Finance: Rude gestures from the "Invisible Hand"

Washington, Jan 27 (IPS/Abid Aslam) -- The 'invisible hand' of the market has received much blame for maiming one 'emerging' economy after another over the past 18 months. Its latest signal could be seen as a rude gesture.

In a report released Wednesday, the Washington-based Institute of International Finance (IIF) said that global economic turmoil demonstrated financial markets' ability to 'discipline' entire countries and urged governments and international institutions to make more room for private players at the policy table.

At the same time, the global association of some 300 multinational banks and private finance firms urged the official sector to let investors decide for themselves how - and whether - to contribute to
international efforts to stabilise countries plunged into crisis by panic-stricken financial markets.

The "highly mobile international capital market ... provides enormous opportunities for economic development in emerging market economies but also represents the potential for sudden and harsh disciplining, sometimes late and excessive, of economies making serious policy mistakes," the IIF said in its 91-page report, 'Financial Crises in Emerging Markets.'

It emphasised the "need for greater consultation between the private international creditors and investors and (between) the investors and the authorities of borrowing countries, and for a corresponding recognition by these authorities that they have a responsibility to keep investors informed."

The document also renewed the IIF's long-time request that the International Monetary Fund (IMF) share with markets more of its data on member countries.

As a matter of routine, governments "should develop a system of regular briefings for private investors on developments in the economy and economic policies," according to the report.

However, "should market sentiment deteriorate or imbalances arise, borrowing countries should seek the advice of their principal private international financial institutions and explore with them possible corrective actions and likely market response," it argued.
Lest readers infer that the private sector was asking to vet economic policies while reserving the right to precipitate crises, IIF chief economist William Cline said at a news conference held to release the report: "The idea is to enhance the stability of the system and avoid some of the rude shocks."

Emerging economies' reliance on jolting short-term capital flows could be minimised, the Institute argued on behalf of its members, if governments removed obstacles to long-term borrowing and direct foreign investment in, for example, infrastructure projects. Financial firms also should use more advanced assessments of financial and credit risks in emerging markets, it added.

"Market-friendly disincentives to short-term (capital) flows, a la Chile, need to be short term and are no substitute for sound macroeconomics and financial institutions," said Cline.

Trouble would remain inevitable, however, and the IIF insisted that, when it arises, "private sector participation in crisis resolution efforts should be on an essentially voluntary and market-related
basis".

Proposed mechanisms include Argentina's six-billion-dollar contingency credit line from private banks. George Soros, the billionaire speculator, also has suggested that private players take out their own investment insurance.
Analysts have warned, however, that such measures would offset potential losses rather than regulate investment in the first place. Martin Khor, director of the Penang, Malaysia-based Third World Network recently described their goal as "sustainable speculation."

Criticism of the international emergency financing packages assembled by the IMF has come from the left and right wings. Most critics seem to share in common at least one fear: that the bailouts contribute to 'moral hazard', encouraging investors to repeat their mistakes by letting them off the hook for their risky gambles. The Institute, however, dismissed that argument.

"Private sector losses in recent emerging market crises have been formidable," the report said. "Based on IIF estimates, foreign equity investors experienced losses amounting to a total of about $240 billion in East Asia and Russia. Foreign banks are estimated to have incurred potential losses of about $50 billion and other foreign investors may have incurred potential losses of about $50 billion."

About a dozen 'emerging markets' - chiefly the Asian 'tigers' - attracted all but about five percent of private foreign investment in the developing world and former Soviet bloc between the early 1990s,
when the latest boom in capital flows began in earnest, and 1997, when such flows peaked and plummeted.

In a separate report, also released Wednesday, the IIF said it expected net private capital flows to 29 leading emerging markets to sink to about $140 billion this year, compared to $150 billion last year and $260 billion in 1997.