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Emerging Markets

The IMF has refused to bailout bond holders before Argentina!

Adam Thomson of the FT has an interesting article arguing that Argentina’s bond restructuring could succeed if Argentina is willing to offer bondholders 30 cents on the dollar, only a bit more than the 23-25 cents it already has said it will offer. Since Argentina has about $100 billion in outstanding bonds (and other, similar debt), Thomson is arguing that Argentina could pull off its restructuring by pleding another $5 billion in cash and discounted future cash flow. That feels about right. The chances of a sucessful restructuring would go way up if Argentina’s offer turns out to be a bit above the current market price of its debt. Bondholders have not gotten much out of Argentina’s recovery, and a succesful restructuring would increase their upside should Argentina’s strong recent economic performance continue. Alas, it is not yet clear that Argentina will sweeten its offer, and even if it does sweeten its offer, it is likely to have a lower participation rate and face more holdout litigation than has been typical of other recent restructurings.Thomson, though, includes an assertion in his article that is false, though it reflects a common (mis)perception: "Argentina’s tactics have shown that when investors buy sovereign bonds they are in effect lending without security or collateral, without the ability to enforce their contract and without the ability to seize assets. Until now this did not matter much because investors knew that IMF bail-outs would always provide the money to pay bondholders back. Argentina’s approach changed all that, and the market is struggling." The first sentence is accurate: it is hard to seize a sovereign’s assets. The second sentence is wrong. Remember Russia? OK, Russia did not restructure its eurobonds, but it certainly restructured soveriegn debt held by foreign investors -- both its ruble denominated GKOs and its dollar denominated London Club syndicated loans, which had been repackaged and sold into the markets. Plus, Pakistan, Ukraine and Ecuador all restructured their Eurobonds before Argentina defaulted. Indeed, one the biggest myths around is that IMF bailouts largely go to pay bondholders. Bonds are long-term obligations, and in most case, shorter-term creditors, not long-term creditors, are the ones who get bailed out. Take Argentina: a run by domestic bank deposits overwhelmed the $10 billion or so net financing that the IMF provided in 2001, and accounted for most of Argentina’s reserve losses. That is why so many bonds are around that need to be restructured: only $7 billion or so of Argentina’s large -- initially above $90 billion -- stock of international bonds came due in 01, and had a chance to get out! The IMF never has provided enough funds to a crisis country to let everyone with a financial claim get out. One other point. Thomson argues that Economy Minister Lavagna’s hard-nosed negotiating tatics played a big role in Argentina’s expected ability to win bigger concessions from its creditors than other debtors. Maybe. But Argentina also ended up with a bigger debt problem than other emerging economies, and thus in a sense had to seek larger than average concessions. Argentina entered into its crisis with a debt to GDP ratio of around 50%, and a massively overvalued exchange rate. A large real depreciation was needed to close Argentina’s current account deficit, and the real depreciation effectively doubled its debt to GDP ratio. Argentina’s debts were mostly in dollars and stayed fixed at @ $140-150 billion (or would have, if Argentina had not pesoized some of its sovereign debt), and GDP collapsed from $280 to @$150 billion. On top of that, bailing out the domestic banking system added another $20 billion or so to Argentina’s debt. (All numbers are ballpark -- i have not gone back and checked them carefully, the precise numbers should be buried somewhere in this IMF document). Tatics matter, but the underlying economic reality that Argentina has too much debt also has helped Argentina’s case.

Blog Post by Brad W. Setser September 21, 2004 Follow the Money
Development

The Bridge to a Global Middle Class

Read an excerpt of The Bridge to a Global Middle Class. The Bridge to a Global Middle Class compiles a unique series of papers originally commissioned by the Council on Foreign Relations in the wake of the financial crises of 1997-98. This thought-provoking retrospective culls the views of economists, international financial institutions, Wall Street, organized labor, and various public-interest organizations on how to fortify the U.S. global financial infrastructure. The effort is the culmination of an eighteen-month study that sought to encourage the evolution of middle-class-oriented economic development in emerging-market countries. In addressing the world economic problems that led to the crises and examining methods to improve the workings of the world's financial markets, Council Fellow Walter Russell Mead and Council consultant Sherle Schwenninger offer ideas and policy recommendations, and they suggest the concrete forms these might take in the drive to offer the developing world an improved standard of living. These papers make a convincing case for middle-class-oriented economic development as the key to global prosperity and stability. U.S. and international policymakers will find these insightful discussions valuable in forming new policy and providing the appropriate stimulus for economic development in emerging economies. A Council on Foreign Relations Book

Book by Walter Mead and Sherle R. Schwenninger February 1, 2003
Indonesia

The Paradox of Free Market Democracy

This paper will situate the recent problems in Indonesia in a more general framework that I will call the paradox of free-market democracy. The basic thesis I will advance is as follows. In Indonesia, as in many developing countries, class and ethnicity overlap in a distinctive and potentially explosive way: namely, in the form of a starkly economically dominant ethnic minority -- here, the Sino-Indonesians. In such circumstances, contrary to conventional wisdom, markets and democracy may not be mutually reinforcing. On the contrary, the combined pursuit of marketization and democratization in Indonesia may catalyze ethnic tensions in highly determinate and predictable ways, with potentially very serious consequences, including the subversion of markets and democracy themselves. The principal challenge for neoliberal reform inIndonesia will be to find institutions capable of grappling with the problems of rapid democratization in the face of pervasive poverty, ethnic division, and an historically resented, market-dominant "outsider" minority.

Report by Amy L. Chua June 7, 2000

South Korea

Korea's Comeback

Overview One year ago, Korea was in trouble. Its banking system, inadequately supervised, collapsed. Industry, lacking financial discipline, expanded unproductively with its "too big to fail" private firms crowding out smaller rivals. Labor market rigidity weakened the competitive position of Korean industry. The financial crisis that resulted gave rise to hopes that significant reform would address all three dimensions of Korea's vulnerability. The crisis provided a window of opportunity to seek a coordinated solution, given that the overall condition of the economy was everyone's concern. However, Korea's quick recovery may have eliminated that opportunity as each interest group focused on its own well-being, resulting in social and political fragmentation. The regional focus of the 2000 parliamentary elections reflected this fragmentation. No consensus emerged on a reform agenda needed to dramatically restructure the economy. With the government lacking support to continue comprehensive reform, new vulnerabilities began to appear. Before the crisis, the government implicitly insured depositors' bank loans to the large conglomerates. These guarantees left the banks with little incentive to develop credit analysis and loan monitoring skills necessary for prudent lending. Now, the government's increased ownership of the nation's capital assets may further weaken market discipline. Again, the insured agents, both firms and bankers, will not take proper care to manage risks. Despite the stalled political reform process, market forces may yet change Korea precisely because the banks are unlikely to resume the central role they once played as the principal source of investment capital. Companies will have to turn to capital market alternatives -- bond, equity markets, and Internet banking -- for sources of new funding. As they seek new forms of financing, firms will be compelled to change management practices, concentrate on shareholder value, and adopt disclosure standards that are more rigorous than what is demanded by Korean law. The collapse of the banks will have another beneficial effect: weakening the cozy links between firms and politicians who once provided privileged access to cheap credit in exchange for contributions

Report by Hilton Root March 2, 2000
Emerging Markets

Building the Financial Infrastructure for Middle Class Emerging Economies

Overview The export-led growth model for emerging economies is driven by their need to service external debt and build foreign exchange reserves. It has foundered in the aftermath of financial crises characterized by collapsing currency and asset values, widespread bankruptcies in real and financial sectors, rising unemployment, and negative growth rates. In many developing countries, a higher volume of exports is needed to earn the same income that previously sufficed to meet external obligations. As a result, profits and wages have fallen, lowering earlier gains in per capita income and threatening past improvements in income distribution, education, and life expectancy. The sustainability of the export-led growth model is also threatened by dramatic increases in the current account deficits, external debt, and domestic debt ratios of the major global importer/consumer. As U.S. ability to maintain its role becomes less certain, fewer countries appear to be willing or able to absorb more imports or to accept current account deficits. Continued slow growth in Japan, the second-largest national economy in the global system, would hamper its ability to assume some of the burden carried by the United States, even if its own adherence to an export-led growth model were not in itself a major inhibiting factor. Continued restructuring, high levels of unemployment, and constrained monetary and fiscal policies within the European Community also do not suggest robust increases in demand for imports of goods and services in the near future. Diminishing returns to the export-led growth strategies that emerging economies have followed (and have been encouraged to follow) during the last two decades will require the development of new strategies to promote growth. Both developing and developed countries will need to reintroduce domestic demand-driven growth as a policy objective. However, emerging economies will require more than a shift in the direction of macroeconomic policy to stimulate demand. Also required will be the development of domestic capital markets and financial systems like those in industrialized countries, which are capable of mobilizing and channeling domestic savings to expand internal economic activity.That, in turn, will require changes in global capital markets and financial infrastructure to support and encourage reinstatement of a role for domestic demand-driven growth in the global economy and particularly in emerging economies.

Report by Jane D'Arista December 1, 1999
Financial Markets

Private Capital Flows, Emerging Economies, and International Financial Architecture

Overview Firms and development strategies based on a rear-view mirror view will leave companies, projects, and entrepreneurs scrambling for capital access. The control of capital in the developed world continues to shift away from private and state-owned institutions and toward public markets. Small and medium-sized firms with the best prospects for innovation and income/wealth generation need to be liberated from their dependence upon bank-based financial systems. They must also have the ability to turn to market-based systems with access to institutional capital providers at home and abroad. Discussion of financial architecture cannot be separated from the problems of concentration of political power, industrial control, and financial capital. Growth and equity in the economy is limited by entrepreneurs' dependence upon commercial banks that are state-owned or directed, and thus historically removed from shareholder and creditor accountability. If politically connected holding companies can shift most of their liabilities to a few subsidiaries and then give those units to the government for liquidation through restructuring authorities, new investment will not occur. As the Wall Street Journal recently reported, hints of recovery promoted by financial assistance packages may well have stalled efforts at financial reform and corporate restructuring. In Thailand, where thousands of companies stopped paying their debt in 1997, restructuring is at a standstill. In Malaysia, corporate debtors have been insulated with a government-directed credit committee. In South Korea, chaebols have expanded their debt and statelinked companies and family conglomerates have resisted change throughout the crisis countries.

Report by Glenn Yago June 10, 1999