(FORTUNE Magazine) – As far as the citizens of Hong Kong were concerned, Wednesday, Oct. 23, couldn't have been a more inauspicious day. In the city's financial center, a plumbing fault suddenly drained an ornamental pool holding a school of carp, a Chinese symbol of prosperity. As the fish lay gasping, the local stock market was reaching the low point of its heaviest drubbing ever--the loss of nearly a quarter of its value in four days.

But then, it hardly requires faith in signs and portents to believe these are scary times in Asia--the raw numbers are apocalyptic enough. Since the beginning of the year, Asian stock markets have collectively lost an amazing $400 billion in value. As everyone from New York to London to Buenos Aires is now well aware, it was the shock waves emanating from Hong Kong in mid-October that set financial markets reeling across the globe. No one knows when all this volatility will end, but one thing is clear: It will stop only when Asian politicians finally push their countries to get their battered economic houses back in order. And that requires making some very tough choices. As Singapore's Senior Minister Lee Kuan Yew recently observed, addressing a top group of U.S. CEOs at the FORTUNE 500 Forum in Boston: "In nearly every economic crisis, the root cause is political, not economic."

Even if all goes well, it will take as much as two years for most of these ex-miracle makers to work their way out of their current problems. In the meantime economists agree that growth in Southeast Asia will slow from around 8% this year to 5% or less next. While that slowdown is bad news for Western multinationals that have been banking on Asia for a big profit boost--one reason stock markets got so spooked--there is a potential payoff: The crisis may finally force much needed structural economic reform in the region. As Hong Kong Monetary Authority Chief Executive Joseph Yam Chi-kwong puts it, all the turmoil is just a "painful but necessary adjustment to the new world of greater competition."

Painful is right. Especially vulnerable countries such as Thailand, Malaysia, and Indonesia must now swallow the International Monetary Fund's bitter medicine and move quickly to acknowledge bad bank loans, cut subsidies, raise interest rates, and bring down their trade and budget deficits. So far the prospects look bleak. Says Douglas Johnson, a senior international investment strategist at Merrill Lynch: "No country in the region has stepped up to the plate--they've been in denial."

Nor are austerity measures alone enough. The tigers and would-be tigers of Asia must also radically reshape their entire economic infrastructures to get in step with the information standard demanded by the new global capitalism (for more, see following story). If their corporations and banks don't, in the lingo of economists, make their financial reporting more transparent--that is, if foreign and local investors can't understand where their money is and what they're earning on it--then these institutions can expect to see that capital pick up and move elsewhere. Finally, these nations must continue to deregulate their industries and forgo their penchant for handing valuable business franchises to "friends" of the ruling party. Such protectionism and cronyism ultimately prevents a nation and its corporations from becoming truly competitive with the best of the world's multinationals.

This doesn't mean, however, that every country in Asia will follow the same road to recovery. The Asia-Pacific region is an extraordinary mix of political and economic arrangements and companies in search of production sites and markets. Understandably, a regional tour uncovers many local peculiarities. Of all the nations in the region, Singapore, Australia, and Taiwan seem the soundest. Yes, their markets may experience some scary swings, but their debt is low, their inflation mild, and their currencies are relatively strong. (Singapore, for example, with zero foreign debt and $80 billion in reserves, so far has had to devalue its dollar by only 12%.) In a sense, all these countries need to do is stay the course.

Singapore, in fact, could stand as a model for other Southeast Asian nations. Over the years it has invested heavily in education and training to move local industries up the technological ladder. It is also taking advantage of cheap labor in foreign markets. In information technology, for instance, Singapore builds industrial parks in Suzhou, China, and Vietnam that manufacture things like telephones. At the same time it has made itself a logistics and shipment hub for the region's electronic trade.

In the long run, the experts argue, countries like Singapore, along with Taiwan and Australia, should actually benefit from the current troubles. Why? It's now cheaper for them to build and operate factories in Southeast Asian countries like Thailand and Malaysia that have dramatically devalued their currencies.

Nearer term, however, the Asian crisis will take a toll. For one thing, it may crimp Australia's growth. Recently, Australian Prime Minister John Howard told FORTUNE that he was expecting a very welcome 3.75% growth for 1997-98, high for his country's developed economy (and perhaps enough to begin making a dent in a stubborn 8.7% unemployment rate). By late last month, however, Southeast Asia's travail plus the El Nino-driven drought were threatening to cut growth to below 3%, which could create even higher unemployment. And if the turmoil were to spread to Japan and South Korea, which take 50% of Australia's exports, even those reduced growth figures will look optimistic.

China, conspicuously immune so far during this crisis, won't escape unscathed either. Beijing's industrial modernization drive is largely financed by investors from Hong Kong, Southeast Asia, and Taiwan--where many companies suddenly have less capital to put into the mainland. Adding to the squeeze, sharp currency devaluations are making such countries as Thailand and Indonesia more formidable export competitors to China. Thailand's 54% surge in exports in September may well be a hint of what lies ahead for the region as a whole.

After stalwarts like Singapore, Taiwan, and Australia, the countries in the best shape in the region seem to be Hong Kong, the Philippines, and South Korea. While the members of this trio all enjoy basically healthy economies, they are struggling with problems in real estate and banking in the cases of Manila and Hong Kong, and with shaky conglomerates in the case of Seoul. Compared with Southeast Asia, South Korea has an advanced industrial economy, much more like Japan's. But its chaebol (large conglomerates such as Samsung and Daewoo) are grappling with stunted profits and debts that, on average, exceed four times their equity capital. They have borrowed relentlessly to expand capacity in a few industries that are now saturated--including petrochemicals and autos. Already several chaebol, notably the automaker Kia, have collapsed under the weight of debts. Says Thomas Dongho Lee, an attorney with the New York law firm Winthrop Stimson Putnam & Roberts: "Korea needs to rationalize its corporations by freely allowing mergers and acquisitions."

Beyond too many factories is another problem. If growth slows in the region, who will fill the hundreds of office towers and luxury condos going up all over the region? Nowhere is this more evident than in the Philippines. One number tells the story: Starting in 1993, annual loan growth to Filipinos surged 40%, then 30%, 41%, and 54%. The result: an alarming property bubble. A glut looms. Though office vacancy rates are low now, they may well hit 15% to 20% in two years. Given how highly linked the entire economy is to the property market, that could be devastating.

If the problems of South Korea and the Philippines are worrisome, those of the shakiest of the Southeast Asian nations--Indonesia, Malaysia, and Thailand--are downright unnerving. That's because all three are suffering from endemic, system-wide economic problems: high debt, corporate cronyism, and overcapacity. Says Rob Reiner, co-manager of the BT Investment International Equity Fund: "There doesn't seem to be a short-term resolution, because for many of these countries, it really is a structural issue."

The first order of business for these nations is to get their fiscal and monetary houses in order. In Malaysia, for instance, Prime Minister Mahathir Mohamad oversees a nation that has invested heavily--some say overinvested--in real estate and infrastructure projects, yet he refuses to raise interest rates to wring excess capacity out of the system (see box).

An absence of political will is what's also plaguing Thailand. There a revolving-door government has allowed the nation to drift into its current crisis. Morgan Stanley predicts that Thailand, which is the most troubled Southeast Asian country, will enter a recession next year with a negative 1.5% growth rate. That's a far cry from only a few years ago when the spunky nation was barreling along at a double-digit pace.

The root cause of Thailand's problems is its current political system. Thai politicians spend millions of dollars getting elected in hopes of recouping while in office. As Singapore's Lee Kuan Yew recently pointed out, Thai politicians, who held personal stakes in many troubled financial institutions, have displayed "a natural reluctance to discipline them."

To the Thais' credit, committees representing a broad range of the kingdom's subjects have come up with practical constitutional reforms that, among other things, would reduce the role of money in politics. And very late in the game, the Thais have finally suspended operations of 58 financial institutions, though the increasingly unpopular Prime Minister Chavalit Yongchaiyudh continues to shrink from other crucial moves.

His reluctance is understandable. Already the prospect of hundreds of thousands of urban workers facing unemployment has raised the worry that civil disorder may soon erupt. Politicians have begun maneuvering for elections, which are now expected early next year. They can't come too soon. As Sutichai Yoon, director of the Nation Group, a leading media company, puts it, "It's difficult to imagine any real resolution of Thailand's economic problems until we have a new, much cleaner, more competent cabinet."

At the heart of most such cleanups is Asia's endemic political cronyism, which leads to monopoly power and protectionism. Nowhere is this more of a problem than in Indonesia, Southeast Asia's largest nation. President Suharto, 76, has ruled for 32 years and is about to get another five-year term, but he suffers from a dangerous myopia. He simply doesn't see anything wrong with the vast business empires his sons and daughters are incessantly building with generous financing from government banks and special tax breaks. Example: the $1.3 billion "national car" venture called the Timor, which is run by his youngest son, Tommy. Despite that massive investment, the poorly made Timor has proved a flop with local consumers.

What exactly should Indonesia and its neighbors do? BT's Reiner says: "They need to let poor or laggard companies go bankrupt. Close down inefficient operations, reduce capacity, and cancel big projects that are unnecessary." That, however, is easier said than done. Essentially, Suharto has gained legitimacy for his highly authoritarian regime by steadily improving living standards. But average income is still a modest $1,200 annually, so even a little belt-tightening could hurt. A slowdown in economic growth (Indonesia expects GDP to rise 5% this year) would seriously curb job opportunities for its large population--a tinderbox for potential trouble. Adding to the growing uncertainty, Suharto has avoided picking a political successor. Rumors swirl that he may try to install his eldest daughter, Tutut, whose credentials beyond her family link are minimal.

On Oct. 31, after lengthy negotiations, the IMF, World Bank, and Asian Development Bank finally came forward with a $23 billion aid package for Indonesia. But right up until the last minute, there had been disturbing signs that Suharto, in order to preserve his political maneuvering room and family fortunes, was trying to avoid such strict discipline. Instead he appears to have hoped that rich neighbors like Singapore, Malaysia, and Aus-tralia would provide billions of dollars to bail out Indonesia--with few strings attached. Those hopes were dashed when Singapore declared that its minimum pledge of $5 billion in aid was firmly tied to the IMF plan, which, among other things, requires Indonesia to sharply cut fiscal spending and save money by eliminating various food subsidies and import controls covering wheat, flour, and soybeans.

The latter may sound like no big deal, but in Indonesia the politics of food is highly sensitive--and extremely lucrative. Before the IMF put its foot down, an Indonesian state agency, known as Bulog, set the price of rice and handed out lucrative licenses to Suharto cronies like the Salim family, which gave them control over agro-businesses like flour milling. "The reduction in Bulog's role is excellent," says P.K. Basu, regional economist for UBS Securities in Singapore. "There will be more volatility in food prices in Indonesia, but it should result in lower prices overall."

What's unclear is whether Suharto will really observe the details of the IMF's plan. If not--and many analysts fear this is a distinct possibility--Indonesia's stock and currency markets will continue to be pounded by foreign investors. That could be a fatal blow to Indonesian corporations already reeling from the damaging effects of the 53% drop in the rupiah to date. According to UBS Securities in Jakarta, the entire 1997 net profit of Indofood, another Salim family holding and one of the nation's largest corporations, would be wiped out by a further fall in the currency.

Beyond their struggles with political reform, Thailand and Indonesia, like the other nations of Southeast Asia, are debating which industries are most likely to lead them back to real prosperity. What they should not do is count on a revival of that old mainstay of the Asian miracle--low-end manufacturing. In many countries businesses like textile weaving, toy manufacturing, or shoemaking have gone, possibly forever. Today lower-cost producers like Bangladesh or Vietnam enjoy the competitive edge. One good illustration: In 1989 Thailand was Nike's second-largest manufacturing source. Today Vietnam and China are primary sources. Why? Simple. Since 1989, Thai wages have increased 79%.

At the same time, much of Southeast Asia's high-end manufacturing--industries like petrochemicals, steel, automobile manufacturing, and computer software--is foundering. The region's greatest weakness is skilled labor. Since it takes years to produce intrepid engineers or innovative software designers, Indonesia, Malaysia, and Thailand are, for now, all net importers of industrial managers, engineers, accountants, and software designers from the U.S., Europe, and India.

Are there any quick-fix solutions to the current slump? In a limited way, yes. At least three countries reeling from the economic meltdown--Malaysia, Indonesia, Thailand--are blessed with oil and other natural resources that can be easily converted into exports. Thanks to the currency devaluations, these products now look like real bargains. Tourism, a great way to generate cash even in hard times, is another critical industry that's automatically bolstered by softer currencies.

It would be a mistake, though, for these nations to think of commodity exports and tourism as anything but temporary cushions. When it comes to long-term cures, Southeast Asia needs to continue pursuing the new industries being generated by the inexorable rise of the global electronics and information industries. That's where the real value lies.

Will Asia be able to capitalize on these opportunities? Again, despite some advantages such as high savings and a strong work ethic, it all comes down to political will. The financial meltdown has underscored the need for aging leaders in Thailand, Malaysia, and Indonesia to prepare for orderly political succession rather than cling to office until they die. Governments should focus more sharply on what has made the region so successful in the past--including honest administration, prudent use of debt, and a respect for market forces. If Asia's nations pursue that course, argues Singapore's Lee, "in two to three years [Western investors] will be kicking themselves for not having seized the great opportunities and bargains that now exist here." One reason to think Asia will eventually take the right path is simply that the alternative is too bleak to contemplate--an end to the miracle, with countries flapping like carp in an empty pool.

REPORTER ASSOCIATES Jeremy Kahn and Rajiv M. Rao