Newsweek, October 12, 1998

Asia's Economy

STARTING OVER: The crisis nations no longer fight the IMF--and are beginning to dismantle the old system of crony capitalism.

By Tony Emerson

The lineup outside the office of Glenn Yusuf, chairman of the Indonesian Bank Restructuring Agency, reads like a Who Was Who of Indonesian business. Each day the defeated tycoons arrive, handing over deeds to office blocks, factories, cruise ships, even shrimp farms, to settle subsidized loans to their failing banks. Fighting to stay afloat, the tycoons say they've handed over $20 billion worth of collateral (though Yusuf says it's more like $9 billion). Yet 40 banks have been closed or seized by the IBRA so far, and the agency has just begun its work--under orders of the International Monetary Fund--to clean up a fly-by-night banking system at the heart of Asia's financial crisis. Five months after the fall of President Suharto, his children are being pursued by the IBRA as deadbeats--and face jail if they don't comply. "We wasted a lot of time," says Yusuf. If Indonesia had begun the bank cleanup a year ago, at the onset of the Asian financial crisis, it "would be on the road to recovery."

Mark those words. They reflect a dramatic turnaround for the IMF in Asia. On the eve of the IMF summit this week in Washington, criticism is mounting in the West that its belt-tightening reforms not only failed to prevent recession in Asia, but made it worse. Yet in Asia, new leaders in the countries under IMF care--Indonesia, Thailand and South Korea--have come to accept the basic IMF diagnosis of the Asian contagion. The "denial syndrome" is fading, and with it official resistance to IMF criticism of crony capitalism, which blames Asia's crippling debt on a kind of unholy trinity of backward banks, mismanaged corporations and meddling politicians. And as the IMF has eased its demands for austerity, the cries of IMF imperialism have faded in Asia. True, both Thailand and Indonesia have closely watched Malaysia's anti-free-market rebellion against the fund, and may still follow. But for now, the ideological divide between the fund and its patients appears to have narrowed.

Much depends on the prospects for the Asian economy, which remain dismal. In its "World Economic Outlook" released last week, the IMF reported that the downturn has accelerated far faster than expected, with many of the regional economies in "deep recession." As confidence evaporates, mechanisms that would normally work automatically to foster recovery appear to be malfunctioning in Asia. The fall in currencies has failed to spark a boom in export revenues, since almost no one in Asia is buying and prices are falling. Falling interest rates have failed to ease the regionwide credit crunch, in part because banks are busy disposing of bad loans, and wary of new commitments. Indeed, the downward spiral may indicate that the Asian economies are even more severely flawed than previously thought, says the "Outlook" report. And progress toward reform, it warns, will determine whether Asia rebounds strongly or faces a "protracted period of slow growth," like Japan of the 1990s.

Perhaps the most optimistic view of the deepening Asian recession is that, outside Japan, at least the old pillars of crony capitalism are collapsing in the former tiger economies. Many of the Asian countries followed the industrial model of Japan, where the same politicians, banks and corporations are still in command eight years after the collapse of its real-estate bubble. In contrast, all the IMF countries have tossed out their old leaders since December. If there is one theme that unites B. J. Habibie of Indonesia, Chuan Leekpai of Thailand and Kim Dae Jung of South Korea, it is a basic recognition of the need for what Kim has called "bone crunching" reform. "The situation could not be more different from Japan, where the average citizen is underemployed but not unhappy," says Nicholas Bratt, a managing director at Scudder Kemper Investments in New York. "In the IMF countries, the depth of the catastrophe, skyrocketing unemployment, bankruptcies and suicides, makes reform a matter of survival, and creates a popular mandate to bring about change."

This unfocused desire for change has been translated by governments into a campaign of action against the banks and corporations. Even as bad debts continue to mount, the IMF last week reported "significant progress" on bank reform, particularly in Thailand and Korea. Five of 26 Korean commercial banks and eight of 15 Thai commercial banks have been stabilized with foreign capital, closed or merged with healthier banks. Under Suharto, reforms promised to the IMF had a way of stalling and vanishing, but Yusuf vows that by the end of next year, the 200 banks will be streamlined to just 20. Contrast that pace of reform with Japan's, where politicians have yet to close one major bank. "It is worth noting that our programs in Asia--in Indonesia, Korea and Thailand--only took hold after there was a change of government," IMF deputy managing director Stanley Fischer said last week.

The fund envisions that recovery will begin as reforms take hold, but it will take more than destruction of the old system to restore confidence. New institutions need to be built, and that takes time. All the IMF countries are struggling to bring antiquated banking systems into the 1990s, creating new supervisory agencies to encourage responsible lending and protect depositors, but so far with mixed results. A year after the collapse of Thailand's economy, the real-estate market is dormant. No one is letting go of property, in hopes that prices will recover. When a group of lenders recently attempted to seize Bangkok's Hotel Nikko Mahanakorn under a new Bankruptcy Act, they found that the law allowed debtors to dodge foreclosure. The IMF is now waiting for Parliament to patch the loopholes. "You have to realize the political constraints," says Reza Moghadam, head of the IMF team in Thailand. "We have to go through the proper channels."

This is a critical obstacle to recovery: the natural tendency of threatened businessmen to play turtle in a storm. Even a popular new president like Kim, long an anti-establishment figure, faces continuing resistance from corporate chieftains. IMF reforms that would open Korea's family-business empires to foreign ownership have prompted ferocious attacks on the fund's "colonial" designs. A recent report from a research arm of Samsung, Korea's second largest conglomerate, describes the IMF as a tool of American free-market ideology and U.S. ambition to secure economic "superiority" in the post-cold-war era. It argues that of 89 nations under IMF care between 1965 and 1995, 16 stagnated and 32 became poorer. Even if a doctor applies his medicine perfectly, the Samsung report acidly concludes, "he should be liable if the patient got sicker or died."

Corporate resistance has slowed a wave of takeovers that the IMF had counted on to bring new capital and new management into Asia. Overall, the number of mergers and acquisitions in Asia is falling, and a few prominent bottom-fishing deals are the exception to the rule. GE Capital has spent $500 million buying Thai loan assets with a face value of $1 billion, and one of Indonesia's top conglomerates, Astra International, recently sold an electronics factory to American investors for $90 million. But strong company opposition has forced Habibie to back away from privatizing state-owned industries. "We should hold on to these companies until the economy recovers and then privatize them, not just give them away to foreigners," says a director of a large state industry.

More often than not, the IMF and Asian governments are now fighting these battles on the same side. Western critics like economist Martin Feldstein take the IMF to task for exceeding its mandate and trying to micromanage Asian recovery. Yet in Indonesia, Habibie is now presiding over a campaign to dismantle the Suharto business empire company by company, as the IMF applauds. Jakarta authorities have canceled Suharto claims to revenue from the national airline, Garuda, the national oil company, Pertamina, and industries ranging from hotels on Bali to ports, power plants and TV stations. Most dramatically, Jakarta authorities have appealed for foreign governments to help recover billions Suharto is suspected of secreting abroad, prompting public denials from the former president and his eldest son, Bambang, that such riches even exist.

In South Korea, Kim has launched a similar IMF-blessed offensive to press the nation's enormous business conglomerates, or chaebol, to cut "big deal" reforms. The idea is to reduce corporate debt and overcapacity by getting the five largest chaebol, led by Hyundai and Samsung, to combine redundant factories in slack industries like steel, autos and petrochemicals. So far, however, the few "big deals" have let conglomerates swap or combine factories without cutting capacity. That reflects the difficulty of persuading chaebol--long nurtured with cheap government loans--to rein in their ambitions now. "Kim can't just order them to sell," says Bratt. "What I believe we'll see over time is increasing steps by the government to starve the chaebol of funds."

Ironically, public pressure once ran strongly against the IMF, but now pushes change--which often means implicit support for IMF reforms. Average Indonesians may not follow IMF-speak, as in "subsidies and monopolies that encourage rent-seeking should be removed," but they are glad it means ending the special privileges of Suharto and his cronies. No doubt, the fund also helped its cause by toning down its demands. In response to signs of social unrest, the fund began to loosen its austerity programs as early as February, allowing lower interest rates, tax cuts and deficit spending to put people to work, send kids to school and feed the hungry. When food riots broke out in Indonesia, the government persuaded the IMF to allow the continuation of food subsidies. Soon, however, the government found that the subsidies were encouraging middlemen to hoard rice and sell it abroad, so the subsidies were lifted anyway. "Ending corruption is the key to Indonesia's recovery," says Dennis de Tray, Jakarta director of the IMF's sister institution, the World Bank. "Everyone--the government, the foreign-aid donors and the public--agrees on that now."

Nonetheless, the threat of renewed social unrest remains very real. The IMF itself warns of increases in poverty and unemployment in coming months, and predicts that economic growth will "bottom out in early 1999." Among the IMF countries only Thailand remains quiet. Brush-fire student protests continue to erupt across Indonesia, and Korean workers have been emboldened by a successful summer strike that blocked threatened layoffs at the Hyundai shipyards in Ulsan. Douglas Paal, president of the Asia Pacific Policy Center in Washington, predicts a fall of strikes, protests and general unrest throughout the region. "It's going to get messy," he says.

And then what? The fund's "Outlook" bows to the emerging consensus among economists that when economies recover, the "Asian miracle" era of near-double-digit growth is probably over for good. The reason: even before the crisis, there were signs of declining competitiveness in Asian economies, and those inefficiencies were only compounded by the flood of foreign money in the 1990s. The inflow of more than $100 billion between 1992 and 1996 went in large part to build real-estate bubbles and redundant factories--not into technology or skills that would actually raise productivity. Now it's highly unlikely that foreign investors burned by the Asian crisis will return with their prior enthusiasm. "They'll be selective next time," says Bratt, who is helping to manage a new $1.3 billion equity fund for small and medium-size Korean companies.

The likely long-term scenario is for a return to modest growth. The IMF predicts 5 percent growth between 2000 and 2003, and others believe 3 to 4 percent is a better bet. Whatever the figure, Western thinkers are only beginning to grapple with the implications of a premature end to the "Pacific Century." Already economists including David Hale of the Zurich Group are raising the questions. Will China fade as a potential economic and military rival of the West? Will Indonesia shrink from its position as de facto leader of Southeast Asia? Can a faltering South Korea afford its ambition of peaceful reunification with North Korea? Has the Asian model been discredited as a guide for other regions? For Asians and their newfound allies at the IMF, it is not yet time to confront the future. They're too busy just trying to survive the next few months.

With Paul Handley in Bangkok, Maggie Ford in Jakarta and B. J. Lee in Seoul.