CATCHING THE ASIAN FLU

By Michael S. Serrill

Maybe you were distracted by the landing of Pathfinder on Mars or were just not paying particular attention when Thailand's currency, the baht, began to fall to earth like a wounded satellite. On July 2 the baht plunged more than 12% in value against the greenback. Then it crashed into the Philippines, Malaysia and Indonesia, where government officials were forced to devalue their currencies. That triggered a region-wide crisis, in which stock markets gave up as much as 35% of their value, inflated real estate prices fell through the floor, banks collapsed, and hundreds of thousands of Southeast Asians, rich and poor, lost their jobs and fortunes.

Last week the reverberations of that early July disaster reached Wall Street, following a brief and awful stopover in Hong Kong. The former British colony had formed the Maginot Line of money, vowing to use its $88 billion in foreign reserves to fight off speculators and keep its highly valued currency pegged to the U.S. dollar at a rich 7.8-to-1 ratio. The gambit succeeded--but at a price: $42 billion of Hong Kong's storied wealth disappeared in short order as the Hang Seng index dropped 6% on Wednesday, then 10.4% on Thursday. The "red chips" of the Hang Seng, the stocks of mainland Chinese companies, were bled white. "This is a full-fledged, absolute crash," said Kent Rossiter, an investment adviser for Nikko Securities in Hong Kong.

Hours later Wall Street was in full retreat. The global economy, once an abstraction to most people, had shown up front and center to deliver the bad news. Investors, fearing that the earnings of large U.S. companies exposed to Asia would suffer, began to sell. On Thursday the market dropped 186.88 points. On Friday, while the Hang Seng recovered, the Dow fell an additional 132.36 points, unable to take comfort in the good news. In New York City, out-of-favor issues ranged from big airlines with Pacific routes, like American and United, to consumer-product companies like Coca-Cola. Semiconductor stocks took a beating, along with high-tech giants like IBM and Hewlett-Packard, which earns 16% of its revenues from the region.

All could face an Asian double whammy, at least in the short run. First, the region's economic crunch will probably cause its consumers and companies to buy less from America. Second, sales by U.S. firms in Asia won't add as much to their bottom line because Far Eastern currencies are worth 20% to 40% less than they were just a few months ago. Warns Sung Won Sohn, chief economist at Norwest Corp., a large bank based in Minneapolis, Minn.: "The collapse of Hong Kong and other Asian economies is spreading like an oil slick that will continue to wash up on America's shores."

Not all of that is bad. Slamming on the brakes of a runaway market may help prevent a worse crash later. Also, devaluation of Asian currencies will make Asian exports cheaper, help keep inflation at bay in the U.S. and deter the Federal Reserve from raising interest rates.

Hong Kong will have a harder time divining any benefits from its predicament. Analysts expect the roiled markets to spell high interest rates, sending the Chinese enclave's crucial property market into a tailspin, leading to economic slowdown, lost jobs and continuing trouble for other nations in the region, particularly Japan, which has a big investment in Hong Kong and other Southeast Asian real estate.

And Hong Kong is one of the more stable denizens of a region where the once grand gown of the Asian Miracle is weekly growing more frayed and tattered. From Seoul to Bangkok, economies that earlier made annual double-digit growth look easy are now strangling on a lethal brew of skyrocketing interest rates, current-account deficits, shrinking budgets and rapid flight of the foreign loans and capital that in many countries underwrote the miracle. "Right now my feeling is one of despair," says a Jakarta stockbroker who has watched the Indonesian stock market drop 33% since July. (It was down 5.8% just last week.) "Looks like it's going to get worse and worse before there's any chance of its getting any better."

How could things go so wrong so fast? One reason is that Asia's "tiger" economies had a virtually unlimited credit line from the world's bankers. The easy money combined with easy virtue in places like Indonesia, where an authoritarian government and crony capitalism led to corruption, poor corporate management and gross overspending on grandiose public projects. The foreign capital borrowed to build many of those projects has become much more expensive to pay back because of devaluations. In fact, much of the debt will have to be restructured.

In Thailand the government has negotiated a $17.2 billion International Monetary Fund bailout that will force it to raise taxes, cut its budget and rein in the worst abuses in its out-of-control financial system. The IMF has also stepped in with new loans for the Philippines, and has begun putting together what could be a $15 billion rescue package for Indonesia.

Meanwhile, economists are slashing their projections for the region. The Goldman Sachs investment firm predicts Malaysia's growth in 1998 will slow to 4%. Investment giant Morgan Stanley foresees that growth in the beleaguered Thai economy, which from 1993 to '96 averaged 8.2% annually, will shrink 1.5% next year.

The crisis has been made worse by the flailing, amateurish response of some of the affected leaders. As Malaysia's currency, the ringgit, and its stock market plummeted, mercurial Prime Minister Mahathir Mohamad implied that international financier George Soros and his ilk were responsible. He then trotted out a familiar, repellent accusation, blaming Jewish speculators who he contended were out to squash the economy of a Muslim country. His proposals to restrict currency trading and otherwise punish foreign investors quickly scared away new investment and called into question the future of what has been one of the world's great economic success stories.

In Thailand the crisis put an end to what an analyst calls "golf-course capitalism" and raised the specter of domestic unrest. With credit growth far exceeding the growth rate of the economy, Thais had been investing in increasingly risky assets, dozens of golf courses among them. "Capital will be more productively used," says David Roche, president of Independent Strategy in London. "The people are the same."

Not quite. Tens of thousands of Thais who until very recently enjoyed a middle-class life have been abruptly thrown into unemployment and poverty. Countless industrial firms, restaurants and other businesses have collapsed. There is no longer a wait to tee off. With 58 banks and finance companies at risk of bankruptcy, some managers are being forced to give up their Mercedes-Benz and drive taxis instead.

Last week Piti Sukakul, managing director of the President Tour Co., was found dead in a hotel room with a bullet wound in his head, an apparent suicide. In spite of the cheap baht, the overbuilt Thai tourism industry has been devastated. "How do we cope?" asked Khunying Chanut Piyaoui, chairman of the Dusit Thani hotel group, speaking of both the hotel business and the overall economy. "It is so unprecedented, so unexpected. Nobody believed it would be so bad, so nobody has any plan or is prepared to deal with it."

Thais are turning their bewilderment into anger. Two weeks ago, at the urging of Finance Minister Thanong Bidaya and the IMF, Prime Minister Chavalit Yongchaiyudh's Cabinet passed a tax on oil of 1 baht per liter. The levy caused such an outcry that Chavalit rescinded it three days later, whereupon Thanong resigned. On Friday the political turmoil deepened. Chavalit shuffled his Cabinet and named banker Kosit Panpiemras as the new Finance Minister. He also set the stage for an early election by pledging that Parliament next month would debate laws facilitating the provisions in a newly adopted constitution that would allow a general election to be held as early as December.

One reason that Southeast Asia's descent into economic turmoil came as such a shock is that, on paper at least, most countries appeared to be in supremely good health, even as their currencies came under attack and their stock markets began to teeter. In Indonesia wages were rising, inflation was low, exports were projected to rise 14% this year, and until very recently analysts stuck to their forecasts of 8% economic growth for a second consecutive year. "There were no obvious warning signals of the kind of catastrophe that was about to hit Indonesia--at least [none] that we were watching," says Dennis de Tray, of the World Bank office in Jakarta.

That's because too many deals were being cut under the table, and countries such as Thailand and Indonesia don't have regulatory agencies capable of swatting the bad actors. "The most important factor is that the financial statements of big companies that have borrowed money offshore are not true," says economist Kwik Kian Gie. "There are many Indonesian companies that are bandits, that have deliberately created financial statements that make things appear much better than the reality." Now the banks have cut off the credit. "Nobody--no Indonesian, no foreigner--wants to bring dollars into Indonesia," says De Tray. "What does that mean? It means they think it's going to get worse."

Hong Kong's new parent country, China, has so far been spared the brunt of the Asian downturn. But last week's stock-market crash made clear that as Hong Kong goes, so goes China's capitalist revolution. Some of the hardest-hit stocks early in the week were the "red chips"--though they recovered most of their losses on Friday.

The question now is whether Hong Kong, the last holdout against devaluation, can stand its ground. Hong Kong chief executive C.H. Tung said his government would do everything in its power, including spending down some of its reserves, to guard the exchange rate. To discourage borrowing by speculators, the Hong Kong Monetary Authority drained liquidity from the economy, which drove overnight bank interest rates as high as 300% last week. The banks then raised the prime rate from 8.75% to 9.5%.

The strategy could backfire. In an economy like Hong Kong's, an increase in the interest rates will hurt the all important property owners, whose companies dominate the stock market and owe billions to the banks. It raises the fear that, as in Japan, real estate deflation could undermine the whole fragile structure. If that happened, the tremors that shook the world's financial markets last week would seem as placid as a sail on a junk in Hong Kong harbor.

Barring another, more serious meltdown, analysts consider it unlikely that the tumult in Asia will trigger a major market correction in the U.S. But that doesn't mean it won't have a lasting impact. David Hale of Zurich Kemper Investments predicts a surge of up to 25% in Asian imports made cheap by devaluation and a contraction in U.S. exports of as much as 15%. The result could be that the U.S. trade deficit, now $191 billion, would balloon to as much $300 billion next year and fan a protectionist outcry.

The message is that interdependence between the U.S. and Asia is real and growing. Boeing projects that it will sell a third of its aircraft there over the next 20 years. Increasingly, when Asia sneezes, as it did last week in Hong Kong, America will catch cold.

--Reported by Robert Horn/Bangkok, Rahul Jacob/Hong Kong, David Liebhold/Jakarta and Adam Zagorin/Washington, with other bureaus

With reporting by ROBERT HORN/BANGKOK, RAHUL JACOB/HONG KONG, DAVID LIEBHOLD/JAKARTA AND ADAM ZAGORIN/WASHINGTON, WITH OTHER BUREAUS