Distress appears in Asian funding markets Just before Christmas, Apollo Global Management, Hong Kong-based hedge fund Asia Research & Capital Management, Goldman Sachs and the World Bank's International Finance Corporation jointly made a $340m loan to Niko Resources, a Canadian company that is a joint venture partner to Reliance Industries and BP in a giant gas project off the coast of India. In happier times, the Indian banks may well have been willing to lend to the cash-strapped energy company but no longer. The banks are not in great shape and are too risk averse to lend to lower rated companies whose head office and assets lie partly outside India. Indian banks" loss cushions remain the weakest in Asia, according to research from Morgan Stanley. The terms of the Niko financing were generous, though fair given the perceived risk and complicated profile of Niko. In addition to a high rate of interest, the lenders have lots of collateral as well as 6 per cent of the royalties the ailing energy firm collects on the project for many years. Companies such as Apollo, Blackstone's GSO arm, hedge funds and the special situations arm of Goldman Sachs, along with private equity firms such as KKR, are taking their credit operations to Asia. In doing so, they are applying the business model they have developed in the US and more recently applied to Europe, where many local banks are suffering from a similar combination of problems - weak balance sheets and a consequent reluctance to make new loans to ailing borrowers. Regulatory changes, which require more capital for virtually anything other than investing in sovereign debt, only aggravate the reluctance. Reluctant banks That reluctance, while prudent on the part of the individual banks, paradoxically deepens the plight of all - if an economy is to grow, it needs credit. But when banks cut back on credit, demand falls, growth slows and the cycle becomes reinforcing as companies discover their cash flows can no longer support their debt. They then default, making the banks even more cautious. That is particularly the case in Asia, which has always relied on credit to grow, especially in north Asia where reliance on credit is particularly crucial to Chinese growth. Today, evidence of distress is appearing in many parts of Asia, creating opportunities for lenders who can charge more for their capital. India may be ground zero for distress in Asia but it is hardly alone. Australia and Indonesia, the most commodity intensive of the Asian markets, are also showing signs of distress, especially in the mining and minerals sectors. KKR just completed fundraising for a $2bn special situations fund and is adding people in the region. Apollo has plenty of demand for its joint venture fund in India. Liquidity squeeze That distress will probably grow. For one thing, China is expected to slow. But even if it does not (and don't forget China's slowing growth is still on an enormous base), that growth will probably be less commodity intensive as the dragon shifts to demand that is driven more by household spending on services than government spending on infrastructure. Moreover, it is unlikely that central bank liquidity will be as generous this year as it was last year. Even if the Fed doesn't tighten - and it is more important to look at rates than it is asset purchases - it is quite possible that the Fed will lose control of rates, and they will rise. That also means a higher dollar and lower emerging market currencies. In addition, it is unlikely that the worst is over either for the Indian rupee or the Indonesian rupiah, which will come under increasing pressure thanks to new limits on mineral exports - exactly at the wrong time. Those who have borrowed in dollars without dollar revenues or without hedging will be further weakened and - more painfully - inevitably downgraded. While the Bank of Japan is expected to further ease this spring, hard as that is to imagine, given the scale of what it has done so far, little of that money will go to buoy Japan's neighbours. Indeed, as the yen weakens, it will put further pressure on the region generally, just as was the case during the Asian financial crisis 17 years ago. Not only will there be less liquidity, the region is likely to get less of it. Though it is hard to calculate the exact scale of the outflows, it is also difficult to see those outflows reversing, given the widespread cynicism over emerging market prospects. Countries that have a robust legal infrastructure are more likely to get rescue finance from players such as Apollo, GSO and KKR than those that do not. And while their capital is expensive, it is surely better than none at all.