"From An Asian Perspective"
January, 1999
By Gary Davis, Davis Consultants Asia, Sdn. Bhd.
The Following article appeared in Insight Magazine in January, 1999.
It was last July in Singapore when Joan Pinder and I first discussed posting articles in Insight that would feature an Asian perspective. IDEMA was expanding its services to all members and our Asian affiliate was our primary topic, partially as a result of the location of our discussion. Little did we know at the time that Asia would become the lead topic of discussion in much wider circles over the ensuing days and months. So much so that Asia, and what is happening here, still dominates the headlines in most financial journals around the world today. Equally lacking prescience, in this particular conversation, was our understanding of just how deep a malaise our industry was entering.
Much has been made in the press and among some analysts of the relationship between the two developments. While there may be some parallels I am not convinced there has been a cause and effect relationship that has occurred to date. As usual the future is less clear. For example, today we would have to question what effect Asia's economic woes will have on PC buying in the future. Asia has long been designated as one of the fastest growing geographic sectors for high technology products. Now there will likely be a substantial dampening of enthusiasm in the ensuing months if not years.
Still, by all accounts, we have not seen a surcease in overall disk drive orders. On the contrary, various published estimates of unit shipments suggest that from 1996 to 1997 we enjoyed a unit growth rate of anywhere from 21% to 26%. In addition most estimates are still pointing to another 18% to 22% unit growth in 1998. While some currency hedging and , in some cases, the use of locally derived debt, has had or may have an impact on the profits of some of the companies in our industry, orders have remained unabated. So what has led us to this state of what Business Week recently called "a weird, profitless prosperity"?
Obviously the industry has overextended with each company, in turn, believing it would capture more market share then it did. It is a condition that we are familiar with. We have been here before. It is very difficult to resist the euphoric feelings of a perceived insatiable marketplace. It wasn't that long ago that most of us shared this euphoria. Remember how you felt about business prospects just three quarters ago? And this is where our very real connections to Asia reside. It is in Asia where our optimism is most tangibly expressed. By an informal count the disk drive industry has started or finished over 10 million square feet of new factory space in various locations in Asia, over just the last 24 months. That is just counting factories for heads, media, and disk drives. Since 1982 when Seagate and Maxtor established small plants in Singapore we have had a growing love affair with the region. And, except for a hitch or two, our respective fortunes grew in parallel.
While the current numbers are unprecedented the fact of being in the midst of an inventory glut, as earlier alluded to, is not. We could argue the direct causes of this repeated bit of history. No doubt it is partially the result of that rare mixture of technological brilliance, competitive spirit, performance confidence, and unabashed forward optimism, that our industry is well noted for. Perhaps that shouldn't change for without that spirit we might not accomplish what we do nor could we weather the types of storms that occasionally visit us. But the recent flight of profits and, subsequently, investor confidence, tells us again that we must consider a modification to the way we do things. Asia, as a region, is undergoing a similar self analysis.
First we need to understand what brought the once booming region here to the current state of affairs. The simple answer is debt. Companies in the worst-hit countries, South Korea, Indonesia and Thailand, borrowed vast sums of money as their economies boomed. Worse, they borrowed much of it in US dollars because interest rates were much lower than those in their own currencies. The exchange rates of local currencies were pegged against the dollar, so they had no fears about having to earn money in local currency to pay back loans in dollars.
This was fine while the economy was booming. But from the middle of 1995, the US dollar started to rise against most of the world's other currencies. Asian currencies pegged against the dollar rose with itso Asia's exports became more expensive and less competitive on world markets. Account balance deficits rose as demand for cheaper imports grew while more expensive exports declined. In 1996 Thailand's export growth, which had been a model for the region, dropped to nearly zero ballooning the current account deficit.
From around May of 1997 it had started to become apparent to traders that Asian currencies would have to abandon the dollar peg and devalue in order to revive exports. There was much resistance. Devaluation would cripple firms which had borrowed huge sums in dollars and would now have to earn much more in local currency to pay back the loans. Most of this resistance took the form of government programs to buy local currencies and sell U.S. dollars, a strategy that in hind sight, compounded the cost and was doomed from the start. As central banks lost billions, investor confidence worsened. On July 2nd Thailand was forced to capitulate and allow the baht to float freely on the market. The slide in value drew scrutiny to other Asian economies where similar circumstances were found, prompting a spreading crisis now popularly called the "Asian contagion" in the press. Since July 2nd, Asia's stock and currency markets have been in turmoil as one country after another grappled with the erosion of investor confidence in the region's economies. Currencies in the Philippines, Malaysia, Thailand and Indonesia lost more than one-third of their value against the US dollar this year. Banks were particularly hard hit because the drop in the value of Asian currencies caused the cost of debt for companies with foreign loans to explode.
Thailand, in addressing the shambles, is dealing with massive economic adjustments because of profligate property lending and lax central bank controls. While Thailand lies at the epicenter of Southeast Asia's lingering currency woes others in the region are faced with similar challenges.
In Malaysia the forecast for growth in 1998 has been pared to 4% from 7-8% in a bid to regain investor confidence. As news rolls in this figure will likely get reduced again. Several large infrastructure projects have been cancelled or placed on hold. A state sanctioned limitation on bank loans to the property sector has been enacted to slow what is seen as a growing glut of inventory in virtually all property sectors. Clearly the authorities are reversing their largesse and turning away from projects that one London economist called "hubris, prestige projects like big towers".
The depth of the problems in Southeast Asia have likely not been completely revealed. So far the experts are shying away from the word recession but it is beginning to look more like the "R" word everyday. Mounting bad loans and failed lenders have severely squeezed credit in Southeast Asia. "Business has no liquidity," says economist Christianto Wibisono of Indonesia, where 16 banks have been liquidated and over half of 43 major conglomerates suffered currency losses exceeding their projected 1997 earnings. The Jakarta property sector has an estimated 3.5 million meters of excess space and a local newspaper has reported that more then 35% of scheduled building projects for 1998 will be abandoned.
At a personal level, local businesses are reporting variously as much as 30% 50% decline in sales of personal products, furniture, and appliances. The large, state founded, automobile manufacturer, which manufactures the Proton, has warned its suppliers to expect as much as a 50% decline in component parts orders in 1998. In the evening coffee shops, and pubs, once jammed with hungry and thirsty customers, are nearly empty, while the local wholesale food market vendors report a brisker walk-in business.
Even the venerable economy of Singapore, once regarded as a safe haven for investors, hasn't been entirely untouched. The Singapore dollar has devalued 19% against the U.S. dollar since mid July and forecasters believe there is more to come. The property sector is beginning to show signs of stagnation and the local car market has shrunk to nearly nothing.
While not necessarily bound together in a cause and effect relationship from a purely economic point of view, the depth and breadth of relationships between our industry and the Asian economies and people are unquestionable. And the parallels are real. For example, with idled capacity, we clearly have borrowed heavily against our future earnings. We, also, have built non productive edifices, albeit with the best of intentions of them being productive.
Much is happening in Asia to correct course. Back to basics is a lesson for Asian companies, many of which were founded only after the last region wide slump in the mid-1980s. For example experts are saying developers have to look at sectors tipped to rebound first, like low-cost homes, instead of such glamour projects like luxury condos. "In some projects we reduced the size of the apartment by half and converted to a more middle-class project," one such developer noted. "We need to switch from marketing want to marketing need."
Scaling back is an obvious tack. Thai computer and communications giant Shinawatra will not launch its Thaicom 4 satellite in 1998 as first planned. Shinawatra Satellite president Dumrong Kasemset will first look for foreign partners for a venture now costing 50% more than the Thaicom 3 bird sent aloft in 1994. "When all else fails, amputation may be necessary" he said in a recent interview.
In another recent interview Nariman Behravesh, chief international economist at Standard & Poor's DRI, said "The key to recovery in the Asian countries hardest hit by the crisis is the speed with which they tackle their structural problems (excessive industrial capacity and banking problems). If they deal with these problems aggressively, as Mexico did in 1995, then they will be able to recover quickly." In the same article, Arthur Alexander, the president of the Japanese Economic Institute said "The signs for whether these countries are turning the corner are the speed of closing down or repackaging failed enterprises, revaluing assets, marketizing prices, and reallocating resources. If the same old banks continue to support the same old failed companies, recovery will be indefinitely delayed." Both of these comments stressed the imperative of speed with which the respective authorities should act.
The prescription amounts to an extraordinarily difficult belt tightening, signs of which are well underway. On a micro scale one story I found very interesting and revealing. A local Malaysian company, operating in the OEM auto parts business, was in the midst of their biggest year ever when the crisis hit. The company swung into action, moving to diversify from exclusive local supply (where tax advantages existed) to a model that included export, where new found competitiveness existed. As the year end neared it became apparent the company was recording its biggest revenue year ever and most profitable. The board of directors , at the time of awarding the traditional annual bonuses, cited the performance by awarding the management team with a company sponsored vacation to Venice, Italy in addition to normal year end cash bonuses which are widely regarded here as a standard remuneration. Spontaneously the management team met and voted to return the cost of the junket to the company, refusing the stipend in a gracious letter to the board. The vote was unanimous.
There are many examples of this kind of determination, both in the private sector and the government sector. To fully understand this determination we should look at what gave rise to the so called "economic miracle" here in the first place. The Honorable Chris Patten, former Governor of then British held Hong Kong, delivering a speech in London , described the fundamentals that had led to the rapid economic growth in Asia.
It seemed to him that the single most important factor in Asia's rise to prosperity had been the "conviction in the hearts and minds of hundreds of millions of Asian men and women that life can and should improve for them and their families. Whatever technical explanations economists might offer, whatever geo-economic forces might have been at work, " the engine of Asia's economic success has been the determination of Asians to haul their families out of subsistence and poverty towards a better life. It amounts to a belief in progress".
The second reason he gave for Asia's economic transformation is economic liberty. "While many of Asia's governments were, and indeed remain, far from tolerant in their approach to civil and political liberties, most have come to recognize sooner or later the need to grant their citizens economic liberty. These governments have come to recognize, often through bitter experience, that enterprise and ambition can do more to transform their economies than regulation and bureaucracy."
Finally, "while a belief in progress and economic liberty would have taken Asian communities part of the way to prosperity, it was free trade which gave Asia its biggest break. Access to North American and Western European markets made possible the rapid export-led growth of the post-war decades". In the same speech he described free trade as an idea, a value, which sustained economic expansion and trade throughout the world.
When we review these underlying fundamentals of Asia's economic rise, we can see that they have not disappeared. If anything, on some points, they will have strengthened. In that recognition we can draw optimism for the recovery process here and draw analogies useful in our own industry. After all, demand has not diminished, innovative application of technology has not ceased, and without doubt, determination has not flagged.
