AWSJ(9/10) 25th Anniversary: Flows Of Short-term Capital To Asia Are Slowing; Will They Ever Return?
September 9, 2001
Dow Jones Newswires
By JASON BOOTH
A funny thing happened in Asia's financial markets over the last few months - they didn't crumble.
Turkey's currency collapsed. Argentina's economy collapsed. Meanwhile, the world is seeing its worst export slowdown in 15 years. Yet among Asia's most volatile markets there was little sign of a financial implosion like that which occurred in 1997-1998. Currencies and bond prices did weaken. But stock markets in Thailand, Philippines and Indonesia largely shrugged off the bad news.
Is this a case of stock markets simply too burnt out and battered to crash? Partly, yes. "Foreign bank credit has simply not returned to the region, so there is relatively little more that can be withdrawn," notes P.K. Basu, economist at Credit Suisse First Boston.
But that's not the whole story. The muted reaction also highlights a remarkable hollowing out within Asia's financial markets since the 1998 financial crisis: The lacunae left by the exit of hot money.
Back in the mid-1990's, when Asian markets were flush with short-term investment money in the form of equity investments and short-term bank deposits, otherwise known as "hot money," word of trouble in other emerging markets sent violent tremors through the region as investors quickly took their money off the table. The July 2, 1997 flotation of the Thai baht triggered a domino effect that sent Southeast Asia's stock markets, currencies, and economies tumbling.
Today that hot money is gone. The Southeast Asian countries of Thailand, Malaysia, Singapore, Philippines and Indonesia have received no net portfolio inflows since the first quarter of 1997, according to Credit Suisse First Boston. In other words, for every one dollar sunk in these countries' stock markets in the last four-and-a-half years, one dollar has been spirited away. More significantly, Credit Suisse also said there was a net withdrawal of US$221.4 billion in bank loans from the region during the 1998-2000 period, a sum equivalent to the gross domestic product of Sweden. All of which leaves the region's finance officials grappling with a new and delicate economic problem as it contemplates the next quarter century of growth: Can the region's economic model, nourished for decades by unceasing flows of offshore capital, suddenly manage without it? And, if not, what must officials do to orchestrate the return of hot money to Asia in a more tempered form?
Not everyone is mourning. The disappearance of hot money "has done Asia good in a number of ways" argues Arup Raha, chief Asian economist at Warburg Dillon Read in Hong Kong. "It has reduced the risk of investing. People are looking at Asia as a long term investment rather than a quick way to make a buck."
Nor is that the only bright side to being marginalized in the world financial system. For starters, the absence of hot money has contributed to financial stability in the region in fundamental ways. Foreign exchange reserves are at least twice the size of short-term debt in all the major Asian nations, a reversal of the situation in 1997 when short-term debt exceeded the size of foreign exchange reserves in countries such as Korea and Thailand. Most countries in the regions are also now net exporters of capital. Thailand, for one, posted a current account surplus equal to 7.6% of GDP in 2000, according to Goldman Sachs, compared with a 7.9% deficit in 1996. Similar reversals were staged in Malaysia, the Philippines and Indonesia.
Most strikingly, perhaps, central banks in the region possess far more freedom than they did before the financial crisis. For starters, interest rates can be lowered or raised based on domestic economic conditions rather than to retain foreign liquidity flows. In 1994-95, for example, Malaysia's red-hot economy found itself in an odd economic conundrum: GDP was galloping ahead at close to 10% annually, fueling worries of inflation, yet Bank Negara couldn't raise rates to cool the overheating economy. Why not? Because an interest rate raise would then have attracted a flood of hot money, further inflaming inflation. Lastly, since its financial crisis most Asian currencies have been allowed to float freely on foreign exchange markets, thus enabling countries to combat the recent export slowdown through managed depreciations of their currencies.
Here's the bad news, however: Without legions of foreign banks and equity investors ready to pump hot money into the region, Asia's growth rates may never recover the kind of swagger they had in the early 90s. Real GDP growth in Asia averaged 5.2% between 1997 and 2000, down from 8.5% in the preceding four years. Growth within the Southeast Asian nations of Malaysia, Thailand, Philippines and Indonesia has plunged to an average of 0.6% from 7.6% in that same period. In spite of the effect hot money had in inflating property and stock market bubbles across Asia, much of it was more sensibly sunk in roads, ports, power, and telecoms. To obtain offshore capital today, by contrast, Asian countries have to pay a steep price: 300-500 basis points over Libor (London Interbank Offshore Rate), depending on the risk profile of the country and project.
Not surprisingly, some Asian nations are now looking around for ways to get a little of that hot money back, albeit in a more controllable form. In May Malaysia scrapped a 10% levy on foreign investors` stock-market profits repatriated within a year of their initial investment. And there are pockets of Asia where hot money, it might seem, never left in the first place. South Korea's stock markets saw a flood of money when it joined the Internet craze, for example. The Kosdaq, South Korea's high-tech second board, soared nearly 300% in 1999, partly due to an inflow of foreign capital. Similarly, Hong Kong technology plays, such as Pacific Century Cyberworks, rose 2,400% between early 1999 and early 2000, only to see its share price plunge more than 90% in the next 14 months.
But with currency volatility now an unavoidable fact of life in Asia, a big deterrent to hot money flows, economists point out that making money in the region just isn't as easy as it once was. In the mid-nineties, for example, when Asian currencies were largely stable, debt arbitrage was a popular and seemingly harmless sport. Investors could borrow cheap money from Japan, where 30-day interest rates were at 0.5% in August 1996, and lend it in Thailand, where rates were 9.5%. Similarly, yen was converted into won in South Korea, where rates were well over 12%. The result was that tens of billions of dollars floated around the region, looking for the highest yields possible.
"It was an easy trade, but it was also unhealthy," recalls Vincent Lo, economist at Merrill Lynch in Hong Kong.
Today the carry trade is defunct. Thai 3-month money market rates have plunged to under 3%. South Korea's short term rates have fallen to around 5%.
More fundamentally, Asia is no longer the only game in town for hot money. American money that once might have looked for high-risk-high-return assets in Southeast Asia can now pan for gold in Silicon Valley. European money need go no further than Eastern Europe, and possibly Turkey, in order to invest in emerging markets.
But for Southeast Asia, what's really standing in the way of attracting more investment money is transparency. When the hot money flowed out of Asia, it exposed a range of irregularities, from lax accounting to outright fraud. "You really can't get people's interest back without some very hard work in terms of corporate governance," says Mr. Lo.
Despite progress toward protecting investors rights in most developed economies such as Hong Kong, Singapore and South Korea, much of the rest of the region has made little progress on this front. "Partly it's cultural," says Joan Zheng, economist at JP Morgan in Hong Kong.
The high proportion of family ownership of public companies makes enforcing corporate governance rules tricky and onerous, as senior executives have a harder time balancing the interests of family and shareholders. Says Ms. Zheng, "You can put the rules in place, but whether people follow them is another question.
---
Mr. Booth is an economics reporter with The Asian Wall Street Journal.
--------------------------------------------------------------------------------
URL for this Article:
interactive.wsj.com
--------------------------------------------------------------------------------
Copyright © 2001 Dow Jones & Company, Inc. All Rights Reserved.
Printing, distribution, and use of this material is governed by your Subscription Agreement and copyright laws.
For information about subscribing, go to wsj.com
Used with permission of wsj.com |
