Allan Meltzer and his cabal of fellow iconoclasts obviously hit something when they fired their round in the debate about the IMF and the World Bank.
Carnegie Mellon University’s Meltzer, chairman of a congressional panel called the “International Financial Institution Advisory Commission”, and his conservative colleague in the American Enterprise Institute, Charles Calomiris of Columbia University, joined forces with Harvard’s Jeffrey Sachs, a card-carrying Democrat and long-time IMF critic, to forge a common view in favour of radical restructuring. Three members of the group, all Democrats, split from the majority and refused to sign the report.
The document arrived at a propitious time.
Public support for the multilaterals, at least in the US, is waning and their legitimacy has been increasingly challenged. Now, with a new managing director preparing to take the helm at the IMF, an opportunity to change course could be at hand although incoming boss Horst Köhler has hinted against radical reform.
Neither the IMF nor the World Bank has been doing an effective job, says the report. It condemns the IMF for not spotting and not dealing with such debacles as the Asian crisis.
Key recommendations for the IMF include limiting its role to quasi lender of last resort to emerging economies. IMF lending would be short-term (120 days with one rollover), at a penalty rate (above the borrower’s recent market rate) and secured by a priority claim on the borrower’s assets. To qualify for IMF lending, a country would need to meet four criteria: it must provide freedom of entry and operation to foreign financial institutions; it must publish in a regular and timely manner the maturity structure of its outstanding sovereign and guaranteed debt as well as its off-balance sheet liabilities; the country’s commercial banks must maintain adequate capital either in the form of equity or as subordinated debt held by non-governmental and unaffiliated entities; the country must meet appropriate standards for fiscal policy to prevent countries from using IMF resources in support of irresponsible government spending.
In addition, countries should avoid pegged or adjustable exchange rate systems. The IMF would be authorized to waive the normal prequalification requirements in cases when a crisis threatened the global economy.
Princeton University’s Peter Kenen, who served as a member of the Council on Foreign Relation’s task force which scrutinized the IMF and World Bank last year, agrees with the Meltzer Commission that a narrowing of IMF conditionality is in order. Kenen says: “I have objections to many of the conditions imposed which take too much time to negotiate and are extremely difficult to implement in the midst of a crisis. The Fund has loaded far too many conditions on these countries.”
Kenen thinks that it would make for the faster implementation of a Fund programme if a lot of the conditions were set out in advance, rather than negotiated in a crisis. Overall Kenen doesn’t give the Commission high marks. “There’s absolutely no weighing of the difficulty involved with some of these things,” complains Kenen, “no discussion of pros and cons. There’s simply a series of flat, dogmatic prescriptions, many of which have been thought about before and rejected for good reason.”
At the Institute of International Finance in Washington, a group that represents the global Financial industry, Lex Rieffel thinks the saddest thing about the Meltzer Commission is that it missed a golden opportunity to educate the public about development assistance and globalization. “The only thing that the IMF has gotten seriously wrong in the last 10 years is the extent to which it has become involved in providing Finance to low-income countries, but there’s no message in that report to explain how the US contributed to that result.”
The G7 sent the IMF down that road largely because their foreign aid budgets have fallen so far over the past 20 years. Taxpayers in wealthy countries don’t want to put much into overseas development because they haven’t seen results. The right thing and the smart thing – as the Meltzer Commission recommends – would be to deliver the bulk of these resources as grants. But that hasn’t been politically feasible. G7 governments, therefore, have been using loans from the multilaterals to fill the vacuum.
But Rieffel points out that lending by the multilaterals to poor countries, if anything, compounds the problem. The multilaterals are treated like preferred creditors. They can’t reschedule and that forces the bilaterals and the private sector to reschedule more. So bad karma hangs over them like a tent. “The Meltzer Commission doesn’t elucidate the political realities of this,” says Rieffel. “It acts as if the US is blameless, that these multilateral institutions are completely the masters of their fate.
Well, ‘we have met the enemy and he is us,’ as Pogo said in that classic comic strip.”
Morris Goldstein, project director for last year’s CFR report, thinks that the Meltzer Commission also made a mistake by not drawing a clear distinction between country crises and systemic crises. Originally, they said that if a country didn’t meet their preconditions, it would get nothing. Then, they added an exception for cases of systemic risk, but they didn’t give much guidance about when the IMF should provide large-scale packages. We spent a lot of time on that in the CFR project.”
Goldstein also complains that the Commission ignored the need for collective action clauses in international bond agreements as well as for private sector burden-sharing when countries run into trouble. “I just can’t understand that,” he said, “we know that if the country has an unsustainable debt position the Fund ought to insist, as the official sector does in the Paris Club, that there be parallel concessions from the private sector.
While they talk a lot about moral hazard, they really pass on some of the key mechanisms for doing something about that.”
Finally, many observers have doubts about another Meltzer recommendation for moving long-term development assistance from the Fund to regional development banks. Yes, it is a problem that the IMF and World Bank are seen as enforcers of US orthodoxy and interests.
But would the regionals be less politicized? “Suggesting that we’re going to get decisions based solely on economics and the merits of the case at the regional banks I think is naive,” says Goldstein.
This much is clear: the IFIs were not created to operate in the type of world they find themselves in today. It’s a world with a globally integrated economy offering the opportunity for countries to tap a huge pool of private, not public, savings. It’s a world that didn’t exist 10 years ago. And the IFIs have yet to catch up.
Consider the World Bank. It has four separate balance sheets and three separate staffs, one president for three institutions. “This isn’t modern,” says Rieffel. “Its charter is an anachronism and the MO [modus operandi] no longer fits today’s circumstances. But don’t blame the staffs. Blame the shareholders.”
Meltzer Commission recommendations aimed at the World Bank and other regional development banks include the proposal that they would phase out, over five years, all resource transfers to countries with capital market access (with an investment-grade credit rating) or with a per capita income above $4,000. And they would impose limits on official assistance, starting at a per capita income of $2,500.
Poverty alleviation grants would replace loans and guarantees for physical infrastructure and social service projects. These grants would go directly to suppliers, as a safeguard against corruption and inefficiency, upon independent verification of delivery.
Though US treasury secretary Laurence Summers has ruled out substantial restructuring at the World Bank, telling the Council on Foreign Relations that the Clinton administration rejects “the idea that these countries should not be in a position to obtain the additional finance, expertise and insurance against instability that access to multilateral development bank programmes can provide.”
It could be different at the Fund. “I think it would have been harder to debate this if [Michel] Camdessus were still there,” says Fred Bergsten, of Washington’s Institute for International Economics, a member of the Meltzer Commission. “It’s hard to distinguish an attack on IMF policies from an attack on Michel personally and, to his great credit, he realized there was a big debate and it might proceed better if he had retired from the scene.”
Dornbusch on contagion
Asia may be bouncing back. But apprehension was in the air when the IMF, the World Bank and the Asian Development Bank convened a conference in Washington to discuss financial contagion. Rudiger Dornbusch, MIT’s celebrated international economist, was one of the prime movers for this event. He talked to James Smalhout.
Would the official community have reacted any differently to the Asian crisis in July 1997 had we known then what we know now about financial contagion?
No, I think that the research shows two things of interest. First, every one of those economies had horrible balance sheets and with an accident you’re going to get a big fallout.
The fallout gets aggravated by lack of liquidity, by a lack of knowing what is happening next in politics, by a question of whether the government will choose to default rather than have a serious fiscal impact in the budget that is politically unpopular.
All of that, I think, is well documented and leaves the policy question of whether you should intervene or not. The answer always is: when it’s big, intervene. I think that will remain the answer. What is big is carefully not defined, neither for the Federal Reserve in relation to domestic banks – other than too large to fail – nor in the case of emerging markets. Everyone has been looking for a victim. Finally, they found Ecuador. It’s so small that it doesn’t make a difierence.
That’s to show that not everybody gets bailed out. So I don’t believe that the research has a direct feedback to our policy action.
But I think that research is important when we paint a picture of how a country is integrated in the world economy. One of the things to consider is the volatility correlations. A shock that happens anywhere happens everywhere. The more leverage there is in the system and the more balance sheets are problematic, anything that happens is big.
Those are important lessons that policy-makers now know and they lead to the next questions.
What are the key vulnerabilities? What’s a good exchange rate policy? What’s the minimum reserve in the banking system? What’s the regulation that avoids mismatching.
All of the right questions are being answered now and, one hopes, are being taken seriously.
Mexico collapses every sixth year. This is the sixth year and they say: “Check the shopping list. We’ll take you over it, one by one. We have a flexible rate. So, that’s our shock absorber. We have long maturities and that is a shock absorber. We have a good budget. That is a shock absorber. So, sure the exchange rate can depreciate, but collapse?” I think that’s pretty good, when a Finance minister understands that there is a shopping list and people check it off to ask whether they can have an accident.
What is your definition of contagion?
I think the right one is that you are standing innocently around and the next thing it hits you. Any participant in traffic knows that you can have an accident because someone runs into your car. That’s contagion. It wasn’t you. It was him. But it was totally stupid to say: “Gee, I didn’t realize this could happen.” That’s what we had in Asia. We were totally innocent. That wasn’t true because they had horrible balance sheets. And to say that it cannot happen is naive. So, I think this traffic analogy is really the right one because it catches them on their key vulnerability. Yes, something happened and it wasn’t caused in Indonesia by itself, but the fact that they were driving drunk really didn’t help.
Here, economists sound much more self-assured about their ability to analyze and predict crises using conventional methods. After Mexico, many economists said their models didn’t work. How do you explain the greater confidence today?
It’s 10,000 papers later, is one answer. And there’s a focus on the balance sheet. That’s really where it happened. And what is a vulnerable balance sheet? Nobody here says they can time it. They can tell you whether someone is exposed and they can use empirical work to say what some of the impact will be on Country X if it happens in Country Y, because there’s a lot of empirical work done on the correlations. So, I think that a huge amount has been done. But the key lesson is: don’t look at the trade balance, go to the balance sheet. If it’s big that’s where it happens. I think there is a hugely better understanding of how to make a crisis. Today, we know how to make one, right? Or, turn it around. They spend a lot more time not on the inflation rate and not on the trade balance, but looking at the maturity matching and how it can go wrong. The bad balance sheet has 10 ways of going wrong. Then, all you need is to ask how will this be triggered in the First place. If there is an election you can be sure that it’s right after.
Do you think foreign investors destabilize emerging markets?
I think when something goes wrong, finding the scapegoat is the First order of business. I think foreign investors are a wonderful influence, just as stockholders are for a company. They beat up management, get them to perform better. It’s a great civilizing influence.
During a crisis with contagion, market movements become more correlated. How can you design a well-diversified portfolio?
If you had invested in the stock market and said what happens in a downturn, you would be asking exactly the same question. You’d be saying that you really needed a lot of utilities. They tend to be less cyclical and what is the utility equivalent? You’d say I’d take three helpings of Singapore and Taiwan, because they have better balance sheets. They may be hit, but they won’t go down as much and maybe you should have less emerging markets.
You’ve seen that the correlations are very high in bad times. Having them spread out isn’t going to get you that far away from it.
They’re all the same. So, I’m saying invest strategically.
Which countries should be overweighted and which countries should be underweighted in view of contagion?
I think that you want to go to countries that have top-rated banks if you want to minimize the downside. That will turn out to be an extremely important factor. Just look at the average rating of banks in a country and say that I won’t go anywhere that has less than “B”. That basically means that you will not go to emerging markets, but you would go to Taiwan, Singapore and Hong Kong.
Over the past decades, do you think we have moved toward a financial system in which exchange rates reflect fundamentals more closely and promote growth for that reason or not?
I have never complained about exchange rates.
People look at the yen-dollar rate over the past three years. We have gone from a world where Japan was about to go totally dead to one where they’re back to life, not big life but some life. I’m not surprised that the exchange rate moves by a very substantial amount. I think the same is true for emerging markets. You come back three months after a crisis. Once the damage is known, the real exchange rate hasn’t moved that much. So I think they’re good. I don’t have much problem with real exchange rates.
If a museum burns down and you have to estimate the damage while the Flames are going up, it’s pretty hard. The Rembrandt might be all right or not. That’s what an emerging market crisis is like. So overshooting ex post reflects the total absence of a judgment about the damage as well as the policy response.
Will the country be friendly to foreign investors or will it be haircut time? I’m not surprised about large exchange rate moves.
Restructuring victory
Thailand’s new bankruptcy court sent out an encouraging message to international lenders in March when it declared the country’s largest debt defaulter insolvent in a benchmark case that paved the way for its restructuring.
Thai Petrochemical Industry (TPI) owes $3.5 billion to lenders including Bangkok Bank, Citibank, the IFC, US Export-Import Bank and Bank of America. Led by its chief executive, Prachai Leopairatana, it argued its assets still exceeded its liabilities, and that Prachai should be allowed to remain in control of the company. In a move widely praised by creditors and analysts, the court took a wider view of insolvency, rejecting the company’s asset valuations and focusing on its inability to service its borrowings since the 1997 baht devaluation.
“It is a landmark which defines how the court will use its latitude in determining insolvency and the ruling for creditors in this case means there will now be more unilateral bankruptcy cases pushed through without the cooperation of debtors,” says Sriyan Pietersz, head of research at SG Asia Credit Securities. “It’s good news in the sense that this was a decision that investors, creditors and debtors were all watching with great concern beyond the issue of TPI,” he adds. The TPI ruling is expected to have a wider impact on the current status of company restructurings in Thailand.
Government officials had observed a slowdown in the rate of restructurings in January as debtors backed off negotiations in anticipation of the outcome of the TPI case.
The ruling in favour of the creditors is now expected to reignite negotiations with hitherto uncooperative debtors. Around Bt315 billion ($9 billion) worth of cases are currently in the process of formal out-of-court restructuring, representing about 15% of total bank non-performing loans. A significant proportion of those could now emerge from deadlock as a result of the TPI decision. “We will be looking to see more restructurings settling out-of-court as relatively healthy but recalcitrant debtors call it a day,” said Pietersz.
Initial indignation over the court’s agreement to allow Prachai to remain in charge of the company has been dismissed as of little concern in the context of his initial appointment as official planner to the restructuring by creditors. When negotiations broke down it required the approval of two-thirds of the creditors to appoint a new planner, and the court was merely following legal provisions by insisting the replacement was appointed through the correct procedure as the steering committee of creditors represented only 48% of the creditors. “Legally he cannot do anything because the official receiver will take action. He cannot move any assets,” says Baker&McKenzie partner Kitipong Urapeepatanapong.
Despite the court ruling, it could take up to another seven months, including two months to appoint the planner, before TPI is restructured, although pre-agreement of much of the work may shorten that timeframe. The key is that the company, despite its massive debts, is still considered salvageable.
Cashflows in the last quarter have been relatively healthy, buoyed by the fact that TPI is the only fully integrated petrochemicals plant in south-east Asia, enabling it the flexibility to switch between products as prices change.
TPI’s problem was that it financed its expansion with US dollar borrowings, as did much of Thailand’s industry, in the belief that the baht would remain stable. “That was their downfall,” says Pietersz.
Kitipong says: “The core decision is good for Thailand because the court did not simply look at the balance sheet.” Previously civil courts have concentrated solely on the balance sheets of troubled companies and whether liabilities outweighed assets. But Kitipong adds: “Thailand still does not have very clear provisions on what insolvency means.”
Notwithstanding the TPI case, Thailand’s codified rather than common law system means the TPI decision is not necessarily binding on future cases. Each will depend on their own facts and presentation, he added. “This case has been watched by foreign investors and banks, and if this company was not insolvent there would have been a big storm coming to Thailand.” Shares in TPI were given permission to resume trading on the Stock Exchange of Thailand once the company had Filed accounts for last year. Gill Baker
