As the sun rose on the New Year, Asian investors and policymakers thought the worst of their travails were over. It appeared that the region had finally settled down after the most miserable year in more than a decade. The International Monetary Fund's record $58 billion aid package for South Korea, coupled with short-term debt rollovers by international commercial bankers, seemed to have stabilized one of Asia's largest economies and bought the entire region some time.
But the calm didn't last more than a microsecond. In the first trading days of the year, Asian stock and currency markets have taken a beating (table). Hong Kong's bourse suffered its biggest one-day drop since its brutal crash last October, shedding nearly 6% on Jan. 7. Many currencies fared even worse. Panicked investors throughout Southeast Asia are dumping Thai baht, Indonesian rupiah, and Malaysian ringgit, among others, and stocking up on greenbacks against even further declines. "You can transfer half a billion U.S. dollars out of Indonesia in one day without any question. The bureaucrats don't have a way to counter that," says a financier in Jakarta, where the rupiah has plunged 36% since Dec. 31 and nervous consumers have started hoarding cooking oil, rice, and other goods.
LOSS OF FAITH. Even the Singapore dollar, long a safe haven, hit its lowest level in more than six years. Indeed, much of East Asia seems to be on the verge of going on a dollar standard as the value of its currencies disintegrates. Already, many companies in Thailand and Indonesia are conducting much of their business in dollars, and consumers are increasingly taking small amounts of local currencies to banks to buy bucks. "There's nothing holding these currencies up," says Michael Unsworth, managing director and head of regional research at Merrill Lynch (Asia Pacific) Ltd.
The current demand for dollars is fueling a bitter and self-reinforcing cycle. As local people lose faith in their own currencies, foreign investment, which is vital to growth, is drying up. That is worsening market sentiment even further, causing currencies and stocks to continue to slide and spooking foreign investors even more.
Amid the panic, markets are aswirl with rumors that Beijing may devalue China's currency. The central banks of the U.S., Singapore, and Japan, whose currency is also weakening, may also try to restore order by selling massive amounts of dollars on foreign-exchange markets. Washington officials concede that they were surprised by the speed of the latest Asian financial collapse. If the hysteria runs much longer, Asia could be sucked into recession or even depression. That could face the international financial system with its biggest test since the oil shocks of the 1970s.
But even if markets calm quickly, Asia faces a large-scale rescheduling of debts and a sharp slowdown in demand in what had been until recently the world's fastest-growing region. "The biggest risk is that Asian instability will trigger a world crisis, as opposed to just a financial market problem," says David A. Wyss, chief economist for Standard & Poor's DRI in Lexington, Mass.
VOLATILITY. The two biggest worries are Korea and Indonesia. Although Korea won a respite by getting foreign banks to roll over $10 billion to $15 billion in loans, it's still scrambling to put together a multibillion-dollar, long-term funding package. Among international commercial and central bankers, there is a continuing concern that Korean authorities don't have a handle on how much the country owes. Many of Korea's giant business groups have not sold poorly performing assets. And suspicions about the commitment of the country's financial mandarins to reform remain high in international financial circles. "Korea is not out of the woods by a long shot," warns Peter Churchouse, a managing director at Morgan Stanley Asia Ltd. in Hong Kong.
Indonesia is even more explosive because of a volatile political and racial mix on top of a dire economic situation. It has more than $100 billion in foreign debt, about $35 billion of which is due by June, and the country's corporate sector is effectively bankrupt. Although 2 million workers have already been fired and the military promises tough action against social unrest, violent demonstrations in the provincial capital of Bandung targeting ethnic Chinese businesses broke out in early January.
More worrisome to the international financial community is President Suharto's seeming unwillingness to make the tough economic choices necessary to stabilize Indonesia. With Suharto's tight grip on the presidency in question for the first time, political fear--not financial reality--is driving policymaking. On Jan. 6, the government passed a budget that calls for a 32% increase in spending and 4% economic growth and is based on an exchange rate almost double the rupiah's current value. The new budget also continues subsidies and tax breaks for politically favored projects such as a national airplane program and a national car program run by Suharto's son.
DERISION. Not surprisingly, traders greeted the budget with derision, even as they were selling out across the region. Notes one U.S. official: "When the history books are written, everyone will gain an appreciation of how badly Asians have handled this mess." But as Asian economies go into a tailspin, the IMF's recipe for throttling down spending and slowing growth is coming under attack from some quarters. Thailand is already trying to wriggle out of its austerity deal with the IMF. "Fiscal tightening just doesn't make any sense in any of the economies because they have had fairly tight fiscal policies," says Andrew Freris, managing director of Asia research at Bank of America.
The bigger key to stabilization may be a quick rollover of hundreds of billions of dollars in commercial bank debts across the region. Commercial bankers are going to have to recognize that debts aren't going to be paid in full and start renegotiating loans and taking losses on corporate debt. Governments will need to face up to the depth of the crisis and cut off funding for the elite's relatives and cronies. Companies likely will be forced to improve their disclosure and treatment of minority shareholders. All that will take time--something that is rapidly running out. As everyone from hedge funds to local consumers scrambles for dollars, Asia is going into a funk deeper than anyone ever thought possible only a few months back.