26th September 1999
Marking the emergence of Colombo's new skyline
By Mel Gunasekera
The Colombo Stock Exchange will shortly form a separate debt securities board to stimulate the secondary debt market.
Companies seeking to list their debt independent of equity will be quoted on the new board. The board will also include debt traded by companies listed for equities, a top CSE official said.
A separate front end will be created for debt activities, as the information required for debt brokers are different to that of equity brokers, CSE Deputy General Manager, Rohan Fernando said.
The CSE board recently approved the new rules for the corporate debt market which include mandatory underwriting, a 2:1 debt/shareholder fund ratio, an average minimum 7.5% shareholder funds for the past three years, a minimum Rs. 50 mn public offering.
Companies are also required to create a redemption fund. This is not meant to be a sinking fund, it will only be a book entry and funds can be used in normal business operations, Fernando said.
It will be mandatory for 50% of the debt securities offered to be in public hands. CSE hopes the minimum float requirement will discourage future rights issues. "This is the only way we can guarantee a secondary market," he said addressing a recent CIMA seminar on debt securities.
Companies listing debt independent of equity should have a bank or a multi lateral agency guarantee; and offer land and building as collateral. "We have also provided rules for asset securitisation, as asset securitisation will become active in the market soon."
However, the debt shareholder fund will not be a criteria for existing listed companies. "That's because these companies are already listed with us and people know them, so it has been done away with," he said.
Underwriting will also not be mandatory for existing companies but if there is a possibility that the issue will be under subscribed, the CSE reserves the right for the issue to be underwritten, he said.
Existing listed companies seeking a quote for debt could either get a bank guarantee, a collateral or an 'acceptable rating' from the rating agency.
"At the time of drafting the rules, the rating agency was not in operation, so we will settle for an investment rating for the moment until our market develops," he said.
However, Ravi Abeysuriya, Managing Director, Duff & Phelps Credit Rating Lanka Ltd., called for rating to be mandatory as 'our debt market is in its infancy'. "If the CSE goes for only investor grade, only high rated debt may find their way to the market," he said.
Fernando also said recent debt issues have surpassed new equity issues (see table)
However, debt market specialist Mangala Boyagoda said the market has attracted mostly banks and financial institutions with the exception of Ceylon Glass Company.
"Banks came in and used the money to beef up their capital adequacy requirements not to develop the debt market."
However he said, if the corporate debt market is to develop, junk bonds must be allowed. "If the market is not developed, they (junk bonds) may kill the market.
We must have some controls initially and gradually relax them."
A steady increase in Chinese tyre imports in the last six months may spell trouble for the local tyre industry. Industry officials are complaining that low priced imports are running down their businesses. Chinese tyre imports in the last six months raced up from two per cent to around 18 % and are priced competitively with re-treaded tyres.
One of the companies feeling the pinch, Associated CEAT (Pvt) Ltd. (ACPL) Managing Director Abhik Mitra told The Sunday Times Business that their bread and butter business was being affected due to these cheap imports. He said the truck and light truck tyre category in which they control around 50 % especially was being affected. "That is the main business and that is the place we have been hurt the most by the import of Chinese tyres," Mitra said.
The company has started exporting tyres such as CEAT from Kelani, but say it needs time to stabilise. The company also plans to make investments of about Rs. 150 mn this year to achieve the quality and the quantity needed.
He added that since these tyres were being sold at almost lower than cost of production and in the absence of anti dumping legislation there was nobody to whom companies could go to, to prove legally that what was happening was wrong. "For some reason Sri Lanka does not have anti dumping legislation but I understand they are working towards it and hopefully there will be something soon," he said. Officials said there could be two possible ways in which the prices could be reduced. Either by having high domestic duties so that prices of imported tyres will be high in the domestic market and offset that against export losses. The other is by reducing its weight.
Richard Pieris MD, Premlal Fernando said such tyres were a deterrent for the re-treading industry. On average 75 % of the tyre value is in the casing and only 25 % is represented by the tread design. "If a tyre is not re-treaded you are just throwing away that 75 % of your tyre. With the imported tyres that is exactly what is happening because the casing is not strong," he alleged.
On average a good quality tyre could be re-treaded more than twice whereas an imported tyre could be re-treaded perhaps once or sometimes not at all, sources claim. Mr. Fernando added that consumers make the decision to buy a low quality tyre probably because of the financial constraint at that time, but do not realise that they would end up paying more in the long run anyway.
Conservationists too are joining the protests as they claim that improper disposal of tyres are a health threat and that it is a major cause of pollution.
An International organisation will be set up to fight corrupt business and government practices here. Transparency International, a non governmental non profit organisation will launch its Sri Lankan chapter at the end of this year.
"Transparency International is dedicated to achieving a responsible business sector, an accountable government sector and an independent judiciary," Trustee, Transparency International Sri Lanka Chapter, Arittha Wikramanayake told The Sunday Times Business. "It will also lobby for free media access to information," he added.
Transparency in government procurement will also be looked into.
The organisation which was founded in 1993 is active in more than seventy countries.
Transparency International maintains a corruption index and ranks countries by the extent of corruption in public administration.
"We will adopt a non confrontational, non political approach at the inception in order to achieve more," Mr Wikramanayake stressed. "Transparency International does not highlight individual acts of corruption but focuses on building systems that combat corruption," he said. Systems which are in place are however expected to highlight corruption. Investigative work is not carried out by Transparency International although it lobbies the government and informs the media.
A national workshop of stakeholders from the private sector, parliament, media and judiciary will be held at the end of the year and a membership drive initiated.
Funding to set Transparency International's Sri Lankan chapter was initially obtained from Transparency International, Germany. Donations and grants will be sought to fund subsequent programmes.
Transparency International has an international board of directors who are elected at an annual general meeting and are prominent individuals of international standing. Its national chapters are financially and institutionally independent.
By Dinali Goonewardena
The shipping industry is in the grip of another fuel crisis following CPC subsidiary, Lanka Marine restricting supplies to ships and increasing fuel prices.
The Greek ship, Pontoporos is stranded at the Colombo port following Lanka Marine Services (LMS) decision to restrict fuel supplies to 100 tonnes per vessel.
The company sells fuel to ships in port. The Greek ship which requires 300 tonnes of fuel oil is forced to remain in port for four days until its fuel requirement is met.
The LMS decision to restrict supplies was introduced arbitrarily without prior notice to bunker brokers, industry sources said.
The restriction of supplies was preceded by a price hike of fuel, they added. Intermediate Fuel Oil prices increased from $ 150 per tonne to $160 per tonne while Marine Gas Oil increased from $255 per tonne to $ 280 per tonne.
Marine Diesel Oil rose from $245 per tonne to $ 270. Prices in competing ports such as Singapore remained substantially lower.
"The shipping industry in Sri Lanka is badly affected including suppliers of bunkers and shipping agents," Chairman, Ceylon Association of Shipping Agents, Pushpa Amarasekera told The Sunday Times Business.
"The country is loosing revenue as ships either bypass the Colombo port or purchase the minimum quantity of fuel required to reach another port and refuel," he said.
"There is an increase in demand for thermal power and not enough fuel to supply ships," General Manager, Lanka Marine Services, S Sivasundaram told The Sunday Times Business. "Therefore we increased prices and when this did not curb demand we restricted supply," he explained. "We will be importing some fuel in two weeks time," he added.
However shipping industry officials attributed the fuel restriction to bad planning by the Ceylon Petroleum Corporation monopoly which they allege is not customer oriented."Fuel prices should be dependent on the international market not arbitrary prices determined by the Ceylon Petroleum Corporation," Mr Amarasekera said.
"The barges which are maintained by Lanka Marine Services to supply fuel to ships are old and cannot go out to sea. This is another deterrent," he said
Bunkering in Sri Lanka remains prohibitively expensive as private barges which are sea worthy have to be hired.
This entails a fee of approximately $1000 to private barges in addition to $ 325 incurred as delivery charges to Lanka Marine Services.
A leading shipping agent said that a similar situation arose a few years ago and the port lost custom as ships preferred to bypass the Colombo port and bunker elsewhere. He said that eventually the Ceylon Petroleum Corporation was forced to export fuel at a loss. "A similar situation will arise again," he predicted.
The shipping industry has been faced with this crisis over the recent years whenever the demand for thermal pover goes up and Lanka mariine supplies more to the plant.
East West Group has launched East West Ferries (Pvt) Ltd to operate ferry services between Colombo and Tuticorin and Colombo and Trivendram. During the south west monsoon the ferry will ply an alternative route between Trincomalee and Madras. "Clearance for the project has been obtained from the Sri Lankan Foreign Ministry, Customs and the Board of Investment and the company is currently seeking the approval of the Indian authorities," Chairman, East West Ferries, Nahil Wijesuriya told The Sunday Times Business.
"We will compete with airlines for customers," Wijesuriya said. He said it takes one hour to go to the Katunayake airport, one hour to fly and a passenger was forced to wait two hours at the airport before the flight-a total of four hours. "By sea the Tuticorin-Colombo route is 145 nautical miles and could be travelled in four hours at a speed of 35 knots, while Colombo-Trivendram would take six hours," Mr Wijesuriya said. The ferry is a Fast Cat which is a sea going aluminium hull.
East West ferries will also compete on price, charging 30 per cent less than air fares. A Colombo-Madras return air ticket costs Rs 10,000 while Colombo-Trivendram costs Rs. 7000.
"We will allow passengers 100 kgs of baggage in comparison to only 20 kgs offered by airlines," Mr Wijesuriya said. The ferry has a capacity of 30 tonnes and can accommodate 300 passengers. "The market for ferry rides will comprise mostly of Indian traders. During the boom passport holders in India were used extensively by Indian businessmen to purchase goods from the Duty Free shops in Sri Lanka and were paid for their services," Mr Wijesuriya said.
East West Ferries (pvt) Ltd requires an investment of US $ 4.5 mn which will be used to purchase the ferry. "An Indian national operating Duty Free shops in Dubai and Fujairah will be investing half the cost of the ferry and will operate a duty free shop on the ferry," Nahil Wijesuriya said. "The Kerala government is interested in investing and the company is also looking for local investors," he added. East West Enterprises will retain a 51 per cent stake of the company.
The Institutional Fund Mangers' Conference organised by the Colombo Stock Exchange will be held on October 4th and 5th at the Colombo Hilton.
The CSE is spending Rs. 10 million on the two day conference with another two days thrown in for a holiday in Bentota or Nuwara Eliya.
Around Rs. 4 million will be funded through sponsorships from NDB, Airtekn Spence, Hatton National Bank and John Keells Ltd.
Cse said that around 350 invitations have been sent out to both foreign and local participants.CSE hopes that about 50 key foreign fund managers would attend the conference.
Several indicators point to an upturn in the Sri Lankan economy.Tea and tourism in particular, are faring well.
Their improved performance would no doubt impact favourably on the overall economic performance.The second quarter's GDP growth of 3.3 per cent ,though much lower than last year's second quarter growth,was an improved performance from this year's first quarter performance of only a 2.7 per cent growth.
The current performance of several sectors of the economy leads us to an expectation of a still better performance in the third and fourth quarters. Tea production has contined to increase this year.From 1993 to 1998 tea production grew by 21 per cent.
Last year's production was a record high of 280 million kilograms.This year's production is likely to be still higher,around 285 million kilograms.Most of the increased production has, of course come from small holdings.Tea prices too were good till the middle of last year.
Then there was a collapse of the market owing to the Russian crisis and a revival of tea production, particularly in East Africa.The situation has changed again.
The international tea market has improved with Iraq's purchases of Sri Lankan tea,an improvement in purchases in the Russian federation and a decline in tea production in some countries.
The increased production of tea coupled with improved prices would have several multipier benefits on the economy.Although tea accounts for only about 2.5 per cent of GDP directly,it has ramifications on several services related to its trade.
Given the diversified corporate ownership of the plantations ,the improved performance would impact on corporate profits and thereby,in due course, the share market.
Tourism has indeed been one of the brighter aspects of our economy this year.Tourist arrivals have increased by 21 per cent during the first seven months and tourist earnings have also increaed by 21 per cent in US dollars.
The improved tourist earnigs too would imply benefits to several activities dependent on tourism. There are good signs elsewhere too.The alarming trend of a decline in industrial and agricultural exports in the first half of this year appears to have been arrested. Still exports show a decline in the first seven months owing to the decreased exports in the first half.
Rubber prduction which had declined in the first half of this year, owing to the impact of the depreciation of South East Asian currencies, has bounced back to some extent.In the first seven months of this year rubber production increased by 3 per cent.
Coconut production too has increased by nearly 6 per cent in the first seven months. It is not our intention to inspire an excessive optimism in the country's economic performance,but merely to suggest that there are signs of an economic recovery. Its impact on this year's overall performance may not be much,but the hope is that an improvement in global economic conditions would result in the Sri Lankan economy performing much better in 2000.
By GERALD P. O'DRISCOLL, JR.
The Asian financial cri sis began in mid-1997 in Thailand; by year's end, it had spread to Indonesia, South Korea, and other countries. The details of how the crisis affected each of the countries vary. Typically, however, there was a collapse in currency values after a period of turmoil in foreign exchange markets. Asset values declined sharply and economic activity turned negative. The turmoil occurred at great economic cost in these countries, whether it is measured in terms of output, investment, or jobs.
Although peaceful changes in the government occurred in Thailand and South Korea, in a number of countries political upheaval followed the economic dislocation. In Indonesia, for example, a long-time political leader, President Suharto, resigned in the face of violent political protests.
Violence and loss of human life accompanied the political upheaval. In Malaysia, Deputy Prime Minister Anwar Ibrahim, an heir-apparent to the office of Prime Minister, was ousted from power. Hong Kong's new political system was stressed as its flexible and resilient economy was tested in ways it had not been heretofore.
The common economic factor in each country is a conjunction of currency and banking crises.
There is a reason for this conjunction: Each country had an exchange-rate system that linked its currency to the U.S. dollar. Systems that fix or peg a local currency to the dollar provide a guarantee to short-term investors that they can make a quick exit with their funds at little or no cost to themselves. That assurance in turn, tends to diminish risk monitoring by investors.
Exposure to loss generates risk management, while financial guarantees anaesthetize investors to underlying risk.
As short-term funds (so-called hot money) surge into countries with already questionable banking systems, lax banking practices are exacerbated and ever more dubious lending is funded. Any shock that undermines investor confidence is likely to lead to a run on both the currency and the banking systems.
To understand what occurred in much of Asia in 1997, it is instructive to look back to Mexico's peso crisis in 1995. Mexico was both a watershed for global public policy and a turning point in international capital markets. As illustrated in Chart 1, the size and scale of the IMF's Mexico bailout was unprecedented.
That chart presents the largest use of IMF funds in each year from 1980 through 1998 and identifies recipient countries.
The funds provided to Mexico in 1995 were out of proportion to any prior disbursement and set a new standard for IMF involvement in a country's finances.3 IMF funding for Russia and South Korea followed in turn.
Note that in the 1980s and l990s, Mexico frequently was the largest recipient of IMF funding. Chart 2 details Mexico's use of IMF funds throughout the 1980s and 1990s. Case histories like Mexico's help to explain the reason that critics of multilateral lending assert it establishes dependency on future such loans instead of fostering sustainable economic growth.4
After the Mexico bailout, investors perceived that the IMF henceforth would bail out any large international debtor-country. Thus, the resolution of the Mexican peso crisis established globally the syndrome known as moral hazard.5
The moral hazard of IMF Bailouts
Moral hazard occurs when the provision of insurance against a calamity, such as fire, alters behaviour in such a way as to increase the probability of the calamity.
Insurance policies typically contain provisions constraining the behaviour of those insured to mitigate against moral hazard. By analogy, the concept has been extended to behaviour in financial markets in those cases in which investors are offered insurance-like guarantees.
In the wake of the Mexico bailout, traders began consciously to invest based on perceived IMF guarantees. In 1995, for example, one official of a major investment house privately told this author that he viewed investments in Russia as possessing an IMF guarantee. Colleagues have told this author of similar conversations with traders.
After the Mexico bailout, then, the existence of moral hazard in international lending became a fact in capital markets and cannot be dismissed as the speculation of free-market economists. That some within the IMF still question its existence is testimony to this agency's continuing state of denial.
If Russia—otherwise a financial black hole—could be viewed as a safe investment, still more were Asian countries. Countries like Thailand, Indonesia, and South Korea were viewed as fundamentally sound. Even if some doubted their ability to absorb all the incoming capital, there was no need for investors to worry in the post-Mexico world of IMF bailouts. Similarly officials in countries experiencing large capital inflows were under no pressure to engage in any needed financial reform.
One consequence of the ill-advised IMF policies in Mexico is that much of Asia now is in economic shambles.6 Political instability is on the rise.
To the extent that the important regional allies of the United States have been weakened economically, U.S. national security interests in the region may have been damaged, too.
Yet at each step in the crisis, the IMF repeatedly applied as solutions programs that contributed to the crisis in the first place. The agency's policies unfortunately have laid the groundwork for future financial crises.
The Asian crisis in detail
The Asian financial crisis began in Thailand in mid-1997. IMF officials have stated publicly that they in fact observed early warning signs of a real estate bubble and a sharply deteriorating current account. They delivered warnings to Thai officials for two years before the crisis, but those warnings went unheeded.7 Considering the moral hazard scenario outlined above, it is not entirely surprising that their warnings went unheeded.
Banking and development policies
Nevertheless, IMF officials should be credited with identifying these financial problems in Thailand. The IMF officials did not anticipate, however, a full-blown regional financial crisis. Nor were they prepared for the magnitude of the problems in the banking sector.
It was in the banking system of the Asian countries that all the flaws of the Asian economic model became evident. Banking policy and practice have been the linchpins of the Asian model of economic development. To varying degrees, Asian governments utilized the banking system to direct funds into favoured investments or toward favoured investors.
There certainly were differences in the economic policies of South Korea, Thailand and Indonesia. The South Korean government, for example, pursued policies to upgrade the skills of the country's labour force and shift output from low-wage, labour intensive activities to high-wage, capital-intensive production.
Thailand's government relied on a large supply of low-wage, relatively unskilled workers to produce such goods as apparel, footwear and toys. Pegging the baht to the U.S. dollar was a key policy decision by the government to maintain Thailand's competitiveness.
In Indonesia, much of the industrial policy was aimed at ensuring that the family and friends of President Suharto benefited from new investment funds. It was perhaps in Indonesia that the system of "crony capitalism" reached its apogee.
Although the specifics of economic development policy differed in each of these countries (as well as in other Asian countries), the common thread was the use of the banking system and foreign exchange policy to manage development. And, in each case, the cumulative effects of the policies led to unsustainable borrowing and investments. In each country, there was a crisis waiting to be triggered by an economic event.
It must be noted that, in contrast to debt crises in Latin America, the Asian economies generally did not have fiscal deficits. Their economies did have large current account deficits, which reflected high private-sector demand for foreign capital.
Although annual savings rates in South Korea and Thailand exceeded 30 percent (as a percent of gross domestic product [GDP]), private investment was even higher. (Indonesia was an exception, with its savings and investment rates roughly equal in 1996.)
A pegged exchange rate fuelled private-sector borrowing Asian borrowers preferred borrowing in U.S. dollars at low, short-term interest rates, even to finance long-term projects. In Thailand, for example, foreign capital inflows supported rapid growth in private-sector lending, much of it to finance a property boom. Thailand's foreign debt rose to 50 percent of GDP of which 80 percent was private-sector borrowing.
Thailand's case illustrates, as do the experiences of other Asian countries, that there is plenty of blame to be apportioned in the Asian financial crisis. It is eminently understandable that, provided the opportunity, a Thai borrower would prefer cheap, short-term loans denominated in U.S. dollars to the more expensive local sources of credit denominated in Thai bahts. Thailand, by pegging the baht to the dollar, facilitated such international arbitrage. That action, although a necessary condition for the eventual crisis, was not a sufficient one.
Here is the point at which the Mexican peso crisis and US and IMF policy responses to that earlier crisis become key. Foreign investors had to be convinced that there was a quick exit option in the event of a crisis. Thailand's exchange-rate policy certainly provided a level of comfort, but that country by itself lacked the credibility to guarantee that foreign investors could withdraw dollar credits as readily as they had made them.
Only the implicit backing of a credible international agency like the IMF—backed by the US Department of the Treasury and the Federal Reserve System — could provide the required level of comfort. Mexico was the test case, and investors drew their comfort from that episode. As one Executive Director of the IMF recently put it,
Banks and other financial institutions have the IMF very much in mind as a source of comfort when making decisions about whether to lend to risky countries, where higher yields can be obtained. 8
Much blame has legitimately fallen on the lax lending practices of South Korean, Thai and Indonesian banks, poor banking supervision, and financial accounting that was anything but trans parent. If South Korea's banks were lax in their lending practices, however, what do we say of the European and American banks that provided interbank funding to Asian banks? That Western banks willingly lent is testimony to a series of guarantees that the banks felt they had been provided. First, the Western banks believed that Asian countries, such as Thailand, would not permit their banks to fail. Second, European and American banks believed that fixed exchange rates insured against currency risk. Third, they had come to believe that there was an IMF guarantee in the event the first two guarantees proved insufficient.
The seeds of the crisis were sown by the decision to peg local currencies to the dollar. In 1994 a weakening dollar improved the price competitiveness of Asian exports. In that year, however, China devalued its currency in order to maintain its competitiveness, an action that put competitive pressure on exporters in Southeast and Northeast Asia. In 1995, the foreign exchange value of the dollar began to rise. By 1996, growth rates for exports had slowed in Asian countries, even declining in Thailand.
Early in 1997, the baht came under pressure as traders began to doubt the viability of its peg to the dollar. Thailand's central bank intervened actively on foreign exchange markets and imposed capital controls in May 1997. On July 2, 1997, its reserves nearly exhausted, the Bank of Thailand floated the baht. The currency fell 10 percent immediately and then weakened further On July 28, 1997, Thailand formally sought IMF assistance.
On August 20, 1997, the IMF announced an assistance package of $4 billion for Thailand. Thus began the IMF's involvement in the Asian financial crisis. As the crisis spread, the IMF's commitments grew in both size and scope. IMF assistance to Thailand now totals $17.2 billion. Commitments to other countries grew in similar fashion. South Korea's total commitment from the IMF and other creditors now stands at $57 billion.
In Thailand, Indonesia, and South Korea, the IMF established a list of reforms that the countries needed to implement ("conditionality"). These reforms were designed to deregulate and liberalize the economy; open the economies to trade and investment; restructure the corporate sector; and resolve bad loans in the financial sector. Success at implementing the reforms has varied by country.
Thailand responded quickly to some of the recommendations. On December 8, 1997, the government permanently closed 56 of 58 suspended finance companies. A government agency assumed control of the assets for liquidation. On February 9, 1998 the government nationalized two banks that had not submitted acceptable recapitalization plans. The capital of two previously nationalized banks was written off. The government's efforts at reforming the bankruptcy laws were thwarted in 1998 by strong opposition. Since that time, the first of a series of laws reforming bankruptcy have been passed.
The case of Thailand illustrates the limits of the IMF's influence. The IMF deals with sovereign states and cannot impose its policies at will. In democratic countries, opposition parties must be placated. Even when a government is genuinely committed to implementing reform, as it is in Thailand, progress can be slow.
Even in countries that have strong leaders but weak democratic institutions, political opposition can halt reform. Indonesia is another example of the limits of the IMF's influence. A severe economic contraction led to political upheaval involving violence, property damage, and even loss of life. Many observers now believe that IMF reforms in Indonesia were overly harsh and attempted to transform the economy too quickly. Political reaction to the IMF reforms has slowed, if not halted the reform process there. l0
South Korea has been an Asian model for democratic political reform and political liberalization. Comparatively little economic reform has been implemented, however. Korean policies generally promoted economic development through large conglomerates known as chaebol. At the time of the economic crisis, the 30 largest chaebol accounted for 80 percent of the country's output. Their growth, however, occurred at the expense of small and medium-sized firms. Admittedly, it is a daunting task to break up these conglomerates and foster a more entrepreneurial economy. The government reportedly has taken its first steps in that process. 11 One of the problems the government has encountered in instituting reform is excessive debt financing by the chaebol. It is generally true that Asian economies relied excessively on debt financing, making too little use of equity investment. The reliance on debt financing is a by-product of using the banking system as the mechanism by which investment is directed into favoured sectors (and, by implication, denied to other parts of the economy). In South Korea, however, such leverage reached astounding levels. The average leverage ratio for the 30 largest chaebol was 330 percent. 12
South Korea's entire economy was leveraged like the real estate sector of the U.S. economy. No market economy can weather normal volatility with such leverage, and the Koreans paid the price in bankruptcies and business failures. The real estate analogy actually points the way to an alternative free-market approach to resolving international debt crises.
Operating as they do with high leverage, many U.S. real estate developers periodically find themselves unable to service their debts. Frequently, the projects are viable if debt-service payments can be reduced.
And it is often the case that the original developer is the most qualified individual to complete the project. In such cases, lenders and borrowers agree to a loan workout, in which debt is reduced (or the term of the loan extended), and often debt is swapped for equity.
Investors may inject additional funds as needed. And some short-term lenders may become medium-term lenders. As the saying goes, "in for a dime, in for a dollar." And, it might be added, in for six months, in for six years.
In essence, South Korea's entire economy, along with those of other affected Asian countries, needs a debt-for-equity swap to reduce leverage. IMF programs are not geared for that solution.
IMF programs emphasize additional lending, and that is sovereign lending. What is needed in South Korea and elsewhere is new private equity investment.
The IMF cannot be the source of such funds, and it has no expertise in securing them.
U.S. lenders and law firms are masters at real estate workouts. Instead of calling in international bureaucrats, countries would be well advised to call in bankers and lawyers from the United States who are veterans of real estate workouts. The outcome not only would avoid international bailouts, but also would contribute to the efficiency of the economies. In fact, the seemingly hopeless debt problems of the major Indonesian conglomerate Bakrie & Brothers were resolved recently by bringing in a skilled U.S. bankruptcy lawyer to do a corporate workout. l3
Given the choice, of course, lenders always will prefer a simple bailout to the tedious process of working out individual bad loans. All the banks and savings and loans in the Southwest region of the United States would have been delighted to have had the equivalent of an IMF bailout during that region's real estate bust. 14 And so, too, would have lenders during New England's downturn. Even though regional banking crises were a consequence, policymakers in the United States did no such thing because of the obvious moral hazard problem that such policies would have engendered. And the economies and financial systems of both regions are demonstrably stronger as a result. Yet policymakers in the United States are complicit in wreaking harm on other countries that they would not inflict on their own.
The need for reform and private equity investment
In each country receiving IMF support, the agency has established conditions for the banking and financial systems.
As already indicated, Thailand has made great progress toward instituting reforms.
Indonesia's political upheaval has obstructed, if not set back, reform. South Korea has laid the groundwork with political reform, but the promise of opening up the banking system to competition has been slow to occur. Allowing foreign banks and securities firms to establish branches in these countries is a critical element of reforming the financial sector.
That is true for four reasons: First, foreign firms bring well-capitalized institutions to the economy with fresh sources of funds; second, foreign institutions basically import higher supervisory standards because they must meet the generally more stringent requirements of home country supervisors; third, in similar fashion, foreign institutions bring their more-transparent accounting standards with them; and finally, foreign financial institutions often have better business practices, which they also bring with them.Backlash to IMF programs
When implementation of IMF recommendations on financial liberalization falls short, it is a reflection of the obstacles that national sovereignty places on internationally imposed reforms. Indeed, it is a fact of life that nationalist opposition is strengthened in reaction to internationally imposed reform, whatever its merits.
But on top of this is the perception that the IMF is a mere instrumentality of U.S. policy. As a visiting delegation of legislators from one Asian country recently observed during separate visits to the U.S. Department of the Treasury and the IMF, not only are the same policies recommended, but in the very same words.15 For foreigners, there is no doubt that the script for the IMF is written in the U.S. Department of the Treasury; consequently, anti-U.S. feelings are on the rise in such countries.
It is important to recognize that IMF intervention generates a nationalist and populist backlash. Many policymakers believe that international organizations, like the IMF, can force governments to implement needed reforms, which they never could accomplish on their own. IMF-imposed programs set in motion a complex political dynamic, however, which makes it difficult to pronounce confidently that the participation of the IMF in the domestic reform process is helpful.
The political dynamic may explain the reason that the IMF frequently must revise its initial conditions, as happened during the current Asian financial crisis. IMF conditionality first brings economic pain and then political reaction. Political reaction slows reform, which leads the IMF to revise its conditions so as to conform to political reality in the debtor country. Instead of an externally imposed reform process, the reform process is adjusted to domestic political conditions.l6
Reforming the IMF
On October 23, 1998, Congress passed the 1999 Omnibus Appropriations Act, which mandates actions that U.S. officials must take before funds can be released. These limited steps toward reform of the IMF must be lauded even if much more needs to be done. Even more important, however, than this legislation is the congressional debate surrounding its passage. That debate shifted the focus from how much money should be provided to the IMF to whether such an organization still is necessary. 17
Unfortunately, the language in the Omnibus Appropriations Act fails to specify concrete actions that the IMF itself must take or specific reforms that it must implement. Instead, the language requires certification that the Secretary of the Treasury has instructed the U.S. Executive Director to the IMF to support congressional reforms. It requires the Executive Director to use the U.S. "voice and vote" in support of reform. On numerous occasions in the past, Congress has adopted this approach, but to no avail. IMF policy has changed little in response to previous congressional reforms, and it is unlikely to change as a result of the most recent congressional effort. 18
There are two major reasons that the "voice-and-vote" requirement is an ineffective means to achieve the stated goals:
First, the IMF operates by consensus rather than formal votes. For example, Kann Lissakers, the U.S. Executive Director to the IMF testified before Congress that, since she became U.S. Executive Director, there had been only 12 formal votes out of more than 2,000 decisions made by the Board. 19
Second, and more important, the U.S. Department of the Treasury exercises influence over IMF policy far in excess of the explicit percentage vote possessed by the United States. IMF policy does not, and will not, deviate in any important or fundamental way from the policy of the U.S. Department of the Treasury. If Congress is displeased with IMF policy, it should express its concerns to Secretary of the Treasury Robert Rubin and Deputy Secretary Larry Summers. IMF policy originates with them and can be altered effectively by them.
Congress also can influence IMF policy in the same way it influences policy in any executive branch agency: through oversight hearings, like this one, and the power of the purse.
Any other route, such as requiring the U.S. Executive Director to use her "voice and vote" in IMF deliberations, diminishes the influence of Congress and is unlikely to have a major impact on IMF policy.
In a real sense, the long delay in effecting U.S. funding for the IMF and the vigorous congressional debate that took place in 1997 and 1998 had more of an impact within the IMF than "voice-and-vote" instructions. The IMF has become visibly more open and transparent about its policies.
Today, it publishes more information on its programs and policies, and does so in a more timely manner, than heretofore was the case. What has not really changed, however, are the policies themselves.
The crucial problem for reforming the IMF is that, from a democratic perspective, the agency is not held accountable for its policies or programs. In a democracy, the electorate holds legislators accountable for their actions. Executive branch officials are subject to legislative oversight. In constitutional systems, the judiciary's independence is protected; but in the United States, even judges can be removed for cause (and in many states, judges are subject to recall or election). Independent agencies, such as the Federal Reserve, are subject to congressional oversight and must stand ready to defend their policies.
International agencies, by their design, are insulated from such democratic accountability. Yet they are amply funded, to the tune of many billions of dollars. Human beings even with the best of intentions will begin to behave irresponsibly when they are shielded from accountability or realistic financial constraints. Nothing short of fundamental institutional reform will alter behaviour. Congress did not accomplish such institutional reform in the 1999 Omnibus Appropriations Act. The only effective interim measure to gain some accountability is to look to the U.S. Department of the Treasury, to which the U.S. Executive Director of the IMF reports. It is here that accountability can be imposed.
Too often, policymaking takes place in a vacuum in which policymakers either are unaware of the histrical dimension of the problem or fail to link the current problem with past policy actions. The Asian financial crisis is embedded not only in the history, culture, and policies of each country, but also in the history of international economic policy in developing countries. That is particularly true with respect to IMF policy in Asia today.
The Asian financial crisis had its roots in the Mexican peso crisis of 1995. The IMF's handling of the Mexico crisis firmly established moral hazard in international lending and sowed the seeds for the Asian crisis. 20 Thus far, IMF policy in Asia largely repeats the policy mistakes in Mexico.
The reforms enacted by Congress are an important first step toward reforming the IMF. Even more important than the reforms, however, was the congressional debate over IMF funding. That debate focused attention on the process and substance of IMF policymaking, and even questioned the need for that organization in the post-Bretton Woods world.
Continued congressional oversight of the IMF and, more important, the Department of the Treasury is crucial to taking the next step toward fundamental reform. Reform requires moving beyond greater transparency to accountability and genuine institutional reform.
Gerald P. O'Driscoll, Jr:, is Senior Fellow in
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