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September/October 2002 Volume 4 Edition 3


In this issue:


(full-text Advisor below, or click on title for single article window)

Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editor: Dr. Jonathan Lemco, Director and Sr. Consultant

Associate Editors: Robert Windorf, Darin Feldman

Publisher: Keith W. Rabin, President

Web Design: Michael Feldman, Sr. Consultant

Contributing Writers to this Edition: Scott B. MacDonald, Keith W. Rabin, Jonathan Lemco, Russell Smith, Jonathan Hopfner, C.H. Kwan, Sergei Blagov, Robert Windorf and David Fuhrmann

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U.S. Corporate Bond Market – Uncertain Times

By Scott B. MacDonald

We remain constructive about the rest of the year for the corporate bond market, though there are many uncertainties - the possibility of another terrorist attack, the potential for a U.S. war against Iraq, and a double-dip recession. Another al-Qaeda terrorist attack on U.S. soil would be a blow to confidence, while it is difficult to quantify the impact of a U.S. war against Iraq. A double-dip recession would obviously be a big negative. Although we do not rule out a double dip recession, we expect the U.S. economy to muddle through. The combination of auto sales, mortgage refinancing, and housing, plus one more Fed interest rate cut, will allow the economy to slide by at around 2.5% for 2002. That stated, we still expect investors to remain very sensitive to any negative news on the economy and to remain focused on corporate earnings (in late September and October for Q3). The equity market will continue to be exceedingly volatile, with seismic-like daily shifts.

Much depends on restoring investor confidence. In August, when we enjoyed a short-lived equity market rally, the corporate bond market saw spread tightening and new issuance. During the third week of August, 28 issuers came forward and brought $16.36 billion in bonds to market, the largest weekly number since March 2002's $26.9 billion. While some economic numbers helped nudge the rally, there was also a sense of relief that most major companies made it through the August 14th CEO and CFO earnings accountability signings without major problems. Indeed, the corporate governance issue, barring any new scandals, is likely to fade as a concern.

It is estimated that potential new investment grade corporate bond issuance for the remaining months of 2002 could be between $90-$100 billion, at least part of which comes from the need to refinance as debt comes due. The next major trigger for the corporate bond market is likely to be Q3 corporate earnings, which start in late September. As corporate governance issues fade, attention will return to more fundamental credit concerns about profitability, debt management, and liquidity. Related to this is the pace of the economy. Most economists are looking for real GDP growth in Q3 in excess of 3%, followed a slower pace in Q4. That could help provide some traction for better corporate earnings through the end of the year. However, there remains considerable nervousness in corporate America and most managers are still looking to trim capital spending -- not increase it. The earnings announcements of the large brokerages, such as Morgan Stanley, thus far have not set a positive tone. JPMorgan Chase's problems, including ratings downgrades, have not helped.

It should also be understood that the drop in U.S. unemployment from 5.9% to 5.7% was largely due to job creation in government, while manufacturing actual had a drop in employment. As we see consumer demand remaining in positive territory, the most likely outcome is that the economy on a whole will not get much worse, but it will not get much better. The same can be said for the corporate bond market.

Interview with Korea's Leading Venture Capitalist:
Mr. Ki-Woong Baek, CEO of KTBnetwork

View the Interview

By Keith W. Rabin

In this issue the KWR International Advisor interviews Mr. Ki-Woong Baek, CEO of KTBnetwork (KTB), Korea's oldest and largest venture capital firm. KTB possesses a twenty-year history, 20% market share and a record of about 1,000 investments and 170 public offerings on the KSE, KOSDAQ and NASDAQ stock exchanges.
Mr. Baek is a leading figure in the Korean venture industry, having engineered many substantial transactions since joining KTB in 1999. This includes eBay's majority investment in Korea's leading cyber-auction house Internet Auction Co. Ltd. in a deal valued at approximately $120 million . Rising to the CEO position in only two and a half years, Mr. Baek joined KTB after a distinguished career as a senior manager at the Hyundai Group and SK Telecom. In this capacity he developed the marketing, planning, financing, and other management skills that have helped him gain one of the most enviable investment records in this emerging sector. Mr. Baek holds a Bachelor of Science degree in Mechanical Engineering from Hanyang University in Seoul, Korea. Mr. Baek has graciously agreed to the following interview with Mr. Keith W. Rabin, publisher of the KWR International Advisor.

KR: KTBnetwork is Korea's largest Venture Capital company. Can you tell us more about your organization and personnel as well as the emerging venture phenomenon in Korea? How has your organization and venture investment in Korea evolved over the past two decades?
KB: Most venture companies have suffered over the past two years and we are no exception. Given our financial strength, however, we are using this time to refocus and renew our competitiveness. To facilitate this process, we began working with Bain & Company, a renowned management-consulting firm, last year. The vision that we developed will help KTB to diversify its investment focus and to advance our operations beyond Korea. Our goal is to establish a leading global investment firm by the end of this decade. To achieve this vision, we are actively improving our core capabilities in venture capital and corporate restructuring, while expanding the entertainment and overseas facets of our business.

As a result, KTB registered to become the first Corporate Restructuring Company (CRC) in Korea. We are currently the most robust company – domestic or foreign -- in this sector with a number one market position. Since entering this field as a pioneer in 1999, we have assembled a team of top-tier experts, building an excellent market reputation and abundant capital -- totaling 43% of total corporate restructuring funds in Korea. As the undisputed leader, we have, as of the end of last year, invested 336 billion won in 34 companies. This includes positions in StarCo, Wise Control, Samhan and Kumkang Industrial, which emerged from bankruptcy or court receivership status and Curitel, Korea PTG, Dongshin Pharmacy and Samsung Pharmacy, which are rapidly moving to normalize their operations. While the Korean restructuring business is at most three years old, we have made substantial progress and look forward to realizing considerable profits in this sector during the latter half of this year.

By introducing this value-oriented and restructuring component to our business we seek to differentiate ourselves from firms such as Softbank and CMGI who retain their primary focus on technology. This will help to stabilize our profitability and revenue flow.

I would add, however, that venture capital is a business that bets on the future. Therefore, there will always be an element of uncertainty in what we do. The current market environment exacerbates these inherent difficulties yet I am certain we will overcome these problems and emerge even stronger in the end.

Buyside Magazine reaches active institutional investors monthly with news and analysis of the equities markets. Buyside takes readers beyond news of the current business climate to report industry and market trends that are crucial for investors to understand -- not simply the latest business trends or product releases. Buyside and BuysideCanada are available in print, and online at www.buyside.com. Subscriber information is available on Buyside's home page.

The U.S. Economy: A Few Bad Apples or Tip of the Iceberg?

By Keith W. Rabin & Scott B. MacDonald

In the face of massive stock market volatility, wealth erosion and concern over almost accounting and corporate governance scandals, there is considerable discussion about the need to cull the few "bad apples" that are giving U.S. business a bad name.

Many analysts and television talking heads note that Main Street is demanding the culprits be apprehended and made to do hard time. Congress has been busy passing legislation to deal with corporate sleaze. This thinking reflects the common perception that most corporations are managed by honest people and that the main task at hand is to root out the egregious examples of fraud that are shattering investor confidence. Then, it is believed, market concern can be alleviated and U.S. firms can return to what they do best - make profits. With U.S. business refocused on profits (as well as better corporate governance), the economic recovery will be assured, the stock market will go back up, and the American public will regain lost confidence in buying securities.
While it is true that most managers are honest and indeed critical to make examples of executives who commit criminal fraud, this type of thinking misses the boat. Yes, the outright deception that characterized the Enron, WorldCom, Tyco and other debacles are special cases, but the late 1990s tendency to engage in highly aggressive accounting practices was highly pervasive -- even though most firms remained within the lines of ethical corporate behavior. It should be remembered that following the Arthur Andersen debacle, there are now 2,400 ex-Andersen accounts forced to reexamine everything that was reported over the last several years. This will have a negative effect on earnings moving forward. It is probable that at the very least a number of firms will have to restate earnings - not a good signal to an already highly sensitive bear market. Therefore, one might view the current paradigm as more similar to exposing the tip of the iceberg than the need to clean out a few bad apples.

As the late 1990s Internet boom accelerated, traditional rules of business behavior and corporate valuation were eroded. In the land grab that characterized this era, growth of market share was seen by many to be more important than profitability. Many concluded it was better to invest in new, speculative firms who had little more than a business plan and venture capital funding. These enterprises enjoyed massive capital inflows without the need to endure the analytical rigors and performance expectations imposed upon companies with real revenues and operating histories. Emerging firms such as Amazon, eBay and eToys quickly amassed market capitalizations that were larger than many Fortune 50 corporations.

To remain competitive, established firms turned to high-octane financial engineers. As if by magic, they transformed balance sheets and income statements in a manner that delivered the progressively improving performance demanded by the financial community. Two exemplars of this trend, Andrew Fastow of Enron and Scott Sullivan of WorldCom, were lionized for their achievements and recognized as being in the forefront of business finance. Each received "Best CFOs" ratings in annual competitions by CFO Magazine. Corporate finance managers recognized this change in sentiment and adapted their institutional values accordingly. The message was clear. CFOs and controllers who wanted to get ahead adopted an aggressive stance. Those that maintained a conservative posture were viewed as old-fashioned relics of the past.

Today, we are presented with a very different dynamic. Many of the practices seen as highly clever and cutting edge only a year or two ago are now viewed as scandalous. Good, conservative accounting practices, which could likely have been grounds for dismissal in 1997-2000, are now seen as desirable virtues. Corporate behavior is beginning to reflect this new reality. This in essence is what is so troubling about the current "bad apple" debate, which maintains that once the few fragrantly fraudulent offenders are rooted out, the "silent majority" of good, honorable companies can regain the valuations they deserve. Matters are not so black and white nor is it a case of good versus evil.

Accounting is far more art than science. As anyone who has engaged in the preparation of complex financial statements can observe, numerous subjective judgements are required as to how to classify and treat each and every item. President Bush acknowledged this phenomenon in a press conference. When asked about Harken Energy, he noted something to the effect "in the corporate world, not everything is black and white and sometimes there are honest disagreements on how to account for complex transactions."

As the smell test of what is normal and ethical shifts from overly aggressive to even mildly conservative, it will have profound implications on the standards that govern audits and the behavior of corporate finance professionals. Most corporations - whether or not they have engaged in any fraudulent behavior -- will be far more reserved in their accounting and corporate profitability will inevitably suffer as a result. This represents an obstacle that has not been sufficiently recognized or factored into the expectations of many analysts and investors.

It therefore does not seem realistic to imagine that even if the U.S. could show dramatic 2002 GDP growth beyond the 2-3% anticipated by most economists, that we will see the earnings revisions that will lead to the rapid upwards valuations needed to lift share prices.

Far more likely is a continuation of the current scenario, in which we continue to slowly work off the excesses of the dot.com era. Real growth and achievements will be masked by a continual procession of announcements concerning accounting and other irregularities - not to mention the major uncertainties caused by the continuing war on terrorism. In the end corporate America will emerge all the stronger. However, a belief that we simply have to uncover all the "bad apples" to rectify all that is wrong with the current market environment will only delay the ultimate resolution of these important issues.

Why Hasn't China's Income Grown as
Fast as its Output?

By C.H. Kwan, Senior Fellow, Research Institute of Economy, Trade and Industry (RIETI), Tokyo

Technological innovation in recent years in the form of modularization has brought drastic changes to the pattern of division of labor among companies, as well as among nations. Multinationals have been relocating their low value-added production processes to developing countries in pursuit of lower cost. China has taken this opportunity to establish itself as a major production base for multinationals. The fast pace of industrialization, however, has not been accompanied by a rapid increase in China's national income in dollar terms, as it have been forced to sell at lower and lower prices in international markets.

Modularization is to decompose industrial processes into segments, or modules. In the case of personal computers, for instance, respective modules such as a hard disk and a display are first produced separately, and then integrated into a complete system. In an industry where this modularity concept is widely applied, there exist established design rules and standards concerning the construction of respective modules. At the same time, modularization also provides flexibility to accommodate new methods of production within these rules. Processes within each module are independent from each other, neither affecting nor being affected by processes in other modules. This makes it far easier to place orders with different companies to undertake different production processes, or to become specialized in the production of a specific module.

Thanks to modularization of production, in many industries, the profitability at various stages of production has come to follow a U-shaped curve – high at the upstream and downstream processes and low at the midstream processes (Figure 1). Stan Shih, Chairman of Taiwan-based Acer Inc., is said to have first coined the term "smiling curve" to describe this phenomenon. Regarding personal computers, for example, value added is high at the upstream, which includes the development of operating systems (OS) and central processing units (CPU), and at the downstream, which includes maintenance services. Profitability is lowest in the midstream process, which involves such labor-intensive processes as assembly.

Modularization eliminates the need for a company to keep all the production processes in a single place or within the same company. Today, it is far more efficient to decompose production into a number of processes linked through a network of suppliers. Indeed, corporate and industrial reorganization has been taking place in a way that shifts away from the conventional integrated production system – typically from raw materials to finished products – to one concentrating resources on a specific area of strength. Likewise, business relations between companies are no longer limited to trade and capital participation, but also include such diversified forms as technology tie-ups and original equipment manufacturer (OEM) contracts.

Along with the progress in trade and investment liberalization in developing countries, inter- as well as intra-company production networks have become increasingly globalized. In accordance with respective countries' comparative advantages, labor-intensive processes tend to concentrate in developing countries that offer low wages, whereas high-tech processes, such as research and development (R&D), are undertaken by developed countries. As a result, there have been growing flows of trade in manufactured goods – especially of parts and intermediate goods – between developed and developing countries. This phenomenon has been called the "horizontal division of labor," as such exchanges are being made within the same industry. It had better be termed "vertical division of labor," however, given the way that processes are being divided between developed and developing countries respectively, with the former concentrating on high value-added and the latter on low value-added processes.

Against this backdrop, China has been taking advantage of its cheap and abundant labor to attract direct investment by multinationals, thereby accelerating the pace of industrial development. Exports of manufactured goods have increased sharply in recent years to account for 90 percent of China's overall exports in 2001. Processing trade, which represents roughly half the overall trade of China, has come to play a more important role in the Chinese economy. With its share of the world's manufactured exports rising, China has been widely recognized as the "factory of the world."

In terms of the smiling curve, however, the segment accessible to China (as well as other developing countries) is largely limited to the part around the tip of the chin, i.e., fields where value added is the lowest. Until the 1970s, as a newly industrializing country, Japan was fortunate that it did not have to compete with low-wage countries because manufacturing was highly concentrated in the industrial countries. Following the end of the Cold War and the integration of the former socialist countries into the global economy, however, cheap labor has become more readily available, and developing countries have been watching their profits fall amid intensifying competition. The smiling curve is thus getting steeper and steeper. For China, this means a decrease in the relative price of the labor services it provides against advanced technologies imported from developed countries, and a worsening of its terms of trade. In the sense that an increase in production has not necessarily led to an increase in real income, China is trapped in a grave situation of immiserizing growth. To set itself free from this trap to become a developed country, China must promote development focusing on the two ends of the smiling curve. But for this, improving the stock of human capital is vital, and China has a long way to go.

Figure 1. The Smiling Curve

Aoki Masahiko and Ando Haruhiko. Mojuruka: Atarashii Sangyo Akitekucha no Honshitsu (Modularity: The Nature of New Industrial Architecture), RIETI Economic Policy Review 4, Toyo-Keizai Shimposha 2002

Related story: "Don't Confuse ‘Made in China' with ‘Made by China,'" C.H. Kwan, China in Transition, April 26, 2002

Korea: Still The Best Comeback Story in Asia

By Jonathan Lemco

Since the "Asian Financial Crisis" of 1997-98, South Korea has made the greatest tangible effort to restructure its financial services industry, reform its Chaebols, and improve public policy making. The leading international credit rating agencies have taken notice, and have raised the nation's sovereign credit rating to A3 (Moody's) and A- (Standard and Poor's). This is the highest rating of any of the Asian nations most affected by the financial crisis four years ago. It also reflects the fact that Korea has now graduated from the ranks of the "emerging markets" to "developed" economy status. This is not to suggest that there is not more work to be done. Inefficiencies remain in the financial, economic and political system. But the progress made thus far has been admirable.

Looking forward to the final months of 2002, we expect Korean economic growth to slow but to remain fundamentally healthy. Exports are poised to continue demonstrating strength, having increased by 19.9% year-on-year in July and August 2002. Furthermore, Korea's solid external balance sheet is reinforced by its strong net foreign asset position of US $44.3 billion in July. Government finances are stable and in balance. The annualized fiscal surplus is currently at about 2% of GDP, and surveys of leading financial economists reveal that the Korean budget surplus is likely to be in the 1.4% range in FY 2002. At this time, inflation is not a serious worry. The core CPI was up by 2.8% in August 2002, and has been consistent throughout the year.

To the extent that there is reduced economic activity in 2003, it will likely be due to global weakness rather than any general stagnation in the Korean economy. Domestic demand was down from the torrid pace of the first quarter of 2002. We expect Korean growth of about 6% in FY 2002 and 5.6% in FY 2003. It was 6.3% in August. Under current economic circumstances, this is quite robust for an industrialized nation.

Furthermore, the government is cutting back on its economy-boosting infrastructure spending, such as for roads and other civil engineering projects, as the economy improves. Government spending rose 4.9% in the second quarter of 2002, compared with 5.5% in the first quarter.

There are obvious challenges to the Korean economy of course. On the political front, the December presidential election is too close to call between three viable candidates. Furthermore, relations between North Korea and South Korea, although much warmer of late, will remain unpredictable for the foreseeable future.

It should also be noted that some analysts have suggested that if oil prices spike up due to a potential invasion of Iraq and the consequent turmoil that might follow, a big "if", then Korea's current account could be pushed into a deficit of –1.0% of GDP in 2003. This is because as oil imports increase and exports weaken, global growth could soften. Higher oil prices would effect Korean domestic consumption, production costs, and net exports such that GDP growth in 2003 could deteriorate by 0.8% in 2003. In addition, the balance of payments surplus that allowed Korea to accumulate $116 billion in foreign exchange reserves could fall. But we are not forecasting dramatic increases in oil prices for the foreseeable future. This is because it is most unclear at this time that there will be an invasion and, even if there is, it is also the case that Iraq exports only a fraction of the oil that it did before sanctions were imposed.

So Korea remains one of the best economic stories in Asia. Unemployment remains relatively low at 3.0%. Also, Korea has developed a consumer culture that was absent before the crisis. Credit cards are used everywhere and consumer debt is increasing at a pace typical of OECD levels. But Korea's high savings rate (32.4% in 2000), its strong household balance sheets, and the resilient underlying economy suggest little reason for concern about the sustainability of the debt.

In addition, the nations' financial institutions continue to improve their balance sheets, although much work remains to be done in this regard. Non-performing assets have been substantially reduced though sales, write-downs and restructurings. Overall, capital at the nation's banks has risen 22% since 1998 and non-performing loans have dropped to just 4.1% of total loans (down from an "official" peak of 18% of loans in 1998 and an "estimated" peak of 25%).

We are confident that barring global calamity, Korea will remain an economic powerhouse in Asia. In fact, since the end of the financial crisis, investors have been amply rewarded for their confidence in the Korean credit.

TRADE TRIALS: Supachai Panitchpakdi and the new WTO

By Jonathan Hopfner

When former deputy prime minister of Thailand Supachai Panitchpakdi succeeded Mike Moore as the director-general of the World Trade Organization (WTO) in September, he carried the hopes of much of the developed world with him. As the organization's first leader from Asia and from a developing country, many non-industrialized nations are confident that Panitchpakdi will ensure their interests are better represented on the global stage.

Judging from Panitchpakdi's conduct so far, these hopes seem well founded. Both before and after assuming his new post, the director-general has continuously emphasized the need for the WTO to be more responsive to the demands of its poorer members. At a conference on global trade held at the United Nations' regional headquarters in Bangkok in mid-July, he warned that the failure of past global trade rounds to address the issues crucial to developing countries – such as the continued refusal of wealthier members to open up their markets to agricultural and textile imports – risked alienating many Asian and African nations. He called on the world's economic powers to bring "much-needed concessions to the negotiating table" at future trade meetings. In addition, he has publicly mulled the idea of establishing a WTO representative office in the heart of the developing world, most likely Africa, as many WTO countries lack the resources to operate permanent missions in the organization's current headquarters of Geneva. This severely dampens their ability to participate fully in everyday trade negotiations.

Conscious of the WTO's image as a force that seems answerable to no one, Panitchpakdi has pledged to increase the organization's accountability by boosting its cooperation with local governments, non-governmental organizations and the public. This, he stated at the conference, would "create more understanding" regarding the WTO and its raison d'etre. He has also expressed a determination to overhaul the WTO's complex – and frequently bogged-down – dispute resolution processes, by making litigation more difficult for members to initiate. "We need to emphasize that developing countries should be helped more than in the past and that the process of dispute settlement is conducted in such a way to postpone litigation as long as possible – litigation is too costly. We must find other options," he told participants in the Bangkok conference.

While Panitchpakdi's sentiments are clearly noble – and provide good reason for developing nations to celebrate – the realities of his new position are somewhat less encouraging. The foremost pressure on the new director-general is time; bickering over who would take the WTO's top post led members in 1999 to split the six-year term between Panitchpakdi and his predecessor, Moore. This gives him only three years to bring much-needed change to the corridors of power in Geneva.

Even before his three years are up, Panitchpakdi faces a more pressing deadline. At talks in Doha, Quatar, last November, WTO members agreed to conclude the next round of trade negotiations by 2004. As the organization's leader, Pantichpakdi's primary task is to push the WTO countries to wrap up these talks ahead of the deadline, a task that is almost certain to be an uphill battle. The negotiations span an unprecedented range of topics and issues. Nearly all of them are contentious, including the liberalization of trade in services and the establishment of international rules governing intellectual property, competition, and countries' biological resources.

Recent unilateral moves by the WTO's more powerful members will likely make future trade talks even more trying. The US has demonstrated its resistance to compromise by passing a bill that grants massive subsidies to domestic farmers and imposing tariffs on a variety of imported steel products, angering many developing countries in the process. In addition, the various members of the WTO can by no means be grouped into clear-cut "developed" and "developing" camps. Even nations of similar economic status often find themselves at loggerheads, as demonstrated by the European Union's WTO-sanctioned decision in September to levy $4 billion of tariffs against American products as retribution for a US foreign-sales tax break. Despite the WTO's promise to focus the next round of trade talks on poor countries, high-profile cases like these show it is economically powerful nations that are once again poised to top the agenda. Though he appears to be facing formidable obstacles, Panitchpakdi has spared no effort to emphasize his confidence that the talks will proceed on schedule. "It is sometimes arduous in pursuing negotiations, but we'll meet the deadline as best as possible," he said in Bangkok. "I'm optimistic we'll be on track."

Crucially, Panitchpakdi seems to have realized that his position itself is a delicate balancing act. His leadership has been championed for so long by developing countries, it is only natural that the WTO's industrialized members would view him with some degree of suspicion, a fact that he seems to have taken into account. Though he has called for developed nations to make room for further imports in their markets, he has been equally critical of poorer nations, many of which have established protectionist barriers of their own. And his views that the WTO needs to streamline some of its inner processes could hardly be contested by members on any side of the political divide.

Thus far, Panitchpakdi has demonstrated foresight, a keen perception and diplomatic savvy. Though it remains to be seen if his tenure will bring about the much-needed change so many voices – from both within and outside the WTO – are calling for, the proposals he has put forward seem to bode well for the future. Even the implementation of one of the initiatives he has discussed – the establishment of a WTO office in Africa, for example – would go a long way toward convincing the WTO's critics that it has taken their concerns into account.

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Cuba on the Mind: Foreign Investment Hurdles

By Scott B. MacDonald

Cuba has long held an attraction for U.S. business. Indeed, there is now an intense debate in the U.S. Congress over whether to abandon the U.S. economic embargo on the country, with the U.S. agricultural lobby pushing hard for the right to sell its goods to Cuba. Well before the break between the United States and Cuba following Fidel Castro's coming to power in 1959, American businessmen were highly active in the island-state. Since the 1960s, U.S. business has been almost entirely absent, forced to leave the field to the Europeans, Canadians, Japanese and other Caribbean and Latin American economies. Yet, for all the criticism U.S. policy toward Cuba has received, especially over the boycott on investing in the Caribbean nation, it is not been smooth sailing for the Europeans, Canadians and others. Indeed, Cuba has been a difficult business environment.

Foreign companies operating in Cuba contend with excessive red tape, lengthy negotiations with the government, and sometimes a lack of skilled talent. The European Union, the largest foreign investor, recently complained to the Cuban government about a lack of information on business laws and regulations as well as their discriminatory application vis-à-vis foreign firms. In addition, the EU indicated that its country's businesses operating in Cuba were forced to repeatedly renew visas and work permits, eating up valuable time.

Although the Cuban government became more flexible in terms of allowing foreign investment into the country during the crisis years of the 1980s, it remains opposed to the idea of privatization nor will it provide foreign investors access to much of the economy. Tourism, once a shining new sector that helped to generate badly needed foreign exchange, has slumped and investment which averaged $268 million over the last five years, trickled to a meager $38.9 million in 2001.

The E.U.'s official complaint was acknowledged by the Cuban government, which indicated it would seek to reduce red tape and shorten the length of negotiations between the local bureaucracy and foreign companies. These negotiations currently take about a year.

The Cuban government has another incentive for easing foreign business regulations. Considering that Cuba is largely dependent on external energy sources, it is actively courting foreign companies to invest more in offshore oil exploration. Some 59 exploration contracts in Cuba's 112,000-sq km section of the Gulf of Mexico have been put up for auction. As the London-based Latin American Caribbean & Central America Report (August 2002) commented: "By opening up its oil sector to joint ventures with foreign companies, Cuba has increased its oil production sixfold over the last decade, to the 3.4 m tones (27 m barrels) recorded last year. It is understandably keen to increase foreign investment."

Two other reasons for greater flexibility from Cuba exist – it badly needs foreign investment to diversify away from sugar and investment prospects would be enhanced if the U.S. ever ends the economic embargo. Economic diversification is critical considering that sugar prices have languished throughout 2002 and that Cuba's industry is not cost efficient. The government has embarked upon a plan to restructure the sugar industry by closing plants and cutting jobs. It is also promoting other forms of agriculture, both for export and domestic use. This too requires foreign investment.

Greatly complicating matters for Cuba's economic transformation, the Caribbean nation has a debt problem. Many of the same governments that have been willing to let their nationals trade and invest in Cuba have also provided trade finance. Most have found themselves out of pocket. Cuba earlier in the 1980s defaulted on its external debt. As Moody's noted in August 2002: "Faced with major financial difficulties, the government has fallen behind on its external financial obligations and has defaulted on short-term debts and supplier payments. The situation has forced several foreign creditors to roll over short-term debts or to reschedule financial obligations." The rating agency also commented that the attitudes of European governments and investors toward Cuba have "soured in recent years leading to a significant decline in foreign investment inflows, which fell to $39 million in 2001, compared with an annual average of $280 million during the previous five years."

In September, it was announced that the French government froze $175 million in short-term credit to Cuba after the Caribbean nation failed to repay an earlier loan. Other countries have indicated that Cuba is in arrears, including Japan (which it owes $1.7 billion), Argentina, Spain, and South Africa. Any new move to provide U.S. credit to finance trade to Cuba should consider the Cuban track record in repayment Consequently, while many U.S. companies look with envy upon their European, Japanese and Canadian counterparts conducting business in Cuba, they should be aware that the grass is not always greener on the other side.


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South Africa's Privatization Program: A Parting of the Ways?

By Scott B. MacDonald

Privatization is always a potentially contentious political issue. Any decision to sell state assets carries with it concerns over how such assets and the services they provide will be used. What kind of balance will be made between the public good and profits? This is clearly one of the key issues facing the government of President Thabo Mbeki of South Africa.

Since the apartheid era ended in the early 1990s, first the Mandela and then Mbeki government have followed prudent economic policies, including tight fiscal policies. As a result, the fiscal situation is well under control, stronger economic growth appears to be taking root, and inflation is low. Despite some tough challenges, the South African economy remains one of the powerhouses in Africa, with the best industrial infrastructure, most skilled work force and most sophisticated financial systems.

The soft underbelly for the South African economy is high unemployment (28.8% according to the IMF for 2001). Together with still considerable discrepancies between rich and poor, partially along racial lines, the issue of privatization is highly emotional in national politics. At the core of this issue is the question – will privatization entail greater unemployment as the private sector ownership seeks greater cost efficiency in a former public enterprise? The answer to this question has become a divisive issue between the ruling African National Congress (ANC) and two of its long-term allies in the struggle against apartheid – the South African Communist Party (SACP) and Cosatu, the country's largest labor federation.

The government's challenge is to maintain and strengthen economic growth, improve the standard of living and address social inequalities. To do this, it requires some degree of foreign investment. To attract foreign investment, the ANC has stepped away from its neo-Marxist roots and adopted a more pragmatic approach, part of which embraces privatization. Last year the government budgeted for $1.8 billion in privatization revenues, a clear sign that it expects to move forward on this issue. Although the process has been slow, the restructuring of public enterprises that was launched in 2000 is gaining momentum. Telkom, the state telecommunications company, is now expected to be divested by March 2003 and the restructuring of Denel, the state defense corporation, is well ahead of schedule.

Along side with the restructuring and sale of state enterprises (also referred to in South Africa as parastatals), amendments to the country's labor legislation are about to come into law. These entail more flexible work practices and streamlined arbitration and conciliation procedures. While such advances may win accolades from foreign investors, South Africa's private sector and the International Monetary Fund, they are becoming a bone of contention with the SACP and Cosatu, the latter of which has members in the government.

For the SACP and Cosatu, state-owned enterprises should be used to reverse the effects of apartheid by delivering affordable services to poor people. As a spokesman for the SACP stated in July: "The SACP calls for the retention of public ownership over parastatals and for them to be strongly aligned with functional government departments." The SACP is basically calling for the government to maintain control of large public corporations in order to redistribute the national wealth – or at least part of it. The Mbeki government raises the not inconsiderable issue of who will pay for it. The last thing South Africa needs is a substantial increase in state spending. Indeed, prudent fiscal policy has been a landmark of the two ANC administrations.

Cosatu is now threatening a two-day national strike in October to protest against possible job losses from privatization. In particular, the union accuses the government of having implemented macroeconomic policies that had destroyed employment and deepened poverty since 1994.

President Mbeki has responded to the attacks from SACP and Cosatu by maintaining his government's policies and in late July by pulling out of the opening address of the SACP annual conference. The snub was intentional and related to the growing contention over privatization.

The privatization issue is a clear reflection that South African politics are entering a new era. The old parties of apartheid have largely been dismantled, while the opposition parties operate on the margin, appealing to a limited segment of the white, colored and Asian populations. In contrast, the ANC has largely represented the majority black population. Although the ANC's roots were neo-Marxist, the party has steered a moderate and pragmatic course through difficult waters of the post-apartheid world. Despite many predictions that an ANC would be a disaster for the South African economy, the party of Mandela and Mbeki has pursued policies that are largely market-oriented.

Now, ideological differences are resurfacing within the ruling coalition, which could give rebirth to a right-left divide in South Africa, placing the majority of the ANC leadership on the center-right. The SACP and Cosatu are gradually evolving into a center-left opposition. The difficult task ahead is how the country's political elite will manage those differences ahead of the next elections in 2004. In the year ahead, there will be ongoing pressure to move back from privatization. This will be a critical test for the Mbeki government. If Mbeki postpones the Telekom privatization, the center-left will be emboldened to go for greater clout in economic policymaking and that in turn could jeopardize the ability of South Africa to continue along a moderate and prudent path to sustainable economic growth, aided in part by foreign investment

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Questions over Russia's New Rapprochement with the West

By Sergei Blagov

In the wake of September 11, the US-Russian reinvented partnership has been heralded as an end to the Cold War Era. However, Moscow's recent overtures towards the "axis of evil" serves as an indication that Russia still faces immense challenges on the path toward integration with the West.

In recent years, the concept of "multi-polar world" has been Moscow's favorite mantra, designed to argue that the US should not be allowed to dominate the world as a single super power. However, in the wake of September 11 the Kremlin presumably came to realize that building a multi-polar world as a counterweight to US dominance has not really worked, while Iraqi or North Korean endorsements did little to sustain Russia's role as a world power.

In the wake of September 11 Russia has undertaken a series of friendly gestures towards the US. Last October, the Kremlin announced a shut down of its Cold War era military facilities, a spy radar station in Lourdes, Cuba and a naval base in Cam Ranh Bay, Vietnam to spare more money for the Russian armed forces.

Russia's initial opposition to the stationing of American military forces close to its borders in Central Asia made its neighboring Central Asian states reject the idea of letting American forces use their territories for their operation in Afghanistan. However, Russia eventually changed its position due to its interest in seeing the Taliban regime fall, as well as in expanding its ties with the US.

Russia's pro-Western course after September 11 quickly reaped major benefits for Russia. Notably, last May Russia and the US signed a legally binding treaty to reduce the two countries' long-range nuclear weapons by two-thirds and "liquidate the legacy of the Cold War." In recognition of Putin's help in the war on terror, the new NATO-Russia Council gave Moscow a role in drafting and implementing a number of joint policies.
Russia's new cooperative face secured U.S. backing for Moscow's efforts to join the World Trade Organization. Russia also received full membership in the G8 group of the most industrialized countries.

The US administration has visibly toned down its criticism of Russia's use of force in Chechnya. There has also been a talk of revoking the main economic sanction against Russia remaining from the cold war, the 1974 Jackson-Vanik Amendment.

Therefore the Kremlin's recent series of advances toward Iraq, Iran and North Korea, could be interpreted as an indication that Russia's perceived drift towards the West is far from irreversible.

For instance, on Sep.2 Russian Foreign Minister Igor Ivanov, after conferring with his Iraqi counterpart Naji Sabri, warned that military action by the United States could entail further troubles in the volatile Middle East.

Moscow's involvement in Iraq dates back to the Cold War era, when the Soviet Union cultivated client states in the Middle East. Thousands of Soviet experts worked in Iraq, and Moscow used to be Baghdad's top arms supplier. Russia is still the largest trading partner of Iraq, which owes Moscow $7 billion in Soviet-era debt. Some inflation-adjusted estimates put the figure at $11-12 billion. Russian oil companies are doing business in Iraq and expect more lucrative deals in the future.

Moreover, Russia and Iraq are now negotiating a 10-year trade agreement, including 67 cooperation agreements in oil, agriculture, transportation, railroads and energy. Iraq's ambassador to Russia, Abbas Khalaf, has said the deal is worth $40 billion. However, neither Sabri nor Ivanov mentioned the proposed agreement, which was seen by analysts as a "Potyomkin deal." Presumably, Baghdad attempted to use the $40 billion figure as a bite to press for more Russian support, while Moscow - by publicizing the figure - might be indicating that it wants to be compensated for lost profits following Saddam's demise.

Obviously, Russia is keen to safeguard its economic interests. Russia is Iraq's largest supplier in the UN oil-for-food program. Of the $18.3 billion in oil-for-food contracts approved by the Security Council since the program began in late 1996, some $4.2 billion went to Russia.

Iraq possesses the world's second largest proven oil reserves, currently estimated at 112.5 billion barrels or 11% of the world's total. It is seen as the ultimate bounty by Russia's oil firms. Baghdad offered Russian oil companies billions of dollars in concessions during the 1990s as it sought to build support in the United Nations. LUKoil, Russia's biggest oil company, signed a 23-year $20 billion contract in 1997 to develop part of the West Qurna field in southern Iraq with estimated reserves of some 700 million metric tons. However, the project has remained frozen under U.N. sanctions, and subsequently ties between Iraq and LUKoil deteriorated because the Russian firm was reluctant to begin work at West Qurna despite the sanctions. As a result, LUKoil was excluded from the oil-for-food schemes.

These days Zarubezhneft, a state-owned oil company that has worked in the Middle East since the 1970s, has emerged as Russia's leading oil player in Iraq. Zarubezhneft has received UN permission to drill 45 exploratory wells in northern Iraq's Kirkuk oil field. Zarubezhneft also had a contract to drill some 100 wells in the North Rumaila field. Now Iraq is reportedly mulling plans to grant Zarubezhneft the rights to develop the Bin Umar oil field with estimated reserves of 3.3 billion barrels. Another Russian company, Tatneft, is to drill on behalf of Zarubezhneft at West Qurna after sanctions are lifted. Additionally, in 2001, state-controlled Slavneft clinched a deal to develop the Luhais oilfield in southern Iraq with estimated reserves of some 500 million barrels.

Moreover, Russia is understood not only to fear losses of the oil concessions that have been signed off by Saddam. Analysts argue that although threats of the US military action against Iraq has kept crude oil prices high -- a victorious US war could presumably entail skyrocketing Iraqi crude exports, pushing oil prices down. Such a scenario could entail annual losses of billions of dollars in Russian oil-export revenues.

It is understood that by flirting with Saddam's regime and other "rough states," Russia has probably aimed to signal to the West that its post-September 11 policy of backing the US has certain limits, notably when Russia's vital oil interests are concerned.
As recently as July 2002, Russia announced that it intended to build five more nuclear power reactors in Iran over the next decade, which was, indeed, a pointed broadening of the scope of its persistent cooperation with Tehran, in defiance of US pressure to the contrary.

Last August, Putin agreed to a trip by President Kim Jong-il of North Korea. Officially, the visit of North Korea's "Dear Leader" was supposed to boost sluggish bilateral trade as well as to discuss Pyongyang's plans to opens its part of the railway as a means to funnel South Korean goods into Europe across Russia.

These actions, combined with long-standing Russian fears and suspicions over Western intentions, demonstrate that Moscow still faces a long path towards full-scale partnership with its Cold War Era foes.

Ukraine: Takin' It to the Streets

By Robert Windorf

Over the past few weeks, political tensions in Ukraine have escalated to troubling heights. Despite court orders to ban them, several nationwide protests by tens of thousands over the past two weeks have called for President Leonid Kuchma's resignation. With Kuchma recently away in Austria in an endeavor to convince political and business leaders to support Ukraine's struggling efforts to join the EU, protests began around the second anniversary of the disappearance of investigative journalist Heorhiy Gongadze. Opposition groups hold Kuchma responsible for his murder, along with the economy's chronic malaise, and alleged fraudulent activities during the March parliamentary elections.

The present political situation has left the Ukrainian parliament in a state of paralysis. Although a recent poll revealed more than 70 percent of the people support Kuchma's removal, the popular former Prime Minister Viktor Yushchenko and other opposition leaders assert strong pro-Kuchma forces have continued to pressure legislators to support the beleaguered president. While opposition parties won the majority of the popular vote in the spring, they have since failed to control parliament, making it very tough to remove the Kuchma regime. Nevertheless, following Yushchenko's participation this past Monday with socialist, communist, and capitalist party leaders at a Kiev rally that reportedly drew more than 20,000, he returned to parliament to negotiate a new coalition, resigned to the premise that no real mechanism exists to force Kuchma to resign. However, it remains to be seen how successful such negotiations will be.

Despite his popularity, Yushchenko has frustrated the hopes of many who seek immediate and radical solutions to the nation's troubles, as he reportedly prefers calculated negotiations to achieve solutions. With the presidential election two years away, Yushchenko and his supports will arguably have plenty of time to unseat Kuchma. However, given the circumstances surrounding the present heated political environment, it should not be ruled-out that a snap parliamentary election could be called before 2004 that might then possibly lead to some dilution of Kuchma's parliamentary power. Given Yushchenko's history of messy disputes with the president's affiliated parties, at present, we believe he will continue to endeavor to work on a new potential coalition; however, his efforts are probably more suited toward the 2004 election.

A spate of unfortunate events during the past year including the unintentional downing of a Russian passenger jet by a missile, a military air show crash, and a coal mine explosion have continued to expose the Kuchma government's apathy and ineffectiveness. While Russia has moved closer to the west during the past year, Ukraine continues to lag far behind. Much is at stake for both sides. Ukraine, a nation of 50 million with important natural resources, represents a strategic bridge between east and west. Aligning it to the west also would no doubt influence Russia to remain in Europe, as well. In addition, on the heels of reports that Iraq may have recently acquired military surveillance equipment from Ukraine in its supposed efforts to prepare for a potential conflict with the west, developments in Ukraine will continue to attract attention.

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Turkish Taffy: Update On the Turkish Political Scene

By Robert Windorf

Over the past few months, the Turkish political scene, like that famous candy from yesteryear, has been quite sticky and has given the nation's political and military leaders and citizens plenty to chew on. Prime Minister Bulent Ecevit's chronic illness, which has left him increasingly politically ineffective to see through the many necessary economic and political reform measures under last year's IMF $16 billion rescue package, led to mass resignations from his cabinet and defections from the ruling Democratic Left Party (DSP) this past July. This was not much of a surprise as many observers had long predicted the eventual collapse of the ruling three party coalition. Despite numerous pleas from his original supporters and the opposition parties, Ecevit originally stubbornly refused to step down or agree to early parliamentary elections. He feared that early elections would further jeopardize Turkey's hopes for EU entry and plunge the economy back into chaos. However, with dwindling options, especially following the quick formation of new political parties by his cabinet defectors, he finally agreed to an election date of November 3rd.

Soon after Ecevit's decision, a few politicians further complicated matters by challenging that date claiming it would not allow enough time for the nation to prepare for the elections. In addition, just last week, an electoral board announced that the head of the Justice and Development Party (AKP), Recep Tayyip Erdogan (the former mayor of Istanbul), would be banned from running in the election because of his past conviction for Islamic sedition. Despite the military and urban middle class' deep suspicions of Erdogan's reported disavowal of political Islam and adoption of secular principles, he vows to fight on, as the AKP arguably remains the most popular political party. Nevertheless, as of this writing, the elections are still scheduled for November and the volatile campaign season is in full swing.

No less than 20 political parties will be vying for seats in the new parliament. The most prominent include the following: Democratic Left Party (DSP), headed by Ecevit, has suffered the loss of more than half its deputies since July and, in turn, fell from second place in the opinion polls to fourth. Nationalist Action Party (MHP), built on rigid nationalist policies, including a tough stance against the Kurds and aversions toward planned reforms to fulfill EU membership, is now the largest party; yet, current polls suggest it may not meet the required 10% quota to retain seats in parliament. Motherland Party (Anap), the junior conservative member of the government coalition, is badly lagging in the polls. Justice and Development Party (AKP), formed last year by moderate members of the outlawed pro-Islamic Virtue Party, at present, stands potentially to gain the most seats leading to worries for the secular establishment. New Turkey Party (YTP), formed by defectors from Ecevit's cabinet, Ismail Cem and Husamettin Ozkan, has become the fifth largest party and reportedly enjoys the support of former revered Minister of the Economy, Kemal Dervis. True Path (DYP), led by former Prime Minister, Tansu Ciller, the main conservative opposition party, holds a powerful nationalist base in rural Anatolia. Republican People's Party (CHP), the main center-leftist rival to DSP which could regain seats in light of DSP's desperate state. Peoples Democracy Party (Hadep), accused by Ecevit of links to the rebels within the Kurdistan Workers Party (PKK), could reach the 10% quota; however, local analysts doubt if the party would be invited to join the future governing coalition.

Given the capricious nature of Turkish politics, we believe it is too soon to predict an election outcome. However, of more importance is to watch the lame duck coalition's actions during its last weeks in power following the recently approved legislation to abolish the death penalty and to establish language rights for the Kurds, bold moves designed to continue to support hopes for EU membership. Yet, we believe that interested observes should keep tabs on developments surrounding Erdogan's fight for recognition and the New Turkey Party's potential to gain more votes than expected.

According to latest reports, the economy rebounded from its recent crisis, as GDP rose by an annual 8.2% during the second quarter (4.7% for the first 6 months). While such a gain may be temporary, it is seen as significant given the 7.4% decline in GDP for all of 2001. However, business and consumer confidence remain low and with the escalating prospects for the west's military actions against Iraq, along with the uncertain political environment, growth may stagnate over the near term. In addition, two major conditions act as roadblocks for sustainable economic prospects: the slow pace of necessary banking industry reforms and insufficient flows of direct foreign investment. While the scale of such investment will largely hang on the prospects for a regional military conflict, outside influences should not delay the continued and overdue redesign of the banking industry.


Is India Heading Into Another Debt Crisis?

By Scott B. MacDonald

PWhile international analysts usually focus on external debt as a key factor of a country's creditworthiness, domestic debt must also be considered. This is an issue for Brazil, Latin America's largest debtor. Increasingly it is an issue for one of the Asia's largest economies - India. Public sector debt (domestic debt) to GDP is currently at its highest ever level of 70.5% of GDP in FY2002. This is from a recent low of 56.5% in F1997. There is a good chance that the debt level could climb even higher, to around 75% by FY end 2003. What is alarming about the rise in domestic debt in India is that both state and central governments do not appear to be unduly concerned about the trend and there is little sign of any relief in the medium term.

The ongoing threat of war with Pakistan, the interrelated security concern with terrorism, the ongoing turmoil in Kashmir, and the larger game of geo-political manuevering vis-a-vis China all appear to be overriding considerations to trimming the budget and bringing public debt under control. Although it is too early to proclaim that India is heading into another debt crisis, it does not take a great leap of the imagination to see that if current trends continue, the South Asian country will have substantial debt management problems.

India's has had problems with its debt burden before. In the late 1980s domestic debt rose substantially, This proved to be a major problem when the international environment turned highly negative in 1991, ultimately causing a balance of payments crisis. In the aftermath of the 1991 crisis, the Indian government worked hard to reduce the onerous debt burden. Public sector spending was controlled and new economic reforms helped bolster growth, which brought in greater revenues. Despite security concerns, Indian finances improved through the first half of the 1990s. However, there was considerable policy erosion in the late 1990s as coalition governments led by the Hindu nationalist-Bharatiya Janata Party (BJP) were forced to strike deals with regional parties to maintain parliamentary majorities. Having a coalition of two dozen parties did not help the policy process. In particular, it weakened debt management.

While central government finances worsened, state governments were allowed to spend in a relatively unconstrained fashion. The end result was that internal debt rose to an all-time high of 70.5% of GDP in FY2002. Prime Minister Atal Bihari Vapayee has remained in office for two terms, but his government is paying the price. Consequently, three key trends mark India's finances - the consolidated fiscal deficit is on the rise, state finances are eroding at a faster pace than before, and off-balance-sheets liabilities are climbing. According to Standard & Poor's, India's budget deficit is expected to reach 6% of GDP in the current fiscal year (ending March 31, 2003). Counting state finances it could be higher, closer to 10% of GDP.

Standard & Poor's is forecasting that the consolidated debt of the central and state governments could exceed 80% of GDP this year, while the public-sector borrowing requirement, including all levels of government and the enterprises they control, may exceed 12% of GDP. Interest payments alone are likely to consume nearly half the central government's revenue. S&P also noted: "Its largely unreformed public sector, whose inefficient operations constrain prospects for economic growth and pose a contingent liability to the sovereign. For example, the cost of bailing out government-owned financial institutions (including the Unit Trust of India, the country's largest mutual fund, which had been bailed out once before in 1998 but not restructured) may exceed 1.5% of GDP. At the state level, the annual losses of electricity boards exceed 1% of GDP, weakening already-poor state finances."

India is not sitting on the brink of another debt crisis - so far. However, the trends are worrying. Unlike in the late 1980s and early 1990s, India has seen strong inflows of foreign exchange over the last few years, with reserves reaching $29.4 billion (5.1% of GDP). In the balance of payments, India's growing flow of "invisibles".i.e., remittances, sofware exports and tourism has helped to reduce pressure. In fiscal year 2002, invisibles accounted for close to $36 billion, equal to 5% of GDP. At the same time, interest rates have declined - always a help for large-scale debtors.

Yet, prospects for resolving the looming debt crisis are mixed at best. The political situation remains complicated, security concerns command policymakers attention and the ability of the government to forge ahead with privatization sales that could help reduce fiscal pressure are bogged down in nationalist and coalition politics. In its most recent Article IV report on the Indian economy, the International Monetary Fund clearly stated its concerns, that "recent trends-large primary deficits, growing debt, and the sharp narrowing of the growth rate-interest rate differential-are creating conditions for potentially unsustainable debt dynamics. The weak fiscal situation leaves little room for maneuver in macroeconomic policies and could entrench the cycle of decelerating growth and deteriorating fiscal balances."

The IMFis not alone in these sentiments. On September 8, 2002, Moody's Investors Service commented: "The government's rising debt service burden is consuming an overwhelming share of its limited financial resources, leaving the authorities with little fiscal room to redress the country's infrastructure and social problems, much less business cycle slowdowns. The fiscal dilemma also constrains monetary policy, dampening longer-term investment and growth prospects. Even with growth at 5%-6%, average living standards are stagnating. The dependence upon non-resident capital to finance the current account gap is also not sustainable, particularly in view of the volatile political scene."

Reflecting many of the same concerns, S&P downgraded India's ratings on September 18, 2002. Maintaining a negative outlook, the rating agency stated: "Continued large fiscal deficits, along with a languid pace of economic reform, would lead to a further ratings downgrade."

Although the government is aware of the issue, there are so many other major issues clamoring for attention. Consequently, the domestic debt problem represents a slow-moving, yet still very real, potential crisis for the government. Unable to push reforms at a faster pace, its privatization program off track, and increasing problems with its power sector (slowing prospects for growth), the BJP government will eventually be forced to return to the domestic agenda.

Prospects for a new Gulf War, with the potential for another spike in oil prices, should worry New Delhi. While it is not likely to provoke another crisis as in 1991, it will push India's finances into a much tighter situation. If unchecked, India will find itself in more dire straits as the decade continues.

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eBusiness Japan: Interview with Keith W. Rabin

This month's interview is with Keith Rabin, president of KWR International, a consulting firm specializing in the delivery of research, communications and advisory services with a particular emphasis on public/investor relations, business development, public affairs, cross border transactions and market entry programs. Keith frequently speaks on trade, investment and economic issues and has authored numerous articles for publications including Bridge News, Journal of Commerce, Market: Asia Pacific, Korea Herald, and Asia Pacific Economic Review. KWR hosted the Japan Small Company Investment Conference in March, when over 200 investors, venture capitalists, corporate and technology executives, analysts, government officials, journalists and other targeted individuals met with eight promising Japanese companies in New York to explore mutually beneficial investment and business transactions and partnerships.
This interview courtesy of

from the September 2002 issue of eBusiness Japan

eBJ: Why did you start the Japan Small Company Investment conference?

Rabin: Over the past few years there has been a lot of attention paid to the economic, regulatory and technological changes that are beginning to reshape Japan's business environment -- trends that promise to accelerate in coming years. This is creating many interesting opportunities both in the export-oriented industries that Japan is renowned for as well as those with a domestic focus. While many foreign investors are coming to understand the potential, they remain largely unaware of the specific companies benefiting from this
transformation and how to pursue these opportunities. At the same time, Japanese firms are finding they can no longer rely upon commercial bank loans as their primary source of capital. This creates a greater need for private equity, M&A and other financial engineering techniques, yet most Japanese firms lack the experience and resources needed to attract and effectively deal with foreign investors. To facilitate interactions, transactions and relationships between Japanese firms and foreign investors, we developed a conference
and support structure to satisfy this demand.

eBJ: Economically speaking, what positive developments do you see in Japan recently?

Rabin: Whereas the U.S. has been actively engaging in deregulation and restructuring and reorganization for two decades, Japan has all or most of its gains before it. While it may be early to allocate capital to the macro indices, there are many micro opportunities emerging. In many cases, it is the problems themselves that are leading to the opportunities.

eBJ: Can you give an example?

Rabin: For example, pessimism about the future has resulted in a delay in marriage and birth rates in Japan. This has troubling implications over the long term, yet it has led to a rapid rise in disposable income among Japanese singles, many who still live at home and young couples, who fit the DINK (Double Income, No Kids) profile desired by so many purveyors of upscale products.

eBJ: Any other demographic trends that are important?

Rabin: Japan's aging population is also giving rise to amazing opportunities in medical equipment and technologies and geriatric care. Women are also taking on an increasingly important role in the workplace.

eBJ: What is your take on the state of IT in Japan?

Rabin: Japan was late to embrace the tech boom that engulfed the U.S. in the late 90s. It just started to take off when the U.S. tech bubble burst about two years ago. The introduction of low-cost ADSL access is leading to high growth in broadband penetration and time spent online. The demand for web services, e-commerce and other technologies and applications is accelerating at a time when they are maturing in the U.S. There are also opportunities to replicate business models and to employ restructuring techniques that have proven successful in the U.S. They can be used to achieve greater economies of scale, profitability and additional revenue sources in Japan, where a ready market of high-income consumers awaits them. Japan also produces many attractive technologies, applications and products. Wireless is one area where Japan remains far ahead of the U.S. and we are only just beginning to enter into the age of convergence and birth of Internet appliances.

eBJ: What kind of help do smaller firms need in pursuing investment opportunities in Japan?

Rabin: Cross-border deals can be complex and costly, both in terms of managing the due diligence, time and other issues and commitments that are part of the transaction process -- not to mention the ongoing communication and interaction that is part of any successful investment. This is especially problematic as smaller firms and investors are often not as sophisticated as larger companies and financial institutions and therefore need more hand-holding and support. The costs are often difficult to amortize within small- to mid-sized transactions, preventing both interested firms and investors from gaining the preparation, counsel and follow-up needed to achieve successful results.

eBJ: How did the Japan Small Company Investment Conference address these issues?

Rabin: We utilized a portfolio approach for our investment conference. It provided a cost-efficient vehicle that facilitated the initial preparation, screening and introductions needed to establish priorities and a more rational allocation of resources to deliver necessary follow-up. Within this mix we were able to showcase two exciting specialty retailers, one that focused on natural foods and another on gardening products. We also featured three firms with specialized software applications oriented toward improving procurement systems, factory automation, graphics technology and document management as well as three others that focused on the semiconductor industry. Through this cross-marketing and promotional effort we were able to gain synergies and an economy of scale that would not have been otherwise possible. It allowed us to attract over 200 investors and other targeted individuals as well thousands of visitors to the site (http://kwrintl.com/jsciconference) that was developed. We continue to receive numerous ongoing inquiries about this event and our plans for the future.

eBJ: Is Japan moving towards a U.S. –style economic model?

Rabin: It is moving in that direction. Japanese firms have traditionally focused more on market share, operational efficiency and product development than profitability and the more intangible financial, marketing and other concerns that tend to preoccupy U.S. managers. Additionally, bank lending tended to be made more on relationships and collateral than the credit- and risk-based approaches used by U.S. financial institutions. As Japan moves away from a main-bank and lifetime employment system to one that is more focused on equity investment and merit-based performance it will inevitably require a shift toward a U.S.-style model.

eBJ: How can Japanese firms benefit from investment by foreign firms in this new environment?

Rabin: Foreign investors can help Japanese firms to better understand and adopt these practices and to build stronger, more competitive companies that are able to adapt to the new environment. They are also not subject to the same cultural and social constraints as Japanese managers. The point here is that this is not rocket science. Many Japanese firms are fundamentally sound but have never had to employ the controls and systems that are used to manage and evaluate U.S. and many European firms.

eBJ: Could you give an example of this?

Rabin: Nissan is one high-profile example. By employing relatively standard corporate reorganization techniques Carlos Ghosn was able to restore the company to profitability. Wilbur Ross and his team at Kansai Sawayaka Bank have also made significant progress, working to introduce a credit- and merit-based culture as well as a wider array of financial services and products. This has helped to significantly expand its loan portfolio and raise profitability in a troubled banking environment.

eBJ: Do you feel Japan has done enough to make it easier for foreign firms to make investments in Japan?

Rabin: While it is not a linear path, Japan is certainly doing more than ever before to make it easier for foreign investors to enter the Japanese market. Much more needs to be done but in my eyes the major obstacles today are more on the cultural and personal than the regulatory level, where most barriers can now be addressed with the help of experienced legal counsel and other support. Part of the problem is that while Japan remains the world's second largest economy, with a well-educated and affluent consumer and industrial base that is increasingly receptive to new ways of doing business, Americans do not sense the opportunity and potential.

eBJ: And why is that?

Rabin: They tend to focus on other markets that are growing at a more rapid rate -- but which are not even forecast to possess the same underlying stability or market characteristics as Japan for many decades. For example, per capita income in China ranged from $2,253 (rural) to $6,280 (urban) in 2000 compared to over $34,000 in Japan. If you are a U.S. company seeking a market for your goods or services which offers the better option? This is not to suggest, however, that this is simply a case of neglect by U.S. firms and investors. Even when there is interest, investors have a hard time obtaining the specific information and contacts they need to make rational investment decisions. For an economy as large as Japan it maintains a remarkably low profile in the U.S., and Japanese firms need to do much more to reach out to American executives or investors to both raise their interest and to make it easier for them to identify and access investment opportunities that meet their interest and requirements.

eBJ: What are the main changes in Japan's business environment that potential investors would like to know?

Rabin: Since the adoption of Japan's "Action Plan for Economic and Structural Reform" in 1997 there has been a steady movement toward deregulation and reform in the Japanese economy. The most recent achievements include revisions to Japan's commercial code to allow adoption of a U.S.-style corporate governance system, new mark to market accounting standards and measures to enhance labor flexibility and pension portability. Many other measures have been adopted in recent years. To enhance corporate competitiveness and
flexibility, steps have been taken to end the prohibition on holding companies, facilitate corporate divestitures without negative tax consequences and to revise the civil rehabilitation law to simplify restructuring and bankruptcy. To promote the development of small and medium enterprises and start-ups, steps have been taken to allow the use of stock options in compensation packages, create a Limited Partnership Act to facilitate the use of venture funding and establish technology licensing organizations to encourage the transfer of university research to the private sector. Many other steps have been taken to promote the use of information technology and e-services, to enhance labor flexibility and to reduce the high cost of doing business in Japan. While one can argue over the pace of progress and the need for more rapid reform, it is also important to recognize the tremendous shift of sentiment within Japanese businesses and consumers. There is far more openness than
ever before to the entry of foreign firms and investors. Only ten or even five years ago, Japan remained eager to go it alone. They are now keenly aware of the need for change if they are to maintain and expand their economic viability.

eBJ: And What are the key issues to keep in mind when attempting to enter into investment transactions with Japanese firms?

Rabin: Americans and other foreign investors need to keep in mind that Japan is not the U.S. While that is part of the attraction and many of the obstacles that were faced in the past are now being addressed, it requires numerous adjustments to allow for cultural, social, legal and regulatory differences. This is not to suggest that U.S. firms need to sacrifice their normal profitability and other objectives when entering into Japan but rather that they must take time to understand the real differences and adjust their expectations so that they can adopt
a sustainable plan of action, investment model and time frame that will allow them to achieve the results they are looking for. Support by experienced service professionals and other people who know the environment is usually advised.

eBJ: Do you have plans to organize additional investment conferences in the future?

Rabin: Based upon our first success we are now in the midst of talking with many companies, investment promotion agencies and intermediaries such as venture capital and investment management firms, investment banks, service firms and securities exchanges who are seeking to showcase clients or portfolio companies. Interestingly, these inquiries are coming not only from Japan -- but all over the world. We are now in the midst of planning and hope to organize an expanded initiative of this kind early next year. If any of your readers have an interest or would like additional information, please have them contact our offices at kwrintl@kwrintl.com .

KWR Viewpoints

What the Bush Administration is NOT talking about......

By David Fuhrmann, Partner, Glenwood LLC

By now there should be no question in anyone's mind that the U.S. will attack Iraq with the intent of overthrowing Saddam Hussein. In truth, I don't have a problem with the idea of removing Saddam Hussein and doing it sooner rather than later. I'm not bothered by what the administration has been proposing, but I am concerned over what they aren't talking about. What isn't the administration talking about? They aren't talking about what happens after the military assault on Baghdad.

U.S. forces will undoubtedly occupy Baghdad in short order. Then what? They aren't talking about it. In fact, the silence from the White House regarding the next step has been conspicuous. The administration has focused exclusively on the need to attack Iraq while studiously avoiding public discussion of what happens when the shooting is over. That's because they themselves don't have a clear idea of what happens next. The subtle but implicit impression being fostered in the public mind is that it's a cake-walk into Baghdad, knock over Saddam, the Iraqis hold elections, we leave, the entire Arab world rallies to our cause, and everyone is happy. In reality, there are any number of unanswered concerns that ought to be considered before the White House has its war, and they aren't talking about those issues.

The same geo-strategic concerns that restrained the first Bush administration from toppling Saddam still apply. The danger of Iraq breaking into pieces, and the potential for civil war and strife among Iraq's disparate ethnic groups remains significant. Why isn't the break-up of Iraq still a concern, how will it be prevented, and who will be preventing it? They aren't talking about it.

What will the cost of war against Iraq be? The number $100 billion has been floated by the administration, but that's just the cost of immediate military operations to topple Saddam. What will be the cost of a protracted American occupation in Iraq, especially one that continues for years? They aren't talking about it.

Might a difficult or protracted engagement in Iraq impact negatively on the willingness and ability of other governments to cooperate with us in the war on terrorism? Will a war in Iraq divert attention and resources from the threat posed by Al Qaeda? They aren't talking about it.

This administration has a visceral antipathy toward "peace-keeping" and "nation-building." There's no hint from the White House that "nation-building" or "peace-keeping" might be needed to return Iraq to the family of "civilized," pro-American, nations. But if it is necessary, the unspoken assumption seems to be that others will step forward to take on that task and help pay for it. Who? They aren't talking about it.

How does one bring "democracy" to a country with neither the social institutions, political experience, or legal systems necessary for such a system to survive and flourish? They aren't talking about it.

Does the existing situation in Afghanistan offer any warnings? We quickly toppled the Taliban and routed Al Qaeda. But Afghanistan today is hardly a model of democracy or a stable and secure country. The regime put in power by force of American arms exists mostly in the minds of Washington policy makers and wishful thinkers. It's authority and control do not extend beyond the city limits of Kabul, and Hamid Karsai, nominal "leader" of Afghanistan, requires American bodyguards. Recent reports indicate the Taliban and Al Qaeda are re-grouping in Afghanistan, and that their ability to launch attacks there, as well as elsewhere in the world, remains undiminished. Why would it be easier to accomplish successful regime change in Iraq than it's been in Afghanistan? They aren't talking about it.

Think about it. We've had a presence in Bosnia for nearly seven years. We've been in Kosovo for four years. We've been in Afghanistan for almost a year. In none of those places has a truly stable, secure government and environment been created, and no one would argue that western forces could be withdrawn any time soon without risking renewed warfare in every instance. Why will Iraq be different? They aren't talking about it.

Indeed, the very notion we can bring "democracy" to Iraq simply by removing Saddam Hussein ignores the socio-political realities of the Arab world. Anyone who assumes that creating a stable post-war environment in Iraq, much less a democratic system, will be easy or quick is guilty of wishful thinking at best and self-delusion at worst. And the administration isn't talking about it.

The political risk for President Bush is substantial. If the administration fails to prepare the public for a long, possibly dangerous, occupation of Iraq, and such a situation comes to pass, as it likely will, then George Bush will find himself entering the 2004 election cycle saddled with a messy, open-ended commitment in a region intensely antipathetic toward the United States. That could easily spell electoral trouble here at home. Given how closely divided the nation was in the last presidential election, his re-election under such conditions would hardly be assured. The domestic political backlash will be far worse if the administration has failed to prepare the public for the potential problems in advance.

The White House should be honest and up-front about the dangers, the difficulty, and the reality that even a protracted US occupation is not likely to lead to a modern, democratic, "westernized" Iraq any time soon. Of course, that could make going to war in the first place a more difficult sell. And, as White House Chief of Staff Andrew Card might say, one wouldn't want to market the product (i.e. war in Iraq) in a bad light. But if the Bush administration fears it can only obtain public support for a pre-emptive war against Iraq by avoiding discussion of hard truths and potential pitfalls, then their real worry should be over how an unprepared public is going to react when some of those things become reality.



The Trade Act of 2002 and the Americas: Be Thankful for Small Favors

By Russell Smith, Willkie, Farr and Gallagher

The Trade Act of 2002, encompassing both renewal of the Andean Trade Preference Act (ATPA) and a grant of new trade promotion authority to the President, is arguably filled with country and region-specific benefits for the Americas. But unfortunately the Act is not a blueprint or even a real impetus for the successful negotiation of a Free Trade Agreement for the Americas (FTAA). U.S. and foreign politics have and will continue to be a substantial roadblock to FTAA negotiations, and the Act itself reflects this reality.

As to benefits, not only was the ATPA renewed, but that renewal was broadened. The Act extends duty-free treatment to textile products, with certain caps for goods produced from regional fabric and yarn. For goods produced from U.S. fabric and yarn, all limits have been removed. Beyond its immediate economic impact, this change represents a dramatic shift in the politics of textile and apparel issues. Historically, the U.S. textile industry and labor unions have succeeded in excluding most textile and apparel imports from trade negotiating authority legislation and to a great extent from agreements concluded under those authorities. This influence began to erode with the textile provisions of the African Growth and Opportunity Act in 2000, but the ATPA provisions are far more generous than those in that previous legislation. The Trade Act expansions were passed over the objections of the U.S. textile industry, but for the first time those objections did not prevail. Such a change indicates that in future, textiles will not control the debate over trade agreements, and probably will not even influence it heavily.

Many other previously excluded products will now be eligible for duty-free treatment under ATPA, including footwear, petroleum and petroleum products, watches and watch parts, handbags, luggage, gloves, and leather apparel. In another important decision that was quite controversial, but ultimately resolved favorably for Ecuador, tuna in airtight pouches will receive immediate duty-free treatment if caught from U.S. or Andean-flagged vessels.

Although there are also new provisions concerning transshipment and criteria for beneficiary status that may require additional actions by individual nations, on the whole the positive outcomes for ATPA beneficiary countries are far greater than any of the requirements imposed on achieving eligibility.

The same may be true of individual countries outside the ATPA, especially Chile. The Act puts the U.S. in a position to be able to conclude balanced FTAs with Chile and Central American countries, and for those agreements to be approved by Congress without amendment. Although difficulties remain in the negotiations regarding various issues, both the U.S. and Chile appear committed to bring an agreement to conclusion after many years of frustration on both sides.

However, the largest "prize" that should result from the Trade Act of 2002--a Free Trade Agreement of the Americas--seems no closer to being achieved now, even with Presidential trade promotion authority. The Act does nothing to resolve those major issues that are preventing progress on an FTAA--the U.S. trade barriers to key exports from major South American nations. One need only listen to statements made at recent U.S. conferences at which the FTAA was discussed. The key sectors involved, including agriculture (citrus and sugar) and industry (steel) have made it clear that they wish to be excluded from any such agreement. Even the U.S. auto industry seeks not market opening, but the protection of their investment from inroads by other countries. This is, of course, not free trade as we know it in NAFTA, and it almost certainly cannot serve as the basis for the successful conclusion of an FTAA.

The FTAA negotiations may begin with much fanfare, and ostensibly with commitments from both sides to serious negotiations. As long as the South American perception is that the U.S. seeks more leverage the Americas, but is unwilling or unable to provide new and vital market access to the key products of its neighbors, on a collective basis, however, the promise of the fanfare and commitments will not be realized. Perhaps some of the mutual benefits that might come from an FTAA will be achieved from the WTO Doha Development Agenda negotiations, where many of the same issues will arise. By this route, the Americas may benefit from global trade concessions in ways that even the Trade Act of 2002 cannot "deliver" in regard to the FTAA.


Emerging Market Briefs

By Scott B. MacDonald

Belize – Launches Bond Issue: Belize has now followed the Bahamas, Barbados, Trinidad & Tobago, Jamaica and the Dominican Republic in launching an international bond issue. In August, Belize issued a $125 million bond, which was largely bought by U.S. investors. The government will use the proceeds to retire short-term debt and other higher interest rate debt, helping to clean up the nation's financial ledger and reduce foreign exchange outflow. Belize is rated Ba2/BB.

Brazil - Waiting for Lula: On October 6, Brazilians go to the polls to election their next president, congress and governors. The real focus is on the presidential contest that pits Luiz Inacio Lula de Silva against Jose Serra. Lula currently leads in the polls and there is now considerable speculation that he could win in the first round, negating the need for a second round on October 27. Lula is a center-left candidate from the Workers Party (PT), has run for four times, and represents a potential new policy direction for Brazil. Serra is the government candidate and a former health minister, who has trailed throughout the contest. Markets clearly favor Serra and the growing probability of a Lula victory has roiled financial and currency markets in Brazil. While there is concern that a Lula presidency would lead to poor economic policy decisions leading to a default on the country's debt, it must also be taken into consideration that Lula has little desire to preside over a severe economic crisis. Moreover, he has only to look south to Argentina to see what happens to a national leader - former President de la Rue - when there is a lack of clear and forceful policies in managing the economy. While a Serra victory cannot be entirely dismissed, most pundits look to Lula as the most probable man to fill Brazil's presidency.

Dominican Republic – Strong growth, but possible worries: The Dominican Republic appears to be well on its way to leading Latin America in terms of economic growth for 2002. Initial forecasts for real GDP growth were in the 3-4% range. However, the pace of growth was 6% for the first half of the year. Even if growth tapers from the blistering average real GDP growth rate of 7% in July, year-end growth will exceed earlier targets, probably coming in around 5-6%. The main drivers for economic activity have been communications, construction and local manufacturing. The main foreign exchange earners, mining, free-zone manufacturing and tourism all fared poorly. The combination of government spending and domestic demand are the major causes behind growth. Although inflation is under 3%, concerns are rising that government spending could be "excessive" and that there is too much reliance on external borrowing. Partially responding to these criticisms, the government of President Mejia has announced a freeze on public spending and curbs on borrowing offshore.

Indonesia – Ratings Upgrade: On September 5, 2002, Standard & Poor's raised Indonesia's sovereign currency rating from 'selective default' to 'CCC+'. The outlook was changed to stable. The upgrade was prompted by Jakarta's earlier announcement that it had successfully rescheduled the repayment of $1.3 billion of debt with the London Club of international commercial banks. Moody's rates Indonesia a notch higher at B3, with a positive outlook.

Philippines - Sadly in the Wrong Direction: At the beginning of the year, the government of President Arroyo promised to turn the economy in the right direction. For many investors and business people in the Philippines this was a breath of fresh. However, things have not gone according to plan and after a period of improvement, economic conditions are gradually eroding. Public sector finances have been disappointing and the country's debt burden is actually growing. Total public debt rose to 83% of GDP in July, up 13% year-on-year. Total public debt was 79% at the end of 2001. Public sector foreign debt is $34 billion, equal to 56% of total public debt. In addition, it is expected that the Philippines will return to international bond markets later in 2002 to help finance its deficit. The Southeast Asian nation is rated Ba1/BB+, with a stable outlook from both Moody's and Standard & Poor's. If the trends of fiscal weakness and growing indebtness continue, we would not be surprised to see the outlooks change back to negative - just where they were when President Arroyo took office.

Trinidad & Tobago – New Refinery: The government of Trinidad & Tobago has given a green light for the construction of a new oil refinery that will more than double Trinidad's current oil production. Already a major Caribbean oil producer, Trinidad's oil production averages around 224,000 barrels per day. When the refinery opens for operations in 2005, an additional 224,000 barrels will come on stream. The government has also recently proposed the construction of a $500 million undersea natural gas pipeline, running from Trinidad to the French Overseas Departments of Martinique and Guadeloupe, with branches extending to Antigua, Barbados, Puerto Rico and the Dominican Republic.

Venezuela – Bad News on Economic and Political Fronts: President Hugo Chavez's efforts to make Venezuela into a country of greater economic equality and less dependent on oil are faltering before the stark reality that populist rhetoric and economic mismanagement do not easily translate into desired objectives. Blaming outside forces, like U.S. imperialists, does not necessarily help either. Despite the relatively buoyant nature of international oil prices, Venezuela is having an exceedingly bad year. Real GDP contracted by 4.2% in the first quarter of the year, followed by an even more biting 9.9% contraction in the second quarter. The currency has depreciated by 46% this year.

Prospects for the rest of the year are not exactly robust. Certainly much of the blame rests on Chavez's shoulders. Although conservative elements of Venezuelan political spectrum (the old political parties and big business) have been confrontational since his election, the president has stimulated widespread middle class antagonism and alienated big labor. In April, elements within the armed forces and a large segment of the public supported a coup attempt that ousted Chavez, before loyalist officers rallied and reinstated the constitutionally-elected president. The abortive coup d'etat left $800 million in damages from looting and lost work. It also left an undisclosed number of dead.

In the aftermath of the April coup, Venezuelan society has remained highly polarized. The army has largely remained behind Chavez as have members of the poorer segments of the population. At the same time, the country's police and National Guard are regarded with some degree of suspicion by Chavez loyalists. The country's largest business association, Fedecamaras, remains staunchly anti-Chavez. Fedecamaras chairman, Carlos Fernandez, recently stated in an interview over public radio: "The president is off his rocker. Only with him leaving power can Venezuela cure itself of the cancer it now has."

For his part, Chavez has been equally diplomatic, stating that his opponents were "the extreme right, religious extremists and racists." To this, he added that he had fought "battles with against a thousand demons" during his three and a half years in office.

Book Reviews

Paul Blustein, The Chastening: Inside the Crisis that Rocked the Global Financial System and Humbled the IMF (New York: Public Affairs, 2001). 431 pages. $30.00

Reviewed by Scott B. MacDonald



Click here to purchase "The Chastening: Inside the Crisis that Rocked the Global Financial System and Humbled the IMF " directly from Amazon.com

Washington Post journalist Paul Blustein has written a well-thought and engrossing account of the International Monetary Fund's role during the Asian financial crisis of 1997-99 and the ensuing contagion that hit Russia and threatened Latin America. He notes that the "Electronic Herd" ("whose ranks included mutual funds, pension funds, commercial banks, insurance companies, and other professional money managers") played a major role in stampeding Asian markets. However, he is careful not to apportion all the blame here - greed, corruption and poor regulation in Asia also played their role in setting the stage for Asia's financial crisis. As the crisis began in Thailand and spread to Indonesia and Korea, Blustein focuses on the IMF's response. The bottom line is that the IMF's approach of large bailout packages, combined with monetary tightening and the closure of banks was the wrong approach. As he states: "Time and again, panics in financial markets proved impervious to the ministrations of the people responsible for global economic policymaking. IMF bailouts fell flat in one crisis-stricken country after another, with announcements of anormous international loan packages followed by crashes in currencies and severe economic setbacks that the rescues were supposed to avert."

One of the major culprits in the failure of the IMF to effectively deal with the Asian contagion, was that the High Command (the IMF, World Bank, and major G-7 countries) had successfully presided over the dismantling of capital controls in much of the emerging markets, a development that was to be seriously undermined by the lag in proper institutions in those countries to deal with volatility, concerns about the creditworthiness of banking institutions and corporate governance. The globalization of capital was "expected to help create a more efficient world economy, raising living standards in rich and poor countries alike. A further justification was that developing countries would reap enormous benefits by establishing modern stock and bond markets to finance their industries instead of relying heavily on traditional (and often corrupt) banking systems." Blustein also points out: "The advocates of globalized capital were by no means unconcerned about the dangers of international crises, and they hedged their recommendations by urging countries to develop proper legal instutitions and improve supervision of their banks before allowing the Electronic Herd to invest large amounts of money in their markets." The message is that globalization is not bad, but without proper institutions to manage the flow of capital it can be a disaster - i.e. Thailand, Indonesia, Korea and Russia.

Blustein provides a good hard look at how the IMF seeks to maintain an image of omniscience as it provides aid and advice. Yet, he concludes: "Peering behind the IMF's facade provides a less confidence-inspiring picture, even to those who broadly share the Fund's views about how to handle countries in economic difficulty." His final advice: "Rather, the main point to bear in mind - is that the current institutions and mechanisms safeguarding the global financial system are dangerously weak, and that boldness is warranted in shoring up the system's defenses before catastrophe strikes anew." Considering that Brazil is likely to threaten another contagion in Latin America, this is sound advice. Yet, at the same time, there must be greater boldness in particular countries in dealing with their own structural and transparency problems that allow leading figures in the government to opaquely move funds out of the country. Still, Blustein is a good read, providing interesting portraits of many of the key players and how they interacted.

Book Review:

The Reckoning: Iraq and the Legacy of Saddam Hussein, by Sandra Mackey, W.W. Norton & Co., New York and London, 2002), 415 pgs., $27.950

Reviewed by Robert Windorf


Click here to purchase "The Reckoning: Iraq and the Legacy of Saddam Hussein" directly from Amazon.com

Since early this year, the Bush administration has dramatically increased its barrage of accusations of Iraq's reported violations of UN sanctions. Furthermore, in the annual State of the Union address, President George Bush identified Iraq as one of the three rogue states, comprising the 'axis of evil,' that have the capacity for nuclear weapons. In addition, as the months have flown by, and the allied forces' daily patrolling of the Iraqi no-fly zones have continued, those accusations have steamrolled into threats of a direct military campaign with the support of the United Kingdom to topple the regime, culminating in Bush's recent UN General Assembly speech in which he called on the member nations to support such a challenging necessary endeavor. In response to this wave of accusations and threats, Saddam Hussein has defiantly responded and sternly warned the west that it would lose the 'mother of all battles' and suffer great agony in its vain attempts to remove him from power. In turn, the global reaction toward the Bush administration's call to arms, despite Saddam's recent acceptance to allow UN nuclear facility inspectors to return to Iraq to carryout their duties, has run the gamut of emotions from strong adherence to strong disagreement and has gone so far to sour the U.S. and U.K.'s diplomatic relations with several of its closest allies, especially Germany and France.

With the global media's up-to-the-minute, over-the-top coverage of this fluid story, it has become very easy for one to lose track of what the clear reasons would be for a potential military strike against Iraq, the numerous consequences thereof, and the prospects for the Iraqi and other Middle Eastern nations in a post-Saddam world, etc. However, for those interested to seek an understanding of and to formulate answers to the many questions surrounding the present Iraqi situation, Sandra Mackey's very timely new book, The Reckoning: Iraq and the Legacy of Saddam Hussein, offers an excellent, very insightful and detailed read. Ms. Mackey, a veteran Middle Eastern journalist, whose previous noteworthy books have examined Iran, Saudi Arabia, and Lebanon, has written a comprehensive account of Iraq's modern history beginning with its developments as a kingdom during the two world wars, the various challenges of its former rulers, the importance and influence of Shiite and Sunni Islam, all of which led to the rise of the Baath Party and Saddam's oppressive regime, and its numerous instabilities and struggles since, including the bloody and senseless war with Iran, the onslaughts against the Kurds, the invasion and surrender of Kuwait, and the chilling consequences of those events. As the book's dust jacket states, it poses a central question: whether a future Iraq without Saddam will be even more unstable and more problematic to the security of the U.S.

Interwoven throughout Mackey's book is the fact that Iraq is not comprised of one people, but many, especially non-Arabs, with the south mainly populated by the Shia and the north, the 'homeland' of the Kurds. Such a reminder lends strong support to discredit the belief that the west's removal of Saddam would ultimately solve Iraq's numerous challenges and many of those within the Middle East and for the west in achieving stability in a region never known for such a luxury. Naturally of concern is what a post-Saddam Iraq would represent and how it would be ruled. Such a monumental challenge arguably eluded the senior Bush and Clinton administrations, as they each had different (and arguably easier) goals within the region following the rebuilding of Kuwait. Now, in the wake of the 9/11 tragedy, the successful removal of the ruling Taliban in Afghanistan, and reported continued Iraqi violations of UN conditions, leading to estimates about Iraq's nuclear capabilities, the U.S. administration now has prepared the world for military actions with the ultimate goal of toppling Saddam. However, as the final chapter of Mackey's book challenges, obviously written prior to the recent heated political debates, if a concerted focus is not undertaken by the west to determine and plan for what a post-Saddam Iraq will be, then Iraq's future disintegration of a country will turn into a nightmare for its peoples and the west.

While reports from Iraqi dissidents reveal growing signs of anxiety among Saddam loyalists who realize they will become targets once he would fall, they more importantly suggest that the U.S. administration's expected campaign, now revealed as an action to 'liberate' the Iraqi people, is not seen as one by many. The majority of the population has suffered the harsh consequences of Saddam's abuse of the oil-for-food program, leading many to question the future warm welcomes for their 'liberators.' Aside from the interested observer, Mackey's book should be required reading for the U.S. administration, as the old adage, "you cannot understand your friend or your enemy unless you understand his history," now loudly rings true.

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© 2002 KWR International, Inc. This document is for information purposes only. No part of this document may be reproduced in any manner without the permission of KWR International, Inc. Although the statements of fact have been obtained from and are based upon sources that KWR believes reliable, we do not guarantee their accuracy, and any such information may be incomplete. All opinions and estimates included in this report are subject to change without notice. This report is for informational purposes and is not intended as an offer or solicitation with respect to the purchase or sale of any security.