| BUSINESSWEEK ONLINE : FEBRUARY 8, 1999 ISSUE | ||||||||
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| COVER STORY
Emerging Markets: 'We're Fighting to Survive' (int'l edition) With Western capital deserting even well-managed businesses, they face a long siege There's nothing fair about what's happening to Burapa Steel Industries Co. The Thai company's top executives weren't cronies of bankers or government officials. They had plenty of foreign customers for the company's high-end steel. They didn't borrow recklessly. Yet Burapa is on the verge of bankruptcy, punished by local and Western trade financiers too scared to lend in a shaky emerging market. Concedes Burapa Managing Director Santisuk Plooksawasdi: ''We're fighting to survive.'' It's the same story throughout Asia and much of the rest of the developing world. The winds that blew hundreds of billions of dollars into emerging markets with hurricane force in the early 1990s have gone deathly still. Now, these economies must struggle their way out of recession with much less Western investment. Data from the Washington think tank Institute of International Finance tell the story: Commercial-bank lending to developing nations plunged from $121 billion in 1997 to an outflow of $10 billion last year, with 1999 shaping up as another shaky year. Bond and equity portfolio flows also dropped severely. That capital won't come gushing back until developing countries show marked progress in structural reform. Unless confidence can be restored quickly, emerging markets may be doomed to years of slow growth as borrowers pay sky-high interest rates for whatever funds they can find. Instead of driving world growth, as they did in the first half of this decade, emerging markets have become a drag. The big danger is that direct investment by corporations will taper off as well. But as prospects for making money fade years into the future, countries such as Russia, Indonesia, and Brazil could drop off the radar screens of many Western corporations that can't afford to wait for the kinds of returns they are getting in Europe and America. What new foreign direct investment does come may be concentrated in a few strategic bets, such as China, Korea, Mexico, or Poland. Behind the caution is a sobering realization among Western lenders: International Monetary Fund rescue plans and government guarantees no longer mean they'll get their money back. Russia exploded the cozy myth that sovereign nations do not default on bonds. And banks are getting the same reality check in China, with Beijing saying it will not cover billions in dud loans to state-owned investment trusts. In Indonesia and Thailand, which still lack functioning bankruptcy courts, lenders are waging an exhausting, company-by-company war to retrieve what's left of their funds. The big lesson of 1998 is that even the Western-led institutions that were designed to maintain order are out of their depth in coping with the trillions in private capital that now rampage through the global economy. The conundrum is what to do about it. The world's policy gnomes are urgently seeking ways to repair the international financial architecture. Debate is raging in the ivory towers of think tanks and lending agencies. Proposed remedies range from schemes to limit the excesses of global hot money to blueprints for entire new world regulatory bodies (table). No grand solution has yet emerged that has much chance of surviving the scrutiny of the world's government and financial institutions. But surprising consensus is forming on some points that economists regarded as anathema only a year ago. Both the IMF and U.S. Treasury, for example, have lined up behind the idea that the IMF should formally become a lender of last resort to keep nations afloat when all else fails. With that would come power to certify if a nation is sound and transparent enough to borrow. And rather than wait until a financial storm hits, the IMF would rely on more preemptive strikes such as the $41.5 billion the agency put up in its attempt to save Brazil. Some of these changes could become policy this spring, when ministers from the Group of Seven industrialized nations meet in Cologne, Germany. The IMF, Treasury, and World Bank also now embrace financial controls by developing nations that they used to vigorously condemn. They agree that floating currencies and free inflows of hot money may be a bad idea for countries with primitive financial systems. They also believe that countries should cooperate in regulating hedge funds, as recommended by the Basel Committee on Banking Supervision. Will these measures really ease market anxieties? Indeed, one reason investors are spooked is that the rules governing emerging markets seem open to revision. Says Deutsche Bank economist Peter M. Garber: ''If you think policy shifts are in the air and markets will become less liquid, that means more risk.'' True, there are encouraging signs of a surge in foreign direct investment in some Asian countries as distressed companies scramble to sell assets cheap. But shoppers are selective. It's shaping up as a banner year for mergers and acquisitions in South Korea, which now has a stable democracy, an aggressive program to clean up banks, and lots of world-class factories. ''But take away Korea, and the Pacific Rim has dropped off the map,'' says KPMG Corporate Finance Director Stephen Blum. What will come back slowly are bank loans and investments in stocks and bonds, the rocket fuel of East Asia's early '90s boom. Much of the region's high savings will be consumed in whittling down its $600 billion overhang of bad debt. In the present climate, any new portfolio investment will remain vulnerable and depend on booming liquid financial markets in the U.S. and Europe. ''The volatility of capital flows is still there,'' warns Stanley Fischer, the IMF's deputy managing director. ''There still is the potential for serious crisis.'' Indeed, the liquidity squeeze has spread far beyond Southeast Asia. Since the financial crises in Brazil and Russia, borrowers in most emerging markets must pay double or triple the rates fetched in the U.S. and Europe for loans and bond issues--if they can raise money at all. Even in well-managed South American economies such as Argentina, manufacturers complain that they can't get financing to fill export orders. ''Across the board, there is no confidence whatsoever'' in emerging markets, says former J.P. Morgan & Co. executive Peter L. Woicke, the new head of International Finance Corp., the World Bank's private lending arm. The IFC is seeking to double its capital so it can make more funds available for emergency trade facilities. Inevitably, this reassessment of growth potential in developing nations will factor into the strategic plans of multinationals. Giants such as General Electric (GE), DaimlerChrysler (DCX), and Unilever Group (UN) will continue to press ahead in big emerging markets, and in some cases, they're making new investments. Strong players such as Gillette Co., which dominates razor markets from Russia to China, see the crisis as an opportunity. ''There are still 150 million people in Russia and another 150 million in the republics,'' says Gillette President Michael C. Hawley. ''With fewer competitors, we can gain market share.'' But other companies face harder choices, particularly smaller players or those that joined the global bandwagon just before the crisis began. Those companies may opt to stay in markets such as Mexico and China. But shakier developing markets are simply consuming scarce capital that could earn much higher returns in Europe and the U.S. Britain's Boots Healthcare International fits that profile. A $500 million maker of over-the-counter drugs, Boot has enjoyed strong growth in Europe. But in the early 1990s, it also set up sales operations in 135 countries. In Russia, sales are so bad that the company has laid off half of its 40 workers and stopped advertising on television. Boots says it won't abandon such countries, but ''we're not rushing into markets that don't seem to be creating value,'' says spokesman Tim Legge. The profit squeeze stems from a dramatic shrinkage of Asia's middle class, the prime customers for everything from canned soups to cars. Between 1987 and 1992, for example, the number of Indonesians making $5,000 or more per year tripled to 13.5 million. That number has shrunk dramatically. In U.S. dollar terms, purchasing power has plunged by 82% in Indonesia and has dropped 43% in Thailand and 34% in Malaysia. Translation: In packaged foods and pharmaceuticals, so much Asian spending power has been wiped out that ''it will take until 2003 or 2005 to get to where companies thought they would be in 1998,'' says A.T. Kearney Inc. consultant George Baeder. ''Second-tier multinationals may have to pull back.'' To restore investor confidence, developing nations must erase the stigma that they are inherently unstable. One reason why Mexico has escaped the worst of the recent panic is greater transparency in its banking system since its 1994 crash. Countries such as Thailand and Indonesia have begun to restructure banks, beef up supervision, and enact tougher accounting and disclosure laws. But reforming financial sectors isn't enough, contends World Bank President James D. Wolfensohn (box). Also, these changes will take years. As a result, aid agencies are discouraging emerging markets from taking any more Big Bang approaches to liberalization. The new conventional wisdom is that the U.S. and European financial systems are big and sophisticated enough to absorb hot-money shocks--capital inflows account for only 2% of economic output. But such funds can leave devastation in their wake in Malaysia and Thailand, where they totaled half of the economy in the mid-1990s. When portfolio managers, banks, and depositors suddenly yanked those funds out, there simply weren't enough foreign reserves to fend off a crash. Many critics believe more ambitious changes are needed to make markets less anarchic. ''If globalization is to succeed, it cannot be a free-for-all,'' says Indian Finance Minister Yashwant Sinha. Some pundits argue that to operate efficiently, the global economy would really need the international equivalents of America's Federal Reserve, the Securities & Exchange Commission, the Chicago Mercantile Exchange, and bankruptcy courts. Few governments, of course, would cede so much sovereignty. Even making the IMF a formal lender of last resort, a de facto role that it already plays, will be hard. The idea is that countries would qualify for IMF help only after their institutions meet rigid financial standards. The IMF would monitor compliance and disclose its findings. If countries don't measure up, ratings agencies would raise red flags, making it more difficult and costly for those nations to borrow. Critics of this scheme contend that the IMF is far too influenced by politics to honestly report such things. Indeed, on close examination, every idea for fixing ''financial architecture'' becomes numbingly complex. Washington is likely to keep pressing the issue because it now knows that distant emerging-market crises matter. The harrowing near-collapse of Long-Term Capital Management because of bond losses in Russia proved that ''globalization means it is possible for a virus to be injected right into the heart of the U.S. economy,'' says Institute of International Finance Managing Director Charles H. Dallara. But what if it turns out that Long-Term Capital was a fluke? The danger is that if the U.S. and Europe continue to coast along, and emerging markets become less relevant to prosperity in the West, ''a lot of these issues will disappear into the ether of grand rhetoric,'' says Jeffrey E. Garten, dean of the Yale School of Management. If so, ''a lot of countries will experience periodic traumas for decades as they integrate into the world economy.'' Globalization promised many things to many countries in recent years. But ''decades of trauma'' must have been buried in the fine print. Now, the search begins for ways to tame capital flows so that they spur growth in good times but avert calamity when trouble erupts. By Pete Engardio, with Owen Ullmann in Washington, Carol Matlock in Moscow, and bureau reports _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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