Understanding the Asian Economic Crisis

By Steven Pearlstein

Sunday, January 18, 1998; Page A32

The basic story of the Asian bubble economics varied only slightly from country to country: Foreign investment -- lured by high returns, stable government and currencies pegged tightly to the dollar -- began pouring in during the early '80s. The foreign money financed factories and power plants, skyscrapers and airports for a booming export economy. Wages rose and a middle class emerged with a taste for the finer things, most of them imported. Success begat success -- and then overbuilding, overlending, overconsumption.

The first signs of serious trouble appeared when the supercharged Thai economy began to slow last spring, triggering a speculative run against the baht by currency traders hoping to profit from a devaluation. In a vain attempt to defend its currency, the Thai central bank depleted its reserves of foreign currency. When the devaluation finally came in July, foreign investors fled -- breaking the speculative cycle.

The Thai crisis was like a pinprick, bursting bubbles across Asia. Stock prices fell, real estate prices plummeted, local currencies went into free falls. Banks and corporations, which had borrowed heavily in dollars, yen and marks, found they could not repay. In one country after another, foreign investors came to realize that what was true in Thailand was true in many of the other Asian Tigers. Weak banks in one country called in loans elsewhere, causing the contagion to spread even faster.

The call went out to Financial 911 -- the International Monetary Fund in Washington. First with Thailand in July and later in other countries, the IMF imposed austerity measures and economic reforms.The IMF's harsh medicine is producing results: weak companies are already beginning to declare bankruptcy, unemployment is rising, living standards are falling and the region looks to be heading into a long and deep recession. Financial markets in some countries have stabilized and rebounded. Governments in Korea and Thailand have recently fallen and even Indonesia's longtime strongman President Suharto is struggling to hold on to power.

How Will the United States Be Affected?

Economic forecasting models show that the troubles in Asia will shave anywhere from a half percentage point to a full point off the growth rate of the U.S. economy this year. That would put it somewhere around 2.25 percent, which is where many economists think it should be, anyway, to avoid an outbreak of inflation.

On the upside, Asia's problems will mean that Americans will pay lower prices for clothing, toys, electronics, luxury autos, steel and other imports -- or American-made goods that compete with those imports. Already, computer prices have begun to come down, while automakers here are preparing to offer big rebates to match price reductions in Toyotas and Hondas.

At the same time, much of the investment capital that has been fleeing from Asia has sought the safe haven of the U.S. bond market, driving interest rates below 6 percent. Already corporations and homeowners are rushing to refinance their debt, freeing up cash that could spur the economy through increased consumer spending and capital investment.

On the downside, profits at money-center banks such as Citibank and Bank of America will be hurt by foreign currency trading and write-offs of loans to Asian banks and corporations that cannot repay them -- at least not for the moment.

And look for employment and profit growth to slow or even disappear at big firms that have relied on Asia for significant sales. These include engineering firms, makers of jet planes and power plants, high-tech firms, oil refiners and drug companies. Last week, both Motorola and Intel reported earnings that were negatively affected by weakness in the Asian markets.


Since June 2:
Stock: -44.7%
Currency: -69.3%

After calls from the leaders of the United States, Germany, Japan and Singapore, and visits from the top two officials of the IMF and the treasury, President Suharto on Thursday renewed his commitment to a package of economic reforms negotiated last October as part of a $43 billion international rescue.

But hopes that the agreement would calm the country evaporated on Friday amidst reports that there were riots in a number of cities on the island of Java as a result of rising food prices. The rupiah fell on the news while opposition leaders renewed their call for Suharto to step down after 32 years in power.

The problems of Indonesia -- a vast country splintered among many ethnic groups -- are as much political as financial, many analysts believe.

Nepotism and crony capitalism also are huge problems in Indonesia. President Suharto has promised reforms, including measures to curb projects controlled by his relatives and friends.

South Korea

Since June 2:
Stock: -33.3%
Currency: -44.7%

Despite a $57 billion IMF rescue plan, South Korea veered last month toward default -- forcing a second, emergency bailout that brought together the Clinton administration, the IMF and international bankers.

The banks tentatively agreed to roll over short-term Korean debts, in exchange for long-term government bonds. Korean officials are set to arrive in New York this week to continue negotiations with U.S. banks over a plan to restructure about $25 billion in debt owed by Korean banks to banks in the United States, Japan and Europe.

Even as negotiations continue, some foreign investors already have concluded that Korean currency and stocks are now bargains. Last week, both staged strong rallies even as other Asian markets foundered.

The newly elected leftist government of Kim Dae Jung has embraced the terms of the IMF's bailout package. These include opening the country's business and financial sector to foreign ownership, removal of controls on foreign currency trading and reform of labor laws to make it easier for companies to lay off workers. The government also has agreed to lift most import restrictions, particularly from Japan, and to refrain from offering subsidies to ailing firms such as the bankrupt Kia motor group.

Some of the positive effects of those reforms, as well as the fall in the won, were already evident last week when the government reported a $3.6 billion trade surplus for December, the highest ever.


Since June 2:
Stock: -35.4%
Currency: -51.9%

Thailand's currency and stock markets have continued to fall despite an IMF-imposed squeeze that has forced rising unemploy-ment, high interest rates and corporate bankruptcies. In Bangkok, the sense of excitement and stylish excess that marked the go-go years -- private jets, fancy clothes, fast cars, flashy jewels -- has given way to a pervasive sense of gloom. Shiny new office buildings sit half empty while storefronts in once fashionable sections now sport signs begging for customers or new tenants.

Thailand has vigorously adhered to a program worked out in June with the IMF, cutting its budget by 19 percent and increasing the value added tax from 7 percent to 10 percent. Insolvent banks and finance companies have been closed and foreign investors for the first time are allowed to invest in the financial sector. Citibank is now considering taking a majority interest in First Bangkok City Bank.

Thai business and political leaders fear that additional help may be needed from the IMF, in the form of additional lending or relief from IMF austerity measures.

They also are worried about the country's biggest financial problem -- the $67 billion in oustanding debt owed by Thai companies to foreign bankers. The country's finance minister this week denied speculation that the country would declare a debt moratorium.

Hong Kong

Since June 2:
Stock: -42.8%
Currency: n/a

Hong Kong's solid-gold reputation -- as a well-run, well-regulated financial center with a currency strong enough to withstand any speculative assault -- has been shaken in recent weeks.

International credit-rating agencies announced that they had put the city's foreign currency bonds on review for possible downgrading. And the city's biggest investment bank, Peregrine Investment Holdings Ltd., was forced to close its doors last week as a result of risky lending, primarily in Indonesia and China. Real estate prices, which had been among the highest in the world, have begun to fall. And tourism, an economic mainstay, has fallen sharply since the hoopla over the Chinese takeover in July.

As a result, the Hang Seng index has swung wildly. And while Hong Kong has vowed to use its enormous stash of foreign currency to defend its dollar, which remains pegged to the U.S. greenback, the rapid decline of neighboring currencies has prompted speculation of a possible devaluation. Hong Kong authorities insist they will hold the line.


So far, China has avoided most of the fallout from the rest of Asia, in part because it hasn't liberalized its economy nearly as much as its neighbors. Its foreign reserves are huge, its trade surplus rising and its currency under tight control.

But beneath this calm economic exterior, China's economy suffers from many of the same problems as the Tigers. Many of its banks are hobbled by bad loans to state-owned firms that still resist the transition to a market system and are effectively bankrupt. Foreign trade and investment are still tightly regulated. Real estate overbuilding is rampant in cities such as Shanghai and Guangzhou. And with currency values falling in countries that compete directly with it for export markets, China will be under extreme pressure to devalue the yuan to prevent its once fast-growing economy from slowing more than it already has.

Worries about a Chinese devaluation were checked Thursday when China's central bank governor pledged that Beijing would not devalue its currency despite competitive pressures from other Asian countries. Visiting U.S. Treasury official Lawrence Summers said the pledge was "the most important contribution that China could make to stability in Asia."


Since June 2:
Stock: -16.7%
Currency: -10.9%

Just as Japan provided the model for the Asian economic miracle, so it, too, has led the way down. Its economy has hovered near recession ever since the speculative stock market and real estate bubble burst in 1990.

Repeated rounds of government public works spending have failed to revive economic growth.

And while the Bank of Japan has pushed interest rates below 1 percent, Japanese banks are so hobbled by bad real estate loans that they are simply unwilling to make many new loans.

The recent fall of the yen has allowed export industries to remain competitive despite shrinking markets throughout Asia.

But most of Japan's big problems lie in its huge service economy, where inefficiency is built in through a tight web of government regulations, subsidies, trade barriers and old-fashioned customs duties.

Last week, the government proposed yet another economic reform package that included a tax cut designed to spur consumer spending and a modest start at closing insolvent banks while relieving others of their bad debts.

The Japanese stock market surged Friday. But many economists believe it's too little to revive the world's second-largest economy, described recently by Massachusetts Institute of Technology economist Rudi Dornbusch as "rich beyond belief, mismanaged like no other place, stuck in a slump and sinking fast."