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FROM THE OFFICE OF PUBLIC AFFAIRS March 15, 1999RR-3018 Distinguished Governors, Mr. President, delegates and friends. Enrique, congratulations on another year of your successful leadership -- with the bank's prompt and successful response to financial crises, the IIC back on track and the FSO funds agreement finally resolved. Burke, welcome. We look forward to working with you. It is good that our bank is strong because the challenges it must meet are formidable. Inclusive prosperity that works for all, integration that supports growth and brings our hemisphere together and strengthening each of our democracies -- these were our central challenges in Guadalajara and they are our central challenges today. But to meet those goals our immediate priority after the events of the past year must be to maintain our forward momentum. So, rather than stressing these broader themes today I want to focus on the narrower financial aspect. Stable finance will not alone educate our children, protect our environment or build our nations. But these things cannot happen without stable finance that tames the cycle of financial boom and bust that has been part of this region's history far too often -- for far too long. Now more than ever, if the gains of the past decade are to be preserved, we must work together to build Latin American confidence in finance -- and build financial confidence in Latin America. What will this require? Above all, it will mean planning for the long term. If governments live day by day, so will investors. The best financial managers hope for the best -- but plan for the worst. Finance ministers and MDBs need to take the same approach. They need policies that will serve them in bad times as well as good. This past year, many in Latin America have again been learning this lesson the hard way. I. The Return of Volatility A year ago in Cartagena we all took cautious good cheer from the fact that the first six months of the Asian crisis had mainly passed Latin America by. Looking around the hemisphere today we can see that our caution was well-grounded:
These major shocks will take their toll on the region for some time to come and no country will be left untouched. But past policies made some countries more vulnerable to these shocks than others. And the decisions governments take today will shape their capacity to contain them:
II. Building Financial Confidence At this time when the global economy is weak and growth is imbalanced, the goal of sustaining financial confidence -- and the flow of capital that confidence can bring -- is a goal for Latin America that is a goal that all can share. However, in this region especially, our goal must not and cannot be to play the same record over. It is not enough for us to act to revive confidence today; this time we must show we have the means to maintain that confidence tomorrow. What will this require? I would focus on four core elements: A. Prudent Public Management of Risk The first is adapting countries' financial policies to the challenge of better developed financial markets than we have ever had globally before. That means governments guarding against the risks that the speed and dynamism of these markets can create. And it means their taking better advantage of the opportunities for better spreading and managing those risks that have been created at the same time. That means more prudent debt management. We now know that countries are courting trouble when they reach for cheap short-term capital. We saw it in Mexico, with the increasing resort to issuing dollar-denominated Tesobonos in 1994 -- and we saw it in Russia in the encouragement of foreign purchases of domestic GKOs. Countries in this region need to think long and hard about the structure of their liabilities, their exposure to rollover and other risks; and about new structures that share more risk with lenders. And they need to recall that longer term debt is the simplest and best kind of insurance of all. At the same time we need to recognize that, while modern financial markets offer less room to err, they equally provide greater scope to plan and prepare. A modern financial planner looks to the futures markets when looking to reduce the company's exposure to price swings. Especially in Latin American countries so exposed to interest rate, foreign exchange and commodity price swings, finance ministries should be thinking along the same lines -- looking for ways to spread or hedge against the risks to which government budgets and the economy as a whole are exposed. And nowhere will innovation be more welcome than when it comes to mechanisms to dampen the effects of feast-to-famine swings in commodity markets. The crude stockpiling or price control approaches that were tried in the past have long since been discredited. But commodity price-based fiscal stabilization funds, such as Chile's CODELCO, mark a different and more promising approach which other commodity dependent nations should explore. The IDBs and other multilateral development banks can help countries efforts in all these areas: first, by providing greater technical assistance to public officials to help them analyze, understand and respond to the risks in their national balance sheets. And second, by helping governments overcome domestic reluctance to pay the price of such insurance -- by supporting appropriate public debt management and hedging programs in MDB lending operations. The IDB's work in Venezuela exemplifies this idea. So does the World Bank's recent work to give countries the opportunity to enter into hedges to offset certain types of exposure created by World Bank project lending. B. Deeper Flows of Capital Building resilience to crises is partly about better management of public balance sheets. But equally important is the resilience of the domestic financial market. Notably:
Private foreign financial sector participation can and already does support these goals in Latin America. Today fully 50 percent of the banking sector, 70 percent of private banks, in Argentina are foreign-controlled, compared to 30 percent in 1994. In Mexico more than one fifth of banking sector assets are foreign-controlled. As these countries are learning, the result is a deeper, more efficient financial market -- and external investors with a greater stake in staying put. The International Financial Institutions have a role to play here, too. Let me applaud the IDB and MIF's support for the work of the Committee on Hemispheric Financial Issues created at the Summit of the Americas in Miami in 1994. And let me urge them to continue with their efforts to disseminate application of the Basle Core Principles for banking supervisors across the region and help develop key parts of the infrastructure for stronger, more efficient national financial markets. C. Appropriate Tools for Crisis Response Preparing for crisis is also about preparing effective ways to respond to crises. Governments in Latin America -- and the international community as a whole -- need to be sure they have modern tools to respond to modern crises, and, critically, more effective tools to protect people from their effects. The IDB, in line with similar innovations by the IMF and the World Bank, has taken an important step here with the creation of conditioned, fast-disbursing premium interest rate emergency loans -- for Argentina, Colombia and most recently, Brazil -- to help defend against the runs on confidence that modern capital markets can produce. Looking forward, the IDB and other MDBs need to think about further expanding their lending instruments, in two ways. First, they could further encourage strong policies -- before crisis strikes -- by providing some backstop for private contingent facilities that countries develop to protect against contagion such as those pioneered by Mexico and Argentina. Any MDB participation in such facilities will need to be appropriately designed and priced and approached with an eye to headroom and reserve requirements that could cause it to crowd out other lending. But the IDB's support for Argentina's repurchase agreements with a consortium of private banks is surely a welcome new departure. Second, we have become convinced that credit enhancements, used strategically, can help to reduce the damage that sudden losses of market access can bring. This will be an important area of innovation for the future. The use of such enhancements should be guided by a number of principles:
These are important ideas for preventing and resolving crises involving the private sector. Other ideas are also under discussion in the international community -- and the voluntary agreements entered into by Korea's private creditors and the different voluntary agreements that have been reached in Brazil's case are very welcome. It will be important as we work through these issues going forward to remember the central irony of financial crises: while they are usually caused by too much lending, they are ended by lending more. To be sure, excessive flows of capital were no doubt an important element in these crises. But excess confidence in emerging markets is not a problem we face today or likely will face in the very near future. If the risk not so long ago was that investors were undertaking too many bad loans -- the risk today is that they will fail to make enough good ones. There is another, perhaps even more important aspect to MDBs' role in responding to crises: minimizing the destructive impact of crises on the crucial mission of ensuring the development and prosperity of all our people. The best the primary reason for wanting to respond better to crises is to lessen the economic and social distress that crises bring. But then preparing for crises has to mean preparing every member of our economy to cope with their effects. Effective social safety nets are morally right because they provide a floor below which no- one should be permitted to drop. And they make sense in narrow economic terms: because they can act as automatic stabilizers for the economy in a downturn; and because adjustments that are less painful for people are more likely to be made in good time. The IDB has heeded President Clinton's call last September for all MDBs to step up their efforts to build effective social safety nets and promote core labor rights in this hemisphere -- but we can and must do more. As the President said, "if we want countries to do tough things, we have to protect the most defenseless people in the society and we have to protect people who get hurt when they didn't do anything wrong." D. Enduring exchange rate regimes No government's search for better ways to prevent crises can overlook the place where so many past crises have begun -- in the market for foreign exchange. To sustain confidence in the future, Latin America, perhaps more than most, will need exchange rate regimes that can command the trust of domestic citizens and of foreign investors, accommodate regional and global integration, and stand the test of time. The merits of more fixed versus more floating exchange rates are forever debated and surely vary greatly from situation to situation and context to context. But the allure of stability in this region is strong and in that context the subject of dollarization has come to be discussed. The decision to make another country's currency one's own is hugely consequential for any country, and is one that has to be considered in a careful and extended manner. On the one hand, dollarization offers the attractive promise of enhancing stability in the dollarizing country by adding to the credibility and discipline of its own policies and advancing its integration with the world economy. On the other hand, the country also must be prepared to embrace that discipline -- and accept the potentially significant consequences of doing without the capacity independently to adjust the exchange rate or the direction of domestic interest rates. While there are many issues, possibilities and approaches, as these are considered it would not, in our judgment, be appropriate for United States authorities to adjust their bank supervisory responsibilities, access to the Federal Reserve discount window, or the procedures or orientation of U.S. monetary policy in light of another country's decision to dollarize its monetary system. Any country contemplating dollarization will have to weigh carefully these considerations and many others. It will surely be appropriate and welcome that its representatives do so in consultation with the United States authorities so that we can jointly think through the implications for both of our economies. I. The Enduring Agenda There are those who say that to call on the IADB -- and the International Financial Institutions more generally -- to focus on crisis response is to distract them from their primary development mission. On the contrary, stable capital flows and sound finance are necessary to the steady economic growth on which the primary development mission of higher living standards and widening opportunities depends. The platform of stable finance is one upon which so much can be laid -- so much that will further the goals for the Americas that we laid down in our Guadalajara meeting in 1994 and the Santiago and Miami Summits. Even as the storms of crises are overhead we must not forget those goals: of inclusion, integration, increased prosperity and strengthened democracies. Nor must we forget the important steps we have already taken toward them. Looking across our hemisphere today, I am confident that a quiet dynamic of
progress has
taken root in the last years of this century that will not easily be reversed. After twelve
months
that have seen President Clinton go to Latin America three times, visiting six countries,
no one
should doubt the United States continued stake in -- and commitment to -- this region's
success.
And we look forward to celebrating our shared progress and cooperation on home
ground next
year -- when we meet in New Orleans. But every interruption is an interruption our
citizens can
ill afford. If the 21st century is to be the century of the Americas -- then its final decade
must
continue to be the decade of Latin American reform. Thank you
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