Piece By Piece, A Financial Recovery Plan?

If the IMF can stabilize Brazil, will a turnaround for the rest of the world begin?

There was no "new global financial architecture." And there was plenty of sniping. But the annual International Monetary Fund Conference, held in tandem with a confab of the Group of Seven industrialized nations, may be remembered as a pivotal moment in the effort to tame the emerging-markets crisis.

At center stage was Bill Clinton. Making three speeches between Oct. 2 and Oct. 6 at meetings of bankers, diplomats, and finance ministers, the President thrust the U.S. into the lead of a global rescue mission. "The global economy simply cannot live with the kinds of vast and systemic disruptions that have occurred over the past year," President Clinton told IMF delegates on Oct. 6.

The growing U.S. involvement and the glimmer of a new approach to the problems that have plagued emerging economies for 15 months is the good news. Even as the meetings continued, other pieces began to fall into place. Japan finally seemed to make progress to address some of its structural problems. And suddenly Republicans in Congress appeared ready to negotiate a deal on the $18 billion in funds that the U.S. has pledged to the IMF.

The bad news is that the President's plans remain vague, coordination between the U.S. and other G-7 nations is still fleeting, and the proposed new solutions, which may help head off future calamities, won't do much to help current victims.

What may determine whether this is the beginning of the solution--or another false start--will be what happens with Clinton's plan to save Brazil and Latin America. Treasury Secretary Robert E. Rubin and Federal Reserve Chairman Alan Greenspan are pushing hard to build a $30 billion firewall, funded by the IMF and private banks, around Brazil. If it holds, it could start to turn the tide. "Brazil is the Rubicon in the sense of restoring confidence to the emerging markets," says Citibank Vice-Chairman William R. Rhodes, who is helping to negotiate The package for an expected mid-October rollout.

To backstop a Brazil rescue, Clinton proposes new IMF powers to lend to healthy economies to protect them from the contagion of indiscriminate capital flight. Clinton's credibility on matters concerning the IMF got a huge boost on Oct. 6, when House Republicans and the White House moved toward resolving their long-running feud over U.S. funding for the cash-strapped IMF. The money, which the Administration expects Congress to approve before it adjourns for midterm elections, would rElease $72 billion in funding from other countries.

On Oct. 7, the Japanese sent optimism--and the yen--soaring with what looks like its most credible recovery plan to date. Tokyo has proposed $70 billion in new public-works spending and steeper income-tax cuts. And the ruling party is trying to hammer out a deal to use public funds to help relieve banks of $1 trillion in bad loans. Despite frequent let downs in the past when Japanese reform packages have fizzled, markets cheered. The yen soared against the dollar, to 121.

At the same time, the prospects for more rate cuts in the West brightened. Spain cut its interest rates a half-point on Oct. 6--double the reduction markets had expected--a sign that Europeans may be ready to follow the U.S. in responding to the recessionary threat posed by the emerging-markets plunge. What's more, Bundesbank President Hans Tietmeyer has now indicated that Europe's rates should drop from today's 4% average to Germany's 3.3% by Jan. 1, when the new European Central Bank takes over. Another cut, to 3%, could come early in 1999--particularly if the Fed keeps cutting U.S. rates. "There is clearly the will to counteract a slide into recession," says Rolf E. Breuer, chief executive at Deutsche Bank.

But it's Clinton's intense focus on the crisis--and its growing threat to American prosperity--that's likely to have the most long-term impact. And the raft of schemes now on the table shows that the U.S. is willing to back away from the kind of harsh demands for budget reforms and market discipline that the IMF has insisted upon for ailing economies. With the U.S. leading, the G-7 industrial nations are now discussing pre-emptive IMF lending to countries that aren't paying their private creditors, "bail-ins" of bankers to force private lenders to share more of the pain of debt workouts, debt-for-equity swaps to ease onerous payment schedules, and modest capital controls to slow the flow of "hot money" into emerging markets.

But the G-7 won't have the luxury to rebuild the financial system until they stop the crisis. That's why Brazil is crucial. Latin America's largest economy lost a third of its hard-currency reserves in September and now has just $45 billion to defend the real. The $30 billion rescue would buy time while newly re-elected President Fernando Henrique Cardoso reins in a soaring budget deficit. "Rapid work is being done to implement this aid," says Argentine President Carlos Menem. Argentina, suffering from commodity price drops, could be the next victim if Brazil falls.

Atop the Brazil rescue, the IMF and other global financial institutions hope to erect a regional defense fund, says Menem. It would be stocked in part with contributions from the world's biggest banks, to protect the rest of Latin America from contagion.

Greenspan is contributing to the defense of the Latin economies as well. The Fed chief and his European counterparts are leaning on bankers to keep their cash in developing countries with sound economies, such as Argentina, Chile, and Mexico.

Will the line hold? Brazil is a good place to take a stand because Cardoso is the living symbol of the fight against hyperinflation, and he has just received a new mandate to press for economic reforms. But his government's deficits are rising, and many economists say the real is overvalued by as much as 15%, making it a target for speculators. And Cardoso's new term isn't getting off to a great start: In an Oct. 7 speech, the first since his reelection, he punted on new proposals to trim spending, promising only to propose new fiscal measures in the near future. That sent the Brazilian market tumbling.

Latin America isn't the only front on which the new approach by bankers and policymakers will be immediately tested. Finance officials are nervously eyeing a new confrontation in Ukraine, which has angered investors by refusing to make dollar-denominated bond payments that would take the country's reserves below the IMF-imposed minimum. To avoid a Russia-style default and further market hysteria, the IMF is pressuring the lenders to take a haircut--and two-thirds have agreed to reschedule their loans. This showdown could test the IMF's new resolve to make lenders responsible for decisions they made during the years of emerging-market euphoria. If the tough stance works, it could be codified in the IMF's rules.

By themselves, such small changes aren't the bold architectural redesigns that victims of the current crisis are crying for. But by drawing a line in Latin America, getting tough with lenders, and spotlighting the urgency for bold action, Bill Clinton and the G-7 have taken a big step toward bucking up the system. "Restoring confidence is the name of the game," says Citbank's Rhodes. That may be the monetary mavens' greatest accomplishment.

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