Financial Journalist

Benchmark, Fourth Quarter 1999

By Gerry O’Kane

London, Friday December 31, 1999: 17.10pm: James Bufton-Tufton, head dealer at Securities 2000, looks panicked as a call light begins flashing on his desktop satellite phone - it’s the satellite line from Jakarta. The office stops. He reaches across and flicks the switch, “Yes.”

“Hidiyat, here in the Jakarta office,” says the voice. Bufton-Tufton says nothing and listens intently. He drops the receiver, it’s left dangling like a bungee chord from the desk, then turns to a colleague.”Call New York, dump all the ADRs we hold in PT Indosat, sell our Indonesian WEBs (world equity benchmark shares) and see if we can’t offlay our holding in that Hamon Asian Market Leaders fund. Jump to it!”

Other dealers start scurrying to their phones calling New York: which fund house has the biggest exposure to Indonesia, which companies are owed money by Indonesia, who are the multinational Indonesian partners; is it Deutsche Telekom or Cable & Wireless? Sell, sell, sell. Oh and by the way dump a pile of Japanese industrial stock. They depend on Indonesian oil don’t they?

Fiction? Not entirely. Firstly, at the cusp of the year most banks and financial houses will be staffed watching for any fallout from the so-called millennium bug, also known as the Y2K problem. Many staff will be issued with satellite telephones in case national phone networks fail. And while PT Indosat may be fully Y2K compliant, even the World Bank has expressed concerns about the overall readiness of Indonesia. After all, they’ve had to put down manic civil unrest, elect a new leader and vote on the independence of East Timor - Y2K’s not been at the top of the agenda. Telecommunications companies are particularly open to systems failure, with devastating knock-on effects.

What is certainly true is that the consequences of any technology failure due to the millennium bug are likely to create ripples throughout global markets. No single Y2K problem is likely to bring a company to a prolonged standstill. On the other hand as it faces an accumulation of failures, including those imported from non-compliant vendors or clients, the company could face serious difficulties.

What to Look for
What should investors be examining? There are several distinct effects of the Y2K bug:
# the markets’ perception before January 1;
# the market effect of failures on investors’ perceptions
# and the economic impact of Y2K failures.
Already Goldman Sachs, a US investment bank, has estimated that the average Gross Domestic Product (GDP) of the OECD countries will fall by 0.6 per cent next year because spending on sorting out the Y2K problem will be curtailed. Even before anything’s happened experts are warning of a drop in growth for the world’s biggest economies.

In August, Credit Suisse Private Banking found that its clients saw Y2K as a threat and were considering shifting asset allocations in favour of cash and away from emerging markets and smaller company stocks. (In the UK, US and especially emerging markets, smaller companies are viewed as the most likely to fail).

Credit Suisse ranked the United States as the best prepared for Y2K, followed by the European Union, Switzerland, South Korea, Japan, Singapore and Hong Kong. However, it lambasted Eastern Europe and the emerging markets of Asia. It named Russia, Brazil, Taiwan, Mexico, Malaysia, India, Thailand, Argentina, China and the Philippines as being in a “danger zone.”

The Y2K problem is the legacy of the way computers were designed in the past. From as early as the 1950s computer engineers tried to save on cost. Memory was expensive and has remained so until the 1990s. To save memory these engineers stored dates with two digits - DD/MM/YY. The problem arises because some systems will recognise January 1, 2000 as the year 1900, making any data relying on dates prone to error. There is no single solution; every chip, every date-relevant coding in programs has to be checked and repaired. And this includes simple chips embedded in products such as microwaves and car engines.

Much of the argument in Asia is that: “it won’t affect us, we don’t have as many computers as the West”.

“This is a global problem affecting not only industrial countries which are highly dependent on computers but developing countries as well,” says James Bond, director of the World Bank’s Energy, Mining and Telecommunications Department and co-ordinator of Y2K grants to developing countries.

“While wealthy countries and large companies have the money and skilled technicians needed to immunise computers and their operating software from the millennium bug, many of our developing country clients cannot muster the resources to tackle a problem that most see as a vague and distant threat,” says Bond.

A Matter of Priority?
Therein lies much of the problem. The emerging economies, not only in Asia but in Eastern Europe, South America and Russia, have had two years of financial trauma. Resources that could have been used to tackle the Y2K problem have evaporated. In addition, there is a lack of resources to pay for compliance and the emerging markets also have a serious dearth of skilled engineers to tackle the problem. But not all financial managers agree with the fears for the emerging markets. Templeton’s Mark Mobius is one such optimist.

“By mere virtue of them being in emerging or undeveloped markets, telephone companies, utilities and banks are not as dependent upon computers and full computerisation as are the developed country companies. The developed country companies have far more complex systems which can more easily be thrown out of kilter than emerging market companies,” says Mobius, manager of one of the world’s largest emerging market funds, the Templeton Emerging Markets fund.

Mobius also argues that those firms which are computerised have more modern machines which were already Y2K compliant.

“The management of emerging market companies face crises on a daily basis (blackouts, brownouts, government intervention, corruption, etc.) and are thus better prepared to handle crises as compared to their developed company counterparts who are not confronted with these problems on a daily basis. Given these reasons, we don’t think that the telephone companies, utilities and banks in emerging markets will be any worse off than their counterparts in developed markets and, in fact, may be in a better position on January 1, 2000,” he argues.

It is not a view technology research companies take, especially since about 98% of installed business software across Asia is illegal and not eligible for official software patches.

“About 35% to 40% of businesses in Asia are expected not to be Y2K ready by December,” Dane Anderson, vice-president for computing systems research, IDC, told an industry meeting in Bangalore earlier this year.

This echoed an earlier study by the US State Department of 161 nations. It found that about half of the countries face a medium-to-high-risk of Y2K computer breakdowns in their telecommunications, energy and transportation sectors. It believes the impact on international trade could create serious problems.

Domino Effect
Examine the PT Indosat scenario: should much of the phone network within Indonesia fail it could take months to fix the problem. As a stock holder of PT Indosat you could be looking at months of negative expenditure and that ignores possible legal ramifications. As a holder of an Indonesian fund any slide in telecom giant PT Indosat’s share price (Indonesia’s largest company) could drag down the index, quite apart from the direct effect of weak communications on companies’ businesses.

Oil producers may find production slowed because they are unable to communicate with suppliers easily, delaying and reducing sales to Japan. Japan goes elsewhere for oil paying an increased price which boosts manufacturing costs met by hiked retail prices. Inflation goes up, the yen gains value against the dollar and so the dominoes keep falling.

This interaction of economic and financial elements cannot be underestimated, especially on the scale it may hit in January. It was the “discovery” of a high level of debts in Thai banks that began the economic crisis in Asia in 1997 and brought down relatively developed economies such as Hong Kong and Singapore. In 1996 when Singapore listed Creative Technologies announced a loss (after three interim reports had already laid out the figures) it dragged down all of Singapore’s electronics stocks. Since the electronics sector was the flavour of the year, the Singapore index fell by 11% in less than 24 hours.

The interaction of the markets shows how badly investments could suffer should something go wrong. The argument throughout most of Asia and South America is that nothing will go wrong. But even the ever-independent Malaysian system is worried. In July Ali Abul Hassan Sulaiman, governor of Bank Negara Malaysia, the Malaysian central bank, told newspapers that despite the majority of critical financial systems reaching compliance in a June test, business would be suspended as a precautionary measure over the New Year. And note the word ‘majority’. Malaysia has also received US$100m to help in Y2K compliance from the World Bank.

Indeed the World Bank has warned of catastrophes in some markets. Bond at the World Bank points out that in a Bank survey at the beginning of 1999 of 139 developing countries only 32 had initiated a national compliance programme. A further 21 were taking concrete remedial steps to safeguard their computing systems, 42 reported awareness of the problem but were not currently taking action and 43 did not respond. The Bank warned that the mere existence of a national Y2K action plan should not be taken to imply that countries will be fully Y2K compliant by the end of 1999.

In the US, managers at mutual fund company T. Rowe Price officially admitted that they have been reviewing Y2K compliance efforts of all the companies whose shares are held in their stock mutual funds. Of the 500 American companies examined, 20 have been put on a watch list and several were sold.

Not Just Equities
The effects of the Y2K problem are however not just limited to equity investments. There are consequences for global growth and the bond markets too. Merrill Lynch’s “Y2K Fixed Income Investor Survey” polled more than 100 firms and found that uncertainty over cash flow may prompt investors to sell corporate bonds and other riskier securities.

While this was only a survey and US analysts always seem to have a vested interest in promoting the US as a safe haven, already US Treasury Bills (bonds) which mature in the first week of January have gone up in price. Investors, unwilling to hold what they consider risky securities and needing cash flow early in the year, are pushing January bond prices up. Others are noticing and companies are selling asset-backed securities and corporate bonds early before the flood of sales some believe will happen. Paul Jablansky, head of research in this sector at investment bank Salomon Smith Barney predicts that as much as US$20 billion could be added to the normal sales of asset-backed securities in the third quarter of 1999.

Stocks that Benefit
Other effects on equities are expected even before 2000, with analysts predicting price benefits for shares dealing in foodstuffs and technology consultancies, while non-US or non-European airlines, were likely to suffer price collapses.

A look at the macro-economic effect of Y2K problems is even more daunting. Gartner Group, a computer consulting firm, has ranked country readiness between one and four, four being most prepared. China, Thailand and Indonesia all rated one. Malaysia, India and Argentina rated two. An analysis by Goldman Sachs calculated each nation’s IT capital, also as a percentage of GDP. The countries most at risk from Y2K are those with large IT capital stock but little effort in fixing the bug.

By using both Gartner’s and Goldman Sachs’ figures you could more clearly view the risk of each country. China, Thailand and Indonesia’s GDP dependent on IT was 4.1 per cent, 5.5 per cent and 7.7 per cent, respectively. For Malaysia, India and Argentina it was 10.2%, four per cent and 14.4% respectively. While few would say all IT systems will fail, Y2K problems could certainly knock a few percentage points off growth in one fell swoop.

Should this happen debts will grow again and fears of default will re-emerge probably pulling down the markets and economies of the West. BENCHMARK is not saying market Armageddon has arrived, but that investors ought to be examining their financial options based on “sell high, buy low”.

With many developed markets at or near all time highs and many emerging markets (especially in Asia) sporting considerable gains this year, it seems that the markets are not fully discounting any nasty shocks on New Year’s eve when the world’s investors will be partying the night away.

The Y2K Investment Bomb, Asia