The Right Stripes? Six Years on from the Dramatic Meltdown on Asia's Tiger Economies, the Region Is at Last Re-Emerging as a Genuine Target for Western Investment. in the First of a Series of Features Focusing on Asia in This Issue, Cathy Hayward Compares How Far the Major Players Have Progressed on the Road to Recovery

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In the early 1990s Asia attracted almost half of all foreign investment in the developing world. But in mid-1997 overseas investors suddenly lost confidence in securities and left the region in droves. The impact was immediate and catastrophic: Thailand's stock market lost 75 per cent of its value that year--South Korea's fell 7 per cent in one day'. Malaysia, Indonesia and Hong Kong experienced similar collapses.

The crisis also put pressure on Japan's economy, which at the time was twice the size of the rest of the region's economies combined. Its GDP growth rate slowed and there was a steep decline in consumer confidence and spending. By contrast, mainland China and Taiwan were largely unaffected by the crisis, because of the non-convertibility of the renminbi and by virtue of the fact that almost all foreign investment was in factories rather than securities.

Six years on, there are signs of recovery across the region. Foreign investors, tired of the slowdown in the European and north American markets, are once again looking east. But, while many Asian investment funds are much healthier, Japan is faring less well.

The basic problem is that the Japanese economy is not growing, according to Ira Kalish, global economist at Deloitte & Touche. Despite short-term interest rates of 0.01 per cent, the money supply is not growing as the country's insolvent banks fail to lend to creditworthy customers.

"The losses of inefficient businesses are covered by failing banks, while strong businesses are starved of credit," Kalish says. "A financial house of cards has been constructed that stymies growth and threatens chaos"

One reason why the situation has taken such a long time to improve is that the Japanese have not been aggressive enough in tackling the problems, says Neiloy Ghosh, head of the Japan growth retail fund at SG Asset Management. "The banking sector has been very weak, and that has affected confidence across the whole economy7

But some investors believe the country is starting to turn the corner. In July the Bank of Japan upgraded its assessment of the economy. Although activity remains fiat, exports and capital expenditure levels in big firms are set to rise. There is reason to believe that this is more than a cyclical improvement, according to Ghosh. The market looks cheap on current estimates and there is a strong prospect that the forecasts will be revised upwards. "Japan remains a geared play on the global economic cycle, hence improving global demand for consumer and capital goods will mean rapidly improving business conditions, "he says.

The decision by many Japanese companies to move much of their manufacturing base to China will reduce operating costs and make Japan more competitive in the region. Sony, for example, believes that by sourcing more component parts from low-cost markets such as China it will raise operating margins from 4 per cent to 10 per cent by 2006.

Shareholder returns are also slowly improving. Tim crisis mode that many Japanese companies have been in has benefited investors. General cost-cutting, redundancies and spending restraint have combined to improve earnings and cash flow. According to the HSBC Japan Economies team, share buybacks for the market ex-financials represented 7 per cent of operating cash flow last year. Combined with dividends, the total cash returned to shareholders was 14 per cent last year, compared to 13 per cent in the previous year and an average of 10 per cent between 1990 and 2002.

All this is helping to convince foreign investors that Japan should no longer be ignored. In June, for example, Tesco gained a foothold in the country with a 17.3 million [pounds sterling] deal to buy convenience store chain C Two-Network. The key benefit of the Japanese market is its size, according to Tesco. It is the second-biggest retail market in the world and is also fairly immature, offering plenty of room for consolidation and growth. …