Emerging Asia's Shaky Recovery

Scant profits point to growing risks

With stock markets down sharply in emerging Asia this year, some observers worry about a potential reprise of the financial crisis and severe recession that hit the region a few years ago. Economist Chen Zhao of the Bank Credit Analyst, a Montreal-based investment publication, thinks it's premature to push the panic button just yet. Still, the current stock market swoon underscores the serious problems plaguing the Asian recovery in the face of a developing global slowdown.

By most measures, emerging Asia's recovery from its 1997-98 debacle has been impressive. Many countries have posted double-digit or near double-digit growth rates for two years, output per capita has returned to pre-crisis levels, and unemployment has fallen. Most countries are also running trade and current-account surpluses.

But the reality, says Chen, is that the hope fueling last year's stock market rally--that capacity cutbacks, currency declines, and sharply lower interest rates would spark a resurgence in profits--has failed to pan out. Corporate earnings in the five crisis-stricken economies of South Korea, Thailand, the Philippines, Malaysia, and Indonesia still languish far below pre-crisis levels, despite a stunning rise in industrial output.

As Chen sees it, three factors are responsible for this profitless recovery. The first is the region's most formidable competitor, the mammoth Chinese economy. With labor costs still only 6.5% of those of Korea and Taiwan (despite those nations' currency devaluations), China has not only been winning market share in the U.S. from its regional rivals but also has been increasingly doing so in high-end computer and electronics products.

Compounding the threat of heightened Chinese competition is the fact that many Asian economies still seem plagued by excess capacity that puts additional downward pressure on prices. Meanwhile, the continuing huge buildup in Asia's semiconductor capacity in Taiwan, Korea, and China, at a time when the global semiconductor cycle is peaking, is yet another harbinger of falling prices and profits.

Finally, Chen points out that most of the Asian economies haven't really tackled their financial systems' bad-debt problems and the restructuring necessary to close down insolvent companies. Many companies continue to rely on export volume expansion to stay in business--a strategy that inevitably heightens both domestic and global deflationary pressures and thus compounds their debt-servicing woes. Only China has taken serious steps to allow insolvent businesses to fail and to reform its banking system.

The bottom line is that structural forces have handcuffed most of emerging Asia to a profit-starved recovery. And with the U.S. and other advanced economies slowing along with global high-tech demand, Asian economies face increasingly trying times ahead. That, in a nutshell, says Chen, is the message in the markets' decline.

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