Rhodes on risk and reform

Rhodes is a friend of finance ministers and central bank governors across Latin America, Asia and central and eastern Europe and offers his views on the progress of financial reform in key emerging markets, identifies the world's trouble spots and pitches into the debates on burden-sharing and the new financial architecture that have raged in recent months.

Could you identify some of the issues that investors have expressed concern about recently?

Obviously the change of government in Argentina, how things are coming along in Asia, and the state of the US economy. The US economy has been the motor for growth in emerging markets. There was a time after 1997 when everyone thought high growth in Japan was essential to pull Asia through. In fact, the US provided that. There are some people who are still concerned about Japan because it is not clear that the consumer is back yet, and there is a need to finalize the restructuring of Japan's financial sector.

There is also a general concern about the possible effect on emerging countries of a major hit to the US equity markets. This concern has been fuelled by the very high US growth rates in the third and fourth quarters and the feeling that the Fed will have to move up interest rates more than initially anticipated, and the consequent effect this could have on these markets.

Since the eruption of the Asian crisis, the US has been importing deflation from that region. But with growth returning in Asia this has now stopped. On the other hand, oil prices are still rising and if the US continues to grow like gang-busters, there will eventually be pressure on wages.

As for Argentina, I was there at the end of last year and was very impressed with the new government's economic team. The new government was able to get the budget through before year-end and negotiated revenue-sharing agreements with the provinces. There was also a concern about the new government's ability to roll over the $17 billion worth of debt due this year. But the country has been able to tap the market successfully and, in fact, Citigroup has just taken Argentina to the market with a $1 billion bond issue which was oversubscribed to $1.25 billion. This is the largest long-term bond issue that Argentina has done in the last three years and is a sign of confidence in Argentina by the international finance community and augurs well for the country's ability to successfully roll over debt coming due.

What's your view on the risks of more emerging markets crises?

The real danger here is complacency. Korea has returned to high growth but is still in the process of finalizing the chaebol and banking sector restructuring. The problems experienced at Daewoo are a good example of the need to finalize chaebol restructuring.

Thailand also has made good progress in returning to growth but needs to finalize the restructuring of its private sector. Indonesia still has tough economic problems to work through and, in the case of China, work still needs to be done on the state-owned enterprises and the banks.

Banking systems are the key, particularly in emerging market countries. If you have a safe and sound banking system, you can weather economic downturns. The absence of this was a problem in Asia and Russia and has been in the past in a number of Latin American countries. Good individual management of banks and competent bank regulation are critical to having a good banking system.

Argentina has done a good job opening up and strengthening its banking system. And the Brazilian banking system has been significantly strengthened over the last few years. This helped Brazil avoid a banking crisis at the time of the real devaluation last year and helped it return to growth more rapidly.

Many emerging market countries are now welcoming foreign participation in their banking systems. Citigroup is studying the acquisition of banks and other financial entities in several key emerging market countries.

In addition to having a safe and sound banking system, it is very important for emerging market countries to have realistic exchange rates and practice transparency on the release of important economic data.

What's your opinion on the new financial architecture, the role of the IMF and the World Bank, bailing-in private sector creditors and on recent events in Ecuador?

For countries that are pursuing proper economic policies, the Bretton Woods institutions should put in place back-up lines to draw on during future economic difficulties or crises, as is being arranged by the IMF in the case of Argentina. The reality is that the private sector accounts for more than 85% of capital flows into the emerging markets.

So the official sector, including the IMF, must work more closely with the private sector, and such participation should be on a voluntary basis.The voluntary approach is the only successful way of bringing in the private sector. There are some members of the official sector, including some at the IMF, who want to interpret or amend article 8.2b of the Articles of Incorporation in a way that could encourage some emerging market countries to default on their debt.

Such a scenario could raise the cost of borrowing and put off financial institutions from lending into emerging market countries.

The game should be to encourage flows to emerging market countries that are following proper economic reform programmes rather than discourage lending into these countries.

As to the question of restructuring or refinancing sovereign bond issues, the outcome of discussions under way with Ukraine, Pakistan and Ecuador will be very important for how this problem is resolved going forward.

With regard to Ecuador, the country has now decided to adopt a currency board system. The success or failure of this decision will depend on the strength of the overall economic programme put in place and the leadership shown in implementing this on the part of the new government.

Argentina was in a similar difficult situation several years ago and was successful in adopting a currency board programme because the country had the proper economic and political leadership.

What other trouble spots are investors concerned about?

Colombia and Venezuela. Although some investors have expressed concern about Colombia, President Pastrana and his economic team are successfully implementing a strong economic reform programme and the country has been able on several occasions to successfully access the international capital markets.

Additionally, the government has announced ambitious plans to control the production and export of drugs from the country with the help of the US. The biggest challenge the government faces is its ability to successfully negotiate a peace agreement with the guerrilla movement, Farc.

The concern in Venezuela is the ability of the country to return to growth after having been hit by the terrible recent floods.

President Chavez has stated that he will announce a new economic programme shortly and investors are anxiously waiting to hear its terms.

Who do you think will be the next head of the IMF?

You need a person who is decisive and not afraid to take tough decisions.

It is not clear that the G7 will be able to reach any consensus soon and, therefore, when Michel Camdessus steps down at the end of February, the deputy managing director, Stanley Fischer, may be called upon to run the Fund on an interim basis until an agreed upon candidate is appointed.