Of all the challenges facing South Korea and the other cash-strapped ''tiger'' economies, none is more critical than restarting the Asian bond market. Remedial measures so far, like massive IMF bailout packages and short-term bank debt rollovers, are woefully inadequate to deal with the region's grave liquidity problems.
Longer-term solutions aimed at debt restructuring all rest on injecting fresh capital using new bonds. Thus, it is now clear that a sustainable recovery is impossible without the renewed participation of long-term institutional investors like mutual and pension funds. But coaxing skeptical investors back into the fray is no easy task. This crisis of investor confidence was amply illustrated by the failure of the $2 billion Korea Development Bank issue last December. Unprecedented yields were not enough to entice investors wary of the IMF bailout plan and Seoul's competence.
A revitalized Asian bond market is stalled for two reasons - weak issuer credibility and inadequate bailout money from the likes of the IMF and World Bank. Neither agency is able to fund additional bailouts; indeed, IMF reserves are almost depleted and won't be replenished soon given Congressional resistance.
In order to overcome both these hurdles, many analysts suggest changing the agencies' roles so that they can efficiently channel capital to emerging market economies during financial crises.
In particular, Japan recently suggested the World Bank guarantee the debt of troubled Asian nations. This idea of transforming the World Bank from primary lender to guarantor is a meritorious one and deserves the endorsement of Japan's Group of 7 partners for many reasons.
This would not spell the end of the World Bank, but merely extend a shift under way since 1994. At that time, the World Bank decided to sharply increase financial guarantees it makes to commercial lenders, thereby encouraging private-sector lenders to finance infrastructure projects. The bank's size and high ''AAA'' credit rating has helped reduce infrastructure funding costs and extend commercial loan maturities.
Similarly, World Bank guarantees will revitalize the publicly traded Asian bond market for three reasons. First, by assuming a portion of emerging market credit risk on a contingency basis, the bank can leverage its capital base and make more credit available to emerging economies than would be possible through direct lending.
Second, a bank guarantee lowers funding costs for countries recently demoted to junk status by rating agencies. This encourages gun-shy investors to re-enter the market without further denigrating the quality of their portfolios. Cheaper financing costs also encourage timely repayment by the convalescing issuer.
Third, the World Bank guarantee would mitigate capital flight that typically accompanies any weakening in issuer fundamentals, encouraging inflows of foreign long-term investment capital.
Transforming the World Bank from lender to guarantor would also facilitate a more rational allocation of capital among emerging countries.
While politics will still influence World Bank guarantee extensions, it will be less a factor among mutual fund managers whose compensation is linked to the performance of their investments. It is therefore less likely that politically corrupt or inefficient regimes will be able to obtain financing on attractive terms, if at all.
In a similar vein, the billionaire financier George Soros recently proposed that a new multilateral agency - the International Credit Insurance Corporation - should be set up to guarantee loans to national governments for a modest fee.
This authority would cap what it will insure based on the borrowing country's debt levels and macroeconomic condition. Creditors wishing to lend money in excess of the ICIC ceiling could do so, but only at their own risk. Thus, the ICIC would make up for what Mr. Soros believes is a failure of free-market forces to rationally allocate credit to the emerging markets.
While transforming the World Bank from lender to guarantor falls short of the Soviet-style central planning model espoused by Mr. Soros, it would go a long way to recharge investor interest in the Asian bond market.
Better yet, instead of creating yet another multilateral bureaucracy, a transformed World Bank would use that institution's already existing, but vastly underutilized, infrastructure.
And by allowing the World Bank to pick specific deals it wants to support, fund diversion or misappropriation by corrupt governments is minimized - a major problem left unresolved by Mr. Soros' alternative ICIC arrangement of extending blanket guarantees to governments up to a predetermined ceiling.
To improve its effectiveness as a tool for economic development, the World Bank recently initiated sweeping reform called the ''Strategic Compact.'' One of its key provisions is that the bank ''act as a catalyst for private-public collaboration.'' In its new role as guarantor of publicly traded Asian debt, the World Bank will fulfill this mandate.