Search Is on for Iceland-Like Hedge Fund in Asia: William Pesek

Commentary by William Pesek

Oct. 31 (Bloomberg) -- It used to be that we searched for economic icebergs in Asia. Now we are on the lookout for Icelands.

Last week, Iceland became the first developed economy to seek aid from the International Monetary Fund since 1976. It needed a $2.1 billion bailout after investors realized it wasn't running an economy, but a hedge fund.

While Ukraine, Belarus, Hungary and Pakistan are also lined up at the IMF's door, Iceland's woes are getting special attention. The thought that even a western European economy that once had an AA rating could implode are bringing back uncomfortable memories about Asia's crisis a decade ago.

The question zooming around markets is this: If the worst- case scenario plays out and the crisis continues, could Asia experience another 1997? Equally important, will investors know it when they see it?

Watch the banks, say analysts such as Mark Matthews of Merrill Lynch & Co. in Hong Kong. ``Bank shares are the canary in the coalmine,'' he says.

In 1997, Matthews points out, bank shares underperformed in Indonesia, South Korea and Thailand before all three nations sought IMF bailouts. More recently, drops in bank stocks also preceded a broader realization of troubles in economies such as Iceland and Hungary.

So, if an Asian economy is on the cusp of an Iceland-like emergency, bank shares are the place to look. And here's the good news: The industry is holding its own. In the last 12 months, they have outperformed the broader markets by 23 percent, Matthews says.

Eyes on Banks

Banks in Asia had only small amounts of the toxic debt now hurting U.S. and European peers. Generally, Asia's banks are reasonably liquid and well-capitalized. Non-performing loans may rise as global growth slows, yet the most likely scenario isn't for a 1997-style crisis. In relative terms, many Asian banks are seen as less risky than peers in other nations.

Korea may be an exception. Matthews says Korean ``banks' outperformance on a 12-month basis has been thin, and more recently they have begun underperforming.'' Investors are more negative on Korea than conditions in Asia's fourth-biggest economy warrant.

Asia is anything but immune to this crisis. The cost of insuring emerging-market debt has risen 2 1/2 times in less than a month, Matthews says. A deep U.S. recession will weigh on export-dependent economies. Slowing growth in Europe, Japan and China mean Asia may soon run out of engines to expand.

Feeling Pain

There also are problems today that didn't exist 10 years ago. The Asian crisis was an emerging-market phenomenon, leaving larger, developed nations less affected. The current one is moving in the opposite direction and knows no borders. As turmoil spreads, all economies and markets will feel the pain.

The Federal Reserve's move to provide $30 billion each to the central banks of Brazil, Korea, Mexico and Singapore showed just how universal this crisis is. Paul Donovan, London-based deputy head of global economics at UBS AG, said in a report to clients yesterday that the Fed's decision to expand efforts to unfreeze markets to emerging nations for the first time was even more significant than its official interest-rate cut.

The trouble is, the U.S. still may be entering into a Japan- like period of stagnation. In cutting short-term rates to 1 percent this week, Fed Chairman Ben Bernanke nudged the U.S. closer to the experience of Asia's biggest economy. Like the Bank of Japan, the Fed is running out of monetary ammunition.

Developing Asia

The U.S. also is borrowing money so fast it's making Ronald Reagan's administration seem downright debt-averse. President George W. Bush inherited a surplus, yet his budgets have resulted in deficits and added $1.7 trillion to the national debt.

Financing from nations such as China allows the U.S. to live beyond its means. Yet the stability of China, the world's largest holder of foreign currency, is becoming less certain. The People's Bank of China on Oct. 29 reduced its benchmark one-year lending rate to 6.66 percent from 6.93 percent.

China's growth slowed to 9 percent in the third quarter. It may keep lowering interest rates after three reductions in two months as the global crisis drags down exports and production. Growth in Japan continues to lose ground, too.

Developing Asia has its own vulnerabilities. Growth rates aren't the problem, with 7.9 percent in India, 6.4 percent in Indonesia, 6.3 percent in Malaysia, 5.3 percent in Thailand, 4.6 percent in the Philippines, 4.3 percent in Taiwan and 3.9 percent in Korea. Yet economies do hit icebergs, and things will cool as U.S. companies fire employees.

The odds don't favor the next hedge-fund economy turning up in Asia. With the exception of Japan, central banks generally have ample room to cut rates; debt-to-gross-domestic-product ratios leave fiscal latitude; and currency reserves offer a cushion. Asia is a very different place than it was in 1997.

If global turmoil worsens, though, Asia won't get off easily. If the region is harboring an Iceland, bank stocks will provide an advance warning.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net