Asian Financial Crisis - Paper

8/7/2019 Asian Financial Crisis - Paper

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EFFECTS OF THE FINANCIAL TURMOIL ON THECONSTRUCTION INDUSTRY IN ASIA

Edward Tang & Patrick Lam

The Asia Miracle

Until recently, Asia has enjoyed an economic boom for nearly a decade. Various auspiciousnames have been dubbed for rapidly industrialising Asian economies, for example, journalistsused to call Hong Kong, Singapore, Thailand, Taiwan and South Korea the "Five LittleDragons". Countries in South-east Asia also formed economic alliances to work hand inhand in creating stability and prosperity for their people. Organisations such as the ASEAN(Association of South East Asian Nations) have reported average annual GDP growth rate of

8 per cent in their member countries. To cite more stunning examples, the GDP Per Capita ofMalaysia has increased by fourfolds; Thailand by fivcfolds and South Korea by tenfolds in thelast ten years. Hong Kong and Singapore have also surpassed developed economies in termsof GDP Per Capita. Figure I shows the transition of GPP Per Capita in several Asianeconomics in recent years:-

7. Singapore

30000 ,-----------------., ,----...,1

, -J --"- -- -- ~-. .. .._- - 7

25000 t---- ---~ oc:/ - --::::==::::::----JUS$

-2- HKChina

-4- 1. Indonesia

2-3. PRChina

~4. S. Korea

__j, Malaysia

-6. Ph ili ppi ne s

8. Thai land

----- 9. Vietnam

GDP Per Capita of ASIAN ECONOMIES(At Current Prices)

Fig. 1 Source of information: ADB

The interdependence of developed economies and developing economics is very intricatenowadays. Until lately, many of the developing economies have adopted export-orientedeconomic policy, thereby creating one-fifth of the world's total exports. To the moredeveloped economies, Asia has hugh market potential for imports as it holds 30 per cent ofthe world's population. The United States alone export 19 per cent of their products to Asiaand this proportion is increasing due to the rise in living standards and affordability ofdeveloping economies, which have created high domestic demand for import goods.Considering the rapid pace of development of these Asian economics, which had mostly beencolonies of Western civilisation and victims of the Second World War, Asia has been rightlydescribed as an Economic Miracle by western media.


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The Bubble Burst

The phenomenal growth rate and abundance of opportunities have lured a lot of foreigncapital into the Asian region. Yet, the degree of governance in terms of monetary and fiscalmonitoring is lax in some developing economies. This has transpired into a spiral effect ofcheap loans, rising property prices and a volatile stock market in most of the Asianeconomies. Taking Thailand and Malaysia as examples, the property markets of theseeconomies had been swamped with new-build residential and office spacc. A lot ofinfrastructure projects were started, notably the overlapping mass transit systems in Bangkokand the new Kuala Lumpur Airport.

A crisis erupted when the Thai baht came under speculative pressure in July, 1997, when itscurrent account deficit ballooned and its domestic lending activities went out of control. Lossof confidence urged the small investors to hedge their foreign exchange exposure, drivingdown Thai currency as they did so. Due to the interwoven trade relationship betweenThailand and its neighbouring economies, a currency contagion was triggered, with ASEANcurrencies depreciating between 15 to 75 percent from their 1997 over-valued positions (Fig.2). Then a capital flight occurred as the currencies of all these economies were attacked byspeculators in tum. The once bullish developers suddenly found their loan servicing costssoar due to interest rate hikes as the various governments attempted to defend their homecurrencies. Bad debts and bankruptcies surfaced, and the chaos propagated like a falling packof dominoes.

Fig. 2 Source of information: Strait Times

What went wrong

Although the financial crisis in Asia unfolded at a quick pace, the cause of the problem hadprecipitated gradually since the boom started to build up a decade ago. Despite the hughamounts of transactions taking place throughout Asia, the financial structure has not maturedto cater for such volume and complexity Relatively speaking, Asian buinessmen areinexperienced in corporate risk management. They often trade under some sort of cartels andoperate with a low level of transparency.


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As the bubble built up, the property and stock markets soared, attracting short termspeculators and became overheated. Some economies had an over-reliance on peggedexchange rates. This resulted in the proliferation of foreign currency borrowing. Foreignfunds flooded the Asian financial market, believing that the returns would be high. Many ofthe foreign investments and loans were not hedged against fluctuations. The strong internal

demand pushed up inflation and current account deficits. With the exception of Hong Kongand Singapore, most Asian economies do not have strong foreign currency reserves, makingthem vulnerable to speculators' attack.

When the bubble burst, governments pushed up interest rates to dampen the overheatedeconomies. Those corporations with a highly geared financial structure was hit the hardest.Non-performing loans began to mount, in tum causing the collapse of weaker financialintermediaries. As the markets for foreign investment dry up, corporations have to downsizeor even close down. Unemployment rate then soars. Most Asian economies have doubledtheir unempolyment rate since the emption of the financial crisis. Construction is one of thehardest hit sectors. For example, up to March, 1998, Malaysia alone has got 11,000construction workers retrenched. Not only is the construction industry showing a downturn,other industries like retail, tourism and transport are having a tough time. By the chain effect,

the construction industry is again indirectly affected. One hotel chain operator has indicatedthat about 60 hotel development projects in the region have been put on hold.

Effects on the Construction Industry

Unlike the manufacturing industry whereby currency devaluation can boost a country'sexport, the construction industry in the developing economies of Asia suffers more from thedownside effects of the crisis. The more a country has to import for its construction needs,the more it has to pay in terms of local currency because of the devaluation. Yet, sheerincrease in construction cost has not been evident in Asia so far because of the counteractingbalance created by dampened demand. In fact, what really hurts is the sluggish propertymarket and the holding back of projects by private developers. Some countries (for example,Japan) have tried to prime pump more public works into the construction market to alleviatethe downturn whereas some countries have done the opposite. Malaysia, for instance, havecut back on its major infrastructure spending which does not contribute to the productivity orperformance of the economy Public sector spending is forecast to fall by 12.3 per cent. Yet,the Malaysian government is trying to save the plunging property prices by boosting creditflows to the construction industry. All in all, it seems likely that the contribution ofconstruction to GDP will show a slight dip in the years ahead, quite contrary to what havehappened in the last decade, when most Asian economies concentrated ill building up itsinfrastructure (Fig. 3).


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2. HK, Chin.

14

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10 / - ,-

8

-+- I. Indonesia

2 +-----------------------------~ -8 Th.lland

o ~ - - - , - - - - - . - - - - , - - - - . - - - - . - - - - . - - - - ~ ~ - - - - - - - - ~

1980 1985 1990 1992 1993 1994 1995 199GJnequalscale)

CONTRIBUTION OF CONSTRUCTIONOUPUT TO GDP IN ASIAN ECONOMIES

Fig. 3 Sourceofinformation: ADB

Asia Showround

An overview of the effects of the financial crisis on the construction industry of specificAsian economies are given below:-

Peoples' Republic of China

China has a huge population (1.1 billion) and its construction investment stood at 1,515billion RMB (US$ 189 billion) in 1996. China has maintained its economic reform policyand open door policy, as a result of which domestic and foreign investments flourish. In therecent Asian financial crisis, China has faced increased competition from South-cast Asianexporters, whose home currencies have depreciated. Whilst the Chinese government isconfident that the RMB will not be devalued, it is taking "rapid, forceful and sensible"approach to ride through the crisis. It needs to keep up with economic growth to generatejobs for the millions of workers made redundant by the scaling down of non-profit makingstate enterprises. The construction industry alone employs 34 million people or 5 per cent ofthe total workforce. The crunch of the Asian financial crisis hit China most in terms offoreign investment. The withdrawal of credit by Japanese and South Korean banks in theregion has choked ventures in China. Foreign investors have turned cautious because theirhome markets are at stake. It has been reported that in the property sector, foreign jointventures are redirecting their marketing efforts to cash-rich local enterprises as the pool ofprospective buyers from other Asian nations dries up. High-tech development zones arelikely to slow down as US and European firms put their new investments on hold because ofthe crisis. Despite foreign investment being reduced by one-third, China's economy grew 7.2per cent in the first quarter of 1998, just a bit slower than the 8 per cent target set by thegovernment for the whole year. Recently, the housing reform in the pipeline has generatedsome potential for the private housing market as residential properties are becoming morecommercialised.


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Hong Kong, China

Having returned to its motherland in July, 1997, Hong Kong is still having an autonomouslegislature and free economy. Therefore, it deserves distinct mention here. Hong Kong has

predicted a 3.5 per cent growth for the year 1998, down from its 5.5 per cent forecast for1997. Tourism-related industries have been hit hard since the 1997 handover, followed byretail and property. Unemployment rate has surged to a record 14-year high of 3.9 per cent.With its strong foreign reserve and meticulous financial policy, Hong Kong dollar, which ispegged to the US dollar, has succeeded in withstanding speculators' attack in the midst of thecurrency crisis. Yet, the high interest rate being deployed to maintain the HK-US dollar linkhas taken its toll in that developers and potential home-owners alike find difficulty il l securingthe necessary finance. Coupled with the slump in stock market, property prices in residentialan commercial/industrial sector have fallen by 30-40 per cent and 20-30 per cent respectively.

In terms of workload in the construction industry, the Hong Kong Special AdministrativeRegion Government has promised a housing completion rate of 66,000 units per annum in thenext few years and an infrastructure spending of HK$240 billion (US$31 billion) in the nextfour years. In the private sector, some developers have slowed down their projects but theycannot postpone for long because they are bound by the terms of the land auction.Construction tender prices still keep on rising due to labour wage increases.

Indonesia

Up to the time of writing this paper, the future of Indonesia remains uncertain. It suffices tosay that this economy has been hit hardest by the financial crisis, forest fires and the recentriots. It is likelythat the development ofIndonesia will be held back for some time.

Before the crisis erupted, Indonesian economy grew 7.8 per cent in 1996 and expected ahigher performance in 1997. In the first half of 1997, approvals for domestic investmentprojects totalled US$26.4 billion whilst approvals for foreign investment projects totalledUS$15.5 billion. Many infrastructure projects such as toll roads, telecommunciation andpower generation were eyed by the private sector. Property development also accounted for53 per cent of the work volume.

After the contagion effect of the currency crisis spread to Indonesia, the fall of the rupiah hasled to scarce liquidity and high interest rates. In the property sector, 800 developers havebeen forced into bankruptcy and the jobs of two million construction workers have beenthreatened. Java's four provinces and south-east Suiawesi province suffer most in terms ofconstruction slowdown. Throughout Indonesia, US$35,000 million worth of developmentprojects have been put on hold, with the US$560 million Jakarta Tower being the mostnotable example because it was planned to beat Malaysia's Petronas Towers as the tallestbuilding in the world. Other projects pending review include bridges between Indonesia and

Malaysia, Java and Sumatra and Surabaya and Madura, all of which had been planned to easetourism bottlenecks. Yet, the exodus resulting from the riots upset all these plans, at least forthe time being. The riots also left behind about 5,000 damaged buildings, which can form asizeable workload for contractors when peace returns to the country.

Malaysia

Before the fmancial crisis unfolded, the Malaysian economy has been one of the strongest inSoutheast Asia with high growth [01 8 consecutive years. GDP growth in 1997 stood at & percent. Active participation of the private sector in infrastructure development was seen,alongside a surge in property and commercial developments. Bank lending supplied the fuelfor the overheated property sector.


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Malaysia (Cont'd)

When the erisis started to take toll in January, 1998 by driving down the Malaysian stockmarket and the currency (Ringgit), the government had to revise the growth forecast for 1998to between 2.5 and 3.5 per cent. Interest rates were raised (the Best Lending Rate is currentlyat 14 per cent) to stabilise the ringgit but this dampened business activities, in particular theproperty sector. Yet, due to a relatively low foreign debt and short term debt, there has beenno necessity for the country to seek IMF assistance and Malaysia has a very good chance ofsurviving the crisis.

Major cities such as Kuala Lumpur and Johor Bahru have an oversupply of office space,shopping space and hotel rooms but medium cost housing costing RMI50,OOOstill continuesto receive good demand. Upmarket residential properties like condominium and landedproperty costing more than RMI50,OOOhave a slow market due to banks' credit squeeze.

The Housing Developers Association of Malaysia recently carried out a survey amongst itsmembers on the effects of the credit squeeze on projects. Feedback from the 123 respondentsindicated that most of their projects under construction would proceed. Negotiations would

be pursued on a case by case basis with financial institutions for those projects with creditwithdrawn. The survey also showed that projects under planning would be deferred and asmall number indicated that they would convert their projects to more affordable categories.The public sector is also affected with many government projects suspended in an effort toreduce expenditure. Ultimately, this will see a significant reduction in construction demandin the near future.

The construction tender prices have become very competitive due to the dampened demandand a reduction in the prices of basic materials, which are in oversupply. The prices ofimported construction materials such as PVC and steel pipes, bitumen and aluminium, etc.have increased by 20 to 30 per cent due to lower ringgit against the US dollar. Yet, there isno fluctuation in labour cost.

Singapore

During the recent currency crisis, the Singapore dollar has got only modest devaluationcompared with other neighbouring Asian economies. Yet, the impact of the crisis can still befelt due to its close links with neighbouring countries, particularly Malaysia and Indonesia,Further still, S. Korea, being one of Singapore's top export markets yet in recession, hascaused Singapore to review its growth forecast for 1998to between 2.5 and 4.0 per cent.

In 1997, the construction sector in Singapore out-performed other sectors and posted a healthy13.3 per cent growth. Yet, since the government introduced effective measures to curb offexcessive heat in the property sector sinceMay, 1997 (before the onset of the currency crisis),the growth figure had actually dropped below that of 19.5 per cent in 1996. The Asian

fmancial turmoil has brought additional downward pressure on the private property market.Large developers are very cautious in taking up new investments. For example, the recentsale of a large piece of land in the Central Business District with buildablecommercial/residential area of over 1.3 million square feet did not attract any bid. Potentialbuyers of properties are mostly adopting "wait and see" attitude as they are not sure when thedownward trend is going to bottom out.

Overall, the construction sector is still expected to grow in 1998, mainly being underpinnedby public sector work. Projects in the pipeline include the NE Line of the Mass Rapid Transitand the Changi Line (leading to airport), the development of Jurong Island (a heavy-industrialestate) and the Punggol 21 (a waterfront housing estate). Singapore contractors have asignificant proportion of their workload coming from upgrading works of existing housing,


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Singapore (Cont'd)

which amount to 12 per cent of all public housing contracts valued at US$2.5 billion. Thatacts as a cushion.

In terms of tender prices and construction costs, a recent sample survey of contractors carriedout by KPK Quantity Surveyors (1995) Singapore Pte. Ltd. indicates the respondents'perception that increased competition will drive down tender prices rather than being pushedup by a weaker home currency. It is fortunate that Singapore imports construction materialsin roughly equal proportions from Asian sources and US dollar-denominated sources, therebycounter-balancing the adverse effects of currency fluctuations.

Thailand

Thailand, being the first country hit by the currency crisis, has more or less survived withpain. In trying to defense the Thai baht, its foreign reserve has dropped from US$38.7 billionat end-1996 to US$2.8 billion in July, 1997. Its banking and financial sectors have been

revamped following instructions from the IMF, which injected US$17.2 billion to save theThai economy. There is at least some signs of recovery.

Before the crisis, there was a lot of over-investments. When the crisis unfolded, the first Thaifirm ever to defalut on a foreign debt payment was from the property sector. Manydevelopers in the real estate industry became cash-strapped and faced a credit crunch whenbanks raised interest rates (above 15 per cent) and restricted lending The credit squeeze wasaggravated by the suspension of a large number of inefficient financial institutions. Manycompleted flats could not be sold since the land title deeds were used as collateral against theloans previously extended by these defunct financial institutions. As the economy has beendown and the property market being sluggish, almost all listed developers have declared netloss whilst the cost of interest remained high. Construction costs have also shot up by 3 percent as a result of an increase in GST from 7 to 10 per cent.

Almost all sectors of the property sector have over-supply situations. As at November, 1997,the take-up rate of residential property has dropped by 12 per cent. There was also negativetake-up growth for office properties. Rentals have fallen by 29.8 per cent by the thirdquarter of 1997. The only prosperous sector is "warehouse", which faces a scarcity oflandto build as most warehouse sites had been redeveloped during the boom.

Conclusion

So far, the financial turmoil has sustained different degrees of "damage" in Asian economiesand yet, there is one thing in common: the property sector is the most vulnerable. As shownabove, the demand for new construction in almost all Asian economies has been dampened,mainly because of less favourable investment environment brought about by the currencychaos and the high interest rates. Now, a lot of hope for revival depends on political stabilityand economic reform, which is already underway in several economies such as Korea andThailand. Economies which have stronger fundamentals such as Hong Kong and Singaporeare likely to lead the bounce-back after a period of adjustment but given the close linksamongst all their trading partners, a concerted effort is necessary to mitigate the effects of thefinancial turmoil and see daylight at the end of the tunnel.


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References

1. ADB (1998), Key Indicators of Developing Asian and Pacific Countries, Asian DevelopmentBank

2. CIDB (1997), Asia-Pacific Construction Report '97, Construction IndustryDevelopment Board, Singapore

3. IMF Interim Report

4. Proceedings of the AsiaConstruct Conference, Hong Kong Polytechnic University,November, 1997

5. Strait Times

Acknowledgement

Contributions from the Hong Kong, Johor Bahru and Shanghai offices of KPK Quantity

Surveyors in this paper are gratefully acknowledged.

Documents

Asian Financial Crisis - Paper