Lock And Load: Gambling With Asia’s Tigers

Author: Eric Uhlfelder

29 October 1997, Mutual Funds Magazine

In a September issue of Smith Barney’s Portfolio Strategist, one seasoned analyst sees a “rare buying opportunity” in the wake of Southeast Asia’s currency and equity collapse. The very next opinion warns investors that moving back into these volatile markets is very risky business. Venture uptown to PaineWebber’s offices and you’ll find a closed-end country fund specialist telling folks to forget Southeast Asia; Latin America is where the true bargains are.

Talk with currency traders and they’ll tell you that more often than not you can’t rely on the key economic indicators that Southeast Asian countries are releasing because they are self-serving, the press isn’t free enough to contradict, and institutional players that know better are compromised from opening their mouths by the threat of being blackballed by local governments.

Ask Fidelity for some guidance and the world’s biggest mutual fund company has nothing to say. Add to all this the nonstop reporting on the region, and an investor is left feeling pretty uncertain if he’ll ever really know enough to make an intelligent decision about investing in the core of the Pacific Rim–Thailand, Singapore, Malaysia, Indonesia, and the Philippines–which imploded this past summer.

We’ll make this easy for those who aren’t the speculative types: Stay away. There are too many good opportunities here on our shores to justify the risks–at least at this time–of investing in these five Asian tigers.

While no doubt there are bargains in the battered Thai, Malaysian, Indonesian and Philippine markets [which have lost half their value through the first three-quarters of the year], it’s extraordinarily difficult to know which companies are going to roar back and which will go under. Fidelity’s Emerging Markets Fund manager, Richard Hazelwood, recently lost his job betting on the region’s quick rebound.

Make no mistake: there’s going to be a lot of debris, especially in the finance and real estate sectors, before local economies revive. And mutual funds aren’t going to provide much certainty. Indeed, can you really trust the same fund managers who were singing the region’s praises just months ago to figure out which companies are going to end right side up after the blood letting?

And stock picking is just half the battle. There is just as much doubt surrounding the stability of the local currencies. More than half the loses American investors have suffered this year in Thailand, Indonesia, Malaysia and the Philippines were the result of devaluing currencies.


For years, the five tiger currencies were pegged to the dollar. This meant that whatever happened to the dollar, happened to the Thai baht, the Indonesian rupiah, the Singapore dollar, the Malaysian ringgit, and the Philippine peso. This was good news during the decade-long rise of the Japanese yen, starting in the mid-1980s, which made Asian tiger products more competitively priced. But since 1995 when the dollar began to soar, this currency connection jack-knifed into the local economies, revealing some frightening fundamental problems in the way these countries have been run. Making matters worse, China, striving for an export-trading edge over her regional neighbors, had devalued the yuan by 35 percent around the same time the dollar began to rise.

The result: A major currency crisis swept through the region this past summer, ravaging equity and bond markets.

What has this meant to the American investor? In Thailand, where all the fun began, every dollar invested this spring bought about 25-baht’s worth of stock. By October, that dollar of stock was now worth less than $0.70–due to currency depreciation alone. Thai shares, which have already been taking a beating for several years, tanked an additional 25 percent, leaving dollar-based investors for 1997 roughly 80 percent worse off than if they had gone into an S&P 500 index fund.


It’s possible that widespread fears and xenophobic rhetoric have caused Southeast Asian markets to overreact, driving down currencies and equities well below their real worth. This is what the contrarian investor is betting on. Templeton’s renowned emerging market fund specialist Mark Mobius gambits that “when everyone is negative and running away from Thailand, that’s the time to buy.” He may be right. But whether he’ll be buying expensive and caught sitting with dead money for a while, we won’t have a clue before this spring when government policy and the markets finally begin to settle down.

The argument for getting back into the Pacific Rim is simple: the strong economies that boiled over into the recent crisis have a lot of growth left in them. Currency devaluation and the equity collapse are normal corrections that demonstrate the markets are indeed still working, cutting away a lot of fat, realigning corporate valuations, prepping the way for the next great leap forward. Just as important, the crisis is finally empowering regulators to clean up the troubled banking sector and to take aim at corrupt government spending. Case in point: Thailand’s adoption of a new draft constitution.

Implications: Too early to tell.

Investors betting on a potent turnaround say just look at Mexico and her neighbors. The regional Tequilla effect [triggered by the collapse of the Mexican peso] was around long before anyone heard of the Asian flu. Now Latin and South America are two of the world’s hottest regions, led by the Mexican and Brazilian bourses, both up more than 50 percent in dollar terms so far this year. The currency crises have been tempered, inflation, trade deficits and foreign debt have been reeled in, and real growth has returned. “Fundamentals in the region,” according to PaineWebber’s country fund analyst Celso W. Sanchez, “are by far the best they’ve been in years, inspiring confidence among international investors.” And so it will be in Southeast Asia–as the argument goes.

Well, maybe. Dereck Hargreaves, emerging market specialist at J.P. Morgan, thinks the region’s problems are “more correctable [than Mexico’s] without a horrible recession.” And Smith Barney’s country fund specialist Michael Porter expects “the strong economic fundamentals of Asian economies will reassert themselves.” But listen to Morgan Stanley’s global specialist, Barton M. Biggs, and his ground-zero reconnaissance reveals that local “governments are not doing the tough things they have to do to clear the markets.”

Clearly, investors need to do more than abstract lessons from one experience before moving back into Southeast Asia; understanding the basic problems is essential to decipher if subsequent public and private sector actions will be adequate to promote economic renewal and make investments profitable. Keep in mind that unlike Mexico 94/95, American interests aren’t parked on the borders of these nations to ensure swift recovery.

Underlying Problems

Emerging market currency crises share remarkable similarities. In a nutshell they involve countries caught spending too much and producing too little. Imports in Thailand, Malaysia, and the Philippines have been 40 percent of their GDPs, twice the average for developing nations. With more money chasing imports than foreigners spend on locally-produced exports, demand for the local currency diminishes and pressure to devalue is exerted. As the former Thai Finance Minister Thanong Bidaya put it, “we became too rich too quickly.”

This is not necessarily troublesome if government policy doesn’t link its currency to another. In fact, currency weakness cheapens the cost of exports and can boost growth. But if a currency is pegged against the US dollar in order to provide foreign investors confidence in investing in local projects [which the five Asian tiger currencies were], then an expanding current account deficit can cause serious problems.

In response, central banks can step in and increase demand for their local currencies by raising interest rates and by using foreign reserves to buy their own currencies. But when money traders sense a currency is overvalued, no policy can stem the tide. This happened in Mexico in late 1994. The Czech Republic is still struggling through a devaluation that cut the value of the koruna by 25 percent this past spring. Several months later, the currency flu struck Thailand and her neighbors.


The collapse of the Thai baht was the culmination of a series of financial troubles that were hidden behind the country’s 8-plus percent perennial growth rate. However, the Thai economy had been sluggish for some time, as evidenced by three consecutive years of major losses on the Bangkok Stock Exchange. Finance and real estate sectors were in real trouble. Years of booming exports and attractive interest rates flooded the economy with capital which was often poorly utilized. With all this money around, speculators had driven up stock prices well beyond reasonable valuations, industry overbuilt capacity and developers glutted a once soaring property market. Banks made ill-advised loans, and regulators were no where to be seen. Extravagant government infrastructure projects and public corruption further soaked up capital.

Many businesses got whacked even worse by trying to exploit the large spread that existed between local interest rates and lower US rates. Thinking the baht’s peg with the dollar was secure, Thai bankers and investors borrowed dollars for projects generating baht. But on July 2, when the central bank was forced to break the currency’s peg to the dollar, the baht collapsed. Suddenly, what seemed like a clever move to save several points on interest turned into double-digit losses. And each subsequent decline in the baht’s value triggered a corresponding rise in debt service that many companies simply won’t be able to meet. One result: two thirds of Thailand’s 91 financial instituitions have been shutdown by the government. But the bigger problem is that an already troubled economy combined with a slew of nonperforming loans and skyhigh interest rates [necessary to support the baht and control inflationary pressures due to the higher prices of imported goods] threatens to turn the currency crisis into a recession.

The Thai central bank also got snared in the collapsing currency market. Trying to quietly boost market support for the baht, the bank made $23 billion in forward contracts to buy the currency at predevaluation prices. This unorthodox transaction never showed up on the bank’s financial records; it’s belated disclosure rattled market confidence in the government. Making matters worse, the forward positions are now coming due, requiring the central bank to buy baht in the mid to upper 20s per dollar even though they are now worth upwards to one-third more, further depleting the central bank’s dwindling foreign reserves.

Were currency traders, as many local leaders contend, to blame for precipitating the region’s economic collapse? Not likely. It’s like blaming a hawk for roadkill. These vultures play a critical role in identifying fundamental weakness, doing just the opposite of what Thai nationals were doing: buying baht, converting them into dollars which grew more valuable as the Thai currency collapsed, then trading the dollars back into baht. It may not be a classic arbitrage, but it sure was close. Currency traders then turned their attention to neighboring economies and uncovered similar, serious problems and opportunities for themselves. And the rout was on.


While Malaysia, Indonesia, Singapore, and the Philippines have been hit badly by the crisis that started in Thailand, their individual forecasts aren’t all bad. Possessing one of the region’s strongest economies, Singapore’s dollar has held up the best through the crisis, down only 10 percent. This has kept the loss on a dollar-based equity investment under 40 percent through the first three quarters of the year. Having the brightest outlook in the region, the London-based Economist Intelligence Unit predicts the Singapore economy to grow around six percent in both 1997 and 1998, with inflation likely to remain low and the current account surplus to expand.

EIU is far less optimistic about Indonesia, projecting that “inflationary pressures will increase and measures to counter them will slow growth.” More disconcerning is the current crisis has increased the “influence of Muslim politicians which threatens an upsurge in public unrest,” and is likely to compromise economic policy-making. With equities down nearly 50 percent in dollar terms over the first three quarters of 1997, near-term prospects are not bright.

Being one of the region’s most mercurial stock exchanges to start, the Philippine bourse has been set reeling by devaluation, down in dollar terms by more than 50 percent so far this year. Even with a strong ruling party, low inflation, a government budget surplus, and an improving current account balance, the economic consultants at Standard & Poor’s/DRI project sluggish growth around four percent over the next couple of years with a significant rise in inflation. But the forecast is guardedly optimistic about the country’s future given the government’s experience in shepherding the economy through two previous devaluations earlier in the decade.

Thailand is likely to remain a basket case for some time to come. EIU predicts “recovery will be slow in coming as domestic demand weakens and export growth fails to resume its recent norm before the end of 1998.” Inflation is rising, and the cost of servicing the country’s huge foreign debt is soaring as the baht continues to fall. Meanwhile, EIU fears that political reform could spark violence.

Meanwhile, Malaysia’s very defensive, nationalistic posturing has thrown currency and securities markets into turmoil, revealing a critical conflict confronting the regions’ leaders: their need to appear in control, not manipulated by foreign interests, while negating responsibility for the collapse of their economies and doing little to correct matters of self-interest. Prime Minister Mahathir’s short-lived attempt to restrict currency trading and short selling sent the ranggit into a tailspin. Setting up a $20 billion fund to subsidize domestic investors only aggravated big international players. And his accusation that Jewish interests are seeking to undermine his Muslim state makes one wonder if his government will get around to addressing the economy’s fundamental problems. As the British weekly The Economist noted, Mahathir’s remedies “display an alarming ignorance of the workings of international financial markets.”

But given all this noise and a market that for the year is down 50 percent in dollar terms, the outlook for Malaysia is actually positive. Standard and Poor’s/DRI expects the country’s perennially high growth rate [averaging eight percent over the past five years] to slow just a bit. Inflation is expected to remain well under control, while the currency is expected to reclaim half its 25 percent devaluation within the coming year.


Investors bent on bottom-fishing the tigers should keep several points in mind. First, don’t equate what is happening in Southeast Asia with our own regular technology corrections. A bad quarter of earnings and excess inventory didn’t trigger the collapse—systemic problems did.

Second, forget the hoopla you’ve heard from fund managers in the past about Southeast Asia; it’s a whole new ballgame now, and it’s going to be a lot harder to make money in this region over the next several years. Don G. Powell, president of Van Kampen American Capital which manages Morgan Stanley’s Asian Growth Fund, thinks regional economic growth will slow and direct foreign investments will decline. Because devaluation hurt all the countries in the region, “it will not [as some suggest] enhance competitiveness but will make the entire region poorer and will have a deflationary effect.” All tolled, Powell rates the Asian market as a long-term hold: “The big picture remains strong, but achieving success will be difficult.”

Third point: The speed in which currencies and equities collapsed across the region reveal how connected the markets are, and that even the soundest plays are exposed to the risk of the region’s weakest link. In other words, as long as there is trouble in the neighborhood, investors aren’t particularly safe anywhere.

Fourth, while the International Monetary Fund, the World Bank, and stronger neighboring nations are extending credit and their so-called expertise to help resolve difficulties, don’t count on local leaders to readily follow their advice. Pride and maintenance of prestige are big factors that affect whether local leaders will now invite greater foreign ownership [essential to recapitalize bankrupt financial operations], embrace more transparent disclosure of corporate and government finances, and forget about high profile development projects they can’t afford.

Lastly, the tiger economies boomed because they efficiently brought their vast pools of labor into the workforce. To effectively compete in the coming years, they now must pursue higher educational standards and development of more value-added commodities. Chief economist of LGT Asset management in San Francisco, John Greenwood, while cautious, thinks that’s possible: “Southeast Asia’s economies still have many strengths, and after a period of correction, they likely will once more grow at rates of six to eight percent per year.”

Investment Options

Still interested?

Well, here are several ways to go. Individual stock picking is very risky business because of inconsistent disclosure standards, and the quality of information reaching the states is at best uncertain. With this caveat, look for the strongest companies in the healthiest industries with minimum foreign debt and with a large percent of revenue generated abroad. This will help shelter businesses from further domestic currency decay and the effects of higher interest rates. These stocks will also likely benefit first when institutional money returns to the region.

Mutual funds are clearly the easier way to invest. Don’t be too shocked by their large sales loads and annual expenses. That’s often the price of playing in emerging markets which demand a great deal of difficult research.

Three types of funds provide the most concentrated access to the five tigers. While specific country exposure varies in regional funds, the five open-ended funds listed below have traditionally offered the greatest play in the five tigers. Access to each nation can also be gained through managed country-specific funds. Keep in mind that returns of both the regional and country funds will be affected by specific asset allocation, cash holdings, and currency hedging.

Barclays Global Investors established passively managed country funds [called WEBS] that track the MSCI indices in the two strongest tigers, Singapore and Malaysia, offering pure exposure to their markets and currencies. Because they trade like stocks on the AMEX, WEBS experience no discount or premiums, and sales charges can be minimized by acquisition through discount brokers.

Clearly, none of these funds have been profitable for a while. However, if you believe the current crisis is finally getting leaders to address some of the big underlying problems–and that’s a big IF–then it may soon be time to lock and load. But hedge your bets by staggering them over time. And keep in mind that no one knows for sure what’s really going on over there.


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