Post-Crisis World Economic Development: Lessons Learned and Thoughts for Reform
FOR IMMEDIATE RELEASE September 21, 1999
World Economic Development Congress
It is a pleasure to address the World Economic Development Congress again. Last year when I spoke to you, we were in the thick of the global financial crisis. At that time, I spoke about the causes underlying the crisis, and what all of us — including export credit agencies (ECAs), such as the Export-Import Bank — could do to address them.
How quickly circumstances changed during the past year! This was an extraordinary year, and I am reminded of how dangerous it is to make predictions. The emerging markets are re-emerging much faster than expected. Yet, all the problems we discussed last year — crony capitalism, the lack of transparency, and the absence of a fair and effective rule of law — have not gone away just because equity markets and currencies have rallied. I would like to talk with you today about where we have come and where we are going in the future. The crisis was never as bad as some thought a year ago, nor are conditions as good today as some may think. The recovery did not resolve many problems.In short, the pace of recovery has far exceeded the pace of reform.
Today, I want to place the crisis in the perspective of what we have learned that needs to be done, what we are doing about it now, and what needs to be done in the future. Based on 40 years` experience in finance, I believe a historical perspective is useful. Consider the American economy earlier this century. The Great Depression caused many observers to criticize the more questionable practices of early 20th century finance, and to call for legal and regulatory reforms. The American government instituted reforms, which made America`s markets trusted and secure enough to help our country achieve decades of sustainable growth and make us the leader in the world`s economy. Those markets have attracted so much capital in the U.S. and have played a significant role in the extraordinary economic results of the past decade. But we must remember that this did not happen overnight, nor was there immediate consensus on the new regulations, nor acceptance of the new institutions that enforced them. The U.S. regulatory and legal structure took years, even decades to develop. We should not think it will be otherwise anywhere else.
In the rush to invest in newly opened markets around the world, it was understandable, if naive, to have expected that these countries and their economies would have been able to develop so quickly, not only the institutions, but the societal norms that govern business practices in established and well-regulated western nations. Practically speaking, the headlong rush to privatize in many developing countries in the 1990s occurred much too rapidly for the countries to pass and implement laws to manage privatization or to have the necessary experience to deal responsibly with open markets. In the wake of the events of the past year, we have learned this lesson. But we will continue to be naive if we now fail to recognize that in many cases the roots of the problems lie not only in a lack of time or experience, but are the result of a pre-existing culture of government-business relations replete with cronyism, corruption and conflicts-of-interest.
Since I will draw on a few examples from Ex-Im Bank`s recent experience, I would like to give you some background about the Bank. Our mission is to support U.S. exports to the developing world. We are 65 years old, and we have supported $400 billion of U.S. exports. This year, we will do a little more than $15 billion, and it would not be impossible for us to support $20 billion of exports next year.
Today we can all see where the problems lie; and we can analyze, criticize and recommend. But ultimately, the authority and responsibility for establishing the sound, transparent and effective financial and legal structures lies with the governments and major economic interests in these countries. They have to recognize that the long-term well-being of their economies depends on their commitment to this goal.
Let me share three quick illustrations with you. The first, Thai Petrochemical Industries is a good example of the problems caused when businesses refuse to conform to international standards. This family-owned company, which faced $3.2 billion in debts to restructure after the baht was devalued in 1997, not only fought restructuring but was determined to withhold vital information—including its account books—from the creditors trying to help it restructure its debt. Its controlling shareholder went even further, using his position in the Thai parliament to try to weaken the new bankruptcy and foreclosure law. Ex-Im Bank fought for creditor rights, and there is now a workout in place. So, the outcome of this case is a modest success. But the very fact that the creditors had to wage this battle and that the company tried to use its political influence to corrupt the entire reform of bankruptcy and foreclosure laws, indicates the depth of the problem and how far there is to go.
An even more dramatic example was the near-death experience of the Philippines` flagship airline, which again demonstrated how Asia`s relationship-oriented business practices continue to triumph over market principles and the rule of law. Ever since Philippines Airlines announced last year that it was suspending payments of is debts due to huge losses exacerbated by the crisis, Ex-Im Bank and other creditors owed $2.3 billion have tried to assert their rights. While there is now a settlement agreement in place, the fact is that throughout the process Philippine authorities have done more to protect the airline`s well-connected owner than to honor creditors` contractual and due process rights. It demonstrates how far the country still has to go to establish a business environment in which foreign investors may have confidence.
One final illustration is from Indonesia, where we saw some progress being made in establishing regulatory authorities. We were encouraged by the establishment of IBRA, the new bank restructuring agency. However, in the case of a company we were involved with called Cibinong, a cement business, we learned after 16 months of discussions that $240 million of the firm`s audited cash balances no longer existed. IBRA has yet to audit Cibinong or replace its directors, and I have written to President Habibie on this matter.
But we do not have to focus only on instances of cronyism and corruption to see the detrimental effect the lack of reform can have on developing economies. The power sector in Asia offers a good case study of how the glacial pace of reform hinders economic development. In the mid-1900s, when East Asian economies were registering 8 to 10 percent annual growth, and investor funds were pouring in, private power financing boomed. In 1996 alone, there was a larger volume of projects in the developing world financed than the cumulative total of all the years preceding 1994. The world`s six largest power project-finance markets between 1994 and 1996 were all in Asia.
The crisis that began in July 1997 has revealed many problems in the Asian economies that have failed to undertake either macroeconomic, technical and/or financial reforms of public-sector power companies so that they could evolve into commercially viable, private entities. Whereas there are now private power companies throughout Latin America, Asia is still dominated by inefficient public bureaucracies. In most Asian countries, power companies do not charge adequate prices to pay for the costs of generating power. Public power companies lose 20 to 30 percent of the electricity they generate due to technical problems or theft. Few companies have adequate financial controls, and most are close to insolvency.
As Asian economies spiraled downward in 1997 and 1998, electricity demand fell and the risk profile for new projects has been downgraded. This has resulted in a sharp downturn in investment in new power plants. Consequently, private, multilateral, and export credit agency capital flows, which had fueled the power-sector expansion, declined significantly. Private power investment in Asia declined from $27 billion in 1996 to $7 billion in 1998.
This particularly describes the situation in Pakistan. Prior to 1996, the Pakistani Government had embraced reform by allowing private power projects to compete with state-owned plants. Investors praised Pakistan for its common security packages and approvals that avoided multiple layers of bureaucracy. The government worked hard to entice foreign financing. Pakistan also pledged to increase power prices to reflect the market and reduce power losses. Partly on this basis, Ex-Im Bank supported $153 million of debt and a $97 million loan to the government for a 586-megawatt gas-fired plant at Uch, and supported $75 million in debt for a 125-megawatt oil-fired plant at Saba.
Today, the completed $653-million Uch plant, which was to supply power to the state-owned Water and Power Development Authority (WAPDA), is still not fully operational. The combination of a change in government, the economic downturn, and sanctions imposed after Pakistan`s 1998 nuclear-weapons test have drastically reduced economic development and power demand. WAPDA has gone from profitability to near-bankruptcy, making it difficult to afford 14 new plants which had been contracted. The new government has not addressed WAPDA`s underlying economic problems. Instead, last year, it issued a notice of intent to terminate nine power projects, including Uch, alleging that corruption was the main reason for termination.
Therefore, Ex-Im Bank faces a difficult decision regarding Uch: to take out or not to take out. And if not to take out, to face the objections of so many others. Normally, upon the successful and timely completion of a project, the Bank would become a direct lender to a project with a reasonably well-known risk profile. However, the cold fact here is that the Pakistani government, WAPDA and other project participants have not yet resolved the project`s problems -- and, therefore, have given Ex-Im Bank no rational basis for making the decision we would like to see.
The lesson should be clear: For private capital to resume investment in the Asian power sector, countries must put in place fundamental market principles — a sound legal framework, privatization and competition, and tariff reforms — and, above all, the institutions and professional staff to impartially implement these principles. It is also important that sponsors adopt basic practices of good business, such as providing contingency equity, or other additional support.
We at Ex-Im Bank have drawn two lessons from this. One, to bring more certainty to the market, we should offer comprehensive cover for the life of a project — which means not to take political-only cover for pre-completion. We will provide pre-completion political-only cover if a sponsor wants us to. The fact is that had we done comprehensive cover pre-completion we would not have many of the problems we have today. We wouldn`t have the difficult take out decisions. Ex-Im Bank recently implemented its first comprehensive pre-completion insurance in Mexico.
Second, it is important to issue guarantees in local currencies. Had we been guaranteeing loans in local currencies, many of the problems we have with some of these projects would not have occurred or would have been reduced substantially.
It doesn`t help us out of the problems we have. In those projects, the question of moral hazard arises when private sector banks think that we should take them out — that it`s the responsibility of the public sector. We need to develop some kind of burden-sharing for troubled projects.
International organizations such as the IMF and the World Bank, together with the G-7 ECAs, have a key role in encouraging reforms that will lead to more effective markets. Since 1990, the G-7 ECAs have financed in excess of $300 billion -- slightly more than the World Bank and regional development banks.
I believe that the ECAs can, and should, do more than support creditworthy exports. Working together, we may be able to encourage specific practices that would demonstrate the benefits of a more transparent, fair and law-based system. If we can marshal the collective power of the G-7 ECAs, we could have an important new force and voice for reform in emerging-market countries. Because we have so many interests in common in the developing world, we should work to create a mechanism that could help us achieve our common goals. For example, we need to work together with Indonesia to strengthen IBRA. We need to work together with the Philippines to prevent another situation like PAL. We must remain engaged and work together with Russia in its difficult reform process.
Having just returned from a week long trip to Russia, I am convinced that — despite the country`s severe economic and political problems — all is not lost. Russia eventually will institute reforms, and our responsibility is to do what we can to help. Not engaging with or withdrawing from Russia would be unwise. As ECAs, our mission is to support creditworthy transactions in high-risk markets, and there are creditworthy transactions in Russia. Ex-Im Bank has disbursed about $2 billion in the last six years, and our loss experience has been just 1.5 percent. Russia is a good example of a country we can help move through the reform process.
More broadly, I intend to call a special meeting of the G-7 ECAs this fall to address how we can coordinate our actions in support of reform in Russia, Asia, and other markets. In February 1998, the G-7 ECAs pledged that they would all remain open in Asia during the crisis. Earlier this year in Tokyo, the G-7 ECAs agreed to work together on the problem of private-sector workouts. At the special meeting I will call, we should consider specific actions aimed at promoting and reinforcing necessary reforms. One step could be to create an ECA working group for each emerging-market country where there is a large volume of troubled private debt.
The global financial structure is still very fragile. Thanks in large part to some sound policy decisions, we escaped in 1999 from what could have been a more serious crisis; yet, the recent global financial crisis is not likely to be the last. But, if ECAs can act in concert as a stabilizing influence, we can add another global institutional cushion to reduce the potential damage of the next crisis.
The process of reform is a long-term task that will require a consistent effort by national governments, international financial institutions, ECAs, and the private sector. Again, we must remember that it took decades for developed countries such as the United States to develop the fair and open practices that give us confidence in our markets. Given its long history of reform and development of solid regulatory and legal institutions, as well as its current authority in the global economy, it is vital that the United States take the lead in this endeavor.
Ultimately, reform can not be merely the rallying cry of Western financiers and policymakers. Genuine, far-reaching reforms are in the interests of Asian, Russian and other crisis-affected economies. Governments and business interests must recognize that comprehensive changes — structural, legal, regulatory, and in the business culture — are not only essential, but ultimately, unavoidable if they are to compete and thrive in a global economy. Ultimately it is up to them. But, it is also up to us to assure that by our participation in their economies we do what we can to assist them and to set the right example.