Despondency and fear hung in the air at last year's IMF/World Bank meeting. The contrast with the prevailing mood of self-congratulation and complacency in Washington last month could scarcely be more stark. The oft-repeated view was that the worst of the emerging market crisis is past, that major emerging-market economies in Asia and Latin America are either well into recovery or poised for it and that growth in the developed economies of Europe and Japan will take the pressure off the US to be the world consumer of last resort.
Kang Bong-Kyun, minister of finance and economy for Korea, says his country will record 7% GDP growth in 1999, following a 5.8% contraction last year. It has rebuilt foreign exchange reserves from close to zero at the end of 1997 to an all-time high of $65 billion, thanks to a record current account surplus of $40 billion in 1998 and $20 billion this year.
Thailand also has rebuilt its foreign exchange reserves to $32 billion, twice its short-term external debt, just two years after nearly losing everything: this on the back of a current account surplus equivalent to 12% of GDP in 1998 and 9% of GDP this year. Growth in 1999 may be as high as 4%, following a wrenching near 10% contraction in Thailand during 1998.
Latin American financial leaders are also optimistic, although having been hit more recently than the Asians they are looking forward to recovery, not yet experiencing it. Regional growth will be zero this year. But it could have been much worse. Pedro Malan, minister of finance for Brazil, which accounts for 35% of the economy of Latin America, predicts growing exports, average 4% GDP growth in Brazil over the next three years, 6% inflation next year and 4% for 2001. If Brazil does well, the whole region does well.
For all this, foreign investors remain a little sceptical.The lesson Alan Greenspan says he draws from recent world financial market crises is the great value for a country in having two well-functioning mechanisms for delivering capital from savers to productive users, so that if one seizes up, another takes the strain. During the US banking crisis of the late 1980s and early 1990s, the country's capital markets provided finance to companies that could earn a return on it. Last year, when the bond markets closed even to investment-grade US companies, the American banking system stepped into the breach to provide credit.
Many emerging economies, though, have neither robust banking systems nor developed capital markets. Of course all pay lip service to banking-sector reform. But how far these good intentions are translating into painful restructuring is in doubt. Thailand has poured public money into recapitalizing the banking system but finance minister Tarrin Nimmanhaeminda admits that non-performing loans still account for 47% of assets at the Thai banks. He hopes two or three more banks will be privatized by the end of this year but he fears that handing over the Thai banking system to foreigners might remove credit to small and medium-size Thai enterprises. He also fears that a too-speedy assumption of bad loans and fire-sale of Thai banking assets would simply promote a culture of default. Thailand and many other emerging countries are feeling their way slowly on bank reform.
And foreign portfolio investors are cautious. The lesson they drew from recent turmoil is that the international crisis-management system is barely up to the task and that liquidity can be illusory even in highly developed markets. They remain risk-averse and many are pricing in rising interest rates in the US and Europe. That's why Argentina still has to pay 700 basis points over treasuries for its funding. That's why developed-world private-sector capital flows into Latin America dropped from $105 billion in 1997 to $85 billion in 1998 and around $60 billion this year. Much of the capital that flows in is from high-grade cross-over bond investors opportunistically seeking yield. It is volatile.
And if markets were to decline in the US because of rising interest rates, a reluctance by foreign investors that account for 35% of the US treasury market to roll over exposure to an economy with yawning trade and current account deficits, a slumping currency and possibly growing inflation expectations those capital flows might be severely disrupted. A collapse in US stock prices would really hurt emerging markets by ushering in complete risk avoidance.
Abby Joseph Cohen, renowned strategist at Goldman Sachs, was another optimist in Washington, predicting that US investors would become less risk-averse, that inflation would stay low, that corporate profits would grow at an average quarterly rate of 8% over the next 18 months and concluding that the S&P500 is now modestly undervalued. Many around the world will hope she and the other optimists in Washington are right. A year from now we will know whether the second half of 1999 really marked the passing of the storm, or a brief respite for financial markets in the eye of the hurricane.