Banks warn on currency threat

The dollar is still overvalued, say bankers

by BBC News Online's Steve Schifferes in Prague

The world's leading private banks have warned that the dollar is still dangerously over-valued despite last Friday's intervention to boost the euro.

The Institute of International Finance, which represents 318 leading financial institutions, said that "a sharp fall in activity associated with abrupt exchange rate changes.. remains a risk in the light of the outsized US current account deficit."

Nobody believes we should be bailed out by the public sector

Sir John Bond, Chairman, HSBC

William Cline, the deputy managing director of the IIF, told the BBC that, althougth the euro was weak at the moment, there could be a sharp change in sentiment when foreign currency markets realised that the US trade deficit - running at a record $450bn a year - was unsustainable.

He said that there was a need to reduce the value of the dollar in a concerted fashion, and he was worried that the US still appeared to believe in a high dollar policy despite the intervention on Friday to boost the weak euro.

The dollar has been boosted by foreigners investing in the US stock market, but the bankers are worried that stock market crash would hit the dollar and cause a slowdown in the US economy.

In a statement released to Gordon Brown, who is chairman of the IMF's main policy-making committee, the bankers warn that such a development could threaten the global economic recovery by "putting upward pressure on interest rates at a crucial time."

It would "increase borrowing costs for emerging market economies and depress demand for their exports."

Even the sharp drop in the Nasdaq index of US technology stocks in April had a significant impact on lending to developing countries, with some countries finding they could no longer borrow money on international capital markets, the bankers said..

Stock markets replace banks

One reason is that most money going to poor countries is now in the fom of investment in the stock market rather than bank loans, which dried up after the Asian crisis of 1997-98.

The IIF projects that private capital flows to emerging market countries will increase from $151bn in 1999 to $188bn in 2000 and $218bn in 2001.

But equity investment will be around $160bn of that total, while private creditors (banks and bondholders) actually received $17bn back from developing countries in 1999, compared to thed $125bn they lent them two years earlier.

Those sharp turnarounds in private sector flows have led to calls for more regulation of private lending, including compulsory "standstills" when private debt repayments are suspended when a country's economy could not stand the strain, and some controls on capital flows.

No mandatory standstills

The International Monetary Fund itself still appears divided on the issue, with some countries (mainly European) favouring IMF support for standstills "which could help reduce financing costs," and "in exceptional circumstances" the introduction of comprehensive exchange or capital controls.

Others, especially the United States, argue that any mandatory standstills "could increase the price and reduce the flow of private capital flows to emerging market countries."

The international banking community is also strongly of this view, and hopeful that they have a ally in Horst Koehler, the new chief of the IMF, who has set up a new group to consult with the private sector.

William Rhodes, the vice-president of Citibank who has negotiated many agreements with countries on rolling over their private sector debt, said that there was no doubt a case-by-case approach was better, and the imposition of fixed rules would make people think twice before investing in emerging markets.

And he refuted claims that the private sector did not suffer as a result of a financial crisis. In Ecuador, which defaulted on its debts last year, private investors lost 40%.

There has been criticism that banks lending to developing countries get a free ride, because in a crisis the IMF will intervene, so they are not careful enough with their lending (the so-called moral hazard problem).

Sir John Bond, chairman of HSBC, said:

"Nobody here believes we should be bailed out by the public sector".