'Hot' money could burn fragile Asian economies

'Hot' money could burn fragile Asian economies

SINGAPORE (Reuters): The good news is Asia is still firmly on
investors' radar screens. The bad news? A big chunk of it is hot
money.

Spectacular rises in regional stock markets at the turn of the
year tended to run out of steam around mid-year, but overseas
cash has continued to trickle back.

With investors keen to take advantage of what are still
relatively cheap stocks, analysts expect volatility-prone short-
term capital inflows such as portfolio investments to remain the
main driving force going forward.

While this might do a lot to boost investor confidence, what
is needed is cash backed by a longer-term commitment.

Foreign direct investment (FDI) has been mixed, with South
Korea favored thanks to aggressive restructuring and reform.

Korea has received plans for fixed investment worth US$10.25
billion for the first 10 months of 1999 and is confident of
meeting a $15 billion full-year target.

At the other end of the spectrum, Indonesia saw a 50 percent
drop in the value of FDI approved by the government between
January 1 and August 15 compared to the same period a year
earlier.

These types of flows contrast sharply with portfolio
investments, which are sentiment-driven and tend to ebb and flow
swiftly in huge amounts, sometimes causing economic disruption.

The risk is that debt-saddled economies, still recuperating
from the crisis, might not be strong enough to withstand big
fluctuations in capital flows.

"If I were a central bank governor in Asia, I would feel very
uncomfortable indeed. The risks are always there for portfolio
disinvestment: the near-term risk is the meltdown of U.S.
stocks," said a treasurer at a U.S. bank.

"In the longer term, there are signs that Asia might soon face
funding constraints that would cut into the region's growth. That
could happen in the next few years, but fund managers won't wait
until then to move their investments out of the region."

More money is expected to storm into Asian stock markets once
the Y2K worry subsides because the valuations are considered
attractive, analysts said.

"Initially, there will be incentives for hot money to come in.
Stocks have gone down a lot in many countries. Investors will be
tempted to make some bucks in this kind of market," said Mangal
Goswami, regional economist at ABN AMRO Bank.

"Longer-term investors will be keenly looking at how the
governments manage the economy and things like policy consistency
and credibility," he said.

Japan is expected to be the major beneficiary of these
portfolio flows as investors take a more optimistic view of its
recovery prospects.

"If you look at Europe, it is actually very expensive indeed.
If you are looking at something cheap on a valuation basis, you
have to look at Japan and some Asian countries," said Andrew
Milligan, of Morley Fund in London.

What Asia really needs are more foreign direct investments,
which are more committed and benign to the economy in the longer
run than hot money flows.

But analysts say patchy economic reforms, lack of proper
infrastructure and excess capacity in many countries could stifle
such investments.

"Plans have been mapped out, and now investors are looking for
the implementation," said Chia Woon Khien, head of Asian research
at Skandinaviska Enskilda Banken in Singapore.

"If these governments want long-term investments, they should
reform the economy...making it more transparent, and more open to
foreign investors. So far, there is not much progress," she said.

Inadequate infrastructure would also limit FDI, and the
problem is likely to be pronounced in places like the Philippines
and Thailand, analysts say.

"The lack of a sound infrastructure base has constrained the
country's capacity to absorb not only more FDI, but also higher
value-added technological investments," Jardine Fleming said in a
recent report on the Philippines.