MASSIVE DEBT, BAD LOANS BROUGHT GROWTH TO A HALT.

Byline: Deborah Adamson Daily News Staff Writer

Gleaming Mercedes-Benzes wait patiently in traffic beneath the soaring skyscrapers of Makati, the financial district of Manila, Philippines.

Executives chat over cellular phones, holding onto laptop computers as they weave through congested sidewalks filled with pedestrians, vendors and beggars. There's a mix of affluence and poverty, of modern technology and the old ways: Cybercafes are in the same city as shanties made of wood and cardboard.

Manila is a Third-World city, not unlike the major cities of the Southeast Asian tigers of Thailand, Malaysia and Indonesia. They have prospered, thanks to rapidly growing economies and massive amounts of foreign investment pouring in over the years.

But that was then, this is now.

Held in awe for years, the Far Eastern ``miracle'' economies are landing with a thud. Massive bank debt, unwise loans, inadequate financial controls and deep currency devaluations first felled Thailand last summer and spread to Indonesia, Malaysia, the Philippines and South Korea. Japan and Hong Kong felt the tremors, as did Europe and the United States.

``Thailand is a disaster. Indonesia needs to restructure itself. Without these changes, it will be a basket case. (South) Korea is in the toilet,'' said Bill Davidson, former USC management professor and president of Mesa Research, an international business issues research firm in Palos Verdes.

How it started

The ``Asian flu,'' ironically, stemmed from the success of its nations.

Their growth rates were astounding: From 1992 to 1995, developing Asian countries had an average real gross domestic product growth above 9 percent.

That's well over their recent historical averages and probably unmatched by any group of similarly sized economies, according to a report by the International Monetary Fund in Washington.

The developing nations in Asia identified by the IMF include China, Indonesia, Malaysia, Thailand and the Philippines.

Among newly industrialized Asian nations, such as Singapore and South Korea, annual output growth reached 7.5 percent in 1994 to 1995.

Asian trade growth was equally impressive, the IMF report said.

Investments pour in

In the first half of this decade, international investments flowed into these countries. By the end of 1996, U.S., Japanese and European banks lent a total of $736.6 billion to China, Hong Kong, Indonesia, South Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand and Vietnam.

Almost 80 percent of the money came from Japan and Europe.

Other capital came from mutual funds and other investors.

From the early to mid-1990s, investors flocked to Asia because investment returns in other parts of the world weren't as good. The United States, for example, was recovering from a recession and interest rates were low.

Ties to the U.S.

But Southeast Asia started unraveling in mid-1995.

Since their currencies were tied to the U.S. dollar, they started appreciating as the dollar gained strength in an improving American economy.

Tied to the U.S. dollar?

Local currencies are backed up by a certain amount of ``hard currencies'' - such as the U.S. dollar or Britain's pound sterling that are easily accepted worldwide. That way, if needed, a country's Central Bank has the reserves to buy back its own money with currency accepted everywhere.

Most Asian countries are linked to the U.S. dollar. With this link, a country can more easily set a fixed value for its currency - such as 30 Philippine pesos to the dollar - which will help its exporters. When the dollar rises or falls, so does the local money.

Ties that bind

So why did that hurt the Asian countries? With a stronger dollar, their products became more expensive and it affected their worldwide exports and growth.

At the same time, according to the IMF, the overall export market started to slow down - industrialized nations weren't importing as much, there was a glut in the global electronics market and a slowdown in Asian growth itself. As such, these Asian nations experienced a decline in export revenues in 1996.

Inflation soars

In the 1990s as well, rapid growth had led to high inflation. Prices of real estate soared. For instance, a modest apartment in a good area of Seoul cost $2 million.

Businesses continued to borrow heavily, preferring foreign loans - channeled through local banks - because interest rates were lower than borrowing in their native currencies.

Between 1992 to 1995, business borrowing in Thailand, Malaysia, Indonesia and the Philippines accelerated sharply.

For example, in Thailand, private sector credit rose from 20 percent in 1992 to 30 percent in 1994, then drifting down to 24 percent in 1995, the IMF said.

At the same time, foreign debt at its commercial banks grew from $5 billion to $46 billion - rising from 6 percent to 24 percent of total liabilities.

Burdened by debt, these nations were increasingly vulnerable to a shift in investor sentiment.

Financial sectors

There was one more weakness the Asian countries weren't addressing: Financial sectors.

Financial institutions were not adequately regulated and supervised. They had limited experience in managing risk and there were lax internal controls. Cozy relationships with some companies and corruption also led to unwise lending.

As business slowed down, companies with large loans became at risk of defaulting. Banks that lent to them became vulnerable as well.

This was the situation in South Korea. Large corporate conglomerates called chaebol - already mired in debt to fund expansion of their businesses - ran into financial difficulty when business slowed down and they couldn't meet their debt payments.

At first, the banks unwisely extended them more credit, often at the behest of the government. But this policy would soon backfire.

The shoe drops

In early 1997, investors became increasingly concerned about problems in Asia.

They started tightening credit - a danger to countries heavily dependent on short-term capital inflows.

Thailand, Indonesia, South Korea, Malaysia and the Philippines had substantial short-term loans. Of the five, Thailand had the most exposure.

Other east Asian countries such as China and Vietnam weren't as vulnerable since they had more long-term borrowings and direct investment from foreigners such as equity capital, where investors own shares of a company. These kinds of capital can't be pulled out easily if investors became nervous.

Thailand gets hit first

In early 1997, commercial banks, investment banks, mutual funds and domestic investors, among others, started short-selling Thailand's currency, the baht. That's because they expected the baht's value to fall, given Thailand's problems.

With many sellers and few buyers, the value of the baht indeed weakened. On July 2, the government abandoned its fixed exchange rate policy and let the baht float.

Under a fixed policy, the government would set an official exchange rate. But once the real market value of the baht started to fall, the government couldn't justify and support its official rate. By floating the baht, the currency was allowed to adjust to its true value in the market.

The baht crashed. It has lost 41 percent of its value, down to 54.25 baht per dollar Friday.

The crisis spreads

After Thailand, the Philippines, Malaysia and Indonesia started to totter as investors saw the same problems in those neighbors.

Residents of these nations with plenty of foreign debt started selling local currency and buying up foreign money to hedge their loans.

By mid-October, currency values against the dollar dropped by 30 percent for Indonesia and Thailand and 20 percent for Malaysia and the Philippines.

With weaker local currencies, the foreign debt these countries owed ballooned. For instance, it took about 30 Philippine pesos to pay off $1 of debt a year ago. Today, it would take around 45 pesos to repay the same $1.

Japan, a developed nation mired in recession, took a hit as its bankers faced mounting bad loans. They had been a major lender to these Asian nations.

In Hong Kong, interest rates rose to buoy the value of the Hong Kong dollar. But the Hong Kong stock market is dependent largely on real estate values, which are highly sensitive to interest rate increases. That was a key factor to the 10 percent drop in the Hang Seng Index on Oct. 23.

Already facing high valuations, the U.S. stock market reacted to the Hong Kong market decline by plunging by 550 points (or 7 percent) on Oct. 27, 1997.

Asia scrambles to stem problems

The cleanup in Asia has begun, often as a condition for receiving billions of emergency loans from the IMF. As of December:

In Thailand, 56 finance companies overburdened with bad loans were closed and interest rates raised in an attempt to stabilize the currency.

The Philippine Congress approved a tax reform package in hopes to stimulate business.

In Indonesia, 16 banks with bad loans were closed and others placed under supervision.

Malaysian authorities launched a program to cut costs and slow down infrastructure spending.

In South Korea, 14 banks were suspended, the interest rate ceiling was raised and measures were taken to liberalize financial markets to make it more market-driven and less susceptible to political intervention or corruption.