International -- Asian Cover Story
CURRENCY CRISIS (int'l edition)
The death of easy money in Southeast Asia will rein in growth
For Philippine businessman Lawrence C. Qua, the news that came on July 11 could hardly have been better. Qua, the president of Manila-based Ionics Circuits Inc., had just heard that his country's central bank had followed Thailand's recent currency devaluation and allowed the peso to fall 10%. Dire tidings for most, but Qua was beaming. Ionics, an exporter of electronic components, earns all of its revenues in U.S. dollars, which now will go a lot further toward paying workers and meeting other costs at home. "The more depreciation, the better it is for us," says Qua. "We'll have a windfall."
Across town, in Manila's Makati business district, Raul T. Concepcion faces a grimmer future. "I'm worried," says the chairman of privately held Concepcion Industries Inc., which manufactures air conditioners and refrigerators for the domestic market. "Power rates and oil prices will go up." And labor groups are already demanding that business leaders increase wages in response. "The gains from devaluation will be lost," frets Concepcion, president of the Federation of Philippine Industries. "We'll be back to square one."
Qua and Concepcion are two of the winners and losers in the currency turmoil sweeping Southeast Asia (table). Having helped force an 18% devaluation of the Thai baht on July 2, currency speculators turned on neighboring countries with exchange rates linked to the U.S. dollar. The Philippines, armed with tiny foreign-exchange reserves and an economy only just recovering from years of torpor, was an easy target. Manila tried to resist the onslaught before giving in on July 11. Then came Malaysia, where the central bank jacked up interest rates to 50% and spent an estimated $1 billion before surrendering on July 14. The ringgit promptly plunged to a 33-month low. Lamented Finance Minister Anwar Ibrahim: "There is a limit to what we can do."
Even some of the region's more predictable currencies have not been immune. Indonesia's rupiah fell to a record low of 2,471 to the U.S. dollar and could weaken further. And despite rising local interest rates, the Singapore dollar might be next, especially since the economy has not recovered from last year's slowdown. Singapore's stock market has already fallen 16% this year. "Nobody is safe," warns John B. Seel, economist with Bear Stearns Asia in Hong Kong.
The Asian meltdown is the latest in a string of competitive devaluations that have rocked global currency markets for five years. Back in 1992 and '93, the European exchange-rate system blew out as ally after ally couldn't keep pace with Germany and its strong mark. When Britain dropped out of the system, a painful chain of devaluations from Sweden to Italy ensued. Then, in 1994, Mexico was forced to devalue the peso sharply against the dollar after a wave of capital flight demonstrated that its economy was no match for the stronger U.S. after passage of the North American Free Trade Agreement. More recently, the Czech Republic has also seen its currency collapse as its trade deficit has mounted. The turmoil has even touched Brazil. Its booming stock market plunged 7% in mid-July amid fears that the Brazilian real would be the next currency to fall.
CHINA'S EDGE. Southeast Asia's situation is more acute. The region does have one major strength: some of the world's highest growth, savings, and investment rates. But like the Latins, Asians had binged on easy-money policies. Now, the Asians--like the Europeans, Mexicans, and even the Japanese--are paying the price. They are also being forced to "become more realistic about steps they need to take to keep their economies healthy in the longer term," says DRI/McGraw-Hill Asian economist Devi Aurora. Central banks will have to reassert their control over monetary policies to regain credibility. And governments will have to reform everything from capital markets to industrial planning to avoid future beggar-thy-neighbor devaluations.
But for now, the clear answer will be to rely on cheapened currencies to deliver export growth. As the world's strongest economy, the U.S. will be the market of choice for Southeast Asians hoping to export their way back to health. Soaring Southeast Asian exports may set off protests from Washington. But the country with an even bigger stake in Asia's currency mess is Japan.
Japanese banks are the biggest lenders to Southeast Asia--ING Barings Ltd. analyst James Phillip Fiorillo figures they have an exposure of roughly $150 billion. Japanese manufacturers are also the region's biggest investors: Japanese direct foreign investment into the region was $5.8 billion by the end of the first half of 1997, according to the Japan External Trade Organization.
How Tokyo handles this crisis in countries where memories of Japan's brutal World War II occupation are still strong will test its ability to take an international leadership role. So all eyes were on Thailand's new finance minister, Thanong Bidaya, as he made his way to Tokyo to meet with Japanese Finance Minister Hiroshi Mitsuzuka and Vice-Minister for International Affairs Eisuke Sakakibara on July 18. Just three days earlier, Mitsuzuka said Japan, if necessary, would join forces with the International Monetary Fund to salvage the tumbling Thai baht and other Asian currencies.
Asia's money meltdown is testing the foundations of an export-led economic model that has delivered years of spectacular growth. But more than a decade of strong exports of semiconductors and other goods blinded policymakers--and the currency market--to the shortcomings of the system that Southeast Asians have used to fuel economic growth. These include stressed-out banks, overheated property markets, rising trade deficits, a glut of factories, and stiffening competition from China.
Indeed, Chinese manufacturers--bolstered by an artificially low renminbi--are squeezing out Southeast Asian producers of garments, electric appliances, and telecommunications gear. At the same time, the emerging Tigers are having trouble competing with South Korea and the former Soviet states in heavy industries such as steel and petrochemicals. Japan, too, is adding to the region's worries. Morgan Stanley, Dean Witter, Discover & Co. analyst Alexander Kinmont observes that Japanese manufacturers "added productive capacity equal to that of France" at home in the 1980s, then built an equivalent amount of capacity overseas in the next decade. Much of that investment was made in Asian low-cost plants.
These factories and others will become even more competitive in world markets now that Asian currencies have fallen. But there is a trade-off. As currencies sink, Southeast Asian consumers will have to cope with higher inflation. Companies will face higher expenses, depressed earnings, and increased borrowing costs. Banks will see more defaults. Construction of factories and infrastructure will be scaled back. And governments will be hard-pressed to make good on free-trade promises. "This is not going to go away quickly," warns Geoffrey Barker, regional head of research at Schroders Securities Asia Ltd. in Hong Kong. "Earnings growth will be disappointing, and there will be very little authorities can do."
In the Philippines, a less expensive currency may help exporters but will mean lower earnings for companies relying on the domestic market. Central bank governor Gabriel C. Singson says the recent interest-rate hike to 32% is a "temporary measure," but he expects inflation, now 4.6%, to double.
Many companies will find it difficult to pass along the increased costs to consumers, says Victor S. Limlingan, professor at the Asian Institute of Management in Manila. "When the Philippines was a closed economy, after a devaluation, everybody would increase prices at the same rate," he says. Now, with increased competition and oversupply in everything from cement to condominiums, "they don't have that opportunity." Weeks before the peso's plunge, food and beverage giant San Miguel was forced to cut beer prices to compete with fledgling Asia Brewery.
Political uncertainty is another concern, as 11 candidates try to succeed Fidel V. Ramos in presidential elections next May. With its history of martial law, revolution, and coup attempts, the country can ill afford more disruptions. "The Philippines has so many variables already," says Ionics CEO Qua. "We don't want to add more and more instability."
Malaysia, too, has problems. The central bank has been trying to cool off the real estate market for months, but analysts still expect a property glut next year. The current-account deficit is inching up and will hit a dangerous 6% of gross domestic product this year. As direct investment tapers off, Malaysians have become more reliant on unstable short-term debt. There also are worries of industrial overcapacity and bleak export prospects. National carmaker Proton is opening a plant with a capacity for 400,000 units annually, more than twice what the domestic market needs.
Back in Thailand, where everything started, manufacturers are battening down. Toyota Motor Corp., for one, is considering raising the prices on vehicles sold in Thailand to compensate for currency losses. In fact, the devaluation couldn't have come at a worse time for Toyota, which plans to increase capacity in Thailand by 20% by early 1998. General Motors Corp., which is building a new plant in Thailand, will benefit from devaluation, since 80% of its output will be exported, says CFO J. Michael Losh.
Thailand's economic woes may bring political ones, too. Most of the pain centers on Bangkok, home to ailing property developers, banks and finance firms, and industrial companies. To avoid social unrest in the capital, Finance Minister Bidaya needs to come up with a recovery plan soon. Kenneth S. Courtis, chief economist at Deutsche Bank Capital Markets (Asia) Ltd. in Tokyo, puts the price tag for cleaning up Thai banks alone at $30 billion, 16% of GDP.
Throughout Southeast Asia, recovery will be hindered by the weakness of the banking system (BW--Feb. 24). Unless policymakers quickly establish ways for banks to securitize bad debts and unload them, governments may end up devoting scarce resources to bailouts. And banks will have less ability to lend to startups that create jobs and growth.
Tight control over exchange-rate policy, which hasn't kept up with the region's growth, must be relinquished. In the first half of the decade, protectionist policies insulated currencies from market forces. Determined to help exporters, governments resisted pressure for currencies to appreciate against the dollar despite billions in capital flowing into the region. "Central banks were sitting in a time warp," says Rajeev Malik, senior economist for Jardine Fleming International Securities in Singapore. "With undervalued currencies and high interest rates, there was a double incentive for money to come in."
The game worked until 1995, when Washington and Tokyo reached an agreement to devalue the record-high yen and fortify the greenback. As the dollar strengthened, it carried the Southeast Asian currencies along with it. But most countries "didn't immediately see that they should make some changes in their management of exchange rates," says Asia Development Bank senior economist V.V. Desai. Not only was the region suffering from overcapacity, but many countries had become reliant on short-term debt to finance huge imports of capital equipment and other items for government infrastructure projects. As a result, says Malik, short-term debt now accounts for about 25% of the region's total.
Not every Asian country mismanaged its currency. Hong Kong has a firm tie between its dollar and the U.S. greenback. Hong Kong boasts strong banks, a current-account surplus, and a commitment from Beijing to put its billions in hard currencies behind Hong Kong's huge reserves. Indonesia has taken another tack. It kept speculators at bay by letting the rupiah depreciate gradually. On July 11, it widened the band in which the rupiah trades, letting it hit a record low against the dollar.
But even a flexible currency policy hasn't saved Indonesia from some of the woes typical of the region. With real GDP growth expected to hit 7.8% this year, the current-account deficit has widened to 4% of GDP from 3.5% last year. And some economists say privately that the deficit may be widening even faster. To help cool the economy, the central bank imposed restrictions on loans for property purchases on July 7.
ROLE MODEL. Still, Indonesia's model has worked well enough that others now see it as an alternative to the perils of free-floating currencies. The Philippines should emulate Indonesia's exchange-rate policy, says Bernardo M. Villegas, a Harvard-trained economist at the University of Asia & the Pacific in Manila. "What businessmen want is predictability, not stability," says Villegas.
Government officials around the region have other tools at their disposal to limit the damage from the currency run. Traditionally, they have ordered tight fiscal policies, without large budget deficits. Exports in the bellwether electronics sector should pick up as demand increases in the West. That's especially true for Singapore, where such U.S. electronics giants as Motorola, Texas Instruments, and Hewlett-Packard are seeing demand for their products surge.
The crisis should also force governments to be realistic about growth. They'll have to develop financial markets to let banks securitize property loans or companies hedge foreign currency. To craft an enduring fix, policies are needed to complement growth--for example, foreigners should be allowed to own land. More importantly, leaders must "find new ways to power their economies, since labor and capital are no longer as cheap as they used to be," observes DRI/McGraw-Hill's Aurora. This means developing a better product mix to reduce intraregional competition.
Asians also will need to introduce more appropriate exchange-rate policies to reflect market forces and prevent spending binges that have to be financed with short-term debt. "The moral of the story is live within your means," says Gan Wee Beng, executive director of Commerce International Merchant Bank in Kuala Lumpur. If not, he adds, "the financial markets will force it on you." After the events of this month, that is a lesson that Southeast Asians should have a hard time forgetting.By Bruce Einhorn in Manila, with Michael Shari in Jakarta, Mark L. Clifford in Kuala Lumpur, Brian Bremner in Tokyo, Hugh Filman in Manila, and Kerry Capell in New YorkReturn to top