Emerging Market Economies Recover, But Debt Restructuring Problems Linger On

Nearly three years after the Asian financial and economic crisis, most economies in the region — and indeed other emerging market economies around the world — have staged a marked recovery. Exchange rates and interest rates have stabilized and economic growth has returned. Nonetheless, less than half of the corporate debt in the Southeast Asian economies that requires restructuring — through conversions of debt into equity, reschedulings or some reductions in principal and interest — in fact has been restructured. As a result, much unfinished business remains.

These are the principle conclusions reached at the second annual conference on emerging market finance organized by the World Bank, the International Monetary Fund and Brookings, held in Florham Park, New Jersey on March 30-31, 2000. This conference brought together academic scholars, financial experts, regulators and policy makers from around the world to discuss papers on the outlook for the world economy, the progress of debt restructuring since the Asian crisis, and measures for reducing risks of future crises.

Some of the highlights of the papers presented at the conference follow:

The Outlook
Uri Dadush, Director of the World Bank Group’s Developments Prospects Group, presented the highlights of the GLOBAL DEVELOPMENT FINANCE 2000 report released by the World Bank on April 4, 2000. The report tracks international capital flows to developing countries, addresses prospects for developing (or emerging market) economies and discusses selected analytical and policy issues in international finance for developing countries. Among other things:

• The report shows that growth in developing countries is starting to recover from the 1997-99 global financial crisis. Output of developing countries is projected to grow at approximately 4% in 2000, steadily increasing to about 5% by 2002. The most rapid growth (about 7%) is projected for the Southeast Asian economies, as a group, that were affected by the financial crisis, followed closely by India and China (5-6%), which together account for almost half of the world’s population.
• The report further projects growth of approximately 2.5% in developed countries, exceptionally strong growth in global trade, and firming of commodity prices.
• The report also projects a gradual recovery in private capital flows to emerging markets over the 2000-2002 period. While short-term external financing to these markets collapsed in the wake of the crisis, foreign direct investment (FDI) held up reasonably well and indeed has now become the single-largest source of stable and reliable longer-term development finance for all developing countries.

The Pace of Debt Restructuring
The corporate and banking sectors in the Asian countries were hit hard by the financial crisis, as were the creditors — both domestic and foreign — to those sectors. Joel Binamira and William Haworth of the Barents Group LLC (a KPMG Company) reported that through September 1999 — the latest date for which figures are available — the corporate sector in Korea had made the greatest progress in restructuring its debts of all the countries in the region; Thailand and Malaysia had made lesser progress; and Indonesia trailed significantly behind. Although it is difficult to provide precise estimates of the degree of progress, the authors’ best estimates are summarized below:

There was broad consensus and emphasis among the experts presenting papers that corporate restructuring is an essential part of the bank rehabilitation process. Bank balance sheets cannot be cleaned unless their principal borrowers — firms in the region — have first restructured their own debts. For this reason, no amount of bank recapitalization and restructuring will help if the financial condition of the corporate sectors in the affected countries remains fragile.

Furthermore, banks in the region cannot be efficient vehicles for transforming national savings into productive investments as long as they remain in government hands. Yet as Stefan Ingves and Dong He of the IMF documented, much of the Indonesian banking system still is under government control as a direct consequence of the crisis. Similarly, government support of Thai banks also has been significant, although the Thai government has largely completed its closure of 56 insolvent finance companies. Two panelists at the conference added that the banking systems in both China and Japan also have not fully come to terms with substantial losses on loans on their balance sheets.

At bottom, debt restructuring is being impeded by the unwillingness of borrowers and lenders to recognize losses and adjust to new realities. However, there are ways in which governments may proactively help.

Michael Pomerleano of the World Bank emphasized that promising solutions need to link corporate restructuring with bank restructuring. One such mechanism has been urged by the government of Korea: the creation of “corporate restructuring funds,” which are managed by foreign investment banks, but financed by domestic banks within the country. The restructuring funds, a hybrid between a private equity and a mutual fund, purchase new issues of equity and bonds of heavily indebted, but potentially viable, small and medium size enterprises. The proceeds from these new issues are used to repay existing debts, in return for commitments by the enterprises to allow stronger, independent directors to help supervise the operational restructuring of the companies.

Several papers noted that the asset management companies (AMCs)—created by governments and banks in the Southeast Asian region to take over non-performing assets — have not met the challenge of disposing of assets. AMCs can help clean up balance sheets of banks quickly, but they must be managed effectively and used aggressively to restructure or sell troubled loans. Otherwise, borrowers who have had their lending relationships severed with their former banks will feel little or no compulsion to repay the debts held by the AMCs.

Managing Risks
Going forward, a major challenge for all countries — especially developing countries — is to insulate themselves against the likelihood and severity of future financial crises. As outlined in the paper by Ashoky Moody of the World Bank and Ken Kletzer of the University of California at Santa Cruz, countries can take at least three “self-help” measures: building up foreign exchange reserves, arranging contingent credit lines (with private lenders and/or the IMF), and penalizing short-term foreign currency borrowings (as Chile did during most of the 1990s). The composition of measures have to be tailored to the individual circumstances.

As for private market participants, various presenters outlined techniques for recognizing and limiting risks. Tim Wilson of Morgan Stanley Dean Witter advocated in his paper broader use of mark-to-market accounting, at least for internal purposes, so that firms and financial institutions are more cognizant of their risk exposures.

This second annual conference on Financial Markets and Development was organized by The World Bank Group , The International Monetary Fund and The Brookings Institution. Michael Pomerleano (Senior Capital Markets Specialist, World Bank), Charles Adams (Deputy Director of Research, IMF) and Robert Litan (Vice President and Director of Economic Studies, The Brookings Institution) will co-edit a volume of the papers that will be co-published by the three organizing institutions in the fall of 2000.