A fresh bout of turmoil hit Asian currencies and shares this week leaving Malaysias equity market 11 per cent down and that of Thailand 10 per cent. Indonesia shares fell 14 per cent and those of the Philippines 17 per cent. Even the Hong Kong market, which had seemed largely immune, fell 8 per cent.
The problem is spreading. Not only were Australian equities sucked into the downturn. Shares in both London and Wall Street were buffeted in the tailwinds of the Asian typhoon.
The severity of the market storm is now raising serious questions about government policies for long-term growth. While the beleaguered governments of south-east Asia ponder over what must be done to calm their markets, and how long they have got to do it, global investors must ask how far Asias troubles are going to spread.
Not long ago, Asian equities were the glamorous end of emerging markets. Now some economists argue, the regions troubles may raise questions over emerging markets as a whole. For the time being, there seems to be no end to the vicious spiral of declining currencies, rising domestic interest rates, weakening growth prospects and collapsing stock markets that has plagued the region this summer.
The strains in the financial system revealed by a region-wide property glut and a sharp deceleration of exports last year are now becoming acute. Tough action by governments may be needed to restore investor confidence, but whether it will come quickly seems doubtful.
Currency are going to fall further, says Angus Armstrong of Deutsche Morgan Grenfell, the investment bank, in Singapore. Asia has not yet found a combination of exchange and interest rates which will lead to recovery.
A lot depends on what happens in Thailand, adds Neil Saker of SocGen-Crosby, a regional brokerage house. But he warns that Thailands position is likely to worsen in the short run.
Not only does the $16.7 billion rescue package put together by the International Monetary Fund and Japan look insufficient to meet Thailands foreign exchange needs. The government of Chavalit Yongchaiyudh is too weak to implement the reforms mandated by the IMF, Mr Saker says.
That raises the prospect of more troubles rippling out from Thailand to the rest of the region. Already Asia seems to be in the grip of a sort of enforced competitive devaluation. Even Singapore, which has high reserves, a large current account surplus and a recovering economy, has allowed its currency to fall.
In theory, the lower exchange rates and lower equity prices, should make Asian equities a bargain for emerging market investors. Jonathan Francis of Putnam Investment Managers in Boston says some of his clients are starting to look selectively at opportunities in Malaysia and the Philippines, though they are keeping away from Thailand and neutral on Indonesia.
But overall the flow of funds seems to be the other way. There have been large redemptions of Asian funds in the US, says Laurence Heyworth of Riobert Fleming, the investment bank.
International fund managers find it more profitable to trade with the movement in emerging markets rather than take a contrarian approach, he says. Recently, Latin America and eastern Europe have been in favour.
Besides, traditional ways of measuring value in equity markets, like price/earnings ratios, are hard to apply in a climate of such violent change.
Thailands stock market is trading on a ratio of around 10 times last years corporate earnings. That looks cheap, but given the likely collapse in earnings of Thai companies over the next 18 months, no one knows how to calculate the forward price/earnings ratio which is what really counts in valuing equities.
Take a flagship company like Siam cement, the Thai conglomerate. Arnab Banerji of Foreign and Colonial Emerging Markets, the investment managers, in London calculates that after the baht devaluation the cost of servicing the companys large foreign debt would wipe out this years earnings if Thailand managed a growth rate of six per cent this year. Since growth is expected to be much lower, the company may run up losses.
Economists think investors are likely to return to the equity markets only when they know the extent of the slowdown and its impact on earnings; and that is likely to happen only when currencies have stopped falling. Unless government policies become tougher, this process may first require exchange rates clearly to overshoot.
People will seek results before they go back in. There will be some strong rallies, but we wont see proper recovery for some time, says Mr Saker. Youll need signs of recovering exports and more balanced economies with lower consumption and savings rising. Only then will people be happy.
Mr Banerji says the regions problems are concentrated in Thailand and Malaysia which allowed their economies to become too highly geared in the boom period of 1994 and 1995. Now there are worries about bankruptcies in both as the oversupply of property is absorbed.
Both countries could recover quite rapidly, he believes, if their government allow bankrupt companies and even some banks to go to the wall as Mexico did after its crisis at the end of 1994. If, like South Korea and Japan, they insist that good companies subsidise bad ones, they face a long period of weak growth, deflation and crisis.
Michael Hughes, market strategist at BZW, the banking group in London, emphasises the need for financial reform. The financial system didnt keep pace with industrial development, he says, so south-east Asian countries are badly placed to absorb the capital flows. But the crisis lies elsewhere, argues Chen Zhao of the respected monthly China Analyst in Montreal.
Mr Chen believes that south-east Asian countries failed to see the competitive threat from China after it devalued the yuan in 1993. Since then China has introduced tax rebates on exports, while prices of export goods have fallen in the wake of anti-inflation policies.
Chinas real exchange rate has fallen, allowing the country to take a greater share of US imports from Asia and putting pressure on the export prices of other countries. Some time next year the tide could turn again in south-east Asias favour, says Mr Chen. It will start to benefit from lower exchange rates, while the Chinese and Japanese economies will feel the effect of the present monetary stimulus from their central banks.
Meanwhile, the markets could be in for a rough ride. Hong Kongs fall is a rude reminder of how problems can spread. Because it is Asias most liquid market and one that has risen sharply this year, it could suffer disproportionately if international investors suddenly decide to pull more money out of Asia.
Mr Hughes says he fears the impact could be compounded if pressure on the currency forces the Hong Kong authorities to raise interest rates, hurting the property market. Such a shock would be bad for confidence generally, reducing global appetite for emerging markets. Similarly, says Geoffrey Dennis of HSBC James Capel, the brokers, in New York, there is a risk of worldwide contagion if Asias currency crisis spreads to the Brazilian real.
The tolerance for taking risks by global investors is reducing, says Mr Hughes. Far from shaking Wall Street, though, that could prove a source of underlying support for the US market as investors flee to quality. The US bond market should do well, as will the dollar, he says.
Also helping underpin US markets may be the flow of ever cheaper imports from Asia thanks to the deflation that has now gripped the region. Insofar as that helps keep US inflation down, it could reduce the pressure for higher interest rates as the economy grows.
For western consumers and businessmen that would be good news. It would be scant consolation for the governments of Asia who now have to set about clearing up a mess which they themselves helped create.
