Asia waits for funds to give recovery a kick

By Alan Wheatley

TOKYO (Reuters): Asia is back in business, but some economists are afraid the region's recovery will start to run out of steam unless badly flagging investment rates start to pick up.

With Asia still awash with capacity the 1997 financial crisis exposed as surplus to requirements, some bankers expect it will take another two or three years before investment claws its way back to pre-crisis levels.

"Consumption and exports have led the rebound, aided by stimulative fiscal policies and regional trade links. However, for the growth story to continue its current speed, investment -- inventories and, more importantly, capital formation -- must start growing in a meaningful way," Warburg Dillon Read's Asia economists said in their March report.

Investment in new plant and equipment is vital to maintain competitiveness as well as to create the new jobs that generate spending power.

But Warburg said investment ratios this year in several countries were likely to be still more than 30 percent below their pre-crisis average. This will put a brake on growth next year, causing consumption to taper off and pointing to a lower growth trajectory in the medium term, the investment bank said.

The weakness in investment is inextricably bound up with the fragile state of Asia's financial system. Even so, an improvement in the health of banks might not be enough to fuel the long-term credit growth that finances capital investment.

"For example, consider Malaysia, where significant bank recapitalization has failed to inspire credit growth," Warburg said.

Desmond Supple of Barclays Capital in Singapore is particularly uneasy about Thailand. He said year-on-year Thai M2 money growth of just 1.5 percent in January is evidence private consumption and investment are not about to take over from exports as engines of growth.

"We're at the high water mark of export growth and yet domestic demand hasn't followed through. You've still got up to two years' worth of surplus capacity in urban centers in Thailand. This is going to weigh heavily on private investment, which was one of the key dynamics to growth pre-crisis," he said.

Superficially at least, emerging Asian economies have something in common with Japan in being unable to recycle huge savings surpluses into domestic investment because of excess capacity and weak banking systems.

In the case of Japan, a Hong Kong-based economist argued, this is in part because asset prices have not been allowed to fall to levels at which fresh investment becomes profitable -- a recipe for deflation as buyers wait for the right time to strike.

But economists say the differences are more important: Japan's plight was deeper than the rest of Asia, which is also recovering more quickly than its powerful neighbor because governments have largely avoided Tokyo's policy errors.

J.P. Morgan says Korea's V-shaped recovery is proof positive Asia need not fall into the Japanese trap.

True, investment last year in Korea rose only 3 percent in real terms after a 20 percent drop in 1998, barely contributing to GDP growth of 10.2 percent. Moreover, J.P. Morgan does not expect fixed investment in Korea to regain pre-crisis levels until 2002.

But this is only to be expected after a deep crisis that depressed capacity use rates and brought home the need for drastic restructuring, said David Fernandez, an economist with J.P. Morgan in Singapore.

Nor is subdued bank credit a worry. When Korea recovered from its last recession in 1993, bank lending did not kick in until some three years later. Early investments were often funded out of cash flows. Fernandez expects other crisis-hit countries eventually to follow Korea's recovery pattern.

"Domestic demand is what we're counting on in stage two of the emerging Asia recovery story. However, I wouldn't say that anything in the pattern that we see now of investment being weak and lagging is anything to be concerned about," he said.

On the contrary, he said the fact that investment is too low to absorb domestic savings is generating sizable current account surpluses that will stand Asia in good stead in the likely event of rising interest rates in the United States and Europe.

"Having current account surpluses still at this stage of the recovery -- not being dependent on massive capital inflows to help them boost the recovery -- makes emerging Asia less vulnerable to external shocks," Fernandez argued.