'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.