| BUSINESSWEEK ONLINE : NOVEMBER 6, 2000 ISSUE | ||||||||
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| COVER STORY
On Their Own Developing nations must figure out how to use hot money--and not get burned On the honor roll of nations that have done the most to improve their financial systems in the last decade, Poland surely ranks near the top. Since the socialist era ended, Poland has swallowed a trunkload of capitalist medicine: It has cleaned up banks, privatized state enterprises, floated its currency, and made it easy for investors to come and go. In a richly symbolic gesture, the new Warsaw stock exchange was installed in the old Communist Party headquarters in 1991. Since then, foreigners have anointed Poland the success story of the old Soviet bloc. They have poured billions into the country. But Jaroslaw Bauc, Poland's young Finance Minister, is anything but cocky. He knows that many foreign investors keep their money in securities that are lucrative but can be sold fast, such as 52-week Polish Treasury bills, which right now yield around 18%. Because of this, Bauc has been trying to rein in a gaping current-account deficit that exceeds 7.5% of gross domestic product--a classic warning sign that the economy depends too heavily on foreign cash. He knows that if foreign investors suddenly bolted, the value of the Polish zloty would plunge. ''[That] could lead to a dramatic slowdown that would be devastating for the economic transformation,'' says Bauc. Poland faces the classic dilemma of the early 21st century emerging market: It needs a steady diet of foreign investment to thrive but must constantly worry that its overseas sustenance will be taken away, leaving the country weak and financially starving. In the last six years alone, capital crises have jolted emerging markets three times--the 1994 Mexican peso crash, the 1997 Asian meltdown, and the 1998 Russian collapse. PREEMPTIVE ACTION. Can it happen again? Of course. The grim truth is that in the fight against hot money, emerging markets are largely on their own. The idea that some kind of global regulatory authority could control the trillion dollars that rockets through the world economy every day was a nonstarter from the beginning. Some reforms, now being put in place, may help. But it's up to leaders in individual countries to figure out how to get the most from short-term money flows without courting disaster. Of all the aspects of globalization, capital markets have proved the most difficult to manage. Most economists agree that countries tend to prosper when they open up to trade. Foreign direct investment, which usually goes into long-term, productive enterprises like factories and power plants, brings similar benefits. But wide-open capital markets have always been controversial. Countries with opaque banks and small, poorly managed economies can easily lure hot money by paying high interest rates on bonds and loans, and once they do, they're heavily dependent on short-term foreign capital. When the flow reverses, devastation usually results. The majority of Mexicans, for instance, have not fully recovered from the steep devaluation and economic crisis that followed in 1995. That has led some leaders to question the orthodoxy that capital must always be free to work. Even champions of free markets have concluded they need some way to call a halt when things go awry. In 1998, for example, Hong Kong intervened in its stock market to fend off speculation so intense it threatened the integrity of the Hong Kong dollar. And given the continuing unregulated flow of money through the world financial system, its leaders still have no regrets. ''Globalization means that if a problem erupts in Sao Paulo, we will be affected,'' says Donald Tsang, Hong Kong's financial secretary. ''Every three or four years or so, we all have to start preparing for another crisis.'' What's emerging is a more realistic view of what open capital markets can and cannot accomplish. A country that absorbs a lot of hot money stands to see a lot rush out. If Poland chooses to put more controls or taxes on foreign capital, less will come in, but it may be able to moderate the flow. The trick is to act preemptively, but not too soon. To try to avoid future shocks, lenders, regulators and multinational agencies like the International Monetary Fund are asking for three categories of reform from both emerging markets and developed-country lenders and investors. -- Better disclosure. Countries that publish foreign reserve and other financial data frequently, as Hong Kong and Mexico now do, are an open book for investors. If it becomes clear that short-term money is pouring into a country at too fast a rate, smarter players will pull back. -- More flexible banking and legal systems that can react to a buildup of nonperforming loans quickly and either renegotiate them or sell them off. ''One of the biggest challenges is training bankruptcy judges and lawyers--and that takes decades,'' says Nina Gross, the Washington (D.C.)-based director of global regulatory consulting for Deloitte & Touche, which advises developing countries on such matters. -- More willingness on the part of developed-country investors and lenders to write off debt during workouts. If emerging market countries have to clean up their financial act, so do Western banks and corporations, which still tend to expect an IMF or government bailout when their bets go bad. These general goals are prompting some specific steps. The IMF now sets standards and codes for disclosure. The agency's new Managing Director, Horst Kohler, recently set up a capital-markets working group, which brings private-sector lenders together with official agencies to discuss ways to improve the stability of the financial system. And the Bank for International Settlements, an international policy and coordinating body for central banks, has set rules for how banks must treat loans to official and private-sector borrowers in emerging markets on their balance sheets. The goal is for banks to better reflect the risk of those assets. ACT OF FAITH. Those goals are all to the good, but on the ground the task of trying to develop world-class financial systems can be difficult and frustrating. Take the case of Thailand. It has implemented almost everything the IMF has recommended, from selling banks to foreigners to setting up bankruptcy courts. But foreign banks and investors continue to shun it (box). Thailand is not the only one suffering. Net private capital flows to emerging markets were only $68 billion last year, well below their 1996 peak of $226 billion, the IMF says. The problem is that most emerging markets desperately need foreign cash to fund growth. For them to embark on a reform program is an act of faith that sound policies, well executed, will eventually bring new investment. It helps if investors see the country as a key economic hub. ''The good thing is that if countries do change their behavior, the capital markets respond favorably,'' says Charles Dallara, managing director of the Institute of International Finance, a trade group of top global banks. After Brazil devalued in 1999, for example, tough measures by its central bank eventually restored investor confidence. One good example of the benefits of restructuring is Mexico. In December, 1994, panicked investors--domestic and foreign--took their money out, draining the central bank's reserves. Mexico had issued $30 billion in short-term dollar-denominated debt. After the subsequent devaluation, holders of that debt wanted their money. In exchange for a $50 billion bailout from the U.S. Treasury and the IMF, Mexico drastically changed its policies. Then-Finance Secretary Guillermo Ortiz (now Central Bank president) began quarterly conference calls with investors. The Bank of Mexico started publishing foreign reserve data weekly--not three times a year, as before. That helped Mexico return to the capital markets within seven months of devaluation, compared with a seven-year wait after the 1982 meltdown. ''To recover market confidence, it was fundamental to be transparent,'' Ortiz says. There are glimmers of light elsewhere. Korea, for example, continues to bear the weight of a huge debt overhang. The Korean Kospi Index is down 51% this year. But there are now plenty of Korean financial players who don't go by the old rules. One is Kim Jung Tae, chairman of Korean Bank H&CB, which just listed on the New York Stock Exchange. Kim, who believes he's the only Korean executive to be paid solely in options, has cleaned up Korean Bank with missionary zeal. Now the bank's shares are among the best-performing of the sector on the Seoul Bourse and a favorite with foreign investors. Among Kim's innovations: credit-scoring borrowers and hiring seasoned foreign bankers to train local staff. ''Our decision-making process is now 100% transparent,'' he says. Policymakers in emerging countries need to learn from such success stories. So whether they like it or not, in the decade ahead, developing countries will probably continue to operate in the Darwinian environment of global markets. And the best they can do is learn from the crises of the 1990s before the first capital crisis of the new century comes crashing down on them. By Julia Lichtblau in New York, Brian Bremner in Tokyo, and David Fairlamb in Prague, with Geri Smith in Mexico City and bureau reports _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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