A False Dawn Changing economic conditions may mean that the region's much-touted recovery from crisis is largely an illusion
By Henny Sender/HONG KONG and TAIPEI Issue cover-dated July 27, 2000
THREE YEARS AFTER the Asian Crisis officially erupted with the devaluation of the Thai baht, the region's unfinished agenda for reform is evident from Japan to Jakarta. The U.S.-dollar debt that got Asia into trouble originally hasn't gone away; it has merely been obscured by benign global economic and monetary conditions.
Those favourable conditions have enabled the region to earn hard currency by exporting its output to the United States and Europe, and made it possible for Asian central banks to lower interest rates while keeping their currencies relatively stable. But while some short-term debt has been converted to longer-term borrowings and some has been changed from dollar debt into local-currency obligations, the absolute debt in Asia outside Japan has hardly changed in more than two years--it is still more than $600 billion.
In the two years to December 1999, central-bank reserves in the region grew by almost $260 billion, and the region's trade balance shifted from a deficit of $40 billion to a surplus of $80 billion, according to data from Morgan Stanley Dean Witter in Hong Kong. But given that the macroeconomic outlook and interest rates are expected to be far less friendly in coming months--as global growth slows and rates continue to move up--not dealing with the debt overhang is especially dangerous. Asia can no longer count on simply growing out of its debt leverage. In short, there has to be more restructuring to cut costs, and more asset sales. That isn't a message that's likely to be welcomed.
"Asia needs to make a distinction between leveraged corporates which are viable and those which are not viable," says Sun Bae Kim, managing director at Goldman Sachs in Hong Kong. "And for those which aren't viable, an exit strategy and bankruptcy have to be considered. And that requires pain." But to introduce such distinctions strikes at the heart of entrenched interests and the complicated intertwining of political and economic power in the region.
First on the agenda: Asia has to develop a balanced financial structure in which banks, the bond market and the equity market all function and all allocate capital to those who can use it most efficiently.
In the recent past, equity markets have been buoyant enough to compensate for weakness in banks, but now the stockmarkets can no longer be relied on. And some analysts, such as Chris Francis, who recently moved to London from Hong Kong to head global credit analysis for stockbrokers Merrill Lynch, contend that governments still haven't done enough to develop their bond markets.
"Governments have continued to stifle their bond markets," he says. "They don't want to see new markets which they can't control; markets where capital can leave." He points out that governments could have floated more public debt as part of their bank recapitalization plans; instead, they chose to issue bonds directly to banks in exchange for troubled loan portfolios.
Meanwhile, progress on dealing with the debt in a definitive manner remains uneven, and across Asia--with the honourable exception of Taiwan--the inability to distinguish between those who deserve to be saved and those who don't continues to be a matter of politics rather than letting markets decide.
Taiwan has become an example of how things can be done. The island has no shortage of either entrepreneurs or venture capitalists. And there is ample money--now more than ever before, thanks to Taiwan's flourishing hi-tech companies. That money flows to companies that use it to move up the value-added chain in manufacturing and manufacturing services and to take Taiwan from being low-cost efficient to leading-edge awesome.
But elsewhere the corporate wreckage is piled up. Cases ranging from Indonesian state-owned shipbuilder Dok Perkapalan Koja Bahari to the now finally bankrupt Japanese retailer Sogo underscore just how much trouble Asia has in saying, whether through the courts or the government: "Thou shalt not be saved."
The amounts owed to foreign creditors--and in dispute--in the case of the Indonesian shipbuilder aren't large: only $11 million. But the fact that the case has come up at all underscores just how stubbornly in denial some entities are. In the Jakarta dispute, the shipbuilder claims that the promissory notes it issued to European and Asian banks don't comprise legitimate company debt; the funds, it says, went instead to the directors whose names were on the documentation. The case is now in a Jakarta court.
Despite very different circumstances, the case of Sogo conveys a similar message, though at least the effort at denial has been thwarted. The fact that at last the company is being allowed to die ends efforts to set up a $6 billion bailout, to have been led by the government. The rescue bid was killed in part by public criticism of it as well as by the refusal of one creditor, Shinsei Bank--formerly the Long-Term Credit Bank of Japan, now owned by a consortium of foreign investors--to take part. Whether or not this precedent will be applied to other corporate walking-wounded remains to be seen.
Government attempts at rescuing companies in extremis make it difficult for a market in the distressed debt of such companies to really blossom outside the orchestrated auctions of the government-run asset-management companies in South Korea and Thailand. "Where we can add value is analysis driven," says Steve Long, fixed-income analyst for J.P. Morgan in Tokyo. "But that is risky in Asia." Where the market has been most vigorous, particularly in Indonesia, it is because owners are using intermediaries to buy back their own debt for a fraction of its face value.
There are very few instances in which creditors have actually had the upper hand. One of the exceptions is the case of Malaysian company Aokam Perdana, which issued convertible bonds in the mid-1990s, when the Asian market was hot.
Aokam needed the money to finance a mill that it intended to provide with wood from its lumber concessions in Sabah. But then prices fell and there were difficulties getting the timber to the mill; the bonds collapsed, at one point trading at 30 cents on the dollar. Eventually a creditor, Credit Suisse First Boston, bought enough of the company's debt to control it--CSFB now holds 72% of the equity.
The struggle between debtor and creditor is being waged with particular ferocity in Thailand, where both sides feel their survival is at stake and many banks have virtually shut down lending. "Everybody has a bunker mentality," says the head of an American bank in Bangkok.
Still, some Thai companies have emerged stronger as a result of the crisis. Total Access Communications, for example, the mobile arm of Thailand's United Communications Industry group and the country's second-largest cellular service provider, saw its bonds crash last year as investors concluded there was no way that the company could pay $500 million due in 2001. But TAC improved its cash flow and recently announced a strategic tie-up with Telenor, a Norwegian telecoms company, that gives it both more technical credibility and bolsters its creditworthiness with its bankers.
Last month, TAC announced it had arranged a 20-billion-baht ($511 million) facility with its banks to help it repay its dollar debt and to upgrade its network. As a result, "we believe the company will have sufficient financial flexibility to address its lumpy debt maturity" next year, say the fixed-income analysts at J.P. Morgan in Tokyo. This increased creditworthiness for TAC is feeding increased competitiveness, which will then further heighten creditworthiness. Too bad, then, that TAC is one of the exceptions.
Other entities, such as Thai Oil, have managed to come to terms with their creditors after painfully drawn-out negotiations, in some cases lasting nearly two years. A third group still can't make the numbers work: For instance, Bangkok Mass Transit System, operator of the Thai capital's Skytrain, owes $1.7 billion to creditors while its earnings from Skytrain are only a quarter of the original income target. And, finally, there is a large and growing group of restructured debtors that are falling back into the "nonperforming" category and which may soon outnumber those who are being restructured and reclassified as performing, says J.P. Morgan's Long.
Such conflicting trends contribute to an image that discourages foreign investors, be they direct or portfolio investors. "If there is the prospect of instability, it makes risk management much harder," says David Fernandez, an economist with J.P. Morgan in Singapore, who adds that investors "just turn off the switch for Southeast Asia."
In South Korea, too, the picture is mixed. To be sure, the lack of liquid funds at parts of the Hyundai Group and the troubles of Korea's merchant banks and investment-trust companies dominate the headlines. "Ultimately, Hyundai's high degree of leverage refocuses attention on how the problem of excessive leverage and thus weakened resilience to external shocks remains an issue in Korea," notes Barclays Capital Asia in a recent report. Still, leverage has come down from anywhere between 600% and 800% to less than 200% of GDP--high, but sustainable.
On balance, progress in Korea is probably more impressive than that of any other of the crisis-hit countries of the region. For one thing, the Koreans kept the system going. Bank lending virtually everywhere else in the region has plunged, and is still going down even where economies are supposed to be recovering, as in Japan, where bank lending contracted 4.6% in May this year compared with May last year. But Korean banks never stopped lending; indeed, lending was up 21% year-on-year in the first quarter, according to data from Goldman Sachs, after rising more than 10% in 1999 from the previous year.
HEALTHIER PATIENTS
For a time, equity markets were strong enough to enable Korean companies to raise money. Two years ago, many Korean companies were also able to turn to the local bond market to refinance bank debt. Indeed, in 1998 issuance was up 62%, and 90% of that was three-year debt, rather than more-dangerous short-term debt, according to data from J.P. Morgan. Recent measures to strengthen the domestic won bond market will help Korea's financial markets develop in a more balanced way.
Some of the steps the government has taken have been dramatic. For example, the decision to let Daewoo fail may have been part of a complicated political agenda. At the same time, though, it signalled that no company in the country had an absolute safety net under it.
Ultimately, what is saving Korea, though, is the fact that many of its companies are basically healthier than Daewoo Group companies. Also, Korean companies in general have shown a willingness to restructure.
If the region is to continue to be competitive, or to regain competitiveness in the case of some countries, new investment is essential, not necessarily in expanding output but in upgrading production. For that to happen, companies have to be creditworthy and financial institutions have to be strong. There is still a long, hard road to be travelled.