Back from the brink

02 July 2007 00:00  [Source: ICB]

IT WAS an acid bath for Asian chemical producers. The 1997 Asian financial crisis tested governments to maintain order as currencies devalued and asset bubbles burst, turning property and bank loans into duds overnight. Companies went broke, and mass unemployment and poverty ensued.

Petrochemical companies also suffered as regional demand for materials collapsed, forcing more debt-burdened companies to the brink of bankruptcy, with some falling into the abyss.

The financial malaise was not contained to Asia, but spread to the US, Europe, and the Middle East, depriving them of export markets as prices were slashed to compensate for a drop in demand.

"It was like experiencing two downturns in the cycle in one big hit," says a prominent trader based in Singapore.

What led the chemical industry in Asia to the brink started off as a result of strong demand and profitability experienced in the mid-1990s. Naturally, investment fever followed, with significant capacity expansions because of strong growth projections. Governments aggressively promoted the development of petrochemicals as a means to rapidly industrialise their countries.

Consequently, ethylene production capacity in Asia expanded by almost twice the global rate from 1992-1997, said a report by the Monetary Authority of Singapore.

It also turned countries into net exporters, rather than importers, causing a shift in the supply-demand balance. Competition intensified when the crisis gripped, as Thai and South Korean producers tried to liquidate inventories to grab much-needed foreign exchange because of their foreign debt exposures.

The flood of cheap petrochemicals created enormous problems later as Indonesian, South Korean and Thai producers faced cash shortages, forcing crackers to cut operating rates and feedstock supplies.

On a broader macro level, weakness in the financial and corporate sector in the region was not fully apparent because of a number of problems. These included: a lack of transparency and corporate governance pegged exchange rates that led to unhedged foreign borrowing inadequate foreign exchange levels and a lack of transparent information from governments.

But 10 years on, regional economies, and, for that matter, the chemical industry, are in much better shape. And the Asian Development Bank expects major economies in Asia to continue enjoying high growth. It is considered to be the world's highest growth region, with the lion's share of global trade and private financial inflows.

This is, in no small part, because of lessons learnt from the crisis. These have helped Asia to benefit from globalisation by coping with the risks of mobile international capital.

The countries most affected by the crisis - Thailand, South Korea, Malaysia and Indonesia - set about strengthening macroeconomic policy, overhauling financial and corporate sectors, and improving corporate governance and regulatory supervision. The latter includes strengthening shareholder rights, and raising accounting standards in tandem with international norms.

This was evident in South Korea, where the government and the corporate sector faced a dilemma of consolidating companies in industries as a result of debt financing and rocketing interest rates. It was not entirely successful, but worked for debt-laden Hyundai Petrochemical, which slid into bankruptcy but was saved by a consortium including LG Chem and Honam Petrochemical. The company later became two firms, LG Daesan and Lotte Daesan.

"Other companies survived through restructuring," says Thomas Yi, an analyst based in Seoul. "Others attracted foreign capital, such as Samsung Total," he adds.

Transparency is key

Thailand also set about aggressive restructuring plans. "Post-1997, Thailand has made a big thrust to improve transparency and governance," says Singapore-based Andrew Katz, global head of chemicals at Standard Chartered bank. "So they [Thai companies] are very careful to structure their business around these concepts and to make sure that any partnerships are done on a clear basis," he adds.

For example, PTT and its respective affiliates have made great strides to improve the structure of the company and its corporate responsibility to shareholders.

"The Thai restructuring has taken a long time but has been done very well," says Paul Hodges, chairman of London-based consultancy International eChem. "Now there are changes in the external marketplace that create a new set of challenges," he adds, in reference to the rise of the Middle East as a major commodity petrochemical player.

Other companies in Asia, notably in Indonesia, are still facing some difficulties. But, on the whole, southeast and east Asian corporates are on solid financial footing. For example, LG Petrochemical, Honam Petrochemical and Lotte Daesan are now in net cash positions, points out Yi.

Countries adopted flexible exchange rates to provide a cushion against external shocks, such as shifts in investor sentiment. That has caused foreign exchange reserves to be inflated, most notably by China and Taiwan. According to the Asian Development Bank, a sharp accumulation of foreign exchange reserves is a significant indicator of a heightened sense of caution following the impact of the crisis. Fiscal policies have also been adopted with gusto to manage or offset the damage that ballooning debt could have on an economy in trouble.

There are several areas that regional economies must cope with. This includes: volatile capital flows managing growth and changing trade and production patterns.

Officials in China, Indonesia, Thailand and other countries must deal with surges in capital, particularly outflows. These flows have become more volatile, with concerns about how inflows can put pressure on currencies to appreciate. The knock-on effect is that upward pressure on a currency provides funds to the financial sector, which, in turn, can lead to asset price bubbles. Funds can move out as quickly as in.

For example, last year, Thailand introduced capital controls because of a sudden inflow of hot money and the rapid rise in the baht, which fuelled an outcry from Thailand's exporters. Analysts were shocked by the draconian controls, which they said would deter foreign capital inflows and create doubts about Thai policy.

"During the financial crisis, a lot of people suffered from the devaluation of the baht, and it still makes people nervous today," says Supachai Watanangura, chairman of the Federation of Thai Industries and Petrochemical Industry Club. "But the country and its business leaders have learnt to manage exchange risk," he adds.

Asia also continues to rely heavily on exports to fuel domestic economies evident in the large current-account surpluses and high rates of export growth. But economists agree that domestic demand will be needed to ensure sustainable growth.

As Asia's share of global exports rises, sustaining high rates of export growth will become increasingly difficult. It becomes less about facing a regional financial disaster and more about coming to terms with the immediate challenge of relying too heavily on exports to China, particularly for South Korea and Taiwan.

"Many companies are on a firm footing but what happens next is critical, since most petrochemical commodity outfits are relying on China's growth either directly or indirectly," explains Hodges.

"China is setting up a lot of new capacity, such as ethylene, and there will come a point where it can supply its own growth needs."

It puts those export-dependent countries on fragile ground, and the Middle East will intensify the problem with its increase in production of commodity-based chemicals.

"Companies are predicting it [petrochemical output] will all go to China, but it can't," Hodges adds. That means a shake-out of players is expected, particularly those with a higher cost base.

But others in the region who are less dependent on the export markets are also worried. "Thai entrepreneurs will have to tighten their belts, cut costs, expand to other markets and move up the value chain," says Supachai. "The next three years are critical, as prices won't be as good as in the past, investment costs will be higher and the business risk greater," he adds.

Weak investment following the 1997 crisis is likely to continue in Asia. Governments adopted strong precautionary instincts that have rubbed off on the private sector.

This may bode well for some trying to weather the impending petrochemical downturn that is widely tipped to take place in 2010, but it may damage their long-term growth aspirations. Projects that were considered viable have been scaled back by many companies in industries in Asia, suggesting that companies are busy strengthening financial defences.

"We have found some evidence that investment has been affected by the perception of increased risk, even if, in many ways, actual risk has been reduced," said David Burton, director of the Asia-Pacific Department at the International Monetary Fund (IMF) in June.

The IMF has called on the region to strengthen the investment climate by improving corporate governance and legal frameworks, broadening financial systems, and enhancing macroeconomic policy frameworks to stave off financial crisis.

It is difficult to gauge whether another 1997-style crisis could grip Asia. A global bird flu pandemic or a nuclear stand-off with North Korea would make an impact, but commentators are more sanguine about the region learning its lesson from the past.

"Ten years after a major financial crisis, Asia is looking at the future with renewed confidence,'' said Burton.


The Asian crisis spread like a contagion from its inception when the Thai baht plummeted on 2 July 1997. Neither the IMF nor the US Treasury saw any threat. But history shows how Malaysia, Singapore, Indonesia, Hong Kong, the Philippines, Taiwan and, finally, South Korea fell like dominoes.

What hit Singapore hard was not exposure to foreign debt but its trade and financial links to parts of southeast Asia. The city state is well known for its large pool of private savings through compulsory pensions and its budget surpluses, but this was not enough to insulate itself.

Singapore trades extensively with its neighbours, including Japan and China. Singaporeans had also invested in stocks and property in the region. It suffered when financially crippled Asian countries drastically reduced their imports.

So how did the government respond? Initial measures underestimated the crisis. These included income tax rebates and tax incentives to business. But during 1998, the government introduced a bigger package worth $2bn (¤1.5bn). This further reduced business costs, rebates on rental of office space warehouses, plus a reduction on power and port charges.

Further measures included boosting education and training of workers, and upgrading some sectors of the economy. This included chemicals. The government targeted Jurong Island as a petrochemicals hub, as part of its infrastructure development. It realised it had to invest its way out after 1997, and identified industries that were key to its success.

"This sent a strong signal to the chemical industry," says Julian Ho, Singapore's Economic Development Board executive director of energy, chemicals and engineering services. "We never wavered in our commitment to the industry," he adds.

Although it would be difficult to protect oneself from a regional economic and banking crisis, Singapore is trying to minimise the industry's exposure to the cycle.

"We are in a sort of transition. We are growing our commodity chemicals to a point of critical mass and moving to lower volume, value added chemicals," notes Ho.

The idea is to develop research and development (R&D) capabilities and push for innovation, which will eventually lead to products that create value. This may reduce volatility associated with commodity-based petrochemicals.

China has also stepped up a gear by using domestically sourced materials and products, reflecting its intention and ability to increase production capacity using more advanced technological capability.

But the key is to make an economy flexible, competitive and as responsive as possible to mitigate external economic and financial risk. This stems from improving education, developing capital markets, a flexible labour pool and fiscal measures.


THE 1997 crisis could have provoked panic at BASF, but a calm determination to stick with its partners in the region paid off

"Asian crisis? What Asian crisis?" might be the response from some of you in view of today's booming economies in China, southeast Asia and the recovery in Japan. The tiger economies are back after the financial turmoil in 1997, and are now rivalling the US and Europe in terms of growth.

Ten years ago, I was stationed in Hong Kong as president of BASF's east Asia division, when the first cracks started to appear in the various economies. At this time, many foreign companies started to put the brakes on their capital expenditure projects, but we did not let the panic in the market unhinge our forward-looking plans to invest in the region, in particular in China.

Between 1990 and 2005, we invested, with partners, ¤5.6bn ($7.5bn) in Asia. Projects included our Verbund sites in Kuantan, Malaysia, and Nanjing, China - the latter being the largest investment in our company's history. We operate these sites as joint ventures, and I know that our respective partners, Petronas and Sinopec, still appreciate that we remained committed to the region even during difficult times.

Over the past few years, Asia-Pacific has established itself as one of BASF's key four regions, not only in terms of sales, but also in earnings. We are starting to reap the benefits of our decision to stick with our investment plans in the 1990s, and it won't stop there. Between 2006 and 2009 we intend to invest more than ¤1bn in further projects, including the expansion of the Nanjing site. Our ambition to be successful in the region is summed up by our goal to achieve 20% of group sales and earnings in our chemical businesses in Asia-Pacific by 2010.

My first-hand experience of the Asian crisis also taught me the importance of being patient in business. A famous Chinese proverb says: "With time and patience, the mulberry leaf becomes a silk gown. BASF's patience has definitely paid off."


While petrochemical players across Asia extol the virtues of moving up - or down, depending on which way you view it - the value chain to minimise any potential slump in the cycle or broader economy, it is no easy task to achieve.

From Thailand to Taiwan, executives have talked about the need to add value. But Singapore-based Andrew Katz, global head of chemicals at Standard Chartered bank is prepared to burst a few bubbles.

"It's tough to move down the value chain without having local demand for these [value-added] products," he explains. Plus, the further you venture into specialty and value-added products, the more problems you face in terms of access to technology, he says.

"You also start bumping up against the big integrated players such as Rohm and Haas, Dow Chemical and BASF. And it takes a huge amount of investment across a substantial number of products to offset the massive petrochemical commodity business," he says.

What the industry should worry about is not if another broader financial crisis will emerge but how it will steer through the impending chemical downturn.

"I am not convinced they [commodity petrochemicals] will all survive the next downturn if it is prolonged,'' says Katz. ''But there is a different management mentality compared with pre-1997. This could give some a sporting chance.

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