Where to expect a recovery in South-east Asia to start

Hamish McRae on the countries taking the lead

IT AIN'T the going down that matters; it is how quickly you come up afterwards.

The collapse of the East Asian economies is getting worse, not better, but you can begin to glimpse clear distinctions between those countries which are adjusting swiftly and those which are botching it. So there seems to be a new rule of thumb for analysts, fund managers, or any companies wishing to invest in the region. Don't spend too much time watching the fall because all the countries are in pretty much the same boat; instead, try to identify the scope for recovery, for that is where the real distinctions lie.

The first proposition is easy to demonstrate. Aside from Japan (which is in a rather different position) the two places with the highest GDP per head are Hong Kong and Singapore. They are the most advanced in economic terms. Both assumed that their very different level of economic sophistication would enable them to escape the regional contagion: they were not emerging economies, they had already emerged. Indeed, many people believed that Singapore would benefit from the regional crisis, as investment would hurry there in a flight to quality.

Wrong. Hong Kong has been hit by a loss of confidence following the Chinese takeover, particularly among the Japanese, which has damaged the tourist trade.

Singapore ought not to have seen a similar collapse, but it has. The result is shown in the graph on the left: domestic demand in both places started to turn down in the middle of last year and now is heading downwards with increasing speed. The figures are not directly comparable, for one is volume, the other value, but the similarity in the pattern is striking. Hong Kong looks like experiencing its first recession since the Second World War. It is perfectly plausible that Singapore will experience recession, too.

If you look at industrial production (right hand graph) a slightly different picture emerges. Thailand, where the crisis first became evident, has been heading south ever since the middle of last year. But elsewhere there was sufficient momentum to carry production upwards for several months. Output in China seems to have peaked around the turn of the year, and only recently has it begun to fall in any dramatic way.

All this would figure: retail sales will respond very quickly to any change in people's perceived circumstances. If we get scared, we stop buying. But industrial production inevitably lags. More surprising, though, is the fact that Thailand and Korea, the two countries at the bottom of the right hand graph, are now seen as the potential success stories of the region, the ones where recovery will take hold most strongly.

This is certainly the view of the International Monetary Fund, which has been impressed by the vigour with which these two countries have been applying reform programmes. You also pick up this view in the investment banking community. And if you want one modest endorsement of it among hard-nosed business people, well, note that Tesco is expected this week to announce that it will take a stake in Thailand's second largest hypermarket operator. Expect, too, foreign participation in the Korean industrial rescues which are now being put in place.

By contrast, Malaysia is not really putting together an integrated reform programme that is attractive to foreign investors, and Indonesia - well, it is very difficult to be anything other than gloomy until political change takes place.

So there is a clearly defined clutch of leaders, with Thailand and Korea in the vanguard, and a tail of laggards, with Indonesia obviously at the back. Hong Kong is a conundrum, for more than ever its future will depend on the attitude of China. Were it still a colony it would react as it has always done in the past: adjust to market pressures with speed and ferocity. But now the market signals may not be allowed to shine through.

At least we do have a clear picture of what is happening in Hong Kong. By contrast, we know very little about what is happening in mainland China. The last figures are now showing a sharp decline in output, but other numbers being published, most notably the foreign reserves, show no sign of crisis. Eventually, it will be possible to put together a picture and, in particular, make a better judgement on the likelihood of a Chinese devaluation which, if it happens, would change the balance of competitiveness in the entire region. But at the moment we are pretty blind.

Sifting through the available information - partly from published data, partly from first-hand anecdotal reports from people who have just returned - my instinct is to expect a big discontinuity in Chinese economic policy within the next six to nine months. Something is going to give. That something may just be the exchange rate, or it may be something more. But that is an intuitive judgement based on partial information, rather a thought- through verdict.

Meanwhile, expect a modest recovery of sorts to begin in both Korean and Thailand. It will not be marvellous; and any regional recovery risks being unseated by external events. The most likely of these is a rise in US interest rates, which would probably have occurred by now had the Fed not been concerned at the knock-on effect on the East Asian region. But it will signal the end of the slash-and-burn approach to rating the region: assuming because one country heads south that all the others will too.

As it has turned out that was the right approach to analysis in the downswing, for they did all head down pretty much together. But it will be the wrong one during the upswing, for they will head up at different speeds.

There is a bigger moral here. When there is bad news the best thing to do is panic: sell everything and don't try to be clever. When there is good news (as there will, in pockets, be from now on), be discerning: it is a time for applying judgement again.