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Asian financial crisis: When the world started to melt

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Following currency devaluations and stock-market crashes, Asia now faces its biggest challenge: a full-blown credit crunch. No big bond issues will be done for the rest of the year, spreads on outstanding bonds have gone haywire and trading has ground to a halt. Local sources of credit have also dried up. Corporate borrowers can expect little help from their bankers; devaluation has blasted a hole in many local banks' balance sheets and they have no money to lend even if they wanted to. Peter Lee reports on the likely shape of things to come.

 December 1997

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Investment bankers are a tough breed, more used to hard negotiations and aggressive trading than to dealing with delicate human emotions. So the Asian capital-markets chief of a western firm pitching to the Thai ministry of finance one Thursday in early November found it difficult to know how to handle the scene that confronted him. "These people were panicking," he says. "I had one senior official literally in tears. Hardly anyone is visiting them any more and they don't know what to do. They were saying 'please help us'."

After a few gruff words of encouragement, the banker came up with one interesting proposal: not for a new bond issue but for a more radical approach to Thailand's financial difficulties. He suggested that the ministry invite an advisory board of international firms - one European, one American and one Japanese - to negotiate with the international creditors of Thai borrowers. This group might offer to take Thai loans off the books of foreign banks at a sharp discount to par, hold them in some kind of fund and then either sell them on to new-money buyers, such as vulture-fund investors or more strongly capitalized foreign banks with less previous exposure in Asia, or somehow reschedule the interest and principal payments so as to keep the restructured loans current and the underlying borrowers solvent.

Only time will tell whether the Thais ever try to adopt this proposal. It may be too radical for them for two reasons. First, unlike the $18 billion IMF support package, it involves a market-led initiative. Secondly, it recognizes the true depth of the problem confronting Asia.

Rather than merely the pricking of a speculative bubble in currency, stock and property markets, this is truly a debt crisis in the making. It may lead to widespread corporate and bank defaults - no-one can yet quite bring themselves to talk about sovereign defaults - and will require something akin to a corporate bankruptcy work-out at the sovereign and regional level.

"Imagine it as a country or a region going into Chapter 11 [bankruptcy]," says the banker. "Countries will have to, as the IMF has suggested, close down certain entities like some of the worst-run banks. There may be a fire-sale of some assets. But even more importantly they must protect the core, viable companies and keep them going. If they feel they cannot, then in the end I couldn't blame them for telling the foreigners to get lost. They have to protect their own people now."

Keeping the viable companies afloat will be tough because in the coming weeks and months Asia faces a massive credit crunch. The international bond and equity markets have to all intents and purposes closed and will not reopen before the first quarter of next year. The only possible exceptions will be for small structured deals involving credit enhancement or securitization of hard-currency revenues.

"Prior to Hong Kong's dive, [when the Hang Seng Index fell 10.14% on October 22 it pushed out already wide credit spreads for Asian borrowers by another 100 basis points or more] there were a lot more options for many issuers in the region which need capital," says Paul Shang managing director at Lehman Brothers. "Following that, the situation as regards issuers' ability to do deals is completely different. The primary markets have been all but shut down. We are telling clients that for the rest of this year at least it is very unlikely that they will be able to go ahead and issue debt or equity on favourable terms." In every country there is a growing backlog of issuers that need to raise capital, some urgently, but simply cannot.

As well as uncertainty about the depth of the crisis in Asia, a year-end effect is holding investors back and exacerbating the problem. Portfolio managers don't want to take any risks between now and the year-end when they will have to mark their positions to market. Even if they think that, say, Korean bonds, with spreads of 250bp, are worth buying on a 12-month to 18-month view, they must also recognize the risk that - with occasionally wild intraday spread volatility of 50bp to 100bp - they may have to account large paper losses in the next few weeks. Even if Korean spreads tighten next year and the portfolio manager eventually locks in a profit, the damage will already have been done. A portfolio manager making a paper loss in new Asian positions is unlikely to receive generous treatment from either his bosses or his investing clients. Investors are more concerned about existing positions, which for the most part they cannot hedge or exit, than about taking new ones. And they are not even thinking about supporting new borrowing.