Ninth Annual Corporate Conference, Remarks by Carla A. Hills

Ninth Annual Corporate Conference

Carla A. Hills _*

Ninth Annual Corporate Conference
Hong Kong, May 7, 1998

Speeches and Transcripts: 1998

I am delighted to participate in the Asia Society’s 9th Corporate Conference in Asia, convened here in Hong Kong, the region’s highly respected financial center.

The circumstance of Asia has changed very substantially since last year’s Corporate meeting, when we gathered in India to talk about the pace of economic liberalization in the region.

As a result of its financial crisis, Asia, widely admired for three decades of annual growth averaging 8 percent, is in the midst of a very painful slowdown.

Because of the increasing linkage of our economies, the repercussions of the financial crisis have affected growth projections worldwide. Recently, the IMF changed its 1998 forecast for global growth down to 3.1 percent—a full percentage point lower than its forecast just six months ago.

In light of the circumstances that exist, it is appropriate that the business and government leaders gathered for this Corporate Conference reflect upon policies that could reinvigorate growth across the region. That is the focus of this session.

I though that I would talk about two broad areas. I start with the need to reform the international financial system because the financial turmoil we are experiencing overshadows all other events in Asia.

Then I would like to say a few words about steps that we can take to improve the business environment, and in so doing encourage economic growth.

Finally, I will conclude by mentioning the extraordinary opportunity we have together to build on the liberalization that has fueled our growth over the past 50 years to ensure that we enjoy similar growth in the 21st century.

Financial Sector Reform

We cannot meet in Asia and fail to talk about the state of its financial sector.

Economists may debate whether the choice and dosage of medicine prescribed by the IMF perfectly suited each of the afflicted Asian economies, but there is no disagreement about the need to strengthen financial systems or the fact that doing so will help to bolster future growth.

Technology, globalization, and deregulation have combined to pen financial markets to a degree never before seen. This has brought enormous benefits to borrower and lender alike.

But the capacity to transmit data instantly not only enhances growth opportunities, it exposes, expedites and enlarges the reaction to perceived risk.

During the 1990’s, foreign lenders, captivated by Asia’s steady expansion, flocked to its markets where the growth prospects appeared very positive, macroeconomic fundamentals sound, and financial returns higher than elsewhere.

As a result, the quantum loans flowing to Asia mushroomed. In the first half of this decade, roughly $400 billion flowed into its developing economies alone, and in some countries, the inflows exceeded 10 percent of GDP.

Some Asian governments, attracted to the notion of cheaper capital coming into the country, even offered tax breaks to encourage offshore borrowing.

This flood of foreign funds, for the most part, flowed through domestic financial institutions to private borrowers, creating a lending boom that became, to borrow a phrase, irrationally exuberant. Efficient capital allocation and risk assessment fell by the wayside.

Prudential supervision and regulation in the region were inadequate to control the increasingly risky transactions. Requirements for public disclosure were weak. Opaque procedures hid off-balance sheet transactions, concealed liquidity problems, and masked the true volume of connected and policy-directed loans.

Notwithstanding the very real impediments to a proper assessment of risk in the region, it is quite clear that some international investors lent to highly indebted financial institutions in Southeast Asia when the prudential standards applicable to them should have prohibited the lending.

As we all know, the credit boom, unchecked, gave way to a bust that has traumatized domestic currency and securities markets.

The question is whether there are policies that could be implemented to prevent a repetition of the current disorder.

Clearly, closing markets to foreign lenders is no defense to the shortcomings that led to Asia’s financial turmoil. Access to foreign capital has been an indispensable vehicle for lifting millions of people out of poverty—and will continue to be vital for Asia’s future growth.

Banning, taxing, or rationing the borrowing of foreign currency introduces an interference in the market without fixing the underlying problems.

The best defense against shocks that can roil financial markets is to build stronger financial systems.

That means ending state interference in the credit system. The market does a better job in allocating credit.

It also means requiring greater transparency to permit an accurate analysis of risk.

It certainly means opening financial markets to foreign service providers. Subsidiaries of strong international institutions bring to the local market not only the financial strength of their parents—which aids in withstanding shocks—but also the established practices regarding accounting, disclosure and risk assessment—which strengthens their operations. These practices tend to be contagious in the good sense.

Most importantly, it means putting in place better supervision of the financial institutions participating in international markets, (which today includes many so-called local banks). That will increase stability, which will in turn increase the confidence of those who would place their capital at risk.

This is a task that we must tackle together, for the need to improve financial supervisions is not limited to Southeast Asia or to developing economies. Industrialized countries have had their currency crises.

The United States was forced to close over 2500 banks and savings and loan associations between 1980 an 1992, Sweden faced severe problems in the early 90’s, and the European Monetary System confronted a crisis in 1992 and 1993.

But improvident banking practices and lax supervision hit developing economies much harder because their banks hold most of their countries financial assets.

When these banks get into trouble, they can put in jeopardy their country’s entire financial system. And, instability that erupts in one market can spread rapidly to other markets, infecting the global financial system.

The challenge is to set, implement, and enforce standards that will govern our international financial system when banking supervision and regulations are typically national in scope and reach.

A number of proposals have been made.

Morris Goldstein at the Institute for International Economics thoughtfully and persuasively argued early on for devising and implementing a set of international rules governing all significant aspects of banking supervision, including such basics as adequacy of capital, risk assessment, international controls, accounting requirements, and disclosure.

Subsequently, the Basle Committee on Banking Supervision, a committee established practices regarding accounting, disclo of the Bank for International Settlements, was persuaded to draw up 25 core principles as a first step in developing a system for effective banking supervision.

These principles are helpful. The question is how can they be implemented and enforced.

It was recently proposed that the members of the IMF agree to “internationally accepted standards” and to vest that body with jurisdiction to promote these standards. It was suggested that the IMF might refuse to complete a country’s annual Article IV consultation if the country failed to provide adequate information.

Others have urged the creation of a new super-national institution.

A Study Group of the Group of 30, comprised of economists and bankers from a diverse set of countries and chaired by Paul Volcker, has taken another track.

It proposes that representatives of international financial institutions, voluntarily work with Central Bankers to develop appropriate international standards and internal controls; and that institutions agree to submit their operations to an independent external global audit to verify their subsequent compliance with the agreed standards and controls.

Such a collaborative effort skillfully sidesteps the prickly issue of sovereignty, and offers the promise of being broadly acceptable to countries of diverse traditions and culture and appropriate to a wide range of institutions.

Leaders on both sides of the Pacific have a huge stake in the success of these efforts and can make a contribution.

Our governments, over the past half century (with substantial help from the private sector) have developed international norms reducing trade barriers, which has caused the global economy to expand at historic rates.

It is time for us to work together to develop an improved system of prudential supervision and regulation that will help stabilize and make more efficient our increasingly integrated financial markets.

It is a sure way to increase confidence in the markets, which in turn will reinvigorate global growth.

Reform of the Business Environment

And, the quality of a country’s business environment can also help or hinder growth. It significantly influences where firms are willing to invest their capital.

A market that is distorted by state monopolies, subsidies, and price controls or limited by restrictions on foreign ownership or cumbersome screening procedures is less attractive to entrepreneurs—domestic and foreign.

Corporate Disclosure

In the wake of the financial turmoil in Asia, investors worldwide are asking many more questions about the countries and firms with which they might do business.

They have become more cautious about investing capital where basic accounting standards and disclosure frameworks are weak. They worry that the opaque balance sheets of firms put up for sale may hide liabilities, turning what looked like an opportunity into a disaster.

A report last month to the Organization for Economic Cooperation and Development recommends creating the first set of internationally recognized corporate governance guidelines to improve board independence and to encourage appropriate corporate disclosure.

A recent survey of international investors documents that most believe that it is extremely important for countries to establish such standards.

To give confidence, government and business leaders here could spearhead an effort to adopt internationally, norms similar to the generally accepted accounting principles, which have contributed so positively to U.S. capital markets.

Rule of Law

Also, we know that the rule of law is key to establishing the confidence necessary to attract investment. In deciding where to place their capital, investors invariably inquire about a particular country’s tax and banking regimes, their bankruptcy and securities laws, and the reported levels of corruption.

Corrupt practices destroy a government’s credibility and rob business of the capacity to compete on the basis of price and quality.

Increasingly, governments are taking a stand against such practices.

In 1996, for example, the Organization of American States adopted a Convention Against Corruption and 23 of the Organization’s 35 members have signed it.

This year the 29 member-nations of the Organization of Economic Cooperation and Development plus 5 other countries reached agreement and are presenting to their national legislatures, a Convention that makes bribery of a foreign public official a criminal offense.

What a grand and positive outcome if government and corporate leaders attending this Conference were to persuade their Heads of State and Ministers attending the Asia Pacific Economic Cooperation Forum in November to commit to adopt the type of disciplines set forth in these new Conventions.

There is not doubt that such a combined and concrete effort to eradicate corruption would bolster business confidence and encourage economic growth throughout the region.

The WTO Ministerial and Asia

And together this month we have a magnificent opportunity to encourage action that would spur global growth. Our Trade Ministers will gather in Geneva on May 18th for their second World Trade Organization ministerial, at which they will celebrate the 50th Anniversary of the General Agreement on Tariffs and Trade.

As WTO members, we have much to celebrate. The removal of trade and investment barriers over the past half century has fueled a fourteen-fold increase in global trade flows. Trade today exceeds $6 trillion annually and constitutes over 20 percent of world output, contributing mightily to the well-being of people worldwide.

A fitting tribute to this 50th Anniversary would be for member nations to put in place a plan to permit an expansion of trade during the next half century as grand and beneficial as the one we are about to celebrate.

To that end, in Geneva, Ministers could announce their intent to launch the Millennium Round of Multilateral Trade Talks at their next meeting, in the year 2000, and begin now to lay the foundations for those negotiations. The aim would be to conclude this Round by the year 2005.

The Millennium Round could encompass not only the important areas of services and agriculture that Ministers have already agreed to negotiate, but also a broad range of issues whose resolution could galvanize global growth.

Think of the boost all of our economies would derive just from the elimination of tariffs on a world-wide basis!

Currently on both sides of the Pacific, there are a number of serious efforts to liberalize trade and investment.

For example, within the South Asian Preferential Trade Arrangement, governments have agreed to become a free trade zone by 2002.

Members of the Association of Southeast Asian nations have pledged to eliminate non-tariff barriers to trade and to reduce tariffs to 5 percent by the year 2003.

The nations of the Western Hemisphere announced in Santiago last month the beginning of negotiations for the Free Trade Area of the Americas with the goal to have an agreement by 2005.

The members of the Asia–Pacific Economic Cooperation forum are working to eliminate barriers to trade and investment by the year 2010 for industrialized nations and 2020 for developing nations.

And the European Commission has proposed (although Member States have not approved) a Trans–Atlantic trade agreement with the United States.

Consolidating these endeavors into a Millennium Round would give us the opportunity to reconcile these regional efforts at trade liberalization with our commitment to strengthening the global trading system.

And, the launching of this new Round would encourage political leaders around the world to make the case for open markets to their often skeptical populaces.

The nations of the Asia–Pacific region have a substantial interest in such an effort. In recent years this region has accounted for over half of global trade and has been the recipient of nearly half of the world’s foreign direct investment.

This region played a key role in ensuring the success of recent multilateral agreements that opened such important sectors as information technology and telecommunications.

Building on this past leadership, our nations together could play a pivotal role in advancing global liberalization in a new Millennium Round, and in so doing reinvigorate growth world-wide into the next century.

I can think of no group better qualified to press forward with these initiatives than the corporate and government leaders assembled here for the Asia Society’s Corporate Conference.

I hope you agree.

*: Carla A. Hills is the former United States Trade Representative. Back.