One year ago, as Asia finished another year of sky-high growth and its leaders boasted of a dawning Pacific Century, a little-noticed bank scandal in Thailand provided a hint of the shock the region was about to receive.
The scandal, at the Bangkok Bank of Commerce, involved billions of dollars in questionable loans, including one to a convicted swindler known as the "Biscuit King." The bank's managers disguised their malfeasance using financial shell games, such as backing loans with vastly overvalued property.
The mess at the Bangkok bank exposed the weakness of Thailand's banks and the lack of government oversight in a deregulated financial system run amok. And though few guessed it at the time, that obscure and complex scandal was the portent for a larger economic meltdown that not only would send Thailand reeling into recession, but later would sweep through Indonesia, Malaysia, the Philippines and, eventually, South Korea, the world's 11th-largest economy.
By the end of 1997, the crisis had left behind bankrupt corporations and failed financial institutions across Asia, and a pile of regional currencies worth up to 40 percent less than before. It exposed a mountain of bad debt wrought by shoddy lending practices, and it underscored a generation of corrupt political and business practices long concealed by high growth figures. And perhaps most importantly, the crisis pierced the bubble of confidence that had allowed Asia to prosper for a decade on foreign investment.
Few can claim to have seen Asia's dramatic change in economic fortune coming. Indeed, at the start of 1997, most economists, regional analysts, and Asian academics and politicians were saying that the region's "miracle" growth was destined to continue well into the next millennium.
Looking back, however, the Thai bank scandal was the first -- and perhaps the most glaring -- of many warning signs that Asia's bubble of prosperity was about to burst. This story, reported with the benefit of hindsight, looks at how the gathering storm clouds in two key places -- Thailand and South Korea -- for more than a year signaled the eventual, region-wide economic crisis to come.
In many cases, the warnings were ignored by government officials anxious to conceal unfavorable news, by foreign investors anxious to keep the funds flowing and by an international community eager to keep the myth of the miracle alive.
"The relative complacency across the globe in the initial stages of the crisis was probably a contributing factor to the crisis," said Andy Tan, a Singapore-based analyst. After the Mexican currency crisis of 1994, Tan said, "there was a sense of complacency that this would be the same."
"If you look at all of these countries," said Bruce Gale, regional manager of the Political and Economic Risk Consultancy, "the problems were known, but there wasn't the political will to do anything about them."
Most analysts here say Asia is in a position to pick up the pieces from the shambles of 1997, as governments to varying degrees show a willingness to recognize the size of the crisis and make the necessary reforms, particularly in the banking and financial sector. As with the savings and loan scandal in the United States, which led to a shakeout of the American finance sector and greater regulation, so too Asia might retool by cleaning up its banking mess.
In most cases, the cleanup will involve shutting down banks and finance companies whose operations already have been suspended -- 16 banks in Indonesia, 14 merchant banks in South Korea, 56 finance companies in Thailand. Other banks will be forced to merge, and laws are being changed from Jakarta to Seoul to allow still other banks to merge with foreign partners.
But the process is likely to be longer than initially thought, and more painful, according to regional analysts, economists and investors. Asia is likely to face recession, more bankruptcies, higher unemployment and perhaps social unrest, they say. Where initially the turnaround seemed likely to come by the end of 1998, most analysts now suspect Asia's troubles could last to the year 2000.
In addition, changes in global trade and investment patterns could slow recovery. Asia now is competing more with Latin America and Eastern Europe, and it may find it difficult to recapture its role as the favorite region for foreign capital. China, with its endless supply of low-wage labor, will challenge Southeast Asians increasingly in their traditional export fields. And perhaps most fundamentally, the crisis of 1997 has sapped investor confidence in the region. Signs of Crisis in Thailand
Thailand, where the Asian collapse began last summer, holds the first clues of its origin and shows how warning signs along the road to disaster either were missed entirely or deliberately ignored.
One year ago, Thailand was coming out of a decade of unparalleled economic growth, averaging 8 percent annually. For nine years in a row, the country reported a balanced budget. The technocrats in charge of financial and economic policy were considered among the most professional in the region; the history of political noninterference in economic management seemed well-entrenched; and the country boasted a relatively open, liberal investment policy.
"Every single person has been caught by surprise by the rapidity of the crisis and the depth of the crisis," said a Western embassy economist in Bangkok.
But Dominique Maire had his doubts. In 1996, Maire was a regional economist for UBS Securities based in Singapore. In September of that year, he and other UBS analysts spent two days in Bangkok talking with officials in charge of economic policy. "We asked what was going on," Maire recalled. "I told them exports were weakening, everyone was still concentrating on strong economic growth, investment plans were still high -- but can you do something to prevent a slowdown?"
"I remember in our case, after two days of meetings, I said, that's it -- it's a major slowdown. That was the trigger point, after which I started cutting major forecasts."
One of the key factors in that 1996 reassessment were figures showing export performance for the last quarter of the year as sluggish at best. The government had at the beginning of 1996 predicted an 18 percent growth in exports, but at midyear, Thailand's export growth was in single digits. Government officials insisted that the earlier growth projections were on target and that Thailand was simply experiencing a brief cyclical downturn that had no long-term implications. And many foreign economists followed that line.
"Everyone was scurrying around trying to find cyclical explanations," said a hedge fund manager with long experience in Thailand. "But the drop in exports was crucial."
In fact, a long-term shift was underway, with profound implications for Thailand and the region. Thailand's traditional exports -- footwear, garments, seafood -- "got creamed," as one U.S. economist indelicately put it. The main problem was increased competition from relative newcomers India, Burma and Vietnam, and from China, whose exports expanded as Thailand's contracted. In addition, higher labor costs and the relatively high value of Thailand's currency, the baht, compared with the U.S. dollar, meant Thais had "priced themselves out of the market," the U.S. economist said.
At the same time exports were collapsing, trouble was brewing on an unrelated front: The country was embroiled in its biggest-ever banking scandal. The issue received little outside attention; because some ministers in the government of then-Prime Minister Banharn Silpa-archa were touched by the scandal, the government tried to hide the depth of the problem.
The Bangkok Bank of Commerce, or BBC as it is widely known, was taken over by a government committee in summer 1996 after it was revealed in parliament that the bank was insolvent because of some $3 billion in outstanding loans, many of them with inadequate collateral. The beneficiaries included the late Rajan Pillai, a biscuit-maker and convicted swindler known as the "Biscuit King," who got three billion Thai baht (about $117 million at 1996 conversion rates), and members of Banharn's Chart Thai political party.
The bank's former president and treasury adviser have been accused of running the bank into the ground. The ex-president is fighting the charges in Thailand, while the ex-treasury adviser is fighting extradition from Canada.
The BBC mess led to the resignation of Vijit Supinit as governor of the Bank of Thailand, the country's central bank, eroding confidence in that institution. More importantly, it focused attention on a banking sector that was seriously out of control.
After Thailand allowed off-shore banks in 1993-94, and began offering high interest rates on deposits, foreigners poured in money, attracted by the relatively stable exchange rates. Flush with foreign cash, the proliferating banks "went out and loaned shamelessly," said one Western diplomat. Facing liquidity problems, and with lax government oversight, the banks covered up their increasing volume of bad loans by making still more loans and, as the economist said, "that's where we were in mid-'96 when the rot started."
By early 1997, the bad news on exports and the worries over BBC combined to put heavy foreign pressure on the baht. Analysts say they now believe the central bank was intervening in the futures currency markets even earlier than first revealed, in spring 1997. On Feb. 12, 1997, the Singapore-based Political and Economic Risk Consultancy group published its "Asian Intelligence" newsletter that for the first time warned of the extent of the impending crisis.
The pressure on the baht in January, the report said, "betrayed worries not just about the gloomy run of Thailand's macroeconomic results, but also about the health of the country's financial institutions." It said "serious surgery is needed to invigorate the country's financial institutions" and warned, "if panic takes hold of the market, reform may have to come to stave off, or respond to, a meltdown."
The meltdown did come, with the government in August suspending the operations of 58 ailing financial firms and going to the International Monetary Fund for a bailout. Korean Corporate Giants Tumble
Just as the crisis in Thailand began quietly with the mess at BBC, in South Korea the scandal had another name: Hanbo. In what should have been a warning sign of South Korea's coming financial crisis, the giant Hanbo Group went bankrupt in January 1997 with a debt of about $6 billion and became the first of the big conglomerates to go under. The scandal caused South Korea's normally pliant banks to mutter publicly about the conglomerates' high debt levels.
The Hanbo group's chairman and his son were convicted of siphoning $400 million from the group to bribe government officials and bankers in a futile attempt to keep the group afloat. To many analysts, the mess at Hanbo appeared unique. But others say Hanbo's crisis was typical, indicative of the rot at the core of Korea's financial and industrial base.
In that February 1997 report, the Political and Economic Risk Consultancy group had rated Korea's banks among the region's most worrisome. "The recent Hanbo crisis has underlined just how much South Korea's banking system needs serious reform," the report said, adding that, among other things, the scandal exposed how Korean banks suffered under the "suffocating embrace from government" that made them "vulnerable to corrupt government officials."
As in Thailand, the banking scandal was the most visible and dramatic warning sign, but the roots of the economic problem were long in the making.
In Korea's case, double-digit growth in plant capacity since 1995 flooded markets with too many products, which then spurred a growth in inventories and price-slashing. This in turn caused a drop in profits for Korean firms that left them helpless in the face of crushing debts. With debts commonly equal to three-to-six times the cash invested in their firms, companies were having trouble finding the cash to make interest payments. The amount of corporate debt reached nearly twice the annual gross national product.
Even in fiscal year 1996, when Korea's economy grew at 7.1 percent (similar to Thailand's stunning growth that same year), 13 of the top 30 conglomerates were losing money, including four of the top 10. The loans kept mounting as investment slowed, indicating that from mid-1996, the firms were using borrowed money to cover operating costs.
Borrowing money and amassing debt seemed an attractive alternative to South Korea's corporate chiefs. It allowed them to navigate lean times while retaining control of their companies, rather than raising cash by issuing new stock and diluting their own stakes.
Merchant banks, relatively new in Korea, also played a role. They were, said Kim Kihwan, ambassador-at-large for economic affairs, "used literally as private coffers" by the conglomerates which owned them. The problems were compounded when companies went abroad for their borrowing, making them vulnerable to the collapse in the currency that occurred later in the year, after Thailand's currency troubles spread.
After the Hanbo mess was exposed, banks began taking a closer look at their loan portfolios, and started calling in loans to the most indebted firms. That created a domino effect of more companies failing.
The biggest blow to confidence came with the July collapse of Kia Motors, the country's eighth-largest conglomerate. Its debts were bigger than Hanbo's, and it brought down one of the country's premier banks, the Korea First Bank.
The crisis in Korea deepened as Southeast Asian currencies began collapsing in July and August. Many Korean merchant banks had borrowed U.S. dollars to buy high-risk bonds in Thailand. In addition, the loss of value of Southeast Asian currencies meant a loss of purchasing power for Korean goods.
Yet as late as September, many analysts, including the IMF, were making optimistic forecasts about Korea, and still predicting positive growth. And as late as November, with more big companies collapsing and the central bank spending half-a-billion dollars each day to prop up the sagging won, the government was still trying to cover up the extent of the crisis.
When on Nov. 12, Stephen Marvin, research chief for SsangYong Investment and Securities, issued a report to investors warning that "no beacon of light is visible" in Korea's financial mess, the finance ministry threatened to slap sanctions on SsangYong if it didn't halt distribution of the document. Tomorrow: Lacking a sense of crisis, Japanese officials are reluctant to overhaul their ailing economy. Richburg reported from Bangkok and Hong Kong, Mufson from Seoul. CAPTION: ASIA IN CRISIS By the middle of 1997, many Asian countries had accumulated huge external debt, much of it invested in domestic projects -- many of them risky -- that were not earning sufficient foreign currency to repay the debt. Moreover, most Asian currencies were pegged to the dollar and had become overvalued as the value of the dollar rose. Asian exports had become less competitive, earning less foreign currency. Finally, speculators worried by these economic troubles and in some cases political instability, sparked an avalanche of selling domestic currencies. July 2: Thai currency, the baht, is allowed to float freely; this in effect devalues the currency by 15 to 20 percent. July 20: International Monetary Fund grants Philippines $1 billion emergency loan, after currency plunges when central bank allows the peso to move in a wider range against the dollar. July 24: Currency meltdown sweeps Asia. Malaysian Prime Minister Mahathir Mohamad blames speculators. A few days later, Mahathir blames American trader George Soros for the Malaysian ringgit's fall. Aug. 11: Thailand is pledged $16 billion in loans in rescue package led by IMF and Japan. Aug. 14: Indonesia loosens controls on the rupiah, and currency tumbles. Aug. 28: Asian stock markets plunge: Manila down 9.3%; Jakarta 4.5% Sept. 4: Philippine peso falls to record low against the dollar before central bank intervenes. Sept. 11: World Bank urges reforms for East Asian financial systems. Oct. 8: Indonesia asks IMF for $10 billion emergency bailout. Oct. 27: U.S. stock market plunges 7.2%. N.Y. Stock Exchange briefly suspends trading. Oct. 23 - 28: Hong Kong stock market loses nearly one-quarter of its value in four days on fears over interest rates and pressures on Hong Kong dollar; other Asian markets also plunge. Nov. 3: Japanese stock broker Sanyo Securities files for bankruptcy. Nov. 11: U.S. Treasury Secretary Robert Rubin urges Tokyo to shore up Japanese banking system. Nov. 16: Hokkaido Takushoku, Japan's 10th largest bank, folds due to bad loans. Nov. 20: Korea begins talks with IMF for $20 billion emergency loan. Nov. 21: Yamaichi, Japan's largest securities firm, collapses; it had been reported in trouble since October. Nov. 24: Korean stocks fall 7.2% on fears that IMF may demand tough reforms. Nov. 25: Tokyo City Bank, a regional Japanese bank, closes. Dec. 3: Seoul agrees on $57 billion IMF rescue package. Dec. 5: Malaysia imposes tough reforms, including public spending cuts to reduce its balance of payments deficit. Dec. 17: Japan announces new reflationary measures, including cut in income tax. Stock market rallies, then weakens. Dec. 18: Koreans elect opposition leader Kim Dae Jung as new president. IMF releases second tranche of Korean loan. Dec. 25: IMF and lender nations agree to speed $10 billion of loans to South Korea. WON RALLIES ON PLAN NO. 2 After two months of declines, the South Korean won rebounded sharply on Dec. 26 after the accerelated bailout plan was announced. The won has traded around the same level since. (This chart was not available) U.S. DOLLARS PER SOUTH KOREAN WON: Dec. 3: IMF reaches agreement on a $57 billion bailout plan for South Korea. Dec. 18: South Korea elects Kim Dae Jung as president. Dec. 25: Agreement reached to make $10 billion of loan package available almost immediately. Won rises nearly 23 percent the next day. SOURCES: Bloomberg News, news services and staff reports CAPTION: Mahathir Mohamad CAPTION: George Soros CAPTION: Robert Rubin