The Rescued to the Rescue

DAVID ROCHEA journey through Asia these days can be deceptive. On the surface, there is still a pervasive gloom. Building cranes are idle, shops empty, offices boarded up. But a few specks of light are breaking through the darkness, some of them coming from outside the region. The U.S. Federal Reserve has cut interest rates--twice--and dollars are being pumped into the world economy to save the global financial system. The dollar's weakness against the yen, meanwhile, is a gift to the rest of Asia, where most currencies are still measured against the greenback. Central banks can now reliquefy their economies by cutting interest rates--without rubbishing their currencies.Asia's crisis, in short, has almost surely bottomed out. Cliff-like falls in GDP and industrial production have stopped. Bare-minimum production, at least, is stabilizing because people have to eat, even in collapsed economies. Things are looking up for the IMF-3, the trio of countries--South Korea, Thailand and Indonesia--that agreed to follow the International Monetary Fund's prescriptions in return for its bailout cash. Each is running a current-account surplus of more than 10% of GDP, achieved as foreign debt repayments lag, tourism picks up and imports (along with living standards) drop. Although disbursements from the IMF and other multilateral agencies are set to drop next year, the flight of private capital is leveling off. Expect net inflows to rise, which will help stabilize the region's currencies further.Thailand and South Korea, in particular, are the countries to watch. If they can take advantage of what has suddenly become a favorable external environment, they may not only spur recovery at home but also help lead the rest of the region out of its slump. It won't be easy. Both Thailand and Korea have reached a state of stable disequilibrium: they are liquid, but also insolvent.PAGE 1|In Thailand, massive debts still prevent local banks from becoming viable. But there are signs of hope. Interest income is rising as deposit rates drop faster than lending rates. Bangkok has closed nearly all of its bust financial companies and nationalized seven bankrupt banks. Foreign financial firms, meanwhile, have purchased two other banks. The remaining institutions have been asked to identify bad assets and transfer them to an asset-management company. A new law will force banks to put delinquent debtors out of business. That will hit balance sheets, but the government will provide recapitalization funds so that banks will be able to lower lending rates. That could lay the basis for investment in export production--and domestic recovery.South Korea faces the most exciting challenge. It has one of the smartest, best-educated workforces in Asia. Its products are now supercompetitive, with unit-labor costs down 45% in dollar terms from a year ago. Made in spanking new factories, Korean products are sufficiently good and well-branded to capture worldwide market share. To investors, that represents a lot of plus-points. The problem is how to unlock this value. To do so will require changing not just the country's economic model but its cultural setup as well. That may prove to be a drawn-out struggle, as efforts to reform the political and economic system clash with the statist Korea Inc. mindset.Seoul can choose between remaining an economic dinosaur or becoming the dominant force for change in Asia. But it needs to act quickly. A strong yen and weaker dollar create a more competitive won that won't last. The critical test will come when one of the country's top five conglomerates, or chaebol, inevitably goes bust. The scenario is easy to imagine. The troubled chaebol chairman will go to Korea's President and ask the government to print money to cover the group's debts. Otherwise, he'll warn, the chaebol will go bankrupt, the masses will be out of work and the President could find his own job in peril. And that's when the government needs to be tough, to break up the chaebol's economic dominance once and for all. Here's how: the President could agree to bail out the group, but insist on starting with its bank debt, converting it to equity. Since the banks are already nationalized, that means the government would effectively own the chaebol. Existing shareholders would be wiped out, allowing the government to make whatever changes it wants: replacing managers, breaking up the group and selling off pieces to both foreign and local investors.Were such a scenario to transpire, Korea's turnaround would truly begin. New, leaner, export-driven companies would be world-beaters. And even without factoring in the increased productivity that would result from breaking up Korea's chaebol, just converting debt to equity would jump-start the return on equity from, say, minus 5% to plus 10%. The whole equity market would soar. Korea would become a blue-sky investment for years! The time to act is now. Before you know it, the yen will slip back to where it came from. Thailand needs to use this breathing space to sort out its financial system, and Korea has to tackle its chaebol. Only then can Asia truly start to put the financial crisis behind it.David Roche heads Independent Strategy, a London investment firm|2