Asiaweek October 23, 1998

IT WAS NOT THE SORT OF THING investors allergic to official meddling cheer about: the government's planned takeover of several banks in a major industrial economy. But on Oct. 12, global markets applauded Tokyo's approval of a long-overdue rescue package worth $500 billion for financial institutions crumbling under tens of trillions of yen in bad loans. Under the scheme, if a bank's capital falls below 8% of its risk assets, the recommended minimum for institutions doing business abroad, the state would either lend money to it, buy its shares - or nationalize it.

In Hong Kong, meanwhile, the government is smiling broadly as the Hang Seng stock index rose above 9,000 last week. That's up about 13% since authorities bought up its component shares in a bid to foil speculators. In early August, hedge funds had sold index-linked futures contracts while attacking the Hong Kong dollar in a bid to force interest rates up. That would have depressed the stock market, leaving the speculators with fat profits from selling the Hang Seng before it fell. But Financial Secretary Donald Tsang Yam-kuen had seen that double play before in October 1997. Instead of jacking up lending rates, Tsang used the reserves both to buy off hedge funds dumping Hong Kong dollars and to purchase Hang Seng stocks, lifting the index.

With mounting losses in currency and futures markets, the attackers eventually took flight. There has been no major assault on the Hong Kong dollar since, and interest rates have receded. Now that the Hang Seng has recovered, the government stands to make hundreds of millions of dollars on its stock portfolio. "We have been shown as the icon of free trade, and that icon has been smudged," Tsang says of the speculative attack. "We had to remove that smudge." Will the government intervene again? "We have no intention - as long as there is no double play," the secretary told Asiaweek.

Daim Zainuddin, Malaysia's economic czar, also has some heavy-handed moves to explain: Kuala Lumpur's currency restrictions which shield its ringgit from attack as it tries to reflate the economy. "They have enabled us to concentrate on the domestic recovery," Daim said in written replies to questions. "Interest rates have come down and liquidity levels have been enhanced." The government has also undertaken billion-dollar rescues of banks and well-connected groups like Renong.

On Oct. 14 the Keidanren, Japan's main business federation, declared: "We in Japan strongly support the currency-control measures adopted by the Malaysian government" as necessary to stabilize the economy. Of such endorsements from abroad Daim said: "There has been an encouraging opinion among international economists who see that some controls are needed by developing countries, given the turmoil we all face."

As the Asian Crisis bites deeper, capitalism in the region is struggling to reconcile its free-market aspirations with the reality of increasing and indispensable state intervention. From bank rescues and market forays to currency curbs and social safety nets, official involvement in economic activity is reaching levels not seen for at least a decade. The dichotomy has marked recent meetings, from the World Bank-International Monetary Fund sessions in Washington to the ASEAN economic ministers discussions in Manila and the World Economic Forum East Asia summit, which convened leading figures in business, government and academe in Singapore. Asked about Malaysia's currency controls, Philippine President Joseph Estrada told the Singapore meeting: "Each ASEAN member has to cope with its own circumstances. But our long experience of controls only led to corruption and the black market. We won't have them."

Meanwhile, Asia's openness to global money flows, which is in fact just several years old for most of the region's economies, is increasingly under question. What Asia does to cope with the giant waves of world capital, from currency controls to curbs on hedge funds, could influence the rest of the capitalist world. Noting the challenge posed by global financial turmoil to the free-market paradigm Tsang says: "We are in a very crucial juncture in economic evolution of modern history."

INTERESTINGLY, MUCH OF ASIA'S drift to greater state intervention is happening with the assent, if not applause, of the markets and that guardian of globalized finance, the IMF. Take Indonesia. Back in 1988, wholesale liberalization in banking spawned dozens of private institutions, which dramatically eroded the state's share of the industry. But this year, Jakarta has had to take over nearly all private lenders, including the largestof them, Bank Central Asia.

Moves to scuttle the state food monopoly Bulog have been shelved to ensure that subsidized rice gets to the poor. Jakarta now plans to restructure it into a non-commercial entity by year's end. And there is recurring talk of monitoring of capital flows, which has helped strengthen the rupiah below 10,000 to the dollar.

Bank restructuring in Japan, South Korea and Malaysia is also expanding government control of the financial sector, which in turn provides tremendous leverage to influence the rest of the economy. State-guaranteed bonds are to raise nearly four-fifths of the $46 billion needed for Korean reform. Korea Asset Management Corp. will then buy dud loans, like its counterparts in Malaysia and Thailand.

In addition, $11.5 billion is to be injected into capital-short institutions - nearly as much as the combined 1997 equity of all 28 Korean lenders in The Asiaweek Financial 500 ranking of the region's largest banks. With that kind of money, Seoul can take over virtually every lending institution in the country (and may just do that for most, given looming write-offs estimated at $72 billion).

Hong Kong has long prided itself as the freest economy on earth, but it too is grappling with Asian capitalism's paradigm shift. As recession threatened in June, the administration of Chief Executive Tung Chee-hwa retreated from its hands-off policy and announced a $5.7-billion stimulus package, including steps to shore up property. Recently, with real estate still sliding, Tung downplayed plans to build more subsidized housing. Such tinkering with the biggest sector of the economy and the stock market seemed to have the desired effect. A surge in apartment sales apparently triggered by Tung's measures fueled the Hang Seng's recent rally.

The Hong Kong government's market foray in August did worry investors fearful of losing out in a contest with the authorities. Recently, Financial Secretary Tsang toured European and U.S. financial centers to explain matters. "There was a total disruption of our market," he argues, referring to the speculative double play. "We needed to remove it to preserve the free market." He stressed that Hong Kong remains a free port and an open economy. But Tsang also sought to enlist his fellow money mandarins in his battle against hedge funds like those of billionaire investor George Soros. He wanted central banks in world financial centers to adopt measures to monitor "rogue" speculators and curb their access to credit.

If Tsang succeeds - a gigantic if, given the clout of billion-dollar speculators and the West's devotion to unbridled trading - central banks would be seeking control over a global market far larger than even the worldwide commerce in merchandise goods. The global turnover in yen trading alone amounts to $1 trillion a day, and the resources of just one large hedge fund can reach tens of billions of dollars. The hot-money flow, says Tsang, "has grown exceedingly large, much larger than the sovereign reserves of a medium-sized country." Accelerated by advanced communications and electronic funds transfer, the speculative capital can destroy many a currency even if its country's economic fundamentals are sound.

Further buttressing the case for keeping tabs on hot money is the debacle at Connecticut-based Long-Term Credit Management, once the most highly touted hedge fund, with two Nobel laureate economists and a former Federal Reserve vice chairman among its top people. Unregulated like other such ventures, LTCM reportedly piled up an estimated exposure of some $100 billion. Major global institutions and even Italy's central bank had investments in the fund, loans to it or derivatives contracts with it. Hence, the Fed had to orchestrate a $3.5-billion bailout of LTCM amid fears that its collapse would destabilize the world financial system.

A year ago, at the World Bank-IMF meetings in Hong Kong, Malaysian Prime Minister Mahathir Mohamad broadcast warnings about hot money. What was dismissed then as an embattled leader's attempt to blame speculators for his country's economic woes is now being taken up as a crusade against destructive capital flows. The Fund's Interim Committee, for one, says "greater transparency is needed on the part of financial-market participants and may require additional regulatory and disclosure measures."

The latest to take up the call is the East Asia meeting of the World Economic Forum. Its Action Plan for Global Growth and Reform of the World Financial System said: "G-7 economies should establish a new regime for the monitoring, disclosure and regulation of highly leveraged short-term financial flows." That's pretty much what Mahathir and Tsang have argued for.

THERE ARE SIGNS THAT the West may take up the call for controls on hot money. But even if the campaign does not prosper anytime soon, Asia is already adopting more and more measures utilizing state power to revive the economy, if not to tame the markets. And it is results rather than free-market principles that would determine whether such moves gain kudos or condemnation. Virabongsa Ramangkura, who coordinated Thailand's IMF program in the previous administration, believes his country should consider capital controls. "It depends on the situation," he told Asiaweek, adding that with regional and global instability, they could last five to 10 years. Also mulling intervention in the currency markets, Bank of Thailand Governor Chatumongkol Sonakul said it may try to slow the baht's recent rise to help exporters.

The IMF too is having to bend with realities. Its Interim Committee has conceded that "temporary impediments to capital movements have been utilized," and has ordered a study of "circumstances under which such measures may be appropriate." Mukul Asher, an economics professor at the National University of Singapore, lauds the Fund for allowing budget deficits in Crisis-hit countries after its initial demand for surpluses proved quixotic. Bangkok was permitted a shortfall equivalent to 3.5% of GDP - previously 1% - while the latest deal with Jakarta in June stipulates an 8.5% deficit. "That's unheard of, but the IMF has done it," says Asher.

Needless to say, all that budgetary largess will boost the public sector's share of economic output. In Malaysia, it has risen eight percentage points to 40% over the past year. In harder-hit Thailand and Indonesia, social-welfare spending, including subsidies for essential goods, will have to expand substantially. Even in relatively affluent Hong Kong, the public is clamoring for more government action to alleviate the recession. Chief Executive Tung's Oct. 7 policy speech drew much criticism for failing to put forward concrete measures and programs.

The wholesale takeover of banks and finance companies is probably the biggest boost to the state's power over the economy, giving it the potential to influence the amount, direction and terms of loans. The Thai government now runs six of the country's 15 banks and nearly all of its 60-odd finance companies. In Malaysia, the state has pumped funds into Sime Bank and 10 other institutions, and authorities plan to merge lenders and bring in new managers. Meanwhile, government-run trusts have been buying stocks heavily, over $1 billion worth, by one estimate. And more bailouts of major companies are expected, with the Renong Group restructuring providing a standard to follow.

Japan's bank reform package due to take effect Oct. 23 is probably the most draconian of all. The Financial Supervisory Agency will appoint new management for institutions in which the government buys shares. First to fall under state control is the long-suffering Long-Term Credit Bank. Soros worries that few other shaky institutions would follow LTCB. "Before you get public money, they chop off your head, if you're the manager," he says. "So everybody at the banks will try to stay alive by calling in the good loans and preventing the bad loans from being recognized." Now, authorities are thinking of forcing banks to get state help. "In some cases, funds may be forcibly injected," says Saiki Akitaka, deputy press secretary to the premier. Tokyo newspapers believe compulsory infusions are planned for most of the country's 18 major banks as early as mid-November.

As with currency controls and market intervention, free-marketeers hope that government takeovers of banks and conglomerates would be temporary. But reverting them to private control will have to wait until there is enough money in private hands to buy off the enterprises. That is not a likely prospect for at least a couple of years, unless governments are willing to take massive losses on the rescue funds. Foreign investors can also be tapped, but it would probably be politically difficult to sell more than 40% of the banking system to overseas interests. And officials may yet get comfortable with the easy access to funds that owning banks affords.

There may arise pressure from the markets and the IMF for governments to divest their business holdings or at least to manage them at arm's length. Both also want changes in the way companies in Crisis countries operate. In his speeches at the Bank-Fund meetings, IMF managing director Michel Camdessus repeatedly stressed the need for better governance and transparency in the private sector. And whose job will it be to enforce these higher standards of corporate behavior? The government's, at least initially.

Camdessus also reiterated the IMF's view that Asia's ills stemmed from rapid financial liberalization without adequate regulation. For countries like China and India which have yet to fully join capitalist Asia, the Crisis can only give pause. "Market reforms must pay attention to pace and sequencing," says Chinese Finance Minister Xiang Huaicheng. Wherever Asian capitalism may go, it will proceed slowly - with the state keeping watch.

- With reporting by Sam Gilston/Washington, Julian Gearing/Bangkok, Arjuna Ranawana/Kuala Lumpur, Murakami Mutsuko/Tokyo, Andrea Hamilton and Alejandro Reyes/Singapore

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