viewpoint

	ASIA	April 13, 1998 VOL. 151 NO. 14
The Outlook: More Ws Than Vs Don't be fooled by recovering markets. Turbulent times lie ahead By Simon Ogus ecent surges in asian currencies, stocks and bonds appear to be telling us that the region's problems are solved and a return to the good times is just around the corner. Even after Friday's dip, most markets are up for 1998. Investors seem to be looking at the experience of Mexico and assuming that Asian governments will press ahead with economic and financial restructuring to enjoy a V-shaped recovery path. Considering Asia's long-term potential-based on its high savings rates, positive demographics, etc.-the argument for a return to an era of rapid growth is compelling. But how long will it take: One year? Two? Five? Longer? To find the answer, consider Japan's recent experience. Observing Japanese policymakers in action-or more accurately, inaction-for more than a decade now has been a mawkish experience. Since the bubble burst there seven years ago, local analysts and gaijin alike have offered all kinds of policy advice. Yet Japan has failed to do anything of substance that might lead to a sustainable recovery. Why have the policymakers and bureaucrats failed to deliver? Surely they know what must be done. But they also have implicitly accepted a prolonged period of sub-potential growth as the price for maintaining social stability. That does not necessarily mean preventing riots in the streets; it means keeping traditional ownership structures and business-political-bureaucratic relationships intact, as a way to support the existing social order and the perks that go with it. In this, Japan is by no means unique (look at France). After all, people have to be pushed a long way before they take to the streets. It was Lenin who said the best way to overturn a nation is to debauch its currency. What leads to revolution is hyperinflation, which destroys incomes across the whole of society, or joblessness on the scale of the 1930s in the West. Politicians rightly calculate that a 10% unemployment rate is acceptable, since 90% of the work force remains employed. So it is understandable why politicians do just enough to maintain the social status quo. Belatedly, many Asian leaders have recognized the need to face their problems, instead of just railing against insidious outside forces. That's a huge step forward from last year and has done much to restore calm to the markets for the moment. However, crises give governments flexibility that rapidly diminishes as the emergency dissipates. Once the pressure eases, it becomes more difficult to push ahead with painful measures in the face of domestic opposition. Japan has been able to drag out its problems for nigh on eight years. The rest of the region does not have that luxury: it will run out of money far more quickly. But even bankrupt countries can keep going for quite a while. As long as policy is not positively destructive, the patient can be kept alive, paper can be shuffled from one account to another and the odd shot of cortisone can be administered when necessary. True, outsiders can apply pressure, but the implicit threat of complete default limits their ability to force through reforms. Although exports from Asia should improve somewhat in the next year, growth rates will not be enough to overcome the twin problems of overborrowing and overcapacity. The road to salvation, therefore, starts with rapid domestic adjustments, far-reaching foreign and domestic debt restructurings and, by implication, a resumption in rapid and sustained foreign capital inflows. How likely are these to occur? Currently we are seeing a modest return of foreign funds into Asian markets, enough to boost currencies and share prices. But until factories and office buildings start to be sold at more realistic prices, countries and financial systems will remain locked in Japanese-style suspended animation, and capital flows will remain transient, opportunistic and insufficient to kick-start economies. No doubt some high-profile deals will be clinched; investment bankers currently crawling all over the region have to justify their salaries somehow. But these could be the exception rather than the rule, since it is just not in the interests of current owners to sell out if they can keep their businesses going hand-to-mouth. Some direct investors may be persuaded to pay more than they should, but the majority will prefer to walk away. Instead of the Vs that the asset markets are describing now, the region will more likely see W-shaped recoveries. These will entail mini-bursts of economic activity accompanied by strong asset-price rallies, and they ultimately will buy enough breathing space for politicians to avoid painful changes. Economies and markets will zigzag up and down without recovering the growth rates needed to burn up overcapacity and restore liquidity to highly indebted companies. Accordingly, this is not an environment for sustainably strong currencies or broad stock market gains. Rather, it favors government or high-quality corporate bonds, as well as stocks of companies that push ahead with restructuring regardless of any national consensus to resist change. Making money in such circumstances will be far from easy. Simon Ogus is chief economist for Asia at SBC Warburg Dillon Read in Hong Kong
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Don't be fooled by recovering markets. Turbulent times lie ahead

By Simon Ogus

ecent surges in asian currencies, stocks and bonds appear to be telling us that the region's problems are solved and a return to the good times is just around the corner. Even after Friday's dip, most markets are up for 1998. Investors seem to be looking at the experience of Mexico and assuming that Asian governments will press ahead with economic and financial restructuring to enjoy a V-shaped recovery path. Considering Asia's long-term potential-based on its high savings rates, positive demographics, etc.-the argument for a return to an era of rapid growth is compelling. But how long will it take: One year? Two? Five? Longer?

To find the answer, consider Japan's recent experience. Observing Japanese policymakers in action-or more accurately, inaction-for more than a decade now has been a mawkish experience. Since the bubble burst there seven years ago, local analysts and gaijin alike have offered all kinds of policy advice. Yet Japan has failed to do anything of substance that might lead to a sustainable recovery.

Why have the policymakers and bureaucrats failed to deliver? Surely they know what must be done. But they also have implicitly accepted a prolonged period of sub-potential growth as the price for maintaining social stability. That does not necessarily mean preventing riots in the streets; it means keeping traditional ownership structures and business-political-bureaucratic relationships intact, as a way to support the existing social order and the perks that go with it.

In this, Japan is by no means unique (look at France). After all, people have to be pushed a long way before they take to the streets. It was Lenin who said the best way to overturn a nation is to debauch its currency. What leads to revolution is hyperinflation, which destroys incomes across the whole of society, or joblessness on the scale of the 1930s in the West. Politicians rightly calculate that a 10% unemployment rate is acceptable, since 90% of the work force remains employed. So it is understandable why politicians do just enough to maintain the social status quo.

Belatedly, many Asian leaders have recognized the need to face their problems, instead of just railing against insidious outside forces. That's a huge step forward from last year and has done much to restore calm to the markets for the moment. However, crises give governments flexibility that rapidly diminishes as the emergency dissipates. Once the pressure eases, it becomes more difficult to push ahead with painful measures in the face of domestic opposition.

Japan has been able to drag out its problems for nigh on eight years. The rest of the region does not have that luxury: it will run out of money far more quickly. But even bankrupt countries can keep going for quite a while. As long as policy is not positively destructive, the patient can be kept alive, paper can be shuffled from one account to another and the odd shot of cortisone can be administered when necessary. True, outsiders can apply pressure, but the implicit threat of complete default limits their ability to force through reforms.

Although exports from Asia should improve somewhat in the next year, growth rates will not be enough to overcome the twin problems of overborrowing and overcapacity. The road to salvation, therefore, starts with rapid domestic adjustments, far-reaching foreign and domestic debt restructurings and, by implication, a resumption in rapid and sustained foreign capital inflows. How likely are these to occur?

Currently we are seeing a modest return of foreign funds into Asian markets, enough to boost currencies and share prices. But until factories and office buildings start to be sold at more realistic prices, countries and financial systems will remain locked in Japanese-style suspended animation, and capital flows will remain transient, opportunistic and insufficient to kick-start economies. No doubt some high-profile deals will be clinched; investment bankers currently crawling all over the region have to justify their salaries somehow. But these could be the exception rather than the rule, since it is just not in the interests of current owners to sell out if they can keep their businesses going hand-to-mouth. Some direct investors may be persuaded to pay more than they should, but the majority will prefer to walk away.

Instead of the Vs that the asset markets are describing now, the region will more likely see W-shaped recoveries. These will entail mini-bursts of economic activity accompanied by strong asset-price rallies, and they ultimately will buy enough breathing space for politicians to avoid painful changes. Economies and markets will zigzag up and down without recovering the growth rates needed to burn up overcapacity and restore liquidity to highly indebted companies. Accordingly, this is not an environment for sustainably strong currencies or broad stock market gains. Rather, it favors government or high-quality corporate bonds, as well as stocks of companies that push ahead with restructuring regardless of any national consensus to resist change. Making money in such circumstances will be far from easy.

Simon Ogus is chief economist for Asia at SBC Warburg Dillon Read in Hong Kong