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Transcript of a Press Briefing on the Global Financial Stability Report|
Wednesday, June 12, 2002
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MR. GRAHAM HACCHE: Good morning, ladies and gentlemen, and welcome to this press briefing on the IMF's latest Global Financial Stability Report, which is the second report in this series.
The contents of the report and today's briefing are under embargo until 11 o'clock this morning.
The report was prepared in the IMF's International Capital Markets Department, or ICM, as we call it, under the direction of Gerd Häusler, Counsellor and Director of the department, who is seated immediately to my right. To Mr. Häusler's right are Donald Mathieson, chief of the Emerging Markets Surveillance Division in the ICM Department, and at the end Garry Schinasi, chief of the Financial Market Stability Division.
I will turn to Mr. Häusler for his opening remarks about the report before we take your questions.
MR. HÄUSLER: Thank you for joining us this morning, and I look forward to your questions in a moment. And if I may, I just have a few opening remarks, assuming that most of you have at least read a large part of the report.
It is, as Graham was saying, only the second in a row, and as I described last time more in detail about the purpose of the report, it is about detecting fault lines in global financial markets, if there are any. And it's a part of the Fund's stepped-up efforts towards crisis prevention. It's a part of a multilateral surveillance exercise. And the report is trying to blend quarterly developments on the one hand with structural features that could potentially impact the stability of the financial system.
We are trying to be focused and not comprehensive and not trying to cover everything. And given that it is a quarterly report, in order to be timely you cannot expect that we are coming up with big-time headlines every time and every quarter have something very juicy and sexy to talk about where the next crash may take place. Very often it is a bread-and-butter analysis.
Now, as we said in the report, at this moment in time, the near-term outlook certainly in mature markets is largely free of imminent threats, mainly because the world economy has recovered and has helped to build support also for financial markets.
But there is one source of uncertainty that is the level and the quality of corporate profitability, which is a theme, as you will have seen, shaping the major issues discussed in this report and recurring quite a few times, and I will go through those sub-issues if you agree.
We are faced with the issue whether more robust corporate earnings, which are needed to encourage capital spending, whether they are coming forward in the weeks and months to come or not. And at this moment in time, the capital investment is the missing component, as we said, of the current economic recovery.
And the level of corporate profitability has been somewhat disappointing in many sectors, not just the so-called TMT (the telecom, media, and technology sector) but in others as well; and, therefore, by definition almost, equity valuations earlier this year have run ahead of themselves.
Now, also the quality of earnings is a concern, and in our first report in March we have been pointing to what some people refer to as creative accounting. And we are, in fact, as I see it personally, we are dealing with the undoing of some corporate excesses with some parts of the financial system having contributed to such developments. But once we have overcome this, hopefully soon, there is a chance for a new beginning in that area where shareholder value on the one hand is respected, without, however, worshiping any short-term share price movements at virtually all costs, including of certain accounting practices.
If all incentives are geared towards short-term developments of the share price, that is a very tempting phenomenon, and maybe a more medium-term-oriented approach might be helpful. Let me explain myself a bit more clear.
The share price is not only a yardstick for investors, but it has been not only a compensation mechanism for senior executives of a company, it has also been an acquisition currency for that company, but it has also been a defense instrument for every company. And, therefore, everything was geared towards the developments of the share price, even short term, and that was a very tempting and powerful incentive to go and to step across, to trespass certain borders.
Now, markets, as we know--and I think that's a very healthy development--have dispensed harsh discipline to corporations whose reported earnings appear unsustainable or derive from such questionable accounting. And this harsh discipline has created powerful incentives meanwhile for corporations to enhance the transparency of their financial accounts and is, therefore, an important part of the market's self-correcting mechanism, something that we all should welcome.
At the same time, however, regulatory changes are also needed to rebuild and safeguard the integrity of financial markets, as the report is saying. Changes are underway in the United States and Europe to that end to strengthen corporate governance and oversight of capital markets and are, therefore, highly welcome. And I think the IMF is lending its support to these developments.
Now, talking about corporate profitability from a different angle, any sustained change in relative corporate profitability between various countries and continents, between the United States, for instance, and Europe or other areas of the world, will also have an impact on capital flows between such areas, and, by definition, these capital flows will have an impact on asset prices across borders and high seas. And this issue of capital flows coming from a change of relative corporate profitability is a theme that most probably the next report will pick up in September.
Corporate profitability also has a bearing on banks, and as we said last time, the credit cycle had turned very unfavorable towards banks, and we may see ourselves now at the tail end of a fairly harsh credit cycle. And as you have seen, there has been quite a bit of strategic downsizing of the cost base of some banks--you read about it in the papers quite frequently--but also a downsizing of balance sheets. And this has already impacted the lending of some banks, not the least to emerging markets. And this trend may probably continue.
Again, another theme under the heading of corporate profitability--and we have devoted a special chapter to that--insurance companies have in the past years shown insufficient profitability in their core business and have tended to engage in more and more capital markets business. I think more disclosure and more transparency will show whether or not and how they will cope with this additional risk in all its configuration.
Now, although insurance companies at this moment in time and some of the few failures we have seen over the past years, they are not generally seen as sources of systemic financial risk, but limited transparency in that direction means that there is quite a bit of unknown factors and potential risks that by definition we are not clearly seeing at this moment in time. But the past failures, as I said--and I want to repeat that--are not associated with widespread turbulence. And insurers, as you know, have liquid assets and illiquid liabilities. They are the reverse in some way from banks, and that is certainly encouraging at this moment in time.
Now, the lack of corporate profitability also has hit in particular over the last years the Japanese corporate sector and, thus, also the Japanese financial sector, as we know. And an upcoming Article IV consultation and the ongoing FSAP--Financial Stability Assessment Program--by the IMF will look into the domestic financial system in Japan more closely. This report in front of you deals with the potential transmission mechanism, transmission channels to the international financial system. And you have seen that we have dealt with three potential mechanisms and came to the conclusion that none of them at this moment in time are really of any very serious concern. One is the repatriation of Japanese overseas assets back to Japan. We felt, given the very poor return that such assets can earn in Japan presently, the likelihood of that happening in any major magnitudes is not there.
A sharp fall of emerging markets financed specifically to Asian countries, we now feel that the Asian countries are in much better shape than some years ago. Not only are their current account positions improved, but also they have higher reserves, better debt structure, and more flexible exchange rates.
And last, not least, the potential contagion via the interbank market is not that much of a concern given that the relations between the rest of the banking system around the world and Japanese banks have loosened quite substantially over the last couple of years.
Let me then point to another feature inside the report, what I tend to call a trilogy. There's the first piece of a trilogy about local securities markets, and the question, can local securities markets serve as a buffer or as an insurance against the vagaries of international markets. And there are two more series to come, and Don Mathieson could point out some more details to that. And we came to the conclusion that the underperformance of emerging market equities from a longer-term perspective does not appear to be primarily due to overvaluations in those markets but, rather, through price/earning ratios in emerging market equities have been quite high for some years. But the main factors that have resulted in the underperformance of emerging market equities are three, the following:
There has been a string of financial crises, starting with Mexico in 1994, which have drastically pruned the U.S. dollar returns on emerging market equities. There have been concerns about corporate transparency and governance. And last, not least, the growing importance of so-called ADRs and delistings have also reduced the universe of liquid stocks in emerging markets and have had adverse impact on both domestic and global investor base.
Let me finish by pointing to some very recent developments that have taken place in the markets, and you are undoubtedly aware of that since this report had its cutoff date and was prepared and cleared, and it takes a little while here.
Let me just, in no particular order, mention maybe three or four developments.
The equity markets and mature markets have, unfortunately I must say, confirmed what we were saying earlier. They have confirmed the concerns about the pace of the recovery and the quality of earnings and will probably continue to do so for some while until there are clearer signs of a turnaround in corporate profitability.
The decline of the dollar versus the euro and the yen since May, about 3 percent vis-a-vis the euro and about 2.5 percent vis-a-vis the yen, you have witnessed, but at the same time, as you saw, European equity prices have not benefited from this development, and there is at the same time also a lack of confidence in the profitability of European companies.
The market is not convinced that if the U.S. equity market is going down necessarily this comes to the benefit of the European market, which leads me to believe that any exchange rate movement at this moment of time should not be expected to be very violent.
Now, in the emerging bond markets, we have seen for some time a rotation, to use the market jargon, a rotation away from Latin America, and particularly from Brazil, and this has led into a significant rise of risk aversion vis-a-vis emerging market debt, particularly with regard to South America, and not necessarily have other regions benefited in the same time. In fact, we can see that cash allocations by emerging market investors have risen, and, therefore, the benefits for the rest of the world was limited.
Now, that leads us to say that the investor base for such emerging market investments are extremely important and have to be watched carefully.
With the decline of bank credit to emerging markets as a source of capital flows, to which I alluded earlier, most specifically from European and Japanese banks, and also with the so-called--again, another market jargon--the crossover investor as opposed to the dedicated, the crossover investor being a less reliable source of funding, the role of foreign direct investment, so-called FDI, has become more and more crucial. And, therefore, the investment climate under which FDI takes place, again, with particular regard to Latin America, has become extremely important. And, therefore, we must be very vigilant against any policies that might be adverse to such investment climate or might even create contagion in that direction.
I will leave it at that as an introduction. Thank you very much. And then I think we are open, my colleagues and I are open for questions.
MR. HACCHE Thank you, Gerd.
Can I ask you to identify yourselves, please, in the usual way? The first question here.
QUESTION: Thank you. I'd like to divide my questions into two parts.
First of all, what's your estimates for capital flows for the remainder of this year and 2003 for emerging markets, both FDI and portfolio, fixed income and equity?
And the second question is: Do you think that countries like Brazil--just you mentioned in your first remarks a rotation away from Latin America and particularly Brazil--how countries like Brazil whose credit quality have deteriorated in the past months will fare, will perform in terms of rolling over its debt due to investors being taking money away and investing elsewhere?
MR. HÄUSLER: The first part of the question on the capital flows I would like to pass on to my colleague to the right, to Don Mathieson. As to Brazil more specifically, I'll give you the choice of answering or passing it back to me.
MR. MATHIESON: Well, we don't formally make forecasts of the flows in the report. I think our focus has primarily been on the conditions of what we call market access for emerging markets. And, again, it's somewhat of a regional story, and I would differentiate between what I would call investment grade and non-investment grade borrowers. Investment grade borrowers continue to have reasonable access to both the bond and syndicated loan markets, and so that doesn't seem to be an issue.
Right at this moment in time, the bond markets are effectively closed for what I would call unsecured non-investment-grade borrowers. They just really cannot enter the market at any price they're willing to pay. And so I think we see that as a condition that's likely to continue in the near term.
So, again, there's also regional discrimination. I think Asian borrowers have been able to access the bond markets quite successfully, both at the corporate and sovereign level. But then, again, corporate borrowers in Latin America have found it much more difficult to access the markets recently.
So that's where we see the market access story at this point in time, but I'll pass you back the Brazil question.
MR. HÄUSLER: Well, on Brazil, as you all know, Brazil's fundamentals have not changed in any negative way. There are some political uncertainties in the market, and that is for the Brazilians themselves to answer that and to get this out of the way. I think the markets do not really look at Brazil in any sort of fundamentally negative way. They're just concerned about the political uncertainties.
QUESTION: Sorry. My question was different. Do you see Brazil in 2003 having difficulties to roll over its debt due to a drying up in capital flows, both FDI and portfolio investment, because investors are concerned to the credit quality of the country and going elsewhere where the credit quality is seen as better?
MR. HÄUSLER: I think it would be unreasonable on my part to speculate about 2003 while we're still in June 2002. As you know--and this was why I made the point about the political uncertainties. You have an election by then. I have no reason at this moment in time to assume that the markets will not be open for Brazil in 2003.
MR. HACCHE: The second row here, please.
QUESTION: Good morning. I'd like to go back to the political question. In the report you say that the market is imposing a political premium risk in Brazil higher than it did in 1998. So my question is: what do you attribute to this and what the perspectives are in your opinion?
MR. HÄUSLER: Well, I can only repeat myself. The market is obviously--and I am just a messenger--somewhat concerned about the upcoming elections in Brazil in October and what kind of policies will be pursued thereafter. And this is at the root of it, and I think there's nothing that I from the Fund can add to that. I mean, you all read that. I think it would be improper for me to speculate, you know, what may or may not be the outcome of the election or what may or may not be the outcome of the economic policy thereafter.
At present, I think the market agrees that the present economic policy of Brazil is, by and large, appropriate.
MR. HACCHE: In the first row?
QUESTION: Anna Willard from Reuters. Can you just clarify? Do you think that U.S. equities are currently still overvalued? And the second question is: you mentioned that policies should be avoided that would deter emerging market capital flows. Ms. Krueger has proposed a new sovereign debt plan, but many analysts, Wall Street analysts, say that if it's implemented it will deter capital flows to emerging markets. So do you think that that shouldn't be put in place?
MR. HÄUSLER: On the U.S. equities, whether they are overvalued or not is a difficult, very difficult question, because it all depends on what future earnings, what your expectations are.
We said in the last report they were richly valued, and they have gone down since, as you know. If corporate earnings were to recover, I think there's no reason why equity--U.S. equities in particular--that's what you asked--should be regarded as still overvalued. But that is, of course, a big if whether or not corporate earnings on a broad spectrum, not just in particular cases, are going to recover. If I knew that, I wouldn't be sitting here, if I knew that for sure. And maybe Garry Schinasi, if you want to add anything on that.
But on the SDRM, on the sovereign debt restructuring mechanism, first of all, this is not part of the report here. We do touch upon capital flows to emerging markets, so it's indirectly related but it's not a subject of this report. And as you would expect, it is the intention of the IMF, and certainly of Mrs. Krueger, to facilitate and to smooth capital market flows to emerging markets and not the reverse.
So I think it would be quite inappropriate to characterize the SDRM as an instrument that may run against capital flows to emerging markets.
MR. HACCHE: There, please?
QUESTION: Peter Goldstein from the Kiplinger Newsletter. You mentioned briefly the dollar, and I see in your report that the following report is going to address the issue of what might happen if the dollar remains weak or goes weaker. I wonder if you could give us a bit of a preview, your views on if, in fact, the dollar does decline faster than it is now, as some analysts are forecasting, what would be the implications for the emerging financial markets?
MR. HÄUSLER: I would like to give Garry Schinasi a chance to come up with that. If I agree with him, I'll shut up. If I don't, I will jump in.
MR. SCHINASI: There's two sides to a market.
We've been saying for quite some time, both within the context of the Capital Markets Report and the World Economic Outlook, that at some point the current account, U.S. current account--and, really, the way we look at it is from the capital flow side--that at some point, as there is productivity catch-up in Europe and hopefully soon in Japan, that the fundamentals would probably dictate that the dollar would stop rising and even start declining.
Now, that, of course, is predicated on the presumption--and there's good reason for the presumption--that the strength of the dollar has been driven by the perception, then the reality of productivity gains, which, as we all know, have been fairly substantial and been associated with the long boom in the United States. So over time it's reasonable to expect that there would be some kind of a readjustment.
Now, your question is really what might be the financial implications of an abrupt decline in the dollar. I think we have some historical experience with that, and you don't have to go too far back. In fact, in the '90s--the late '80s and the early '90s, and again in '98, there were fairly substantial adjustments in the dollar-yen rate, just as an example.
If you remember, the dollar went from something on the order of 135. It actually broached 80 in London trading on one day, and then, of course, it went back to 125, 130. I think now we're sitting at about 123.
And within the mature markets, while from time to time there are increases in volatility and some adjustments in other asset markets, it's hard to recall any real difficulty in the adjustment. Now, that is not to say that there aren't implications, and one of the things we will be looking into in the next report are some of these implications for capital flows, and in particular to the emerging markets. But that's something we're going to be looking to in the future.
MR. HÄUSLER: Let me just add a sentence. If one takes the view that these capital flows are driven largely by relative gains and losses in productivity, productivity differentials and growth differentials, essentially, which have worked very much in the favor of the United States over the last--broadly speaking, the last eight to ten years. Now, there may be some--there may be a view that this will not be sustained in the way that we saw it; and, therefore, by definition, the flows may become less and, therefore, by definition, the dollar may become softer as opposed to the past.
I personally take the view that any such correction--first of all, it's in nobody's interest if such a correction were to take place in any abrupt way. But also maybe because I'm European I take the view-- I don't expect any such productivity differentials to be reversed in any quick way. I don't think given the economic structure in the United States, which is a very flexible economy, as everybody knows, and given certain rigidities in the European economy about which we have talked also for many, many years, it is hard to envisage that such productivity differentials would be reversed abruptly and quickly with all the consequences for capital flows and exchange rates.
I don't want to sort of pre-empt the next chapter, and maybe we come out differently, but you asked for some sort of--a little curtain grazer, and this is what I think about it.
MR. HACCHE: The fourth row there, the lady?
QUESTION Mr. Häusler, you mentioned corporate profits several times. What do you expect for the development of corporate profits, and what could be the driving forces that would lead to more robust earnings?
MR. HÄUSLER: It's not easy to answer that question. It goes beyond this report because this is a report about financial stability. So we take earnings as they come, if you like, and it would be more of a research nature, you know, to look very deeply into what is driving--what are the determining forces for corporate profits.
One is pricing power. One of the reasons is that we see pricing power in many areas and in many countries is quite limited, not the least here in the United States. And that is, of course, the positive result of that is low inflation.
The second is, of course, the recovery as such, and I think the third one is somehow related. I think we have to accept that corporate profits, when you compare them today as opposed to the past, in some cases you will have something of a statistical rupture because you will have changes in accounting undoubtedly are coming forward, and if they're not imposed by the regulators, they will be imposed by investors. So you will have to be very careful in comparing earnings today with yesterday.
This is not a comprehensive answer, but I would feel uncomfortable in going too deeply into the question what is driving corporate profits in the world economy.
MR. HACCHE: The gentleman there?
QUESTION: I'm sorry I didn't have time to look at the report before coming here. Is there anything about the capital flows performance in the last period? Are you updating the capital flows report here?
MR. HÄUSLER: You mean to emerging markets? QUESTION: Yes.
MR. MATHIESON: Yes, there's a discussion of the flows, particularly in the last quarter, that is in the report, and it compares it going back with earlier periods as well. So there's, I think, fairly comprehensive coverage of the flows.
MR. HÄUSLER: Let me just clarify. The reason why so far we have chosen to make it quarterly is not because we expect a crisis to happen every quarter and to have global fault lines every quarter. The reason for a quarterly report so far has been to give you an update on the capital flows in a more timely fashion as if we did it differently.
You will remember that the capital markets report that these two gentlemen were heading was an annual report, but it was also complemented by a quarterly report on emerging markets finance by a different division at the time. And we have blended this into one, and this is why we made it into a quarterly report, to precisely update on capital flows.
MR. HACCHE: Yes, in the front row here, please?
QUESTION: J Would you go as far as making some kind of a link between the decrease in the dollar and the crisis in corporate governance in the U.S.?
MR. HÄUSLER: That's difficult to answer: "yes" and "no" is too simple an answer for that.
I have no doubt that the recent decline of the dollar has something to do with the corporate profitability. I said this time and again. Now, as I said, corporate profitability has something to do with the level of corporate earnings due to, you know, pricing power and all the rest. So there is an element of that.
However, as I said, also, there is one element of the quality of the earnings and accounting practices. Now, if you regard that as corporate governance, I would say, yes, there is a bit of an element in there undoubtedly. But it would be too simple to make that into a mono-causality.
MR. HACCHE: One more question? I thought there was another hand up here.
QUESTION: According to this report, the Japanese banking problem is still (inaudible) international financial markets. So what kind of policy is needed for Japanese Government to address the banking problem?
MR. HÄUSLER: As you would expect, we have no magic solution either. All I can tell you is what others have told the Japanese time and again, that is, you have to go to the root of the problem, and that is the insufficient profitability of the financial sector and the insufficient corporate restructuring that has taken place with the clients of Japanese financial institutions that has produced those non-performing loans. And I think that's also a lesson that can be learned from the United States in the so-called S&L crisis in--when was it, late '80s? I think it was late '80s, early '90s--is that a quick and decisive restructuring with the corporate sector and then, you know, by definition, follow up with restructuring of those loans is the best way to come out of those problems. But, again, this is nothing that is sort of personal or anything that is ingenious on my part here.
MR. HACCHE: Thank you. I remind you of the 11 o'clock embargo, and thank you all for coming.
MR. HÄUSLER: Thank you very much.
[Whereupon, the press briefing was concluded.]
IMF EXTERNAL RELATIONS DEPARTMENT