IMF sees little contagion from Japan woes

By SHIHOKO GOTO, UPI Senior Business Correspondent  |  March 14, 2002 at 2:47 PM
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WASHINGTON, March 14 (UPI) -- Japan's financial system continues to drag down the country's economy, but a Japanese banking crisis is unlikely to have a severe effect on the global economy, the International Monetary Fund said Thursday.

On the other hand, the collapse of U.S. energy trading giant Enron Corp. could potentially rock the global financial system in the future, given the magnitude of the company's bank exposures to other energy companies in financial difficulty, among other factors, the IMF said.

Releasing its first edition of the Global Financial Stability Report to be issued henceforth on a quarterly basis, the IMF's study focuses on some of the strengths, but largely the weaknesses, prevailing in the world's financial system to date.

In light of the Enron debacle, companies in both industrialized and developed countries should enhance their disclosure system, said IMF international capital markets department counselor Gerd Hausler. He pointed out that the, "self-correcting mechanism of the financial markets ... is the first line of defense for the market economy," adding that without adequate information and transparency, investors will not be able to take appropriate financial decisions.

The IMF stressed, however, that Enron's bankruptcy so far only had a limited impact on the U.S., and indeed world, economies. Nevertheless, its collapse underlines the inadequate oversight of financial activities of non-financial corporations, the ineffectiveness of private market discipline under inadequate information disclosure, and the misallocation of retirement savings, the agency stated.

"We can expect closer scrutiny of creative accounting" as a direct result of Enron, Hausler cautioned. He also warned that given the tendency of the credit cycle to lag behind that of the business cycle by about two quarters, the number of U.S. defaults and bankruptcies is likely to peak in the third quarter.

But on Japan, Hausler was less wary of the repercussions the country's financial woes may have on the overall world economy.

"The interaction of Japanese financial institutions (in the global market) has become less important over the past two to three years," Hausler said, pointing out that Japanese banks have been retreating from operating overseas since the country found itself in the economic doldrums over the past decade.

"The contagion effect from Japanese banks has diminished as they have withdrawn rapidly from international operations," Hausler said. "The exposure of non-Japanese investors (to Japanese banks has) decreased, and contagion is less of a concern," he added.

That could be the case for looking at the Japanese private banking sector on its own. However, the country still remains the world's second-largest economy, with one of the highest savings rate and is heavily invested in U.S. assets including treasuries. These factors, combined with the fact Japan is one of the biggest development assistant donor nations, means the continued demise of Japan's financial system is more likely to hurt both industrialized and developing countries severely.

As for Argentina's financial crisis, on the other hand, the IMF repeated the broader consensus among international economists that the country's downfall has not had a significant impact on the global economy, nor is it likely to aggravate the world financial system any further, given that its decline did not take investors by surprise.

The IMF stated that if investors are well aware of a financial crisis hitting a certain country well in advance, the likelihood of a contagion effect spreading across the region -- as it did in the mid-1990s in East Asia and Russia -- will markedly decrease.

To that effect, the latest IMF report aims not only to analyze, but also to wave a red flag on particularly weak spots that have the potential to upset the overall global economy.

It also has come up with a "core early warning system model" by evaluating its "exchange market pressure" index. This model measures the monthly percentage depreciations in the nominal exchange rate and declines in foreign exchange reserves. If these measures exceed their means by more than three standard deviations the country is at a financial risk.

The problem, however, is that the IMF declines to comment on where each member country is at the moment, according to its index, and has shied away from making any specific comments on what measures countries should take in order to avert an economic downturn should they be at risk.

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