Capital inflows, bank deregulation and financial institutions: from repression to crash? Argentina and South Korea compared. Leonardo E. Stanley, CEDES ∗
CENIT-‐GDAE-‐RIS “Towards Inclusive and Development-‐Friendly Global Economic Governance: Evolving a Southern Consensus”. A Ford Foundation funding Project. ∗
Associate Researcher at CEDES, e-‐mail:
[email protected]
Index 1. Introduction ......................................................................................................................................... 2 2. A Micro – Macro approach. ............................................................................................................ 6 2.1 Macro: The case for capital controls .................................................................................. 6 2.2 IMF lesson 1: Argentina ........................................................................................................... 9 2.3 IMF lesson 2: South Korea .................................................................................................... 15 2.4 Micro: Beyond Basle regulation ......................................................................................... 20 3. An Institutional perspective ........................................................................................................ 28 3.1 Liberalization at both multilateral and bilateral ........................................................ 28 3.2 Argentina institutional path towards globalization .................................................. 33 3.3 The KORUS FTA and South Korea rupture with the past ....................................... 38 4. Conclusions ........................................................................................................................................ 44 4.1 A hard learning process: Lesson 1 – Argentina ........................................................... 44 A hard learning process: Lesson 2 – South Korea ............................................................. 47 A hard learning process: Lesson 3 – Crisis, what crisis? ................................................ 48 6. References ........................................................................................................................................... 51 7. Annex: Tables and Graphs ........................................................................................................... 58
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“Unrestrained convertibility in the capital account is in fact a luxury, desirable in itself, enjoyed by a handful of countries which have either a very developed or a very underdeveloped domestic financial system”. Carlos Diaz – Alejandro, 1984
1. Introduction In the past, foreign shocks spread to national economies mainly through trade channels, and transmission of such shocks took time. After globalization and increasing capital account liberalization, shocks arrive at domestic financial markets almost immediately. When coupled with financial deregulation, freeing completely the capital flows might certainly increase the probability of a crisis. In this sense, countries with larger, better-‐developed, and more open financial systems did worst in the last crisis. As a result many countries are taking a more nuanced view regarding the role of short-‐term foreign capital, after recognizing that such inflows may give rise to asset bubbles and macro instability. To same extent, the actual situation began its trend after the collapse of the Bretton Woods system in the earliest 1970s, implying the irruption of a new flexible exchange rate system and the dismantling of former controls on capital flows. The shift towards free markets becomes accelerated with the coming to power of Margaret Thatcher and Ronald Reagan in 1979 and 1980 respectively. The predominant neoliberal vision perceived increased financial activity as beneficial for development and, Keynesian-‐Myskian caveats were set aside. By the same token, the efficient market hypothesis substituted Keynes´ beauty contest parabola of how financial market actually behaves1. That was the central message arriving from the developed world, and being vociferated by the International Financial Institutions (IFIs), throughout a collective of instructions enclosed under the Washington Consensus. Henceforth, rescue package originated at the International
1 Financial market deepening via capital account liberalization, henceforth, could spread the benefits
on a worldwide basis. Barry Eichengreen (1999) summarized the idea “There are clear benefits from being able to borrow internationally. Capital mobility creates valuable opportunity for portfolio diversification, risk sharing, and intertemporal trade. By holding claims on foreign countries, households and firms can protect themselves against the effects of disturbances that impinge on the home country alone. Entrepreneurs can pursue high-‐return domestic investment projects even when domestic finance is lacking. Capital mobility can therefore enable investors achieve higher rates of return. And, higher rates of return can encourage saving and investment, ultimately supporting faster rates of growth”.
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Monetary Fund (IMF) or World Bank (WB) lending practices, both introduced new clauses of financial deregulation and capital account fully convertibility. Under this new framework, developing countries were urged to liberalize their capital account and deregulate their financial sector. In other words, a micro-‐macro initiative was under operation. Sooner than later Wall Street began to move forwards the institutionalization of this scenario, both at the bilateral and multilateral foray. International investment agreement (IIAs)2 would swiftly become at the centre of a new legal framework supporting the liberalization task3. Financial liberalization was also integrated at the Uruguay round, and numerous new instruments were soon launched at the newly created WTO, including those introduced by the General Agreement on Trade in Services (GATS)4. Henceforth, either on a bilateral or multilateral basis, developing and emerging economies passed through a [legal or institutional] process of financial deregulation and capital account liberalization. Certainly, since the early 1970s financial flows become to increase at amazingly rates, benefiting to emerging and developing countries. Capital inflows were certainly not aside from cyclical downturns and sudden stops. A group of Latin American countries experimenting with financial liberalization abruptly become aware of this sort of problems. Policies were mainly oriented towards ease the domestic market up from government intervention. Advances at the institutional front were not severe, however. From a micro perspective, the banking industry remained weakly supervised. At the institutional front, developing countries policy space remained uncontested, as legal constraints were absent at the international level. Twenty years later most countries in the region embarked on a neoliberal path, including new and deepest financial liberalization measures. Financial 2
Among others, IIAs include the following: Bilateral Investment Treaties (BITs), Free Trade Agreements (FTAs), Regional Trade Agreements (RTAs), and Economic Partnership Agreements (EPAs). 3 Initially built-‐in a bilateral format, investment liberalization will spread later under a free trade
scheme. Particularly, following the signal of the North American Free Trade Agreement (NAFTA). 4 It might be also consider the Agreement on Trade-‐Related Aspects of Intellectual Property Rights (TRIPs), and the Trade-‐Related Investment Measures Agreements (TRIMs)
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deregulation included now a more pressing stance on banking surveillance and accountability. In the movement towards financial liberalization and deregulation a group of developing countries and emerging economies accepted to reduce capital regulations, including the reduction (or elimination) of controls on capital inflows. A group among them went further accepting to institutionalize this stance, either by accepting more liberalizing commitments at the WTO sphere or by virtue of the signature of BITs or FTAs. From this day forward and from an institutional perspective, CML began to undermine their policy autonomy. By mid-‐90s, however, the Washington Consensus was under attack. Economic instability in countries like Mexico, Thailand, Russia and Brazil highlighted the growing uncertainty and risk attached to this kind of openness. The end of the regime becomes visible after the Argentina collapse. Unfortunately, except from a reduced group of scholars and some policy makers, few in the north become aware of the magnitude of the problem. As the world experiences its worst financial crisis for years, there is now a widespread feeling that bold innovations in global finance governance are needed. Likewise, policy – makers worldwide become enthusiastic to undertake a more pro-‐active regulatory policy towards capital inflows. However, this return could ended to be fragile. On the one hand, and despite the current economic crisis, Wall Street ambitions towards capital account liberalization on emerging economies and developing remain intact. As rules continue to be uncontested, economic liberalization might persist to be legally binding in some countries of the region (i.e.: capital controls could be contested by foreign investors). On the other hand, prudential regulation of the financial sector continues to be under stress. The paper analyzes the liberalization wave, and its legal consequences for developing and emerging countries. In a first part, the paper comments the macro and micro consequences observed at emerging economies when defying the monetary trilemma. In a second section, it looks at the financial services institutional transformation launched at both, multilateral and bilateral level. In particular, at both sections it scrutinizes the experiences of market liberalization and financial crash suffered by Argentina and South Korea in recent years, and the
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institutional changes introduced by both countries at this stance. For Argentina, the institutional scheme ended in crash, the unanswered question is whether a comparable institutional transformation could bring Korea to affront similar consequences in the future.
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2. A Micro – Macro approach. 2.1 Macro: The case for capital controls The incompatible trinity (or "trilemma ") is a term used in discussing the problems associated with creating a stable international financial system. It refers to the impossibility to achieve simultaneously the triple contradicting, but desirable goals of fixing its exchange rate (to foster stabilization of trade and growth), of running an independent monetary policy (to achieve domestic monetary policy goals) and of freeing completely its capital flows (for an optimal allocation of resources). According to the Mundell-‐Fleming model, a small, open economy cannot achieve all three of these policy goals at the same time: in pursuing any two of these goals, a nation must forgo the third. Under the golden standard, the trilemma was fully operative. Capital flows were almost unfettered and currencies tied to gold. Henceforth, monetary policy was absent from the policy discussion. But, in the end, the system collapsed because it allowed governments no domestic monetary flexibility and external shocks were passing through the national economy without further restrictions. The financial architecture settled down at the Bretton Woods radically altered the previous scheme, introducing a more stable regime although a closed one. Currencies were pegged to the dollar, which in turn, was tied to gold. Until the 70s, international financial markets were tiny and highly regulated, generalized categorized as “repressed”. Capital controls were present in most countries, both on inflows and outflows5”. At the beginning of the seventies the previous consensus collapsed, and perceptions [over the costs and benefits of regulate the capital account] began to change drastically. The system of fixed exchange rates broke down, and a new 5
Capital controls could take a quantitative or qualitative character, affecting inflows and / or outflows. Among the regulations affecting capital inflows could be mentioned those introducing minimum stay requirement or limiting local agents (domestic firms and residents) from borrowing in foreign currencies, or the introduction of unremunerated reserve requirement (URR). Exchange controls or taxes / restrictions on outflows could be cited as an example of management techniques affecting outflows. Price-‐based techniques include the Tobin tax or the URR, whereas quantitative – based measures include quantitative limits on foreign ownership of domestic companies stock or reporting requirement and quantitative limits on borrowing from abroad.
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market-‐friendly era began. A true crusade against financial regulation and capital controls unleashed, and monetary authorities at developing countries were seen as the territory to conquest6. Financial services also advanced in that direction, and liberalization and deregulation transformed the banking industry. Exceptions, however, remained important among countries and regions alike. In particular, regarding the opportunity and degree of capital account opening, or with respect to the exchange rate system to be followed7. One of the main problems caused by uncontrolled capital movements is their effect on the real exchange rate. A surge of capital inflows, especially short term, can cause the domestic currency to appreciate8. The monetary authority can mitigate this by introducing sterilization measures, although an expansive use of them has important fiscal costs (Ocampo, et. al.; 2007)9. Alternative, the government could neutralize currency appreciation by encouraging local firms to invest abroad (outward FDI) or by maintaining a permissive policy towards capital controls, thus helping investors to invest abroad (i.e.: capital flights). Capital controls have important supporters, some new fans and a significant group of (persistent) critics10. After an ostracism of almost 30 years, it seems that the
6 CML (the crusaders motto) was inspired in neoliberal paradigm of perfect capital markets. This theory treated economic agents as being perfectly informed and fully rational. Markets, on the other hand, operate under conditions of perfect competition, and no market imperfections exist. In short, too much perfect! 7 In this sense, several countries in Asia pegged their currency with the dollar in order to catching up the US economy. Asian countries were also particularly cautious with respect to the policy timing, maintaining controls on the capital account for years. Sequencing was as well important in deregulating the banking system at Asian countries, as nowadays exemplifies China. 8
The quantitative easing policy followed among industrial economies (US), might be actually aggravating the problem for emerging markets and developing economies. 9 Sterilization operations might also result in additional capital inflows, as an interest rate increase
push financial investors from abroad to buy local titles. 10 The subject has been discussed from time to time, and particularly after the arrival of a financial collapse. Henceforth, the discussion has an important record among those analyzing the Latin American region, whereas the debate is more recently for those focusing at Asia. There are plenty of recent works on the issue, including Epstein (2009), Gallagher (2010), and Grabel (2010). Even the IMF recently recognized the case for capital controls (IMF Technical Note, 2010). In addition, discussions and / or empirical data could be found at INTERNET or specialized BLOGSPOT, including the Econbrowser (http://www.econbrowser.com/); Economist View (http://economistsview.typepad.com/) Triple Crisis blog (http://www.triplecrisis.com/), East Asian Forum (http://www.eastasiaforum.org), the Bretton Woods Project (http://www.brettonwoodsproject.org/index.shtml), VOX (http://www.voxeu.org/) or those
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former group is beginning to outweigh the latter group. The current situation has also raised concern on several policy makers about the importance to re-‐regulate the financial sector11. Henceforth, a brief historical recount could be helpful. Back to the 70s, funds become intermediated by the banking system. Overflowing with liquidity thanks to large, readily available deposits (eurodollars) and strongly rising petroleum prices (petrodollars), the transnational banks set out to find new clients, mainly in newly independent and Latin American Countries (LAC). Meanwhile, the historical IMF position favouring capital controls become radically altered, notably by changing its charter to include a mandate to promote CML. At the same time, a secular move toward more financial deregulation began in many countries, including some developing ones. Nonetheless, when the crisis arrived to the region, the Bretton Woods financial institutions were altering their lending practices, adopting a more orthodox economic policy stance, which by the very nature were increasingly foreign investor-‐friendly ones (Mortimore and Stanley, 2009). The IMF did so primarily by way of its Stabilization Programs packages whereas the WB did so mostly through Structural Adjustment Programs12. The debt crisis cost LAC a decade of growth. LAC policy space was seriously damaged, including its capacity to introduce capital controls or re-‐regulate its financial sector. At the early 1990s the situation had changed once again. Capitals were returning to the developing world, particularly under the form of portfolio investment, changing the nature of finance, as bonds replaced loans. Markets in developed countries were also expanding, and new financial instruments were appearing and others growing in importance (Turner, 2010)13. However, these new emerging hosted by Newspapers and Journals http://blogs.ft.com/beyond-‐brics/)
(for
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FT´s
Beyond
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11 Take, for example, the Financial Stability Forum (FSF). These forum recommendations are directed to update the regulation of the banking industry but also working on other sensible financial (as those related to accounting standards and credit rationing agencies). 12 These institutions often utilized cross-‐conditionality in their programs and sometimes in coordination with regional development banks. 13 A huge market in interest rates derivatives grown from almost zero in 1987 to over $ 400 trillion
in 2007. Similarly, global credit derivative contracts (GCDCs) and collateralized debt obligations (CDOs) grew from zero in the mid 1990s to over $ 60 trillion (2007) and $ 250 billion (2005).
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markets were not exempted from bust and crisis, to finally break apart. Starting at Mexico (1994), financial crisis will later spread through Southern Asia (South Korea, at 1997), arriving at Russia (August, 1998), Brazil (January, 1999), and Turkey (February, 2001). The “financial -‐ crash world tour” would finally arrive to Argentina, at December 2001. However, policy advisors and most academic pundits found no relationship between propensity to financial crisis and openness to foreign capital flows14. Although they failed, market pressure and international financial institutions maintained this principle in practice (Ocampo, 2010), and capital controls did not return (Walter, 2006). Take by case the position adopted at the IMF Hong Kong meeting in 1997, at the midst of the Asian crisis, asking member countries to made capital account liberalization a binding commitment (Bhagwati, 1998; Turner, 2010). The following paragraphs introduce the experiences of Argentina and the Korea Republic, including the main policy response introduced by authorities in both countries in the aftermath of the crises.
2.2 IMF lesson 1: Argentina Until the mid-‐1970s Argentina followed a strategy of import substitution industrialization (ISI). Between 1964 and 1974 GDP grew by an average of 4,4%, whereas industrial production increased at 6,7%. Under the ISI model the state became an important economic actor, including its leading role in the financial front through the fixing of interest rates and by rationing resources to (selected) investors (or projects)15. Capital inflows and outflows were strictly limited, including important restrictions on remittances and limitations in foreign exchange transactions. Notwithstanding, in 1975 the country suffered a huge
Finally, it should be also be noted the immense growth of commodities futures trading (Turner, 2010). 14 Others authors, however, adverted from the fragility of the situation and the high correlation observed between financial liberalization and the probability of suffering a financial crisis augmented (Kaminsky and Reinhart, 1999; Eichengreen and Bordo, 2001). Certainly, the likelihood amplified when liberalization is coupled with deregulation of the domestic banking sector (Kaminsky and Reinhart, 1999, Eichengreen, 2010). 15 As bank reserve requirement were generally settled at very high levels, bank-‐lending capacity was limited.
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macroeconomic crisis, making clear the incapability of the model to increase productivity and, henceforth, to maintain the country competitiveness. This discouraging evolution in competitiveness, in turn, resulted in recurrent balance-‐ of-‐payments crises and stop-‐and-‐go cycles determined by the availability of foreign exchange, generating increasing inflation and macro instability. For authors like McKinnon or Shaw, financial repression (FR) was among the main culprits for the persisting macroeconomic distress16. The idea seduced the military elite around the time of the coup d´etat. Henceforth, in order to curb the vast macroeconomic dilemma, the dictatorship launched an ambitious liberalization package, a shock therapy directed to remove (or reduce) the number of controls over the economy, including the reduction of trade barriers, the gradual removal of capital controls and the freeing of interest rates. Financial liberalization, in turn, was accompanied by the passing of the Financial Entities Law, in 1977, whereby financial institutions were allowed to organize themselves as universal banks. A new stabilization program was also put in place, introducing a new exchange rate regime: a preannounced rate of crawl (the “tablita”). The program captivated, in particular, financial investors, as it promised important and (apparently) safe returns17. The credibility of the economic program, however, become under stress after the Central Bank of Argentina was forced to rescue of several banks from systematic failure in March 1980. Problems aggravated soon after when the monetary authority became required to finance the public sector deficit. Consequently, and in order to seduce investors, the government raised interest rates on peso deposits18. An opportunity for arbitrage was evident, marking the beginning of the end for the neoliberal experiment. At early 1981, a balance of payment crisis marked the end for the dictatorship duple Videla – Martinez de Hoz. 16
By leaving interest rate at market forces, the economy would automatically adjust to the equilibrium levels, and henceforth, a more efficient allocation is obtained. The economy is thought to perform under a Wiksellian framework, were savings equals investments, and interest rates movements only affects savings decisions via the substitution effect. But, in real world saving decisions are also income and wealth effects. The approach also misses the role played by liquidity constraints under financial repression, and the fact that financial liberalization may stimulate consumption rather than savings. 17 The new legislation passed by the government in 1977 allowed banks to accept deposits from
non-‐residents denominated in foreign currencies. Originally investors were obliged to kept deposits for a year, although the requirement was later relaxed until its abandonment in 1979. 18 By the end of 1980 the interest differential adjusted for announced depreciation was approximately 3% per month
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At the aftermath of the crisis, the Argentina economy reversed prior liberalization measures, reintroducing several controls previously dismantled, including those affecting the capital account. Nevertheless, been harshly constrained by the external debt and low commodity prices, the Argentinean economy failed to recover19. In the spring of 1989, inflation spiraled out of control, and President R. Alfonsín was forced to resign six month ahead of schedule. The launch of the convertibility plan in March 1991, introducing a fixed one-‐to-‐one dollar-‐peso exchange rate, enabled Menem’s Government to stabilize the economy after the chaos that followed the debt crisis,20. Dollarization of the local economy become highly encouraged by the national government, by making legally feasible to write contracts in foreign currencies and allowing foreign currencies to be used as an alternative means of payments. More or less simultaneously, Argentina embarked in a process of trade deregulation and liberalization, reducing tariffs significantly and dismantling practically all barriers. Likewise, authorities lifted almost all previous restrictions on international investments, including those banning or limiting foreign participation in key economical sectors21. Financial markets were liberalized and deregulated, and former restrictions on the entry of foreign banks were raised. Privatizations soon became one of the pillars of the new economic programme, enabling the government to reduce its external debt, remove the financial liabilities generated by public utilities from the public sphere, and last, but not least, attract fresh FDI22. Argentina’s macroeconomic performance improved notably and the country entered into a solid upward spiral of growth, with the national economy expanding by around 9% per year in 1994. Foreign direct 19 During the period 1981-‐89, average real GDP growth was negative at -‐0,7 percent, and real income in 1989 had slid to 90 percent of its 1980 level. 20 The plan required the monetary base to be backed with international reserves (2/3) and dollar-‐
denominated Argentina central bank securities at market prices (1/3). Argentina’s Central Bank was effectively converted into a currency board that could only issue domestic currency in exchange for foreign currency at a fixed rate. 21
In 1994, the country granted foreign investors the national treatment status, including those participating at the financial sector. 22 Privatization revenues, on the other hand, postponed the resolution of the historical low saving rate of the Argentina. The problem will become more accurate at the end of the nineties, when public deficits began to increase pari passu with foreign investors demands of greater fiscal discipline.
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investment began to arrive at the country, particularly directing at the utilities sector (gas, electricity, telecommunications)23. However, the exposure of the economy to international capital flows volatility remained immense, at the same time that the space for policy options was sinking24. And, unfortunately, the Tequila crisis arrived. The economy slumped, with gross domestic product falling by 2,8 percent in 1995. The financial sector was particularly affected as bank deposits plunged by 18% in less than five months (from 20-‐12-‐1994 to 12-‐5-‐1995), forcing monetary authorities to assist financial entities in problems25. Fortunately, the government obtained additional financing from official and private sources, plus the assistance from IFIs. In order to maintain the credibility on the system, authorities undertook several actions, including the introduction of new legislation and further encouraging the arrival of foreign entities26. Accordingly, whereas in 1994 only 15% of total Argentine banking system assets was held in foreign banks, its market share increased to 55% in 1998 and 73% in 2000 (De la Torre, Levy Yeyati and Schmukler, 2003), denationalization process that coincided with an accelerating process of banking concentration (Damill, et.al., 2010)27. In order to keep the Convertibility alive Menem and Cavallo played tough enough, allowing interest rates to increase up to 40% and raising (unpopular) taxes (basically, VAT rate from 18 to 21 percent). They demonstrated their commitment to the model and to the economy orthodoxy, and (temporarily) succeeded (Blustein, 2005). Contentedly the challenge becomes quickly overcome, and the economy recovered in 1996. Henceforth, Argentina became a showcase of successful reform in LAC and President Menem was hailed as an example to follow in the 1998 annual meeting 23 A second boom of FDI took place at 1997-‐99 period, when a much large fraction of Argentinean
assets where sold to foreign residents, including the privatization of YPF, the former state-‐owned, company at the oil and gas market. 24 Sterilization operations were reduced whereas former controls on the capital account were completely lifted. Henceforth, the government become prisoner of investors´ mood and obliged to constantly seduce them (reputational game). 25 The convertibility eliminated Central Bank role as lender of last resort 26
The government have previously modified the Law of Financial Entities granting national treatment to foreign banks and removing a former ban on market entrance (Damill, et.al., 2010). 27 As a consequence of the Tequila, financial entities in operation reduced from 205 to 158, being 106 at 2001.
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of the IMF and World Bank in Washington28. Thinks were not equal, however, after a new series of financial crises broke out in 1998. Thereafter the Argentine economy slipped into a downward spiral towards depression and crisis. A year later, Argentinean GDP experienced a 3,4% plunged, mostly driven by an impressive fall in investment (13,6%). Decreasing consumption, on the other hand, relapse trade balance deficits as imports almost collapsed. But public debt keeps increasing (surpassing the $ 100 billion barrier in 1999), and foreign investors began to carefully observe the Argentinean fiscal deficit. As the government offered higher yields, however, they kept on buying Argentinean bonds29. Once the new elected government of De la Rua took office in December 1999 recession was installed. Nevertheless, investing banks and rating agencies maintained their “interest” in the country, continuing the selling of Argentinean bonds all around the world, particularly among less informed investors in Europe and Japan30,31. In order to keep alive the convertibility plan, the government also obtained in a trial to shield the convertibility and revert foreign investors mood, the government agreed a three-‐year standby arrangement for $ 7,2 billion in March 2000, augmented by $ 13,7 billion at January 2001. The bailout agreement (the “blindaje”) was an initiative commonly introduced by the Fund in order to assist emerging countries at financial distress32. In September 2001, the IMF loan was
28 As exemplified by the enthusiastically words pronounced by the former IMF Director Michael Camdeessus at the occasion “[I]n many respects the experience of Argentina in recent years has been exemplary, including in particular the adoption of the proper strategy at the beginning of the 1990s and the very courageous adaptation of it when the tequila crisis put the overall subcontinent at risk of major turmoil… [S]o clearly, Argentina has a story to tell the world: a story which is about the importance of fiscal discipline, of structural change, and of monetary policy rigorously maintained”. 29 Higher interest rates reflected, in turn, pessimistic perceptions from investors or higher country-‐ risk (“riesgo país”). As documented at Blustein (2005), the influence of both, investment banks and rating agencies, in attracting foreign investors was superb. Certainly, those actors were not forcing Argentine authorities to avoid a prudent fiscal policy. 30
Syndicated investment banks tailored a number of their offering to Europe attracted by regulatory leaks, and small investors appetite for higher yields (Blustein, 2005). Consequently, Italian retail investors were among those convinced to sue Argentine at the (international) tribunals to claim for the full payment of their bonds. 31
From January to September 2000, the Argentine government borrowed nearly $ 6 billion by selling dollar-‐denominated bonds, at interest rate from 11 3/8 per cent to 12 per cent. It borrowed another $ 4 billion – plus by selling euro denominated bonds, mostly to European retail investors, paying annual interest of 8 1/8 per cent to 10 ¼ per cent (Blustein, 2005). 32 By fixing the loan at U$ 14 billion, the bank surpassed in excess Argentine’s lending limits.
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newly extended up to $ 22 billion from which, $ 3 billion were used in support of a possible debt-‐restructuring operation Macroeconomic perceptions in local businessman plunged and unemployment and social indicators worsened as the new economic team preferred to reassure foreign investors expectations by introducing a tightening fiscal policy. But the new package did not help in reversing pessimistic perceptions from economic agents, condemning the convertibility to fall. In a latest attempt to rescue the plan and impede massive capital outflows and a generalized run on banks, the government introduce financial controls (termed the “Corralito” or little corral”). Likewise, foreign currency transactions were prohibited preventing both, local and foreign investors to transfers funds abroad. A month later, in January 2002, the peso was officially devalued, and all the bank deposits and debts were converted in pesos33. The local economy began its recuperation thereafter, to great extent, thanks to the instauration of a competitive exchange rate policy. During the 2003-‐2009 period, Argentinean GDP grow at a rate of 8,5%. Previous liberalization measures on the capital account were phased out, as the government introduce several controls following the crisis34. In particular, and following the 2001-‐02 crisis, the Central Bank of Argentina (BCRA) introduced a 90 days residence requirement [to be further extended up to 1-‐year residence period]35 and a 30% tax on incoming funds. Restrictions were also affecting commercial operations; as importers currencies requirements required BCRA approval whereas exporters become obliged to vend their currencies earnings to the BCRA. Capital controls began to be relaxed by the end of 2002, but resumed when the latest crisis made its arrival. After private enterprises began to flight capitals
33 Dollar deposits were converted at 1,4 pesos to the dollar, while dollar loans were subject to one-‐
to-‐one conversions. 34 As Argentina maintained its capital account open until the latest days of the convertibility scheme,
outflows of capital augmented during 200-‐01 ($ 23 billions left the country in that period). Controls were reintroduced at December 2001, but funds poured out throughout the stock market channel. 35 BCRA A/3712 September 2002. It would be extended to 180 days one year later (BCRA A/3972), and up to 1 year (BCRA A/4359).
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responding to increasing political turmoil and increasing macro instability, the government reintroduced some policy measures in order to block capital outflows.
2.3 IMF lesson 2: South Korea Since the early 1960s to last eighties Korea economic policy was inspired by a export-‐led growth model. From the time when General Park launched its wide-‐ ranged economic reform in 1963 to year 1997, the real per capita income growth averaged more than 6% annually. On the whole, the Southern Korean miracle rested on a particular mix of market incentives and state direction, together with a highly repressed financial market (Amsden, 1994; Chang, 2008). Domestic savings (plus international aid) financed capital accumulation during this period, whereas capital inflows either in the form of portfolio investment or FDI were not in attendance. Industrial policy guided financial system behaviour, and (national) banks funds were basically directed to the productive sector36. Loans were mainly allocated according to the government choice and its policy goals, facilitating the expansion of large business conglomerates. As occurred in many Asian countries, and after a brief experiment with floating, the Korean won was pegged to the dollar, and it would remain so until 198037. Likewise, international capital flows were highly controlled and financial repression widely extended (Noland, 2005). Controls were present in several sectors, including a broad range of areas from foreign exchange and strict restrictions were also imposed on FDI if not directly banned – similarly, outward FDI required official approval and was subject to strict regulations. Trade policy was also under government scrutiny,
36 General Parker Lee launched the development project in the early 1960s. Under this regime, the government-‐channelled funds to those firms that had succeeded in exporting its goods – originally, light manufacturing goods such as textile and apparel and footwear. A decade later, South Korean government introduced the Heavy and Chemical Industry Promotion Plan (HCIP), targeting 6 heavy manufacturing industries for development. The plan favored the creation of large business conglomerates (Chaebols). 37 For example, Japan pegged its currency at 360 per dollar for two decades. In February 1980, South Korea moved off a strict dollar peg and began to peg the won to a basket of currencies that constituted the Special Drawing Right plus a policy adjustment factor. Thereafter, the currency depreciated against all currencies in the basket.
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particularly on the imports side38. The local currency was nonconvertible and, as experienced by other developing countries, the Korean government also discouraged any offshore market in won or won-‐denominated instruments. Current accounts were also firmly controlled by the government and strict exchange restrictions were applied to all capital outflows till the 1980s. Liberalization, nevertheless, began to gain momentum in the late 1980s to be finally adopted in the 1990s39. At the aftermath of the 1997 financial crisis, henceforth, Korea Republic turned definitively into the neoliberal path40. The Kim Dae-‐Jung government accepted the mainstream view and implemented the restructuring programme suggested by the IMF (Turner, 2010; Lee, 2010) and, unquestionably, deeply backed by the US government (Crotty and Lee, 2005)41. The financial sector was at the centre of the changes to the economic system, as the government indentified financial repression and industrial conglomerates -‐ chaebol corporate governance as the culprit of the crisis42. Henceforth, Korean authorities adopted a profound liberalization package after the crisis, implying more deregulation and privatization. Likewise, the government raised the short-‐ term interest rate along imposing a restrictive fiscal policy (Crotty and Lee, 2005),
38 The government introduced in 1978 an import diversification program (IDP), whose objective
was to restrict imports from specific countries but Japan, with which Korea was experiencing a serious trade deficit (Cheong, 2002). 39 In adopting the package, pressure from the US was important, certainly. But, Korea interest to
joint the OCDE also pushed in the same direction. 40 Certainly, the arrival of General Chun in 1979 marked a turning point in South Korean economic policy. In this sense, the new government launched a financial liberalization package in 1982. But, financial repression and capital controls were maintained. Foreign participation in financial markets and domestic firms´ access to foreign capital continued to be limited. Likewise, alternative sources of corporate finance were suppressed (Nolan, 2005). 41 “The IMF´s major shareholder governments made no secret of their view that IMF assistance should be accompanied by strong reforms. The U.S. authorities in particular insisted that strong reforms should be a condition of IMF support” (IMF, 2003, p. 185, quoted at Crotty and Lee, 2005). 42 The 1980s financial deregulation implied the expansion of the non-‐bank financial institutions
(NBFIs), financial entities mainly dominated by the chaebols. NBFIs grew rapidly, intensifying the financial power of the conglomerates that, in turn, were profiting from more freedom in investment and financing (Lee, 2010). During 1996-‐97, an important number of firms enter into bankruptcy (including, among others, Hanbo Steel and Kia Motors), and dragging their lenders with them (as, for example, Seoul Bank and Korea First Bank) (Sohn, 2002). In the aftermath of the crisis, Chaebols were coerced to merge, strategy that become know as the “big deal”. In exchange they received extensive tax benefits and financial support (Amsden, 2001).
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certainly in tandem with a traditional IMF discourse43. Macroeconomic numbers were, unquestionably, in that direction, with year 1998 to be considered as the worst in Korean economic history (Lee, 2010), GDP plunged 6,9% whereas consumption reduced a 10,6%. IMF recessive policies were suffered the most by the corporate sector, as credit crunch left Korean firms with lesser funds. As a result, corporate investment collapsed in 1998, and fixed investment shrank by more than twenty per cent (Lee, 2010)44. Henceforward, Korea initiated a new macro trend, where investments become less relevant and private consumption incentivised45. The government went further from the IMF package, deepening the original trade liberalization programme46. In terms of investments and business environment, foreign investors were among the most benefited (Noland, 2005; Lee, 2010)47. FDI deregulation continued its pace, and the 1998 Foreign Investment Promotion Act removed many of the former restrictions48, including cross – border M&A operations. Similarly, restrictions on remittances were completely lifted under the new legislation, guaranteeing foreign investors legally and unconditional transfers of funds, even under circumstances of exogenous shocks (Sohn, et.al.; 2002).
43 At the 2008 crisis, in contrast, the government conducted an aggressive expansionary fiscal policy
– including a generous stimulus package (Kim, undated). 44 The fall in gross investment ascended to 22,9%. The low investment ratio persisted even after the 2004 recovery. Although firm’s cash flows were recovering fasts, Korean bosses paid their debts and maintained liquid. 45 From a 35-‐40% range in the 1990-‐97 period in 1990-‐97, gross investment descended to 25-‐31%
thereafter (Crotty and Lee, 2005). 46
Liberalization was undertaken in two rounds. Under the first the government eliminated subsidies and the import diversification program (IDP), reduced the number of items subject to adjustment tariffs, revised import procedures and (partial) liberalized the services sector. At the second round, the focus was on reducing regulations on trade (Sohn et.al., 2002). 47 As for example, increasing the foreign ownership ceiling in Korean companies up to 55% (December, 1997), to finally fully liberalize it (May, 1998). Likewise, the government lifted previous regulations on corporate bonds. 48 At September 2001, some 1029 business areas were entirely open to foreign investment with only
8 business areas partially open (primary industry (rice and barley; beef cattle framing, and fishery); wholesaling of meet; publication of newspapers and periodicals; energy industry; maritime transportation; air transportation; telecommunications; and specially chartered banks such export-‐ import banks) and 2 areas entirely closed (radio and TV and broadcasting) to foreign investors. A year later, around 99,8% of all business sectors were open to foreign investments (Sohn, et.al., 2002).
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Following the reforms the government allowed long-‐term deposits by non-‐ residents in domestic financial institutions, further deregulation of domestic firms´ short-‐term borrowing, partial deregulation of real estate investment abroad, along accepting foreign currency transactions by all financial institutions and individuals (Lee, 2010). Liberalization measures in the M&A front along lower asset prices and depreciation of the won encouraged foreign companies to enter in the Korean market (Sohn, et.al., 2002; Lee, 2010). Furthermore, and as observed at Argentina in the aftermath of the Tequila crisis two years before, South Korean monetary authorities encouraged the entry of foreign banks in order to give a boost to the national financial system. Either by acquiring or by equity participation, foreign capital invested directly in the Korean banking industry (Lee, 2010)49. The economic performance, however, was rather unsatisfactory since reforms become implemented (Crotty and Lee, 2001; 2006) but recovering with the arrival of the new millennium. Liberalization of the capital and foreign exchange markets increased foreign capital inflows into the economy thereafter, but at the price of rising volatility and macro inconsistencies. Under this new scenario credits become redirected towards consumption (Nolan, 2005; Lee, 2010). As capital account liberalization led to won appreciation, on the other hand, and the government forced domestic financial institutions to purchase monetary stabilization bonds (MSBs) in order to sterilize inflows50. Open market operations, in turn, increased the Bank of Korea vulnerability to interest rate differences and exchange rate fluctuations (Kim, et.al.; 2008). In order to impede exchange rate from appreciation is Korean authorities introduced a set of measures encouraging
49 The foreigners´ share in the banking industry passed from 16,4% in 1997 to 50,2% in 2003, and 57,8% in 2007, a share similar to those experienced at Latin American countries. Three of the top ten foreign banks operating in Korea at 2006 were from the US, controlling 25% of the commercial banking market. Citigroup is one of the leading players in the market (USITC, 2010). 50 MSBs returns, however, were highly costly for the government (Kim, et. al., 2008). A variable deposit requirement (VDR) on capital inflows was an alternative. Despite to be a controversial instrument, and potentially challenged by foreign investors, it become explicitly authorized under the Foreign Exchange Act of 1999 (Noland, 2005).
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capital outflows51. Conditions were also mature enough as to inflate a bubble affecting the real estate market. After 2006, however, capital flows turned negative, including the balance of portfolio investments as foreigners decide to go short on their investments (BOK, 2009; Lee, 2010)52. But, in order to suppress real estate price increases the BOK maintained its differential interest rate differential maintained. Henceforth, the Korean banking system continued to attract massive funds from abroad and capital account remained positive.53 The subprime crisis produced an abruptly change of expectation in investors. The banking sector suffered from de-‐leverage as it was not able to roll-‐over its short term debt (Kim, undated). Expectations on exchange rate appreciation, on the other hand, led foreign investors to rescind derivative contracts and remain liquid. In sum, all the above led to the collapse of stock prices and instability of the domestic financial and foreign exchange market (Lee, et.al., 2010). Following Lehman Brothers collapse, the Korean won had depreciated by over 25,4% whereas the stock price plummeted by 27,2%. Nevertheless, the new government of Lee Myung-‐back continues strongly persuaded with the new financial-‐led growth strategy initiated a decade before, aiming to convert South Korea, and Seoul in particular, in the financial hub of northern Asia. As it will be commented in the next section, the Korea-‐US Free Trade Agreement (KORUS FTA) is pushing in the same direction. But, despite their advocacy towards financial liberalization and capital account openness, the government has now plans to (re) introduce controls in order to curb capital inflows, including a withholding tax on foreign investors´ bond
51
Measures included the relaxation of restrictions on overseas real estate investment, encouragement of fund-‐type overseas portfolio investment, and deregulation to boost corporate expansions overseas (Kim, et.al., 2008). 52 Residents’ investments abroad in real estate increased from U$ 22 million in 2005, to U$ 2,7
billion in 2007! Overseas equity investment also augmented during these years, but less spectacular: from U$ 11 billion to U$ 50 billion. 53 The high interest rate policy, in turn, was set by the monetary authorities in order to suppress the real estate price increase.
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holdings along further limits on currency forward trading54 (FT, S Korea Plans capital controls, October 19, 2010). Following growing military tension in the Korean Peninsula and frightened from a sudden reversal of flows, Korea announced its intention to apply a levy on banks´ foreign – exchange borrowings (Bloomberg, “South Korea Imposes Levy on Foreign Exchange Borrowings to Stop Outflows” December 20, 2010).55 On October, this year, the government also imposed a limit of 250 % of equity capital on foreign banks and 50 % on domestic banks to reduce volatility in capital flows (Bloomberg, 2010)56. The next section analyse the issue from a micro perspective, including a critical vision over the regulatory and prudential measures affecting the banking industry.
2.4 Micro: Beyond Basle regulation The provision of financial services has undergone a transformative expansion in the last decades, moving away from a largely domestic market to an increasingly internationalized space. Consequently, whereas in the past foreign shocks spread into the host economy mainly through trade channels and with an important lag, nowadays shocks affects the domestic financial markets almost immediately57. As capital flows are canalized throughout the financial system, transforming flows into bank liabilities almost instantly. Therefore, it becomes relevant to put the bank system into the picture. As financial intermediaries, on the other hand, banks have a dual, and generally, pro-‐cyclical role, spreading credits (during booms) and 54
Yoon Jeung-‐hyun, South Korea’s financial minister declarations at the Parliament “We are preparing to counter the potential problems that liquidity flows into emerging countries sparked by low interest rates worldwide can cause”. 55
Finance Vice-‐Minister announced the government intention “to regulate systemic risk from excessive capital inflows and outflows”, deciding to introduce a bank levy to curb this problem. 56 The government is preparing new measures in order to stop the won from appreciating. As an example, it might be tightening the cap on banks´ holdings of foreign – exchange derivatives. Furthermore, in order to tackle speculators, South Korean regulators began to audit of how banks should handle foreign-‐currency derivatives. Likewise, on December 8, 2010 the National Assembly passed a bill that will from January 1st tax interest income from treasury and central bank bonds by as much as 14% and put a 20% levy on capital gains from their sale. 57 The standing role of the financial market appeared after the collapse of the Bretton Woods system. Until the 70s, on the one hand, international financial markets were tiny and highly regulated and capital controls were worldwide used. On the other hand, foreign investment flows were scarce and capitals arriving to developing countries were almost under the FDI form.
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disseminating the crisis (starting the burst). Financial deregulation coupled with capital account fully convertibility; certainly, increase the likelihood of banking crisis, especially when banks funded themselves on wholesale markets abroad (Eichengreen, 2010). Regulating cross-‐border transactions becomes imperative, henceforth, as financial globalization has altered the traditional transmission mechanism. In order to postpone such an adjustment, cross-‐border regulation includes reserve requirements on cross-‐border inflows, minimum stay periods for incoming capital, and prohibition of certain transactions –e.g., lending in foreign currencies to economic agents that do not have revenues in those currencies. Regulating the banking industry at the national level has also become imperative. Bank supervision and regulation come into the sphere of the Basle Accord, including the formulation of capital adequacy standards -‐ fixed at 8%58. Critics highlighted the rigidity and simplicity of the standards, along its inadequacy to encourage long term lending and investments (Stalling, 2006). Standards would become later replaced by new set market friendly rules, the Basle II Accord59, by which regulation become replaced deregulation with self-‐monitoring of risks60. The new approach was ill conceived as it failed to perceive when the risk arises (Stalling, 2006, Tarullo, 2008)61. Furthermore, the new capital requirement fixed 58 The Committee on Regulation and Supervisory Practices was created by the Group of Ten (G-‐10)
at mid-‐seventies, as a response to the failure of HERSTATT Bank causing significant disturbances in currency markets around the world. The Committee has not formal legal existent or permanent staff, functioning at the Bank of International Settlements at Basel, Switzerland. In 1975, the Committee launched its first paper introducing the principles for supervisory responsibilities and twelve years later it published its “Core Principles for Effective Banking Supervision” (Tarullo, 2008). 59
Around the same time, the US Congress passed the Gramm-‐Bliley-‐Leach Act dismantling the regulatory architecture introduced by the Glass-‐Steagall Act of 1933. 60 The Basle II Accord was negotiated between 1999 and 2004, been they main objectives to produce the rules by which minimum capital requirements would be set under domestic bank regulatory policy in each country represented on the Basle Committee on Banking Supervision. Its internal rating-‐based approach was at the centre of the new regulation. 61 The new framework is not only inappropriate for measuring risks among emerging economies, but also at those involving developed countries financial systems. Tarullo (2008) criticize Basle II approach on the basis that it would not have been adequate to contain the risk exposed by the subprime crisis. In particular, he critically assesses the advanced internal rating based (A-‐IRB) approach, as being enormously complex, full of opportunities for bank and national supervisory discretion.
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under the new accord reinforced the pro-‐cyclical trend characterizing the former agreement. Advance countries and emerging market economies have different point of interest from each other62. Emerging market economies have special interest on cross-‐ border flows and liquidity risk management of the foreign currency, not just of those in local currency. As witnessed in the latest crisis, currency crisis in emerging markets might begin to spread by foreign investors flea one country after another, endangering the squeeze in currency liquidity. Thus, for emerging market economies, the key task against external shocks is to manage properly the balance of payment in a national dimension, as well as the foreign assets and liabilities in a corporate dimension (Lee, et.al., 2010). Analysed countries have important differences, as for example respecting the legal figure granted to international banks operating at Korea and Argentina (foreign branches versus subsidiaries). Also both countries financial sectors classified as repressed prior to the reform, the banking sector in Argentina characterized for a more important presence of the State, a larger number of banks and a less concentred market63. Following the liberalization process, similarities were on the rise, with the exception that State run banks become more important at Korea after the crisis. The case of South Korea comes first. Within a decade of interlude, the country suffered two foreign currency liquidity crises. Before the crisis, foreign borrowing was the main channel through which foreign capital flowed to the country as other transactions were banned. After the first crisis the government fully liberalized capital inflows, including foreign investment in the short – term money market. Likewise, and with the objective of modernize the banking sector, authorities encouraged the arrival of 62
Historically, however, today developed countries defended the sequencing argument, putting firstly in the list, a proper regulatory and supervisory body. 63 At 2004, Argentina hosted a total of 206 banks against 30 in Korea. The three largest banks concentrated 39,1% of total deposits in Argentina, whereas in Korea the market share of the three largest banks was 52,8%.
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operators from abroad64. The Foreign Investment Promotion Act of 1998 becomes the legal instrument opening up financial institutions to foreign investors. A new wave of FDI arrived at the banking industry, now under the form of green-‐field investment and M&A, ending with a majority presence in the industry (Yi, et.al., 2009)65. Capital outflows were also being stimulated by authorities (Nolan, 2005; Kim et.al., 2008). At the institutional front, the government enacted a new legislation encouraging full-‐scale deregulation in capital markets (Lee, 2010)66. Under the new scheme, domestic investors become entitled to invest abroad, whereas non – residents were also allowed to make deposits and open accounts denominated in Korean won. The opening of both the bond and securities markets amplified the channels for capital inflows and outflows67. Financial regulation was certainly poor when the 1997 crisis made its appearance68. After the [first] crisis, henceforth, the government began to push for strict prudential regulation as indicated by the Bank for International Settlements (BIS) (Lee, 2010)69. Similarly, the government introduced new regulations in order 64 Foreign banks could enter at the Korean banking sector in three different ways: either through foreign bank branches making corporate loans, through running both its retail and wholesale level bank business under its own brand name, or through directly acquiring stock ownership in the stock market (Yi, et.al., 2009). 65 FDI in the financial sector increased form $ 341 million in 1997, to $ 2.580 in 1999, and to $ 1.925 in 2000. Of the seven major domestic banks (Kookmin Bank, Woori Bank, Hana Bank, Shinhan Bank, Korean Exchange Bank, Korean Citi Bank, Standard Chartered First Bank), only Woori Bank was not foreign owned at the end of 2006 (Yi, et.al., 2009, p. 131). 66 The “Capital Market and Financial Investment Services Act”, which merged six individual acts. The
new legislation introduced the negative-‐list approach along a broader definition of financial investments. 67 Bond market activity significantly expanded after 2003, whereas stock market capitalization more
than tripled between 2000 and 2005 (Kim et.al., 2008). 68 To the extent that many authors blamed domestic governance failures as one of the main factors originating the crisis – particularly predominant in official circles in the developed world. A similar vision could be found at the IMF, at describing, “financial sector vulnerability was at the root of the Asian crisis”. But, on the other hand, irresponsible liberalization could be blamed. According to Yi, Miller and Jeon (2009) since 1993 Korean authorities were relaxing controls, in particular, benefiting the arrival of foreign banks 69 In 1999, Korean authorities integrated four supervisory bodies (the Office of Bank Supervision, Securities Supervisory Body, Insurance Supervisory Body, and Non-‐bank Supervisory Authority) into a single new entity (the Financial Supervisory Service). By the end of 2006, the New Basel Capital Accord were passed to major banks (Kim, et.al., 2008).
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to avoid maturity mismatches in bank’s foreign currency assets and safeguard systems such as variable deposit requirements (VDR) were also set up (Lee, 2010). However, and despite all the above institutional changes, at the hike of the 2008 financial turmoil economic agents began to redirect funds abroad (Lee et.al., 2010)70. But, the problem was predated. Since 2006 the external debt began to increase rapidly, a phenomenon largely attributed to loans related to trading in derivatives market to be repaid by future foreign exchange revenue (Lee, 2010). Korean banks were hedging risks throughout swap operations. But, again, in order to make the funding costs cheaper they were borrowing USD with short-‐term maturity. When Lehman Brothers collapse, banks become to suffer from de-‐ leverage. As a result, and resembling the 1997 crisis, the economy was suffering from another currency-‐mismatching problem, although banks were now the most affected players71. Thinks gets worse, however, as most banks relied on short-‐debt, introducing a maturity mismatch problem [to the commented, currency mismatch one] (Kim, undated). Henceforth, and overall, the crisis confirmed the “pro-‐ cyclicality of the banking sector. From a strategic perspective, the plan to attract FDI was ill conceived, as it provided important incentives (Lee, 2010), but few conditions. At Korea, developed country banks in particular were more than willing to lend to the emerging markets countries before mid-‐1997, but they tended to do so in dollars or yen (often at short maturities). When banks withdrew credits and helped to precipitate the crisis, IMF the international rescue efforts also largely ensured that international banks were repaid (Walter, 2006). Argentina 2001 crisis comes next, whose financial system strength served as an example to other emerging economies. To begin with, it might be remember that under the currency board the Argentine banking system was heavily exposed to a
70 As Korea has achieved perfect FX liberalization both local and foreigners’ investors were leaving funds. Local investors were allowed to buy foreign real estates without restrictions, whereas offshore funds and overseas funds domiciled in domestic jurisdiction were also permitted to outbound foreign equity related investment. 71 During 2006 -‐ I Quarter to 2008 -‐ III Quarter, U$ 168 billion flowed into Korea. From this total, U$ 137,4 billions were funded by the banking sector. After 2008 -‐ IV Quarter, and despite the Korean government declared a loan guarantee, lenders withdrew from banks U$ 59 billion (Kim, undated).
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devaluation of the peso against the US dollar. This helps to explain why the collapse of the convertibility regime has become associated widely with a dramatic banking crisis. Authorities, as a consequence of the limited deposit insurance scheme designed under the convertibility plan, particularly considered liquidity provisions72. Likewise, and in order to preserve the solvency of the financial system, the government introduced strong capital requirements, going beyond 8% recommended by the Basle Committee73. The regulatory front showed several weaknesses, however. The financial system was ill equipped to deal with a modification in relative prices, in particular, how the banks response should be to additional capital requirements posed by the change. But, there were no regulatory alternatives for non-‐tradable producers dealing with repayment problems related to exchange rate risk. High regulatory standards introduced via Basle Accord also failed to prevent the excessive risk introduced by public sector lending (Damill, et.al., 2010)74. Argentina needed to keep its debt ratios in check, particularly its debt to GDP ratio. As the fiscal burden deteriorated exchange risk amplifies, forcing monetary authorities to increase interest rates in order to maintain investors´ interest75. Consequently, the bank system became overexposed to a sovereign default (increasing bank’s solvency problem) and, additionally crowding out funds from private agents. After the Tequila crisis, and following the massive outflows experienced by domestic banks, the Menem’s government introduced a number of reforms in order to strength domestic banks encouraging, at the same time, the entrance of 72 The absence of an institutional safety net (i.e.: lending of last resort), however, becomes one of the Achilles’ heels of the Argentinean financial system. An important currency -‐ mismatching problem was also underestimated along the system exposure to a public sector default (Damill, et.al.; 2010). 73 Argentina adhered to the 1988 Basle Accord in 1995 and, one year later, to its 1996 market risk
amendment. 74 Developed countries sovereign risk is considered to be negligible and, henceforth, they offer lower yielding. However, raising debt concerns have increased risks for an important group of countries (others some among them still benefits from “club effects”). But, what really aggravated the Argentinean case was to be forced to borrow in foreign currencies (“the original sin”). When the collapse finally arrived, 27% of financial credits were holding in public sector pockets. 75 After the arrival of the crisis in 1998, the fiscal burden deteriorated progressively, both at national and provincial level. As recession advanced, some provinces were forced to introduce cuasi-‐money.
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foreign institutions. Likewise, Argentina advanced into the privatization process, in which the government got rid of practically everything with the sole exception of the National Bank (Banco de la Nación Argentina -‐ BNA). Prudential regulations were also expanded, introducing now new and strong “market evaluation” test (colloquially known as the BASIC system) along the enforcement of Basle plus regulations76. Following this set of policy measures, a significant process of mergers and acquisitions took place in the industry (Burdisso and D´Amato, 1999), strongly supported by the Central Bank (Damill, et. al., 2010). As a result, 9 banks were holding 67% of all deposits at year 200077, with 2 public institutions leading the list (BNA and Banco Provincia) (Economist. March 4th, 2000)78. Interest rates spreads, however, did not diminish despite the system gain in efficiency and foreign banks were certainly more cautions when extending credits. When evaluating the role of foreign banks, the picture is more nuanced than expected. Certainly, as financial risk increased they began to reduce their exposure (Dominguez and Tesar, 2005), unmasking their proclaimed fortress – in particular, when looking at the limited assistance from headquarters to subsidiaries in distress (Moguillansky, et.al., 2004; Damill, et.al, 2010)79. Foreign exchange mismatching, in the other hand, further encouraged the interest rate arbitrage benefiting foreign banks the most as they confronted lower hedging costs (Damill, et.al., 2010)80. Independently of their origin, banks were mainly redirecting funds 76 The government passed several reforms into Organic Chart of the the Central Bank of Argentina (BCRA) including a new article in the financial entities law (Damill, et.al., 2010). 77 Bank concentration as measured by total assets at the 20th largest banks, passed from U$ 23
billion in 1994 to U$ 80 billions in 1998, implying a significant increase in their market share (from 34% to 61%). 78 Six out of the seven followers were foreign owned banks. Spanish banks were at the top of the list,
reflecting BBVA (Banco Francés) and Santader (Banco Río) participation in the Argentinean financial sector. 79 In the case of the U.S. legislation establish that a bank ins not obliged to pay deposits made in a subsidiary abroad if it is unable to do so because: a) a state of war, insurrection or civil revolt exists; or b) because it is prevented by an action or instrument of the government of the host country, undertaken without explicit agreement with the bank. This law was added to the existing legislation in 1994, after Citibank was taken to court by depositors in the Philippines and Vietnam and lost the respective cases [Section 25C of the Federal Reserve Act, section 326 of the Riegle-‐Neal Interstate Banking and Branching Efficiency Act, codified in 12 US Code Section 633] (Moguillansky, et. al., 2004) 80 By the end of 1998, financial system external debt reached U$ 17,5 billion, almost 20% of the banking sector total liabilities.
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towards private consumption, real estate mortgage and commercial lending81. Lending to private agents, however, began to be curtailed following the Asian crisis, to plummet thereafter. Banks have not curtailed, however, their lending to public sector entities, despite weaker repayment guarantees (Damill, et.al, 2010), demonstrating that their rent-‐seeking relationship with the State have not changed. Asymmetric pessification, however, exacerbated banks balance sheet problems82. Following the crisis, the government introduced important changes in prudential regulation, beginning by modifying its terms of adherence to the 1988 Basle Accord, reducing the minimum risk-‐weighted regulatory capital coefficient back to 8%. Among other measures monetary authorities also banned foreign currency lending to private agents (except for those having incomes in U$). Likewise, it introduced a ceiling to commercial banks on their liquidity holdings of foreign currencies. State owned banks, on the other hand, played an important contra-‐ cyclical role, after the 2001 crisis.
81 Under the convertibility scheme, certainly, the set of relative prices were not favouring credits
towards the productive sector. 82 As explained by Blustein (2005, p. 192-‐3) “To head off mass bankruptcy, the government decreed
that most people who had borrowed in dollars could repay their loans in depreciated pesos, at the rate of one peso per dollar. At the same time, to appease savers, the authorities announced deposits would be converted at a different rate – 1.4 pesos per dollar. As a result, the banking system, which was already on its knees, was rendered prostrate. The disparity between what banks could collect form their borrowers, and what they owed their deposits, added up to billions of dollars in new losses….As for depositors, they felt cheated, notwithstanding the concession the government had given them…Their angry reaction lead to a deepening of the banking system’s woes, as thousands of them obtained court orders requiring the return of their deposits in full, and money began draining anew from the banking system…”. Banks´ balance sheets were also disturbed by their own mismatching problem, as they were forced to cancel (former) credits in foreign currency (for example, with their headquarters) from local operations.
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3. An Institutional perspective 3.1 Liberalization at both multilateral and bilateral A “regulatory consensus” was floating in academic circles since the Bretton Woods Conference, drawing the attention from policy makers. Likewise, IMF explicitly recognized to member states the right to institute capital controls83. But, the previous consensus broke up with the collapse of the dollar-‐standard in 1971, signalling the beginning of a new era of financial liberalization and market deregulation. Thereafter, a relatively small group of investor countries, led by the USA, took advantage of the unique historical events to implement a strong push towards foreign investment liberalization, particularly in developing countries and economies in transition. These changes resulted from the increasing negotiating strength of the principal investor countries and weakening negotiating strength (coupled with greater external vulnerability) of developing countries and economies in transition. The International Financial Institutions (IFIs), the USA and a few other investor countries seized the moment to dramatically alter the existing relationship between investor countries and host countries. Financial deregulation and capital account liberalization were part of the central message emanated at Washington. Financial services deregulation becomes one of the leading issues for those representing the US delegation at the Uruguay Round. Since the early 1980s American negotiators were pulling developing nations to open their financial markets and to bring capital convertibility. The objective was finally achieved with the signature of the GATS, which became a constitutive part of the newly constituted WTO (Hoeckman & Kostecki, 2009). The agreement included all internationally – related services, defining four ways or modes of trading services84. WTO financial commitments, in particular, are included in the 83 According to IMF [original] Chapter VI, all member countries had the right to control capital movements. 84 Usually referred as modes. Mode 1 includes services supplied from one country to another. Mode
2 encompasses consumers or firms making use of a service in another country (officially consumption abroad). Mode 3 relates to those operations involving a foreign company setting up
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GATS Annexes on Financial Services, the Second and Fifth Protocols of the GATS (commonly referred under the Financial Services Agreement – FSA), the Understanding on Commitments in Financial Services, and countries´ GATS schedules of financial services commitments. Specific commitments made by members are backed by national treatment and market access clauses, both determining the liberalization impact of the agreement. Henceforth, and in contrast to other international agreements, financial rules introduced under the WTO constitute a ceiling (Public Citizens, 2009), meaning that once accepted rules could not be reversed (Raghavan, 2009)85. Likewise, commitments made under mode 1 (Cross-‐border supply) and mode 3 (Commercial presence) might enforce signatory countries to open its capital account (Gallagher, 2010)86. To some extent, GATS ended to dent financial regulation at local level, including prudential measures aimed to curb financial crisis propagation. However, some WTO members, mostly OCDE countries, introduced more liberalizing commitments than requested. As a result of this market – friendly behaviour, some countries (37 over 100) compromised to inhibit themselves in the use of capital controls, including Argentina but not Korea (Gallagher, 2010, at page 8). Likewise, some members committed themselves to a “standstill” rule, meaning that they are forbidden from rolling back deregulation (or liberalization) for the expansive financial services they commit (TWN, 2010). In relation to the introduction of prudential regulation, although the WTO / GATS Annex on Financial Services contain a “carve out” provision ensuring that the agreement will not undermine domestic law or regulations87. This guarantee presents several loopholes that
subsidiaries or branches to provide services in another country (officially commercial presence). Finally, mode 4 includes individuals travelling from their country to supply services in another (presence of natural persons). Considering its composition, three are the principal elements conforming GATS: a main text, including general obligations and disciplines84; annexes dealing with rules for specific sectors; and individual countries´ specific commitments applying selectively to each of the sectors covered by the agreement 85 In this direction goes the standstill provision contained in the Understanding’s Article (A) (Public Citizens, 2009). 86 In particular, Footnote 8 at GATS Article XVI (Market Access) and Article XI (2). Taking together, these provisions indicate that a country making commitments in the mode 1 and 3 may explicitly be required to open its capital account. Nevertheless, the author recognizes that some exceptions may apply. 87 “Notwithstanding any other provisions of the Agreement, a Member shall not be prevented from
taking measures for prudential reasons, including for the protection of investors, depositors, policy
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ultimately could prevent the introduction of new regulation (Public Citizen, 2009; TWN, 2010; Gosh, 2010)88. Once a commitment has been made allowing for certain kinds of financial activity, the country cannot impose any prudential regulation if they run counters such commitment. In other words, having already committed to deregulate, a country cannot easily undo their legislation (Gosh, 2010)89. WTO members were obliged not to impose restrictions on capital transactions in a way inconsistent with the specific commitment they had assumed with regard to such transactions (WTO, 2010b). But, as liberalization commitments made under the GATS/WTO scheme are far from homogenous (Van Aaken and Kürtz, 2009), it continues to be some room to introduce exceptionalities or prudential measures to those who opted to preserve their policy space. Likewise, as commitments followed a “positive list” approach, further exceptions were always available.90 WTO members are also entitled to undertake prudential measures, including the use of temporary non-‐discriminatory restrictions on payments and transfers in the event of a serious balance-‐of-‐payments problem and external financing difficulties (WTO, 1997) 91. As a result, capital exporters countries considered investment-‐related rules settled at the Uruguay Round suddenly outdate. Henceforth, negotiators from developed
holders or persons to whom a fiduciary duty is owed by a financial service supplier, or to ensure the integrity and stability of the financial system. Where such measures do not conform with the provisions of the Agreement, they shall not be used as a means of avoiding the Member’s commitments or obligations under the Agreement”. 88
Prudential measures could be challenged if they are undermining the regulatory constraints otherwise established in the agreement. The absence of any definition for “prudential regulation”, left the issue subject to interpretation by WTO dispute resolution panels. 89 Gosh (2010) exemplifies the point considering at policies directed to limit the size or total number
of financial services suppliers in those sectors which liberalization commitments have been made (“covered sectors”). Similarly, he also mention the limitation a country have at banning risky financial services once it has been previously committed. 90 In contrast, initiated at NAFTA PTAs launched by the US followed a negative list approach, which give less room for developing countries to protect their policy space. 91 In particular, countries could invoke balance of payments problems following GATS, whose Article
XII – Paragraph 1 states “In the event of serious balance-‐of payments and external financial difficulties or threat thereof, a Member may adopt or maintain restrictions on trade in services on which has undertaken specific commitments, including on payments or transfers for transactions related to such commitments. It is recognized that particular pressures on the balance of payments of a Member in the process of economic development or economic transition may necessitate the use of restrictions to ensure, inter alia, the maintenance of a level of financial reserves adequate for the implementation of its programme of economic development or economic transition”.
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countries went for more at the Doha Round (Public Citizen, 2009), with the European representatives been among the more aggressive instigators (Blustein, 2009). Nevertheless, and away from industrialized economies pressures, a group of developing countries were going beyond their commitments92 at the GATS-‐ WTO93. Signalling practices of this sort were unsurprisingly common at mid-‐ nineties. Developed countries promptly realize this additional concession, becoming excited to institutionalize it. Henceforth, they began to promote further compromises at new PTAs. As the usual leverage played at their side, industrialized countries introduced more stringent clauses on the bilateral front – later, under a FTA basis. Liberalization at the bilateral and regional level: To the infinity and beyond Bilateral Investment Agreements (BITs) made their appearance on the international scene at the instigation of European investor countries seeking more protection for their investment in emerging developing countries, as a way to depoliticize foreign investment disputes in those countries. BITs fundamental provisions include a wide variety of principles and rules, counting those asserting the non-‐discriminative treatment among foreign investors (including the Most Favoured Nation, MNF clause), entry and establishment conditions, definition of investors and investments, specific dispute settlement provisions, and free transfer of payments. But, despite uniformity in broad principles, dissimilarities among treaties were common in the past. The number of PTAs (basically BITs, later RTAs & FTAs) really exploded after the Uruguay Round, and mainly directed to increase foreign investors guarantees along the prosecution of more pro-‐market policies (liberalization) among Latin America and Eastern European countries. BITs rose from 386 agreements in 1990
92 Commitments appears in schedules, listing the sectors being opened, the extent of market access being given along any limitation on national treatment introduced by the parties. 93 Undoubtedly, commitments to open markets are the outcome of negotiations [although members have different degrees of freedom at the negotiation table]. Comparing data on specific GATS commitments for financial services with measures of actual policy in this sector for 123 countries, Barth, Caprio and Levine (2006) conclude that, in practice, applied policy is much more liberal than what committed to in the GATS.
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to 2,676 at the end of 2008, involving more than 180 countries. Likewise, over the same period, IIAs passed from less than 10 to 259. The US becomes the main diffuser in this new era, firstly under a bilateral scheme, later through the diffusion of FTAs. Overall, their agreements were basically looking to improve market access [for their transnational companies]94. Instructed with this liberalization mandate, U.S negotiators went for more, at both the bilateral and regional level. The signature of the NAFTA agreement in 1994 would become the first step in that direction (Manger, 2009)95 and, certainly very influential in the region (Sauvé, 2006). Under this new scheme, foreign investment liberalization translated, among others, into a broad definition of investment, increasing restrictions on expropriations along other WTO plus requirements. The new model also included stringent conditions towards the free transfers of funds96, introducing an absolute standard with mostly any exceptions (as those related to balance of payments crisis). Likewise, it also followed a “negative list” approach, practically eliminating all exceptions97. In short, specific clauses in US RTAs and many BITs affected the way that host States could impact the operations of the foreign investment established in their territory, including more stringent conditions towards financial liberalization. In this sense, the 2004 model BIT essentially forces partners to liberalize their capital accounts, regardless of the nation’s institutional capacity (Anderson et. al., 2009). Henceforth, host country policy room for capital controls or safeguards provisions are practically inexistent. 94 US policymakers opted as of the 1980s for dedicated BITs targeting developing countries, building
on the success by European investor countries. In the process, US policymakers become emboldened and included new goals for their BITs, such as to bolster the claim that the Hull rule remained customary international law by establishing a network of treaties that include this principle, and to take advantage of the new ICSID general consent for resolving foreign investment disputes (Mortimore and Stanley, 2009). 95 The framework introduced at NAFTA Chapter 11 would become known as “the 1994 model”. This
model text was replaced by a modified version in 2004. The Obama administration is actually working in a new version. 96 In the vocabulary of US BITs, funds could be transfer [by the foreign investor] freely and without any delay. 97 By virtue of the negative list approach, everything goes liberalized unless the countries list the
exceptions to the market access at the time of signing the FTA. Two particular problems: a) at the time of listing, the government may not know that a particular financial instrument actually present (and not being listed), it becomes later dangerous; and, b) even if the government is aware of all current financial instruments, because of the list of exceptions is decided once and for all at the time of signing the FTA, the government cannot list as an exception financial instrument that come into existence in the future (TWN, 2010).
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George H. W. Bush initiative “Agenda for American Renewal” was certainly very ambitious in terms of financial deregulation and capital account liberalization. Even after initiated the financial crisis, the US refused to allow for any sort of capital controls on the FTAs under negotiations (Anderson, 2009; TWN, 2010). If Republicans refused to walk out on this guiding principle, with the assumption of Barak Obama at the Presidency other voices began to be heard.98 But, as the Korean experience will describe, the initial push towards financial reform and institutional change ended to be very weak. At the end, once more Wall Street’s interest prevailed, and US negotiators maintained their former ideals of financial liberalization and bank deregulation.
3.2 Argentina institutional path towards globalization Foreign investment has played a very important but volatile role in the Argentine economy in the last 30 years, strong during the 1970s and the 1990s, when inflows reached highs of 8% of GDP and virtually absent during the 1980s debt crisis. These highs were associated with three different types of investor: first, in the 1970s, transnational banks that extended large syndicated loans; then, in the 1990s, with financial intermediaries who lent voluminous sums in bonds and TNCS that made very significant direct investments. In other words, Argentina was attractive to a multitude of different foreign investors but in an on-‐again-‐off-‐again manner. Argentina’s new ability to attract foreign capital was based in good part on improved market prospects in the context of the neo-‐liberal reform program introduced by the Menem government in the early 1990s. The Convertibility Law in March 1991 was fundamental to stabilizing the economy, based on the introduction of a fixed one-‐to-‐one dollar-‐peso exchange rate, after the inflationary 98 Towards this end, the Obama’s administration launched the Advisory Committee on International
Economic Policy Submits Reports on Review of US Model Bilateral Investment Treaty, settled at the Department of State, the committee advices the US government in international economic policy, including a review on the US model BITs (US Department of State, 2009). In the same direction, Congressman Michal Michaud (D-‐Maine), launched a proposal to modify US BITs model in order to preserver “the ability of each country that is a party to such agreement to regulate foreign investment in a manner consistent with the needs and priorities of each such country”, and that “allows each party that is a party to such trade agreement to place prudential restrictions on speculative capital to reduce global financial instability and trade volatility” (Michaud, 2009 quoted at Gallagher 2010, page 18).
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chaos that followed the debt crisis of the 1980s. This extreme measure was costly in economic policy terms as it effectively tied the hands of national policymakers in fiscal and monetary matters; however, it greatly enhanced Argentina’s credibility with the international investor community and the Washington-‐based international financial institutions (IMF, World Bank and IDB). Argentina signed over 50 BITs in the 1990s to provide increased protection to foreign investors in the hope of attracting much greater quantities of foreign investment.99 More or less simultaneously, Argentina moved ahead with an ambitious program of privatizations along a wide deregulation and liberalization process. The privatizations soon became one of the pillars of the new economic program. From an aggregate point of view, the sale of public assets and the use of the debt-‐capitalization scheme enabled Argentina to attract fresh foreign investment, reduce its external debt and remove the financial liabilities generated by public utilities from the public sphere. Privatization was also seen as focusing on a quest for credibility, tying the fate of the privatized firms inextricably to the success of the convertibility plan. On 23 December 2001 Argentina shook the international financial community by announcing a default on its external public debt of over US$ 100 billion – by the time, a quarter of all debt traded in the emerging bonds market. In January 2002, the Argentine peso declined to one third of its value and the Government “pesified” public utility rates (converting dollar-‐denominated contract provisions to pesos) provoking a large number of IA-‐ISDS cases100. The Argentine economy went into a tailspin in good part due to twin foreign investment crises: external public debt and foreign direct investment. 99 Argentina has more BITs in force (54) than any other LAC country. It has 16 with industrialized countries, such as Australia, Austria, Belgium and Luxembourg, Canada, Denmark, Finland, France, Germany, Italy, Netherlands, Portugal, Spain, Sweden, Switzerland, United Kingdom, and United States, as well as 38 with other countries, namely, Algeria, Armenia, Bolivia, Bulgaria, Chile, China, Costa Rica, Croatia, Cuba, Czech Republic, Ecuador, Egypt, El Salvador, Guatemala, Hungary, India, Indonesia, Israel, Jamaica, Korea, Lithuania, Malaysia, Mexico, Morocco, Nicaragua, Panama, Peru, Philippines, Poland, Romania, Russian Federation, South Africa, Thailand, Tunisia, Turkey, Ukraine, Venezuela, and Viet Nam, 100 US President Roosevelt introduced a similar policy in 1933, when passed a resolution nullifying the gold clauses in both private and public debt contracts. The validity of the resolution was challenged in court, but the Supreme Court upheld it.
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A little over three years later and with no help whatsoever from the IMF, Argentina shed its default status when its unilateral offer was widely accepted (by over 75%) by external public debt bondholders101. Argentina achieved what no country had achieved before, that is, the bondholders not only accepted a large cut in principal, but also agreed to a lengthening of maturity and a reduction in the interest rates to be paid. The outcome of the swap far exceeded Argentina’s expectations, especially given that it had worked out its default unilaterally without the intervention of the international financial institutions or the assistance of G-‐7 governments. A group of unsatisfied bondholders, however, went to courts (US tribunals). Tough a few among them, mostly Italian bondholders, opted for ICSID facilities. With regards to the FDI crisis, the abrupt end of exchange rate parity opened a new front in the dispute with foreign investors, in this case with those who had invested in the real sector, especially public utilities. Under the agreements signed in the 1990s, foreign investors felt that they were entitled to full compensation from the Government. Although most foreign investors in Argentina were affected by the change in the exchange rate model, the bulk of the complaints came from those with some kind of interest in public utilities, mainly those associated with the energy industry (gas and electric power). The predominance of this type of foreign investment was due not only to the guarantees offered under BITs but also the advantages related to national regulations (for example, rates set in dollars and indexed to the United States wholesale price index). As a result, national legislative provisions, regulatory terms and the BIT network bound the contractual framework102. This mechanism helped the Menem government to demonstrate its commitment to the new international standards promoted by investor countries and the Washington financial institutions, but it also became the main base for foreign 101 In June 2010, Argentina reopened its debt exchange, bringing the total amount of restructured
debt to 92,6%. The high level of acceptance could mainly be attributed to the share of distressed bonds held by banks (U$ 10 billion over a total of U$ 20 billion). Investment funds hold another U$ 4 billion whereas the rest was in hands of individuals and other creditors (iMarketNews.com, March 23, 2010). This second restructuration operation, however, did not include defaulted Brady bonds, debt which Argentina is seeking to solve (DowJones.com. December 6, 2010). 102 Thus, seeking to attract foreign investors and guarantee the success of the reforms, the neo-‐
liberal Menem government ended up accepting a system of “complete” contracts, and thereby accepting risks that normally would be shouldered by the foreign investor. Argentinean sovereign bonds were also affected by the problem of “complete” contracts (Stanley, 2009).
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investors’ legal proceedings. The spirit of the restrictions Argentina had imposed upon herself (the convertibility scheme combined with the BITs) was to minimize the possibility of contract renegotiation with privatized firms, since the magnitude of the commitments made any alteration, however necessary, too costly. Ultimately, the crisis demonstrated the intrinsic “incompleteness” of the contract scheme implicit in the regulation of the privatized firms. The collapse of economic policy and the sharp deterioration of the business environment after successive administrations demonstrated that the Menem government had painted Argentina into a corner and the current government it was both unable and unwilling to abide by the terms of the existing contracts. This produced a sharp reaction from foreign investors, which was manifest in a torrent (more than 45) of ICSID lawsuits103 that raised the country’s contingent liabilities to around US$ 20 billion104. The emergency measures adopted by the government affected the economic and financial equation of foreign investors. In the case of the regulated sectors (with pesified rates), the higher the level of indebtedness in dollars, the larger was the impact of these measures. Hence, regardless of the sector, most of the disputes brought after 2002 cited the effects of the devaluation on contracts in general and on the rate-‐setting system in particular. Foreign investors maintained that the Government of Argentina had agreed to assume the exchange-‐rate risk then broke its promise in January 2002. 103 It should be mentioned that five of these were filed while the convertibility regime was still in place. At ICSID were registered 43 cases, whereas 3 cases were filled under the UNCITRAL rules. Awards have been issued in 12 cases (3 of them denying jurisdictions of the Claimants, 1 later suspended); an annulment decision has been issued in only one case and request for annulment are pending in other six cases; one award is being challenged before the Washington, DC courts. Eighteen cases are still pending (including one recently launched, but nor related to the 2001 crisis), and proceedings have been suspended or discontinued in 18 cases. The most vehement attacks came from regulated firms belonging to the energy sector (gas and electric power), which initiated 22 lawsuits (19 before ICSID and 3 before UNCITRAL), by virtue of the strong vertical and horizontal links presenting these industries (Stanley, 2004). 104 This total does not include figures introduces by Italian bondholders claims at ICISID, including: ICSID case ARB/07/5 (Giovanna A. Beccara and Others v Argentina Republic), case ARB/07/8 (Giovanni Alemanni and Others v Argentina Republic) and, case ARB/08/9 (Giovanni Alpi and Others v Argentina Republic). The fist one involved an enormous class-‐action style claim filed almost 195.000 Italian nationals and seek U$ 4.4 billion in compensation. The Alemanni case involves a small fraction of claimants asking for a lower amount of reimbursement. The third collective of claimants are reclaiming for a debt of € 6,5 million plus U$ 560,000 (Luke Peterson, “Argentina Faces a Third Treaty Claim by Holdout Bondholders: Experts differ as to Prospects).
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But, although most of the cases cited more than one cause, pesification was the primary motivation for the lawsuits brought against Argentina (Stanley, 2004). In some cases, however, investors´ voracity was the sole motivation behind the lawsuit (Stanley, 2009)105. Whatever the reasons given, however, the filing of cases was generally a strategic move towards positioning at the renegotiation stance (utilities) or when asking for total reimbursement (bondholders). Hence, after the economic emergency legislation was passed and the lawsuits filed, there ensued a wrangle between the Argentine Government, the foreign investors and the Washington financial institutions (World Bank and IMF)106. When the Argentine crisis broke out the international system failed to provide a solution to either the losses of foreign investors caused by the country’s inability to apply the rates stipulated in the original contracts or the sovereign default. Foreign direct investors were shocked to find that the World Bank was unable to oblige the Argentine authorities to abide by the original terms of utility contracts. The bondholders found that the IMF was unable to force the Argentine Government to renegotiate its debt under any kind of pre-‐existing scheme or provide assistance to bondholders who opted not to accept the swap offer ––“holdouts”–– in the hope of a better deal from the Government of Argentina. For its part, the Argentine Government, in its dual capacity as host country and debtor, was appalled by the functioning of the international system, because of the way it explicitly favoured 105
Vulture funds ended with an important portion of Argentinean distressed sovereign debt, obtained at deeply discounted rates in order to speculate in litigation against the country. As most of the bonds issued by Argentina recognized New York jurisdiction, claims were filled at the US and US District Judge Thomas Griesa become in charge of the claims. 106 The Argentine response began by challenging the arbitral tribunal, questioning its transparency, the process by which the arbitration panel was selected and the fact that the foreign investors were allowed to engage in forum shopping, i.e. select the tribunal most likely to provide a favorable judgment. By the same token, Argentina threatened not to recognize ICSID’s jurisdiction, claiming that cases should be heard in the local courts first. Lastly, in mounting a defense —that actually formulated in the case of CMS Gas Transmission Company and the denial of jurisdiction in others— the Government’s strategy was to deny that the steps it had taken after declaring the economic emergency (i.e., pesification and rate freezes) amounted to indirect expropriation. Since all the lawsuits cited a single cause, the logic of the economic emergency legislation was central to the Government’s strategy. With its proposals rejected and its arguments disallowed, the Government shifted its stance. One of its lines of approach was to seek to have the privatized firms withdraw their suits as a goodwill gesture in the context of contract renegotiation. Another, in view of the arbitration tribunal’s award in the CMS case, was the Government’s suggestion that it might not acknowledge any possible awards. Anyway, at the end, the government played “accommodate” strategy (Mortimore and Stanley, 2009).
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foreign investors, the lack of objectivity of the international financial institutions (basically IMF) and attempts to condition the country’s economic policy to fulfilment of (by then impossible) international commitments. As a result, and in view of the social dimension of the crisis, that is between 1999 and 2003 the proportion of Argentines living below the poverty line doubled, from 27.1 to 54.7% of the population, the Government found itself forced to choose between using scarce resources to alleviate the economic and social suffering of the Argentine population caused by the crises and allocating them to meet their international obligations to foreign investors. Action taken by the Argentina government spawned, in turn, “the greatest wave of claims by foreign investors against a single host country in recent history” (Alvarez and Khamsi, 2009). Ultimately, the international finance and investment community, which had celebrated Argentina’s adoption of a risky neoliberal policy framework failed to provide the country with specific solutions to resolve the multiple crises it was facing. It proved to be another example of one government limiting the policy options of succeeding governments to deal with the crises provoked in large part by the policies of the former. Finally, the BITs network later became a conduit for IA-‐ISDS demands by the bondholders that had not accept the unilateral swap offered years earlier. This left the impression that the IA-‐ISDS system was warped to serve foreign investor interests at any cost.
3.3 The KORUS FTA and South Korea rupture with the past South Korea was an active contributor of the bilateral scheme in the past, signing its first BIT in 1964 with Germany. After the signature of this agreement, Korea continued this trend and actually has more than 70 BITs in force107. Agreements 107 South Korea signed a total of 77 BITs, of which 68 were finally ratified and become legally binding. A total of thirty-‐seven agreements were signed in the nineties, but sixteen in the previous years and fifteen in the 2000s. Partners include: Albania, Algeria, Argentina, Austria, Bangladesh, Belarus, Belgium and Luxembourg, Bolivia, Brazil (not ratified), Brunei Darussalam, Burkina Faso (not ratified), Cambodia Chile China Congo DR, Costa Rica Czech Republic, Denmark, Egypt, El Salvador, Finland, France, Germany, Greece, Guatemala Honduras, Hong Kong (China), Hungary, India, Indonesia. Iran (not ratified), Israel, Italy, Jamaica (not ratified), Japan, Jordan, Kazakhstan, Kuwait (not ratified), Lao PDR, Latvia, Lithuania, Malaysia, Mauritania (not ratified), Mexico, Mongolia, Netherlands (not ratified), Nicaragua, Nigeria, Oman, Pakistan, Panama, Paraguay, Peru, Philippines, Poland, Portugal, Qatar, Romania, Russian Federation, Saudi Arabia (not ratified), Senegal, Slovakia, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Tajikistan, Thailand, Trinidad
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followed the traditional objective of “protecting” foreign investments from sovereign’s will. Despite the enthusiasm on the subject, an agreement with the US was never achieved. As the country embraced a new trade policy in the nineties, the government launched a new market opening strategy institutionalized by the signature of PTAs. In this direction, the government commence negotiations with different partners around the world which, as a result, introduced Korea at the FTAs scheme, first with Chile108, later with Singapore, and the European Free Trade Association (EFTA). Thereafter, negotiations were launched with the Association of Southeast Asian Nations (ASEAN)109, the European Union (EU)110 and India, whereas actually it maintain talks with Japan111, Canada, Mexico, Australia, New Zealand, Malaysia and MERCOSUR. The political relationship between the US and South Korea could be considered to be special and resilient112. Nevertheless, trade relationship between both countries has not been exempted from disagreements. Foreign investment, in turn, has and Tobago, Tunisia, Turkey, Ukraine, United Arab Emirates, United Kingdom, Tanzania D.R. (not ratified), Uzbekistan, and Vietnam 108
Chile becomes the first country to have negotiations with, as Korea recognized the political experience in the subject of his partner and, also, the complementarities between both economies. The most difficult talks those dealing with agricultural issues. 109
The Framework Agreement on Comprehensive Economic Cooperation (the FTA agreement) becomes sequentially negotiated. The investment chapter was finally signed at June, 2009, three years later than the agreement on goods and two from the signature of the one dealing with services (ASEAN-‐Korea FTA on Investment signed. At Bilaterals.org, posted by Bernama, June 2, 2009). 110 To become effective at July the 1st 2011, if ratified by the European Parliament (EU signs free-‐ trade deal with South Korea, its first with an Asian nation” Reuters, Oct 10 2010) and introducing pressure over the US FTA approval (“Obama gov´t want Congress to approve Korea FTA beforte July: Kirk” Yonhap, 2011/01/12. 111 Japan is Korea’s second trading partner. Discussions were fiercer as political and historical demands added to economic policy questions (Cheong, 2002) as the role of Japan in the early twenty-‐century. Anti-‐Japanese sentiments are still present in the Korean society, whose inhabitants continues to demand for a formal apology from the former colonizer for past misdeeds as well as distortions in Japanese history textbooks, territorial disputes over Tokdo Island, and the issue of compensation for comfort women during world war II. From an economic perspective, Korean policy-‐makers were concerned about the possibility of economic subordination and growing trade deficit with Japan. Nevertheless, Ogura Kazuo, then Japanese Ambassador to Korea, officially launched discussions at September 1998. A month later, under President Kim Dae-‐Jung visit to Japan, parts agreed to initiated a joint-‐study on the issue 112 The US – South Korea military alliance have more than fifty years. Strategically, not only serves as a buffer against the North Korean dictatorship but also to deter China´s increasing power in the region.
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always been a sensitive topic in the bilateral economic relationship (Cooper, et.al.; 2010), reflecting the US interest at the South Korean market, and the continues refusal of the South Korean authorities to opening the economy113. Differences, however, began to be set aside at the late 1980s -‐ early 1990s, marking the passing of a new era of market friendly development. The completion of the Uruguay Round at 1995, and Korea accession to the OECD in 1996, strengthened this trend. The push towards financial liberalization and bank deregulation continued its pace during the nineties, now with the additional support of the IMF. Talks with the US were launched at Washington, in June 2006114. On June 30, 2007, the two countries signed the proposed U.S. -‐ South Korea Free Trade Agreement (KORUS FTA). At the moment the agreement is pending from Congressional approbation in South Korea115 and the US116, although objections remains in both sides117. In occasion of the G-‐20 meeting, both countries agreed to re-‐launch conversations in order to finally approve the agreement. KORUS FTA structure resembles the structure of other FTAs previously signed by the US administration, including the recently signed with Dominican Republic – Central American FTA (DR-‐CAFTA).
113 Disagreement reflected, in part, the Asian prejudice to American investors legal demands. Although Asian countries were among the most fervent adherents to BITs, none of their countries signed a bilateral agreement with the US (Stanley, 2008). However, South Korea and US negotiated an agreement but failed over US opposition to South Korea’s so-‐called screen quota on domestic films and the latter’s resistance to lifting or reducing it (Cooper, 2010). 114 In the late 80s the US government become firstly interested at Korean openness. Talks among
partners began over Korea’s large merchandise trade surplus with the US favoured by an undervalued won – as for the US negotiations (Amsden, 2001; page 329). 115 The KORUS would, soon or later, be approved at South Korea, as the ruling party controls the
Unicameral National Assembly. Furthermore, the Assembly’s Foreign Affairs, Trade and Unification Committee have already approved the agreement (Cooper; et.al., 2010). 116 Negotiations in the US Congress were conducted under the Trade Promotion Authority (TPA). In order the agreement to enter into force, the Congress should approve implementation legislation. It is expected that President Barack Obama will submit the agreement to Congress at January 2011. 117 During the last Presidential meeting on November 11, 2010, South Korea’s President, Lee Myung-‐ bak and US President Barack Obama announced that had not resolved the outstanding issues, as: agriculture (including beef, rice, oranges, and sanitary and phytosanitary provisions); autos; textiles and apparel; and other manufactured goods (capital goods machinery and equipment; electronic products and components; and, steel)
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The general principles settled down in the agreement include a far-‐reaching definition of investment118, the principle of national treatment, the most-‐favoured-‐ nation treatment, the minimum standard of treatment. Likewise, KORUS FTA set limits on government expropriation of covered investments. It also require each partner to allow for the free transfer of financial capital pertaining to covered investment both into and out of the country, although it allows some exceptions119. Finally, and similarly to most modern agreements, KORUS FTA establish procedures for the settlement of investor-‐state disputes involving investment covered under the agreement. The two countries committed to provide national treatment and most-‐favoured-‐ nation treatment to the services imports from each other; promoted transparency in the development and implementations of regulations in services providing timely notice of decisions on government permission to sell services; prohibit limits on market access; prohibit foreign direct investment requirements, such as export and local content requirement and employment mandates120; and, prohibit restrictions on the type of business entity through which a service provider could provide a service121. It allows U.S. companies to supply financial services on a cross-‐border basis, including management services for investment funds and international transit insurances. Likewise, the two countries agreed to the “negative list” approach in making commitments in services – a really valuable principle obtained by US negotiators. 118 Investment includes: investment agreements between a government and a foreign firm with
respect to natural resources, certain procurement construction activities and more; investment authorizations; enterprises; shares, stock, and other forms of equity participation in an enterprise; bonds, debentures, other debt instruments, and loans; futures, options, and other derivatives; turnkey, construction, management; production, concession, revenue-‐sharing, and other similar contracts; intellectual property rights; licenses, authorizations, permits, and similar rights conferred pursuant to domestic law; and other tangible and intangible, movable or immovable property, and related property rights, such as leases, mortgages, liens, and pledges. 119 Originally Korean negotiators wanted safeguards applicable in case of foreign exchange crisis, a
petition refused by the US. At the end, parts agreed to introduce safeguard at the cost of maintaining financial liberalization (Ahn, 2008).
120 Under chapter 13, neither party could require financial institutions of the other party to hire individuals of a particular nationality as senior managers or other essential personnel, nor could a party require more than a minority of the board of directors to be nationals or residents of the other party (USITC, 2010, at page 4-‐9) 121 In particular, each party would be required to permit a financial institution of the other party to provide new financial services on the same basis that it permits its own domestic institutions to provide (USITC, 2010, at page 4-‐9).
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According to the agreement, South Korea committed to reduce barriers to trade and investment in its services sector, including the financial. Furthermore, it guarantees the right to full American ownership of a financial institution in Korea. It might also be the case that Korean prudential regulations be deemed illegal under the new treaty (Gallagher, 2010b). In addition, the agreement commits partners to refrain from limiting the size of financial institutions (PublicWatch, 2010). Likewise, the commitments are ratcheted, meaning that when new services emerge in one of the economies, the FTA automatically covers those services – unless identified as an exception (Cooper; et.al, 2010). Finally, in relation to the capital control issue, the KORUS FTA financial chapter might be read as forbidding any limit to the transfer of capital (PublicWatch, 2010). The agreement has, without doubt, important diplomatic and security implications (Schott, 2007; Cooper, et.al., 2010). From an economic perspective, the agreement could reinforce trade and investment flows between partners122. For the US the agreement entails a diplomatic victory, which helps to restricts the increasing Chinese influence in Asia (Ahn, 2008; Cooper, et.al., 2010). Looking at the financial and other services chapters123, it become evident that the US obtained a great deal (Cooper, et.al.; 2010)124, certainly, a “model agreement in financial services” (www.KOREAUSPartnerhip.org125), “no better, more sophisticated trade arrangement for financial firms” (Toppeta, 2010)126. In particular, under the terms of the FTA Korea’s remaining nontariff impediments to banking services stands at 122
Korea is the United States seventh-‐largest trading partner based on total trade. The US merchandises trade balance with Korea moved from a $ 2,9 billion surplus in 1996 to a $ 13,9 billion deficit in 2006. In 2005, US services exports to Korea were approximately $ 10,3 billion, and US services imports from Korea were $ 6,3 billion. On the other hand, the US holds the largest single-‐ country share of FDI stock in Korea, with 30% (USITC, 2010). 123 Trade in services cut across several chapters of the KORUS FTA: Chapter 12 (cross-‐border trade in services); Chapter 13 (financial services); and Chapter 15 (Telecommunications); Chapter 11 (foreign investment); among others. 124 See, for example, a collection of statements of support for the US-‐Korea Trade Agreement at the US White House web page. 125 The Korea-‐US Trade Partnership declared it as “a groundbreaking achievement, providing more
extensive provisions related to financial services than ever before included in a U.S. FTA”. 126 Remarks by William J. Toppeta, President – International MetLife. April 6.
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29%, well below the actual 76% accepted by Korea at GATS127 . Citigroup´s Laure Lane and corporate co-‐chair of the US-‐Korea FTA Business Coalition, made a similar statement, qualifying it as “the best financial chapter negotiated in a free trade agreement to date”128. KORUS FTA obtained the support of both, big trade unions
and
business
associations
(US
government,
http://www.whitehouse.gov/the-‐press-‐office/2010/12/03/statements-‐support-‐ us-‐korea-‐trade-‐agreement). As a result, the US service sector is particularly exultant with KORUS FTA approval, as the agreement includes liberalization measures “in excess of the current General Agreement on Trade in Services (GATS) regime” (USITC, 2010).129 Surprisingly enough, instead to focus on the increased access to the US market, South Korean negotiators emphasized “the medium and long-‐term gains that would stem from increased allocative efficiency of the South Korean economy, particularly in the services industries”.
127 Non-‐tariff impediments are condensed in a measure: the tariff equivalent (TE), which measures the percentage increase in prices due to trade impediments relative to the price that would exist in the absence of trade restrictions. 128 She participates as corporate co-‐chair of the US-‐Korea FTA Business Coalition. 129 However, the agreements have also its detractors in the US, among them NGO Public Citizen’s
Trade Watch (www.tradewatch.org). Public Citizen’s doubts relates to the increasing rights granted to South Korean investors by the treaty, which could end challenging US judiciary autonomy.
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4. Conclusions 4.1 A hard learning process: Lesson 1 – Argentina The vagaries of the relationship between foreign investors and host countries sometimes favoured the former, and sometimes benefited the latter. In the 1990s, however, the balance tipped excessively towards foreign investors, as they had managed to enhance the guarantees and legal certainty that developing countries and transition economies provided, by introducing into their contracts with debtors a series of clauses waiving sovereign immunity in the case of default (as the transnational banks had done in the 1970s under the syndicated loan system). Foreign investor’s guarantees and advantages were then further expanded as the bilateral scheme become more widespread and a dispute settlement mechanism was introduced enabling them to sue the host country directly. Argentina became the first sovereign nation to experience the muscle of this new scheme. When the Argentine crisis broke out, however, the international system failed to provide a solution to either the sovereign default or the losses of foreign investors caused by the country’s refusal to apply the rates stipulated in the original contract. The bondholders were horrified to find that the IMF was unable to force the Argentine Government to renegotiate its debt under any kind of pre-‐existing scheme or provide assistance to bondholders who opt not to accept the swap offer –holdouts-‐ in the hope of a better proposal from the Government of Argentina. For its part, the Argentine Government, in its dual capacity as debtor and host country, was also appalled by the functioning of the international system, because of the way it explicitly favoured foreign investors, the lack of objectivity of the international financial institutions (basically IMF) and attempts to condition the country’s economic policy to fulfilment of international commitments. As a result, and in view of the social dimension of the crisis, the Government found itself forced to choose between using resources to alleviate the social suffering caused by the crisis and allocating them to its international obligations to foreign investors. As push comes to shove, the government opted not to renegotiate
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contracts and massively defaulted on their external obligations at the price of being forced to a financial asylum since then130. The Argentinean case results interesting, furthermore, because it exemplifies the malfunctioning of capital controls. During the 2001-‐02 crisis investors profited from the legal loopholes at stock market in order to legally flight capitals abroad. In particular, investors used their bank deposits either to purchase Argentine stocks listed at the NYSE [an equity termed American Depository Receipts (ADRs)] or, by a lesser extent, throughout the purchasing of shares of non-‐Argentinean firms at the local stock market [the so called, CEDEARs]. Capital outflows resurged under the Kirchner administration, as investors lost confidence on the government economic macroeconomic programme following the crisis with the rural constituency. Uncertainty rose thereafter as political turmoil and social tension mounted, initiating a new phase of capital flights. Outflows were also responding to external factors, as the collapse of Lehman Brothers at September 2008 and the collapse at international financial markets that followed. The first case demonstrates the relevance of properly closing legal leaks as investors quickly profited from all legal loopholes to flow out their capital from the country. The second highlights the ineffectiveness of capital controls if macroeconomic policies are not properly functioning. The Argentinean experience also raises serious doubts on the Basle rules effectiveness, particularly in the measuring of systematic risk in emerging economies. Prudential regulation overestimate private agents capacity to take decisions properly, under a context where price signals became highly distorted and the rules of the game were ultimately unstable (Damill, et. al., 2010). In other words, the monetary trilemma cannot be eluded even if the banking industry is being “properly” regulated. Finally, from an institutional perspective, and considering the recent financial crisis, might be constructive to reconsider the Argentina experience at ICSID. At 130 Completely aisled from international markets, the government becomes forced to fulfil their foreign exchange necessities by means of three sources: current account surplus, multilateral lending and by the selling of Central Bank’s reserves. Increasing commodities prices, including soybean and other crops, boosted government fiscal resources (as the exports of agricultural goods are being taxed).
45
the beginning of the new millennium, and following the collapse of their economy, social disruption and a massive political turmoil, foreign investors rushed to international arbitrational courts in order to maintain their privileges. As an example, take the CMS case against the country, on which the Argentinean government sustained it exemption from any liability for breaching the US-‐ Argentina BIT on the grounds that a state of necessity (the financial, economic, social and political crises in the context of which the emergency measures were taken)131, an argument based on customary international law and Article XI of the US-‐Argentina BIT. The tribunal did not accept Argentina’s necessity defense, and awarded CMS US$ 133 million in compensation132. The ruling was later partially annulled, but the decision on the state of necessity was upheld133. After considering the Argentinean experience, some legal scholars were wondering why foreign investors claims against the US have not yet materialized (Peterson, 2009; Reed, 2010). In view of the set of measures introduced since 2008134 and after carefully reading most prominent economist, an arbitrator might seriously tempted to consider whether US policies responded to a “grave and imminent peril”; and whether the measures were “the only steps available” to safeguard its interest. Furthermore, it could affirm those government policies and their shortcomings significantly contributed to the crisis.
131 The CMS and LG&E cases, both involving United States investors in the Argentine natural gas distribution market, and both concerning emergency measures taken by the Argentine government over the period of 1999 to 2002, resulted in conflicting conclusions regarding the “necessity defence”. The discussion on the necessity defence brings to the surface the tension between national policy space and foreign investment protection, and the contradictory awards in the two cases reveal the problem of incoherence in arbitral decisions under the ICSID rules 132 Although the tribunal understood that neither the essential interests of the United States nor of the international community had been seriously impaired by the measures taken by Argentina, it questioned whether “an essential interest” of the State (of Argentina) was at stake, whether there was a “grave and imminent peril”; and whether the measures taken by Argentina were “the only steps available” to safeguard its interest. It also affirmed that Argentina’s “government policies and their shortcomings significantly contributed to the crisis”. Since the conditions for acceptance of a necessity defence must be cumulatively satisfied, the Tribunal ruled that the necessity defence was not applicable under customary international law. 133 In a similar case, paradoxically, the ICSID tribunal recognized the potential severity of economic crises, accepting the necessity defence for a specific period (from December 21, 2001 to April 26, 2003), “during which it was necessary to enact measures to maintain public order and protect its essential security interest”. In other words, the “state of necessity” was recognized. 134 The US government initiated a series of extensive market interventions after 2008, starting with Fannie Mae and Freddie Mac bailed out, to continue with large sums of capital injections to several car manufacturers and US banks. Foreign investors might also try to challenge the local – purchasing requirement introduced by the US government.
46
A hard learning process: Lesson 2 – South Korea Among divergences presented by these two countries, South Korea differentiated from Argentina at having desisted to participate in any RTAs with the US. This, in turn, might have prevented Korea to be legally challenge at international courts at the aftermath of the previous crises. However, this could easily pass away if the KORUS FTA is finally approved – increasing the fiscal costs of an eventual new crisis. At the midst of the financial storm, and after re-‐introducing capital controls in order to stop economic agents to destabilize the national economy, but the government might be accepting an agreement that penalize this sort of policies. Likewise, considering the negative list approach followed at KORUS, the Korean government might found surprised by the explosive potential of existing financial instruments or the perils associated with appearance of new ones. On relation to the monetary trilemma and the Korean response, authorities in the nineties opted began to move away from capital controls introducing, instead sterilization measures along encouraging capital outflows. But, their efficacies become contested when financial volatility was back. Volatility, in turn, becomes more pronounced at the latest crisis because, in contrast to the nineties, the Korean economy was now more open to international markets. As observed in Argentina when contrasting the nineties against the eighties, the older “buffers” that prevented financial leaking during the past crisis were lately absent. Furthermore, in contrast to the 1997 crisis, under the latest portfolio (mainly equity) investment and borrowings outperformed FDI inflows. The banking industry, on the other hand, advanced in the compliment of international standards and, without doubt, the Korean financial sector become more open and internationalized than in the previous crisis. Nevertheless, the economy increased their vulnerabilities to sudden large-‐scale withdrawals of foreign capital. In other words, as the capital account happens to be more open and the bank industry more deregulated, chances for increasing volatility are becoming more important, showing how relevant become to better manage financial opening or to advance in the controlling of capital inflows (Kim, undated). In the same direction, Lee, Kim, Kim and Song (2010) are suggesting an “intermediate” macro-‐financial system, with partial capital controls, a flexible exchange rate system, and relative
47
independence in monetary policymaking. Their so-‐called structuralist policy also considers the relevance of sound regulation and supervision, including a correct assessment of spreads movements (Lee, et.al., 2010)135.
A hard learning process: Lesson 3 – Crisis, what crisis? Financial liberalization did not bring the benefits originally predicted; instead it increased macroeconomic volatility and market turmoil. Among others, and constructed after the experience of Argentina and the Korea Republic, this paper found two points important to discuss followed by a caveat on institutions and international financial architecture. On the one hand, the present situation show how dysfunctional could capital inflows be for the hosting economy if unregulated. But, capital management techniques are unquestionably back into the discussion and certainly trendy between academic and policy -‐ makers. Suddenly, policy makers along academic researchers in the north become aware of the problem imposed by financial deregulation and capital market liberalization. However, emerging markets joy continues to be legally contested by virtue of the WTO commitments plus RTAs specific clauses originally signed. Whereas regulation for managing systematic risk is commonly accepted, this has not been the case for government involvement in exchange risks management. The currency-‐mismatching problem, appearing firstly in the seventies, has certainly been more relevant among developing countries and emerging economies136. Unfortunately, this problem is not part of the agenda. Partly because this issue is relevant only to EM economies and they have little influence in setting up a new financial architecture. The cases being analysed showed that cross-‐border finance has been left almost entirely out of the agenda. In particular, it has not required
135 The authors note that currency crisis pivoted around the government’s withdraw from regulating the real side of economy, the financial sector, and especially the international capital market, the so-‐called “Frenkel-‐Neftci” cycle has began. 136 All commercial banks have maturity mismatch problem as they borrow short-‐term money and lend the funds to individuals and companies in a long term. The maturity mismatch occurs directly due to the time structure of interest rates, but also due to the structural inconsistency of the financial system.
48
any regulation on the subject as currency mismatching was no part of the global finance (Lee et.al., 2010; Ocampo, 2010). Similarly, Basel II dominated financial regulation and bank supervision, but inducing self-‐regulation and avoiding to tangle the problem posed by the presence of uncertainty. Henceforth, liquidity risk was absent in the discussion (Lee et.al., 2010), being the Financial Stability Fund (FSF, 2008) the only entity beginning to work on the problem. The international financial crisis has, on the other hand, also showed how inappropriate the current international monetary and financial architecture is for managing today’s global economy. To prevent future crisis, sound regulation and supervision are necessary. Capital controls are part of the toolkit, but certainly nor the simply response for the monetary trilemma neither a panacea at preventing sudden stops. The calls for and steps to taken to reform such architecture are, therefore, welcome. Similar calls for reform were, however, as well made after the sequence of Asian, Russian and Latin American crises, but they led at best, to marginal reforms in the international architecture (Wade, 2009). In contrast, both IFIs evaluation programmes and institutional reforms induced by the Basle Agreement, continued to constrain developing countries policy space (Stalling, 2006). The fact that this time industrial economies have been at the centre of the storm brings hope to firmer action (Ocampo, 2010), along the expectation for a profound change at the international financial architecture. Certainly, only when the crisis arrived to northern, developed, countries the IFIs message became to change137. But, despite IMF new mood, initiatives at Basel, and new US financial regulations, private actors and US negotiators continue to push emerging and developing countries to liberalize their financial services. Correspondingly, a real banking reform has been postponed once more. Whether this reflects incapacity to domesticate powerful financial lobbies or the fact that those regulating them have been captured (Stiglitz, 2010) is beyond the scope of this paper. On the contrary, despite former initiatives launched towards an institutional reshaping, the US BIT model maintains its pressure towards increasing financial liberalization and bank
137 Certainly some professionals working at the IMF were reluctant to endorse the official position after the Asian crisis.
49
deregulation. However, this might not be neither surprising not at all inconvenient [for the US]138. But, also, the above push might also be revelling Wall Street weight at the decision-‐making process at Washington and the solidity of the services led growth model – despite sceptics. The institutional continuity might be showing that concerns over the global economic and financial markets were imprecise (crisis, what crisis?), and the pragmatism US policy.
138 From a strategic perspective, this vision might not be surprising if considering the relevance of the services industry for the US economy. On the one hand, in quantitative terms, it represents more than ¾ of the country gross domestic product, employing 4 out from 5 of their labour force. On the other hand, American service companies qualify among the most competitive and efficient in the market (USITC, 2010).
50
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7. Annex: Tables and Graphs Table 1: Argentina and Korea Republic, basic indicators (1980-‐2010) Argentina
Year
GDP Current Prices GDP per capita (U$ Dollars, (U$ Dollars) Billions)
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 e
209.005 169.749 84.292 103.983 116.751 88.182 106.038 108.718 127.343 81.701 141.329 189.583 228.763 236.491 257.425 258.017 272.219 292.988 299.080 283.761 284.540 269.098 102.723 129.544 153.005 183.001 214.042 262.041 328.028 310.057 351.015 Source: IMF
7.477,83 5.966,58 2.913,66 3.544,07 3.912,58 2.905,51 3.449,53 3.496,89 4.046,48 2.564,37 4.344,56 5.750,17 6.845,08 6.972,55 7.493,51 7.418,73 7.734,46 8.229,00 8.306,54 7.795,95 7.735,45 7.242,35 2.738,14 3.420,78 4.002,64 4.741,91 5.492,40 6.658,16 8.253,18 7.725,46 8.662,99
Korea Current Account Balance GDP Current Prices GDP p er capita (U$ Dollars, (U$ Dollars, Billions) (U$ Dollars) Billions)
-‐2.573 -‐5.721 -‐2.917 -‐2.436 -‐2.495 -‐1 -‐2.859 -‐4.235 -‐1.572 1.095 4.665 0 -‐6.468 -‐8.043 -‐10.981 -‐5.104 -‐6.754 -‐12.118 -‐14.467 -‐11.909 -‐8.955 -‐3.782 8.768 8.142 2.658 4.700 6.772 5.923 4.807 6.189 6.016
64.385 72.399 77.524 85.962 94.945 98.502 113.737 143.378 192.113 236.233 270.405 315.575 338.171 372.209 435.590 531.139 573.001 532.239 357.510 461.808 533.385 504.584 575.930 643.760 721.976 844.866 951.773 1.049.239 931.405 832.512 986.256
1.689 1.870 1.971 2.154 2.350 2.414 2.760 3.445 4.571 5.565 6.308 7.289 7.730 8.422 9.757 11.779 12.587 11.582 7.724 9.906 11.347 10.655 12.094 13.451 15.029 17.551 19.707 21.653 19.162 17.074 20.165
Current Account Balance (U$ Dollars, Billions)
-‐5.312 -‐4.607 -‐2.551 -‐1.524 -‐1.293 -‐1 4.709 10.058 14.505 5.344 -‐2.014 -‐8.417 -‐4.095 1 -‐4.024 -‐8.665 -‐23.120 -‐8.287 40.371 24.522 12.251 8.033 5.394 11.950 28.174 14.981 5.385 5.876 -‐5.776 42.668 26.041
58
Table 2: Financial repression and financial liberalization, Argentina and Korea compared Domestic Financial Country Capital Account Sector Stock Market Liberalization Index Argentina Apr 76 -‐ Nov 78 PL Jan 77 -‐ May 82 FL Jan 77 -‐ Feb 82 PL Jan 77 -‐ Nov 78 PL Dec 78 -‐ Feb 82 FL Jun 82 -‐ Sep 87 R Mar 82 -‐ Dec 88 R Dec 78 -‐ Dec 88 R Mar 82 -‐ Nov 89 R Oct 87 -‐ Oct 01 FL Jan 89 -‐ Oct 01 FL Jan 89 -‐ May 91 R Dec 89 -‐ Oct 01 FL Nov 01 -‐ Nov 02 R Nov 01 -‐ Jun 04 R Jan 89 -‐ Nov 89 PL Feb 02 -‐ Mar 03 PL Dec 02 -‐ FL Jul 04 FL Dec 89 -‐ Oct 01 FL Apr 03 -‐ May 05 FL Nov 01 -‐ Nov 02 R Jun 05 -‐ PL Dec 02 -‐ Jun 04 PL Jul 04 FL Korea Jan 93 -‐ Dec 95 (PL) Jan 88 -‐ Dec 94 (PL) Jan 91 -‐ Apr 98 PL Jan 93 -‐ Dec 95 PL Jan 96 (FL) Jan 95 (FL) May 98 FL Jan 96 FL
Source: Smuckler Notes: (R) Financial repression; (PL), Partial Liberalization (FL) Full Liberalization. Table 3: Bank regulation, supervisory activities and self-‐regulating monitoring (at 1999) Concept Capital Requirement Risk -‐ Adjusted Capital ratio Capital Index of bank Index of banking activities Regulatory Index -‐ General Supervision power -‐ Index Immediate correction index Restructuration power index Solvency declaration index Indulgency index Supervision Index -‐ General Certificate auditing International Rating Agencies Bank board qualification Divulgation index Deposit assurance index Subordinated debt index Private monitoring index
Ratio % (0-‐6) (0-‐3) (0-‐4) (0-‐16) (0-‐6) (0-‐3) (0-‐3) (0-‐4) (0-‐1) (0-‐1) (0-‐1) (0-‐3) (0-‐1) (0-‐1)
ARG 11,5 16,4 6,0 2,0 1,8 37,7 12,0 0,0 3,0 2,0 3,0 20,0 1,0 1,0 1,0 2,0 0,0 1,0 6,0
KOR 8,0 9,3 5,0 1,0 2,3 25,5 10,0 4,0 3,0 2,0 1,0 20,0 1,0 1,0 1,0 3,0 0,0 1,0 7,0
Source: Stalling (2004)
59
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Graph 1: Chin – Ito Capital Account Index (%
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!"#
%$ !"#
%$./0% 12/%
Source: Chin
60
