FEER: A False Dawn (E. Asia)

[Stephen E Philion <philion@xxxxxxxxxx>]

A False Dawn
Changing economic conditions may mean that the region's much-touted recovery from
crisis is largely an illusion

By Henny Sender/HONG KONG and TAIPEI
Issue cover-dated July 27, 2000


THREE YEARS AFTER the Asian Crisis officially erupted with the devaluation of the
Thai baht, the region's unfinished agenda for reform is evident from Japan to
Jakarta. The U.S.-dollar debt that got Asia into trouble originally hasn't gone
away; it has merely been obscured by benign global economic and monetary
conditions.

Those favourable conditions have enabled the region to earn hard currency by
exporting its output to the United States and Europe, and made it possible for
Asian central banks to lower interest rates while keeping their currencies
relatively stable. But while some short-term debt has been converted to
longer-term borrowings and some has been changed from dollar debt into
local-currency obligations, the absolute debt in Asia outside Japan has hardly
changed in more than two years--it is still more than $600 billion.

In the two years to December 1999, central-bank reserves in the region grew by
almost $260 billion, and the region's trade balance shifted from a deficit of $40
billion to a surplus of $80 billion, according to data from Morgan Stanley Dean
Witter in Hong Kong. But given that the macroeconomic outlook and interest rates
are expected to be far less friendly in coming months--as global growth slows and
rates continue to move up--not dealing with the debt overhang is especially
dangerous. Asia can no longer count on simply growing out of its debt leverage.
In short, there has to be more restructuring to cut costs, and more asset sales.
That isn't a message that's likely to be welcomed.

"Asia needs to make a distinction between leveraged corporates which are viable
and those which are not viable," says Sun Bae Kim, managing director at Goldman
Sachs in Hong Kong. "And for those which aren't viable, an exit strategy and
bankruptcy have to be considered. And that requires pain." But to introduce such
distinctions strikes at the heart of entrenched interests and the complicated
intertwining of political and economic power in the region.

First on the agenda: Asia has to develop a balanced financial structure in which
banks, the bond market and the equity market all function and all allocate
capital to those who can use it most efficiently.

In the recent past, equity markets have been buoyant enough to compensate for
weakness in banks, but now the stockmarkets can no longer be relied on. And some
analysts, such as Chris Francis, who recently moved to London from Hong Kong to
head global credit analysis for stockbrokers Merrill Lynch, contend that
governments still haven't done enough to develop their bond markets.

"Governments have continued to stifle their bond markets," he says. "They don't
want to see new markets which they can't control; markets where capital can
leave." He points out that governments could have floated more public debt as
part of their bank recapitalization plans; instead, they chose to issue bonds
directly to banks in exchange for troubled loan portfolios.

Meanwhile, progress on dealing with the debt in a definitive manner remains
uneven, and across Asia--with the honourable exception of Taiwan--the inability
to distinguish between those who deserve to be saved and those who don't
continues to be a matter of politics rather than letting markets decide.

Taiwan has become an example of how things can be done. The island has no
shortage of either entrepreneurs or venture capitalists. And there is ample
money--now more than ever before, thanks to Taiwan's flourishing hi-tech
companies. That money flows to companies that use it to move up the value-added
chain in manufacturing and manufacturing services and to take Taiwan from being
low-cost efficient to leading-edge awesome.

But elsewhere the corporate wreckage is piled up. Cases ranging from Indonesian
state-owned shipbuilder Dok Perkapalan Koja Bahari to the now finally bankrupt
Japanese retailer Sogo underscore just how much trouble Asia has in saying,
whether through the courts or the government: "Thou shalt not be saved."

The amounts owed to foreign creditors--and in dispute--in the case of the
Indonesian shipbuilder aren't large: only $11 million. But the fact that the case
has come up at all underscores just how stubbornly in denial some entities are.
In the Jakarta dispute, the shipbuilder claims that the promissory notes it
issued to European and Asian banks don't comprise legitimate company debt; the
funds, it says, went instead to the directors whose names were on the
documentation. The case is now in a Jakarta court.

Despite very different circumstances, the case of Sogo conveys a similar message,
though at least the effort at denial has been thwarted. The fact that at last the
company is being allowed to die ends efforts to set up a $6 billion bailout, to
have been led by the government. The rescue bid was killed in part by public
criticism of it as well as by the refusal of one creditor, Shinsei Bank--formerly
the Long-Term Credit Bank of Japan, now owned by a consortium of foreign
investors--to take part. Whether or not this precedent will be applied to other
corporate walking-wounded remains to be seen.

Government attempts at rescuing companies in extremis make it difficult for a
market in the distressed debt of such companies to really blossom outside the
orchestrated auctions of the government-run asset-management companies in South
Korea and Thailand. "Where we can add value is analysis driven," says Steve Long,
fixed-income analyst for J.P. Morgan in Tokyo. "But that is risky in Asia." Where
the market has been most vigorous, particularly in Indonesia, it is because
owners are using intermediaries to buy back their own debt for a fraction of its
face value.

There are very few instances in which creditors have actually had the upper hand.
One of the exceptions is the case of Malaysian company Aokam Perdana, which
issued convertible bonds in the mid-1990s, when the Asian market was hot.

Aokam needed the money to finance a mill that it intended to provide with wood
from its lumber concessions in Sabah. But then prices fell and there were
difficulties getting the timber to the mill; the bonds collapsed, at one point
trading at 30 cents on the dollar. Eventually a creditor, Credit Suisse First
Boston, bought enough of the company's debt to control it--CSFB now holds 72% of
the equity.

The struggle between debtor and creditor is being waged with particular ferocity
in Thailand, where both sides feel their survival is at stake and many banks have
virtually shut down lending. "Everybody has a bunker mentality," says the head of
an American bank in Bangkok.

Still, some Thai companies have emerged stronger as a result of the crisis. Total
Access Communications, for example, the mobile arm of Thailand's United
Communications Industry group and the country's second-largest cellular service
provider, saw its bonds crash last year as investors concluded there was no way
that the company could pay $500 million due in 2001. But TAC improved its cash
flow and recently announced a strategic tie-up with Telenor, a Norwegian telecoms
company, that gives it both more technical credibility and bolsters its
creditworthiness with its bankers.

Last month, TAC announced it had arranged a 20-billion-baht ($511 million)
facility with its banks to help it repay its dollar debt and to upgrade its
network. As a result, "we believe the company will have sufficient financial
flexibility to address its lumpy debt maturity" next year, say the fixed-income
analysts at J.P. Morgan in Tokyo. This increased creditworthiness for TAC is
feeding increased competitiveness, which will then further heighten
creditworthiness. Too bad, then, that TAC is one of the exceptions.

Other entities, such as Thai Oil, have managed to come to terms with their
creditors after painfully drawn-out negotiations, in some cases lasting nearly
two years. A third group still can't make the numbers work: For instance, Bangkok
Mass Transit System, operator of the Thai capital's Skytrain, owes $1.7 billion
to creditors while its earnings from Skytrain are only a quarter of the original
income target. And, finally, there is a large and growing group of restructured
debtors that are falling back into the "nonperforming" category and which may
soon outnumber those who are being restructured and reclassified as performing,
says J.P. Morgan's Long.

Such conflicting trends contribute to an image that discourages foreign
investors, be they direct or portfolio investors. "If there is the prospect of
instability, it makes risk management much harder," says David Fernandez, an
economist with J.P. Morgan in Singapore, who adds that investors "just turn off
the switch for Southeast Asia."

In South Korea, too, the picture is mixed. To be sure, the lack of liquid funds
at parts of the Hyundai Group and the troubles of Korea's merchant banks and
investment-trust companies dominate the headlines. "Ultimately, Hyundai's high
degree of leverage refocuses attention on how the problem of excessive leverage
and thus weakened resilience to external shocks remains an issue in Korea," notes
Barclays Capital Asia in a recent report. Still, leverage has come down from
anywhere between 600% and 800% to less than 200% of GDP--high, but sustainable.

On balance, progress in Korea is probably more impressive than that of any other
of the crisis-hit countries of the region. For one thing, the Koreans kept the
system going. Bank lending virtually everywhere else in the region has plunged,
and is still going down even where economies are supposed to be recovering, as in
Japan, where bank lending contracted 4.6% in May this year compared with May last
year. But Korean banks never stopped lending; indeed, lending was up 21%
year-on-year in the first quarter, according to data from Goldman Sachs, after
rising more than 10% in 1999 from the previous year.


HEALTHIER PATIENTS

For a time, equity markets were strong enough to enable Korean companies to raise
money. Two years ago, many Korean companies were also able to turn to the local
bond market to refinance bank debt. Indeed, in 1998 issuance was up 62%, and 90%
of that was three-year debt, rather than more-dangerous short-term debt,
according to data from J.P. Morgan. Recent measures to strengthen the domestic
won bond market will help Korea's financial markets develop in a more balanced
way.

Some of the steps the government has taken have been dramatic. For example, the
decision to let Daewoo fail may have been part of a complicated political agenda.
At the same time, though, it signalled that no company in the country had an
absolute safety net under it.

Ultimately, what is saving Korea, though, is the fact that many of its companies
are basically healthier than Daewoo Group companies. Also, Korean companies in
general have shown a willingness to restructure.

If the region is to continue to be competitive, or to regain competitiveness in
the case of some countries, new investment is essential, not necessarily in
expanding output but in upgrading production. For that to happen, companies have
to be creditworthy and financial institutions have to be strong. There is still a
long, hard road to be travelled.