Articles from Martin Khor - Part 2 (fwd)

[Robert Weissman <rob@essential.org>]

INDEBTED COUNTRIES NEED ORDERLY DEBT WORKOUT
 
(Second of 3 articles on the UNCTAD Report on the Financial Crisis)
 
By Martin Khor, Third World Network (twn@igc.apc.org).
 
 
SUMMARY:  A country with high external debt and facing a currency
attack can theoretically defend itself through four methods.  But 
three of the methods (high interest rates, keeping high foreign
reserves, lender of last resort) are inadequate or non-existent.
The UNCTAD Report, released in mid-September 1998, advocates the
fourth option: a standstill in debt servicing, accompanied by
exchange restrictions and followed by an orderly debt workout.  An
international system for debt workout, similar to Chapter 11 of the
US bankruptcy code, is urgently needed. 
 
------------------------
 
Countries coming under speculative attack and who want to avoid an
uncertain economic recession or collapse may have little choice but
to resort to two presently unconventional measures -- capital
controls and a "debt standstill" (or temporary stop in servicing
external loans).
 
This message is part of a set of analyses and proposals put forward
by the United Nations Conference on Trade and Development (UNCTAD)
in its Trade and Development Report 1998 released last week.
 
In a chapter on "the management and prevention of financial
crises", the Report says that theoretically there are four lines of
defence an indebted country can take if faced with a massive attack
on its currency:
 
   ** Domestic policies (especially monetary and interest rate
policy) to restore market confidence and halt the run;
 
   ** Maintain sufficient foreign reserves and credit lines;
 
   ** Use of an international lender-of-last resort facility to
obtain the liquidity needed;
 
   ** A unilateral debt standstill accompanied by foreign exchange
restrictions, and initiation of negotiations for an orderly debt
workout.
 
Examining each of these options, UNCTAD finds that although the
first three are theoretically possible, in reality they either
don't work or are not in existence.  Therefore, in the present
crisis, the fourth option should be considered seriously.
 
The first option (tight monetary policy and high interest rates),
favoured by the International Monetary Fund, has not worked for
ailing Asian countries.
On the contrary, says UNCTAD, higher domestic interest rates
increase the financial difficulties of the debtors and reduce their
incomes and net worth, increasing the likelihood of default. "Thus,
they provide no incentive for foreign lenders to roll over their
existing loans or extend new credits."
 
The second option (maintaining high reserves) might work if the
reserves are large enough and have been built up through trade
surpluses, as a few countries have.  But there are many problems if
reserves are increased through borrowing:  the cost for carrying
such reserves would be very high, the reserves may not be enough to
stem a big attack or large fund withdrawals, and moreover the
borrowed funds in the reserves are also vulnerable to withdrawals.
 
On the third option, there has not been an international lender of
last resort to provide liquidity to stabilise currencies in
developing countries facing currency crises.  Instead, after the
currency has collapsed, there have been IMF-coordinated bailouts.
 
These bailouts are however designed to meet the demands of
creditors and to prevent default, says UNCTAD, and they pose three
problems:  they protect creditors from bearing the costs of poor
lending decisions, putting the burden entirely on debtors; they
create "moral hazard" for international lenders, encouraging
imprudent lending practices; and the funds needed are increasingly
large and difficult to raise.
 
UNCTAD thus proposes the fourth option: setting up an international
insolvency procedure whereby a country unable to service its
foreign debts can declare a standstill on payment and be allowed
time to work out a restructuring of its loans, whilst creditors
would agree to this "breathing space" instead of trying to enforce
payment.
 
What UNCTAD is proposing is actually an extension of national
bankruptcy procedures (similar to Chapter 11 of the US Bankruptcy
Code) to the international level for countries facing debt
difficulties.
 
Bankruptcy procedures are especially relevant to international debt
crises resulting from liquidity problems as they are designed to
address financial restructuring rather than liquidation.
 
In the US Code, no receiver or trustee is appointed to manage the
debtors' business and debtors are left in possession of their
property. The procedure is to facilitate a three-stage orderly
workout.
 
In stage one, the debtor files a petition and there is an automatic
standstill on debt servicing, giving debtors-in-possession a
breathing space from their creditors, who are not allowed to pursue
lawsuits or enforce debt payment. This prevents a "grab race" by
creditors, and the debtor can formulate a reorganisation plan.
 
In stage two, the Code provides the debtor with access to working
capital to carry out its operations, by granting a seniority status
to debt contracted after the petition is filed.  This debtor-in-
possession financing can be granted if approved by the court and
does not depend on the existing creditors' agreement.
 
Stage three sees the reorganisation of the debtor's assets and
liabilities and its operations.  The plan does not need unanimous
support by creditors (acceptance by 50 percent of the creditors in
number and two thirds in amount of claims is sufficient) and the
debtor can get court approval of the plan.
 
These procedures are used not only for private debt.  Chapter 9 of
the US Code deals with public debtors (municipal authorities),
applying the same principles as Chapter 11.  The recent successful
workout of the Orange County debt was under Chapter 9.  There are
similar arrangements in most other industrial countries.
 
UNCTAD proposes an international mechanism using the same
principles.  One suggestion, by K. Raffer in a 1990 academic
article, is an international bankruptcy court that applies an
international Chapter 11 drawn up in a United Nations treaty.  
 
The court would have powers to impose automatic stay, allow debtor-
in-possession financial status and also restructure debt and grant
debt relief.
 
UNCTAD says a less ambitious and perhaps more feasible option is to
set up a framework to apply key insolvency principles (debt
standstill and debtor-in-possession financing) combined with
established debt-restructuring practices, with the IMF playing a
major role.
 
However, there are many objections to giving so much power to the
IMF, on grounds of conflict of interest (as the IMF is also a
creditor, imposes conditionality, and its shareholders are
countries affected by its decisions).
 
An alternative, which UNCTAD seems to favour, is to set up an
independent panel to determine if a country is justified in
imposing exchange restrictions with the effect of debt standstills
according with the IMF's article VIII, section 2(b).   
 
The decision for standstill could be taken unilaterally by the
debtor country, then submitted to the panel for approval within a
period.  This would avoid "inciting a panic" and be similar to
safeguard provisions in the World Trade organisation allowing
countries to take emergency actions.
 
These debt standstills should be combined with debtor-in-possession
financing so the debtor country can replenish its reserves and get
working capital.  This would mean the IMF "lending into arrears."
 
UNCTAD argues that the IMF funds for such emergency lending would
be much less than the scale of bailout operations.  The IMF can
also help arrange for private-sector loans with seniority status.
 
As regards government debt to private creditors, reorganisation can
be carried out through negotiations with creditors, with the IMF
continuing to play an important role of bringing all creditors to
meet with the debtor government.
 
For private sector debt, negotiations could be launched with
private creditors immediately after the imposition of debt
standstill.
 
The above proposal by UNCTAD has been badly needed.  In the absence
of such an international system, developing countries have been at
the mercy of their foreign creditors and investors, who can
suddenly pull out their funds in herd-like manner.
 
Without protection, these countries first face a liquidity crisis
which in turn produces a solvency crisis and then an economic
crisis.
 
If a Chapter 11 type of international bankruptcy procedure is in
place, a country facing the imminent prospect of default can
declare a debt standstill, get court clearance for protection from
creditors, obtain fresh working capital, restructure its debts, and
plan for economic recovery which in turn can eventually service the
debts adequately.
 
With such procedures, countries facing a "cashflow problem" can nip
it before it worsens and thus prevent a major crisis.  Both the
debtor country and its creditors gain.
 
Contrast this with the present messy situation, where in the
absence of a fair system, all creditors rush to exit the country,
each hoping to recoup its loan before other creditors take out
their loans.
 
And then when the debtor country has its back to the wall, the
creditors as a group usually demand, in a restructuring plan, that
the government not only pay higher interest on its loans, but also
take over or guarantee the payment of the loans contracted by
private banks and firms.
 
It might be argued that a country already near default could
unilaterally declare a debt moratorium and then dictate its own
terms for debt restructuring.  However, few countries have the
courage to do so, as the foreign banks may probably gang up and
deny any new credit, thus threatening the countries' capacity to
pay for essential imports.
 
Last month, however, a rapidly ailing Russia did declare a
moratorium not only on its foreign debt but also on its domestic
government bonds (most of which are held by foreign investors), at
the same time as floating the rouble, which has since devalued
sharply.  It is also stating the terms of debt restructuring.
 
The foreign banks have expressed outrage at these terms and are
clamoring to negotiate with the government, even threatening to
seize the assets of Russian banks located abroad.
 
By taking unilateral action, Russia was trying to preempt an even
greater crisis for itself, and is forcing the foreign investors and
creditors to take their share of the loss.
 
This on-going drama also shows how necessary it is to have an
internationally agreed debt workout procedure.  In its absence, the
situation is bound to be messy, whether in the case of a country
unilaterally declaring a default and moratorium (as Russia did), or
in the case of countries that helplessly watch as the foreign
creditors pull their money out.
 
If the rich creditor countries are serious about reforming the
global financial system, then the international bankruptcy
procedures put forward by UNCTAD (and also by others in the past)
should be urgently considered.
 
For there are many more countries that presently face the threat of
capital flight and could be on the brink of debt default.  Action
should be taken before the financial bleeding spreads to these many
other countries.
 
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USING CAPITAL CONTROLS TO DEAL WITH A FINANCIAL CRISIS
 
(Third of 3 articles on the UNCTAD Report on the Financial Crisis)
 
By Martin Khor, Third World Network (twn@igc.apc.org).
 
SUMMARY:    Capital controls are not new but have been used by most
countries until recently, and many nations still have them.  The
UNCTAD Report describes a wide range of capital controls that have
been or can be used, and for which purposes.  It concludes that in
the light of the Asian crisis and the current international
financial turbulence, governments should be allowed to make use of
such controls to insulate their economies from the effects of
speculation and volatility. (This is the third in a series on the
UNCTAD report).  
 
-------------------------------
 
 
 
To protect themselves against international financial instability,
developing countries need to have capital controls, since these
constitute a proven technique for dealing with volatile capital
flows.
 
This is a key part of proposals to prevent and deal with financial
crises contained in the Trade and Development Report 1998 published
recently by UNCTAD (the UN Conference on Trade and Development).
 
The report comes to this conclusion after surveying several other
measures (such as more disclosure of information and greater
banking regulation) that have been proposed by the industrial
countries and the International Monetary Fund.  
 
UNCTAD finds these proposals to have merit but inadequate to deal
with the the present and future crises.
 
It therefore stresses that developing countries should be allowed
to introduce capital controls, as these are "an indispensable part
of their armoury of measures for the purpose of protection against
international financial instability."
 
Although it was released on 16 Sepetmber, the UNCTAD report was
finalised in July.  The writing of the report thus predates the
sweeping capital control measures taken by the Malaysian government
on 1 September.
 
The new Malaysian policy seems to be consistent with the rationale
and advice provided by the UNCTAD Report, which in turn marks the
first time since the Asian crisis began that an influential
international agency has called for the use of capital controls.
 
The Report notes that good economic fundamentals, effective
financial regulation and good corporate governance are necessary
may be needed to avoid financial crises, but by themselves they are
not sufficient.
 
Experience shows that to avoid these crises, a key role is played
by capital controls and other measures that influence external
borrowing, lending and asset holding.
 
Control on capital flows are imposed for two reasons:  firstly, as
part of macroeconomic management (to reinforce or substitute for
monetray and fiscal measures) and secondly to attain long-term
national development goals (such as ensuring residents' capital is
locally invested or that certain types of activities are reserved
for residents).
 
Contrary to the belief that capital controls are rare, taboo or
practised only by a few countries that are somehow "anti-market",
the reality is that these measures have been very widely used.
 
UNCTAD notes that they have been a "pervasive feature" of the last
few decades.  
 
In early post-war years, capital controls for macroeconomic reasons
were generally imposed on outflows of funds as part of policies
dealing with balance of payments difficulties and to avoid or
reduce devaluations.
 
Rich and poor countries alike also used controls on capital inflows
for longer-term development reasons.
 
When freer capital movements were allowed from the 1960s onwards,
large capitak inflows posed problems for rich countries such as
Germany, Holland and Switzerland.  They imposed controls such as
limits on non-residents' purchase of local debt securities and on
bank deposits of non-residents.
 
More recently, some developing countries facing problems due to
large capital inflows also resorted to capital controls.
 
For example, when faced with a surge of short-term capital inflows,
Malaysia in January 1994 imposed these capital controls:  banks
were subjected to a ceilig on their external liabilities not
related to trade or investment; residents were barred from selling
short-term monetary instruments to non-residents; banks had to
deposit at no interest in the central bank monies in ringgit
accounts owned by foreign banks; and banks were restricted in
outright forward and swap transactions they could engage in with
foreigners.
 
These measures were gradually removed from 1995 onwards.
 
When Chile was faced with large capital inflows in the early 1990s,
it took measures to slow short-term inflows and even to encourage
certain types of outflows.  The main step was that foreign loans
entering Chile were subjected to a reserve requirement of 20
percent (later raised to 30 percent).  
 
In other words, a certain percentage of the each loan had to be
deposited at the central bank for a year, without being paid any
interest.
 
Also to prevent excessive inflows, Brazil in mid-1994 imposed
controls such as an increase in the tax paid by Brazilian firms on
bonds issued abroad, a tax on foreigners' investment in the stock
market, and an increase in tax on foreign purchases of domestic
fixed-income investments.
 
The Czech Republic faced large inflows in 1994-95 and it imposed a
tax of 0.25 percent on foreign exchange transactions with banks,
and also imposed limits on (and the need for official approval for)
short-term borrowing abroad by banks and other firms.
 
Besides the specific cases above, the UNCTAD Report also lists down
examples of capital controls on inflows as well as outflows.
 
Controls on inflows of foreign direct investment and portfolio
equity investment may take the form of licensing, ceilings on
foreign equity participation in local firms, official permission
for international equity issues, differential regulations applying
to locan and foreign firms regarding establishment and permissable
operations and various kinds of two-tier markets.
 
Some of these controls can also be imposed on capital inflows
associated with debt securities, including bonds.  Such inflows can
be subjectto special taxes or be limited to transactions carried
out through a two-tier market.
 
Ceilings (as low as zero) may apply to non-residents' holdings of
debt issues of firms and government; or foreigners may need
approval to buy such issues.  Foreigners can also be excluded from
auctions for government bonds and paper.
 
UNCTAD also lists other controls commonly used to restrict external
borrowings from banks.  
 
 
They include a special reserve requirement concerning liabilities
to non-residents; forbidding banks to pay interest on deposits of
non-residents or even requiring a commission on such deposits;
taxing foreign borrowing (to eliminate the margin between local and
foreign interest rates); and requiring firms to deposit cash at the
central bank amounting to a proportion of their external borrowing. 
 
As for controls on capital outflows, they can include controls over
outward transactions for direct and portfolio equity investment by
residents as well as foreigners.
 
Restrictions on repatriation of capital by foreigners can include
specifying a period before such repatriation is allowed, and
regulations that phase the repatriation according to the
availability of foreign exchange or to the need to maintain an
orderly market for the country's currency.  
 
Residents may be restricted as to their holdings of foreign stocks,
either directly or through limits on the permissible portfolios of
the country's investment funds.
 
Two-tier exchange rates may also be used to restrict residents'
foreign investment by requiring that capital transactions be
undertaken through a market in which a less favourable rate
prevails, compared to the rate for current transactions.
 
Some of these techniques are also used for purchases of debt
securities issued abroad and for other forms of lending abroad. 
Bank deposits abroad by residents can also be restricted by law.
 
UNCTAD also notes a current trend where accounts and transactions
denominated in foreign currencies are increasingly made available
to residents.
 
It says that capital controls can include restrictions on
residents' bank deposits denominated in foreign currencies and on
banks' lending to residents in foreign currencies.
 
Such loans and deposits can increase currency mismatching, which is
a potential source of financial instability, as it enables large
shifts between currencies during crises, putting pressure on the
exchange rate and resulting in insolvencies among debtors.
 
Besides capital controls, UNCTAD also makes two other proposals   
for better managing external assets and liabilities.
 
Firstly it warns of the dangers of a country allowing its residents
to undertake easy borrowing in foreign currencies, and allowing
them to make bank deposits denominated in foreign currencies.
 
To guard against this UNCTAD says there should be strict
enforecment of prudential rules that match the currency
denominations of financial firms' assets and liabilities with
measures that increase the costs of foreign borrowing (through
imposing taxes, special reserve requirements or cash deposits at
the central bank).
 
 
Also, limits can be placed on bank lending and deposits in foreign
currencies.
 
Non-interest bearing reserve requirements can be imposed on
deposits in bank deposits in foreign currencies, thus reducing or
eliminating the interesrt paid on them and diminishing their
attractiveness.
 
Secondly, UNCTAD says the Asian crisis starkly showed the risks of
failure to enforce separation between the onshore and offshore
activities of a country's banks.
 
Some countries set up offshore centres whose activities are subject
to lighter regulations and some tax privileges.  
 
One such centre, the Bangkok International Banking Facility (BIBF),
set up in 1992, was a conduit for funds received from abroad, which
were recycled to the domestic market, much of it used to finance
speculation in stocks and property. As much of 95 percent of the
funds raised by the BIBF was lend domestically.  
 
In contrast, the Asian Currency Units, which conducts offshore
banking in Singapore, has stricter rules that restrict the use of
the Singapore dollar as an international currency and control the
ACU's involvement in domestic banking business.  In 1996, 63
percent of the ACU's liabilities were from overseas sources and 42
percent of its assets were loans to banks abroad.
 
Pointing to this contrast between the Thai and Singapore offshore
centers, UNCTAD says it is feasible to have measures that insulate
offshore banking from the domestic market, and thus contribute to
financial stability.
 
In conclusion, UNCTAD says recent financial crises and frequent use
of capital controls by countries to contain the effects of swings
in capital flows point to the case for continuing to give
governments the autonomy to control capital transactions.
 
It questions recent moves in the IMF to restrict the autonomy or
freedom of countries to control capital flows.
 
Ways have not yet been found at a global level to eliminate the
cross-border transmission of financial shocks and crises due to
global financial integration and capital movements.
 
Thus, conclude UNCTAD, for the forseeable future, countries must be
allowed the flexibility to introduce capital control measures,
instead of new obligations being imposed on these countries to
further liberalise capital movements through them.
 
The UNCTAD report has quite clearly made out the case for capital
controls.  It is important to note, however, that these controls
should not be treated as a panacea that by themselves can cure
recession ills.
 
Capital controls can also have some disadvantages, and have their
own limitations.  They however can be an important part of a set of
policies that can protect a country facing a turbulent and hostile
external situation, so that it can reduce exposure to financial and
economic chaos, at least for some time.
 
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