Asia Is Trapped in the Tornado

Recession in the U.S. could clobber export-driven economies

In early September, Nintendo Co. (NTDOY ) was gearing up for the Japanese launch of GameCube, its first console in five years. Then came the Sept. 11 attacks on New York and Washington. Nintendo expected to move 450,000 units on Sept. 14, but wound up selling just 300,000 in three days.

Even Japanese consumers, far removed from the terrorist attacks, were too obsessed with the tragic events to splurge on what was billed as one of the hottest new products of the year.

No one can accurately predict the economic fallout from the attacks. Ditto for the U.S.'s global war on terrorism. But already signs are emerging of what could shape up as the next Asian crisis. "It is quite serious," says Japan's Eisuke Sakakibara, who was finance vice-minister for international affairs during the 1997 financial crisis. "Japan was already in recession before the incident and many other Asia economies were heading into recession as well."

The worst-case scenario goes something like this: Asian exports, already weak in a region that depends on shipments to the U.S. to drive growth, start to plummet. Unemployment shoots up. So, too, do bad debts. That puts a greater burden on banks still shouldering dud loans left from the crisis. Another round of competitive devaluations kicks in. The region's sputtering corporate and bank reforms are set back even further, as are Asia's hopes of regaining speedy growth rates. Without fast growth, unemployment rises steadily, the region's standard of living drops, and the Asian miracle becomes a memory.

It's not clear that these events will unfold, of course. But the likelihood of such a far-reaching crisis has increased. Asia is getting slammed by the fall in U.S. trade, especially in electronics. Reflecting China's faltering export machine, Hong Kong's exports fell 9.1% in August. U.S.-bound shipments from Korea, Taiwan, Singapore, and Malaysia are expected to be off 20% to 40% from the same period last year in the final quarter. "In the worst-case scenario, we could see a decline of up to 20% in U.S. sales over the next six months," says Yukio Shohtoku, managing director in charge of overseas operations for Matsushita Electronic Components Co. (MC ). If sales fall in the holiday period, Shohtoku adds, "we'll have to downsize manufacturing operations in Asia, the U.S.--and even Japan."

This could be just the beginning. ABN Amro Holding economist Eddie Wong has slashed his 2002 growth forecasts for most of Asia's economies by two to four percentage points. Except for the sheltered economies of India and China, Wong figures no other Asian economy will grow more than 3% next year: Many will be nearly flat. In Japan, Nomura Securities Co. predicts that pretax profits at the 400 largest nonfinancial companies will decline 20% this year, with at best single-digit recovery in 2002. The Morgan Stanley Capital International Index that tracks Asian markets outside Japan came within a whisker of its 1998 crisis levels on Sept. 21 before rallying the following week.

Japan is set to slump further--more bad news for the rest of the region, which is heavily dependent on trade with the Japanese. The world's second-largest economy will contract about 0.8% this year. Just-released figures show June electronics production down 15.6% from a year earlier, continuing a pattern of accelerating declines in this key sector. Sony Corp. and Matsushita Electric Industrial Co. (Panasonic) had been counting on a pickup in U.S. consumer purchases of digital cameras, digital TVs, and other gadgets during the holidays to pull them out of a slump. That's not in the cards.

AUTO SLUMP. Like their peers around the globe, Asia's airlines and hotels are being hit hard. Japan Airlines' profits are likely to be cut drastically this year, from $596 million to $344 million, says HSBC Holdings PLC analyst Douglas Hayashi. The situation looks even worse than during the Persian Gulf War a decade ago. Then, traffic declined about 9% over six months. "This time," says Hayashi, "we face the prospect of a big hit in demand" on top of already lower traffic.

Japanese and Korean carmakers, which had seen brisk growth, are also getting rocked. U.S. auto sales plunged 23% in the first week after the attacks. Demand at home remains frail, and all of Japan's carmakers are losing money in Europe. Honda Motor Co., which earns two-thirds of its profit in the U.S., could suffer most from a prolonged sales drop. "We may have to trim production," says CEO Hiroyuki Yoshino.

Some companies could hit the wall. South Korea's battered Hynix Semiconductor Inc. was fighting for its life even before Sept 11. Now, a planned lifeline from its banks is in doubt. Other second-tier electronics companies also could run aground. Among them are Taiwanese semiconductor makers ProMOS Technologies, Powerchip, and Mosel Vitelic. Powerchip and ProMOS had counted on stock offerings that now look dicey. Powerchip pulled its listing in the wake of the terrorist attack and is scrambling for money to build a chip plant. Mosel, which owns half of ProMOS, has denied reports that it has requested government assistance.

At least Asia has a financial cushion built up from booming exports in 1999 and 2000. Asian nations have slashed overseas borrowing and built up big stashes of foreign exchange. By the end of last year, for example, Korea's short-term debt had fallen to 46% of foreign reserves, compared with 284% at the end of 1996. And because Asian companies have had limited funds to spend on new factories, they won't have to struggle with huge overcapacity.

Governments also are acting quickly this time around. Central banks have been slashing interest rates. On Sept. 25, Malaysia and Singapore announced their second fiscal-stimulus packages of the year. With the push for economic and corporate reform waning, governments are more prone to pump money into the economy through direct spending and by lowering interest rates. And with the world in crisis, the International Monetary Fund isn't going to tell them not to. Singapore has weakened its currency, and South Korea and Taiwan are expected to follow, says Enzio von Pfeil, CEO of Hong Kong's Commercial Economics Asia Ltd. That should make exports more competitive when demand picks up.

PURGING BAD LOANS. At the same time, the crisis could provide Japanese Prime Minister Junichiro Koizumi with the political cover to ram through reforms. Already, the Bank of Japan has responded to overseas pressure by pumping liquidity into the system. And Tokyo has proposed a much tougher bank plan than expected. The Financial Services Agency has ordered a fresh round of bank audits and promised the IMF access to bank books. The betting is that the officially acknowledged $145 billion bad debt figure for Japan's banks will be ratcheted up closer to $700 billion. Recognizing the true magnitude of the problem is an important first step to fixing the sector. And it appears the government's bailout vehicle, the Resolution & Collection Corp. will get a big increase in funding.

Yet the scale of Japan's crisis grows larger every day. The government, for example, may want to push the 30 biggest delinquent borrowers into bankruptcy in a desperate bid to purge the bank system of bad loans. In these jittery times, with Japan sinking deeper into recession, it's the kind of effort that could sharply drive up unemployment and prolong the pain.

Last time, Asia's crisis was home-grown. This time, the problem began in the U.S., and Asian executives and policymakers desperately hope that America turns around fast. The alternative is too frightening to contemplate.

By Mark L. Clifford in Hong Kong, Brian Bremner and Irene M. Kunii in Tokyo, with bureau reports

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