Opportunities in the wake of the economic storm are there - but watch out for hidden shocks.
The financial crisis in Southeast Asia and Korea is moving into its second year - and it's far from over. Massive declines in asset prices in local currencies combined with a sharp decline in the foreign exchange value of these currencies presents attractive investment opportunities for U.S. and European firms - as well as a major challenge. With local firms and financial institutions short of cash, assets are for sale at amounts far below their reproduction costs. Furthermore, because the countries are short of equity, governments - Korea's in particular - are relaxing restrictions on foreign purchases of domestic securities and assets. The challenge is to minimize profit declines associated with the turbulence in asset markets and the foreign exchange market.
What spurred the crisis was that the banks headquartered in Seoul, Jakarta, Hong Kong, Shanghai, Kuala Lumpur, Bangkok, and Manila were involved in Ponzi finance, much as the banks in Tokyo and Osaka had been in the late 1980s. Borrowers were using cash from new bank loans to pay the interest on outstanding loans, enjoying a process of "evergreen finance." This rapid expansion of domestic credit attracted funds from investors and banks in the U.S., Japan, and Europe. As total foreign indebtedness climbed to $350 billion for those countries as a group, the flow of billions in new foreign money each year enabled these countries to finance trade deficits that ranged to 8 percent of their GNPs.
With the exception of Korea, each of these countries had a bubble in its real estate market. Once foreign investors realized the scope of overbuilding, the flow of new foreign money to Southeast Asia and Korea declined sharply, and Indonesia, Thailand, Malaysia, and Korea were no longer able to finance their trade deficits. When it became apparent that banks would incur large loan losses, a "flight to quality" ensued as individuals and firms moved funds from domestic banks into currency, foreign banks, and foreign currencies. Foreign investors and banks, particularly Japanese banks, followed suit, seeking to reduce their loan exposures.
But today, trade balances in the region have improved, initially because of a sharp decline in imports. Within months, exports will surge as currency depreciations drive a striking improvement in competitive price position. As rising exports...