The Asia-Pacific economic crisis is hurting many of the region's producers, but those able to weather the storm will emerge more competitive than ever

by Ali Malassu

A change of scenery for Asian producers

The turnaround in the economic fortunes of most Asian countries last year can only be described as dramatic. At the start of the year growth rates were still exceptionally high compared to other world regions, but as the year progressed Asia-Pacific countries began to show signs of an economic slowdown. The economic crisis which followed is still making headlines and its effects continue to be felt around the world.

The drama has had a substantial impact on paper consumption in the region and on the global pulp and paper industry. Paper and paperboard consumption totaled 88.8 million tons in the 12 largest consumer countries in Asia-Pacific in 1997, up by three million tons, or 3.5% from 1996
(Figure 1). In 1998, it is estimated that the total Asia-Pacific paper and paperboard market will fall by one million tons - the first decrease since 1981 - as a consequence of the rapidly deteriorating economies and purchasing power.

For the time being at least, the one safe house for paper and paperboard demand in the Asia-Pacific region is China and it is expected to drive the Asian pulp and paper markets in 1998. Most other countries in the region will see paper consumption decrease on an annual basis.

There is always the risk, however, that in the prevailing downturn Chinese market growth could falter. This would lead to a significant melt-down of the regional markets with unpredictable repercussions on the global scene.

Exchange rate changes have caused significant changes in trade flows and market structure. Due to improved cost-competitiveness and aggressive pricing, export-oriented companies have been able to increase their sales and operating margins. On the other hand, domestically oriented companies are suffering from weaker domestic demand, resulting in decreasing sales and profitability.

The largest paper and paperboard producers in Asia-Pacific region outside Japan are Asia Pulp and Paper (APP) and Hansol Paper, followed by Siam Cement (Figure 2).

These companies are also among the largest paper exporters in Asia and they have substantially increased their exports in late 1997 and in 1998.

The largest paper manufacturers in Japan are Oji Paper, Nippon Paper Industries, Daishowa Paper Manufacturing and Daio Paper.

But as a consequence of the ongoing wave of pulp and paper industry restructuring, ownership changes and divestments and new investments, the main Asia-Pacific producers may look somewhat different in the medium term.

Balancing act

The changes in demand and supply balances will also have an impact on international trade flows. A likely scenario could include:

• Decreasing imports of newsprint to Asia as the product is increasingly substituted by domestic paper. Newsprint exports from Asia-Pacific to the USA's west coast will grow, at least in the short term.

• Falling mechanical printing paper imports in Asia due to substitution by domestic coated woodfree paper and Japanese bitokoshi paper.

• Domestically made woodfree paper replacing foreign imports and an increase in intra-regional trade. Indonesian uncoated woodfree paper quality has so far been inadequate for the western markets, but the quality is improving. Moreover, exports of converted stationery products such as note pads from Asia to the west will increase.

• An increase in coated woodfree paper exports from Japan and Korea to the USA, at least in the short term.

• Unbleached kraftliner being increasingly substituted by domestic recycled fiber-based linerboard, and consequently decreasing imports from North America in the short term.

• Regional cartonboard supply outstripping regional demand, and consequently changing the trade balances in certain cartonboard grades. High-quality virgin fiber-based cartonboards will continue to be imported from the west, while imported white-lined chipboard will be increasingly substituted by domestic equivalents.

• Declining sack paper imports from overseas, mainly from North America, as a result of the decreased construction activity in Asia. Imports from Asian sources will be less affected.

• Regional supply imbalances and increased export pressures due to new tissue paper capacity in certain areas.

Favorable business conditions throughout the past decade and expectations for continued demand growth exerted a strong influence on investment decisions in Asia. The pulp and paper industry was no exception. In late-1997, confirmed investments in Asia's paper and paperboard industry from 1995, totaled 22 million tons/yr, representing some 50% of the total committed capacity increases in the world. The present economic instability and increasing scarcity and cost of capital in Asia has led to significant re-adjustments in the region's pulp and paper industry investments.

Chemical market pulp consumption is expected to increase. Several bleached hardwood kraft pulp (BHKP) projects in Asia have been postponed or cancelled, and this is gradually easing the threat of regional overcapacity. But still regional BHKP exports from southeast Asia are expected to increase.

In line with expanding capacity and the slowdown in demand growth, net imports of paper and paperboard have decreased from 7.9 million tons in 1996 to 6.9 million tons in 1997. The demand in the Asia-Pacific region is expected to decline further in 1998, while production will increase with some new paper machines starting up. Viewed in this light, net imports are expected to decline to three million tons by 2000 (Figure 3).

The above forecast is based on the following assumptions:

• Most of the decided projects will materialize in the coming years. With reasonable operating rates domestic production will replace some imports from the west.

• Demand growth in China will not be as fast as it was during the first half of this decade.

• China will remain relatively self-sufficient in paper and paperboard, despite the significant number of closures of non-wood pulp and paper mills in the country over the past two to three years. Recent paper machine installations and increasing imports of market pulp should safeguard the market.

The current economic crisis is expected to have little impact on long-term demand growth projections. It is estimated that net imports will increase to 8-9 million tons by 2010.

Restructuring accelerates

The Asian crisis is expected to accelerate restructuring and consolidation of the Asian pulp and paper industry with the smallest and most inefficient mills being shut down and viable production units being merged into stronger financial entities. Domestically oriented, small and inefficient mills will seek to establish a market niche, while modern, export-oriented and large mills will tend to concentrate their efforts on producing commodity products for global markets. Concentration on key business areas with a sustainable competitive position is expected to gain momentum in the near future.

The number of bankruptcies has increased, especially in Korea. Mergers and acquisitions as well as divestitures and spin-offs of existing assets, such as power and chemical facilities, will continue throughout the region.

International involvement in the Asia-Pacific pulp and paper industry will increase. Indonesian and Korean companies, in particular, are actively searching for western partners. The key drivers for western companies to invest in the Asia-Pacific region include the desire to expand and get a foothold in a growth market, the availability of inexpensive assets and economic liberalization and relaxation of ownership codes. Several western companies have already acquired, or are in the process of acquiring Asian companies.

The most important consequence of industrial restructuring will be increasing internationalization of the Asian paper industry. This will change the operating environment for the region's companies, exposing them more to international markets, including the financial markets. After the crisis, Asia-Pacific companies will become more established and competitive players in the world's pulp and paper industry.

Low cost

The near-term implications of Asian economic turmoil include a negative impact on the growth of pulp and paper demand, while depreciated currencies have translated into a significant cost advantage for Asian pulp and paper companies. Many Asian companies are now looking at the opportunity of using their new cost competitiveness to expand their presence in export markets through aggressive pricing.

Changes in exchange rates will have an immediate impact on labor and domestic wood costs, while fuel and chemical costs will be less affected due to US dollar-denominated supply. As far as energy and chemical costs are concerned, the impacts of devaluation vary from country to another, depending on the need and desire of the respective governments to pass on price increases.

The full advantages of devaluation on manufacturing cost levels will be short-lived, though, as prices of key raw materials readjust to a new equilibrium. All unit costs are expected to increase in the medium term, eliminating part of the competitive advantages gained in the short term. For example, the short term effect of the devaluation on manufacturing costs for Indonesian market BHKP producers is a 40% decline from an average level of $210/ton to $125/ton (Figure 4).

In the medium term, after allowing for adjustments in input prices, the manufacturing cost level would settle around $160-165/ton. Even so, this would still be some 20-25% lower than the pre-devaluation manufacturing cost level.

The major Asia-Pacific producers are among the cost leaders in the BHKP market as well as in uncoated woodfree paper deliveries to Europe, based on C/F prices to European ports. At the same time the major Asian companies have significantly lower landed costs on the domestic Asian markets compared to western newsprint and linerboard suppliers. Domestic companies are expected to retain their strengthened market position in Asia in both the short and the medium term.

Currency depreciation has taken its toll, however. It has had an adverse effect on capital costs, and companies with high levels of leverage have faced increasing difficulties when seeking to refinance. The debts of most Asia-Pacific pulp and paper companies are denominated in either US dollars or Japanese yen and this has made the companies highly dependent on the international financial markets.

Due to improved cost-competitiveness and aggressive pricing, export-oriented companies have been able to increase their sales and operating margins. Domestically oriented companies are suffering from weaker domestic demand, resulting in decreasing sales and profitability.

Leap of faith

Asia-Pacific pulp and paper markets and industry are going though a very sensitive readjustment phase, and it is more important than ever to carry on intensive monitoring of the sector. Short-term risk factors need to be weighed up against the longer term fundamentals and development potential of the region.

Generally, large producers with established export sales and strong financial backgrounds are expected to benefit from the crisis, whereas highly indebted companies with weak financial backing or those with small and inefficient mills and domestically oriented sales are at risk (Figure 5).

For international companies, the current situation provides an opportunity to establish or strengthen operations in Asia-Pacific and it is expected that their involvement in the region's pulp and paper industry will increase in the near future.

The fundamentals for long-term economic and pulp and paper industry growth in the region still exist. Once measures to stabilize, restructure and liberalize the region take effect, economic growth as well as a rise in pulp and paper consumption should start. And from the crisis, Asia-Pacific pulp and paper companies will emerge as more competitive players in the international pulp and paper markets.

The article is based on a multiclient study "Asian Turmoil - Reshaping the Pulp and Paper Markets and Industry" by Jaakko Pöyry Consulting (Asia-Pacific) Pte Ltd. For any further enquiries please contact Ali Malassu at tel +65.733.3331 or fax +65.734.6198 or Ritva Carvalho at tel +358.9.8947.2639 or fax +358.9.878.2482