Asia Comes Down with the American Flu

The markets are jittery about a U.S. double dip

For the better part of this year, as U.S. stock markets reeled, investors started looking again to East Asia as an oasis of opportunity. Bourses in South Korea, Thailand, and Indonesia, fueled by buoyant domestic demand, surging exports, and improved financial sectors, were among the world's best performers. As booming China sucked in record imports, hope rose that Asia could rely on a powerful new economic engine. Even Japan began resembling a safe haven for global capital; the Nikkei average soared 21% between February and June.

Then came the June and July meltdown--and in short order, a stream of disappointing economic news from America sent Asia's markets tumbling back to earth. In the U.S., most economists assure there's little danger of a double-dip recession. But in Asia, investors are thoroughly spooked by evidence of slowing U.S. economic growth and declines in manufacturing orders and consumer confidence. After two weeks of frenzied selling, the Nikkei has lost all of this year's gains. The bull market in South Korea, where foreigners own 36% of all shares, has abruptly halted. The Kospi index is down by almost a third since April 22. And in Taiwan, where anxieties have been heightened by a new war of words between Beijing and the government of Chen Shui-bian, stocks are off 15% for the year. Hardest hit have been shares in exporters of electronics, steel, and auto parts. Chip giant Taiwan Semiconductor Manufacturing Co. (TSM ), for example, has seen its shares swoon from almost $2.60 a share in the spring to a recent $1.37.

Even if a new U.S. rally pushes Asian stocks back up, the point has been driven home: The region's economic fate remains heavily linked to that of the U.S. East Asian economies depend on exports for anywhere from a fifth to half of their output, and American imports account for 10% of Asia's gross domestic product, notes Morgan Stanley economist Andy Xie. Just as the end of the U.S. tech bubble threw Taiwan, Japan, and Singapore into recession in 2001, America's recovery helped push the region's exports up by 13% in this year's first half.

That's why Asia has so much riding on whether America can avoid a double dip. Should the U.S. slip back into recession, Xie figures, growth in non-Japan Asia would fall from a projected 5.8% next year to a limp 3.5%. As for Japan, recovery hopes would be dashed. Half of the 5.7% annualized growth Japan posted in the first quarter came from exports. And a decline in U.S. consumer spending would add to woes generated by the yen's 10% appreciation against the U.S. dollar. Indeed, the yen's rise to 120 already has forced Canon Inc. and Fujitsu Ltd. to trim this year's sales forecasts for digital cameras, printers, and optical telecom equipment. "Just when Japan's economy seemed to be getting some momentum on the back of exports, the yen has strengthened, and that's quite worrying," laments Toyota Motor Corp. (TM ) President Fujio Cho. As a result, Japanese executives such as Sony Corp. (SNE ) Chairman Nobuyuki Idei are urging the Bank of Japan to intervene more strongly to weaken the yen.

Asian markets also have been reminded of their dependence on foreign capital. One-third of the money in the Thai stock market, for example, comes from the U.S. On Aug. 2, Bank of Thailand Assistant Governor Bandid Nijathaworn warned that the "slowdown in the U.S. might reduce money inflow, which is important to stimulate our recovery." U.S. investors account for most of the $3.5 billion pulled out of Japanese stocks since June, pushing the Nikkei to an 18-year low. That in turn is compounding Japan's long-running banking crisis, as the stock market losses undercut the capital base of major money center lenders. HSBC Securities Inc. equity strategist Garry Evans thinks there is a 30% chance a U.S. contraction would force Tokyo to launch an expensive bank bailout. A U.S. double dip "could have some disastrous consequences," Evans says.

Asia's strongest exporters hope the impact will be light. "The U.S. economy certainly seems to be surrounded by negative factors," says Honda Motor Co.'s (HMC ) North America chairman, Koichi Amemiya. "But we still expect total demand for autos to exceed 16 million units this year," only a slight decline from 2001. Executives at South Korea's Hyundai Motor Co., meanwhile, say they continue to expect strong growth in models such as its $20,000 Santa Fe sport-utility vehicle.

Other companies predict exports within the region will offset any U.S. decline. Samsung Electronics Co. says China, Japan, and other Asian markets now absorb 30% of its digital televisions, memory chips, and notebook computers--the same as the U.S. And Samsung isn't cutting its 2002 profit forecast of nearly $4.8 billion. "We think we can achieve our earlier projections, despite what's happening in the U.S.," says Senior Vice-President Chang Il Hyung. China imports from Taiwan, meanwhile, leaped 30% in June. "Taiwan's export performance is becoming less dependent on the uncertain U.S.," says Deutsche Bank economist Jun Ma.

China is indeed becoming an increasingly important customer: Imports from Asian neighbors have surged 22% this year. Montreal-based BCA Research estimates China accounted for 70% of Asia's export growth in 2002. However, many of those imports are of components and raw materials used in computer products, appliances, and garments assembled in China and then exported to the U.S., so they could decline as well. It will be another decade before China "is big enough to make up the slack related to the downturn in the U.S. economy," says Goldman Sachs & Co. Asia Managing Director Fred Hu.

That's especially true in industries like semiconductors, computers, and cell phones. Information technology products account for 37% of Asia's exports. Taiwan Semiconductor depends heavily on orders from U.S. chip companies. Korea's LG Electronics Inc. says its sales of digital display products, including PC monitors, TVs, and DVD players--a business that leaped 30% in the second quarter--also are vulnerable. "If troubles persist through next year, everybody will be hit," says Park Hyeong Il, an LG general manager.

It's clear that the trade and capital flows that bind Asia and the U.S. run deep and wide. If the optimists are right, and America's recovery remains on track, that's great news. But lacking solid evidence of that, expect investors to approach Asia with great caution.

By Brian Bremner in Tokyo, with Moon Ihlwan in Seoul, Dexter Roberts in Beijing, and Bruce Einhorn in Taipei

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