EFFECTS OF THE FINANCIAL TURMOIL ON THE CONSTRUCTION INDUSTRY IN ASIA

Edward Tang & Patrick Lam

The Asia Miracle

Until recently, Asia has enjoyed an economic boom for nearly a decade. Various auspicious names have been dubbed for rapidly industrialising Asian economies, for example, journalists used to call Hong Kong, Singapore, Thailand, Taiwan and South Korea the "Five Little Dragons". Countries in South-east Asia also formed economic alliances to work hand in hand 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 of Malaysia has increased by fourfolds; Thailand by fivcfolds and South Korea by tenfolds in the last ten years. Hong Kong and Singapore have also surpassed developed economies in terms of GDP Per Capita. Figure I shows the transition of GPP Per Capita in several Asian economics in recent years:-

7. Singapore

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

The Bubble Burst

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

A crisis erupted when the Thai baht came under speculative pressure in July, 1997, when its current account deficit ballooned and its domestic lending activities went out of control. Loss of confidence urged the small investors to hedge their foreign exchange exposure, driving down Thai currency as they did so. Due to the interwoven trade relationship between Thailand and its neighbouring economies, a currency contagion was triggered, with ASEAN currencies 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 by speculators in tum. The once bullish developers suddenly found their loan servicing costs soar due to interest rate hikes as the various governments attempted to defend their home currencies. Bad debts and bankruptcies surfaced, and the chaos propagated like a falling pack of 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 had precipitated gradually since the boom started to build up a decade ago. Despite the hugh amounts of transactions taking place throughout Asia, the financial structure has not matured to cater for such volume and complexity Relatively speaking, Asian buinessmen are inexperienced in corporate risk management. They often trade under some sort of cartels and operate with a low level of transparency.

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~ As the bubble built up, the property and stock markets soared, attracting short term speculators and became overheated. Some economies had an over-reliance on pegged exchange rates. This resulted in the proliferation of foreign currency borrowing. Foreign funds flooded the Asian financial market, believing that the returns would be high. Many of the 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 Kong and Singapore, most Asian economies do not have strong foreign currency reserves, making them vulnerable to speculators' attack.

When the bubble burst, governments pushed up interest rates to dampen the overheated economies. 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 financial intermediaries. As the markets for foreign investment dry up, corporations have to downsize or even close down. Unemployment rate then soars. Most Asian economies have doubled their unempolyment rate since the emption of the financial crisis. Construction is one of the hardest hit sectors. For example, up to March, 1998, Malaysia alone has got 11,000 construction 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 indicated that 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's export, the construction industry in the developing economies of Asia suffers more from the downside 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, sheer increase in construction cost has not been evident in Asia so far because of the counteracting balance created by dampened demand. In fact, what really hurts is the sluggish property market 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 alleviate the downturn whereas some countries have done the opposite. Malaysia, for instance, have cut back on its major infrastructure spending which does not contribute to the productivity or performance 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 credit flows to the construction industry. All in all, it seems likely that the contribution of construction to GDP will show a slight dip in the years ahead, quite contrary to what have happened in the last decade, when most Asian economies concentrated ill building up its infrastructure (Fig. 3).

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1980 1985 1990 1992 1993 1994 1995 199GJnequalscale)

CONTRIBUTION OF CONSTRUCTION OUPUT TO GDP IN ASIAN ECONOMIES

Fig. 3

Source of information: ADB

Asia Showround

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

Peoples' Republic of China

China has a huge population (1.1 billion) and its construction investment stood at 1,515 billion RMB (US$ 189 billion) in 1996. China has maintained its economic reform policy and open door policy, as a result of which domestic and foreign investments flourish. In the recent Asian financial crisis, China has faced increased competition from South-cast Asian exporters, whose home currencies have depreciated. Whilst the Chinese government is confident 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 generate jobs for the millions of workers made redundant by the scaling down of non-profit making state enterprises. The construction industry alone employs 34 million people or 5 per cent of the total workforce. The crunch of the Asian financial crisis hit China most in terms of foreign investment. The withdrawal of credit by Japanese and South Korean banks in the region has choked ventures in China. Foreign investors have turned cautious because their home markets are at stake. It has been reported that in the property sector, foreign joint ventures are redirecting their marketing efforts to cash-rich local enterprises as the pool of prospective buyers from other Asian nations dries up. High-tech development zones are likely to slow down as US and European firms put their new investments on hold because of the crisis. Despite foreign investment being reduced by one-third, China's economy grew 7.2 per cent in the first quarter of 1998, just a bit slower than the 8 per cent target set by the government for the whole year. Recently, the housing reform in the pipeline has generated some potential for the private housing market as residential properties are becoming more commercialised.

Hong Kong, China

Having returned to its motherland in July, 1997, Hong Kong is still having an autonomous legislature 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 for 1997. Tourism-related industries have been hit hard since the 1997 handover, followed by retail 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 is pegged to the US dollar, has succeeded in withstanding speculators' attack in the midst of the currency crisis. Yet, the high interest rate being deployed to maintain the HK-US dollar link has taken its toll in that developers and potential home-owners alike find difficulty ill securing the necessary finance. Coupled with the slump in stock market, property prices in residential an 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 Administrative Region Government has promised a housing completion rate of 66,000 units per annum in the next few years and an infrastructure spending of HK$240 billion (US$31 billion) in the next four years. In the private sector, some developers have slowed down their projects but they cannot 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 to say that this economy has been hit hardest by the financial crisis, forest fires and the recent riots. It is likely that 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 a higher performance in 1997. In the first half of 1997, approvals for domestic investment projects totalled US$26.4 billion whilst approvals for foreign investment projects totalled US$15.5 billion. Many infrastructure projects such as toll roads, telecommunciation and power generation were eyed by the private sector. Property development also accounted for 53 per cent of the work volume.

After the contagion effect of the currency crisis spread to Indonesia, the fall of the rupiah has led to scarce liquidity and high interest rates. In the property sector, 800 developers have been forced into bankruptcy and the jobs of two million construction workers have been threatened. Java's four provinces and south-east Suiawesi province suffer most in terms of construction slowdown. Throughout Indonesia, US$35,000 million worth of development projects have been put on hold, with the US$560 million Jakarta Tower being the most notable example because it was planned to beat Malaysia's Petronas Towers as the tallest building 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 ease tourism bottlenecks. Yet, the exodus resulting from the riots upset all these plans, at least for the time being. The riots also left behind about 5,000 damaged buildings, which can form a sizeable workload for contractors when peace returns to the country.

Malaysia

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

Malaysia (Cont'd)

When the erisis started to take toll in January, 1998 by driving down the Malaysian stock market and the currency (Ringgit), the government had to revise the growth forecast for 1998 to between 2.5 and 3.5 per cent. Interest rates were raised (the Best Lending Rate is currently at 14 per cent) to stabilise the ringgit but this dampened business activities, in particular the property sector. Yet, due to a relatively low foreign debt and short term debt, there has been no necessity for the country to seek IMF assistance and Malaysia has a very good chance of surviving 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,OOO still continues to receive good demand. Upmarket residential properties like condominium and landed property costing more than RMI50,OOO have a slow market due to banks' credit squeeze.

The Housing Developers Association of Malaysia recently carried out a survey amongst its members on the effects of the credit squeeze on projects. Feedback from the 123 respondents indicated 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 credit withdrawn. The survey also showed that projects under planning would be deferred and a small 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 to reduce expenditure. Ultimately, this will see a significant reduction in construction demand in the near future.

The construction tender prices have become very competitive due to the dampened demand and a reduction in the prices of basic materials, which are in oversupply. The prices of imported 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 is no fluctuation in labour cost.

Singapore

During the recent currency crisis, the Singapore dollar has got only modest devaluation compared with other neighbouring Asian economies. Yet, the impact of the crisis can still be felt 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, has caused Singapore to review its growth forecast for 1998 to between 2.5 and 4.0 per cent.

In 1997, the construction sector in Singapore out-performed other sectors and posted a healthy 13.3 per cent growth. Yet, since the government introduced effective measures to curb off excessive heat in the property sector since May, 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 recent sale of a large piece of land in the Central Business District with buildable commercial/residential area of over 1.3 million square feet did not attract any bid. Potential buyers of properties are mostly adopting "wait and see" attitude as they are not sure when the downward trend is going to bottom out.

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

Singapore (Cont'd)

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

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

Thailand

Thailand, being the first country hit by the currency crisis, has more or less survived with pain. In trying to defense the Thai baht, its foreign reserve has dropped from US$38.7 billion at 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 the Thai 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 Thai firm ever to defalut on a foreign debt payment was from the property sector. Many developers in the real estate industry became cash-strapped and faced a credit crunch when banks raised interest rates (above 15 per cent) and restricted lending The credit squeeze was aggravated by the suspension of a large number of inefficient financial institutions. Many completed flats could not be sold since the land title deeds were used as collateral against the loans previously extended by these defunct financial institutions. As the economy has been down and the property market being sluggish, almost all listed developers have declared net loss whilst the cost of interest remained high. Construction costs have also shot up by 3 per cent 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 negative take-up growth for office properties. Rentals have fallen by 29.8 per cent by the third quarter of 1997. The only prosperous sector is "warehouse", which faces a scarcity ofland to 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 economies and yet, there is one thing in common: the property sector is the most vulnerable. As shown above, the demand for new construction in almost all Asian economies has been dampened, mainly because of less favourable investment environment brought about by the currency chaos and the high interest rates. Now, a lot of hope for revival depends on political stability and economic reform, which is already underway in several economies such as Korea and Thailand. Economies which have stronger fundamentals such as Hong Kong and Singapore are likely to lead the bounce-back after a period of adjustment but given the close links amongst all their trading partners, a concerted effort is necessary to mitigate the effects of the financial turmoil and see daylight at the end of the tunnel.

References

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

2. CIDB (1997), Asia-Pacific Construction Report '97, Construction Industry Development 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.