FROM THE OFFICE OF PUBLIC AFFAIRS

I am delighted to have the opportunity again to address such a distinguished group, a group that has done so much to further the development and economic integration of this hemisphere. What I'd like to do today is step back a little and take stock of the hemisphere, looking at where we've been, what we've accomplished, and what we still need to do.

An Eventful Four Years

The last four years have been eventful ones for Latin America. Much progress has been made in individual countries and much progress has been made regionally.

Trade integration has become a reality. During NAFTA's first two years, U.S. exports to our partners grew 22%, or nearly $31 billion, despite the economic difficulties in Mexico.

But NAFTA is only one of the many new agreements in the region -- at least two dozen by my count. MERCOSUR in particular is taking shape and showing success: Brazilian trade with its MERCOSUR partners grew from $3.6 billion in 1990 to $13.1 billion last year. And the leaders of the region are all committed to building the Free Trade Area of the Americas -- covering the entire hemisphere -- by the year 2005.

That commitment was reached at the Summit of the Americas in 1994. And while it received the most attention, a great deal more was accomplished in Miami: we agreed on initiatives to strengthen democracy, to work towards the eradication of poverty and discrimination, to integrate and develop the region s financial markets, and to pursue sustainable development and conservation of the environment. We are moving forward in these areas. We have established 11 working committees, covering issues ranging from market access to intellectual property to the FTAA.

In finance, the past four years have been particularly eventful -- we have enjoyed higher highs and suffered lower lows than ever before. At the beginning of the period, markets were recognizing the great achievements of Latin America and private capital flows soared -- from a net $17.3 billion in 1990 to $64.2 billion in 1993. In 1994, with rising U.S. interest rates and repeated political shocks in Mexico, private flows fell dramatically, to $48.5 billion. Last year, with Mexico s problems being worked out, private flows remained roughly constant, but this year they will show a strong recovery.

Even better news is that the flow of direct investment into the region has grown even more sharply -- from $9.4 billion in 1990 to $52.4 billion last year. Last week, I met with Pedro Malan, who I believe you heard from yesterday. He told me that Brazil received $5.4 billion of FDI inflows in the first six months of 1996 -- more than 1995's full-year record.

This recovery was, in large part, the result of President Clinton's bold course of action to preserve progress made in Mexico, the region, and emerging markets worldwide by assembling financial support needed for Mexico to deal with its liquidity crisis. This support gave Mexico time to take decisive action to restore stability. And it did: with strong macroeconomic policies and structural reforms to improve the country s infrastructure and promote private sector involvement in activities formerly reserved to the state, like railroads, electricity and even pension fund management. Importantly, Mexico set a strong example for the rest of us in improving the quality and speed of dissemination of economic statistics. Confidence was restored, and Mexico has since repaid the U.S. a net $9 billion in principal, well ahead of time, as well as an additional $1.36 billion in interest.

Mexico s experience reinforced my belief that strong policies matter more -- not less -- in a world of abundant and instantaneous capital flows. This chastening experience has benefitted other countries throughout the region and elsewhere and we have seen a redoubling of the commitment to sound policies.

The international community is also encouraging and sustaining sound policies: a year and a half ago, in the wake of the Mexican crisis, the G-7 outlined a series of proposals to improve our capacity to prevent and manage future financial crises, through stronger disclosure standards and improved IMF surveillance, expansion of the resources available to the IMF in emergencies, and measures to facilitate market-based solutions to sovereign financial crises. These initiatives are now well underway, and we believe they will make a major contribution to improving our capacity to deal with future challenges.

Next on the Agenda: Financial Market Development

Good macroeconomic policy -- difficult as it can be -- is not enough. Financial market development is also needed if a foundation for sustained growth is to be built. Well-functioning and well-regulated financial markets are essential:

to mobilize the investment that is so crucial to future growth; to ensure that available savings -- still too scarce in the region -- are used efficiently; to help make workers more productive through these investments, and thus permit higher real wages and incomes; and to facilitate international trade, which continues to be key to the region's prosperity.

The downside -- the costs of weak financial markets -- are just as clear. As a result of a number of problems -- macroeconomic shocks, moral hazard, looting, and inappropriate relationships between borrowers and their creditors -- countries throughout the world have suffered the costs of cleaning up banking problems. These costs have been high: from roughly 3% of GDP in the United States to a substantial but yet to be calculated amount in Japan to more than 15% of GDP in Spain. Latin countries are no strangers to these costs: Chile's banking crisis of 1985 cost that country almost 20% of its GDP, while Venezuela lost 17% of GDP to its 1994 crisis. The process continues in many countries, and the costs remain to be reckoned.

Leaders in the region recognized the importance of financial market development at the Miami Summit -- before the Mexico crisis. This recognition continues, both regionally and globally.

At June's G-7 Summit in Lyons, leaders highlighted the importance of strengthening financial systems. The G-7 outlined the key elements of what we believe should be the next phase of this agenda. The centerpiece is an effort to develop an international consensus on how to strengthen financial systems in emerging markets.

We are building this consensus in the hemisphere. Earlier this year, Secretary Rubin hosted a meeting of Western Hemisphere Finance Ministers in New Orleans that established a work program for developing, liberalizing and integrating financial markets in the region. The ministers clearly reaffirmed their commitment to work together for more solid financial systems capable of meeting the region s needs for growth and stability. Let me emphasize that financial system modernization must embrace the full range of financial activities in a modern economy -- from pension funds to commodity markets, from insurance policies to common stocks, from the biggest company to the smallest entrepreneur. As we head to the next Summit of the Americas in Santiago, Chile in early 1998, we will be building on a record of solid progress.

Promoting worldwide prosperity is only one reason that the international community has focused on strengthening financial sectors in emerging markets. Another is that the weight of emerging economies is now of a magnitude that what happens in the developing world can affect the global economy.

In an increasingly-integrated world, financial disruptions are more likely to spill across borders. The existence of "reputational externalities" increases the risk of contagion effects -- characteristic of the Mexico crisis.

Troubled banking systems often drive macroeconomic policy off course by creating fiscal obligations and by driving imprudent monetary policy.

Conversely, governments can shy away from tightening policy because of fears that this will provoke a financial crisis.

A Framework for Strong Financial Systems

A successful approach has to recognize that, in an imperfect world, we cannot expect to eliminate these vulnerabilities. Rather, we can reduce their incidence and scale, limit their potential for damage, and better contain the fallout when things fall apart. We don't have all the answers to these challenges. But I think we do have some answers.

Let me focus for the moment on banking, because nowhere else is it more important to avoid damage. What do we need to do?

First, strong supervisory regimes are essential. This means tough entry requirements; prudential norms for capital, liquidity and currency exposure; limits on connected and directed lending; strict rules that govern income recognition, classification and provisioning; reporting and disclosure requirements; a rule-based regime for remedial actions; consolidated supervision; and a framework for dealing with insolvent institutions.

Second, the rules and standards have to be enforced by a thorough system of bank examination. Supervision needs to be backed up by an independent bank supervisory authority with the ability to enforce compliance. Elegant risk-weighted capital ratios are not enough. The bank examination process has to be on-site, detailed, regular and complete, focusing on credit quality and internal controls to gain an accurate picture of the true condition of the bank.

Third, supervisors need a framework in place to deal with problem banks and situations, or systemic threats. Early warning systems, prompt corrective procedures and clearly delineated authority to intervene in failing institutions can all contribute to a more stable banking system. A deposit insurance system is part of the equation, but it is crucial that the safety net leaves a proper balance of incentives for bank owners, managers and depositors to minimize moral hazard.

Finally, the supervisory regime has to be complemented by a strong credit infrastructure. Among other things, this means strong accounting standards on international norms; a functioning bankruptcy system; and a well developed legal regime.

This is not a comprehensive list. Many of these problems could be addressed in the first instance through privatization of remaining state-owned banks. Measures to counter money laundering and other illicit activities are other elements in any effort to enhance the integrity of, and public confidence in, financial institutions.

My emphasis on regulation, however, should not be mistaken for a fear of innovation. Rather, it is a recognition that an appropriate level of regulation is vital to instill confidence in any financial system, and that confidence is itself a prerequisite for financial market development. This principle of striking the right balance between regulation and innovation is equally applicable to all facets of financial activity: whether securities markets, insurance, pension fund management, or micro-enterprise lending. With higher confidence, greater diversity of financial products, a broader range of participants, and more competition, financial markets will charge lower costs to borrowers, will generate more domestic savings, and will increase the level of productive investment, the key to future prosperity.

The International Strategy

Let me talk more directly about the policy architecture that I envision for strengthening the financial system. This strategy has three parts:

First, guidelines and principles developed by the international organizations of banking and securities regulators. The international organizations of banking and securities regulators have already done substantial work toward identifying the core principles, practices and objectives that underlie sound banking and securities supervisory regimes and sound legal and operational infrastructures for financial markets. The challenge now is to modify and refine these to fit the specific circumstances of emerging markets.

Second, enhanced surveillance of national financial systems by the IMF. The Fund must recognize that its objectives need to go beyond its traditional moniker -- it s mostly fiscal. It needs to recognize the threat that financial system vulnerabilities pose to macroeconomic stability, and to take a more active role in addressing them.

Third, technical assistance and financial sector lending by the multilateral development banks. The World Bank and the regional development banks, including the IDB, can contribute -- and are contributing -- by strengthening financial systems through financial sector lending programs and by helping to develop the institutional capacity for regulation. In New Orleans, the hemisphere s finance ministers called on the IDB to establish a training program for banking and securities regulators in the hemisphere. The banking part is well underway, with the securities part to follow.

The process I have described is not one that will be completed a year, or even a decade from now. There is much to do, in the international arena and in every country in the region, to address this challenge. But in an era of a global capital market that mobilized more than $200 billion in capital to emerging markets last year, it is absolutely essential that we work to meet Secretary Rubin's challenge to develop institutions that are as modern as the markets.

Looking Ahead

While international cooperation is vital, in the end it is the actions of individual countries that will create prosperity. In the wake of Mexico, markets lumped developing countries -- and especially Latin countries -- together. Now, they are again distinguishing individual country challenges and outlooks, as they should.

Markets are showing great confidence in the region. I share that confidence for a number of reasons:

Let me start with the U.S. In the first half of the year, real GDP grew at a 3.3% annual pace, and we expect 2.6% growth for the full year, close to the economy's long-run potential. Consumer price inflation is forecast at 3.2% for 1996, easing to 2.8% in 1997 and 1998. Unemployment has been steadily falling, reaching a seven-year low of 5.1% in August before moving up slightly in September. The U.S. deficit is now the smallest in the G-7, as a share of GDP. This fiscal consolidation has contributed to a benign global interest rate environment -- perhaps the single most important factor for promoting financial stability and economic development in Latin America.

For the developing countries of the hemisphere, the outlook is also good. For the group as a whole, the IMF is projecting growth of 3% this year and 4% in 1997. Regional inflation should fall from 35.6% last year to 20.6% this year to 13% in 1997. Let me turn now to the three largest countries:

Brazil. For 1997, a consensus forecast is for 10.7% consumer inflation. Who in this room could have conceived of such an outcome 27 months ago when the real was introduced amidst 50% monthly price rises? Growth, meanwhile is projected to increase to 4.3%, from this year s 2.7%. Brazil still faces stiff challenges, including fiscal and social security reform, privatization, and -- not least -- banking sector restructuring. The Cardoso government has recognized these challenges, and is working hard to address them.

Argentina. Argentina has had a difficult 18 months. But growth resumed in the second quarter of 1996 and Economy Minister Roque Fernandez told me last week that he expects growth of 5% for 1997. Most private economists do not disagree by much. Argentina s inflation rate, meanwhile, is in line with G-7 numbers. Argentina recognizes that to achieve sustainable growth with low inflation it must increase productivity and continue to strengthen its financial system. President Menem is proceeding with difficult labor market reforms that will serve to raise employment and to reduce the cost of doing business in Argentina, and is taking steps to privatize banks and to strengthen regulation.

Mexico. Mexico s progress is well-known. Inflation is falling -- from 8% a month in April 1995 to 1.3% in August 1996 -- and second quarter GDP this year was 7% higher than in the same period last year. Interest rates have fallen by half, to their lowest level since before the crisis and the peso has firmed. Most remarkably, Mexico has regained access to international capital markets, having issued about $13.5 billion this year. Mexico has also replenished its reserves, to over $15 billion, while reprofiling its debt maturities to ensure a realistic amortization schedule.

Progress is being made in the hemisphere s smaller countries as well. It has not escaped my attention that the largest privatization in the hemisphere this year was in Peru. Venezuela has taken important steps towards reestablishing a sound economic policy framework. Even the poorest countries in the hemisphere -- like Haiti, Nicaragua and Bolivia -- are making progress in stabilization and reform.

These four years have been eventful, and exciting. Over the next four, we will continue to experience highs and lows. I hope and expect, however, that as a result of the reforms being carried out in the region and internationally, volatility will be lower. For someone who has sometimes felt that his stock was denominated in Mexican pesos, that is of no small significance.