Transcript of a Press Conference on the 1999 International Capital Markets Report

September 8, 1999



Division Chief
Capital Markets and Financial Studies Division
IMF Research Department

Assistant Director
IMF Research Department

Division Chief
Emerging Markets Studies Division
IMF Research Department

IMF External Relations Department

MR. DAWSON: --International Capital Markets Press Conference. The report and the contents of this conference are embargoed until 11 a.m. this morning.

Joining me this morning are members of the Fund's Research Department, which prepared the report. Assistant Director of Research, Charles Adams; Gary Schinasi, the Chief of the Capital Markets and Financial Studies Division; and Don Mathieson, who is Chief of the Emerging Market Studies Division in the Research Department.

Charles will open the press briefing with a few remarks, and then he and his colleagues will take questions. As a matter of transparency, could you please identify yourselves when you have questions.

Thank you very much.

MR. ADAMS: Thank you very much, Tom. My name is Charles Adams, and I'm very pleased to be here on the occasion of the release of the 1999 International Capital Markets Report.

Let me make a few introductory remarks, and then we can open the floor to questions. Those of you who have attended press conferences in previous years will know that the International Capital Markets Report, together with the World Economic Outlook, constitute the core elements of the Fund's multilateral surveillance activities. There are two distinguishing characteristics of the Capital Markets Report. First, we focus in the report on the global or international capital markets, developments and issues in these markets. And, secondly, the report, to a much greater extent than other Fund reports, is based extensively on discussions with private market participants, in addition to national authorities. We have a substantive input from our discussions with the private sector.

In terms of the report that we've prepared this year, you should not be surprised by the emphasis we've given to the issues and policy challenges raised by the turbulence in international financial markets in 1998.

Indeed, a rather critical element of this year's report is to try to improve our understanding of these periods of turbulence and study the policy issues raised by them. There are three themes, in particular, that I would emphasize in this year's report.

The first has to do with the nature, causes and policy challenges raised by the turbulence in the mature financial markets last year, following the problems in Russia and Long-Term Capital Management. We pay considerable attention to the issues raised by this turbulence, and in particular, the implications of high levels of leverage for systemic risk.

A second theme of the report is how small and medium-sized markets have been affected by turbulence in international financial markets and how they have responded to the pressures. Particular emphasis is placed on what we characterize as the nonstandard responses a number of countries have taken when faced with extreme external pressure. The cases we look at are Hong Kong, Malaysia and Brazil.

And, finally, the report looks at the experience and role of the credit-rating agencies during the recent financial crises. This is both with a view to improving our understanding of the role of these agencies through the ratings they provide, and the lessons these agencies are taking out of the crises. In a forward-looking sense, as I'm sure many of you will be aware, the Basle Committee, among its proposals on capital standards, is proposing to make greater use of external credit ratings in the amount of regulatory capital that banks will need to set aside for sovereign lending.

I will now turn the floor open to questions.

QUESTIONER: Just in terms of the hedge fund area, it would appear that the IMF would, perhaps, like to see a little more than just the first line of defense that would appear to be the fall-back position for people looking at the issues of regulation or surveillance of hedge funds.

Are there any sort of--is that the case? Do you believe that the next lines of defense will actually be considered or is it just a case that transparency and disclosure will be a sort of compromise middle ground between the private sector, who don't want any new rules, and the regulators who would like more clarity and more responsibility?

MR. ADAMS: This is an issue that, as you probably know, is still being discussed both within the Fund and in other fora including the Financial Stability Forum that is looking at highly leveraged institutions. Let me just make a couple of observations.

I think there's a clear recognition coming out of the turbulence last year that the approach that was used before, relying on market discipline and risk management of counterparties to highly leveraged institutions, did not work well. There's a clear recognition that we need to go beyond that approach.

The difficult issues have to do with how far one goes. At this stage, I don't think we or any of the main national authorities are thinking in terms of direct prudential regulation of hedge funds (however one might define them). The thinking is mainly in terms of enhancing market discipline. And that, of course, requires information and disclosure on the part of hedge funds, both to their counterparties and to the markets. It also requires improvements in risk management and the like.

We would see the approach to addressing the systemic issues raised by hedge funds or highly leveraged institutions, in the first instance, as being a matter of making much more effective use of market discipline, including better controls on the part of counterparty banks and securities firms that deal with highly leveraged institutions; and in terms of the regulatory/supervisory process, attempting to fine-tune incentives for how banks, in particular, deal with HLIs.

Having said that, of course, and as you allude to, there's a substantive issue about how much additional information hedge funds might voluntarily provide. And it may be the case down the road that certain countries may consider changes in laws or regulations to require greater disclosure by hedge funds to the market.

QUESTIONER: When the crisis hit in 1997, and then later on--and we saw the response from Malaysia-- later on we saw the capital controls imposed by Malaysia, the IMF and the Clinton administration were quite critical of that stance. In reading the section on Malaysia in this report, it seems like the IMF is not so sure that those were the wrong decisions by Malaysia any more. Do you care to comment?

MR. ADAMS: Don, do you want to?

MR. MATHIESON: Well, I think there are a number of points that we made in the discussion of the Malaysian controls. All of these nonstandard responses were used after periods of fairly sharp turbulence in the marketplace, and in the case of the Malaysians, a period where there was a lot of pressure on domestic interest rates and also on the exchange rate.

And as I think we noted in the report, one of the vulnerabilities of the Malaysian system is that it has a very high ratio of corporate bank debt to GDP. As a result, the corporate sector is quite sensitive to interest rate changes. One of the reasons the Malaysians utilized capital controls was to segment domestic and international financial markets so as to allow them to sustain lower interest rates than they thought they would otherwise have been able to do.

In addition, the controls came on after most of the external pressures had been felt. We then entered a period where not only Malaysia, but many of the other Asian economies saw less external pressure and, indeed, there was a recovery in a number of the economies after that point.

So in that sense, the controls were never fully tested. And so it's somewhat difficult to judge completely how effective they would have been under a period of intense pressure. From what we could tell, in the period where there was not the intense pressure, there was not a significant level of evasion. But, again, the pressures had been relaxed at that stage of the game.

So I think the problem we face in evaluating controls like the Malaysian ones is, indeed, that, in some sense, the external situation changed. And in addition to that, the authorities did undertake a number of actions, particularly in the area of restructuring the banking system and also in the corporate sector, that helped improve the economic situation.

So, again, using that window of opportunity, as they did, again makes it a little more difficult to isolate the effects of the controls, per se.

QUESTIONER: Following up on that, so you're not really, you're not saying that these capital controls were either good or bad. You're saying you can't judge them. And to follow on from that, what does that assessment mean for the longstanding or maybe now on-the-back-burner push to include liberalizing capital markets into IMF conditions, IMF charges?

MR. ADAMS: Let me make two observations. First, as I think Don has made clear, when one looks at the imposition of capital controls by Malaysia, one needs to look at the whole package. One needs to look not just at the capital controls but also at what the Malaysians did with the "window of opportunity" provided by the controls.

And I think there is some basis for believing that the Malaysians used the opportunity provided by the controls to push forward with some important financial sector and corporate restructuring.

Now, in terms of a final evaluation, one has to look at the implications of these kinds of measures both in the short run and over time. Now, we have obviously passed the September 1st deadline and haven't seen a massive exodus of capital flows. But in terms of a full evaluation, one needs to look at some of the implications this may have over time.

The second part of the question has to do with the implications this has for the Fund's views on the amendment to the Articles of Agreement on capital account liberalization. As I think you're probably aware, coming out of the Asian crisis and the financial sector vulnerabilities and weaknesses, there has been a rethinking of issues to do with sequencing and the packaging of liberalization. There is a recognition of the need to do a much better job in appropriately sequencing the liberalization process.

So, yes, we're obviously influenced by that experience.

QUESTIONER: You talk about the risks posed of a drop in U.S. equity prices or the dollar. Can you talk about how imminent that problem is and what kind of ramifications you see.

MR. ADAMS: I'll have Gary answer that very quickly.


MR. SCHINASI: We're really not in the business of making calls in markets. We are in the business of trying to evaluate the risks. Clearly, as we've been saying for a couple of years now, the major equity markets, not just the U.S. equity market, are very high in terms of price-equity ratios and other scale variables you might use.

There are some justifications for those valuations. In the end, the market, more or less, prices equities on corporate earnings. And as long as corporate earnings are maintained, then valuations can be maintained. So it really gets down to whether or not the U.S. economy will be able to maintain corporate earnings.

This also applies to the European equity markets. There the feeling among equity analysts, at least, is that, as growth prospects improve in Europe, those valuations can be sustained, with some variations between countries. So we don't know whether a stock market correction is imminent or not.

On the value of the dollar, as we said last year, and I think as we say this year, the currencies have been quite variable, though things seem to have settled down a bit in terms of variability. The dollar has weakened somewhat. There is concern about yen strength and what impact that might have on the Japanese recovery. But I think you'll hear more about that during the WEO press conference upcoming.

The adjustments in exchange rates would be less of a concern and a risk for global liquidity and markets more generally were they to occur in an orderly fashion. And I think it's reasonable to expect that that would happen, though we must note that over the last few years there have been some rather wide and abrupt swings in exchange rates, mostly surrounding other periods of turbulence or turbulence created by other factors or shocks, such as the Asian crisis, and the abrupt movements associated with Long-Term Capital Management.

But I think the general expectation would be that exchange rates would adjust in an orderly fashion. There is the risk that they won't, though, and that's what the report discusses.

MR. DAWSON: Next question?

QUESTIONER: The report, and you gentlemen both make mention of bad risk management on the parts of private sector as one of the factors in the crisis. And I'm wondering whether we are seeing put into effect a change in the international architecture, given that, in recent years, beginning with South Korea and including Ukraine, and Romania and, most recently, Ecuador. There has been participation in rescues by the private sector. You know, whether their arms were twisted or whether they went willingly, we shall see.

We're beginning to hear calls from private creditors that this is going to raise spreads and could cut some countries off from access to capital. My question is, is this a bad thing or is this a good thing in that private creditors will become more discriminating and will be likely to lend to sounder policy regimes at more favorable terms, thereby providing a model for other governments to follow.

MR. ADAMS: Let me just make a general point, and then perhaps my colleague, Don, could take some of the specific points.

On the issue of the pricing of risk, I certainly think that if you look back to the period before the Asian crisis and the spreads on lending to emerging markets in general, and moving down the credit spectrum of a fairly wide range of countries in that process, there are important questions about the pricing of risk--whether, in fact, risk was mispriced before the crisis.

So if you ask the general question of whether we like to see, quote/unquote, "a better pricing of risk," we would certainly not want to be in those types of situations of very sharp spread compression.

Now, towards that end, there are various things that one can think about as regards transparency and disclosure of information, the banking system and capital standards, etc. And there is also, of course, the fact that some countries will, from time to time, run into difficulty servicing their debt. One would look to mechanisms that can, in those circumstances, facilitate restructuring and, in some sense, preserve value. But, of course, in a fundamental sense, much of our work is concerned with the crisis prevention part of the story, which is to try and get a better pricing of risk beforehand, to try and ensure that the institutions that intermediate financial flows do so prudently, and enhance risk management. Down the road, we need to deal with those cases where, whether due to adverse shocks or whatever, there are difficulties encountered in debt service.

Don, I don't know if you--

MR. MATHIESON: I think if you look at the period after the Russian crisis, what one sees is, I think, clearer emphasis on credit risks on the part of the markets. And it shows up in a number of ways, and we discuss this in the "Recent Developments" chapter.

You see a much greater preponderance of issues being rated investment grade from the emerging market side. And this reflects the fact that the markets are just much more receptive to better risks, at this point in time. And in many cases, this investment rating has been achieved by particular packaging of receivables, et cetera, that allow the particular issue to have a higher rating than maybe even the country rating. This greater emphasis on creditworthiness doesn't seem to be disappearing from the marketplace, in any respect. I think, in fact, it may be receiving more emphasis as we go forward.

QUESTIONER: Can you have some comments about the figures of the capital flows to emerging countries that has been very low last year and some perspective.

MR. MATHIESON: Well, I think we've got the figures in the report for the first half of the year, and I can update you a little bit on what we've seen over the last couple of months as well. Basically, the information that we have on a timely basis is on new bond issues, on syndicated lending and issues of international equity.

And what we have seen in the first quarter of the year is that the sum of these issues was valued at about $32 billion. It rose to $49.7 billion in the second quarter. In comparing June and July, June would have been in the figures for the first half of the year, June, the flows were about $17 billion, and then they declined in July to about $13.3 billion.

That has involved a somewhat mixed pattern of issuance. As we noted in the report, there has been more or less a secular decline in syndicated bank lending to emerging markets over the last couple of years, as banks have shown, shall we say, reluctance to expand their activities in this area. And a lot of the emphasis has really been focused on bond market issuance during recent years and, in fact, the re-entry, if I can put it that way, post-Russia, was primarily through the bond markets, and we still continue to see that pattern.

And there has been a modest level of international equity issuance that has continued, mainly associated with various forms of privatization in the emerging markets, but also some corporate issues.

In general, the pattern that we talk about in the report still continues. It's primarily the sovereigns that can access the global markets. The corporate sector is still having, from what we can tell, a fair amount of difficulty accessing international markets. This is particularly true, of course, in countries where the restructuring of the corporate sector has not progressed very far. But it is true even in other countries where the corporates are not in as great of difficulty. Again, this is part of the emphasis by investors on better risks.

QUESTIONER: The report talks about the number of favorable developments that have occurred since last fall's turbulence, but it also says that conditions in financial markets remain fragile. Could you elaborate a little bit on that. And specifically, are you talking about the U.S. stock markets and what it might do as part of that fragility?

MR. ADAMS: Let me make a couple of observations.

I think conditions have clearly improved substantially compared with the situation last year. And that's a sort of bench mark.

In terms of the issue of fragility, this touches on a couple of the points that Don just made, on the emerging market side. External financing flows still remain very low. At the same time, one of the things we've seen, following the problems of Long-Term Capital last year and cutbacks in leverage, is a cutback in the amount of capital allocated to market-making in emerging market bonds.

So even though we've seen a pickup in flows to several emerging markets, particularly in Asia, this year the volumes are relatively low. As a result, we are somewhat susceptible, in terms of volatility.This adds one element of fragility to the situation.

Gary mentioned earlier in the context of the mature markets concerns about equity valuations and whether medium-term corrections in the dollar would be orderly. At the same time, in the emerging markets, given that the adjustments in financing are still ongoing, given the reduced investor base, and the possibility of some cutbacks associated with Y2K issues, there are element or fragility.

QUESTIONER: In your review of the Australian and South African experiences with being pushed around, I think it's the phrase that went in the report, by currency people who, sensing a tightening in the Asian currency markets, decided to short currencies that offered greater liquidity and perhaps the same or a mirror-like exposure to those sort of conditions. Malaysia, in anticipating that, seemed to use that as one of the reasons to implement its exchange controls.

What do you think governments like Australia and South Africa have learned from that close call, almost, they've had with people shorting their currency for reasons that really had nothing to do with their own economic fundamentals, other than the fact that they reflected quite accurately the turmoil, to a degree, in other places?

MR. ADAMS: Let me make a couple of observations on the pushing around, as you characterize it, in the case of Australia and South Africa.

One has to think about the pressures these economies faced last year, whether associated with shorting of their currencies by certain hedge funds or other sources. They probably reflected two things. One, there was a genuine concern during the course of last year about a deepening and spreading of the Asian crisis, what this might imply for world activity and for commodity prices. Associated with those concerns, there were some spillovers on markets like Australia, like Canada and some of the other commodity-producing countries.

At the same time, given the situation in several Asian markets, people who wanted to hedge positions in these markets may have been doing proxy hedging in markets like Australia, where there was reasonable liquidity and they were capable of putting on positions. There may have been some elements of proxy hedging or proxy plays which also influenced these markets.

The authorities in countries like Australia and South Africa, like other authorities that come under speculative pressure, have expressed concern. Personally, I think the Australian authorities, in fact, handled that episode relatively well, but it is a source of concern for them.

Some of the issues related to these positions in small and medium-size markets are currently being reviewed in the context of one of the working groups of the Financial Stability Forum; the working group on highly leveraged institutions. And, in fact, we in the Research Department are involved in that group, and we visited Australia, New Zealand, and some other countries to discuss these issues.

QUESTIONER: How much of this lowering in capital flows do you think can be related to the fact that the exchange rate system in emerging markets have been changed and perhaps the markets expect additional change in exchange rate regimes in different countries and to what point that kind of concern can be explained and it can be partly behind these lowering capital flows. You have exchange rates change in Brazil, and we have in Chile expectation of a change in Colombia, some people talking about the effect that the China devaluation could have in Hong Kong, and people also concerned about the exchange rate regime in Argentina.

MR. ADAMS: I think that's a very difficult question. I would, at a general level, say that if you looked at capital flows to emerging markets over the last few years, the thing that probably would strike one was the significant pickup through 1997, and then a sharp pullback first from Asia in `97 and into early '98 for some other regions.

Subsequently, following the crisis in Russia, and the problems of LTCM, and pullbacks from some other regions, there was a significant turnaround from very large inflows to significantly lower levels and higher spreads in secondary bond markets.

Looking at the Asian crisis, some of the reasons for the pressures were the relatively fixed exchange rate regimes some countries had before the crisis and the fact that much foreign currency borrowing was not hedged.

So once exchange rates started going, a rush to hedge some of these foreign currency exposures probably contributed to the pressures. During the course of '98, concerns about particular exchange rates, dollar-yen, Chinese renminbi, possible spillovers to Hong Kong, at the margin influenced things.

But I would see this against, or sort of superimposed on, a bigger picture, in terms of the overall course of developments, and the responses of countries. But clearly, the particular regimes influence the situation at particular times.

QUESTIONER: To what degree are you seeing Y2K concerns impacting the flow of funds, and might one expect some countries to face, and certainly the corporate sector, as well, and emerging markets, to face financing difficulties as we go further into the second half of this year?

MR. ADAMS: Let me just make a couple of observations on that.

We clearly are seeing in some prices in the mature markets Y2K-type spikes. They are clearly there. And there certainly have been some indications, including I think around the time a few weeks ago when some of the swap spreads in the mature markets increased, some bringing forward of financing in anticipation of Y2K.

This is something that we at the Fund are looking at very carefully, and are specifically looking at the issues of preparedness, and how particular countries might be affected. There will actually be some sort of discussion of this ahead of the Annual Meetings.

Looking at the situation across countries, many countries either will be able, or are prepared, to deal with Y2K-type issues. Alternatively, in the event that there are any disruptions, we think many countries will be able to handle them. We don't think there are going to be major problems. We are, however, in close collaboration with our members, looking at situations where there may be potential problems, and we're looking at how we might deal with those.

MR. DAWSON: A couple more?

QUESTIONER: Can you talk about what you see as the main dangers ahead. If the world markets now have recovered pretty well, where are the possible weak points and what steps should governments or companies take to try and avoid recurrence of another crisis?

MR. SCHINASI: I think your first question pinpointed two of the danger points, if you want to call them that, two of the risks, the downside risks. So there's the equity markets. Rapid and large adjustments in exchange rates creates waves of potential turbulence in other markets. So that's another one.

I would say that the liquidity concerns evident in the Y2K spike, if they get significantly higher than they are now, could start affecting flows, not just to emerging markets, but within the mature markets to higher risk companies that would need funding. That's a risk, probably way out in the probability distribution of potential problems. But it's there, and that's what's being priced into the Y2K spike, which as of today I think is about 50 basis points. It was higher much earlier in the year, and it's been bouncing around 40 to 50 basis points. So that's a concern.

As far as what companies, banks, and even countries can do about it is pretty much a theme in this report, which is improved risk management at all levels. Maturity composition of debt, of financing needs, should be well managed Position-taking, credit risk assessments or counterparty risk assessments--measures are being taken to improve all of those. Measures are also being taken to improve transparency and disclosure so that there can be better risk management.

But in the end, it's up to the individual companies, banks, investment banks, and even authorities to be aware of these risks--hopefully, they read this report--to be aware of these risks and to improve their ability to monitor and assess those risks and then make the necessary adjustments in their portfolios, whether they are national portfolios or a portfolio within a company.

MR. DAWSON: Maybe one more question. We're running out of steam.

QUESTIONER: I guess I have a question for Mr. Mathieson. And the question is about the relative importance of political factors, such as, for instance, electoral cycles. In Russia, we are on the eve of a couple of very important elections. In your experience, do such considerations really have a discernable effect on the capital flows to a market, to an emerging market? Probably you have examples from other emerging markets post-communist. And how does this relate, how can this relate to the current situation in Russia?

MR. MATHIESON: Well, I think it is--there have been past episodes where capital flows have clearly been affected by political developments, such as civil unrest. We also know that, for example, the credit rating agencies, when they rate issues, sovereign issues, in particular, do try to take into account what they see as the political stability of the country that is being rated. And they argue that the ratings are influenced by those considerations, as well as the economic fundamentals that they look at in the process.

So there is no doubt that political factors do affect capital flows and do affect things like credit ratings and the pricing of spreads in emerging markets, for both sovereigns and corporates. Because at the end of the day, one of the concerns of investors is with transfer risk. Will the debtors be able to make the payments? And that will clearly be influenced by how stable the political environment is.

MR. DAWSON: That's it. Thank you everybody. And remember the embargo until 11 a.m., Eastern Daylight Time.

[End of Press Conference.]


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