[Senate Hearing 107-]
[From the U.S. Government Publishing Office]
S. Hrg. 107 - 1017
INSTABILITY IN LATIN AMERICA:
UNITED STATES POLICY AND
THE ROLE OF THE INTERNATIONAL COMMUNITY
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
INTERNATIONAL TRADE AND FINANCE
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
ON
UNITED STATES POLICY AND THE ROLE OF THE INTERNATIONAL
FINANCIAL COMMUNITY CONCERNING ECONOMIC INSTABILITY IN LATIN AMERICA,
PROSPECTS FOR ECONOMIC AND PRODUCTIVITY GROWTH, AND THE INTERNATIONAL
MONETARY FUND
__________
OCTOBER 16, 2002
__________
Printed for the use of the Committee on Banking, Housing, and Urban
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PAUL S. SARBANES, Maryland, Chairman
CHRISTOPHER J. DODD, Connecticut PHIL GRAMM, Texas
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii JOHN ENSIGN, Nevada
Steven B. Harris, Staff Director and Chief Counsel
Linda L. Lord, Republican Staff Director
Martin J. Gruenberg, Senior Counsel
Thomas Loo, Republican Senior Economist
Amy F. Dunathan, Republican Senior Professional Staff Member
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
______
Subcommittee on International Trade and Finance
EVAN BAYH, Indiana, Chairman
CHUCK HAGEL, Nebraska, Ranking Member
ZELL MILLER, Georgia MICHAEL B. ENZI, Wyoming
TIM JOHNSON, South Dakota MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii
Catherine Cruz Wojtasik, Staff Director
Daniel M. Archer, Republican Staff Director
(ii)
?
C O N T E N T S
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WEDNESDAY, OCTOBER 16, 2002
Page
Opening statement of Senator Bayh................................ 1
Opening statement of Senator Sarbanes............................ 14
WITNESSES
John B. Taylor, Under Secretary for International Affairs, U.S.
Department
of the Treasury................................................ 3
Prepared statement........................................... 42
Daniel K. Tarullo, Professor of Law, Georgetown University Law
Center......................................................... 29
Prepared statement........................................... 46
Michael Mussa, Ph.D., Senior Fellow, Institute for International
Economics...................................................... 31
Prepared statement........................................... 51
Scott A. Otteman, Director of International Trade Policy,
National Association
of Manufacturers............................................... 33
Prepared statement........................................... 67
(iii)
INSTABILITY IN LATIN AMERICA:
UNITED STATES POLICY AND THE ROLE OF
THE INTERNATIONAL COMMUNITY
----------
WEDNESDAY, OCTOBER 16, 2002
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Subcommittee on International Trade and Finance,
Washington, DC.
The Subcommittee met at 10:05 a.m., in room SD-538 of the
Dirksen Senate Office Building, Senator Evan Bayh (Chairman of
the Subcommittee) presiding.
OPENING STATEMENT OF SENATOR EVAN BAYH
Senator Bayh. Good morning, everyone. I appreciate your
being here on a rainy morning and your interest in this
important issue.
I am going to make a brief opening statement and then,
Secretary Taylor, we look forward to hearing from you, as we do
the other panelists.
First, let me formally call this hearing before the
Subcommittee on International Trade and Finance to order.
Chairman Sarbanes will be joining us at some point in the
next 45 minutes or so. And I know that the Ranking Member,
Senator Hagel, would also want to welcome you and the other
panelists. The Secretary has been good enough to be with us
before and I welcome you back to the Subcommittee once again.
The Subcommittee is meeting today to hear testimony
regarding the instability in Latin America and its relationship
to United States policy and the role of the international
community.
Our witnesses will include John Taylor, the Under Secretary
of the Treasury for International Affairs. As Under Secretary
for International Affairs, Mr. Taylor serves as the principal
advisor to the Treasury Secretary on international issues, and
leads development of policies in the area of international
finance and economics. Mr. Taylor will explain the United
States' international economic policy and related issues.
Mr. Taylor, thank you again for joining us.
Our second panel includes three very distinguished
individuals. Professor Daniel K. Tarullo, Professor of Law at
the Georgetown University Law Center. Professor Tarullo teaches
in the areas of international economic regulation,
international law, and banking law. From 1993 to 1998, he was
successively Assistant Secretary of State for Economic and
Business Affairs, Deputy Assistant to the President for
Economic Policy, and Assistant to the President for
International Economic Policy.
Mr. Tarullo will discuss how the previous Administration
successfully addressed the international financial crises of
the 1990's, as well as examine what the United States' policy
should be in the future.
Mr. Tarullo, thank you for joining us this morning.
Also with us is Dr. Michael Mussa, Senior Fellow, Institute
for International Economics.
Prior to joining the IIE, Dr. Mussa served as Economic
Counselor and Director of the Department of Research at the
International Monetary Fund from 1991 to 2001, a very active
decade, where he was responsible for advising the management of
the Fund and the Fund's executive board on broad issues of
economic policy and for providing analysis of ongoing
developments in the world economy.
Dr. Mussa, who is joining us for the second time, will
testify about the effectiveness of the International Monetary
Fund and the rest of the international community in dealing
with Latin American economic instability.
Dr. Mussa, thank you for joining us. He has not arrived
yet.
I was reading some very interesting testimony of our
witnesses, Mr. Taylor, yours, Mr. Otteman, as well as Mr.
Tarullo's, last night. Dr. Mussa actually contained a reference
to his family cat in his testimony, which is a first in my
experience, but I will explain that later in my questions to
the doctor. It was actually amusing and had some relevance to
our discussion today.
Finally, Scott Otteman--I hope I am pronouncing that
correctly--Scott is with us from the National Association of
Manufacturers. Frank Vargo was originally going to be with us,
but was otherwise delayed. So, we send him our regards. Scott
is the Director of International Trade Policy for the National
Association of Manufacturers, which is the largest multi-
industry trade association in the United States.
As NAM's Trade Policy Director, Scott is responsible for
monitoring and analyzing all U.S. trade negotiations and
disputes, including the World Trade Organization and its
recently launched Doha Development Agenda, the Free Trade Area
of the Americas negotiations, and ongoing talks with Chile and
Singapore.
In addition, he works closely with legislative offices on
Capitol Hill to advance the top trade priorities of
manufacturers, such as the enactment of Presidential Trade
Promotion Authority.
Scott will explain the real impact of instability in Latin
America on the American business community and to employment
and economic growth in this country, and will offer
recommendations from the manufacturing sector's point of view
about what can be done in Latin America.
Scott, thank you for joining us this morning as well.
A brief statement of my own and then, Mr. Secretary, we
will get right to you.
America has a strong interest in global economic stability
and growth. At the microeconomic level, more American jobs are
dependent upon demand from abroad than ever before.
Scott, I think we will hear some from you in that regard.
At the macro level, a greater percentage of our gross
domestic product is derived from exports than at any time in
our recent past, and at a time of sluggish domestic growth,
foreign markets are more important than ever before.
At the geo-political level, a development abroad is also
very important. Democracy and international security are more
likely to flourish when economies are stable and prosperity is
expanding.
There is currently a debate about how best to advance
America's interests. Some argue for intervention to achieve
greater stability within distressed nations and to limit the
spread of contagion to other nations. Others argue that
intervention creates moral hazard and that the unfettered
discipline of markets offers the best long-term guarantee of
stability.
This hearing will explore several questions related to this
debate.
What are the principles that guide U.S. support for
economic intervention? Are they solely economic? If so, what
are they? Do geo-political factors play a role? If so, how do
we prioritize them? Is the political sustainability of the
economic policy prescriptions that we offer as a result of
intervention considered? If so, how so?
Has the policy of the Administration changed from that
originally espoused, to that actually implemented? In this
regard, we will pay particular attention to the cases of
Turkey, Brazil, Argentina, Uruguay, and Pakistan and compare
them to the Argentine experience, once a poster boy for
economic reform, now considered by many to be a pariah.
The Committee does this out of the conviction that
transparent analysis consistently applied promotes certainty,
which in turn limits the likelihood of both contagion and moral
hazard resulting from miscalculations by debtors and creditors
alike.
Finally, the hearing will explore alternative mechanisms
for debt relief, sovereign debt restructuring mechanisms, so-
called SDRM's, and also, collective action clauses, so-called
CAC's. What would the benefits of these mechanisms be? What are
the potential detriments? What are the barriers to their
adoption? And finally, are they mutually exclusive, or are they
potentially complementary?
To explore all of these questions, we are very grateful for
the presence of the Under Secretary, Mr. Taylor. And thank you,
you have been very generous with your time to the Committee in
the past. So much has happened since you were here last
February. I appreciate your coming back with your full agenda.
We look forward to hearing from you.
STATEMENT OF JOHN B. TAYLOR
UNDER SECRETARY FOR INTERNATIONAL AFFAIRS
U.S. DEPARTMENT OF THE TREASURY
Mr. Taylor. Thank you very much, Mr. Chairman. And thanks
for inviting me to this hearing.
We have written testimony which I would like to put into
the record and make some opening remarks.
Senator Bayh. It will be included.
Mr. Taylor. Thank you.
Strengthening our ties with Latin America and encouraging
economic growth in the region are central to President Bush's
overall economic agenda, not only because we want to help our
neighbors, but because we realize that stability and growth in
the region is in our interest as well. The United States
benefits greatly from strong neighbors and we risk losses when
Latin America goes into economic turmoil.
When I testified before this Committee last February,
economic and financial conditions throughout much of Latin
America were improving, with the exception of Argentina. Growth
seemed to be picking up after the slowdown of last year
associated with the slowdown throughout the world economy.
However, conditions throughout the region have become more
difficult since last February. Risks have risen and economic
growth this year seems to be coming closer to zero than to
positive territory. Clearly, raising economic growth in the
region must remain a high priority for the United States and
for the countries of the region.
However, considering Latin America as a single entity
overlooks some important differences between countries. For
example, Chile has very strong economic policies. It is ranked
among the most open, competitive, and economically stable
countries in Latin America. It grew by nearly 7 percent in the
1990's, well above the average of the region. Similarly,
Mexico, after experiencing nearly 70 percent inflation and
near-zero growth throughout the 1980's, grew at an average of 5
percent in the late 1990's, and its growth is picking up now,
along with the United States.
I would say that El Salvador stands out among those
countries that have made tremendous strides by pursuing sound
economic policies and emphasizing private-sector growth.
Bolivia, Peru, and Colombia are now working to implement a
strong policy mix that I believe will enhance stability and
raise economic growth.
I would particularly note that President Bolinos in
Nicaragua and President Maduro in Honduras are taking very
aggressive actions to deal with corruption in their countries,
which has been an impediment to economic growth.
As you know, Brazil has experienced significant turbulence
relating to election uncertainties in the last few months,
despite strong economic policies and efforts to keep inflation
low and deal with fiscal policy reform. For Uruguay, events in
neighboring Argentina have contributed to significant
difficulties, especially this past summer. I believe the
Uruguayan authorities, working in cooperation with the United
States and the international community, have been able to deal
with these problems and there are improvements taking place
right now.
Regarding Argentina, which I testified about just last
February, I believe that in the last few months, we are
beginning to see some stabilization following the significant
deterioration in 2000 and 2001, the freeze on the bank
deposits, the end of dollar-peso con-
vertability, and the default on its debt. As we speak,
Argentina and the IMF are working to conclude an agreement
which could create a short-term program to help begin economic
growth in the economy by establishing a clear monetary and
fiscal framework.
I would also like, Mr. Chairman, to comment briefly on one
of the points you made in your opening remarks, and that is the
nature of contagion in emerging markets generally.
When you look at the impact of the crisis in Russia in
1998, you see an impact in many, many parts of the world far
and unrelated to Russia, including Latin America and Asia.
Interest rate spreads increased at the time of that default in
a way that many people commented on referred to the concept of
contagion. In contrast, the events that occurred around the
world at the time of the crisis in Argentina culminating last
December were completely different. In fact, interest rates on
sovereign debt showed no such increase as occurred in 1998 in
the case of Russia.
I believe this represents a marked change in the nature of
contagion between countries.
Just for example, and to be sure, risk spreads did not
increase in Asia at that time. They did not increase in Europe.
And through much of this year, after the default in Argentina,
there was no
impact in Latin America as well. Recent events are related to
the direct connectedness between Argentina and Uruguay and
election uncertainties in Brazil.
So it seems to us that in recent years, investors have
become more skilled at differentiating between countries,
between good policies and bad policies and focusing on
fundamental economic assessments. And that has changed the
nature of contagion. We have sought to promote further
evolution in this direction by emphasizing that our policy
decisions will not be based on unfounded claims of contagion.
Of course, we recognize that there are important direct
links between countries, as I have already indicated in the
case of Uruguay and Argentina, but I would call that
interconnectedness, direct interconnectedness, rather than
contagion itself.
So going into the future, what we need to do to raise
economic growth in the region and work with the countries is to
focus on raising productivity growth. Part of our overall
international economic agenda has stressed productivity growth
throughout the world, and that stress applies to Latin America
with great importance. I am optimistic that productivity growth
in Latin America could improve greatly. The truth is that
productivity growth was only 0.7 percent in Latin America in
the 1990's. It was 1.7 percent in the developed countries in
the world more generally and 2.7 percent in the East Asian
developing countries. So a 1 or 2 percent gain would make a
huge difference in living standards and the reduction in
poverty throughout the region.
The first step to raising productivity is to seek to
implement appropriate policies that encourage productivity. And
here, President Bush has focused on three types of policies
that I think are important and apply to any country. The first
is ruling justly. That is, to follow the rule of law, concern
about enforceable contracts, and to be sure about the
importance of corruption and eliminating it and reducing it.
The second is to invest in people. That is, to keep the human
capital high by strong education and strong health. And the
third is to encourage economic freedom. That is, to reduce
barriers to trade throughout the world, as well as the informal
barriers to trade that exist within countries because of
regulations.
There is a long list of policy initiatives that we are
engaged in with Latin America. I mentioned some of them in my
testimony. The reform of the North American Development Bank,
an institution that has not been working well since it was
created in 1993, is an initiative that Mexico and the United
States have been engaged in for the last year and a half, have
made real progress and legislation to carry out those reforms
is now in the Congress.
The Partnership for Prosperity intiative with Mexico is
something that President Bush and President Fox have instructed
the economic officials in both countries to work on,
emphasizing private-sector growth.
An effort to work harder to have remittances going from the
many immigrants in the United States back home to countries in
Latin America to make it cheaper is another initiative.
Relative to the size of the economies, especially in Central
America, there is a huge amount of money that is sent home from
immigrants to their families. I was in an elementary school in
El Salvador this summer and asked the children in the class how
many had relatives in the United States, and it was virtually
95 percent. And in El Salvador, approximately 25 to 30 percent
of their income is in the form of remittances from the United
States.
We can help these countries prosper more if we make it
easier for immigrants to remit funds back to these countries.
As you know, we are pursuing a free trade agreement with
Chile right now. We hope to conclude that as soon as possible,
now that the Trade Promotion Authority has been passed. The
President has notified the Congress about initiating talks on a
free trade agreement with Central American countries, and we
are pursuing a free trade agreement with the Americas as a
whole.
We are supporting the Inter-American Development Bank, the
World Bank, and the IMF to be of assistance, focusing on good
policies. As I indicated, the President has delineated and
focusing on measurable results to make sure that the funds are
used effectively. Our negotiations with the World Bank's IDA
program, in the past, replenishment has forged new ways to make
these funds more effective through grants and through an
insistence on measurable results.
So, in conclusion, Mr. Chairman, I think that in spite of
the recent turbulence in some countries in Latin America, that
the region has enormous potential and that we can look forward,
with the right policies, to better economic prospects in the
region in the
future.
Thank you, Mr. Chairman.
Senator Bayh. Thank you, Mr. Secretary.
I am grateful for your time. Let me say at the beginning, I
admire your optimism, and I understand the importance not to
gratuitously undermine confidence.
I am reminded of someone in a much different context who
came to visit me the other day and gave me a definition of a
pessimist I had not head before. He said: ``A pessimist is an
optimist who has access to better information.''
[Laughter.]
There is some information out there that would suggest that
it may be a difficult road, but I understand the importance to
look at the glass as being half full and to do what we can to
buttress confidence and take your comments in that light.
Let me begin by asking you something, Mr. Secretary, in
your prepared testimony, about the size of interventions that
the IMF has conducted and that we have supported. I am sure you
are aware--the President made statements back during the
campaign that we would not be supporting the kind of large
interventions we had in the past. The Secretary made some
comments to that effect in his testimony at his confirmation
hearings. There have been other statements. You are familiar
with this.
And then in your testimony today, you say, ``We are working
to increase discipline in terms of access to IMF resources that
will
reduce the size of IMF packages . . .'' in order to ``. . .
reduce the risk of moral hazard.''
That has been pretty much a consistent explanation of the
policy throughout. Let me list some of the interventions that
have taken place and just ask for your reaction.
With regard to Brazil, I think there was a $15 billion IMF
program for Brazil equal to roughly four times the normal
annual IMF access limit committed in September 2001.
With regard to Turkey, a further $12 billion increase in
IMF support was committed to Turkey in February 2002, raising
the total support to $31 billion, a record for the IMF up to
that time in absolute amount, in support relative to IMF quota,
and as a share of the country's GDP.
With regard to Uruguay, given their size, a relatively
large $1\1/2\ billion augmentation of the IMF support in June
2002, and a further increase in official support, raising total
committed support to $3.8 billion in August 2002, setting a new
record for the ratio of official support to GDP.
And finally, the $30 billion augmentation of IMF support
for Brazil committed in September of this year, just a couple
of months ago, setting a new all-time record for the absolute
level of IMF support committed to a single country.
Given our desire to try and reduce the size of these
interventions, how do we explain the series of relatively large
interventions that we have, in fact, supported over the last
couple of years?
And again, I say this not to be critical. I am just trying
to explore perhaps--there is either a disconnect between our
stated policy and our actual implemented policy, or perhaps
there has been an evolution in policy to take into account
changed circumstances.
Can you react to the list of interventions in light of the
policy pronouncements?
Mr. Taylor. Of course. Thank you very much for the
question.
I do not believe that there has been a change in our policy
with respect to where we intend to go, which is to try to
address some problems that existed in the emerging markets and
still exist. And those problems are that the flows of capital
to the markets diminished greatly in the late-1990's. The flow
of capital from 1992 to 1997, on the private side, based on net
calculations, was over $150 billion a year in that period.
In 1998, 1999, and 2000, the flows dropped to less than $50
billion. Some people refer to that as a sudden stop. There were
quite a few crises that occurred in many countries around the
world in the mid- to late-1990's. And interest rate spreads
remain still very high and it is a burden on the taxpayers in
these countries.
So these are the kinds of problems that we want to address
with our emerging market policy. And part of that is, as you
say, Mr. Chairman, to reduce the size of packages and to make
the packages more interpretable, clearer to the private sector,
to the official sector and to the countries themselves.
Two of the countries that you mentioned--Turkey and
Argentina--were in crisis as we started in the Administration.
And we worked hard to improve the situation. I believe Turkey,
with the proposals that we put through, the prior conditions
that Turkey was in, has greatly improved. Inflation is down and
economic growth is up.
The program that we dealt with when Uruguay was, I think, a
classic focus on significant monetary issues, exactly the
issues that the IMF was designed to handle. Uruguayan
authorities had good policies in place. They were hit hard by
the shock in Argentina.
We developed a surgical, I would put it, well-focused plan
to deal with the problem in their banking sector. The size of
that program was because it focused on keeping the payment
system going, and I think it was very effective.
Now with respect to the overall size questions that you
mentioned, one of the important principles that we have tried
to follow and indicated at the beginning was that in order to
begin reducing the size of packages and to make the size
clearer to people in the market, we wanted to have the focus be
on the IMF, on the international financial institutions, rather
than provide additional support and additional access from
bilateral contributors such as the United States, the G7, and
the G10.
The case of Turkey was the first place that we established
this principle. And that program did not have large bilateral,
large-scale, medium-term support from the developed countries.
That is, in fact, why the program was a little larger from the
IMF. The overall program was smaller.
Similarly, in Brazil, the program that was just put through
the IMF, it was smaller than the program in 1998, which was
approximately $42 billion. As you mentioned, this program was
$30 billion.
The reason is that the bilateral side of this program was
not there as it was earlier. The additional contributions from
countries around the world, which has the same notion and the
same concept of funds was not there, so the overall program was
smaller.
And with respect to Uruguay, the only kind of bilateral
support that was there was a short-term bridge loan from the
United States which was very important to get those banks open
as soon as possible.
I believe if you look at this general strategy, we are
adhering to it. We are focusing on the IMF, which has, after
all, a limited overall supply of resources. That puts a budget
constraint on their operations. It puts accountability where it
belongs, on the people who are working closely on the programs.
We think it is working.
The last thing that I would say about this, Senator, is I
think the strategy that we are taking is one that has to be
implemented gradually. We would like to reduce the problems
that I mentioned at the beginning. It does require changes in
policy. But to change that overnight, to suddenly say there is
going to be a stop of funds without any notification, I think
can be disruptive.
As an example of that, let me just finish with this problem
that has arisen in Argentina. Argentina had a crisis in the
fall of 2000, an IMF program. When we came in, they were off
that program. So, we said, rather than make a sudden change,
let us give a
waiver in the spring of 2001.
In the summer of 2001, they were beginning to run into
difficulties because of a bank run, people pulling money out of
the banks. As a result, we decided in that context that an
augmentation of the program would be clear, but with a clear
emphasis that the debt was beginning to be a problem and needed
to be addressed and we focused the nature of our program on
that.
Then, finally, in December of last year, after a lot of
indications of what we would do when the situation became
clearly unsus-
tainable, and when the program was off track, we supported the
IMF decision to stop the support to Argentina because the
policies at that point in time did not merit it.
It seems to me that that is very consistent with the
strategy that we would like to take, and that is to support
countries that are doing the good things and have the good
policies, but to hold back in unsustainable situations and hold
back in situations where the countries are not following good
policies. And we are trying to adhere to that as closely as we
can.
Senator Bayh. Well, let us use that as an example, Mr.
Taylor. You have outlined here a fairly pragmatic approach with
regard to Argentina. You intervene when it seems that there is
some hope for accomplishing some good, and you do not when it
clearly would just be throwing good money after bad. That seems
to be a sensible approach to things.
I would like your reaction to--and I say this not to be
critical, but just as an observation that there has been an
evolution in a more sensible direction. But it is my
observation that perhaps we have made a shift from an
ideologically based policy to a more pragmatic policy. You
mentioned the change in capital flows was one of the reasons
that we supported some of these interventions.
It would seem to me that our policy might be described as,
we would prefer not to support these large interventions, but
if the circumstances justify it, we will do so. Is that a fair
commentary?
Mr. Taylor. I hope that we would be pragmatic in policy
decisions and maintaining a set of principles, such as the one
I indicated, trying to limit access, just trying to be more
predictable.
By the way, trying to deal with this restructuring issue,
which you want to come back to, on the sovereign debt side.
Trying to deal with crisis prevention. Adhere to those
principles. But there is no but about it. In practice,
decisions come to us and we have to do the right thing at that
time.
I believe that what we have done here is be guided by these
principles. We are always going to be pragmatic. These are very
important issues. They affect many people's lives. And I
believe that the strategy of gradually moving in a direction to
address the problems that exist is the right approach to take.
I believe it has always been pragmatic, Senator.
Senator Bayh. Thank you, Mr. Secretary. Let me ask about a
couple of specific instances, one I believe that you just
addressed. The first is the $8 billion augmentation for
Argentina in August 2001. Everything in hindsight appears to be
clear. With the benefit of hindsight, was the decision to
support augmentation a mistake?
Mr. Taylor. I do not believe so, Senator, no, it was not.
Senator Bayh. Do you think the money will ever be repaid?
Mr. Taylor. I certainly expect the money to be repaid.
The decisions at that time, as I indicated, had to do with
Argentina in a crisis, had been in a crisis for several years.
And what we would like to do at that point is ultimately get
them back on a strong path, with strong economic growth, help
the people of the country and the region.
And to do that, we thought at that point in time, the
augmentation was appropriate. Of that augmentation $3 billion,
by the way, was dedicated to trying to move ahead on the debt,
a debt swap. Five billion dollars was dedicated directly to the
bank problem that they had in time. So, I think it was designed
in an appropriate way.
I would also say, Senator, in terms of moving gradually
toward a policy of limiting access, this seemed to me important
to do. After all, there was very little contagion from
Argentina at that time. Moving gradually I think was part of
that.
When the event actually took place last December, when the
IMF stopped support, it did not have the impact that the
Russian default had in 1998. There was, as I said in my opening
remarks, very little ripple effect, not even in other parts of
the world, but not much in Latin America at the time, either.
Uruguay was right next door and we dealt with that problem.
I think if you look at the policy and you see the impacts,
it was important to move gradually in the decision of last
December, of last August, as well as the decision to have a
waiver in April 2001, I think was correct.
I sincerely wish that Argentina did not have to go through
the problems they went through this year. That is a tragedy.
But in terms of signaling our behavior and our changes, I think
we did the right thing.
Senator Bayh. Thank you. Let me return to that for just one
moment. And the reason I do so is not to play gotcha, or say,
well, it was a mistake, although I must say that, I guess from
my vantage point, I can afford to be a little more pessimistic
about the outcome of these things than can you. But the reason
I return to it is for the benefit of decisions going forward in
an attempt to learn from that decision, if perhaps it has not
turned out quite as we had hoped, and what can that do to
inform us about making future decisions when confronted with
circumstances somewhat similar to those--we hope there won't be
too many similar to those--but future sets of circumstances.
What have we learned from the Argentine experience? Where
did we go wrong? Why did they deteriorate so dramatically? What
did we not know at the time the augmentation was made that we
know now, and how can we apply that to future circumstances?
Mr. Taylor. Argentina made some very important reforms in
the early 1990's--controlling spending, on the tax side and on
the convertability side, got the inflation down by huge
amounts, and the economy grew very successfully in the early-
1990's through the mid-1990's.
About that time, Argentina started to move back on those
policies, on the spending side, on the tax side, and
ultimately, began to raise questions about their convertability
law.
And when those actions began to take place, the economy
started to deteriorate. There were shocks from abroad, to be
sure, as all countries are subject to, but the policies were
not conducive to economic growth and economic growth faltered.
I would say that that is, to me, the main lesson of
Argentina, is that countries----
Senator Bayh. It happened so precipitously after our
decision in August 2001. What didn't we know? Was there just
not transparency of information coming out of Argentina? We
augmented and then, pretty quickly, they headed downhill.
Mr. Taylor. No, I would not characterize it that way at
all. What happened is, in the period of 1998, 2000, 2001,
growth was getting slower, problems were arising. There were
two or three periods where sovereign debt spreads increased by
quite a bit. The debt was growing, raising questions about
sustainability.
We tried to work with them, as we are continuing to work
with the economic officials in the country to help them with
the policies. We gave them the support. I do not think that it
was a mistake to do that support last August, and I think it
was effective in the sense of keeping the contagion down
throughout the region and throughout the world.
It was an assistance there. And that is one of the things
that I think we would like to try to do, is when there is a
damage effect, such as in the case of Uruguay, try to deal with
that contagion, which we did.
But we do not really see, as I see, the contagion effects
that existed in the past and I think the policies are one
reason for that.
To me, the lesson that I would stress most of all is, when
a country has demonstrable problems with the sustainability of
its debt, and where it chooses to address those problems by
restructuring, there should be a more orderly way for the
country to do so. And that is one of the reasons why we are
pursuing some reforms of this sovereign debt restructuring
process. And you mentioned two approaches that are out there.
I think that if we can make those changes, it will be
easier to adhere to the access limits that we would like to
adhere to, because there will be a route for countries to take
if they get into this very unfortunate situation of
sustainability.
I believe countries should not get to that state. It is a
mistake for countries to get to that state. They should take
every effort they can not to get into the state of
unsustainability. But when it happens, we have to find a way to
make it more orderly. And that is really the main lesson, I
think, from these recent crises.
In 1996, the international community suggested collective
action clauses. If we had started in 1996 on introducing
collective action clauses into these debt instruments, the
world would be completely changed. The emerging market debt
would have changed, and I think in a very constructive way.
What we are trying to do now is let us get back to this. It
is at the top of our agenda. Let us get the collective action
clauses working with the private sector and the emerging
markets themselves into these debts, so when these very
unfortunate events happen, it is a smoother, a more orderly
process.
Senator Bayh. As you know, that is on our agenda today as
well, and I do think that this debate about where we go forward
is an important part of this process, just as we attempt to
learn from past decisions.
However, if I could just offer an unsolicited opinion about
one of the other lessons that we learned, and that is why I
alluded to it in my comments.
The implementation of sound economic policies and the
political sustainability of those actions in the country in
question, it seems to me, are inextricable. And perhaps we did
not have as great an understanding of the internal political
dynamic and problems in Argentina that we now have, and their
ability to really make the hard decisions and to not just talk
about them and propose them, but really implement them, not
only at the Federal, but also at the provincial level, is
something that I think we know a lot more about now than we did
then.
So perhaps a focus on some greater political analysis,
combined with economic analysis, is something that we could
benefit from going forward. Is that a fair observation?
Mr. Taylor. I agree with that. We can improve our economic
analysis, but we also can improve our political analysis.
I would say, though, and this is something that President
Bush has emphasized, that the ownership of the policies by the
countries really should be their responsibility.
It is so important for whatever policy is taken, that it be
owned by the country, that in a democracy, the people have
chosen that policy, rather than have it be imposed from the
outside, whether from the United States, the IMF, or whatever
organization.
And President Bush has emphasized this ownership and
accountability on the part of countries. We are working toward
that. I believe the Millennium Challenge Account emphasis on
good policies in the countries and aid will go to the countries
that are following good policies, and it will not go to
countries for economic development if they are not following
the good policies.
It is a new approach which I am excited about. It goes in
the direction of making the policies that will cause growth
more likely, and I think that there is still tremendous
evidence that countries like Chile, who are following good
policies, are succeeding, and countries which have chosen,
unfortunately, poorer policies, like Argentina in the late
1990's, are not succeeding.
And that is the lesson and we need to encourage that. But
the countries themselves have to make the decisions. It is
their political system. It is their country. And we just want
to emphasize that as much as we can.
Senator Bayh. Thank you, Mr. Secretary.
I mentioned there were two examples. We touched upon the
Argentine one. I would now like to ask you about Brazil. And
again, it is in the context of--welcome, Chairman Sarbanes.
We are joined by the Chairman of the Banking Committee,
Senator Sarbanes.
Thank you, Paul. I would be happy to interrupt my
questioning here.
Senator Sarbanes. No, no. Thank you.
Senator Bayh. I would touch briefly upon the topic of
Brazil. And the point I wanted to make, which I alluded to in
my opening comments again, is the importance of transparent
policy consistently applied, it seems to me leads to better
outcomes in the long run.
If we were making statements about discouraging people from
an expectation that there were going to be significant
interventions because of our preference not to do so, that is a
consistent point of view. Favoring interventions is also a
consistent point of view. When we waffle around in the middle,
we can run into some difficulties. I would just like to mention
Brazil as an example. And I say this not to criticize the
Secretary, but I will just get right to the point.
We were discouraging the belief that there would be
significant interventions. Comments, perhaps offhandedly, later
softened, were made that had the effect of perhaps undermining
confidence in Brazil, which then we decide that we need to
intervene, and because of lower confidence, the size of the
intervention is greater, or the cost is greater than it would
have been otherwise. So do you want to comment upon the case in
Brazil and some of the comments that were made, the effect on
confidence? I think the ultimate package, although you
mentioned the absence of bilateral assistance, at least at the
time, it struck observers as being about twice the size that
the market had been expecting. I am kind of wondering if that
was in some ways related to the damaged confidence in the
markets that existed at that time.
Mr. Taylor. No, the size of the package and the profile was
something that the Brazilian officials had been discussing and
had thought about with the IMF.
In fact, the profile is important to mention. The lion's
share of the funds would be disbursed after the new
administration begins in office in this program. And that was
one of the ideas that the Brazilians focused on, that if the
different candidates in the election could agree to a certain
common denominator with respect to a sound fiscal policy, and
agree to continue that after the election, then the funds would
continue to be distributed. So the size and the timing were
based on the circumstances in Brazil.
I would also say, Senator, you mentioned this in your
introductory remarks, but Brazil also came to the international
community in the summer of 2001, when Argentina was undergoing
the crisis that we just talked about.
Their IMF program from 1998, which I said was $42 billion,
including the augmentation from other sources, was coming to an
end at the end of last year. And they asked for a new program,
considerably smaller than the old one, but it made sense at the
time.
Senator Bayh. I guess my question goes to our own policy
and the consistency of our approach.
Mr. Taylor. Okay.
Senator Bayh. Which, as I said, we seem to be evolving to
the right direction.
Let me just read you the quote, and again, I say this not
to be personally critical of the Treasury Secretary. This is at
the time Brazil is very much in play in the markets: ``Throwing
U.S. taxpayers' money at the political uncertainty in Brazil
doesn't seem brilliant to me.''
That is a direct quote from the Secretary. And you can
imagine how the markets received this. When we turn around and
do exactly that, when we describe it as not a brilliant idea,
perhaps that has some effect on the kind of steps that we have
to take.
Mr. Taylor. Well, I think the Secretary's comments, I do
not know the context of those, exactly. There was clearly a lot
of discussion about the uncertainty relating to the election.
As I say, right at that point in time, we had had an
augmentation of a new program from Brazil, so people
interpreted that in that context. It may not come to the
conclusions or raise the questions that you are raising.
I believe that we should be as clear as possible to the
markets about what our intentions are. You cannot lay out every
decision and every contingency into the future. But you can try
to be clear.
I think that is what we are trying to do. I mentioned
moving gradually to a new type of policy, trying to reduce the
number of crisis countries. When something comes up like
Uruguay, let us be clear why we are doing that. It is because
they are so close to Argentina and we can narrow in and help
them in this particular case, and come as close to the
principles as we can.
I hope I am answering your question satisfactorily,
Senator.
Senator Bayh. You are doing an admirable job, Mr. Taylor,
under somewhat difficult circumstances.
I guess I would sum up and ask the Chairman if, at this
point, he would like to comment. But as I said, it seems to me
that it is a logical approach to try and limit interventions,
or it is a logical approach to favor interventions.
We seem to now be gravitating toward a pragmatic third
approach, which there are also underpinnings for if we set
objective criteria transparently for meeting interventions.
My point is that when we seem to swing from one to the
other in the context of a particular intervention, there are
costs to that, if you undermine confidence and you have what
might appear to some to be an inconsistent application of
policy. That is the only point I am trying to make. We should
arrive at an approach, stick with it consistently. And it seems
to me that that is the best way to move forward.
Mr. Taylor. I agree with that. We will try to continue to
work to be clear about what the principles are, what the
problems are we are trying to solve, and adhering to those as
best we can in the real-world environment that we face.
Senator Bayh. Thank you, Mr. Secretary.
Chairman Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Senator Bayh.
First of all, I want to commend Senator Bayh, who chairs
our International Trade and Finance Subcommittee, for holding
today's hearing.
Oversight of the conduct of international economic policy
is a vital function and significant priority of this Committee.
In fact, earlier this year, Senator Bayh chaired an oversight
hearing with Secretary Taylor, as a matter of fact, on the
economic problems confronting Argentina. Earlier, I had chaired
a hearing of the Full Committee with Secretary O'Neill on the
Treasury Department's Report to Congress on International
Economic and Exchange Rate Policy. This morning's hearing
carries on that oversight effort.
I think it is fair to say that the United States has a very
large stake in economic and political stability in Latin
America.
Further, the response by the United States and the
international financial institutions to the problems of Latin
America has significant implications, I believe, for the
conduct of policy elsewhere in the world.
In that regard, I have considerable concern over the way
the Administration has responded to the problems in Latin
America. That point is made rather forcefully by some of the
witnesses who will come on the second panel.
In fact, I am going to depart from usual protocol because I
have not figured out an answer to this yet myself.
As a matter of tradition, we put the Administration's
witness on first. Then we hear from the panel, which usually is
a balanced panel. But we get, on occasion, some sharp
criticisms of the Administration's policy. Of course, by that
time, the Administration's witness has testified, answered
questions, and left. So the panelists are coming, as it were,
after the fact. And we never get the two meeting.
What I am going to do this morning is quote from some of
what the panelists will tell us subsequent to the Secretary's
departure and ask the Secretary to respond to that.
Michael Mussa, who is the Senior Fellow at the Institute
for International Economics, and was formerly the Economic
Counselor and Director of the Department of Research at the
IMF, says in his oral statement here to the Subcommittee this
morning:
I see a fundamental inconsistency between the U.S.
Administration's rhetorical opposition to large-scale
assistance packages to aid in emerging market financial crises
and the actual practice of supporting a remarkable number of
such packages.
Indeed, despite its continuing rhetorical opposition, I
count at least six occasions when the Administration has
endorsed large-scale assistance packages during the past 20
months.
I believe that the glaring inconsistency between these
facts and the Administration's rhetoric has done significant
damage. Other countries have been confused and in some cases,
offended, by the confusion in U.S. policy.
In particular, officials in Brazil and in much of Latin
America took umbrage at Secretary O'Neill's remarks last
summer, suggesting that further official support for Brazil
would be a waste of money that would be opposed by the U.S.
Government, a policy statement that was soon disowned and then
reversed.
For the international community to play a constructive role
in the resolution of emerging market financial crises, it needs
to behave in an understandable and reasonably predictable
manner. Otherwise, other key actors will not be able to
function in a sensible manner.
Constructive leadership from the United States is essential
in defining the responsible role that is to be played by the
official community. Recently, such leadership has been lacking.
What is your response to that?
Mr. Taylor. Senator, when you look at the decisions that we
have made since the start of the Administration, I believe they
are consistent with a set of principles that we have been
trying to
adhere to. Those principles are designed to deal with some real
problems that have existed in the emerging markets since the
mid- to late-1990's. The first of them is the significant drop
of private capital flows to the markets. The second is a large
number of crises that came in the 1990's compared to the 1980's
and earlier periods. And third is continuing high interest
rates on debt that emerging market countries have to pay.
Our strategy is designed to deal with those by working at
better crisis prevention, at trying to deal with the reform of
the debt restructuring process, at being clearer and more
predictable about
access, and I will come back to that in a minute. And that
strategy is something that we have articulated in testimony and
in speeches. It is one that we make clear to the markets when
we talk to people in the markets and to countries when they
talk to us. In particular, many countries in Latin America.
Why might one think that there are inconsistencies? One
possibility is part of our endeavor to reduce and make the
access policy clear is to focus more attention on the IMF and
make the IMF accountable for the decisions.
We are doing that by saying, whenever we can, we would like
to have significant, large-scale, medium-term support from the
bilateral community, from the United States, from the G7, not
part of these packages. That basically puts more focus on the
IMF.
Now, as a result of that, the IMF part of the package could
be larger. But the overall package will be smaller. And so, I
would just give you the examples of this.
The 1998 package for Brazil was $42 billion. The package
that you are raising now as an inconsistency, quoting Dr.
Mussa, was $30 billion.
For what it is worth, and I think the size of the recent
one is appropriate and the timing is appropriate, it is
smaller.
The case of Turkey, there were requests for the United
States to go along to augment the IMF's contributions. We
thought it was important not to do that, in the effort of being
more predictable.
What is the market to expect where sometimes the official
sector beyond the IMF is in and sometimes they are not? If they
realize it is the IMF, then it is an effort to be more
predictable.
So it was the IMF and the international financial
institutions in the case of Turkey.
Senator Sarbanes. Let us take the Brazil example.
Mr. Taylor. I think there is a consistency, Senator.
Senator Sarbanes. Well, I am having a hard time finding it.
Let us take the Brazil example.
On June 21, shortly after Brazil's government tapped a $10
billion line of credit with the IMF, Secretary O'Neill
suggested that the Bush Administration would block additional
IMF loans to Brazil saying, and I think that Senator Bayh
quoted this before: ``Throwing the U.S. taxpayers' money at a
political uncertainty in Brazil doesn't seem brilliant to me.''
He added, ``The situation there is driven by politics. It
is not driven by economic conditions.''
This is in The Wall Street Journal, June 24.
Later that same day, Secretary O'Neill issued a statement
clarifying his remarks, in which he asserted that: ``The
Brazilian government is implementing the right economic
policies to address the current difficulties.''
Now, what is the policy thread that runs through that? I am
having a hard time finding it.
Mr. Taylor. These are, I take it, quotes from the same day
you are referring to? I believe they are from the same day.
Senator Sarbanes. Yes.
Mr. Taylor. It seems to me, Senator, when you take a quote
out of context, you know very well that you run the danger of
misinterpreting. And it is important, as Secretary O'Neill did
on that day, to provide the context for his earlier quote, and
he did that, and I think the context made it clear that, just
as I said before, our policy is to support countries who are
following good economic policies to create strong private-
sector productivity growth. And the message from the quotes
that you mentioned is that.
Senator Sarbanes. You think I have taken them out of
context?
Mr. Taylor. Senator, I do not know if you have----
Senator Sarbanes. Did the Brazilian government take them
out of context in terms of its very strong reaction, reaction
so strong--let me read you the statement that the Secretary put
out on June 21. ``To clarify my earlier comments, the Brazilian
government is implementing the right economic policies to
address the current difficulties.''
This is after he has said that throwing U.S. taxpayers'
money to political uncertainty in Brazil doesn't seem brilliant
to me.
Because of these policies, we have consistently supported
Brazil, including through its current IMF program, launched
last summer, and last week's $10 billion drawing on that
program. Brazil has not requested new funds and its economic
fundamentals are strong.
Brazil is a critical regional and global partner of the
United States. It seems to me that the Secretary is
backtracking pretty fast in that statement.
Mr. Taylor. The policy, as articulated by the Secretary and
the Administration is to support countries with good policies.
Senator Bayh. Mr. Taylor, forgive me for interrupting. I
was just pointing out to the Chairman, most importantly, the
markets reacted adversely to those comments. So, they were
looking at it in the context of the overall statement and
apparently they reached the conclusion that something was
amiss.
Mr. Taylor. This is a question about the market reaction to
particular statements by Secretary O'Neill?
Senator Bayh. No, just that the markets reacted to the
comment that it was not a brilliant idea to engage in the
intervention and then the clarification had to be issued to
help calm the impression that the markets had reached.
Senator Sarbanes. Well, I take it that you are telling me
that this was all part of a thought-out strategy. In other
words, it was part of a thought-out program that the Secretary
should make these remarks, that you should get the kind of
reaction that you got from Brazil, and then the Secretary
should issue his clarifying statement. That was all thought
out, that was part of the program?
Mr. Taylor. I did not say that, Senator.
Senator Sarbanes. Oh, okay. What are you saying?
Mr. Taylor. I am saying that we have a policy with respect
to our economic support and it is to support countries that are
following good economic policies. We have been clear about
that. The Secretary has been clear about that. The President
has been clear about that.
Senator Sarbanes. Well, you say that you are not going to
do these big programs and then you do them every time. I do not
understand what is happening.
Let me carry the Brazil thing a step further.
In July, Secretary O'Neill told Fox News Sunday that aid
will be forthcoming only after Latin American nations can
assure that the aid: ``Doesn't just go out of the country to
Swiss bank accounts, upsetting financial markets and setting
off a diplomatic tiff with Brazil.''
And in another turn-around, on August 1, the Secretary
released a statement saying: ``I continue to favor support for
Brazil and other nations that take appropriate policy steps to
build sound, sustainable, and growing economies.''
Just 1 week later, the IMF announced the $30 billion loan
for Brazil. The Treasury Department was quick to issue a
statement to express its support and even its pleasure at the
announcement.
Which obviously leads to the question, in light of all
these contradicting statements, what was the strategy with
regard to Brazil?
Mr. Taylor. The strategy is the same as our strategy for
any country. And that is to support countries who are following
good economic policies, to stress the ownership of those
policies.
Brazil, under the leadership of the Central Bank President,
Arminio Fraga, has instituted a good program to get inflation
down from the horrible hyper-inflation levels that Brazil
experienced. They have adopted a fiscal responsibility law to
deal with the provinces. The President has instituted great
improvements in the social sectors in the economy. So it is a
good set of policies and we are supportive of that.
The question about consistency it seems to me is answered
by looking at what we have done with respect to countries, the
overall strategy that we have put forth in testimony, in
speeches, where it is all laid out. And I think if you spend
all the time taking excerpts from remarks, that that is not the
way to look and evaluate a policy.
Senator Sarbanes. Mr. Secretary, I am not taking excerpts
from remarks, in the sense that these were remarks that were
made that created a major reaction. The reaction was so strong,
that it then led the Secretary to issue ``clarifying
statements.'' There was tremendous confusion about what the
Administration's policy was, and is. And I think that is a
problem.
Now you can sit at the table and say, well, you are just
picking a quote--and if there had been no reaction to it, if
there had been no consequences flowing from that, that would be
a reasonable point for you to make--why are you pulling this
little quote out and using it? But I am focusing on the quote
because it created major reaction.
Let me quote you what Dan Tarullo, who is also on the next
panel, says in his statement.
And I apologize, Mr. Chairman.
Senator Bayh. No, no. Please continue, Chairman Sarbanes.
My comment, Mr. Secretary, was, I understand you have to
defend the Secretary. My comment was that I think it is
incorrect to in any way imply that the Chairman was taking
quotes out of context because the market had an adverse
reaction to the totality of the comments.
Senator Sarbanes. Let me just quote Tarullo.
``The voice of a U.S. economic official is itself an
important instrument of policy. A consistent, measured, and
coherent voice establishes credibility, reassures market
actors, and enhances U.S.
economic leadership. The absence of such a voice has just the
opposite set of consequences. While I think it unfair to hold
the Administration responsible for all the financial problems
faced by emerging markets . . .''--and I would insert, I would
certainly agree with that--``. . . I think it legitimate to
criticize the lack of consistency, coherence, and restraint in
its statements and actions.''
Now, I think that is right on point.
Mr. Taylor. Well, Senator, I do not think it is, and if I
could respond, if this is a question that I could respond to.
Senator Sarbanes. Sure.
Mr. Taylor. Throughout this period that you are referring
to in Brazil, part of my job is to be in close contact with the
economic officials in the other countries with, for example,
Arminio Fraga.
Secretary O'Neill is equally in close contact with the
officials in those countries. He made a trip to the region at
roughly the same time that you are referring to these quotes.
He has a great deal of knowledge of Brazil and supports the
Brazilian people, has friends there, business contacts, over
many years. Our relationship with the Brazilian economic
officials is good and continuous. And the same with the
markets.
Markets move for many reasons. And I believe that what we
have been trying to do and what the Secretary has been trying
to do effectively is to maintain the contacts with the people
in the markets, with the officials in Brazil. It is a very good
relationship and as I have tried to indicate, there has been a
great deal of consistency with how we have approached it.
With that, again, you can refer to quotes and I can
continue to respond. But I think if you put this in the broader
context of all the testimony that the Secretary has done, all
the speeches that he has given, I have given, and others have
given in the Administration supporting the overall policy of
the President on emerging markets and developing countries,
trying to improve the lives of the people around the world,
trying to focus on water for people who do not have enough
water, the whole ramification, the whole spectrum of policies
is dedicated to improving--and if you look at the whole
context, I think you are going to see a very impressive change
in policy on the development side and the emerging market side
that is already beginning to have effects. So put it in the
overall context, Senator. I would ask you to do that.
Senator Sarbanes. Are you suggesting to me that the
Brazilian authorities welcomed these quotes from the Secretary
that I read?
Mr. Taylor. You will have to ask the Brazilians what they
thought about that. I know we have had good contacts with the
Brazilians. The Secretary has good relationships.
Senator Sarbanes. If they did welcome them, why did they
react the way they did, forcing you all to make a clarifying
statement? And also, then, to come along with these other
statements about what a wonderful partner they have been and
the importance of the economy, and so forth, all of which I
agree with. But why was that necessary if they did not welcome
them?
Mr. Taylor. Well, because it is the whole context. If there
is a particular statement that is made and it is quoted, let us
give it the context. I think anyone would like to say, if there
is one sentence that is pulled out of remarks and that is
getting attention, let us give it the whole context that it
belongs in.
Your assumptions about the reasons for the changes I cannot
agree to. But I can say that the effort is to put the whole
thing in context. And I think the whole context is good and
effective.
I support what the Secretary is doing.
Senator Sarbanes. Mr. Chairman, I would just close with
this. I want to quote Tarullo again. You will have him on the
next panel.
``The voice of a U.S. economic official is itself an
important instrument of policy. A consistent, measured, and
coherent voice establishes credibility, reassures market
actors, and enhances U.S.
economic leadership. The absence of such a voice has just the
opposite set of consequences.''
Thank you for doing this hearing.
Senator Bayh. Thank you, Chairman Sarbanes, for your time.
We are very grateful to you, and for the Full Committee's
support of our hearing.
Thank you.
Mr. Taylor, I have a few more questions. I know we have
kept you a while.
Let me return to the topic of contagion. You have suggested
once again that the market is getting better at evaluating
risks and so forth, and that what we have traditionally
considered to be contagion is not as great a risk as it used to
be. And in the case of Uruguay, I think you used the term,
direct interconnectedness. How would you differentiate between
direct interconnectedness and what we would traditionally
consider to be contagion?
Mr. Taylor. The former is where there is a trade flow or a
financial connection. Tourism, for example. Montevideo is just
across the river from Buenos Aires.
Senator Bayh. So it is physical proximity?
Mr. Taylor. That is one way to measure it. Frequently,
there is more trade between countries that are close to each
other. Not all the time, but it is frequently a way.
But the other would be where there is no real connection.
Let us take Brazil and the Philippines, for example. Or take
Russia and Argentina. In 1998, when Russia defaulted, there was
an impact in Argentina. But there is very little direct
connection in terms of trade flows between the countries, say,
compared to Argentina and Uruguay. In 1998, there was an
impact, a visible impact on the spreads on interest rates in
Argentina after that default in Russia.
Senator Bayh. Are interest rate spreads the only thing you
look at to determine whether there has been a contagion effect?
Mr. Taylor. No, but that is the one that has been given the
most attention in the markets. It is the one that people refer
to mostly in the financial crisis earlier. No, there is clearly
other things to look at.
Senator Bayh. Let me read a couple of quotes and get your
reaction to this. You are aware that there is another school of
opinion on whether contagion continues to be a potential
problem or not.
This is a story from The Wall Street Journal on Monday of
this week. It is entitled, ``Guilt By Association--U.S.
Officials Insist
Financial Contagion Is Over. Period. Not So Fast.'' That is the
headline. And let me read you a couple of quotes and get your
counter-argument here with regard to Argentina.
``But with Argentina in default on most of its government
debt, investors also focused on whether Brazil could sustain
payments on its own debt regardless of the outcome of the
balloting, suggesting that there was more than just political
risk there at play.''
This is a quote--`` `Seeing Argentina, nobody wanted to
take chances and give Brazil the benefit of the doubt,' says
Walter Milano, head of Emerging Markets Research at BCP
Securities, Inc., a brokerage firm in Greenwich, Connecticut.''
That sounds like classic contagion to me, with everyone at
the risk premium rising, not because of political factors, but
just because of a generalized fear spawned in Argentina that
Brazil might also have been in trouble.
The second quote is, and this deals with the spread of
political risk. `` `People are much more concerned about making
long-term investments and they are reviewing contracts backward
and forwards,' says David Gould, Director of Global Economic
Analysis for the Institute of International Finance.''
``There is a sense among international investors . . .,''
he says, that once a country opens its markets, ``. . . it
doesn't mean they are open forever.''
You know what is going on in Argentina with the bankruptcy
laws and the abrogation of contracts and that kind of thing.
What do you say about these comments? It sounds as if at
least some people are perceiving the existence of good old-
fashioned contagion out there.
Mr. Taylor. I found that the stance that we took early in
the Administration that contagion had changed got quite a bit
of criticism when the Secretary made it and when I made it.
But the things we referred to were the spreads, and that
was the measure. And in fact, we turned out to be quite
correct, as I have indicated with respect to comparison of
Russia and Argentina.
But I have also noted that people have sometimes developed
new interpretations of contagion or perhaps referred to old
ones. I really do not think it makes a difference.
One of them is this political contagion idea. And the idea
is that perhaps countries see the politics or policy changes in
one country, or investors see those changes, and worry that
another country is going to take those same policy stances,
same policy changes. I do not see a lot of that, to be honest,
because I see the message from poor policies such as----
Senator Bayh. I am sorry, Mr. Secretary. You do not see a
lot of what?
Mr. Taylor. I do not see a lot of the so-called political
contagion.
Senator Bayh. What is going on in Brazil?
Mr. Taylor. There was a lot of concern that the halting of
a privatization in Peru was due to political contagion, that
people said, we do not want that privatization because we see
what is happening in Argentina.
It was completely wrong. It was a local issue. The people
in the community wanted to be involved in the privatization.
They indicated their views. The government has changed. It had
nothing to do with political contagion. It did not exist.
The other thing is, this is speculation. You said that we
should improve our political analysis. That is probably right.
But what would be the message that a country would get from
what Argentina has done in the last year, changing the
bankruptcy law in a negative way. It is fortunately fixed now.
It would be negative. These were leading to bad, have led
to bad results. And I think the message, by looking at it, and
maybe, comparing Chile, is that we should do what countries
that are succeeding do, not what countries that are failing do.
So you can speculate about what is going to cause policies
to change, but to me, countries and investors will look around
and follow the policies that work. That is not to say that
investors do not get worried when they see a policy change in
one country that looks bad that another country might adopt it.
But I think there is just as many who might view it the other
way.
When I talk to people in the markets, I hear both sides.
Actually, that is what markets are all about--differences of
opinion. Every quote you get from one side, there has to be
somebody on the other side of that market.
Senator Bayh. Indeed. How do you interpret what is going on
in Brazil, then, if they have, as we have said, sound economic
policies, and yet, they have had great turmoil here, a lot of
it focused on the potential outcome of this election. Isn't
there at least an element there of looking to--there is
uncertainty about what path a new government will adopt. Is it
possible to say that that is not exacerbated by what has
happened in Argentina?
This man is saying that they are looking at contracts back
and forth. What kind of policies a new government might be
inspired to implement?
Mr. Taylor. I agree with you. There is uncertainty about
the election.
Senator Bayh. Your position, that is all indigenous to
Brazil. That is not affected by what has happened in Argentina?
Mr. Taylor. I think, for the most part, it is an issue in
Brazil. It is an issue of what the new administration will do.
They will make their decisions like anybody else, on the
basis of many factors. They may look to Argentina, but what
they find might be a policy to follow which is more conducive
to economic growth, by doing the exact opposite of what is done
there.
But the uncertainty about what a new administration will do
is there and I think that is the reason the policies on the
inflation side, on the fiscal side, on the social side, have
been good in Brazil. I think the markets would like to see good
kind of policies continue. There is uncertainty about that, as
you know, Senator.
Senator Bayh. Just to digress to the broader point that I
was making initially that you returned to.
It is in some respects a dilemma. You cannot reward bad
political decisions because you will just get more of them.
On the other hand, I think when we evaluate policy
prescriptions, there is an element of realism in terms of what
the society in question will tolerate. There is a threshold of
pain beyond which you go, you are going to be self-defeating as
well. Now how to strike that realistic medium, that balance, is
the challenge, and it is not an easy one. But to ignore the
need for a balance, I just think is going to be self-defeating,
too.
Mr. Taylor. Yes. That is why I think that we have to be
gradual as we implement these new ideas.
Senator Bayh. I think we have talked about contagion in the
context of Uruguay, in the context of Brazil.
I was curious about one thing. We talk about interest rate
spreads and absence of political contagion. I believe earlier
this year, it may have been in August, Brazil's credit rating
was downgraded to the point where only Argentina and Nigeria
have a lower credit rating now. What is the market reflecting
there? What are the credit-rating agencies reflecting there?
Mr. Taylor. I would say the same thing the markets are,
this uncertainty about what will happen.
Senator Bayh. In your opinion, it is mostly indigenous to
Brazil. It is not a heightened risk premium.
Mr. Taylor. Chile is right next door to Argentina. They
remain with investment-grade rating. Mexico is investment-grade
rating and their policies are good.
I think you have to look at those cases, too.
Senator Bayh. Let me shift gears for just a moment and ask
you about the IMF and our relationship to the Fund. I am told
the top five borrowers now have 80 percent of the Fund's
exposure, which is the highest concentration in history. Is
that a prudent level of risk to run?
Mr. Taylor. That is a measurement of the existing loans
that are out there. There is a lot of liquidity that the IMF
still has.
Senator Bayh. It seems like a pretty high concentration.
Mr. Taylor. What you say is completely true. There are a
lot of other Fund programs, but they are very small. The large
fraction is in these countries. It does not represent a risk
element of the kind that the figures indicate because the IMF
has not lent out all the funds that it has. There is a lot of
liquidity that is there, if you like.
Of the loan portfolio, it is out there and disbursed. It is
concentrated. But I think you need to view that as part of a
broader portfolio, funds which have not been disbursed.
Senator Bayh. How much of their available funds has been
disbursed? I do not have that figure.
Mr. Taylor. The figure is approximately 30 percent. I
believe 25 or 30 percent. I will have to get back to you on
that, Senator.
I know they have about $90 billion that is in liquidity at
this point in time that can be used for further programs.
Senator Bayh. Let me ask you another question with regard
to our relationship with the IMF. And I know that you get
criticized either way. If you are too aggressive, you get
criticized. If you are too passive, you get criticized.
There is an impression on the part of some that this
Administration has been a bit more passive in attempting to
suggest what the appropriate policy might be to the Fund.
As the largest shareholder, what should our relationship to
the Fund be? Don't we have some obligation to determine what we
think is sound policy and urge them to adopt that? If so, have
we been doing that?
Mr. Taylor. Most certainly, we have a responsibility and we
have been doing that. We are in close contact with Fund
management. The Secretary has regular meeting with the managing
director of the Fund. I have close contacts with the
management. The staff interacts an awful lot. And, yes, we are
very engaged with the Fund.
I do not think there is any substitute for that, Senator. I
wish there were, but it really is the kind of thing where you
have to occasionally get into the details and look carefully at
a program and go over there and talk and get the numbers out. I
do that myself. I think it is very important to do it. I would
not describe the relationship as passive.
We would like to have the Fund accountable for its
decisions and responsible for its decisions. But that does not
mean that we cannot be engaged.
And if I could just say one more thing on this. In the
broader group of international financial institutions, we are
trying to have our executive directors get engaged more with
the development of programs and loans and not wait until they
come to the board and have to vote yes or no, but actually get
involved in the creation.
When I was just recently in the Philippines at the Asian
Development Bank, I spoke to the President about having our
Ambassador there get engaged at a very early stage in the
development of loans and grants. They have agreed to do that.
That is just an example of how I think in order to affect
the institutions in a positive way, you just cannot wait until
the things come to the board and say up or down.
So, we are doing that, big time.
Senator Bayh. Certainly, in my opinion, we are not
hesitating to express our preferred policy to the United
Nations these days. I cannot see why the Fund would be much
different.
I agree with your statement. You would take exception to
the characterization that we have been more passive with regard
to the Fund.
Mr. Taylor. Yes, sir, I certainly would. Yes.
Senator Bayh. One last question with regard to our
relationship to the Fund. And then I am going to get to the
other panel. But at least we will spend some time on the
alternative debt restructuring mechanisms because that was part
of the agenda here today. About fixed exchanged rates. What
should the policy be with regard to that? What would you
recommend regarding currency boards like Argentina's? And if
they appear to be unsustainable, do not just postpone the day
of reckoning with greater consequences at the end of the day?
And forgive me. You had something in your statement that
alluded to what your answer might be. But I thought we would
flesh it out a little bit. You say most countries now maintain
``. . . floating exchange rates, helping them to adjust more
easily when faced with economic shocks.''
Mr. Taylor. Yes. I believe that flexible exchange rates are
better than these pegs that had existed and were more common in
the past. And we are moving to a very healthy, greater degree
of focus on keeping inflation low, and that frequently means
that the exchange rate is going to be more flexible.
However, I do think that there are good cases where you can
have a very credible connection to another currency. And one
example of that is El Salvador, which had dollarized very
successfully.
And that is kind of the other extreme, Senator, where you
have locked into another currency and you can benefit from
that. That creates its own type of stability.
The problems are in between the flexible and this super-
strong connection. And I think that is the good thing about
what is happening, and maybe the reason why there have been
fewer crises so far, and I hope that continues in terms of the
number of countries, is that there is more floating and more
focus on keeping inflation down.
Senator Bayh. And as you know, there is this--I will call
it a theological position out there that fixed-exchange rates
are good in almost all cases. We have learned from hard
experience I think that sometimes that is not true.
Mr. Taylor. Yes. This is an area where I think theology
does not really help you very much.
Senator Bayh. It is not the only area where you get into
religious debates these days.
[Laughter.]
But certainly one of them. Just two final questions and
then let us turn to the debt restructuring alternatives.
I would like to ask you about one other dilemma that
occasionally comes up, Mr. Secretary. You said in your
testimony that not every crisis results from a fiscal deficit,
for instance. And so, not every program should automatically
require fiscal retrenchment, an eminently sensible statement.
What do we do in cases, and there are some, where there is
no doubt that a lack of fiscal discipline is a part of the
long-term problem, part of the underlying difficulty that is
affecting an economy, but in the short run, demanding fiscal
rectitude may exacerbate the economic downturn that we are
attempting to pull the country out of. What do you do about a
situation like that? There are a couple of them out there.
Mr. Taylor. Well, when you make reforms, which is really
what you are talking about, reforming of fiscal policy toward a
sounder approach, there is always a question about how rapidly
to do it. And I think that that is really the way to answer
your question.
If in the particular circumstance a country can get out of
these fiscal problems, but it needs to do it over several years
rather than overnight, and it can continue for several years,
then that would be a way to alleviate a lot of the pain.
I, at one time, did calculations that if a country could
very credibly commit to a gradual reduction in the fiscal
deficit, that it would begin to have its own positive effects
right away because it would see that there is going to be less
borrowing in the future. That could bring interest rates down.
If it could credibly do that, it could alleviate a lot of
the pain. And I would certainly encourage countries that can
achieve that credibility to do so. But we are still in a
situation where there is really not enough fiscal
responsibility in many countries, and I just want to talk about
globally at this point.
We still have a problem with debts. Interest rates the
countries have to pay are still too high, and that is because
of these problems on fiscal responsibility, primarily.
I would certainly like to talk more about how important it
would be to have sound fiscal policies.
Senator Bayh. Well, a lot of it gets back to political
credibility. The last time you were here, we were focusing on
Argentina, and there has been a real problem there with
pronouncements that sound good, but they are never implemented.
And so, I think that the posture that we have adopted at
the time the provision of assistance with the actual
implementation of reforms is a very judicious course of action.
But you do hear these criticisms out there of the Fund that
occasionally prescribes fiscal discipline at a time of economic
contraction which, the argument goes, only exacerbates the
problem.
Mr. Taylor. I hear that criticism and it is an example of
one reason why we want to be in close contact and would want to
look at the programs carefully to make sure that it doesn't
happen.
Senator Bayh. At the same time, they have to make better
long-term fiscal decisions to ever really have a sustainable
recovery.
So it is a balance, and I am glad to hear your answer on
that.
One last aside, and then let us get down to the issue of
CAC's and SDRM's, just briefly. And to the other panelists, I
thank you for your forbearance here.
The President of Colombia was in town a couple of weeks
ago. I was very impressed with President Uribe. We have clear
U.S. interests implicated there and a host of challenges, in
addition to economic ones.
This gets me into another area. When, if ever, is it
legitimate to consider geo-political factors in addition to
economic ones? As you are aware, some people have suggested
that played a role in the case of Turkey, possibly Pakistan. We
now have Colombia, which has in the past attempted to pursue
sound economic policies.
When President Uribe outlined his prescriptions for dealing
with the host of challenges, they seemed eminently sensible to
me, but politically very difficult.
I cannot claim to be a student of the Colombian political
scene, but if we were attempting to do some of these things in
this country, I can know how difficult it would be.
When is it appropriate to consider noneconomic factors in
the provision of assistance? And was that an element in the
case of Turkey and Pakistan?
Mr. Taylor. Well, speaking generally, there is, of course,
a big role for assistance to countries for reasons that are
political or are security-related. There is no quarrel with
that at all. But what we need to try to do is to make sure that
that assistance is not counter-productive with respect to the
economic side of the policy.
That is, I think, something that we are emphasizing a lot.
You mentioned Colombia. In Colombia, the President is taking on
a real challenge and we want to be of assistance. We hope we
can help his country economically, too. But we want to make
sure that our support for the economy is because the economic
policies are good and that that can help the economy and focus,
if you like, the security assistance on these other areas. So
it is difficult to separate, but I believe we can and we should
keep trying to do it.
The same thing is true in Turkey. The assistance for Turkey
in the past has been certainly related to security issues. But
what we need to do is have our economic assistance based on how
we can support them economically.
One last example of this is this Millennium Challenge
Account that the President has proposed. That economic
assistance is supposed to be based on policy. That part, that
new money, is supposed to be on economic policy grounds,
economic growth, not on the other issues that you mentioned.
And I believe it will be if we adhere to the principles that
the President wants to follow and that you want to follow. But
that does not mean that our other assistance is not sometimes
going to go for issues related to security. But there is a way
to separate the two.
Senator Bayh. Do you consult with the State Department, or
the Defense Department, with regard to those aspects of
assistance?
Mr. Taylor. We have a lot of good discussions and a lot of
coordination with Defense and State and Treasury in the
Administration, yes, on exactly these issues. Yes.
Senator Bayh. Thank you.
Mr. Secretary, let me just ask one or two quick questions
because we are going to have a vote coming up at noon and I
want to give the other panel a fair amount of time. I do not
have to leave at noon, but I have to leave shortly thereafter.
You have been associated with the collective action clause
initiative. The Fund leadership has been associated more with
the sovereign debt restructuring mechanism. Can you just
briefly discuss the comparative advantages or disadvantages of
the two approaches, and tell me, are they mutually exclusive,
or might there not be some way to move along parallel tracks
here?
I know some have suggested that because it would take
Congressional action, the sovereign debt approach might take a
little longer, so you try and encourage the CAC's in the
shorter run. What are the comparative advantages and
disadvantages in your mind of the two?
Mr. Taylor. One important advantage of the collection
action clause is we can move those very quickly. We are
encouraging the issuers in the private sector to do that.
Last April, we outlined some basic parameters that we think
these clauses should have. The majority action, so that there
can be a change in the terms, some representation of the
creditors, some way to deal with legal actions in a way that is
constructive. And the private sector is actually working quite
well to pursue that, I think. It has been a much more positive
response to that approach than we have heard in the past. As I
said, these kinds of things were first suggested in 1996.
So that is the advantage. I think the purpose, just to be
very sure, is to make the process more predictable, to make the
markets work better. We do not want to encourage default in any
way. We do not want to increase the cost of it, do not want to
increase the likelihood. It is to make the restructurings more
orderly when they occur. The sovereign debt restructuring
mechanism requires statutory changes. As you say, that means it
will take a longer period of time.
Senator Bayh. Are you suggesting that the Congress cannot
act quickly, Mr. Secretary?
[Laughter.]
Mr. Taylor. There are a lot of legislative bodies in the
world that are required here.
Senator Bayh. Mexico made a statement not long ago that
they were not inclined to incorporate CAC's. Is that because
they fear higher interest rates will be required? And if so,
what do you do about that if the issuers--they do not perceive
it as being in their interest to include them, and therefore,
do not?
Mr. Taylor. Well, some issuers have already indicated a
strong interest in pursuing it. For example, Russia, South
Korea, have been positive about it. But the concerns that
countries raise, and you mentioned the example of Mexico, is
exactly that, that the costs of borrowing will be higher.
The evidence, however, suggests that that need not be the
case. For example, there are collective action clauses in the
United Kingdom markets. They exist. The studies that have been
done do not see that they are more expensive. In fact, for good
performers like Mexico, such clauses reduce the price of
borrowing.
I think there needs to be more discussion on this. In the
mean-
time, some countries are interested in pursuing it in the New
York market. The New York market is where these do not exist.
They do exist in London. We want them to move ahead in the New
York market, and I can see some interest in it at some point.
Many emerging markets have indicated strong reservations
about the sovereign debt restructuring mechanism approach. But
with respect to collective action clauses, there is much more
enthusiasm at this point in time, and we should welcome it.
Senator Bayh. On the part of the lenders?
Mr. Taylor. On the part of the lenders, certainly. We
should welcome that, which we are.
At the same time, I think from a public policy point of
view, we want to consider what an alternative would be, what
the sovereign debt restructuring mechanism would look like. We
haven't seen a complete proposal about it yet. And that is one
of the reasons why we are still discussing it.
Senator Bayh. Last question, and then one closing comment.
Is this made more difficult by the fact that a lot of the
borrowing today is in the form of bond issues, as opposed to
bank loans? Doesn't that complicate the issue here a bit?
Mr. Taylor. It is more complicated because there is more
diffuse holdings of the securities. And people all over the
world, small investors--that makes it more difficult. That is
why these clauses will make a big difference, because it is a
way for voting to take place if there needs to be a change in
the terms.
Senator Bayh. There is enough institutional holding,
though, that you could still get a super-majority sufficient to
move forward under these clauses?
Mr. Taylor. Yes, we believe there is.
Senator Bayh. Okay. My last comment. First of all, thank
you for your time, Mr. Secretary.
Mr. Taylor. Sure.
Senator Bayh. You have been very generous. I would simply
say, and I think you have outlined that this is your desire as
well, let us pick a policy and stick with it. Make it as
transparent as we can, with as much objective criteria as we
can. I think that lowers the uncertainty and reduces both the
risk of contagion and moral hazard. That really was the purpose
behind the hearing today. So, I urge you in that effort and
look forward to continuing our work together.
Mr. Taylor. Thank you very much, Mr. Chairman. I appreciate
your last remark particularly.
Senator Bayh. Thank you.
[Pause.]
Thank you very much, gentlemen, for your patience. The
first panel took a little bit longer. We had a lot of ground to
cover.
Why don't we just move from your vantage point from the
right to the left, starting with you, Mr. Tarullo, then to Dr.
Mussa, and finally, Mr. Otteman.
By the way, Dr. Mussa, I indicated before you arrived, I
got a good chuckle about reading about your cat last night.
[Laughter.]
I thought there were definitely some analogies to be drawn
there. It is not often that I get a chuckle out of testimony
before the panel, but it was welcome. Thank you.
Mr. Tarullo, let us begin with you. I think, as he
suggested, the Chairman did a good job of drawing upon some of
your comments in his questioning. And so, given the hour,
please go ahead.
STATEMENT OF DANIEL K. TARULLO
PROFESSOR OF LAW
GEORGETOWN UNIVERSITY LAW CENTER
Mr. Tarullo. Thank you, Mr. Chairman. Let me say just a
couple of things, because Senator Sarbanes did point to one
issue I wanted to raise.
The another point I wanted to make, which I will state
briefly here, is what is really at stake in the issues
implicated in this hearing.
I think it is really nothing less than the medium-term
direction of economic policy in South American countries. It
was, not quite 8 years ago that the leaders of all but one of
the countries in this hemisphere met in Miami for the Summit of
the Americas, hosted by President Clinton. At that time, the
sense of optimism and sense of engagement were really quite
extraordinary. And here we are, fewer than 8 years later,
feeling quite nervous about both the political and the economic
direction of Latin America.
Now, we can sit here and worry about it. The question is
what can we do about it? And that is where your hearing plays
an important role, because you are focusing attention on the
existence and implementation of coherent policies.
In my judgment, both the Administration and the Fund need
to be rather more proactive than they have been. So, it seems
to me, that in addition to the problem of coherence which you
and Senator Sarbanes pointed out before the earlier panel, that
we do have a problem of a certain absence of proaction.
I believe that the Administration needs to help Argentina
find a way out of its economic calamity and do so in a way that
indicates a continuing effort by the Administration to come up
with a menu of policies that might help the country move
forward. I think simply waiting by the phone, although an
admirable effort at restraint and nonimposition of policies,
leaves a confused government in a confused state.
I also think we need to help Brazil find a way into
successful regional integration. And that two counsels
continued engagement and continued efforts on the trade side,
as well as on the financial side. But there again, I think our
presence needs to be not just privately indicated, I think it
needs to be publicly apparent as well.
In the case of the Fund, Senator, there is a certain irony
here. For years, many people, myself included, have been
critical of the Fund for an excessive focus on fiscal policies
or on exchange rate policies or an excessive imposition of
conditions for IMF resource programs.
The histories of Argentina and Brazil--as my fellow
panelist, Mike Mussa's work has quite successfully shown--may
indicate an insufficient attention on the part of the Fund to
some unsustain-
able policies that go against the grain of the Fund's own
predisposition: The long-term run-up of debt and the fixed
exchange rate policies, were problematic.
But that observation does raise the very delicate questions
of sovereignty and how much intervention we do want the Fund or
the U.S. Government to make in these circumstances. And that is
one issue where I do not think there are any clear answers and
I do think a continuing dialogue in fora such as this are quite
important.
Finally, Senator, as you know, and Senator Sarbanes has
said on many occasions, Congress cannot make policy on a day-
to-day basis. That is why you have an oversight function.
But it does seem to me that this is a little bit like
chairing an interagency meeting.
I always found that Treasury, State, and the other agencies
were somewhat resistant to programs coming from White House
staff as to what they should do. However, if you called a
meeting, asked a question, and threw a piece of paper on the
table, the chances were that by the next meeting, the agency
would have its own program addressing the same kind of problem
that you wanted them to address. And I think a hearing like
this does very much the same thing and thus I applaud and
appreciate your conducting it.
Thank you.
Senator Bayh. Thank you very much, Mr. Tarullo.
Dr. Mussa.
STATEMENT OF MICHAEL MUSSA, Ph.D.
SENIOR FELLOW
INSTITUTION FOR INTERNATIONAL ECONOMICS
Dr. Mussa. Thank you, Mr. Chairman.
Senator Bayh. Elmer.
Dr. Mussa. Elmer the cat, yes. Actually, he had a longer
name--Elmer Aloysius Alcibiades Yenom, but we won't get into
that.
Senator Bayh. Family name?
Dr. Mussa. No. Yenom is money spelled backward, so it is
not entirely irrelevant to the Banking Committee.
[Laughter.]
I have a long written statement and an oral statement that
you have already quoted from and that Chairman Sarbanes has
already quoted from.
Let me discuss three main points.
The first point, quite briefly, the obvious inconsistency
between the Administration's rhetoric on large financial
support packages and the fact that they have supported an awful
lot of them.
To clarify one key fact, we really have had bigger packages
more frequently than in the past. Take the case of Brazil.
There was a $15 billion precautionary package now most of which
has been drawn. To that has been added from the IMF another
$30-plus billion. So the total is $45 billion from the Fund
alone.
Forty-five billion dollars was the largest previous package
also for Brazil, consisting of $20 billion--this was in 1999--
from the Fund, about $10 billion from the World Bank and IDB,
and another $20 billion from bilaterals.
Now, we have $45 billion just from the Fund, plus another
$8 or $10 billion, I do not know how much additional money from
the IDB and the World Bank. So there is no doubt that the
present official support package for Brazil is the biggest in
history. And it may well get bigger.
Second point in this area, in addition I believe to the
problems that you have already discussed about the
inconsistency of policy, I think there is a substantial problem
that this inconsistency has contributed to poor management of
actual financial crisis.
And here I disagree very much with Secretary Taylor. The
decision made in August 2001, to augment international
financial support for Argentina was the worst single decision
made in the 10 years that I was at the IMF. By that point, it
was clear that they were headed down the drain and they needed
to do a restructuring.
Common sense suggested officials who were ideologically
opposed to large assistance packages are poorly qualified to
make decisions concerning their design and implementation.
Senator Bayh. Clerics make poor economists? Is that the
case?
Dr. Mussa. Well, I think it is rather like asking a
conscientious objector to serve as the commandant of the Marine
Corps.
Now, turning to the situation in Uruguay and Brazil, which
was also on your list of questions. There is no doubt that
Uruguay was going to suffer substantial either contagion or
direct effect, whatever you want to call it, from Argentina.
Nevertheless, little was done to help Uruguay until this
spring, when large bank withdrawals and capital outflows caused
the collapse of Uruguay's crawling exchange rate peg regime.
Then IMF support was rapidly augmented to roughly five
times the normal limit. But this was not enough, and in August,
further official support, not just from the Fund, up to a total
$4 billion was committed.
For the time being at least, this solution of throwing more
money at the problem has contained the crisis. But it is still
unclear whether Uruguay can get through its present
difficulties without a comprehensive debt restructuring. And
this is an issue that has just not been consistently faced yet.
For Brazil, so far, the international community has adopted
a more sensible approach to a difficult situation. We had a
precau-
tionary package more than a year ago and this summer, when more
pressures came, as Secretary Taylor indicated, another $30
billion was added, in the very useful form of a little bit of
additional money now and a substantial commitment provided the
new government was prepared to continue with sound policies.
That was the right decision because delay until after the
elections has been essential to get a government elected that
will have to take the key decisions for Brazil going forward.
In my view, however, the present policy path featuring
Brazil's continued commitment to moderately strong policies
backed by substantial official support is a prescription for
disaster.
As reflected both in interest rate spreads on Brazilian
bonds and the exchange rate on Brazil's currency, financial
markets see this approach as woefully inadequate, and the
market will make this assessment a self-fulfilling prophecy.
There are two viable approaches, one based on prompt
recognition that comprehensive restructuring of Brazil's
internal and external debt is unavoidable and needs to be
managed with as little economic and financial disruption as
possible.
The other is based on substantially strengthened economic
policies, including a primary budget surplus of at least 5
percent of GDP backed by measures to constructively involve
Brazil's private creditors and supported by a meaningful
increase in committed international assistance.
If another catastrophe like Argentina is to be avoided,
tough decisions soon need to be made, with the clear
recognition that the middle ground is untenable.
Finally, much attention has recently been focused on the
issue of the SDRM. I am highly skeptical about this proposal
for two key reasons.
First and foremost, if a workable SDRM had existed, it
would have done little material good in helping to avoid or
resolve the major emerging market financial crises of the past
decade. I count 10 of them. Only in the present crisis in
Argentina has default by a sovereign on its foreign law debt
been a major issue. In the other nine, the SDRM would not have
been relevant at all. And for Argentina, while there is a large
default and a few suits have been filed, legal actions have not
been a factor at all in Argentina's economic collapse. GDP
dropping 25 percent, it is not because of legal actions.
Second, and this is where Elmer comes in, while it is
arguable that an SDRM can be moderately helpful in some
situations and is worthy of further study, there is good reason
for caution in moving forward.
Those most concerned with emerging market debt, its
issuers, its investors, and its dealers, generally oppose an
SDRM, and some very strenuously. Their analysis may be wrong,
or their motives may not be entirely pure, but their concern
should not be lightly dismissed.
Moreover, in considering the SDRM, I do point to the Elmer
principle. Elmer was a docile and affectionate feline, except
for the ferocity he displayed in confronting other male cats.
In dealing with this problem, my father, who was a wise man,
advised, it is usually a mistake to try to referee a cat fight.
You are likely to get scratched and bitten, and your
intervention is generally not appreciated by the principal
participants.
Disputes in a sovereign default are much like a huge cat
fight, with many hissing and howling combatants and their
lawyers. The international community, whose own motives may be
questioned and whose authority is limited, should think
carefully before volunteering to referee such affairs.
Senator Bayh. Thank you, Dr. Mussa. He will be forever
memorialized in the annals of the Congressional Record.
[Laughter.]
Mr. Otteman.
STATEMENT OF SCOTT A. OTTEMAN
DIRECTOR OF INTERNATIONAL TRADE POLICY
NATIONAL ASSOCIATION OF MANUFACTURERS
Mr. Otteman. Chairman Bayh, I am pleased to be here pinch-
hitting, as you said, for Frank Vargo, my boss at the NAM, to
talk a little bit about the effect on U.S. business from the
crises in Latin America over the last couple of years.
I particularly want to talk about how this affects not only
U.S. business, but also U.S. jobs and the U.S. economy.
The subject of today's hearing, Argentina's economic and
political crisis and the spillover effects to its neighbors,
has immediately affected U.S. companies in two clear ways.
First, it has provoked a dramatic decline in U.S. exports
to South America. Second, it has substantially harmed the
conditions for doing business faced by U.S. firms that are
invested and operating in the region.
United States exports to Central and South America so far
this year have fallen 16 percent from the same period a year
ago. The three largest proportional declines were to Argentina,
Uruguay, and Brazil.
United States exports to Argentina have plummeted a
stunning 67 percent, dropping from an annual rate of $4.5
billion to $1.5 billion, a $3 billion fall. Exports to
Argentina face a triple whammy. First, there is low demand due
to 4 years of recession and depression in that country. Second,
they face a huge competitive disadvantage due to the 70 percent
devaluation of the Argentine peso, which, as you know, makes
foreign imports much more expensive than similar domestic
goods. And third, there are import curbs imposed by Argentine
authorities to improve the country's current account balance.
United States exports to Uruguay, meanwhile, have fallen 53
percent and exports to Brazil have dropped 26 percent, from an
annual rate last year of $16.5 billion to $12.2 billion so far
this year.
The Commerce Department estimates that each $1 billion of
exports supports approximately 12,500 U.S. jobs. This implies
that the export losses over the last year to Argentina, Brazil,
and Uruguay may have impacted over 90,000 American jobs.
With respect to United States investment in South America,
the income earned on those investments has dropped
precipitously. For instance, United States foreign direct
investments in Argentina, the worst case, have lost $2 billion
in the last 9 months alone.
Given the depths of Argentina's crisis, it makes sense that
those U.S. businesses with operations in Argentina are the ones
that have been most severely hurt. I refer you to my written
testimony for a fuller description of some of the crisis-
related measures taken by Argentina's authorities, which
continue to impair companies' abilities to function without
suffering substantial losses.
Perhaps the longer-term danger the current situation poses
for United States business and for the common interests of
Latin America and the United States is the emerging perception
among the people and politicians of the region that financial
crises and economic stagnation are somehow caused by free-
market reforms.
Here, I think I am a little less sanguine than the Under
Secretary was in the sense of there being potential copy-cat
effects of politicians looking at the inability of the reforms
so far to produce the desired results.
Senator Bayh. The danger of political contagion that he and
I were talking about?
Mr. Otteman. Yes. In our view, however, any attempt to turn
back the clock by returning to an import substitution model or
other policies of the past will be a costly mistake. Although,
in hindsight, some of the reforms of the late 1980's and 1990's
perhaps could have been carried out more gracefully, maybe at a
different pace or in a different sequence, the main problem
continues to be not that reform has gone too far in Latin
America, but rather, that the reform process in many cases has
not yet gone far enough.
A few words about Brazil in light of its size and the
extent of United States private activity there.
If financial collapse were to spread to Brazil, the
potential negative impact on U.S. business would be vastly
enlarged. Some 400 of the United States Fortune 500 companies
have operations in Brazil. A Brazilian financial disaster such
as Argentina's would not only undercut the operations of United
States firms invested in and trading with Brazil, but also
could spread investor panic and depress growth prospects
throughout Latin America and perhaps the rest of the developing
world, similar to what we initially saw with Mexico in 1994 and
with Asia in 1997. In my opinion, though, this unwelcome
scenario is far from inevitable and certainly can and must be
avoided, if at all possible.
U.S. policymakers and the international financial community
have important roles to play in avoiding this type of disaster.
I will leave it to my co-panelists, who have hands-on
experience in these matters, to make recommendations to the
U.S. Government and IMF. However, the experience of our members
who are international traders and investors leads us to believe
that the most critical role in avoiding such a crisis will
inevitably fall to Brazil itself. Regardless of who wins the
October 27 presidential run-off, the new Brazilian President
can do much to allay the concerns found in financial and
business circles today.
For example, he might appoint an experienced economic team
that understands international finance and recognizes the
importance to Brazil's future of deeper and broader integration
into the world economy. He could also make it manifestly clear
that his government will honor its international debt and other
obligations. He could reaffirm Brazil's commitment to
successfully negotiate a Free Trade Area of the Americas by the
agreed deadline of 2005.
Once the immediate threat of financial crisis is averted in
Brazil, Argentina, or elsewhere, there are additional steps
that must be taken to achieve a stable democratic and
prosperous Western Hemisphere. I will just mention one. That
is, this idea of the Free Trade Area of the Americas being
reinvigorated now that the United States has Trade Promotion
Authority.
Senator Bayh. Thank you, Mr. Otteman. Forgive me for
interrupting. That buzzer you just heard, I think, was them
calling a vote, which means I have about 10 or 12 minutes
before I dash over there.
Would you mind if we submitted the rest of your statement
for the record and I went to some questions for the panelists,
yourself included?
Mr. Otteman. Certainly, Mr. Chairman.
Senator Bayh. Thank you very much. I appreciate your
willingness to do that.
Senator Bayh. Mr. Tarullo, moving quickly, you heard the
Under Secretary say that, in his opinion, the phenomenon of
contagion was really not what it used to be for a variety of
reasons.
I think I know what your reaction to that will be. Can you
give us your opinion?
Mr. Tarullo. Senator, in my judgment, the nature of
contagion depends on the nature of the financial crisis. It is
obviously the case that we do not have the situation of the
mid- to late-1990's when there was a lot of short-term
portfolio investment around the world which could flow out very
quickly. That was the kind of contagion that we experienced in
the 1997-1998 period.
Although it is important to be analytically careful to
distinguish different reasons for different kinds of contagion,
it is equally important to address the effects that actually
are entailed. And that is where I fear that there is a certain
acquiescence by the Administration in things that they call
interconnectedness, or political contagion. These are all
phenomena that have the effect of spreading economic problems
and thus they all require a response.
Senator Bayh. Without getting into semantic arguments, the
point here is that they are contagion, nonetheless. Different
forms, different types, but they are destabilizing to the local
economies. They spread to other nations and eventually affect
our interests. Is that correct?
Mr. Tarullo. That is correct, Senator. And to the degree
that the contagion is so-called real economy contagion, or what
the Secretary called interconnectedness, that is a lot easier
to predict. It did not take a lot of analysis to know that
Uruguay was going to have problems when Argentina went into a
financial crisis because all the Argentine citizens have their
money in Uruguayan banks.
Senator Bayh. But we waited, and then had to come up with a
much larger package in the event. Correct?
Mr. Tarullo. Correct.
Senator Bayh. Postponing the day of reckoning only
sometimes makes it more difficult.
Mr. Otteman, for your members, this is not a theoretical
issue. It is a real issue. And as I understand your testimony,
you see a risk for premiums for doing business in other
countries being affected by all of this. Correct? Politically
and otherwise? Argentina is having an impact on American
businesses attempting to do business in other Latin American
countries. Is that correct?
Mr. Otteman. I do agree with the Under Secretary that the
main effect has been the trade effect with the neighboring
countries and that you have not seen the spread. But with
Brazil, there could be a much greater potential for that in
terms of the size of the economy and the size of the United
States company involvement there.
Senator Bayh. Mr. Tarullo, back to you, and then possibly
to Dr. Mussa.
The Under Secretary was admirable in his attempts to defend
the consistency of the policy over the last couple of years as
it related to some of the statements that had been made.
But it does seem to me, and I think to Chairman Sarbanes,
that there has been a certain amount of cognitive dissonance,
shall we say, within the Administration which has led to some
inconsistencies and therefore, higher costs and greater
problems.
Hence, my request that he pick a policy, let's stick with
it. We are going to have fewer problems if we do that. Is that
your impression as well? There has been some cognitive
dissonance here? And if so, what do you think accounts for
that? Is it ideology running into real-world problems?
Mr. Tarullo. Senator, I do agree with you. Let me start
with a somewhat more sympathetic note for the Administration.
These are not easy problems. There are no simple solutions
out there. And one thing I think we can applaud the
Administration for doing is resisting in practice simplistic
solutions that have been urged upon it.
Senator Bayh. That would be the more absolutist ideological
approach. Correct?
Mr. Tarullo. Correct. And indeed, the risk is that one
adopts a rhetorical position that seems highly principled, some
might call ideological, and then rather regularly departs from
those principles in practice.
It seems to me that that gives you the worst of both worlds
because the markets and other governments are not able to plan
based upon your stated policy, and then they cannot see the
relationship between what you actually do and what you say.
Senator Bayh. Uncertainty has real-world costs.
Mr. Tarullo. Correct. And Senator, that is not to say that
there needs to be absolute consistency and a kind of hard-line
that people just stay with. Evolution and flexibility, sure.
But the markets and, other governments need to see a strain of
consistency in a policy.
Senator Bayh. Rhetorical consistency would be beneficial as
well. I think as Chairman Sarbanes was exploring in some
detail, there have been a couple of cases where statements have
been made that were not helpful. Let us just put it that way.
Dr. Mussa, why the inconsistency in your opinion?
Dr. Mussa. Well, I think, as you suggest, I would divide it
into two problems.
One, I think there have been some unfortunate statements
that have been made in less than formal context, which I think
should have been regretted at the time. And two, I think the
other problem has been substantive, that the policy really has
not been clear. There has been clear rhetoric opposing large
packages and there have been a lot of large packages.
[Laughter.]
That is the reality that you need to do something about
these crises, even if it was not what you were thinking before
you were in office. But this is not just a perception that I
have.
Senator Bayh. Forgive me for interrupting. Has the
ideological reluctance to intervene, when forced to be
confronted with reality and forced to change, has that
contributed to the increased size of these packages?
Dr. Mussa. Well, I think that is a very difficult judgment
to make. There are 6 or 7 instances.
I do think geo-political considerations have clearly played
a very important role in Turkey, and particularly after
September 11. Whether Secretary O'Neill's comments and the
reactions to them induced a larger Brazilian package or not, I
do not know. I think that that package, backloaded, was the
right thing to do in the circumstances, whether or not there
had been any such unfortunate remarks.
I would note that this problem is not just in our
perception. I quote Peter Costello, the Treasurer of Australia,
from his official
release statement to the IMFC.
What counts is what the Fund actually does rather than what
it says it will do. Ultimately, as the quality of the judgments
that are taken in each case and whether the frameworks are
applied consistently which will determine whether the Fund is
successful in helping to resolve crises.
In effect, each decision will be part of an ongoing process
of defining the role and success of the Fund. It is important
that its actions are consistent with the stated intentions.
This has not always been the case.
Senator Bayh. The market players look at the actions, not
just the rhetoric. But consistency of both would be helpful and
it has been problematic in both cases. Is that a fair summary?
Dr. Mussa. I think so. And also, in the 20 meetings of the
IMFC and its predecessor committee that I attended, long and
boring meetings, that is as explicit a criticism in an official
statement as I have ever seen.
Senator Bayh. Well, candor can be refreshing. Beneficial at
times, too.
Let me shift gears to Brazil, Dr. Mussa, starting with you,
and them Mr. Tarullo.
You said that the markets have priced--and the status quo
is heading us down a very dangerous path here. You said tough
decisions will be needed. You outlined a couple of different
alternatives.
You are not a Government official, so you can tell us what
you really think. Lula is likely going to win the election.
Will he be willing to make the tough decisions that, in your
opinion, are required to rectify the situation?
Dr. Mussa. I am really not certain. It would be very
difficult for him because it would require backing away from a
number of his key campaign pledges and a number of positions
that he has held for many years, wanting to increase public-
sector investment, wanting to do, in effect, fiscal expansion
to generate employment, wanting to raise the minimum wage, and
other things.
Senator Bayh. You are talking about running a surplus of up
to 5 percent. Is that the kind of thing that the government
would be likely to do?
Dr. Mussa. Well, right now, the primary surplus is a little
below 4 percent. So it is a matter of--you have to send a
signal that shocks the market into believing that you are
actually going to follow a significantly different policy path
than they are anticipating and that it is built into current
market interest rates and prices and the exchange rate because,
as Mark Twain observed, ``it is hard to build a reputation on
what you are going to do.''
So if it is a promise of what policies are going to be 2 or
3 years down the road, it doesn't mean anything. They need to
see you deliver it.
Senator Bayh. Speaking of that, how did you interpret the
dramatic and unexpected rise in interest rates yesterday?
Dr. Mussa. The Central Bank, which has been keeping with
the Selic rate, which is the overnight interest rate in the
interbank market, down at 18 percent, finally had to give that
up because the government was not able to roll its debt and the
exchange rate was sinking through the floor. So, they kicked
the rate up to 21 percent. That is not going to be enough. But
it is the signal that they are running out of room. And much of
the Brazilian debt is domestic, much of it is linked to the
Selic rate. Once they get in the business of pushing the Selic
rate up and it reached 45 percent in early 1999, it is going to
be clear that fiscal sustainability is an impossibility. So the
signal that they have already needed to take the first step
down that road, was not a reassuring one.
Senator Bayh. Mr. Tarullo, what is going to happen in
Brazil and what do we need to be doing about it?
Mr. Tarullo. Well, Mr. Chairman, like Mike I would not want
to make a prediction, not because of an unwillingness to make
predictions, but it is just a very difficult situation.
Senator Bayh. Well, let me phrase my question a little bit
differently. You pointed out that we waited a little late in
the game to address Uruguay. Let us learn from that experience.
Mr. Tarullo. Here is, though, what I think that we can do.
Let us hope, and we can hope, that everything breaks right: The
debt can be sustained without restructuring. Brazil will get
back on a path of economic growth and there will be a strong
and stable government.
Having said that, we know that in the real world, things do
not always break right. So what can we be doing right now? I
think that maintaining the package that was put in place is a
good idea. I think it needed to be done.
I was disappointed in the absence of the so-called private-
sector involvement. It did not appear to me that the
Administration or the Fund did very much to try to elicit more
formal commitments on the part of private investors to maintain
the rollover, or to make additional investments where
appropriate. Instead, they accepted a rather loose--and so far
as I can tell from people on Wall Street--not very well-
observed commitment to maintain a presence in Brazil.
So, the first thing, I think we need to have done, and
maybe we can still do, is to engage with the private creditor
community.
Second, and related to that, is my point about the
Administration's voice itself being an instrument of economic
policy.
It is not dispositive. You cannot just say something and
make it be true. But if the Administration does engage with the
new president, whether it is Mr. da Silva or Mr. Serra (if he
makes a comeback), and can get an understanding on a certain
set of policies while at the same time understanding the
political exigencies that the victor faces, then a positive
signal will have been sent to the markets. Then the markets
might--might--be willing to be a little bit more tolerant and a
little bit more patient.
If, on the other hand, you have the election of a president
who says, ``I am going to change a lot of the things'' and the
Administration stands back and has no voice, then I fear that
the markets are themselves going to fear the worst, the reason
stated in Mike's Mark Twain quote.
Senator Bayh. So, you would argue for being more proactive,
and it is your impression that the Administration to date has
been a little too passive, that we should be more proactive in
trying to define some sustainable economic policies?
Mr. Tarullo. Exactly, Senator. As I said in the prepared
testimony, there is a wide spectrum between imposing policies,
on the one hand, and just sitting by the phone. I think we need
to be somewhere in the middle, and we need to recognize that by
being somewhere in the middle we can actually elicit a very
positive response from the country because they know we care
about them.
Senator Bayh. Dr. Mussa, I am interested in your comments
about this passivity.
I would just make one comment of my own, Mr. Tarullo. And
that is, if you wait to be able to, ``impose your policies upon
another country,'' that ordinarily can only be done when the
crisis of such magnitude, it is more difficult to correct.
Mr. Tarullo. Excellent point, Senator.
Senator Bayh. Yes, Dr. Mussa.
Dr. Mussa. I think one has had to wait until the election
is over because it is the new government that will have to make
the decisions and implement them.
I do not think one can impose the decision. But I think
that one needs to pose the question clearly and starkly. There
are no easy, attractive options. I think proceeding with the
present fiscal surplus, which is credible and significant, the
market says, that is clearly not enough, not marginally enough,
woefully not enough.
So the new Brazilian government is going to need to choose,
do you want to do a restructuring internally and externally,
which also involves private creditors as well, or do you want
to go the strengthened policy path with more official backing
and involvement of private creditors, which also involves
backing away certainly from many of Mr. Lula's campaign
promises.
It is their choice.
Senator Bayh. Either course involves backing away.
Dr. Mussa. Absolutely. It is their choice. But the notion
that there is this kind of easy option in the middle, that I
think does not exist and I think that the IMF and the U.S.
Administration need to say clearly and forcefully, that option,
although we would like it, if it were possible, is just not
available.
It is your decision. It is a very tough one. And we will
try and back you as constructively as we can once you have made
it.
Senator Bayh. I apologize. I am going to have to run here,
Mr. Otteman. I do have a couple of questions for you.
In a different context, it reminds me somewhat of the
situation we faced in 1992. We had President Clinton coming
into office, who had run on a modest fiscal stimulus program
and quickly became convinced of the virtues of fiscal
discipline, in bringing down the deficit at the time, followed
that path with some remarkable results. But it did require a
willingness to give up some previous statements and to turn
against some natural constituencies. I am wondering if in our
system, the ability to do that might be a bit greater than in
the Brazilian political system.
But this gets back to my points that I emphasized
throughout, the interconnectedness of sound economic policies
with an understanding of what is politically sustainable within
the culture and the country that you are attempting to help,
and you get into some difficult decisions there.
So, as I said about the pessimist being the optimist with
access to greater information, which is a nice segue to you,
Mr. Otteman, you look at some of this information and it is
very difficult to be optimistic.
But, Mr. Tarullo, I hope that you are correct with the
optimism that you have given us here today.
Mr. Otteman, quickly, and I do apologize. I am going to
literally have to run. How many American jobs do you think are
at stake here, could be lost with more and more Americans
depending upon exports abroad if the situation in Latin America
continues to deteriorate? Do you have any estimates of that out
there in the real world?
Mr. Otteman. No, we haven't done any calculations beyond
what the Commerce Department has done in terms of linking the
export-related jobs to U.S. jobs.
Senator Bayh. But if Brazil were to fall into a situation
of real crisis, I assume it would not be insubstantial, the
number of American jobs that would be at risk.
Mr. Otteman. I think it would be a multiple of the
Argentine figure that we cited in the testimony.
Senator Bayh. This is a real-world problem that is going to
affect real businesses in our country and working Americans, if
we do not handle it as best we can. Correct?
Mr. Otteman. Yes.
Senator Bayh. This is a matter that tends to end up on the
back pages of business sections or is of interest to
economists. But my point is that people on Main Street are
going to be affected if we do not get ahead of the curve here
and learn from past experience and do a better job of trying to
handle this one. Is that a fair observation?
Mr. Otteman. Of course, yes. I pretty much agree.
Senator Bayh. Last question, and I apologize for having to
run.
The business community has expressed some frustration about
the lack of enough proactive intervention by the
Administration, or attention by the Administration. What would
you recommend? What would the NAM and its members recommend?
Mr. Otteman. Well, we are not in the business of
recommending really on these financial issues, at least I am
not in a position to do that.
Senator Bayh. Just focus on it, come up with a policy and
implement it?
Mr. Otteman. Exactly. I thought the discussion between you
and the Under Secretary was very helpful, and it seemed like
you were both on the same page when it comes down to the bottom
line. I hope that you would continue in that direction. But we
are just hopeful that the crisis situation can be brought under
control so that we continue to pursue in Latin America the
broader policies that they need both for the benefit of their
people and that we need to be able to do business there.
Senator Bayh. Thank you, Mr. Otteman. I apologize. I have
been told I have one minute. I do not have on my track shoes,
so I am going to need to move.
I do want to thank you, gentlemen. I appreciate your
forbearance with regard to the time and your courtesy in
arriving. Thank you very much.
Dr. Mussa. Thank you.
Mr. Tarullo. Thank you, Senator.
Senator Bayh. We have benefited from your insights.
Mr. Otteman. Thank you.
Senator Bayh. The hearing is adjourned.
[Whereupon, at 12:22 p.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow:]
PREPARED STATEMENT OF JOHN B. TAYLOR
Under Secretary for International Affairs
U.S. Department of the Treasury
October 16, 2002
I would like to thank Chairman Bayh and Ranking Member Hagel for
holding this hearing to discuss United States economic policy toward
Latin America and the role of the international financial institutions.
Strengthening United States ties and raising economic growth in the
many countries of Latin America are central to President Bush's agenda,
not only because we want to help our neighbors, but also because their
stability is in our interest. The United States benefits directly from
having strong neighbors and reaps tangible economic gains when the
region fares well. But we risk losses when Latin America undergoes
economic turmoil--not least because of the increasing integration
within the hemisphere.
When I testified before this Committee last February, economic and
financial conditions throughout much of Latin America, with the
exception of Argentina,
appeared to be picking up after the slow growth last year associated
with the recession in the United States and the global slowdown.
However, since then, conditions throughout the region became more
difficult, and economic growth this year is likely to be zero at best.
This is in contrast to other developing and emerging market
regions where growth is positive this year--about 6 percent in Asia, 3
percent in Eastern Europe, and 3 percent in Africa. Clearly raising
economic growth in the
region must remain a high priority.
An Economically Diverse Region
Considering Latin America as a single entity overlooks its
diversity--from extremely poor nations confronting difficult
development challenges to economies with sophisticated financial
markets. Some countries in Latin America are performing well
economically; they have implemented good economic policies. Others are
just beginning to implement good policies, and have much to look
forward to. Still others have recently experienced crises or are
potentially in danger.
Mexico and Chile's strong economic policies and sound political
foundations have set them apart in the region. Chile remains ranked
among the most open, competitive, and economically stable countries in
Latin America--factors that help to
explain its average annual growth rate of 6.8 percent throughout the
1990's, a figure well above the regional average of 3.3 percent. After
experiencing high inflation (70 percent annual average) and near-zero
growth throughout the 1980's, Mexico's economy grew by an average of 5
percent per year between 1996-2000 after its leaders had begun to
implement a series of key free market reforms--including the North
American Free Trade Agreement.
A number of countries are striving to implement strong economic
policies, but still have a way to go to realize their full economic
potential. El Salvador stands out among those that have made tremendous
strides by pursuing sound policies, while Bolivia, Colombia, and Peru
are also working hard to implement a strong policy mix that will
enhance stability.
Other countries have experienced significant turbulence in recent
months despite policy fundamentals that have generally been strong. The
United States is closely watching Brazil and strongly supported IMF
assistance in August because its economic policies have been strong.
Events in neighboring Argentina contributed to significant difficulties
in Uruguay this summer, but the Uruguayan authorities have responded
strongly in cooperation with the international community.
Finally, Argentina is beginning to stabilize though it remains in
crisis following significant deterioration in 2000 that culminated in
late 2001 with a freeze on bank deposits, an end to dollar-peso
convertibility, and a default on its debt. Argentina and the IMF are
working to conclude an agreement in the near future that will help
Argentina to strengthen its monetary and fiscal framework.
In the wake of Argentina's crisis, the experiences of different
Latin American economies and other emerging markets have been
instructive. In the months after Argentina's collapse, we saw little
impact on other emerging market countries, even in Latin America. This
stands in contrast to the effects of Russia's crisis in 1998, which was
accompanied by immediate and sharp rises in the borrowing spreads for
other emerging markets, even those that had few real links to Russia.
It seems that in recent years investors have become more skilled at
differentiating between countries and markets based on fundamental
economic assessments. We have sought to promote a further evolution in
this direction by emphasizing that policy decisions will not be based
on unfounded claims of contagion.
We have, however, supported programs where there was direct or
fundamental interdependence between countries--as in the case of the
effect of Argentina on Uruguay--in order to mitigate such effects.
Improving Prospects for Productivity Growth
Raising living standards and expanding support for democratic
institutions in Latin America depend critically on achieving higher
levels of economic growth--a key concern in a region where one-third of
the people live on less than $2 per day. The United States is working
to help create an environment where the private sector can be the
engine for productivity growth.
Productivity merits special emphasis because only by raising
productivity--the amount of goods and services that a worker produces
per unit of time with the skills and tools available--can countries
raise per capita income. And the higher the rate of productivity
growth, the faster poverty will decline. Simply put, the ticket out of
poverty is higher productivity jobs.
Long-term trends in productivity growth have shown improvements in
Latin America in the 1990's. According to the Inter-American
Development Bank (IDB), the 1990's had higher productivity growth than
the 1980's, reflecting economic
reforms especially in the macroeconomic areas. Productivity growth was
0.7 percent per year in Latin America in the 1990's after averaging
less than zero in the 1980's.
However, I am optimistic that productivity growth in Latin America
could
improve by a much greater amount. While productivity growth was 0.7
percent in Latin America in the 1990's, it was 1.7 percent in the
developed countries and 2.7 percent in the East Asian countries. That 1
percent or 2 percent productivity difference would make a huge
difference in living standards over time.
The first step to raising productivity growth is gaining an
understanding of why productivity is so low. Productivity depends on
two things: capital per worker and the level of technology. If there
are no impediments to the flow and accumulation of capital and
technology, then countries or areas that are behind in productivity
should have a higher productivity growth rate. More and more evidence
has been accumulating that there are significant impediments to
investment and the adoption of technology that are holding countries
and people back.
The United States is seeking to reduce these impediments to higher
productivity growth by emphasizing the need for policy steps in three
areas. As identified by President Bush these three areas are: ruling
justly, investing in people, and encouraging economic freedom.
First, poor governance, the lack of rule of law or enforceable
contracts, and the prevalence of corruption create disincentives to
invest, to start up new firms, and to expand existing firms with high-
productivity jobs. This has a negative impact on capital formation and
entrepreneurial activity.
Second, weak education systems impede development of human capital.
Workers without adequate education do not have the skills to take on
high-productivity jobs or to adopt new technologies to increase the
productivity of the jobs they do have. There is wide agreement that
better education is key to productivity growth.
Although the labor force in Latin America grew at similar rates as East
Asia in the 1990's, the rate of educational improvement was slower
during the past decade. There are, of course, important educational
success stories. For example, in Brazil the Bolsa Escola program, which
provides funds to families with low incomes whose children attend
school, has led to higher enrollments.
Third, too many restrictions on economic transactions prevent
people from trading goods and services or adopting new technologies.
Lack of openness to trade, state monopolies, and excessive regulation
are all examples of restrictions that reduce
incentives for innovation and investment needed to boost productivity.
For example, in Latin America on average it takes 12 legal and
government administrative steps to start up a business. In Canada, it
takes 2 steps to start up a business; in the United States it takes 4
steps.
Raising productivity rates involves steps to foster a stable
macroeconomic environment, boost the skills of individual workers, and
introduce market forces to help channel resources most effectively. In
promoting these policies, however, we must remind ourselves that there
is no shortcut to sustained economic growth and that good results
require a patient commitment over a long period of time.
Achieving U.S. Policy Objectives
The United States is seeking to encourage increases in economic
growth in Latin America through an array of concrete policy steps at
the bilateral, regional, and multilateral levels.
President Bush signaled the U.S. commitment to bilateral efforts
earlier this year when he proposed a dramatic increase in foreign aid
through the Millennium Challenge Account initiative. Beginning in 2004,
increased assistance will be available to strong performing countries--
those that govern justly, invest in their own people, and create a
favorable climate for private enterprise--with the total increase
reaching $5 billion per year starting in 2006. These funds provide a
powerful incentive for countries to create an environment conducive to
growth.
The United States has also launched several country-specific
initiatives, such as reform of the North American Development Bank
(NADBank). President Bush has long recognized the need for serious
reform of this institution. He and President Fox, who had also proposed
reforms, decided to do something about the problem. The United States
and Mexico established NADBank in 1993 for the purpose of helping
border communities cope with the environmental pressures relating to
the North American Free Trade Agreement in the United States-Mexico
border region. But during its 7 years of operation, the overall
performance of NADBank was unsatisfactory. NADBank had approved only
$23.5 million and disbursed only $11 million in loans to projects,
despite having $405 million in authorized paid-in capital and a total
lending capacity of $2.7 billion.
We have made much progress in the reform effort. In order to better
use the authorized funds at NADBank, the reforms called for increasing
the amount of support from grants and low-interest rate loans, allowing
NADBank projects to go deeper into Mexico, merging the boards of
NADBank and its project-certification sister institution the Border
Environmental Cooperation Commission, and allowing retained earnings to
fund supply-side water conservation projects on both sides of the
border. The reforms were negotiated last spring and summer. The needed
legislation has passed the House and is pending in the Senate.
Another example of an initiative with Mexico is the Partnership for
Prosperity--an initiative aimed at strengthening Mexico's economy
through a number of measures to improve access to capital, build
capacity, and stimulate private investment in areas that do not yet
fully benefit from NAFTA.
One key area that could greatly facilitate the flow of capital to
Latin American countries involves reducing the cost of remittances sent
from abroad. The Inter-American Development Bank estimates that Latin
Americans living in the United States send an average of $200 to their
native countries an average of seven to eight times per year. These
remittances surpassed $23 billion last year--about one fifth of total
worldwide remittances--and represent an enormous resource transfer to
families and businesses that can make direct use of the funds. Although
remittance charges are declining, they still range from 6 -15 percent
of the remitted amount plus an exchange margin that ranges from 3-5
percent. Increased competition as more and more traditional financial
institutions offer remittance products should help to lower costs.
Trade has enormous significance for spurring productivity gains and
growth in the region. With approval of Trade Promotion Authority, we
are strongly committed to rapid progress in reducing trade and
investment barriers throughout the hemisphere. The Doha Agenda of
global trade talks will give particular emphasis to promoting
development. At the same time, the United States expects to sign a free
trade agreement with Chile soon, will continue to work toward
completion of the Free Trade Area of the Americas by 2005 as co-chair
of the process with Brazil, and has announced the United States
intention to begin negotiating a free trade agreement with Central
American countries starting the first of this coming year.
The International Financial Institutions
At the World Bank and Inter-American Development Bank, the United
States is supporting development projects and programs that address the
basic causes of low productivity, including projects to raise health
and education levels, increase access to clean water and sanitation,
and improve the climate for private sector development. A key element
of this strategy has been the successful U.S.-led effort to have the
International Development Association (IDA) expand the amount of grant
financing it provides to poorer countries in order to boost development
prospects without adding to country debt burdens. We will also continue
our efforts to have the multilateral development banks make operational
a system to better measure, monitor, and manage for development
results. Measuring development results figures prominently in the most
recent IDA round in that the agreement's contribution structure allows
donors to increase their funding levels if concrete measurable
results are achieved. We are convinced that donors and developing
countries will benefit from routinely quantifying development
achievements and understanding the reasons for success and failure.
Within the IMF, the United States is working to strengthen
mechanisms to detect potential crises early and act preemptively to
address sources of vulnerability. We are also working to ensure that
the IMF is effective in situations when a financial crisis develops.
The IMF is most effective when it focuses on the areas central its
expertise: monetary, fiscal, exchange rate, financial sector, and debt
management policies. At the same time, we are working to increase
discipline in terms of access to IMF resources to reduce the size of
IMF packages and thereby reduce the risk of moral hazard--for example,
the belief that in a crisis, large-scale IMF assistance will protect
investors from the consequences of their decisions. We have also
refrained from providing longer-term bilateral loan assistance in
crisis cases, as was done in the past. Emphasizing that the IMF must be
the key source of emergency support and avoiding recourse to bilateral
assistance allows the availability of IMF resources to act as a natural
constraint on the size of official financing packages.
We have taken into account a number of considerations to assess
when and whether the international financial institutions should
provide support to countries, particularly in light of crises and other
challenges in Latin America.
First, and most important, countries must be committed to
implementing credible and sustainable economic policies. Such policies
should embrace a number of principles: strong or improving fiscal
accounts, incentives for private sector investment in order to promote
growth, steps to strengthen financial systems, and sound monetary and
exchange rate policies. Not all actions can be accomplished
immediately, of course, but it is important to begin the process as a
means of putting economies back onto a sustainable path, as a signal of
the authorities' intentions, and as a first step toward re-establishing
confidence.
Second, experience has shown that lending programs that lack strong
ownership by a country's leaders are likely to fail; we should not
support such programs. Narrowing the range of conditionality to
critical issues helps increase country ownership over effective
programs. And in the context of crisis lending, providing official
sector support to countries with strong ownership over high-quality
economic programs that promote economic growth is the best way to
ensure that official sector interventions in time of crisis are laying
the basis for a return to economic health over the long term.
Third, it is important for the IMF and for other institutions to
structure international financial and development packages properly so
that strong incentives for good policy performance are maintained.
Prior actions that must be completed
before a lending program begins, for instance, can sometimes be a
useful means for a country to demonstrate its commitment before
international funds are disbursed. ``Backloading'' the financial
assistance, with smaller amounts of money provided initially and larger
amounts provided later on, can help to ensure that a country's
performance does not weaken over time. Lending conditions within a
program should also be carefully targeted, focused on those issues that
contributed to a crisis and addressing steps that are most essential
for future success. Not every crisis results from a fiscal deficit, for
instance, and so not every program should automatically require fiscal
retrenchment.
Argentina, Brazil, and Uruguay
Let me provide an update on three of the key countries in the
region that have received particular attention in recent months--
Argentina, Brazil, and Uruguay.
Argentina has not yet reached a new agreement on an IMF program,
but has recently made some progress in developing a short-term program
to restore monetary stability. We hope that an agreement will be
reached soon. Bush Administration
officials, including Secretary O'Neill, have stated on numerous
occasions both privately and publicly that we want Argentina to
succeed. The United States has strongly supported efforts to provide
Argentina breathing room as it works with the IMF to develop a
sustainable economic plan. For example, the United States has backed
four extensions this year of repayments to the IMF (totaling
approxiamately $4.9 billion) and has also worked to accelerate lending
from the World Bank and Inter-American Development Bank.
But finalizing an agreement between the IMF and Argentine
Government has not happened quickly. The extensive economic problems
Argentina has confronted--a dramatic reduction in output, debt default,
extensive deposit and foreign exchange restrictions, provincial
government deficits, and a sharp depreciation of the exchange rate--
have required a significant amount of time and attention. Given the
importance of Argentina's economy to the region and Argentina's need to
get back on an economically sustainable path, we believe it is
essential that Argentina's monetary and fiscal framework be
strengthened as a basis for a new lending program. Encouragingly, in
recent weeks, there have been some signs that parts of Argentina's
economy have stabilized.
For Brazil, we strongly supported the August decision to provide an
expanded IMF lending package given confidence in the current policy mix
and the firm belief that the short-term liquidity pressures facing
Brazil can be alleviated through continuing such policies. Furthermore,
the design of the program ``backloaded'' the large majority of IMF
resources so that much of the financing will be provided only if sound
policies are maintained. The key policy conditionality underlying the
program includes maintenance of fiscal prudence and concrete steps to
reform major impediments to growth such as the current tax code.
Comments by presidential candidates in recent weeks reaffirming support
for the main pillars of the program increase the chances of its
success.
In Uruguay, the United States supported a $3.8 billion official
sector package, and drew on the Exchange Stabilization Fund to provide
a short-term bridge loan until IFI financing could be put in place. We
did so because Uruguay had a strong record of sound policies and we
were convinced that the Uruguayan Government had a strategy to address
its difficulties--particularly in the banking sector--and was committed
to implementing that strategy.
While we do not yet know the final outcome, initial results in
Uruguay have been encouraging. Since the IMF program was announced, we
have seen increased stability in the financial system and continued
strong performance by Uruguay. Under the IMF program, net deposits in
the nonintervened banks have increased. As a
result of this improvement in financial sector confidence, only one-
third of the $1.5 billion in IMF resources targeted for the financial
sector has been used. Uruguay still faces a difficult regional economic
environment, but its leaders have shown their willingness to commit to
necessary reforms and long-term economic goals.
Outlook for the Region
In spite of recent turbulence, I remain confident about the
region's prospects. First, the current economic cycle of slow or
negative growth will improve, especially as the U.S. economy continues
to gain strength. At about 38 percent of GDP, exports comprise a large
percentage of income for the Latin America region as a whole.
I believe that many countries within the region have made important
progress over the past decade in strengthening the economic
institutions and policies that will improve their growth prospects. In
a number of countries, for instance, central banks have focused more on
keeping inflation low. And many countries have abandoned soft exchange
rate pegs and maintained floating exchange rate regimes, helping them
to adjust more easily when faced with economic shocks. Others, such as
El Salvador, have been successful with full dollarization.
Across the region, the private sector now contributes a larger
percentage of GDP than it did during the 1980's, which will help Latin
American economies regain their dynamism more quickly. Many countries
now have more extensive trade and financial linkages amongst themselves
and with developed economies--such as the United States and Europe--
than they did in the past. This is a factor that will help to
accelerate their recovery once conditions improve. Finally, Latin
America also has a strong human capital and resource base that provides
a solid underlying foundation for future growth.
----------
PREPARED STATEMENT OF DANIEL K. TARULLO
Professor of Law, Georgetown University Law Center
October 16, 2002
Mr. Chairman, Senator Hagel, I appreciate your invitation to
testify today. I am currently a Professor at Georgetown University Law
Center. As you know, between 1993 and 1998, I held several economic
policy positions in the Administration, ending as Assistant to the
President for International Economic Policy. I testify today purely in
my individual capacity as an academic, with no client interests or
representation.
What Is At Stake
The importance of the topic of this hearing is difficult to
overstate. If the world economy continues to stumble over the next year
or two, much of South America may be afflicted with financial and
business crises that produce another ``lost decade,'' such as that
which gripped the region in the wake of the debt crisis of the 1980's.
The human costs of that decade are incalculable in any meaningful
sense. Yet out of that tragedy there did arise a renewed commitment in
most countries of the region toward both democracy and market-oriented
economic reform. By the time of the Summit of the Americas held in
Miami in November 1994, most of the hemisphere looked forward to
sustained economic growth. That confidence was shaken just a few weeks
later by the onset of the Mexican financial crisis. In 1998, the spread
of the Asian financial crisis threatened to halt the progress that had
been achieved. Today, Argentina is losing ground rapidly, and much of
the rest of the continent is in danger of doing likewise.
The debt crisis of the 1980's helped convince Latin American
countries to abandon the policies of the 1960's and 1970's that had
laid the groundwork for crisis. Today, there is a growing sentiment in
the region for abandoning the market-oriented policies of the 1990's
that are blamed by many for the current difficulties. There is a real
risk that countries in the region will fail to differentiate between
specific policies that may indeed be tied to their financial problems,
on the one hand, and a basic embrace of market economy policies on the
other.
The consequences may be very serious. First, some countries could
revert to
import substitution and other failed policies of the past. This would
be a prescription for economic stagnation. Second, if economic troubles
persist long enough, democratic institutions may themselves become
discredited, threatening the considerable progress of the last couple
of decades. Third, because the market reforms of the last decade are
widely characterized as part of the so-called ``Washington Consensus,''
the United States may be blamed for the region's troubles. If so,
prospects for true partnership with South American countries would be
dashed. We might
instead return to the bad old days of chronic mistrust and occasional
confrontation.
Our interests and our values are thus very much at stake. We cannot
solve Latin America's problems. But we can, and must, adopt an
activist, supportive set of policies to reassure these countries that
we stand behind them and to offer, at least, the outlines of a path to
integration in the global economy that produces sustained and equitable
growth.
The Origins of the Current Crises
The disheartening fact is that Argentina and Brazil, South
America's two largest countries, are again in financial distress.
Argentina, of course, has defaulted on its external sovereign debt. Its
banking system has been dysfunctional for 10 months. The country is in
severe recession, having suffered a double-digit drop in GDP over the
last year. Brazil has, with the assistance of the International
Monetary Fund, thus far contained the damage from the pressures on its
currency and equity market in advance of the presidential election. But
its position is tenuous, to say the least.
The origins and characteristics of the Argentine and Brazilian
travails differ in many particulars. But it is important to note that
the recent financial histories of these countries are closely
intertwined. The Brazilian financial crisis of late 1998 and early
1999, itself an outgrowth of the Asian financial crisis, had a
pronounced negative effect on the Argentine economy. Both nations have
been seriously affected by lagging growth in European and North
American export markets. And contrary to official expectations,
Argentina's default on its external debt late last year has had
contagion effects upon Brazil and other South American countries.
So too, longer-term developments in these countries bear important
similarities. Each returned to democratic rule less than 20 years ago.
Each implemented a managed currency regime in the early 1990's in
successful efforts to vanquish runaway inflation. Each is struggling
still to escape the tendency toward lax fiscal policy that has
afflicted them for decades. Each implemented genuine market-oriented
economic reforms in the 1990's, and took steps to strengthen their
banking systems. But each still lacks some of the institutional
capacity to support and regulate effectively a market economy.
There is considerable disagreement among official and unofficial
observers as to the precise origins of the current crises. Indeed, the
blame game is now being played with characteristic vigor by critics and
defenders of the governments themselves, the IMF, and the U.S.
Government. It seems to me that, while fair-minded people may disagree
over the relative weights to be assigned, the chief proximate causes of
both nations' problems are reasonably clear.
In Argentina, three factors stand out. First, the government ran
significant budget deficits and thus incurred substantially greater
debt during the 1990's. Much of this sovereign debt is denominated in
dollars and much of it is owed to foreign lenders. Running budget
deficits in bad economic times is generally good policy. But Argentina
increased its total public debt to GDP ratios by more than a third
during some of its best economic years, leaving it vulnerable to debt
servicing problems during an economic downturn.
Second, the currency board that had been instituted a decade ago in
a highly successful effort to tame inflation became a major source of
distortions in the economy. This policy device, well-suited to
inflationary times, is highly problematic during a recession. By tying
the value of the peso to the dollar, Argentina's ability to increase
export earnings was severely constrained during the extended period of
dollar strength. Argentine productivity was not keeping pace with
American productivity growth, yet the relative prices of Argentine
products remained valued as if this were the case. At the same time,
the currency board made borrowing in dollars seem a bargain.
Third, the series of shocks that beset the world economy--
particularly emerging markets--beginning in late 1997 exacerbated the
problems created for Argentina by loose fiscal policy and the albatross
of the currency board. Slowing United States and European economies
meant less vigorous export markets for Argentina. Flows of long-term
direct investment dried up. The 1998 Brazilian crisis and subsequent
devaluation of the real struck another blow to the Argentine economy,
with its fixed exchange rate.
By early 2001 many people--myself included--thought that the
combination of Argentina's fiscal policy, currency board, and external
debt position was unsustain-
able. By late 2001 nearly everyone, the IMF included, had reached the
same conclusion. The default and devaluation of late 2001, while
perhaps inescapable, left both the Argentine economy and political
system in disarray. Only now, nearly a year later, do we see glimmers
of hope that Argentina's problems may have bottomed out. Even if this
proves to be the case, full recovery is a long ways away.
In several important respects, Brazil's situation is different and
more favorable than that of Argentina. Brazil abandoned its managed
exchange rate regime in early 1999 and has thus escaped in recent years
the shackles of the strong dollar. Brazil has significantly reformed
the fiscal relationship between state and federal governments that has
so bedeviled Argentina. Indeed, Brazil has recently been running a
primary budget surplus of between 3 percent and 4 percent of GDP
(although its debt servicing costs are so high that it still has a
substantial bottom-line budget deficit).
Unfortunately, Brazil's situation resembles that of Argentina in
two important respects. First, Brazil's public sector debt rose
dramatically during the 1990's. In fact, Brazil's public debt increased
faster than Argentina's, nearly doubling during the decade, to about 60
percent of GDP. While this borrowing is less dollar-denominated and
external than Argentina's, Brazil's external exposure is still
sufficiently high (about 40 percent of total public debt) that it was
vulnerable to changes in international capital market conditions and
sentiment. Second, like Argentina, Brazil has been buffeted by the
cumulative effects of South American economic problems and by uncertain
prospects for global growth.
Finally, of course, the growing prospect of a change in Brazil's
ruling coalition has, throughout the last several months, applied
enormous pressure on Brazil's currency and equity markets. As Mr. Da
Silva's election prospects brightened, culminating in his leading the
vote-getting in the first round of elections, markets became edgier. Da
Silva's commitment to significant social change and policy stances in
earlier elections have unnerved some investors, notwithstanding his
repeated commitments to honor Brazil's debt obligations.
The Role of the IMF
Consideration of the role of the IMF in the Argentine and Brazilian
situations is perhaps best divided into discussion of: (1) the Fund's
short-term decisions to provide or, eventually in the case of
Argentina, not to provide assistance programs; and (2) medium-term
issues concerning the wisdom of the Fund's advice to, and monitoring
of, emerging markets.
Decisions on Stand-By Credits
The Fund's decision to provide a stand-by arrangement for Argentina
in late 2000 was a questionable one, which has since been characterized
by some from the outgoing Clinton Administration and the Fund itself as
a close call one way or the other. It was difficult to see how
Argentina's fiscal situation could feasibly and sensibly be reversed
quickly enough to render its external debt obligations sustainable.
Adding more multilateral debt seemed the triumph of hope over
experience.
If the 2000 program was questionable, then the additional
assistance program
announced in the summer of 2001 was simply mistaken, as the Fund itself
now essentially acknowledges. Renegotiation of Argentina's external
debt, abandonment of the currency board, or both were clearly required.
Perhaps a Fund package accompanying such measures would have had a
chance of success, though one suspects it may have been too late to
pull off a reasonably smooth landing. By the end of 2001, the Fund had
reconsidered. It made no further assistance available to an Argentine
government unable to meet its external debt payments and beset
internally by rising popular anger.
The decision not to provide further assistance for the muddling-
through efforts of the Argentine government is certainly defensible.
What seems less defensible, at least to an outside observer, was the
apparent withdrawal of the Fund (and the United States) from the field.
While Fund officials continued to make sympathetic noises about a
willingness to help Argentina, it was hard to discern proactive efforts
to assist in organizing a dialogue with creditors or in formulating a
set of interim policy measures that would contain Argentina's downward
slide and accelerate an economic turn-around. It may well be that the
political situation in Argentina was by November 2001 so chaotic as to
foreclose any coherent policy response by the government. If so, the
mistake in having provided stopgap programs in late 2000 and mid-2001
is all the more telling.
In the case of Brazil, the Fund offered what I consider to be a
very successful program for Brazil in December 1998. Indeed, in
retrospect that program and Brazil's own economic management look to
have been the turning point in the financial crisis that had started in
Asia and was spreading to other regions. Brazil abandoned its exchange
rate regime in the early stages of this program. As the 1998 stand-by
arrangement was expiring, the Fund offered another program in September
2001, largely on the basis of unfavorable external developments. The
Fund conditioned the program on achievement of primary surplus targets.
Late last summer the Fund reached the sound conclusion that
investor uncertainty in advance of the presidential election could
itself lead to financial crisis, regardless of the policies eventually
followed by the new president. By announcing a program that had a large
``headline'' number but that withheld most of the assistance until
after the new administration's policies become clear, the Fund was
attempting a delicate balancing act. I agree with the Fund's effort to
strike this balance and hope its formula succeeds.
My reservation about the program as announced was that it was
unaccompanied by any formal private sector actions. If Brazilian
policies, the world economy, and investor sentiment all break the right
way, Brazil's situation may stabilize and its external debt may become
sustainable. Given the size of that debt and the reality of a teetering
world economy that may soon be shaken by major military conflict, I
worry that debt rescheduling may be necessary. My own predisposition
would have been to include some form of private sector involvement--
such as commitments on net capital inflows in the medium term--in the
initial plan, so as to enhance chances for its success. If
restructuring becomes necessary in the coming months, further financial
disruption is essentially inevitable.
The Fund's Advice and Expectations
It is very difficult for the Fund to escape criticism in the case
of Argentina. The Fund has had multiple programs over several decades
with the country. Moreover, as is now regularly pointed out, through
much of the 1990's the Fund praised
Argentina as an exemplar of privatization, market-oriented reform, and
financial stability. Something was obviously wrong or missing in the
Fund's prescriptions.
Yet it is important not to jump from this observation to the
conclusion that every policy the Fund recommended was unsuitable or
that its recommendations were the chief causes of the 2001 financial
implosion. I should quickly note that I have certainly disagreed with
Fund policies in the past, whether general or country specific. Up
until quite recently, the Fund was on a campaign to eliminate all of
the controls on capital inflows, with no more than nominal attention to
the capacity of a country's financial system to absorb big inflow
surges. The Fund's sometimes reflexive emphasis on fiscal tightening
even in the midst of fiscal distress has often been inappropriate. Fund
endorsement of privatization without regard to transitional and
ownership arrangements can be ill-advised in some circumstances.
But privatization--whether well or poorly conceived--did not cause
Argentina's financial crisis. And the Fund's response to Argentina's
fiscal policy which is most susceptible to criticism is its failure to
insist on more fiscal discipline during years in which economic
performance was relatively good. Or, what amounts to a variation on
this theme, perhaps the Fund should have pressed Argentina to limit its
external sovereign borrowing. Likewise, the Fund might be criticized
for not urging Argentina to abandon its currency board, since one of
the principal lessons which the Fund drew from the Asian financial
crisis is that a fixed exchange rate in an environment of free capital
flows vastly increases the risk of financial crisis in emerging
markets.
In assessing the Fund's dealings with Brazil, one might similarly
criticize the Fund's acquiescence in the rapid increase in sovereign
debt levels. Here, though, the criticism is less justified. In 1998,
Brazil was a kind of firewall against the further spread of financial
crisis. Insistence upon greater fiscal austerity in that period would
have been counterproductive. Indeed, the Fund would have itself been
subject to the recurring criticism that is pithily summed up in the
witticism that IMF stands for ``It's Mostly Fiscal.'' By 2001, the Fund
was conditioning a program on maintenance of a significant primary
budget surplus.
Like Argentina in 2001, Brazil's exchange rate regime had helped
create the conditions for crisis in 1998. Export earnings were
artificially restrained by an overvalued currency, and short-term
dollar debt was artificially attractive. Some have charged the IMF with
the responsibility for Brazil's imposition of a crawling peg exchange
rate in 1994. It may be fair to say that the IMF was once too tolerant
of fixed exchange rate regimes--a position that it has now changed. But
it does not accord with my understanding to say that the IMF urged a
fixed-rate regime upon Brazil in 1994 (or, for that matter, upon
Argentina in 1991). On the contrary, at least at the staff level there
were serious misgivings about this policy step by Brazil.
What conclusions can we draw about the role of the Fund from the
recent Argentine and Brazilian experiences? I believe these experiences
reinforce one fundamental point and raise one fundamental question.
The fundamental point is that a presumption of private sector
involvement should obtain whenever the IMF approves a sizeable stand-by
credit to assist countries unable to service their sovereign debt.
Usually the private sector involvement will be important for achieving
a sustainable program for the country. Private sector involvement will
always be important for creating a set of incentives for lenders and
borrowers that are more closely correlated with the risks actually
involved in specific debt transactions. The nature of the private
sector involvement can and should vary with the particular
circumstances of the debtor country. Sometimes commitments to maintain
existing levels of exposure will be adequate. And sometimes
rescheduling may be appropriate. Less frequently, some reduction in the
debt stock itself may be necessary. But in all cases the private sector
involvement must be real rather than specific. That means the
development and publication of satisfactory, precisely-stated terms.
The fundamental question raised by the Argentine and Brazilian
experiences is the degree to which we want the IMF to assume
responsibility for the economic policies of emerging market countries
with actual or potential debt problems. It should be clear from the
preceding discussion that the rectification of possible IMF mistakes
would have come only at the expense of substantial infringement on the
sovereign decisions of a democratically elected government. Should IMF
officials have pressured Brazil in 1994 not to adopt the pegged
exchange rate? Should the Fund decide when a country should stop
borrowing abroad? Should the trade-off between containing runaway
inflation now and the risks of debt and currency imbalances later be
made by the elected representatives of the people or by the Fund?
These are not easy questions. Uncorrected national policies may
lead to requests for sizeable IMF stand-by credits. When a country is
in crisis and seeking substantial international resources, some
imposition of conditions is inescapable, as in any lender-borrower
situation. Earlier reform would obviously be preferable. It is
certainly incumbent upon the IMF to sound private and, in unusual
circumstances, perhaps even public warnings about unsustainable
national policies. How far the member states of the IMF want the Fund's
staff to go in forcing policy decisions upon countries not in immediate
crisis seems to me a subject in need of substantially more exploration
and debate.
The Role of the Administration
It is apparent from the foregoing discussion that the situation in
Argentina was already deeply troubled when the Administration took
office in January 2001. The agenda for reforming the so-called
international financial architecture had stalled. Quite frankly, the
problems in the international financial system are not susceptible of
quick and easy solutions, so one can hardly criticize the
Administration for failing to solve those problems in less than 2
years. But, I regret to say, having been dealt a bad hand, the
Administration has not played that hand particularly well.
The voice of a U.S. economic official is itself an important
instrument of policy. A consistent, measured, and coherent voice
establishes credibility, reassures market actors, and enhances U.S.
economic leadership. The absence of such a voice has just the opposite
set of consequences. While I think it unfair to hold the Administration
responsible for all the financial problems faced by emerging markets, I
think it is legitimate to criticize the lack of consistency, coherence,
and restraint in its statements and actions.
When the Administration took office, it proclaimed the end of large
IMF ``bail outs.'' Although many were skeptical that such a blunt
policy approach was optimal, it was certainly a clear position. The
Administration's endorsement of a program for Turkey did not appear a
real departure from this position, since most people understand that
there is an implicit ``security exception'' to any stated international
economic policy.
But the misguided program for Argentina and the defensible programs
for Brazil and Uruguay have obviously undermined completely the
Administration's stated policy position. The current Administration
view appears to be that it will not support ``unsustainable'' IMF
programs. I do not think one can find any Administration that has ever
stated its support for unsustainable IMF programs. In the absence of a
clearer policy statement, it is hard to know where exactly the
Administration stands.
Similarly, with respect to reforms of the international financial
system, just a few months ago the Administration publicly rejected IMF
proposals for a sovereign debt restructuring mechanism (SDRM), in favor
of voluntary terms in bond indentures. Again, one might agree or
disagree with that position. Yet just a few months later the
Administration appears to have endorsed the IMF plan. While one should
always be mindful of Ralph Waldo Emerson's observation that ``a foolish
consistency is the hobgoblin of little minds,'' it is not reassuring to
see the Administration walk away from a strongly stated position with
no explanation of why its views had changed.
The relative passivity of the Administration during and after
financial crises has also been disappointing. I understand and
appreciate the Administration's view that it cannot impose solutions on
Argentina or any other country. But it seems to me both ill-advised
foreign policy and wasteful economics to have simply stood by and
waited for Argentina to come up with an acceptable plan. Things are
only made worse when Administration officials make off-handed comments
critical of the country suffering through the crisis. The confusion and
uncertainty attending a financial crisis afflict all participants.
Generally speaking, an active role by the United States is necessary
for expeditious movement along the path to a solution. There is a wide
spectrum running between efforts to impose economic policies and
sitting by the phone waiting for the Argentines to call. I would
suggest that the better U.S. position is somewhere in the middle of
that spectrum.
I am glad that the Administration has eschewed the simplistic
solutions to complex financial problems that some have urged upon them.
But the complexity and seriousness of problems require the exercise of
leadership. While the U.S. agenda for international financial reform
may have to be developed and implemented in stages, with continuing
refinements, our direction and aims should be clearly stated and
consistently advanced. The retreat of the United States from a clear
leadership position on the problems of specific countries and on the
broader issues of reform is costly as a matter of both foreign and
economic policy.
Conclusion
At the risk of repetitiveness, let me end where I began. It is very
much in the U.S. interest that the rest of this hemisphere consist of
well-established democracies that produce equitable economic growth for
their peoples. While there will always be good-faith differences of
view as to the most appropriate U.S. policies in support of these ends,
there can be little doubt that an active presence in attempts to solve
national and regional problems is imperative. To me, this imperative
means both a more visible presence in efforts to reverse Argentina's
economic slide and a more consistent, active leadership role in efforts
by the international community to address systemic international
financial problems.
----------
PREPARED STATEMENT OF MICHAEL MUSSA, Ph.D.
Senior Fellow, Institute for International Economics
October 16, 2002
Thank you, Mr. Chairman and Members of the Subcommittee.
It is a pleasure to participate in this timely hearing concerning
the difficult economic situation in Latin America and the efforts of
the United States and the international community to ameliorate these
difficulties.
This year, Latin America is suffering from its worst economic
performance in nearly two decades, with real GDP for the region
projected to drop by 2 percent--the largest decline since the darkest
days of the debt crisis in 1983. Argentina is an economic catastrophe,
with real GDP expected to fall a further 15 percent this year to
roughly 25 percent below its 1998 peak. Uruguay is also in a severe and
prolonged recession, facing a decline of another 8 to 10 percent in
this year's output. Hit by domestic political turmoil, Venezuela's
economy will probably shrink about 5 percent this year.
Other countries in the region are not faring as badly; but none are
doing well. Brazil, which has the region's largest economy, will be
lucky to achieve 1 percent real economic growth this year--following
upon 4 years where the average annual growth rate has been well below
Brazil's potential. More importantly, Brazil now teeters on the brink
of a major financial crisis that--if not averted--would push next
year's growth sharply negative. Even the region's best consistent
economic performer, Chile, faces another year of distinctly subpar
growth. And Mexico, the region's second largest economy and the Latin
American economy that has by far the most important economic linkages
to the United States, will probably grow by less than 2 percent this
year and remains at very significant risk if the U.S. economic recovery
loses forward momentum. Thus, as general background for this hearing,
it is relevant to recognize that the present economic situation in all
of Latin America is not good, and there is considerable concern that it
may not get much better anytime soon.
Of course, several important factors have contributed to Latin
America's present economic difficulties and to the risks going forward,
with the most relevant factors differing considerably across individual
countries. The global economic slowdown and the weakening of many
commodity prices have had a negative impact on exports from the entire
region. Diminished inflows of direct foreign investment to Latin
America have also partly reflected the weaker worldwide investment
climate. Meanwhile, conditions in world financial markets have turned
distinctly less hospitable toward emerging market borrowers--a factor
of particular importance for relatively heavy indebted Latin American
countries. And, negative spillovers within the region have also been
important for some countries, most notably the severe negative
consequences for Uruguay of the economic catastrophe in Argentina.
Despite the clear importance of such external factors, however, the
most important causes of Latin America's present distress lie in
domestic economic weaknesses and in how these weaknesses have
interacted with adverse external developments. This is especially so in
Argentina where (as I have argued elsewhere) the combination of a very
rigid exchange rate regime and persistent imprudence in fiscal
management ultimately led to a disastrous economic and financial
crisis.\1\ A similar story applies to Brazil's present predicament. A
large build-up of net public debt (from 30 percent of GDP in 1994 to
over 60 percent of GDP today) and a large external financing
requirement (relative to merchandise exports) for the combined public
and private sectors have made Brazil particularly vulnerable to an
adverse change in financial market sentiment that now threatens to make
sovereign default and/or systemic private default a self-fulfilling
prophecy. Indeed, even for Uruguay where adverse external shocks have
undoubtedly played a particularly large role in present difficulties,
the high vulnerability to these adverse shocks was seriously
exacerbated by the large prior build-up of public debt and the
substantial foreign exchange risk exposure of Uruguay's financial
system.
---------------------------------------------------------------------------
\1\ See Michael Mussa, Argentina and the Fund: From Triumph to
Tragedy, Policy Analyses in International Economics, No. 67, Institute
For International Economics, Washington, DC, July 2002.
---------------------------------------------------------------------------
Clear recognition that Latin America's present difficulties and
challenges reflect primarily domestic weaknesses and vulnerabilities
that have been significantly exacerbated by adverse external
developments is essential to understanding the particular issues that
are the main focus of this hearing. The international economic and
financial system does not function perfectly, and its malfunctioning is
partly responsible for the instability now gripping much of Latin
America. Confusion and inconsistency in the policies of the United
States Government and of the official international community
(particularly the International Monetary Fund) have, in my opinion,
contributed to the malfunctioning of the system and, accordingly, have
made the problems of Latin America somewhat more difficult than they
might otherwise have been. Conversely, a more sensible and consistent
set of policies of the international community to address potential and
actual crises in emerging market countries--with credible leadership
and support from the United States--could help Latin America emerge
more rapidly and successfully from its present travails. Nevertheless,
the principal tasks of managing the present difficulties, reducing the
likelihood of their recurrence, and laying the foundation for a more
prosperous future necessarily lie with Latin Americans themselves.
With this general principle in mind, I turn to address three
specific issues raised in the letter of invitation to this hearing.
First, what is my understanding and
assessment of the United States Administration's policy concerning so-
called ``bailouts'' of emerging market countries facing actual or
potential financial crises, especially as how it relates to Uruguay and
Brazil? Second, what is my evaluation of the approach that the IMF has
taken in the cases of Uruguay and Brazil, in comparison with that
adopted in the recent case of Argentina? Third, what should the
international community attempt to do about problems of sovereign (or
systemic) bankruptcy?
United States Policy Toward Large-Scale Official Support
Perhaps there is, somewhere, a very careful explanation of the
present U.S. Administration's general policy toward official financial
support for emerging market countries facing financial crises. Perhaps
this statement somehow rationalizes the rhetoric which suggests that
the policy is to oppose ``large-scale bailouts'' and the facts which
show actual Administration support for official support packages on a
scale and at a pace that dwarfs past efforts in this area. As a more
than casual observer of these matters, however, I am befuddled by the
glaring inconsistency between the Administration's words and actions;
and I am far from the only one to suffer this confusion.
There has been little ambiguity about the Administration's
rhetoric. In line with the analysis and recommendations of the majority
of the Meltzer Commission, even before it took office, many of those
who now hold positions of responsibility for economic policy in the
present U.S. Administration voiced their opposition to ``large-scale
bailouts'' of countries facing financial crises and of these countries'
creditors. After a year and a half in office, the Administration's
rhetoric on this issue has changed little--beyond the recognition that
there may be ``special cases'' where large-scale official support may
be appropriate and that new mechanisms for dealing with sovereign
bankruptcies should be implemented or at least studied.
The facts, however, belie this rhetoric. Within barely 3 months of
taking office, the Administration supported a large expansion (about
$10 billion) of the already significant official support package for
Turkey from the International Monetary Fund. This raised IMF support
committed to Turkey to over 1,500 percent of its IMF quota, in
comparison with a normal (cumulative) access limit of 300 percent of
quota. Nine months later, after the tragedy of September 11 emphasized
the geopolitical importance of Turkey, the Administration endorsed a
further massive
expansion of IMF support for Turkey (about another $12 billion). This
raised IMF support committed to Turkey to about $31 billion or roughly
2,800 percent of
Turkey's IMF quota. In absolute amount, as a ratio to IMF quota, and
relative to Turkey's GDP (of about $200 billion), this was by far the
largest amount of IMF support ever committed to a single country up to
that time.
In August 2001, the Administration supported an $8 billion increase
in IMF financing committed to Argentina, on top of the $20 billion of
official support (from the IMF, World Bank, IDB, and the government of
Spain) that had been committed in early January. This raised the ratio
of official support committed to Argentina to GDP to a level that was,
up to that time, exceeded only by the combined support committed by the
U.S. Treasury and the IMF to Mexico in early 1995.
In September 2001, the Administration also participated in the IMF
decision to extend about $15 billion in precautionary financial support
to Brazil, in light of risks of contagion from the deepening crisis in
Argentina. The committed IMF
support, available for disbursement over a period of 15 months,
amounted to 400 percent of Brazil's IMF quota, compared with a normal
annual access limit of 100 percent of quota When, in the face of
sharply deteriorating market sentiment, Brazil drew the bulk of this
previously committed support in July 2002, Secretary O'Neill initially
indicated strong United States opposition to any further IMF support
for Brazil. This opposition, however, was soon reversed; and in August
the United States Administration supported the commitment of an
additional $30 billion of IMF support for Brazil, raising total
committed IMF support to a new absolute record for a single country
(but as a ratio to Brazil's GDP only about half that of Turkey).
For Uruguay, an IMF program with about $750 million of committed
financing (about 200 percent of Uruguay's IMF quota spread over 2
years) was established in March 2002, succeeding an earlier program
with about $200 of committed support. It soon became apparent, however,
that this moderate level of support was woefully inadequate to meet a
crisis involving massive withdrawals from Uruguay's banks and
corresponding capital outflows. With strong encouragement from the
United States Government, official support committed to Uruguay has now
been raised to $3.8 billion or about 20 percent of Uruguay's GDP. This
puts little Uruguay at the top of the league table--displacing Turkey--
as the country with the highest ratio of committed official support to
GDP.
It might reasonably be argued that geopolitical considerations,
especially in the aftermath of September 11, make Turkey a special case
that merits significantly larger official financial support than would
normally be appropriate--just as geopolitical considerations plausibly
argued for somewhat special treatment of Russia during the 1990's.
However, it is difficult to see how important geopolitical
considerations weigh in the case of Uruguay. More generally, with six
cases during its first 20 months in office (Turkey in February 2001,
Argentina in August 2001, Brazil in September 2001, Turkey again in
February 2002, Uruguay in June and again in
August 2002, and Brazil again in September 2002) in which the
Administration has endorsed large international support packages for
emerging market countries, it is nonsense to suggest that the
Administration has a consistent policy of opposing such packages.\2\
The Administration's rhetoric says something that its actions strongly
contradict.
---------------------------------------------------------------------------
\2\ In large support packages, there has been greater reliance on
IMF's financing and less reliance on bilateral official financing than
before 2001. In particular, there has been nothing similar to the $20
billion of bilateral official support that the United States Treasury
extended to Mexico in 1995-1996. Nevertheless, looking at total
commitments of official support (excluding the phony commitments in the
so-called second lines of defense), the scale of recent commitments of
official support, relative to any relevant standard, has been larger
recently than in the past.
---------------------------------------------------------------------------
Has this inconsistency done real damage? I fear it has, in at least
three ways.
First, officials in other countries have been confused and, in some
cases, offended by the inconsistencies in U.S. rhetoric and actions.
Quite rightly, many in Brazil (and many elsewhere in Latin America)
took umbrage at Secretary O'Neill's remarks this summer criticizing
official support for Brazil as a waste of the hard earned money of
United States citizens to finance capital outflows from Brazil to Swiss
bank accounts. Brazil has always repaid its official financial
support--so that there is no reason to suggest that such support,
whatever it might be used for, ultimately comes at the expense of
United States citizens. Moreover, this summer Brazil was facing severe
pressures on its currency because of capital outflows related to a
general decline in market confidence. No doubt, this included capital
outflows by Brazilian residents; but it also primarily reflected
cutbacks in external credits to Brazil and a falloff in direct foreign
investment into Brazil. In this situation, negative comments by the
U.S. Treasury Secretary were certainly not helpful in restoring
confidence--even if they were not a principal cause of Brazil's
difficulties.
Second, for the international community to play a constructive role
in dealing with emerging market financial crises, it needs to behave in
a reasonably predictable manner and in accord with a reasonable set of
principles and policies. This is essential for both the governments of
emerging market countries and for the creditors of, and investors in,
these countries (both foreign and domestic) to be able to function in a
responsible and stabilizing manner. Obviously, circumstances will
differ in individual cases, and no precise blueprint can be established
for how all possible contingencies will be handled. Some amount of
``constructive ambiguity'' may also be useful. However, the
international community needs to set reasonable rules of the game that
can be understood by it various participants--or the already difficult
problems of emerging market financial crises will be even more
difficult. In this important area of international affairs, as in most
others, constructive leadership from the U.S. Government is essential.
Ideologically based policy rhetoric that is fundamentally and
transparently contradicted by policy actions does not supply such
leadership.
Third, actions speak louder than words; and judging by the
Administration's
actions, there is a relatively wide array of circumstances where large
packages of international financial support (beyond the normal access
limits of IMF support) need to be considered as part of the response to
emerging market financial crises. In what circumstances should such
support packages be considered? How should they be structured? When
should they be augmented? When should they be terminated? These are
critical questions of judgment that the international community needs
to be able to address. And the answers to these questions that are
stated as the policy of the international community need to be
reflected in the actions taken in individual cases; and conversely.
This point was emphasized by Peter Costello, the Treasurer (Finance
Minister) of Australia in his remarks to the September 28 meeting of
the IMF's International Monetary and Financial Committee:
``. . . what counts is what the Fund actually does rather than
what it says it will do. Ultimately, it is the quality of the
judgments that are taken in each case and whether the
frameworks are applied consistently, which will determine
whether the Fund is successful in helping to resolve crises. In
effect, each decision will be part of the ongoing process of
defining the role and success of the Fund. It is important that
its actions are consistent with its stated intentions. This has
not always been the case.''
Indeed, I believe that this is part of the explanation of what went
wrong in the misguided decision to expand IMF support to Argentina in
August 2001--a decision that I have characterized as the worst single
mistake of the IMF during the past decade. In December 2000, the IMF
agreed, with the full participation of the outgoing United States
Administration, to a large international aid package for Argentina in
order to provide the Argentine authorities with one last opportunity to
avoid sovereign default and a disastrous economic and financial crisis.
Everyone knew that there was significant risk that this effort might
not succeed, especially if the Argentine authorities failed to carry
through on their commitments to achieve moderate additional fiscal
consolidation. But to those who saw large support packages as
appropriate in some circumstances, the risks seem to be worth it,
especially in view of the alternative.
With earlier large support packages, there had also been
significant risks of failure, and some actual failures. Allowance for
this possibility was made in how the packages were designed and/or
implemented. In Mexico, in early 1995, the policies of the Mexican
authorities initially proved inadequate to halt a collapse of
confidence and catastrophic depreciation of the peso. Appropriate
strengthening of these policies, backed by continued commitment of
large-scale international support, was essential to achieve success. In
Korea in December 1997, a rapid run-off of international bank credits
threatened to overwhelm the government's modest reserves and available
official financing, thereby forcing a catastrophic financial collapse.
Facing up to this challenge, on Christmas eve, the policy strategy was
changed; the major industrial countries moved to encourage their
commercial banks to roll over their Korean exposures, with the backing
of guarantees from the Korean government. The new strategy stemmed
reserve losses and helped to reestablish stability. In Russia in the
summer of 1998, the size of the initial IMF disbursement in a large
official support package was cut back when the Duma failed to pass key
legislation required under the IMF program, and the support package
lapsed after the first disbursement when the Russian authorities
defaulted and devalued. In Brazil in the autumn of 1998, a large
official support package backed a stabilization program that, at the
insistence of the Brazilian authorities, sought to preserve that
country's crawling peg exchange rate regime. In view of substantial
doubts about the viability of that exchange rate regime, however, the
support package did not permit unlimited use of these resources to
defend the exchange rate. When the policies of the Brazilian
authorities proved inadequate to sustain market confidence, the
exchange rate regime collapsed. As a condition for continued official
support, Brazil then had to move to a floating exchange rate regime.
Thus, in all of these cases where large support packages were used, the
possibility of failure was recognized (at least implicitly), and
approaches to deal with this possibility were considered and
implemented.
In Argentina by the summer of 2001, it was clear that the
stabilization effort was failing and there was no reasonable
expectation that the Argentine authorities could implement policies to
correct the situation. Without commitment of additional official
support of at least $30 billion--something that the official community
was not prepared to contemplate--sovereign default and collapse of
Argentina's convertibility plan had become unavoidable. Understandably,
the Argentine authorities were loath to recognize this fact. But the
leaders of the international community (at the IMF and in key finance
ministries) should have known better. Augmenting the support package
for Argentina and disbursing another $6 billion of IMF financing in
early September 2001 was a stupidity. The collapse was merely postponed
by a few weeks, Argentina was stuck with $6 billion more of official
debt that it now finds very difficult to repay or reschedule, and
potential opportunity to manage the inevitable collapse in a less
catastrophic manner was lost.
To what extent did general disdain of senior U.S. officials for
large official support packages contribute to the serious mismanagement
of this particular support package. It is difficult to know, especially
because relatively limited practical inexperience with these issues
probably also played a role. However, common sense suggests that those
who are ideologically opposed to large international support packages
are probably not very well prepared to manage them effectively. By
analogy, while we do not want war mongers as our military leaders, a
conscientious objector is not suitable as Commandant of the Marine
Corps. If the United States endorses an international system that uses
large packages of official support as part of the mechanism for dealing
with emerging market financial crises--as is implied by the actions of
successive U.S. Administrations--then the responsible U.S. officials
need to understand and appreciate both the uses and the limitations of
this tool of international economic policy.
Uruguay and Brazil
Uruguay is a small country with a GDP of only about $20 billion,
less than a one-tenth of the size of the Argentine economy and barely 3
percent of the size of the Brazilian economy.\3\ Because of its small
size, I normally do not pay much attention to Uruguay. However, because
of Uruguay's close economic linkages to Argentina (and to a lesser
extent to Brazil), it was clear even to me that Uruguay was in for
serious trouble (on top of an already ongoing recession) as Argentina's
crisis deepened over the course of last year. This judgment was clearly
shared by most of the relevant staff at the IMF. The report for the
annual Article IV consultation with Uruguay (dated September 21, 2001)
emphasizes that ``. . . Uruguay is highly vulnerable to further shocks
in the region.'' [Emphasis in original.] Nevertheless, nothing special
was done last year to help Uruguay contend with the adverse spillovers
that were obviously likely to come from Argentina, other than
continuing with a modest IMF program (with support of about $200
million or about 50 percent of Uruguay's IMF quota spread over 22
months) that had been established in May 2000.
---------------------------------------------------------------------------
\3\ Large fluctuations of exchange rates over relatively short time
periods can change dramatically the dollar value of the GDP of emerging
market countries. In the medium term, however, real exchange rates (for
example, exchange rates adjusted for movements in national price
levels) are relatively stable. The dollar values of countries' GDP's
referred to in this statement
reflect what the GDP is at normal values of exchange rates when the
economy is operating near its potential. For Argentina, GDP is about
$250 billion, for Brazil it is about $600 billion, for Uruguay it is
about $20 billion, and for Turkey, it is about $200 billion. In
comparison, U.S. GDP is about $10 trillion.
---------------------------------------------------------------------------
With the existing IMF program due to expire at end March 2002,
negotiations for a new program were underway during the winter of 2002.
They concluded with an agreement (approved by the IMF Executive Board
on March 25, 2002) that committed about $750 million of IMF support
spread over 2 years. This amount was almost at the upper limit of
normal access for Uruguay to IMF resources. Nevertheless, I believe
that the technical staff at the IMF understood from the start that this
new program fell far short of what was likely to be needed to help
Uruguay successfully confront its impending crisis--mainly but not
exclusively the result of contagion from Argentina. Whatever might have
been the views of the technical staff, however, the management of the
Fund and the Fund's major shareholders were not, at this point, willing
to contemplate yet another IMF program beyond the normal access limits.
A special characteristic of Uruguay is that it has a large banking
system relative to the size of its economy, with assets of public and
private banks amounting to about 50 percent of GDP. Most of the
liabilities of the banking system are denominated in or indexed to the
U.S. dollar, and a substantial part of bank deposits are held by
nonresidents (mainly Argentines). Banks maintain large foreign-exchange
assets to offset their foreign-exchange liabilities, but are
nevertheless exposed to considerable risk from sharp depreciation of
the peso against the dollar. Uruguay also has a substantial public
debt, and the ratio of public debt to GDP has risen rapidly since 1998
as the economy has been in recession and the government's fiscal
position has deteriorated. The decision to double (to 15 percent per
year) the rate of depreciation of the peso against the dollar in June
2001 was necessary in view of the deterioration in Uruguay's internal
and external economic situation; but, as a portent of troubles to come,
this did not ease concerns about the banking system or the rising
public debt ratio.
In spring 2002, the problems latent in Uruguay's economic and
financial situation began to deepen. Large outflows of bank deposits,
including substantial outflows by nonresidents, put downward pressure
on the exchange rate and rapidly ate into both the liquid foreign
assets held by public and private banks and the central bank's foreign
currency reserves. Facing huge reserve losses it soon became necessary
to allow the peso to float (for example, sink) against the dollar. By
late May, a new IMF mission was on its way to Uruguay with the
announced intention of
negotiating a substantial augmentation of IMF support. In mid-June,
Deputy Managing Director Eduardo Aninat announced that IMF management
would endorse an increase of IMF support for Uruguay of about $1.5
billion--bringing total committed IMF support to over 600 percent of
Uruguay's IMF quota, more than double the normal cumulative access
limit.
As most of the technical analysts suspected, even this large new
commitment of IMF support was not enough to contain Uruguay's deepening
crisis. In early August, IMF Managing Director Horst Kohler announced a
further augmentation of IMF support committed to Uruguay--this time,
about another $500 million. The World Bank and the Inter-American
Development Bank (IDB) would also chip in increases in their support,
bringing total official support committed to Uruguay to $3.8 billion,
or roughly one-fifth of Uruguay's GDP.
However, even at this stage, it is still unclear whether the large
amount of official support will be enough to enable Uruguay to resolve
its financial difficulties without a restructuring either of its public
debt or of the assets and liabilities of most of its banking system.
Indeed, despite repeated augmentations of its financial support, the
international community has never really faced up to the fundamental
questions of whether, and under what policies and conditions, Uruguay
can successfully emerge from its present crisis without a comprehensive
debt restructuring, or whether a comprehensive debt restructuring is
not, in fact, an essential part of the solution of Uruguay's
difficulties. Rather, the strategy seems to have been to throw more and
more money at the problem in the hope that it will go away--perhaps
with the recognition that what is a lot of money for Uruguay is not all
that much from the perspective of the international community.
In summary, my view is that the performance of the international
community in its efforts to assist Uruguay during the past 9 months
fell considerably short of the best that one might reasonably have
expected. Tiny Uruguay was facing a major potential financial crisis--
mainly reflecting contagion from Argentina. From the start, it was
clear that moderate levels of official support, within normal access
limits, would clearly not be adequate to forestall the crisis. Only
massive official support or a very painful restructuring of Uruguay's
public debt and financing system would do the job. The international
community, however, was not prepared to face up to this choice. It
dithered. As the crisis deepened, significant official support was
pledged, but not enough to be entirely convincing. The result has been
that large-scale support that might have been sufficient to resolve the
problem if fully
committed at the start has instead still left significant risk of
further troubles. Moreover, even with a record ratio of official
support to GDP, it is still unclear whether the strategy will work for
Uruguay, or whether a resolution involving comprehensive debt
restructuring might be either better than what has been done and/or
still necessary.
In the case of Brazil, I believe that the performance of the
international community has been much better, notwithstanding important
mistakes by the U.S. authorities. Recognizing that Brazil might suffer
adverse spillover effects from Argentina's crisis, a precautionary IMF
program was established in September 2001. Under this program, Brazil
progressively accumulated the right to draw up to about $15 billion of
IMF resources, under the condition that it maintain a responsible
fiscal policy (with a primary budget surplus of at least 3\1/2\ percent
of GDP). The objective was to reinforce confidence in Brazil's economic
policies both by supplying an important supplement to Brazil's own
foreign exchange reserves (of $30 billion to $40 billion) and by
providing the monitoring of an IMF program to help assure that critical
economic policies remained on track.
Nevertheless, there clearly remained a significant risk that a
financial crisis might beset Brazil. To demonstrate that this risk was
anticipated, not merely recognized in hindsight, I quote from my
International Economics Policy Brief on ``Prospects for the World
Economy: From Global Recession to Global Recovery,'' released as PB02-
02 by the Institute for International Economics in early April 2002.
``The major question for Latin America (aside from the
uncertainties about Argentina) is the likely performance of the
Brazilian economy--which accounts for 40 percent of Latin
America's GDP. . . . The key question for Brazil is whether
growth will reaccelerate as global growth recovers, or whether
uncertainties arising from the October elections and spillovers
from Argrentina may provoke a crisis of confidence in the
sustainability of Brazil's debt dynamics, leading to another
economic downturn.
``The fact is that, for an emerging-market country, Brazil has
a relatively high ratio of public debt to GDP. Most of this
debt is either quite short-term, has floating interest rates
that adjust rapidly to movements in short-term market rates, is
denominated in foreign currency, or has some combination of
these features. This implies that if for any reason (including
rising doubts about Brazil's ability to meet its debt service
obligations), interest rates on Brazilian debt rise or the
foreign exchange value of the real [Brazil's currency] falls,
Brazil's debt service burden and/or the ratio of debt to GDP
will rise--contributing to worries that debt dynamics may be
unsustainable. Moreover, Brazil has a relatively small share of
exports in GDP and, accordingly, is dependent on a continuing
inflow of foreign capital to finance a significant current
account deficit and also to finance a continuing rollover of
substantial foreign indebtedness. Thus, apart from possible
concerns about the stability of public sector debt dynamics,
there are also potential concerns about the financing of
Brazil's external payments. If confidence is lost in either of
these key areas, a crisis would likely ensue . . .
``As an optimist, I assume that the chances are three to one
that Brazil will navigate through the difficulties of 2002
without a crisis . . .''
Unfortunately, this optimism was short lived. During May, opinion
polls began to show a significant lead for the Worker's Party
presidential candidate, Luis Ignacio Lula da Silva (Lula) and
relatively weak support for the candidate of the ruling coalition, Jose
Serra. This provided a trigger for increased market concerns about what
might happen in Brazil after the election. The interest rate spread on
Brazilian Brady bonds, which had stood at about 700 basis points above
U.S. Treasuries in early April, began to rise and breached 1,000 basis
points in June. The real came under downward pressure as foreign
creditors began to cut back their Brazilian
exposures and Brazilians scrambled for foreign exchange to meet debt
service obligations and pay for the trade deficit.
During the summer, as Lula's poll results remained strong and
Serra's results generally weakened, the crisis deepened, with interest
rate spreads widening to 2,000 basis points and with the real sinking
to well beyond 3 to the dollar (versus about 2.3 to the dollar at the
start of the year). While shifting poll results clearly influenced
these developments, the true underlying cause was the vulnerability in
Brazil's public debt and external payments positions and the problem of
``multiple equilibrium'' that these vulnerabilities generated. John
Williamson, my colleague at the IIE presents a very useful and
insightful analysis of this problem in his International Economic
Policy Brief, ``Is Brazil Next?'' issued as PB02-07 by the Institute
for International Economics in August.
Under the general assumption that the Brazilian government
continues to run a responsible fiscal policy with a primary budget
surplus of 3\1/2\ to 4 percent of GDP, there are two possible outcomes
for Brazil's public debt dynamics: stable and un-
stable. If people believe that the debt dynamics are stable, then the
holders of Brazilian government debt (both domestic and foreign) will
probably be satisfied with real interest rates on this debt 7 to 8
percent. These would be very high real interest rates for an industrial
country like the United States, but in line with what real interest
rates have been in Brazil and in many other emerging market countries.
At this level of real interest rates, experience suggests that the
Brazilian economy can grow in line with its potential--a real GDP
growth rate of perhaps 4 percent. In this situation, starting with a
public debt to GDP ratio of 60 percent, a primary budget surplus of
3\1/2\ to 4 percent of GDP would be sufficient to put the debt to GDP
ratio on a downward path. Thus, confidence that public debt dynamics
are sustainable leads to the result that they will be sustainable.
On the other hand, if people believe that the Brazilian government
cannot successfully manage its finances without restructuring the
public debt, they will demand high real interest rates to compensate
for the risk of the losses they will take in the event of a
restructuring. At a real interest rate of 10 percent, with a debt to
GDP ratio of 60 percent and a real GDP growth rate of 4 percent, it
takes a primary budget surplus of 4 percent of GDP just to stabilize
the debt to GDP ratio. At real interest rates above 10 percent, public
debt dynamics are unstable (without an increase in the primary budget
surplus). Higher real interest rates also reduce the likely growth rate
of the Brazilian economy which worsens prospects for debt
sustainability. Most importantly, by making debt sustainability less
likely, higher real interest rates promote even higher real interest
rates in a vicious cycle. At present, interest rate spreads on Brazil's
external foreign currency debt imply real interest rates above 20
percent.\4\ There is no doubt that these interest rates embody a very
substantial premium for the risk that the Brazilian government may have
to restructure its debt. If in coming months confidence is not somehow
restored and interest rates are brought well down from present levels,
debt restructuring will become a self-fulfilling prophecy.
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\4\ Real interest rates on Brazil's internal debt are significantly
less than 20 percent. In particular, about half of the domestic debt is
denominated in domestic currency and bears interest at a rate directly
linked to the interbank overnight rate, the Selic rate. The Central
Bank has been holding the Selic rate at 18 percent. With inflation now
running at least 5 percent and probably headed upward, the real
interest rate on the Selic linked domestic debt is in the range of 10
to 12 percent. But, without the imposition and effective implementation
of stringent capital controls, the Central Bank will not be able to
keep the Selic rate down at 18 percent if market interest rate spreads
on Brazil's external dollar-denominated debt remain above 20 percent or
even 15 percent. Indeed, the Brazilian government is already
encountering difficulty in the auctions in which is seeks to roll over
its (relatively short-maturity) Selic-linked debt. Eventually, if
market determined real interest rates on Brazil's external debt remain
very high, domestic real interest rate will rise to meet them.
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Of course, the preferred outcome from this multiple equilibrium
situation would be for confidence in debt sustainability to produce
that result (assuming that the Brazilian government continues to
deliver a very responsible fiscal policy. John Williamson and many
others argue that this is the economically appropriate solution that
the market should either naturally seek this solution or be pushed
toward it. While I appreciate this position, I also tend to share the
skepticism of one of my other IIE colleagues, Morris Goldstein.\5\
While sometimes fickle, the market is not completely nuts. After
several years of large private capital inflows and official acclaim for
its economic policies, Argentina has recently defaulted on a large
volume of public debt. The situation in Brazil is in some respects
(relatively high public debt and a high ratio of external liabilities
to exports) similar to that in Argentina. And despite recent official
praise for Brazil's sound policies, the policy track record is not
entirely reassuring.
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\5\ Mr. Goldstein's analysis of Brazil's situation and the likely
need for a comprehensive debt restructuring were presented in a public
lecture, ``Is a Debt Crisis Looming in Brazil,'' at the Institute for
International Economics on June 22, 2002. The main points are
summarized in an op-ed column, ``Brazil's unwatched borrowing,'' in the
Financial Times, August 29, 2002.
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In particular, during the 8-year tenure of President Cardoso, the
net public debt to GDP ratio has risen from 30 percent to over 60
percent. In addition, the government has spent large privatization
revenues. Part of the increase in net public debt is explained by the
recognition of previous off-the-books losses or ``skeletons'' and,
especially recently, by the sharp increase in the domestic burden of
dollar-denominated or dollar-linked debt arising from the large
depreciation of the real. But not yet all of the skeletons have
emerged; and the choice that the Brazilian government made to issue
dollar-linked debt clearly involved substantial contingent liabilities
that are now being manifest at a particularly embarrassing time. Thus,
in Brazil, the market knows that it has something to worry about, and
sweet talk is not going to be enough to persuade it otherwise.
What has the international community done to help Brazil in its
deepening predicament? Having met the conditions for its September 2001
IMF program, in July, Brazil exercised its accumulated rights to draw
on IMF resources to the tune of about $14 billion. More importantly,
the IMF agreed to a new stand-by arrangement (formally approved and
announced on September 6, 2002) that committed about an additional $30
billion of IMF support to Brazil, subsequently supplemented by
additional commitments from the World Bank and the IDB. The new IMF
program provided only an additional $3 billion immediately and
committed another $3 billion for potential disbursement before year
end; and it reserved the remaining $24 billion for potential
disbursement during 2003, conditional on the new Brazilian government
maintaining responsible fiscal and monetary policies. The objective of
the new IMF program was two fold: to provide Brazil with some
additional resources to help meet near-term market pressures (mainly by
allowing Brazil to utilize an additional $10 billion of its own foreign
exchange reserves); and to help restore market confidence by assuring
significant additional IMF support based on continued sound policies.
Market reaction to the initial announcement of the new IMF program
(in August) was positive, but this lasted for barely a day. Markets
soon figured out that the new program had not significantly altered the
fundamentals of Brazil's economic and
financial situation nor the uncertainties associated with the upcoming
election.
Nevertheless, I believe that this new program was the right
approach in the circumstances. Unlike Argentina by the summer of 2001,
the situation in Brazil is not (yet) hopeless; and comprehensive
restructuring of Brazil's public debt and probably most of its private
debt is not (yet) inevitable. The Brazilian elections (which will
necessarily bring a change of government), however, are a critical
barrier to taking the key decisions about what strategy to adopt to
deal with Brazil's present predicament. The present Brazilian
government is unwilling to contemplate debt restructuring because it
sees it as unnecessary and highly destructive, and probably also
because it realizes that restructuring would signal the failure of the
policies of the past 8 years. On the other hand, the present Brazilian
government cannot credibly commit to policies that will remove the risk
of restructuring; the responsibility for the design and implementation
of such policies belongs to the next Brazilian government. That new
government will not be determined until the elections are finished.
Before the elections, no sensible candidate wants to contemplate and
certainly not talk about the possibility of a debt restructuring. And
it is very difficult to be specific and credible concerning policies
that may be needed to avoid restructuring when no one even wants to
admit that such a terrible thing is possible.
In this situation, delay of critical decisions until after the
Brazilian elections has been the only available and desirable option--
even if such delay came at the cost of a few more billions of Brazil's
dwindling foreign exchange reserves and some further shortening to the
maturity of the government's debt. Once the elections are over,
however, critical decisions will soon need to be made. In view of the
calendar for debt refinancing, this cannot wait until the start of the
2003 when the new Brazilian government formally takes power. Key
members of the new economic team will need to be designated before mid-
November. The new government-to-be will urgently need to begin to make
clear the main elements of its policy approach, and will also need to
begin to build political support to enact and implement the needed
policies--as it prepares to assume office. The first few months in
office then will become critical for establishing whether the new
government will be successful in putting its policies in place and what,
under these policies, Brazil's economic future will look like.
What are the relevant policy strategies for the new Brazilian
government and what role should the international community play in
supporting them? I believe that there are two distinct policy
strategies worth considering, with the middle ground between being
essentially untenable.
Unfortunately, the untenable middle ground appears to be what is
intended in the most recent IMF program for Brazil. As I understand it,
this program envisions a respectable policy effort that would keep the
primary budget surplus at just below 4 percent of GDP and maintain a
monetary policy targeted at keeping inflation in the low single digits.
There would be no effort to press the private sector, inside or outside
of Brazil, to do anything special to support the stabilization effort.
Official support would amount to the sums already committed by the IMF,
World Bank, and IDB. The problem is that the situation in one where
restoring market confidence is the critical issue. The market is
already well aware of existing IMF program, and the market clearly
judges it to be inadequate--not just marginally inadequate, but very
substantially inadequate. While it is possible that, after the
elections, for some unforeseeable reason, there would be a large
spontaneous recovery of market confidence, it seems foolhardy to base
Brazil's economic strategy on this thin hope. The result is likely to
be that after another $10 billion to $25 billion of official support is
disbursed to Brazil and frittered away in vain efforts to avoid
default, the collapse will come. Then, in a disorderly way, virtually
denuded of reserves and of international support, Brazil will undertake
a messier-than-necessary debt restructuring. Probably it will not be
quite as bad; but it will look much like Argentina all over again.
On one side of this untenable middle ground is a basic policy
strategy that recognizes that, because of highly negative market
sentiment and limited ability of the Brazilian government and the
international community to act sufficiently forcefully to substantially
improve this sentiment, comprehensive debt restructuring is practically
unavoidable. The effort would then be to manage this restructuring with
as little damage as possible. This would be no easy task. The
comprehensive debt restructuring would necessarily include both the
Brazilian government's external and internal debt. In addition, the
assets and liabilities of Brazil's financial system would probably need
to be restructured, as would most of Brazil's private external debt. To
accomplish all of this without profound damage to the Brazilian
economy, as well as to its Brazil's domestic and external creditors--as
has happened in Argentina, would be a daunting task.
To complete this task with minimum unnecessary damage to all
concerned will require continued sound fiscal and monetary policies.
Use of already committed official financial support would also be
important--but to help smooth out the inevitable difficulties of
comprehensive debt restructuring, rather than blow it away in further
futile efforts to delay a necessary restructuring. The result would
probably still be a sharp negative shock to the economy (and to the
government's public support); but if handled constructively, a
comprehensive debt restructuring need not necessarily lead to a
disaster of the magnitude of Argentina.
The other viable policy strategy is to adopt a vigorous, all-fronts
effort to create a situation where comprehensive debt restructuring is
not needed and clearly perceived as not needed. In my view, at a
minimum, this requires that the Brazilian government credibly commit to
fiscal policies that will raise the primary budget surplus to at least
5 percent of GDP (under reasonable economic assumptions) and maintain
the surplus at this level at least until the debt to GDP ratio declines
below 55 percent. A primary surplus of at least 4 percent of GDP should
be maintained at least until the debt to GDP ratio declines below 50
percent. [The first objective could be met quite rapidly if the
strategy is credible and appreciation of the real reduces the domestic
currency value of Brazil's dollar and dollar-linked debt.] The policy
strategy should also include responsible measures to persuade
Brazilians both that they should be satisfied with reasonable real
interest rates on the large volume of domestically held Brazilian
government debt and that they should refrain from large-scale capital
flight. Brazil's foreign creditors should also be officially
encouraged--in their own self-interest and as their essential
contribution to an ambitious stabilization effort--to behave
responsibly in maintaining and restoring their credit exposures to
creditworthy customers. For its part, the official international
community should pledge its continued financial support to Brazil--at a
higher level than has already been committed, and clearly conditioned
on stronger policy commitments from the Brazilian authorities and with
some meaningful measures to assure constructive behavior by the private
sector inside and outside Brazil.
How much additional official support might be contemplated? For a
truly strong and credible stabilization effort with a good chance of
success, it does not pay to be chintzy. Official support committed to
Uruguay (which may not be enough) is at 20 percent of GDP. If official
support for Turkey is augmented again next year (as I think likely),
that too will rise to about 20 percent of GDP. For Brazil, official
support at the level of 20 percent of GDP would amount to about $120
billion, somewhat more than double the substantial amount that has
already been committed to Brazil. This sounds like--and is--a very
large amount of money, reflecting the fact that Brazil has a large
economy. Arguably a more modest commitment of official support, around
$100 billion would be enough. However, in the business of large-scale
official support packages, a key point to remember is that moderately
large packages backing moderately strong programs tend to result in
moderately large disbursements and program failures. Large support
packages backing very strong programs are often not fully disbursed and
generally lead to success. As General MacArthur observed about war, in
the large package business, ``There is no substitute for victory.''
To be clear, I do not advocate war as the solution to all political
differences among nations. Nor do I advocate large official financing
packages as the answer to all potential and actual emerging market
financial crises--including the crisis presently unfolding in Brazil. I
raise the possibility of increasing official support for Brazil to the
range of $100 billion to $120 billion primarily to dramatize a key
point--directly relevant to the issues posed for this hearing. Consider
the established policy, backed by the implicitly present U.S.
Administration in the actions recently taken in the cases of a small
country, Uruguay, and a moderately large country, Turkey. Apply this
same policy consistently to a very large emerging market country,
Brazil. What do you get? A package of international support that is
truly enormous!
Would it be a good idea to proceed with such an enormous support
package for Brazil? Even someone who believes, as I do, that large
international support packages are appropriate in some circumstances
would be compelled to say, ``Better think long and hard before doing
that one.'' \6\ The general point is that similar careful thought
should go into all cases where the potential scale of official support,
relative to the size of the country, is quite large. The merits in all
of these cases need to be weighed carefully because they set the policy
of the international community. The approach adopted for a small
country where large official support relative to the size of the
country is comparatively modest in absolute terms sets a precedent for
the approach that should be followed, in principle, for a much larger
country where the absolute scale of official support could be enormous.
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\6\ IMF resources alone are probably not adequate to finance
commitments of another $40 billion to $60 billion to Brazil. Even for
the IMF's contribution, it would probably be necessary to activate the
New Agreements to Borrow (NAB) under which the IMF can borrow
additional resources from key members. Also, official bilateral
contribution would probably be needed to finance a large augmentation
of the package for Brazil. All of this, hopefully, would help to focus
the minds of those who control the IMF on what they are trying to do
and on the appropriate means for accomplishing it. The IMF should not
shield high officials from their responsibility.
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Consistent with the general policies that I believe should apply in
such cases, I would recommend that commitment of substantial additional
assistance to Brazil (or disbursement of much of the remainder of what
has already been committed) should be undertaken only under tight
conditionality. Specifically, the new Brazilian government must
prepared to commit to policies that raise substantially the likelihood
that comprehensive debt restructuring can be avoided. The acid test
that these policies be sufficiently forceful that they go a
considerable distance toward restoring confidence in financial markets
to a degree that induces a large reduction of interest rates without
which fiscal sustainability is impossible.
It is far from clear that the new Brazilian government will want
to, or be able to, undertake such policies. This would surely require
backing off from key campaign pledges like hikes in minimum wages and
large new public investment programs. It would require measures to cut
public spending and/or raise revenues that would undoubtedly face
fierce political opposition. But the only other viable strategy--which
will lead sooner or later to comprehensive debt restructuring--is also
surely no bed of roses. The new Brazilian government will have to make
some very tough choices--and quite quickly. Only if the government
decides to pursue policies that provide the essential basis for a
strategy that avoids comprehensive debt restructuring should the
international community entertain the possibility of supporting this
strategy with commitments of significant additional support. Brazil
must not be another case, like Argentina, where large official support
is disbursed and frittered away because the officials of the country
and the officials of the IMF and its leading shareholders are not
prepared to face up to reality and to their
responsibilities.
Moreover, the international community, and especially the IMF,
really cannot afford a big failure in Brazil. After the crises in Asia
and Russia and the debacle in Argentina, the credibility of, and public
support for, the IMF have been seriously damaged. Institutional
recovery after another big failure would probably be very
difficult.
Indeed, the IMF's own finances are a growing matter of concern. For
many years, there have been a few countries that have fallen into
prolonged arrears on their obligations to the IMF. But the total amount
of these arrears has remained relatively small. Now in the aftermath of
the Asian crisis, Indonesia is in a situation where it has a large
amount of IMF credit (about $8 billion) and where there is some
question about when it may be able to begin substantial net repayments
to the Fund. For Argentina (with about $14 billion of IMF credit
outstanding), the issue is more immediate--without an agreement on a
new IMF program which effectively rolls over most of the large payments
coming due during the next year, Argentina will probably be forced to
go into arrears to the IMF and to the World Bank and the IDB. For
Turkey, there is already a large volume of IMF credit outstanding, and
the amount appears likely to continue to increase for some time and
probably quite substantially. Where and when Turkey will get the
resources to begin substantial repayments to the IMF remains an
interesting question. For Uruguay, IMF credit already outstanding (now
about $1.5 billion) is not that large in absolute amount, but if
Uruguay became unable to make scheduled repayments to the IMF, this
alone would about double the amount of IMF credit that is now formally
in arrears.
If Brazil (which already has about $17 billion of IMF credit
outstanding) were to go the way of Argentina, there might well be
another large chunk of IMF lending that either goes into arrears or
needs new programs just to roll over obligations to the IMF. If Brazil
does follow this course, large further disbursements to Brazil in the
near future will only make the problem of the IMF's finances that much
worse.
In the long-run, I doubt that countries like Indonesia, Argentina,
Turkey, Uruguay, or Brazil will fail to repay their obligations to the
IMF. But there is still a rising risk that an important part of the
IMF's resources will be tied up with a few countries that are unable to
repay in a timely matter. This would seriously hamper the ability of
the IMF to respond to the needs of its other members and to play its
proper and intended role in the international monetary and financial
system. It would also contradict the letter and spirit of the IMF's
Articles of Agreement. Members' use of IMF resources is supposed to be
``temporary,'' and that IMF programs are supposed to contain adequate
safeguards to assure that use of the IMF's resources is, in fact,
temporary. If these principles are violated on a substantial scale,
then the IMF is not fulfilling its important responsibilities, and
those primarily responsible for its stewardship, both inside and
outside of the institution, are failing in their primary
responsibilities.
Sovereign Default and Debt Restructuring
One of the proposals for helping to deal with emerging market
financial crises that has recently received much attention is the
suggestion of creating a sovereign debt restructuring mechanism (SDRM)
through an amendment of the IMF's Articles of Agreement. A SDRM would
provide an internationally approved set of procedures for a sovereign
debtor in default (or potential default) on its obligations to reach an
agreement with its creditors to restructure its obligations in a manner
that would plausibly allow it to meet its new obligations while
treating its various creditors in a responsible manner. Under such an
SDRM, the existing rights of creditors to sue in national courts to
seek recovery of their claims would be suppressed (at least for some
period) and would be superseded by an agreement between a qualified
majority of creditors and the sovereign on a debt restructuring.
Anne Krueger, the First Deputy Managing Director of the IMF, has
been at the forefront of those suggesting that a SDRM is needed and
desirable. A good deal of work on this issue has now been done by the
IMF staff, which is reported on the IMF's website at www.imf.org. The
issue has been discussed by the IMF's Executive Board. At its meeting
on September 28, 2002, the IMF ministerial committee, The International
Monetary and Financial Committee, directed that work on this issue
should continue with the objective of examining specific proposals at
its meeting next April. The IMFC, however, has not endorsed the
establishment of a SDRM. Beyond ministerial endorsement, establishment
of a SDRM would require approval and ratification by members
representing 85 percent of the voting power of the IMF--including
formal ratification of an amendment to the Articles of Agreement by the
U.S. Congress
It is essential to understand that present proposals for a SDRM
would apply sovereign debt issued by all members of the IMF, but only
to debt of sovereigns issued under foreign law. Sovereign debt issue
under domestic law (which is the vast majority of sovereign debt,
particularly for industrial countries like the United States) would not
be covered. Official loans to sovereigns by other governments and by
the international financial institutions would be excluded from the
SDRM. The SDRM would also not apply to other (nondebt) obligations of
the sovereign whether contracted under domestic or foreign law. Also,
the SDRM would not apply to private debts or other contractual
obligations, whether within a country or across national boundaries,
regardless of the legal jurisdiction of the contract. These limitations
are vitally important because they clearly imply that there are many
important issues in typical emerging market crises that a SDRM does not
address at all.
Of course, one might consider a systemic restructuring mechanism
(SRM) that would address the restructuring of all of a country's
obligations, domestic and foreign, debt and nondebt, and public and
private, regardless of questions of legal jurisdiction. Such a
monstrosity, however, would be inconsistent with the most basic
principle of the present international order--the principle that
sovereign nations are responsible for the management of their own
internal affairs. When a sovereign and its creditors chose to write
their debt contracts subject to the law of another country, it is
reasonable for that other country and for the international community
to establish some rules for how defaults should be handled. It is quite
another thing for the international community to assert the right to
intervene in a sovereign's treatment of its domestic debt or into
disputes among private contracting parties. This would imply
extraordinary authority for the international community to intervene
into the economic, financial, and legal affairs of sovereign nations,
potentially including the overruling of national laws, court decisions,
and even provisions of national constitutions.\7\ Most countries would
rightly and strenuously object to such intrusions; and the
international community would be exceedingly unwise to consider any
mechanism that would systematically involve it in such intrusions. (As
my colleague on this panel, Professor Tarullo, is better qualified to
discuss this particular issue, I will leave further comment to him.)
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\7\ Under the conditionality associated with IMF programs,
countries are often required to undertake policies requiring
legislation or even constitutional modification. But an IMF program is
negotiated with a country's authorities who are free to reject the
program and its conditionality if they so choose. A SRM that applied
universally to IMF members, regardless of their wishes in individual
cases, would represent a much greater infringement of the principal of
national sovereignty.
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Arguably, a SDRM limited to the foreign-law debt of sovereigns
would improve on present procedures for resolving sovereign defaults.
Take the case of Argentina--which involves by far the largest default
by an emerging market sovereign on its foreign-law debt. Excluding
bonds held by Argentine institutions (where the legal status is
somewhat obscure), there the Argentine government has about $50 billion
(face value) of foreign-law bonds outstanding, spread over more than 80
separate issues, and at least 5 different legal jurisdictions. Some of
the bond issues have collective action clauses which allow a qualified
majority of bondholders to agree to a restructuring and impose its
terms on all holders of that issue. Many of the bonds, however, follow
U.S. legal practice and require that each bondholder preserves the
right to pursue legal action for collection unless he individually
agrees to a restructuring. Clearly, resolving Argentina's sovereign
default on its foreign-law debt will be a legal nightmare that is
likely to take many years to conclude.
If it were applicable to Argentina, a SDRM along the lines that has
been discussed within the IMF would help to cut through at important
part of this legal nightmare.\8\ Existing legal requirements would be
suppressed, and qualified majorities of the holders of all separate
bond issues would be able to agree to restruc-
turings of their particular issues. A qualified majority of the holders
of all the bonds would (through means that I do not entirely
understand) be able to agree to an overall restructuring. This would
still leave difficult problems of actually reaching agreement within
and between different groups of bondholders and between bondholders and
the sovereign. But individual bondholders and small groups of
bondholders would have much less latitude than at present to disrupt an
agreement and/or to stay out of an agreed restructuring in order to
pursue their claims independently.
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\8\ A newly created SDRM probably could not be applied on an ex-
post basis to Argentina. But consideration of how a SDRM would work in
this case is very useful for consideration of what a SDRM might
accomplish in cases where it would apply.
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Granted that a SDRM might proved helpful securing more orderly
restructurings of sovereign foreign-law bonds when they fall into
default, should creating a SDRM be a high order priority for reform of
the international financial system? I have been, and I remain, highly
skeptical. Whatever might be its advantages or disadvantages in
resolving sovereign defaults, there is no credible reason to believe
that a SDRM would meaningfully reduce either the likelihood of emerging
market financial crises or the severity of such crises when they occur.
Anyone who doubts the validity of this bold assertion should read
carefully the literature on the SDRM (especially that recently produced
at the IMF) to find the detailed analysis of how a SDRM would have
materially reduced the frequency and severity of the many emerging
market financial crises that we have seen in the past decade. There is
no such analysis. Instead, the sense of urgency for consideration of a
SDRM has been built on two concerns: (1) existing legal procedures do
not
provide an orderly and reliable means for resolving sovereign defaults
on their foreign-law bonds; and (2) there has been a lot of highly
damaging emerging market financial crises in recent years. But is there
any meaningful link between these concerns--a link that is absolutely
essential to establish an urgent case for a SDRM. A little reflection
on the facts clearly indicates that there is no such link.
Take the present crisis in Argentina. Among the major emerging
market financial crises of the past decade, this is the only case where
sovereign default on a large volume of foreign-law debt has actually
occurred. Undoubtedly Argentina is now undergoing a severe economic and
financial crisis. Real GDP is down 15 percent from its year ago level
and is down about 25 percent from its peak in 1998--the worst output
drop suffered by Argentina in this century and surely one of the worst
suffered in all of Latin America. But what has the default of the
Argentine sovereign on its foreign-law debt contributed to this
catastrophe? And what would a SDRM have done to lessen this damage? To
both questions the answer is--practically nothing. Default on Argentine
government debt held by Argentine banks has played some role in the
collapse of the Argentine banking system, but this debt has effectively
been transformed into domestic-law debt. As far as the sovereign's
foreign-law debt is concerned, the Argentine government has simply
stopped paying both the interest and the principal. Bondholders have
complained. A few have filed suits in European courts; but foreign
courts have not authorized seizures of Argentine assets. More
generally, actions by Argentina's disgruntled foreign bondholders have
simply not played any significant role in Argentina's present economic
disaster.
Down the road, of course, it is possible that difficulties in
restructuring Argentina's foreign-law debt will create problems for the
Argentine economy. When might these problems come and how severe might
they be? No one can know for sure, but experience and common sense
suggest that the problems probably will not come soon and, relative to
Argentina's present difficulties, will likely not be that severe. In
particular, the case that is cited as exemplary of the problems that
can arise in the absence of a SDRM is the case of Elliot Associates v.
Peru. In this case, many years after the Peruvian government had
defaulted on some foreign-law bonds, a hold-out creditor was able to
secure a court judgment enforcing payment under the original terms of
the debt contract. This cost the Peruvian government some money, but it
had no significant negative impact on the performance of the Peruvian
economy. The example of Elliot Associates may encourage hold-out
creditors in the case of Argentina; and this may delay and complicate
negotiations over debt restructuring and ultimately cost the Argentine
government some money. However, negotiations over debt restructuring
will probably drag out for some time in any event, and payments to
hold-out creditors are likely to be even further in the future--by
which time the Argentine economy will hopefully have enjoyed
substantial recovery.
Sovereign defaults on foreign-law debt have also occurred recently
for some
smaller emerging market economies, notably Ecuador and Ukraine; and
Pakistan has recently restructured much of it foreign-law debt. I am
not an expert on these cases, but my general impression is that
restructuring has proceeded relatively smoothly, despite the absence of
a SDRM. A much larger and more complicated sovereign default, such as
that of Argentina, might ultimately prove much more difficult to
resolve. But, so far, the fears about the extreme difficulties of
sovereign debt restructuring in the absence of a SDRM, and especially
about the great damage likely to be done to the countries involved,
have not proved to be well founded.
Looking to the major emerging market crises of the past decade,
other than the present crisis in Argentina, sovereign default on
foreign-law debt simply did not play a significant role.\9\
Specifically, in the Mexican crisis of 1995, the main problem was an
overvalued exchange rate and difficulties in rolling over the tesobonos
(domestic-law debt) and international credit lines to Mexican banks
(private debts). In the Argentine crisis of 1995, sovereign default was
not a serious risk. In Thailand's crisis of 1997-1998, the problem was
an overvalued exchange rate and actual or
potential defaults on foreign credits extended to Thai financial
institutions and corporations. In Indonesian, the problem was credits
extended to Indonesian corporations by both foreign and domestic
financial institutions. In Korea, the problem was an over-leveraged
domestic corporate sector, weak banks, and international credits to
Korean financial institutions. In Russia in 1998, lack of fiscal
discipline led ultimately to default on the government's GKO's--
domestic-law debt denominated in domestic currency--as well as
widespread default by Russian banks on foreign-currency hedge
contracts. In Brazil in 1998 -1999, doubts arose about fiscal
sustainability, but default on the sovereign's (mainly domestic-law)
debt was avoided. In Turkey since early 2001, there have been questions
about debt sustainability for the government and the banking system;
but most of the debt in question is domestic-law and/or private. The
growing volume of official debt of Turkey, mainly to the IMF, would not
be subject to a SDRM. In Brazil at present, there are worries both
about fiscal sustainability and about external payments viability; but
most government debt is domestic, and most external debt is private. In
Uruguay at present (if this is considered a ``major'' emerging market
financial crisis), there are concerns about the sustainability of the
public debt, which is mainly domestic-law debt; as well as with the
stability of the domestic banking system which has a large volume of
foreign-currency denominated liabilities. Thus, in all of these cases,
it is hard to see that if a SDRM had been available it would have done
much good; certainly it would not have been a magic bullet that would
have avoided a crisis or substantially diminished its severity.
---------------------------------------------------------------------------
\9\ In arguing that a SDRM would probably be of limited practical
use, Edwin Truman, my colleague at the IIE, has emphasized that most of
the large emerging market financial crises have not involved sovereign
default of foreign-law debt as a major issue.
---------------------------------------------------------------------------
Even if a SDRM would do little good in dealing with potential or
actual emerging market financial crises, if it might occasionally do
some good, is there reason to oppose it? Might it also do significant
harm? There is at least some reason to be concerned with this
possibility. Those who are most directly concerned foreign-law debt of
emerging market sovereigns--the issuers of such debt, the investors in
such debt, and the underwriters and brokers of such debt--generally
oppose a SDRM. The issuers fear that their borrowing costs will go up
because investor will demand higher rates to compensate for increased
risks of losses from defaults under a SDRM. Investors object because
they fear that their rights to recover when a sovereign defaults will
be compromised and eroded by a SDRM. (Indeed, some are so fearful that
they have chosen to embrace the more modest proposal of requiring
collective action clauses in all emerging market debt issues--provided
that the ``nuclear option'' of a SDRM is abandoned.) The market makers
fear that the volume and profitability of their business will decline
under a SDRM. They may well all be right.
The argument on the other side is that market for foreign-law
sovereign debt presently benefits from an implicit subsidy that leads
to too much issuance of such debt, too much investment in such debt,
and too much dealing in such debt. The implicit subsidy comes from the
expectation that, if default threatens, the international community
will step in with large packages of official support that will, to some
meaningful extent, shield both the borrower and the investor from
losses to which they otherwise would rightly have been subjected.
Indeed, the principal supporters of proposals for a SDRM include
particularly officials from those governments that are the major
suppliers of the financing in official support packages. Many of these
officials believe that there are huge problems of moral hazard arising
from large official support packages, and they see a SDRM as a
desirable innovation to help cut back on such packages.
On this controversy, I have a relatively neutral position--both
sides are wrong. The fears that the market for emerging market
sovereign debt will be destroyed by a reasonably structured SDRM are
probably exaggerated. Indeed, it is possible that a well-structured and
competently implemented SDRM might improve the functioning of the
market to the mutual benefit of issuers, investors, and dealers. On the
other hand, concerns about substantial moral hazard arising from
(properly implemented) international support packages have no
analytical or factual foundation.\10\ And, as previously discussed, a
SDRM would have little practical relevance to most emerging market
financial crisis.
---------------------------------------------------------------------------
\10\ The assertion that there is a substantial problem of moral
hazard arising from large international support packages is often
advanced with great vehemence and conviction (for example, in the
majority report of the Meltzer Commission), but little evidence or
rigorous analysis has been presented to back this assertion. Instead,
like a principle of religious faith, proof is supplied primarily by
loud and repeated incantation. Those who have analyzed the issue
carefully generally conclude that this asserted problem of moral
hazard, while not entirely bogus, has been much exaggerated. See, in
particular, O. Jeanne and J. Zettelmeyer, ``International Bailouts,
Moral Hazard, and Conditionality,'' Economic Policy, 33, October 2001,
pp. 409 -431. I have also examined this issue quite extensively; see
Mussa, et. al., ``Moderating Fluctuations in Capital Flows to Emerging
Market Economies, in P. Kenen and A. Swoboda (eds.), Reforming the
International Monetary and Financial System, International Monetary
Fund: Washington, DC, 2000, pp. 75-142; M. Mussa, ``Reforming the
International Financial Architecture: Limiting Moral Hazard and
Containing Real Hazard'' in D. Gruen and L. Gower (eds.) Capital Blows
and the International Financial System, Australia: McMillan Publishing
Group, pp. 216 -236; and M. Mussa, ``Reflections on Moral Hazard and
Private Sector Involvement in the Resolution of Emerging Market
Financial Crises,'' paper presented to a conference at the Bank of
England, July 2002.
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What then should be done about a SDRM? For the present, I would
recommend that it continue to be studied; but for two reasons, I would
oppose its implementation. First, there is the general conservative
principle that it is generally unwise to adopt potentially important
innovations when a clear need for them has not been demonstrated and
when the possible advantages and disadvantages are not well understood.
The fact is that a SDRM would have done little to help reduce the
likelihood or severity of past emerging market financial crises. There
is no reason to believe that a SDRM is urgently needed now.
Second, there is what I refer to as the ``Elmer'' principle. Elmer
was the cat we had when I was a child about 50 years ago. For a feline,
Elmer had a particularly affectionate and docile disposition--except
when confronting other male cats, when he exhibited extreme hostility
and aggression. In dealing with this latter problem, my father wisely
advised, ``It is usually a mistake to try to referee a cat fight. You
are likely to be scratched and bitten; and your intervention is
generally not appreciated by the principal participants.''
A sovereign default on its foreign-law debt creates a situation
analogous to an enormous cat fight--only involving batteries of lawyers
in addition to the primary participants. The interests of the debtor
conflict with those of creditors as the debtor strives to pay less and
creditors seek to collect more. The interests of different creditors
conflict as each attempts to maximize his own return. The interests of
other claimants on the sovereign resources (including holders of
domestic-law debt) also come seriously into play; the more they get,
the less is available for holders of the sovereign's foreign-law debt.
At present, the international community stands largely aloof from
the fray, leaving it to the contending parties to work things out as
best they can.\11\ Under a SDRM, the international community would
become a referee of the conflict--at least as far as establishing and
attempting to enforce some general guidelines concerning the resolution
of differences between the sovereign and holders of its foreign-law
debt. Rightly or wrongly, the international community is likely to be
accused by all parties of failing to treat their interests fairly, and
is likely to be called upon by all parties to use its authority to
support their particular interests. And even if the international
community could somehow determine what a ``fair'' resolution was, it
would probably be unable to enforce it on all relevant parties--perhaps
especially on the sovereign in default and on some of the domestic
claimants on the sovereign's resources. It seems to me that the masters
of the affairs of the international community would want to think long
and hard before embarking of such a hazardous and probably thankless
venture.
---------------------------------------------------------------------------
\11\ The IMF's policy of ``lending into arrears'' does imply modest
official sector involvement in the resolution of sovereign defaults on
external debt--just as did the earlier IMF policy of not lending into
arrears. Under the present policy, the IMF will, in some circumstances,
lend to a country that is in default on its obligations to private
external creditors--provided that the sovereign is making reasonable
efforts to resolve the situation. This policy presumably gives the
sovereign a little more leverage versus his creditors than did the
earlier policy of not lending into arrears (which tended to give a
little more leverage to creditors). The IMF's judgment about what
constitutes a reasonable effort, however, is not intended to be used to
influence in any detailed way how disputes between sovereigns and their
external private creditors are resolved.
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PREPARED STATEMENT OF SCOTT A. OTTEMAN
Director of International Trade Policy
National Association of Manufacturers
October 16, 2002
I am Scott Otteman, Director of International Trade Policy at the
National Association of Manufacturers (NAM). The NAM is an organization
of 14,000 member firms--10,000 of which are small or medium-sized. Our
members produce the vast bulk of U.S. manufactured goods and are world
leaders in productivity and product quality.
I am pleased to be here this morning to discuss the financial and
economic situation in Latin America and to present the NAM's views on
how this affects American business, American jobs, and the U.S.
economy. We can look at the relationship from three perspectives: (1)
trade--the exports and imports of goods and services; (2) investment--
the direct participation of United States firms in Latin American
economies; and (3) the effect that financial instability in Latin
America might have in terms of a spillover to the broader global
economy. While the first two aspects are of considerable significance,
it is the third aspect that is probably of the greatest concern to the
business community.
The United States-Latin American Commercial Relationship
To begin with, Mr. Chairman, I think it is useful to review the
size of the United States-Latin American economic relationship. It is
an important relationship for the U.S. economy, but it is especially
critical for the Latin American countries' economies. For purposes of
my testimony, Mr. Chairman, today I am going speak only of the
countries in South and Central America. Mexico, while sharing language
and cultural heritage with the rest of Latin America, over the past 10
years has been integrating its economy with North America through the
North American Free Trade Agreement (NAFTA). As a result, Mexico's
economy is increasingly insulated from economic winds that may affect
Central and South America.
United States exports to Central and South America last year were
almost $60 billion, about 8 percent of United States exports to the
world. Imports from the region were $67 billion last year, about 6
percent of our global imports.
Fully 88 percent of our exports to Central and South America are
concentrated in manufactured goods, including computers, aircraft,
turbines, plastics, and a broad range of machinery and electrical
machinery. Petroleum is our largest import from the region, accounting
for about one-third of the total. Apparel is our second largest import
from Central and South America, followed by a range of manufactured
goods, agricultural products, and raw materials. Our imports are
changing in the direction of more manufactured goods, as is seen in the
fact that our largest imports from Brazil have become commercial jet
aircraft and electrical machinery.
United States foreign direct investment in South America, both
overall and in manufacturing, is about 6 percent of worldwide United
States direct investment. In 2001, the value of United States
investments in South America stood at $83 billion, with $36 billion
invested in Brazil and $18 billion in Argentina--the two largest South
American recipients of United States direct investment.
The Effect of Financial Instability
Argentina's economic and political crisis and its limited spillover
effects to its neighbors have immediately affected United States
companies in two ways--via a dramatic decline in United States exports
to South America and by substantially worsening the conditions for
doing business faced by United States firms operating in the region.
Among the companies based in the region, clearly the hardest hit are
those based in Argentina itself, though there are trade effects that
have also impacted the business environment in neighboring countries.
Exports
United States exports to Central and South America so far this year
have fallen 16 percent from the same period a year ago. The three
largest proportional declines were to Argentina, Uruguay, and Brazil.
Table 1, attached to my statement, shows the changes in United States
exports to all countries in the region.
United States exports to Argentina have plummeted a stunning 67
percent--dropping from an annual rate of $4.5 billion to $1.5 billion--
a $3 billion fall. Exports to Argentina face a triple-whammy: (1) very
low demand due to 4 years of recession/depression in that country; (2)
a huge competitive disadvantage due to the 70 percent devaluation of
the Argentine peso, which makes foreign imports much more expensive
than similar domestic goods; and (3) foreign-exchange curbs imposed by
Argentine authorities to improve the country's current account balance.
Exports to Uruguay have fallen 53 percent, though because Uruguay
is a much smaller market, the dollar decline was only $240 million.
United States exports to Brazil have dropped 26 percent, from an annual
rate of $16.5 billion to $12.2 billion--a $4.3 billion fall.
As a rough rule of thumb, the Commerce Department estimates each $1
billion of exports supports approximately 12,500 jobs. This implies
that the export losses over the last year to Argentina, Brazil, and
Uruguay may have impacted possibly over 90,000 American jobs.
The declines in United States exports to Argentina and Brazil are
in line with the decline in these countries' overall imports from the
world. For example, Argentina's global imports so far this year have
fallen 63 percent--meaning they are only about one-third as large as
they were last year. Brazil's total imports have fallen about 23
percent.
Investment/In-Country Operations
U.S. investment in the economies of these countries has been
sharply affected as well. United States balance of payments data show,
in fact, declining investments to South America, concentrated in
Argentina and Brazil. Income on United States investments has
plummeted. United States foreign direct investments in Argentina have
lost $2 billion in the last 9 months.
Logically, those United States businesses with operations in
Argentina are the ones that have been most severely impacted by that
country's financial crisis. In responding to the crisis, the Argentine
government has forced the conversion of dollar-denominated payments to
local currency-denominated payments at a one to one ratio, when the
real market exchange rate is closer to one to four (so-called
``pesification''). This step alone has slashed the anticipated income
stream of U.S. subsidiaries invested locally by 75 percent and made
severely undermined the value of many of the underlying assets. At the
same time, efforts to recoup these losses by seeking higher prices or
charging higher rates for services have been in many cases forbidden,
putting many companies--foreign and domestic--in an untenable position
and causing many local bankruptcies.
Non-payment of contracts is perhaps the biggest fallout from the
crisis for those on the ground in Argentina; it has sapped business
confidence and resulted in suppliers demanding upfront payment rather
than accepting credit. United States firms in Argentina are finding
that even peso-denominated debts are often not being paid by bankrupt
or near-bankrupt customers.
United States subsidiaries have been undermined further by a series
of measures the Argentine government or legislature has taken to
attempt to preserve foreign exchange reserves. This includes the
institution of an export tax on a nearly across-the-board basis. For
companies that are export-focused, as are many United States operations
in Argentina, this new tax partially or wholly undermines the renewed
competitiveness won at the altar of the devalued peso. Needless to say,
this new tax, imposed as a last resort to raise hard currency, comes at
a time of tremendous weakness for most firms.
In addition, the crisis has led the government to impose import
controls, limiting the expenditure of dollars on critical inputs needed
to sustain or augment production. For example, some U.S. agribusiness
firms--which otherwise have good prospects for renewed growth because
of the devaluation-related potential for increased exports--find their
ability to take full advantage to be hampered by a lack of access to
key inputs, such as seed, fertilizer, and farm equipment.
Furthermore, even companies with dollar reserves are missing debt
payments denominated in dollars because the Ministry of the Economy
must grant permission for such transactions.
Add to these costly measures the understandable worker
disgruntlement and the heightened kidnapping and security threats faced
by business executives and their families as a result of the drop-off
of more than half the Argentine population below the poverty line, and
you see that United States companies--along with others--face a very
challenging business environment in Argentina today.
Intraregional Trade
Argentina's problems have also affected United States companies'
operations in neighboring countries, though clearly to a lesser extent
than those based in Argentina itself. The impact has occurred primarily
because of lost trade due to the collapse of sales to Argentina, which
had been a significant portion of sales for many export-focused
companies in an increasingly integrated South America.
A broader ``contagion'' effect--with severe pressure on the
domestic currency and the banking system, as foreign and domestic
investors rush for the exits--has also been seen in Uruguay. But in the
case of Brazil, our understanding is that most financial experts
attribute the recent pressure on the Brazilian currency to uncertainty
surrounding the outcome of Brazil's current presidential elections and
the new government's possible economic team and policies rather than to
fallout from Argentina.
The United Nations' Economic Commission for Latin America and the
Caribbean (ECLAC) has done some estimates of the decline in
intraregional trade in South America due to Argentina's economic
problems. ECLAC says Argentina's imports from its neighbors are
expected to tumble from $6.5 billion in 2001 to $2.2 billion this year.
Uruguay has been hit the hardest, with its goods exports to Argentina
falling 70 percent in the first 4 months of 2002 compared to the same
period in 2001. Brazil has also seen its merchandise exports to
Argentina slide dramatically. Argentina accounted for 11 percent of
Brazil's exports in 2000, but now only account for 4 percent. The 62
percent decline in Brazil's exports to Argentina so far this year is
equivalent to an overall decline of 7 percent in Brazil's total
exports. United States companies' Brazilian and Uruguayan operations
are among the firms suffering from these trends.
Political Impact
Perhaps the longer-term danger for United States business and for
the interests of Latin America and the United States in the Western
Hemisphere is the emerging perception among the people and politicians
of the region that financial crisis and
economic stagnation are somehow caused by free-market reforms. Over the
past 15 years, newly democratic Latin American governments made
tremendous strides in opening their highly regulated, over-protected
economies--controlling inflation, attracting foreign investment,
privatizing state enterprises, and lowering trade barriers. Until 1997,
these reforms yielded substantial though uneven growth. It seemed only
a matter of time before the open-market policies known as the
``Washington Consensus'' would deliver on the promise of broader
prosperity across the region. Over the last few years, however, growth
has slowed, and recurring financial instability has continued to be a
major problem. Increasingly, leading actors on the Latin American
political scene are raising questions about the free-market model's
ability to provide sustainable economic growth and development.
The collapse of Argentina, whose governments in the 1990's were
viewed throughout Latin America as among the most aggressive
implementers of open market
reforms, threatens to further inflame protectionism and antireform
sentiments in the Americas. Attributing Argentina's current predicament
to ``outside forces'' or globalization per se may be a popular way to
win votes, but it cannot restore confidence or form the basis for a
reactivation program that allows one to actually
govern and deliver sustainable results to society.
In our view, any attempt to turn back the clock by returning to
policies aimed at substituting inefficient domestic production for
competitive imports or rolling back other reforms would be a costly and
disastrous mistake. Although some of the reforms of the late 1980's and
1990's could have been carried out more gracefully--perhaps at a
different pace, or in a different sequence--the main problem is that
the reform process has not advanced deeply enough. Rather than return
to the past, Latin America needs to continue opening its economy to
trade and investment. The so-called ``first generation'' reforms I
mentioned earlier need to be complemented with ``second generation''
reforms that promote respect for the rule of law (judicial reform), tax
reform, labor market mobility, limits on government spending,
educational reform, and sensible regulatory regimes. No amount of
populist rhetoric can alter this reality.
An Even Bigger Concern: Brazil's Future Policies
If financial collapse were to spread to Brazil--either because of
contagion from Argentina, uncertainty provoked by the new Brazilian
government's economic and
financial policies, or some combination--the potential negative impact
on United States business would be vastly enlarged. Some 400 of the
United States Fortune 500 companies have operations in Brazil, which
continues to be South America's most dynamic economy and the eighth
largest economy in the world. A Brazilian financial disaster such as
Argentina would not only undercut the operations of United States firms
invested and trading in Brazil, it could spread investor panic and
depress growth prospects throughout Latin America and perhaps the rest
of the developing world, similar to what we saw initially with Mexico
in 1994 and with Asia in 1997. I want to underscore that, in my
opinion, we are far from this scenario, which is one that certainly can
and must be avoided.
U.S. policy and the international financial community have
important roles to play in avoiding this type of disaster. I will leave
it to the financial experts to make recommendations to the U.S.
Government and international financial institutions. However, the
experience of NAM member companies as international traders and
investors leads us to believe that the most critical role in avoiding
such a crisis inevitably falls to the Brazilians themselves. Regardless
of who wins the October 27 run-off, the new Brazilian President can do
much to allay (or enhance) the uncertainties found in financial and
business circles today. Here are a few suggestions:
Appoint an experienced economic team that understands
international finance and recognizes the importance to Brazil's
future of deeper and broader integration into the world economy.
Make clear that the new Brazilian government will honor its
international debt and other obligations.
Reaffirm Brazil's commitment to successfully negotiating a
Free Trade Area of the Americas by no later than 2005, as President
Cardoso pledged, along with 33 other Western Hemisphere leaders, in
1994.
Take the lead among Latin American nations in insisting that
the FTAA include chapters or provisions that fully protect foreign
investors, fully respect and
enforce intellectual property rights, expedite shipments through
customs, and guarantee transparent, nondiscriminatory competition
for government contracts. (Naturally, Brazil should seek to
negotiate an FTAA agreement that is strongly in its interest, just
as United States officials are doing to promote the achievement of
United States interests. But the important thing is that the
incoming Brazilian authorities make it plain that, contrary to
their campaign rhetoric, they recognize the FTAA is essential for
Brazil's future.)
In the cases of Argentina, Uruguay, and Brazil, one of the most
important things that must be restored is confidence. Investors, both
local and foreign, must become confident that government officials and
international institutions can stabilize the situation and ensure the
preconditions for resumption of growth. Local residents will not bring
their savings back to their countries and foreign investors will not
resume investing until they believe their capital will be safe.
Looking to the Future
Once the immediate threat of financial crisis is overcome, there
are additional steps that must be taken to achieve the stable,
democratic, and prosperous Western Hemisphere that should be the
ultimate objective of U.S. foreign policy. In particular, I would call
your attention to the need to advance several initiatives that aim to
bring about a stronger rules-based system with improved adherence to
the rule of law and to practices of good governance.
The most important step would be for Latin American governments,
including Brazil as I mentioned earlier, to reiterate their support for
the Free Trade Area of the Americas (FTAA) negotiations and urge that
the agreement be concluded as quickly as possible. Prior to the United
States Congress' approval of Trade Promotion Authority earlier this
session, Latin American and Caribbean governments could legitimately
question the United States' commitment to completing the FTAA. That is
no longer the case, and with the United States prepared to issue its
initial FTAA market access offers as early as this December, the ball
is now in the Latin Americans' court. A clear signal from governments
throughout the region that they want to negotiate seriously and
expeditiously would have a strong positive impact on investors, for
embracing the FTAA means that governments intend to face the future
with a better and more transparent set of rules that will govern not
just trade, but also investment and commercial practices. And more than
anything else, embracing the FTAA demonstrates that governments intend
their countries to be open markets--open internally and open to trade.
In this regard, it is instructive to recall the experience of
Mexico in its two economic crises of the early 1980's and the mid-
1990's. In the 1982 debt crisis, Mexico nationalized its banking
system, curbed imports, and took other steps that scared off domestic
and international investors. As a result, Mexico was not able to regain
access to international financial markets for 7 years, and it suffered
through the so-called ``lost decade'' of stagnant growth and deepened
poverty. But in the 1994 peso crisis, Mexico was constrained by its
membership in the General Agreement on Tariffs & Trade (now the WTO)
and the NAFTA agreement from adopting similar antimarket, populist
measures. After some initial financial miscalculations, Mexico took
remedial measures in 1994 and 1995 that were market-sensitive and gave
investors confidence in the economy. Though a deep downturn resulted,
its length was limited, and a catastrophe was averted. Mexico regained
access to international financing in just 7 months.
Today, as we approach NAFTA's tenth anniversary, investors have
many fewer fears about Mexico's future. Even though Mexico is suffering
a mild economic downturn linked to its relative dependence on the soft
United States market, investors remain confident because of its NAFTA
obligations and because of the economic and political reforms that have
been carried out during the NAFTA years. The same can happen in South
American countries, where, in many instances, similar levels of
confidence are now absent.
Chile's experience is also instructive. Chile is arguably the most
open economy in South America. Its economic and trade reforms have led
to the most rapid rate of economic growth in the continent and to an
extremely high degree of investor confidence. This confidence is one of
the reasons that Chile received an astonishing 70 percent of all new
United States foreign direct investment directed toward South America
last year.
Additionally, the Inter-American Convention Against Corruption
should be rigorously implemented by all countries in the Western
Hemisphere. The United States has long been a leader in the fight
against corruption in world markets, starting with the Foreign Corrupt
Practices Act of 1977. I recognize that the scandals of the past year
demonstrate that no nation has its hands completely clean when it comes
to corporate corruption. But the United States nonetheless has led, and
must continue to lead, this fight throughout the hemisphere, because
bribery distorts economies and corruption eradicates faith in governments
and economic systems. Corruption undermines social values and democracy,
and leads to massive diversion of scarce economic resources away from
intended purposes. It retards economic growth and discourages foreign
investment. Adherence to the convention, and the establishment of
transparency measures for government procurement, would do much to help
reestablish the confidence that domestic and foreign investors need.
Conclusion
Along with local businesses and companies around the world that do
business with South America, United States firms are clearly being
impacted by the economic downturn in South America. This includes both
United States exports to the region and United States company
production and other business operations in South America. As is
evident in the available data, as well as in the anecdotal information,
the effect is very marked--especially with respect to Argentina.
U.S. businesses and their employees, of course, want to see a
restoration of stability and a return to economic growth just as
quickly as possible. American firms are good corporate citizens of the
countries in which they operate, and are concerned not just for their
own operations but also for the conditions facing the people in those
countries. The economic catastrophe in Argentina has brought with it a
particularly tragic cost in terms of people's lives and their
aspirations for the future.
It is our sincere hope that the U.S. Government, the international
financial institutions, and other governments in the Western Hemisphere
can learn from the lessons of the past and work together to promote
policies that not only avoid repeating such tragedies in the future,
but also lay the groundwork for broadening prosperity throughout the
Americas.
Thank you.