estimates, says World Bank international finance specialist Ashoka Mody. "It'll be a long, hard haul recasting these economies from government-driven to market-driven."

MANILA'S CLEAR. Nor is it likely that all East Asian emerging markets will thrive in unison, as they did when they were known as the "flying geese," led by Japan. The first to recover will likely be South Korea and Thailand, the earliest to tackle their financial problems, and the ones that basically stuck to their International Monetary Fund commitments. The Philippines, whose banking problems were least severe before the crisis, already seems to be out of the woods.

South Korea is generating the biggest buzz. Since it was rescued by the IMF and foreign banks in December, 1997, Seoul has rebuilt its foreign reserves to $59 billion. It posted a $4.9 billion trade surplus in the first quarter. President Kim Dae Jung also is honoring Seoul's pledge to sell weak or failed banks to foreigners. On Apr. 12, Goldman Sachs & Co. said it will buy 17% of Kookmin Bank. Foreigners will also likely snare Seoul Bank and Korea First Bank. Explains Hyun Oh Seok, director general of the Finance Ministry's economic policy bureau: "The crisis has taught us that we can't prevent exposure from the global economy."

The capital markets are rewarding Seoul. In the past month, state-owned Korea Electric Power Corp. raised $655 million in an offshore equity placement, while the Korea Development Bank floated a big debt offering. Consumer-products giant Cheil Jedang Corp. cut its debt nearly in half and boosted profits tenfold by selling assets and cutting costs. Apart from Daewoo, the government also has persuaded Samsung, Hyundai, and LG Group to abandon overlapping investments in such industries as cars and computer chips. "One of the positive things is that Korea should come out of the crisis with a stronger and more diversified industrial base," says Citi's Rhodes, who engineered the 1997 financial rescue.

But Korea hasn't gone nearly far enough. Debt levels at the five biggest chaebol are still rising. Asset sales are not reducing overcapacity. "They aren't shutting down the capacity, they are just shunting it around," says Richard Samuelson, Korea research director at Warburg Dillon Read.

The remaking of Corporate Thailand also has been slow going. A handful of conglomerates have restructured. Siam Cement Co. is shedding noncore units such as autos to whittle down its $5 billion debt. But Thailand still has $63 billion in dud loans, roughly half of all banking assets. Nearly two years since the crash forced them into default, conglomerates such as Thai Petrochemical Industries PLC, which owes $4 billion, are still haggling with foreign creditors over debt workouts.

Until March, there was no reason to rush. Then the government of Chuan Leekpai was finally able to maneuver Western-style bankruptcy laws through the legislature. But foreign creditors still can't seize assets from deadbeats, so few dare make new corporate loans.

Malaysia also expects a mild recovery this year, after imposing capital controls. But times are still tough. PRK Builders, a $2 million maker of specialized steel products, says business is picking up after dropping 50% last year. But that's because half of its competitors went bust. PRK also isn't pursuing business as much as it could because it fears customers won't pay. Even though interest rates dropped from 18% last year to 6%, it's not investing. "Everybody's scared to death about taking risks," says Product Development Manager C.Y. Chan. At pipemaker Engtex Sdn. Bhd., the only growth is coming from government contracts. "We still see no light from the other side of the tunnel," says Sales Manager Francis Loh.

The Malaysian government has been buying up bad loans. But cynics think the official total of $21 billion is way low, and that the bailouts have mainly helped wobbly conglomerates run by friends of Prime Minister Mahathir Mohamad. What's more, foreign direct investment--which is key to Malaysian exports--fell by 40% in 1998 and isn't likely to pick up this year. New projects in Penang, whose industrial zone is home to Intel, Motorola, and Seagate Technology, have plunged.

Then, there is Indonesia. The Indonesian Bank Restructuring Agency now says it may cost double the original estimate of $34.5 billion to bail out its corrupt banking system. Inflation is at 45%, and the economy is still shrinking--by an estimated 4% this year--after contracting by 14% in 1998.

A handful of Asian economies are still on their feet. Taiwan was saved by its tight links to U.S. semiconductor and computer industries and by agile contract manufacturers, such as Acer, Quanta, and Asustek Computer. Singapore is slumping mostly because of its neighbors--and has been using the downtime well. It is restructuring state-controlled companies, upgrading telecoms and education, and luring new Western investment in semiconductors, software, and chemicals.

CHINA WORRIES. But the health of Asia's best economies continues to depend on the region's giants. With Indonesia still a nightmare, it's too early to say when growth in Singapore can reach 4% to 5%, says Finance Minister Richard Hu Tsu Tai. "We will have to wait for Indonesia to settle down," he says.

A downturn in China, meanwhile, could ruin Hong Kong's fragile recovery. Tourist arrivals are up 14%, and banks are lending again. After an Apr. 20 land auction by the government raised $193 million, much more than expected, developers are again talking about hiking flat prices. But unemployment is at 7% and rising, and exports haven't yet hit bottom. Property analysts such as Nicholas Brooke don't think consumer demand justifies the high bids. "When people sit back and realize it is all a lot of hype and the economic fundamentals are not great, we'll hear notes of caution from the government," he says.

The picture across the border isn't comforting either. Economists figure China already would be nearing recession were it not for the billions that Beijing is spending. Few economists believe the official first-quarter growth figure of 8.3%. Much of the spending is on big public works of questionable value. Exports have shrunk by 7.9%, and foreign investment is off 14.6% so far this year. And China is just starting to chip away at its mountain of bad bank debt.

Policymakers elsewhere face the same quandary: You can't have a healthy economy when your banking system is effectively a black hole. Money goes in but doesn't come out into the real economy in the form of new loans.

Cutting through the fog of Asia's recovery at a time when so much capital is flowing in isn't easy. Clearly, the region is out of immediate danger. With luck, the stronger financial markets, improved consumer sentiment, and bold restructuring moves will kick in and keep recovery on track. Unfortunately, nearly two years of crisis have not been enough to alter systems that revolve around immature banking networks and profitless corporations. If Asia rebounds with the same flaws intact, the chances of returning to sustainable high growth are dim.

By Brian Bremner in Tokyo, with Sheri Prasso in Manila, Jennifer Veale in Seoul, Jonathan Moore in Kuala Lumpur, and Joyce Barnathan