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AUGUST 13, 2001

INTERNATIONAL -- ASIAN BUSINESS

Asia's Answer to the Slump: Spend

Governments hope to build their way out of trouble

In early July, Singapore became the first Asian nation outside Japan to be shoved into recession by the global downturn. Days after announcing the sober news, the government--never one to sit on its hands--unveiled a $1.2 billion stimulus package, or 1.4% of gross domestic product. Singapore will spend on infrastructure, lower certain taxes, and allow citizens to temporarily cut payments to the state pension fund. Said Minister for Trade & Industry George Yeo: "If the global economic situation worsens, we have the resources to do more and will be ready to do so."

The urge to prime the pump is getting stronger in Asia. Several nations have been running deficits since the 1997-98 financial crisis. And now that the worldwide slowdown is hammering tech exports, governments from Taiwan to South Korea to Malaysia are requesting supplementary budgets in an effort to give growth a boost (chart).

SMALL MARKETS. The good news is that thanks to relatively low levels of sovereign debt, these governments can afford some stimulus. The bad news, says Jun Ma, a Hong Kong-based economist at Deutsche Bank (DTBKY ), is that government spending will have "only a marginal impact on these economies." While it's true that China managed to spend its way through the Asian crisis and add an estimated 2% to economic growth, it has an enormous domestic market that is ready to consume goods made locally. Thailand, Malaysia, and Singapore have small domestic markets that cannot generate much demand. Only a renewed American appetite for Asian tech exports will give these countries a real lift.

Pump-priming, of course, is smart politics even when it isn't great economics. Notes Craig Chan, regional economist for ING Barings in Hong Kong: "Governments can't just sit back and watch things sink."

Besides, deficit spending is about the only weapon left in Asia's recession-fighting arsenal. Although central banks have aggressively slashed interest rates in tandem with the U.S. Federal Reserve, the cuts likely will do little to stimulate capital investment or consumer lending. Why? The banks are sitting on so much bad debt that they're not acting the way banks should. "Banks aren't lending," says Chi Lo, senior economist at Standard Chartered Global Markets in Hong Kong, "so Asian governments need an alternative to boost growth."

For now, the region won't have much trouble raising money to finance these spending sprees. Savings rates average about 20%, so governments can tap local investment. Thailand is expected to sell $7 billion in domestic bonds this year. Nor are foreign investors punishing Asia for problems in other emerging markets. Asian companies may be having trouble issuing debt, but government bonds are still welcome to foreign investors. Malaysian debt sells for just 218 basis points over U.S. treasuries, Thai debt 140 basis points, and South Korean debt 135.

Foreign investors like Asian government debt because most of the governments still have manageable budget deficits. But the official deficit numbers don't include hidden costs, including the amount governments may have to fork over to bail out banks that are saddled with dud loans. If one assumes that half of nonperforming loans in Malaysia will never be repaid and that the government will have to support banks when they write these debts off, the additional cost comes to 6.5% of gross domestic product. And that doesn't include high-priced bailouts of politically connected companies such as Malaysia's Renong group, which governments won't allow to go under. Those costs may yet wound these countries as they seek to raise money.

The trick is to know when to turn off the tap. Japan has spent $1 trillion over the past decade in a futile attempt to goose domestic demand. Much of that money went into unneeded, politically expedient infrastructure. By contrast, Thailand, Taiwan, and Malaysia really need new roads, schools, and health-care facilities. But Japan once had a manageable budget deficit, too--and proceeded to spend itself into near ruin. If the region's economy stays stalled, the temptation to keep building regardless of need may prove too strong for politicians to resist.

By Bruce Einhorn in Hong Kong, with bureau reports

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Confronting Asia's structural weaknesses

By John Thornhill and John Burton

Published: August 9 2001 18:47GMT
Last Updated: August 9 2001 19:25GMT

When Asian finance ministers met in January at the Japanese port of Kobe to swap notes and sip sake they confidently predicted that Asia would be the fastest-growing region in the world this year. As Asia's economies continued to rebound from the financial crash of 1997-98, the officials forecast that regional gross domestic product would expand by 5 per cent in 2001, outstripping the faltering US and lacklustre European economies.

Seven months later the outlook is starkly different. Economic growth rates have dropped alarmingly across Asia; many countries are lagging behind the US and Europe and the region is now forecast to grow at less than 2 per cent this year.

Japan is again flirting with recession. Taiwan has recorded first-quarter GDP growth of just 1.1 per cent - its lowest in 26 years. The South Korean, Malaysian and Hong Kong economies are decelerating sharply. Even Singapore, which sailed through the Asian financial crisis virtually unscathed, has seen its economy contract by 0.9 per cent in the second quarter.

Goh Chok Tong, Singapore's prime minister, delivered a sombre address before Thursday's National Day, urging employees not to be "fussy" if they were laid off and temporarily to take up more menial jobs normally filled by migrant workers. "We have to wait for the wind to pick up before we can fill our sails again," he said. The government is now forecasting GDP growth of no more than 1.5 per cent in 2001 - a sharp fall from the 9.9 per cent growth achieved last year.

The critical question confronting many Asian economies is to what extent their current economic ills are just a cyclical phenomenon, stemming from the slowdowns in the US economy and the global electronics cycle, and how much they reflect underlying structural problems, as in Japan. Excess capacity, feeble banking systems, weak domestic demand and private sector bad debt problems still dog much of the region.

There are big questions here. Has Asia's startling recovery from the financial crash of 1997-98 been a false dawn? Are other Asian countries going to have to face the same restructuring dilemmas that Tokyo has been spasmodically grappling with for more than a decade?

There is no doubt that the slowdown in the US has had a savage impact on many export-oriented Asian economies. The drop in demand was widely forecast early in the year but the deceleration has been more pronounced - and painful - than even the pessimists feared.

The main reason for Asia's woes has not been the overall weakness in the US economy so much as the collapse of spending on information technology equipment. Inventories of components are still piling up even as industrial production has been falling - though there are signs that US orders for semiconductors and other electronic components may have bottomed out in June.

George Leung, a regional economist at HSBC in Hong Kong, argues that it is the more sophisticated and open economies with a high exposure to the IT cycle that are most at risk. Electronic goods account for 55 per cent of Singapore's domestically produced exports. Taiwan, which manufactures about half of the world's laptop computers, is similarly vulnerable.

"Most Asian countries still have structural problems but this time the drop in the growth rate is more related to the US demand picture. There is a very strong relationship between US manufacturing and Asian export growth," he says.

Ironically, those countries that have the most pressing structural problems and suffered the worst in 1997-98, such as Thailand and Indonesia, have proved more resilient in the current downturn. Since the crisis, many less developed Asian countries have significantly improved their economic flexibility by adopting floating exchange rates, re-building hard currency reserves and paying down external debts.

Asian countries are also seeking to take advantage of the economic momentum of China, where strong domestic demand may sustain GDP growth of 7.5 per cent this year. In spite of its ideological antagonism, Taiwan has been relocating many factories to the mainland to exploit lower land and labour costs and tap into surging local markets.

Yet the cyclical slowdown has cruelly exposed the remaining structural weaknesses across much of the rest of Asia and the lack of domestic demand, in particular. The issue is whether countries such as Korea, Malaysia and Singapore can restructure their economies to mitigate the effects of the export slowdown. There are some tentative signs that these countries are beginning to do just that.

In Korea, the global demand for cars and ships has helped to offset the fall in electronics. Domestic demand is also becoming a more important factor as banks have begun to shift their focus from corporate to retail banking. The government has been trying to stimulate the economy by increased fiscal spending, including a Won10,000bn ($7.8bn) package announced this week for infrastructure projects in the second half.

But the biggest potential problem is the slow pace of corporate restructuring, such as the delayed sale of Daewoo Motors to General Motors and the state rescue of Hynix, the semiconductor manufacturer. In a report on Korea published last week, the Organisation for Economic Co-operation and Development warned that further corporate reform was essential to protect Korea from further economic crises and enhance its long-term growth potential.

In Malaysia, the slowdown has apparently persuaded the government to speed up corporate restructuring. It recently announced the takeover of the heavily indebted UEM-Renong, Malaysia's biggest conglomerate, and the removal of its chairman and main shareholder. This marked a change from previous policies of rescuing favoured companies, while keeping the management.

The UEM-Renong deal appears to be part of Malaysia's efforts to shed its pariah status among international investors and to help attract new investors to the stock market. Weak share prices have recently undermined consumer confidence, which threatens domestic demand. The Kuala Lumpur index has risen in recent weeks in response to the government's shift on corporate reforms and a resulting wave of proposed mergers and acquisitions.

Singapore's recessionary plunge has underscored its special vulnerability to global economic conditions, a state of affairs that has existed ever since it emerged as an important regional trading port in the late 19th century. Moreover, its small population of 4m means that it cannot rely on domestic demand for growth.

But the government appears determined to diversify its economy. It is trying to attract foreign investments into the pharmaceuticals sector to reduce its dependence on electronics. It is also aiming to transform its leading companies into multinational operations in imitation of other small countries, such as Switzerland and Sweden.

Such state-owned companies as SingTel, the island's telecommunications group, and Singapore Airlines, have announced a string of proposed overseas acquisitions in recent months. "While government-linked companies were once passive, they have suddenly become aggressive in expanding overseas," says Charlie Lay, regional economist for SG Securities in Singapore.