Oct 24, 2008

World - West is in talks on credit to aid poorer nations

Mark Landler

WASHINGTON: With the financial crisis engulfing developing countries from Latin America to Central Europe, raising the specter of market panic and even social unrest, Western officials are weighing coordinated action to try to stabilize these economies.

The International Monetary Fund, which is in negotiations with several countries to provide emergency loans, is also working to arrange a large credit line that would allow other countries desperate for foreign capital to borrow dollars, according to several officials.

The list of countries under threat is growing by the day, and now includes such stalwarts of the emerging market as Brazil, South Africa and Turkey. They have become collateral damage in a crisis that began in the American subprime housing market.

The fast-growing economies of the developing world depend on money from Western banks to build factories, buy machinery and export goods to the United States and Europe. When those banks stop lending and the money dries up, as it has in recent weeks, investor confidence vanishes and the countries suddenly find themselves in crisis.

The details of the arrangement are still being worked out, but it could be supported by Japan and several oil-producing countries, a fund official said. The fund has not yet approached the Federal Reserve, according to officials, although the Treasury Department has expressed interest in the proposal.

Two weeks ago, the Fed set up unlimited swap agreements with the European Central Bank, the Bank of England and other central banks to ease the severe credit turmoil in Western Europe.

This time, the focus would be on emerging markets with good economic records that are having trouble borrowing dollars.

"There needs to be some action to help these countries," said Neil Dougall, chief economist for emerging markets at Dresdner Kleinwort in London. "There has been a severe drying-up of liquidity there, and it is early days. The tsunami has only just reached their shores."

The monetary fund has about $250 billion available for all types of loans. That could be supplemented by funds from central banks, officials said, though they dismissed a rumor that circled the globe on Thursday that the fund was arranging a $1 trillion credit line.

Whatever the amount ultimately pledged, it would represent the most concerted international response yet to what economists warn could be a volatile, dangerous new phase in the crisis.

"We view it seriously," said Clay Lowery, assistant Treasury secretary for international affairs. "There are a lot of emerging markets that have come under increased pressure recently."

Unlike in the United States and Western Europe, banks in these countries bought few of the mortgage-related securities that undermined the financial system. But as banks stopped lending — either to each other or anyone else — that credit squeeze has hit emerging markets hard.

Stock markets and currencies have plunged, foreign capital has fled, trade flows have slowed and, in an echo of past financial crises, investors have begun to worry about governments' defaulting. Many have heavy debts in foreign currencies, but the cost of repaying that debt has increased as their home currencies' values have declined. To compensate, they are seeking dollars to repay the loans.

On the list of endangered countries, economists put Hungary, Russia, Ukraine, Pakistan, Turkey, South Africa, Argentina, Iceland, Estonia, Latvia, Lithuania, Romania and Bulgaria.

The economic woes of these countries could reverberate back to the United States, experts say, because many of them are trading partners, at a time when exports are one of the few bright spots in the American economy.

"Our whole economic prospects are going to turn on whether the emerging markets keep growing," said C. Fred Bergsten, the director of the Peterson Institute for International Economics. "It could be the difference between a moderate downturn and a deep downturn."

The crisis has been indiscriminate in its victims. It has worsened the problems in countries like Iceland, Ukraine and Argentina, which had festering economic or political troubles. Argentina, in particular, has drawn criticism from economists for its decision this week to nationalize the country's private pension funds, worth $30 billion.

But the turmoil also hit South Africa and Turkey, which economists had praised for their sound policies.

Among the earliest victims have been countries, like Hungary, where companies and even individuals borrowed heavily in foreign currencies. As credit dried up and their local currencies plummeted, they have been unable to roll over those loans. In even healthy countries, near panic has ensued — leaving people bewildered by the sudden reversal in their fortunes.

"We were not an obvious target," said Peter Akos Bod, a former governor of the Hungarian central bank. "I could not see major problems in Hungary's economic outlook. But there is sort of a panic."

Economists say the inability to borrow foreign currency is dangerous because it can quickly turn healthy economies into sick ones, as companies and potentially even governments default on loans.

"Right now, it's a liquidity problem, but if it goes on long enough, it can become a solvency problem," said Yusuke Horiguchi, the chief economist of the Institute for International Finance.

Horiguchi said that developed economies bore responsibility for easing this problem, because it stemmed from the crisis in their banking system.

Indeed, the financial rescue packages announced by the United States and European countries have aggravated the problem. Safeguards like attempts to stabilize their banks and government guarantees behind some bank lending have made banks in developing countries look less secure.

In a gesture to the precarious situation, President George W. Bush made an unscheduled appearance this month at a meeting of finance ministers from the Group of 20 countries, organized by the Treasury secretary, Henry M. Paulson Jr. Bush also agreed to convene an emergency meeting of the group on Nov. 15 to develop responses to the crisis.

Beyond reassuring words, there is a limit to what the United States can do to solve the problems of these countries. Paulson is overseeing the largest rescue program in the United States since the Great Depression. He cannot devote anywhere near the amount of time that a predecessor, Robert Rubin, devoted to the Asian and Mexican crises during the Clinton administration.

"The most important thing the United States can do is stabilize its financial system," Lowery, of the Treasury, said. "The other thing we can do is to support the actions taken by emerging-market countries."

On Thursday, the central banks of Brazil and Mexico intervened heavily in the foreign exchange market to support their currencies. Hungary obtained a loan of up to 5 billion euros from the European Central Bank.

And Hungary has overcome deep reluctance and begun negotiations with the International Monetary Fund for emergency loans, as have Iceland, Pakistan, Belarus and Ukraine. Countries are traditionally averse to such loans because they come with strict conditions.

"I'm totally unhappy about having to borrow from the IMF," Akos Bod, the Hungarian central banker, said. "I thought in my lifetime, we would never have to borrow from the IMF"

As the largest shareholder in the fund, the United States can exert influence on its policies. Administration officials said the highest-ranking American at the fund, John Lipsky, the first deputy managing director, would lead the fund's effort to extend loans to a broader range of countries.

The idea, they said, was proposed at a board meeting on Wednesday by Dominique Strauss-Kahn, the French managing director, who is the subject of an internal investigation into whether he abused his power in conducting a brief affair with a worker at the fund.

Economists praised the idea of giving emerging markets access to dollars. But the key to the effort's success, they said, is whether the fund can line up support from central banks.

"The IMF has only $200 billion of its own resources, which is not enough collateral," Simon Johnson, a former chief economist of the fund, said. "It would be spectacular if they could pull this off."

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