Capital Access Index: Emerging and Submerging Markets By Glenn Yago and David Goldman

Overview Asia's continuing financial crisis has challenged conventional wisdom on both sides of the Pacific. Asian countries, hoping to regain some ground by increasing exports and reduce balance-of-payments deficits, agreed to try the traditional macroeconomic approach advocated by the International Monetary Fund-they devalued their national currencies. Unfortunately, this only made their situation worse. It is no longer controversial to argue that private markets do a better job of allocating capital than state-controlled banks in cahoots with politically-protected local monopolies. Yet considerable confusion remains regarding how to repair Asia's shattered institutions. In Southeast Asia, the banking sector and a great deal of all private corporate assets now belong to the state. Currency valuation and double-digit interest rates have swelled the cost of debt service to unbearably large proportions of GDP, ranging from 13 percent in the Philippines to 48 percent in South Korea. Non-performing bank debt across the region totals 30 to 40 percent of GDP, and financial institution insolvencies are forcing states to step in. In light of the defeat of long-held beliefs, deciding what Asian countries should do to recover requires a new kind of economic analysis. Our research demonstrates that access to capital-the means to transform human talent and energy into wealth-is the key to economic success. Traditionally, conventional macroeconomic theory has paid little attention to the quality of capital markets, but markets now have taken center stage. To better analyze the role of markets in a country's economic health, we have developed a set of indicators of capital access. Though the countries differ in may ways, the indicators paint a common picture: Economies fare best where capital is cheap, plentiful, and fairly allocated, and fare worst where capital is dear, scarce, and arbitrarily allocated. The indicators make the following simple considerations:

1. If a state consumes or directs a large portion of capital flows, it strangles the private deployment of capital.

2. If a few entrenched firms dominate capital markets, they bar the way to new entrants.

3. If capital remains outside the formal economy, it cannot be concentrated and employed efficiently.

4. If governments pursue arbitrary financial policies (for example, by

devaluing the currency), they add a risk premium to the cost of capital. 5. If foreigners are excluded, onerous local monopolies tend to form. 6. If governments tax rewards to risk capital, entrepreneurs are discouraged

from taking risks. 7. If governments hand over national economic management to supranational

agencies, they place local firms in the procrustean bed of arbitrary macroeconomic doctrine.

8. Broad, deep, liquid capital markets provide greater economic benefits than narrow, shallow, illiquid ones.

In short, state-directed capital flows concentrated in a small number of financial institutions and corporations hampers growth. Capturing the quality of capital markets through quantitative variables is a balancing process. For example, some countries are "underbanked," in the sense that too few resources are deposited into and lent out by the banking system. Other countries suffer from excessive bank lending. In the first case, we should find a low ratio of bank balance sheets to GDP. In the second case, we should find poor bank credit ratings or perhaps an unstable national currency. No set of indicators is perfect; but by assembling the most comprehensive set of indicators that the data permit, we can reduce distortions and gain a clearer economic view. The Asian Crisis In Asia, economic development planners often focused solely on export-led growth at the expense of capital formation at the economy's roots. This led to success in the battle, but at the expense of losing the war. A glaring example is household capital formation. In the United States, the residential mortgage market is roughly the size of GDP; in Asia, mortgage markets are primitive and concentrated in a few prosperous urban districts. Forcing artificially high savings rates led to dependency upon domestic sources of investment. The lack of capital markets (despite some activity in the late 1980s) created dependence on institutional, rather than market sources of capital. That strategy could not keep an economy growing. Moving toward a more sustainable and shared capitalism in Asia requires aligning the interests of investors and employees, entrepreneurs and governments, foreign strategic partners and domestic corporate leaders. Figures 1-6 chart the decline of Asian capital markets since the beginning of 1997. The prevailing story is that the crisis erupted when short-term, unhedged debt invested in realestate and excess manufacturing capacity in the region grew so large as to induce capital flight. With capital leaving, currencies depreciated and asset prices fell. This exacerbated problems for private balance sheets and an overextended banking sector. The true pictureis much more complex, with not one but many Asian crises occurring together. Though these crises are not related, common to all are patterns of crisis denial, delayed downgrades, bank runs and devaluations, restrictions on the movement of people and capital, and corporate and bureaucratic paralysis. Countries that have begun to address these conditions have improved their chances of recovery.

The problems in Asia expose fault lines in global financial development and question the ability of transnational agencies to predict or protect against coming tremors. As recently as the beginning of this decade, IMF investment was similar in size to total net private direct investment in the global economy. By 1996, private investment had outpaced IMF investment by a factor of four (see Figure 7).

The current crisis cannot be resolved by the IMF or by each country alone, but only through long-term increased capital access. Reducing business crises requires enhancing the flow of funds between advanced economies and emerging ones through private capital markets. We are still just beginning to build the financial infrastructure to facilitate this capital flow. In advanced economies, especially in the United States, capital markets have become the predominant channels through which capital moves. As these markets grow, capital ownership broadens. As Figure 8 shows, securities increasingly have replaced traditional funding channels worldwide. Banking intermediation has grown as well, but its historical dominance has been eclipsed by the flexibility and innovation of increasingly complex capital structures that fuel economic growth.

Globally, this early stage of financial revolution is leading commercial and investment banks to converge. Competition often hinges on innovations that serve a new and growing market as privatization and market liberalization continue to expand economic participation worldwide. As our rankings show and recent experience demonstrates, this process is neither linear nor evenly distributed across regions. As Figure 9 shows, the uneven development of capital markets particularly hampers Asia relative to Latin America. Sizable transactions related to project financing, interest rate arbitrage, and large-scale development financing all accelerated bank lending to debtor countries in Asia.Japanese and European banks developed the greatest exposure, representing 35 percent ($260.6 billion) and 42.3 percent ($318 billion) of lending to Asia, respectively (see Figure10).

A recent Milken Institute study presents evidence that the bank-lending boom of 1990-96 contributed to the financial crises in several Asian countries.1 Figure 11 presents this evidence graphically, correlating the growth in bank lending with a crisis index (the sum of the depreciation rate minus the percentage change in international reserves) we constructed for each country. These findings suggest that the growth rates of bank credit and indices of poorly performing loans were leading indicators of exchange rate and international reserve difficulties in Asia. We found no evidence of contagion, in which the currency difficulties of one country were transferred to other countries. All of the countries that suffered the most serious financial difficulties did so because each had real economic difficulties, associated in large part with an excessive growth of bank credit and bank loan and insolvency issues. This was not a problem of credit itself, but of borrowing short and lending long, of too much state-directed credit, and of the absence of corporate bond and equity markets linked through analysis, research, and investing (see Figure 12).With Asian financial institutions so concentrated-each focusing on building its capital, its reputation, and on surviving-it will be impossible to count on traditional financial leaders to fuel growth.

Asia needs to spread out its economic and financial power. It must open up its financial markets, let in new firms, and make way for new financial technologies that, if used correctly, can rebuild its economies and societies. The public marketplace needs to be developed, with public and private institutions, the mutual fund industry, and private investors all taking part. This democratization of capital will have the benefit of reducing the concentration of industrial power. As the Milken Institute Capital Access Index suggests, both the increasing level of market capitalization as a percentage of GDP and the broadening of market capitalization to include firms of all sizes are important harbingers of recovery and growth. For example, between 1930 and 1997, the percentage of the total U.S. market dominated by the top 25 firms dropped steadily. When control over capital is shifted from a few financial institutions to many, it results in an immediate increase in people looking for new businesses to finance. As Figure 13 shows, Asian capital markets are still restrained by excessive concentration.

Watching financial catastrophes unfold is not unlike the experience of confronting approaching icebergs-one hopes that the force of observation will change circumstances. The Milken Institute Capital Access Index emerges from this particular triumph of hope over experience; by focusing attention on the world's economies, its goal is to guide investment and regulatory policy so as to help us avoid future crises. In future iterations we will expand upon the indicators of quantitative economic factors, risk measures, and the political, regulatory, and institutional dimensions of financial markets, industrial organization, and corporate finance that affect capital access, the spark plug of growth and crisis resolution. Glenn Yago is Director of Capital Studies at the Milken Institute. David Goldman, a former Research Associate at the Milken Institute, is currently Vice President at Credit Suisse First Boston. C. Michael Bates, Research Assistant at the Milken Institute, provided research assistance.Thanks also to Greg Beier, Research Analyst; James R. Barth, Senior Finance Fellow; R. Dan Brumbaugh, Jr., Senior Finance Fellow; and Lalita Ramesh, Research Associate, for their work on this project. All are at the Milken Institute. 1 "The Role of Governments and Markets in International Banking Crises: The Case of EastAsia," by James R. Barth, R. Dan Brumbaugh, Jr., Lalita Ramesh, and Glenn Yago, was presented at the 73rd Annual Western Economic Association International Conference in Lake Tahoe, June 28-July 2, 1998.

Introduction to the Milken Institute Capital Access Index This ranking differs substantially from other very responsible efforts by the Simon Fraser Institute,2 Wall Street Journal/Heritage Institute,3 and World Economic Forum4 by focusing on capital access, the most salient dimension of a country's economic environment that allows it to realize its growth potential. The Milken Institute Capital Access Index focuses on market factors alone and not on political ideologies. We examine empirical market factors regulating the entry and exit, origin and destination of capital flows. Thus, our rankings focus less upon macroeconomic policies and issues than do other economic rankings, and more upon recent revolutions in corporate finance theory and practice. The ability to tap capital markets and structure corporate finances to facilitate business growth strategies is key. Obviously, the macroeconomic environment can constrain or enhance that capacity, but this index focuses upon finance variables that link microeconomic behavior to macroeconomic performance. We measure capital access according to the depth, breadth, and liquidity of markets. Risk measures include the volatility of interest rates, currencies, and equity prices. These risk factors have the greatest impact upon foreign portfolio flows, domestic capital formation, firm formation, and aggregate growth. Even though we do not incorporate political factorsper se, some policy information can be gleaned by examining our government-control factors, which are indicative of the role of the state in determining patterns of economic performance. The Milken Institute Capital Access Index is an equally weighted index of 17 variables, divided into three categories: quantitative, risk, and qualitative. 2 James Gwartney and Robert Lawson. Economic Freedom of the World: 1997 Annual Report (Vancouver, B.C.: Fraser Institute, 1997). 3 Kim R. Holmes, Bryan T. Johnson, and Melanie Kirkpatrick. 1997 Index of Economic Freedom. (Washington, D.C.: The Heritage Foundation and The Wall Street Journal, 1996). 4 Klaus Schwab. The Global Competitiveness Report 1997. (Geneva: World Economic Forum, 1997).

Ranking of Emerging Capital Markets

Country Score Rank Quantitative Measures

Risk Measures

Qualitative Measures

Singapore 100.0 1 97.7 78.3 100.0

Taiwan 96.3 2 89.9 100.0 23.6

Hong Kong 92.9 3 100.0 66.3 92.7

South Africa 81.2 4 76.0 74.5 52.7

Chile 80.0 5 86.8 71.7 29.1

Israel 76.6 6 65.9 76.1 43.6

Greece 72.9 7 65.9 69.0 45.5

Argentina 72.0 8 50.3 75.0 56.4

China 72.0 8 77.5 97.3 0

Panama 71.4 10 50.4 64.1 89.1

Malaysia 70.8 11 75.2 65.8 21.8

Turkey 70.2 12 72.9 57.1 52.7

Peru 69.2 13 51.2 68.5 60.0

Brazil 66.5 14 71.3 63.0 14.5

Morocco 65.5 15 60.5 67.4 20.0

India 64.3 16 66.7 71.2 0

Czech Republic 64.0 17 59.7 66.8 14.5

Philippines 62.2 18 57.4 56.0 45.5

Hungary 60.6 19 43.4 73.9 9.1

Ecuador 59.7 20 54.3 51.6 52.7

Mexico 56.0 21 66.7 44.6 25.5

Thailand 56.0 21 82.9 40.8 0

Slovak Republic 50.8 23 45.0 54.9 10.9

Nigeria 49.8 24 48.1 40.2 47.3

Venezuela 45.2 25 45.7 39.7 27.3

Poland 44.3 26 29.5 69.6 0

Egypt 43.1 27 56.6 59.2 0

Indonesia 37.8 28 56.6 26.3 0

Korea 20.6 29 51.9 39.1 0

Russia 18.2 30 42.6 32.1 0

Bulgaria 9.8 31 22.5 21.7 0

Quantitative Measures:

1. Government spending/GDP 2. Equity market capitalization/GDP 3. Private-sector domestic credit claims/GDP 4. Government debt/GDP

Risk Measures:

5. Interest-rate spread between U.S. Treasury bonds and domestic public debt 6. Stock market volatility 7. Interest-rate volatility 8. Currency volatility 9. 90-day interest rates 10. Velocity of M1 money supply 11. Equity market liquidity 12. IPOs in a given year as a proportion of total share issues

Qualitative Measures:

13. Moody's bank ratings 14. IMF program 15. Capital controls 16. Allowed foreign ownership 17. Capital gains tax

Definition of Variables QUANTITATIVE MEASURES Government spending/GDP. Ratio of government expenditures, as reported in the Government Finance section of the IMF's International Financial Statistics, to GDP. The data include lending operations. Equity market capitalization/GDP. Ratio of the total value of all securities traded on the exchanges for each country, as reported by the International Finance Corporation's Emerging Market Database, to GDP. Debt market capitalization/GDP. Ratio of domestic credit/claims on private sector, as reported in the monetary survey of the IMF's International Financial Statistics, to GDP. Government debt/GDP. Ratio of long-term debt that is public and publicly guaranteed, as reported in the World Bank's Global Development Finance report, to GDP. RISK MEASURES Spread to U.S. Treasuries on long-term debt. Interest rate spread between benchmark issues and U.S. Treasury bonds as reported by Bradynet. Stock market volatility. Annualized standard deviation of monthly changes in market capitalization, based on data from the International Finance Corporation's (IFC) Emerging Market Database. Short-term interest rate volatility. The volatility measure is the annualized standard deviation of monthly changes in a short-term interest rate, based on data from the IMF's International Financial Statistics. Currency volatility. Annualized standard deviation in weekly changes in the exchange rate of the local currency to the U.S. dollar, based on data from Datastream and Bloomberg. 90-day interest rates. Data are from Datastream. Velocity of M1. Ratio of GDP to the money supply. This figure is representative of the number of times a given unit of the local currency is spent on final output in a given year. M1 data are from the IMF's International Financial Statistics. Equity Market Liquidity. For any given exchange, average monthly value of shares traded as a percentage of total market capitalization. Monthly figures were obtained from the IFC's Emerging Market Database. IPOs as a share of total issues. Ratio of initial public offerings in one yearto the number of companies listed on the exchange at the year's end, based

on data from the IFC's Emerging Market Database. QUALITATIVE MEASURES Moody's bank strength rating (dummy variable). Data from Moody's. IMF program (dummy variable). Assigned 1 if the country had $2.9 billion or more in outstanding borrowing from the IMF, 0 otherwise. Data from reference 1. Capital controls (dummy variable). Assigned 1 if not fully convertible for foreign investment, otherwise assigned 0. Data from money center bank foreign exchange departments. Note. GDP figures are from Bloomberg, Datastream, and the Economist Intelligence Unit (EIU). Allowed foreign ownership. Index score of less than 3 resulted in a 0; an index score of more than 3 resulted in a 1. An index score of 3 required an assessment of the barriers to foreign ownership to determine variable value.Based on data from Index of Economic Freedom. Capital gains tax. Individual capital gains tax data from the Index of Economic Freedom. GDP figures are from Bloomberg, Datastream, and the Economist Intelligence Unit.

Country Briefs

SINGAPORE

Rank: 1 of 31 Score: 100.0 Economic Summary and Outlook Singapore has enjoyed strong economic growth since the early 1990s, peaking with a real GDP growth rate of 10.5 percent in 1994. Since then, growth has been more moderate, in the 7 to 8 percent range. Economic growth in 1998 is threatened by a depressed demand for exports (about 50 percent of Singapore's exports go to the region hit by the Asian crisis) and a weak demand for electronics. Quantitative Performance Singapore scored second-highest in the quantitative component of the Capital Access Index, with consistently strong rankings in each quantitative category. Government spending as a share of GDP was about 10 percent, though this share could increase as large spending cuts are not expected. Likewise, its government debt as a share of GDP is one of the smallest among Index countries; given that the government is expected to keep running a surplus, this measure of capital access should continue to perform strongly. Singapore also had the fourth-highest ratio of market capitalizationto GDP. However, given the recent pounding stocks have taken on the Singapore exchange, this measure could be significantly impacted in coming months. Risk Performance Despite having a seemingly low risk rating of 78.3, Singapore is the third-best performer in this Index. Singapore's greatest shortcoming is an extremely volatile interest rate, despite the fact that its short-term interest rate is the lowest in our group of countries. Additional risk weakness can be attributed to an extremely volatile equity market, one that sends investors on gut-wrenching rides. Despite this volatility, Singapore's equity market has one of the best liquidity ratios. Thus, Singapore's economy makes its transition back to a comfortable (positive) growth rate; and, as market transparency is increased, we would not be surprised to find increased investment in equities and less market volatility. Furthermore, this economic turnaround could lead to an increase in IPO activity, which would increase Singapore's risk rating. Qualitative Performance As is traditional for Singapore, this well managed nation-state at the tip of Malaysia achieved the highest ranking. Relatively strong banks, limited capital controls, and an active derivatives market all strongly contribute to putting Singapore in the top slot.

TAIWAN

Rank: 2 of 31 Score: 96.3 Economic Summary and Outlook Real GDP in Taiwan has grown by an average of about 6 percent annually since the beginning of the 1990s, though 1998 could see a slightly lower growth rate. As is the case with most of the Asian Index countries, Taiwan could be hurt by decreased exports. Some of this reduced demand could be offset by increased demand in the United States, the largest importer of Taiwanese goods, which recently entered into a bilateral trade agreement with Taiwan. Quantitative Performance Taiwan's weakest performance in the quantitative section of the Index was in government spending, which was 14.2 percent of GDP. The performance of this variable is expected to improve as growth in government spending is outpaced by growth in GDP. The government is expected to run a deficit again this year despite the fact that it is supposed to eliminate its budget deficit by 2001. This deficit will be financed both by previous surpluses and new bond issues, which could impair Taiwan's performance in the government debt category. Taiwan's equity-market capitalization as a share of GDP was the fourth-highest among countries in the Index, and total market capitalization increased by $48 billion (16.7 percent) in the first quarter of 1998. Risk Performance Taiwan performed exceptionally well in the risk category, earning the highest score of 100.0. China followed Taiwan with a score of 97.3, while the third-best performer scored a distant 78.3. Taiwan's short-term interest rate was the second-best among countries in the Index and suffered from much less volatility than did the leader. Taiwan's stock exchange experienced relatively low volatility and offered investors the most liquidity. The IPO market was also one of the most active markets in the Index. April marked the opening of Taiwan's first futures exchange, the Taiwan International Mercantile Exchange (TAIMEX). Though foreign investors are currently prohibited from trading on the TAIMEX, exchange officials are in the process of having current futures trading laws amended to permit foreign investment. Qualitative Performance Taiwan closely followed Singapore in qualitative measures. Taiwan pursued a remarkable strategy of developing small and medium-sized businesses in the course of its economic development. Consequently, Taiwan's economy isnot dominated by conglomerates, as are Korea's and Japan's, and has therefore been the star performer during the Asian crisis.

HONG KONG Rank: 3 of 31 Score: 92.9 Economic Summary and Outlook Contrary to expectations, Hong Kong's economy has wilted while its system of governance has remained intact. Property prices have collapsed, the stock market has lost half its value, and investors are worrying not about if, but when the Hong Kong dollar's peg to the American dollar will break. Currently, the peg is expected to break next year (perhaps as part of a broader RMB devaluation). GDP is expected to slow this year to 3.5 percent and recover a bit next year. Quantitative Performance Hong Kong was the top performer in the quantitative category of the Capital Access Index, scoring 100.0. Hong Kong has no government debt, though its government spending rank was near the middle of the pack. The ratio of debt-market capitalization to GDP was the second-best among Index countries, signifying high individual access to capital. Equity-market capitalization was 242 percent of GDP, earning Hong Kong second place in this variable behind Malaysia's 259 percent. Risk Performance In contrast to its quantitative performance, Hong Kong's risk performance indicated several areas for improvement. A highly volatile stock market earned Hong Kong the third-lowest rating among countries in the survey. On one hand, its equity market liquidity is average and IPO activity is not as robust as it could be. On the other hand, Hong Kong's peg to the U.S. dollar provided investors with the lowest exchange rate risk, though this could change in coming months. If Hong Kong is faced with another currency attack, it could either raise interest rates, to the detriment (and chagrin) of business, or it could spend some of its large foreign exchange reserves to defend the peg, an option that China would not favor. Recent reductions in the short-term interest rate could help this measure of risk; but again, any currency attack threatens further reductions and could lead to interest rate hikes. Accordingly, interest rate volatility in Hong Kong was one of the highest in the Index. Qualitative Performance Hong Kong followed Taiwan closely in qualitative performance scores. With perhaps the most open economy in Asia, Hong Kong has confounded critics by retaining its excellent legal and bureaucratic systems-something few were optimistic about a year ago. Oddly enough, the property and stock markets have collapsed, something most were quite optimistic about a year ago. As long as Hong Kong retains its superb investment environment, it will

continue to place strongly in qualitative measures and will likely remain a vibrant gateway to China.

SOUTH AFRICA Rank: 4 of 31 Score: 81.2 Economic Summary and Outlook Though South Africa has done well in providing its entrepreneurs access to capital, its growth rate has not been as impressive as that of some Asian countries. The rate of real GDP growth in 1997 is expected to be lower than the 3.2 percent registered in 1996, though there is a good chance of recovery in 1998. South Africa's exports are well diversified, which should help to dampen reduced demand from Asian countries. Quantitative Performance South Africa owes a lot of its performance in the Index's quantitative sectionto its stock market capitalization, which was the third-highest at 188 percent of GDP. Further expansion in the debt market sector could fuel an even better quantitative performance. South Africa's score was hampered primarily by its government spending patterns. Given that the country's finance minister approved an increase of 6.4 percent in government expenditures and that its GDP growth rate should be less than this, government spending will continue to be a drag on South Africa's Index performance. Though the country currently enjoys a low ratio of government debt to GDP, recent persistent government deficits threaten this variable's stability. Risk Performance In the risk category, South Africa earned a slightly lower score than it did in the quantitative section (74.5 versus 76.0). While low stock market volatilityearned the country high marks, similarly low market liquidity worked against the country's ranking. Increasing IPO activity would be a boon for access to capital, as South Africa's IPO activity as a share of total issues wasin the bottom half of Index countries. Though short-term interest rates were not among the lowest, South Africa offered investors more stable interest rates than did most of the other countries. Finally, a recent increase in currency volatility associated with the dip below 5 rand per U.S. dollar threatens to weaken the country's currency risk rating. Qualitative Performance In the wake of apartheid's fall, South Africa continues to maintain a decent environment in the view of our qualitative measures, with some weakness inbanking. As banking crises are the culprit in many a market's demise, South

Africa's banks are a matter of substantial concern and should be closely monitored until they revive.

CHILE Rank: 5 of 31 Score: 80.0 Economic Summary and Outlook Chile, the top-performing Latin American country in the Capital Access Index, has enjoyed economic growth in excess of 7 percent since the beginning of the 1990s. However, growth could be moderated in 1998 by low copper prices and increased demand for foreign goods and services. Chile's central bank continues to maintain a tight monetary policy in an effort to reduce inflation. Quantitative Performance Chile performed fourth-strongest in the quantitative section of the Index, behind Hong Kong, Singapore, and Taiwan (the top three overall Index performers). With a ratio of equity-market capitalization to GDP of 0.98, the total value of companies traded on the Chilean exchange was just about equal to the 1997 GDP for the whole economy. Continued upheaval in Asian countries has hampered further growth in market capitalization, as exports to this region account for more than 30 percent of Chilean exports. Government debt as a share of GDP has been low; given the continuing federal surplus, this variable should continue to fortify Chile's Index rank. One potential red flag for access to capital is government spending, which last year was about 18.5 percent of GDP. Risk Performance Chile also performed quite well in the risk category, thanks to having the lowest stock market volatility of any country in the Index. However, the market volatility measure might be artificially low due to the fact that Chilean securities are so illiquid. In fact, Chile had the sixth-worst turnover ratio in the Index. While liquidity may be lacking, its IPO was more robust than that of any other Index country. Further strength in the risk category was provided by a low short-term interest rate, although early 1998 saw interest rate hikes. Investors in Chile are subject to relatively low exchange rate risk as the central bank has vigorously defended against attacks on the peso, spending about $1 billion of foreign exchange reserves in the latter part of 1997. Qualitative Performance Chile posted excellent results in the qualitative evaluation, with its primary weakness surfacing in capital controls. Though some capital controls are at

work, they are designed explicitly to force money to be invested in Chile for the longer term. In light of Chile's performance during the Asian market turmoil, this practice has worked well.

ISRAEL Rank: 6 of 31 Score: 76.6 Economic Summary and Outlook After liberalizing shekel convertibility substantially, the government's reform programs may face new hurdles with rising unemployment and growing social tension. As economic growth slows to 1 percent this year, the trade deficit may come under pressure and government spending probably will increase. Quantitative Performance Israel's scores in the quantitative section were for the most part quite good. The major exception was the ratio of government spending to GDP, which was an amazingly high 43.8 percent-the worst performance in the Index. Clearly consumers and investors are not being allowed to exert enough influence on what is produced and consumed by the economy. Whereas government spending crippled Israel's quantitative score, low government debt as a share of GDP bolstered it. Further support came from high equity-market capitalization and high debt-market capitalization as shares of GDP. Risk Performance In terms of risk, Israel's stock market offers the third-lowest volatility of all Index countries. Once again, though, the level of stock market volatility might be artificially low because the market is relatively illiquid. More activity in the IPO market would improve Israel's risk rating, as this would provide entrepreneurs with another avenue from which to obtain capital. Borrowers in Israel can look forward to one of the lowest nominal interest rates of countries in the Index, while positive differentials over international rates are helping to keep shekels in Israel. The shekel was relatively stable in 1997, but recent shekel activity has increased exchange rate risk as the shekel has bounced between NIS 3.55 and 3.7 per U.S. dollar. Qualitative Performance Israel remained high on the qualitative performance measures in spite of a long history of government involvement in economic decision making. Israel is making substantial gains in privatization and reducing government involvement in micromanaging the economy. Also noteworthy, the government has made meaningful progress in fostering the development of high-tech startup companies through an "incubator" program.

GREECE Rank: 7 of 31 Score: 72.9 Economic Summary and Outlook Greece has enjoyed positive economic growth since 1993, the last time the economy contracted. Official government estimates place real GDP growth at 3.8 percent for 1998, up from the 3.5 percent registered in 1997. The devaluation of the Greek drachma earlier this year against the ECU will help fuel exports to the European Union, while interest rates should continue to drop. Quantitative Performance Greece's worst-performing variable in the quantitative section of the Index was its ratio of government spending to GDP. The government influenced 31.4 percent of the economy's production and consumption, although cuts in budget expenditures required for entering the European Monetary Union could decrease this measure over the next few years. Low equity-market capitalization also inhibited Greece's quantitative ranking; but this measure should improve in the next Capital Access Index, as total market capitalization has increased by more than $20.6 billion, or 68.2 percent, since the end of 1997. Though Greece's government debt as a share of GDP is among the lowest of Index countries, access to capital in terms of debt-market capitalization is relatively weak. Risk Performance While Greece's performance in the risk component of the Index was for the most part better than its performance in the quantitative section, two categories kept Greece from scoring even higher. First, Greece suffered from major exchange rate volatility in 1997, especially in the wake of the Asian currency crisis. Secondly, interest rate volatility was the fourth-highest among Index countries. These two variables appear to have a brighter future with the recent currency devaluation, which has stabilized the currency against the ECU and has allowed interest rates to fall sharply. Greece is one of the few Index countries to enjoy both low stock market volatility and relatively high market liquidity. Additionally, Greece has a relatively active IPO market among Index countries. Finally, the fall in interest rates could assist Greece in earning a significantly higher risk score. Qualitative Performance Greece scored well in the qualitative area, especially with a low capital-gainsrate and decent ratings for its banks from Moody's. As European Union moves forward, Greece appears ready to take the path of structural reform

needed to prosper in a more dynamic regional economy.

ARGENTINA Rank: 8 of 31 Score: 72.0 Economic Summary and Outlook Argentina appears to have been immune to the Asian crisis. Real GDP growth for 1997 could register in excess of 8 percent, stronger than the 4.3 percent registered in 1996. Export growth remains strong though import growth has recently been stronger, threatening an already swollen current-account deficit. The IMF would like to see the government slow the economyby tightening fiscal policy, but strong foreign investment flows have allowed Argentina to avoid this. A slowdown in financial inflows could threaten the economy. Quantitative Performance Argentina's quantitative score of 50.3 was hurt by the country's low equity-market capitalization. At the end of 1997, the Buenos Aires Stock Exchange had a market capitalization of $59.3 billion, or roughly 18.3 percent of total GDP. By the end of the first quarter, market capitalization had increased only by 1.7 percent-not a promising sign for this component of the Index. Access to capital as measured by the ratio of debt-market capitalization to GDP was similarly low; in fact, in both categories Argentina was the ninth-worst performer. However, low government spending buoyed its quantitative score, as did a low ratio of government debt to GDP. Both of these quantitative measures should grow stronger as the government strives to meet deficit limits imposed by the IMF. Risk Performance Argentina fared much better in the risk section of the Capital Access Index, earning a score of 75.0. Though a relatively dry IPO market persisted in Argentina throughout 1997, dragging the risk score down, low market volatility provided investors with a relatively less-risky home for their capital. Like some of the other Index countries, market volatility may be understated because of relatively illiquid market conditions. Strength in this component is attributable to Argentina's low short-term interest rate-the fourth-lowest in the Index. Furthermore, Argentina has the second most stable exchange rate. Qualitative Performance Argentina placed well in the qualitative performance measures, except for its relatively high capital gains tax rate. Argentina survived the Asian turmoil more or less unscathed as did its primary trading partner, Brazil;

hence Mercosur continues to progress toward becoming a real trading bloc. With continued growth amid low inflation, Argentina's evolution to a modern market economy is progressing well.

CHINA Rank: 8 of 31 Score: 72.0 Economic Summary and Outlook Since making the transition to a market-based economy, China has enjoyed one of the strongest economic growth rates in the world. Though real GDP growth has slowed from its double-digit rate, its 1997 growth rate of 8.8 percent is laudable in light of the crisis that swept Asia. What factors immunized China against the Asian epidemic? First, China's foreign exchange reserves were in excess of $139 billion, more than enough to finance a year's worth of imports. Additionally, capital controls prevent China's currency from being converted for capital account transactions. Furthermore, the foreign direct investment mix in China is weighted more toward long-term investment than it was in the economies devastated by the currency crisis. Quantitative Performance China's strong score of 77.5 in the quantitative portion of the index is explained by its government's spending patterns. The ratio of government spending to GDP is the seventh-lowest in our group of countries, while the ratio of government debt to GDP is the fifth-lowest. These categories could be hurt, however, by an expansionary budget announced last March by Finance Minister Liu Zhongli. China was also one of the top-performing countries in its ratio of debt-market capitalization to GDP. The Shanghai Stock Exchange has been strong in 1998, up 5.2 percent at the end of the first quarter from US$ 206.37 billion at the end of 1997. Continued strength in this aspect of the Index could help China's Index rank climb even higher. Risk Performance China scored its highest marks in the risk category of the Index. Despite the fact that China does not have a highly developed equity market, its market shows more liquidity than those of most other emerging-market countries. The positive impact of a highly liquid market is partially offset by a market volatility that ranks only in the middle of the pack. Low IPO activity also hurts China's score. Capital controls in China help keep currency volatility to a minimum; therefore, short-term interest rate volatility is lessened. Additionally, China's short-term interest rate is one of the lowest in our Index countries, thereby increasing capital access. China's Index score should be bolstered further by the reduction in interest rates that was announced in March.

Qualitative Performance Tied in our ranking with Argentina for eighth place, China is of primary importance in the present Asian crisis. Except for its relatively high capital gains tax, China placed well in our qualitative measures; but this could change substantially. Statements by the government encouraging banks to lend more to failing state-owned enterprises combined with reports that up to a third of trust companies are insolvent may send China into a banking crisis. More pressing, though, is the broader worry about the fate of the RMB. This concern has deepened with the Japanese government's decision not to intervene as the yen weakens.

PANAMA Rank: 10 of 31 Score: 71.4 Economic Summary and Outlook Economic growth in Panama is on the upswing after performing sluggishly from 1994 to 1996. Real GDP growth in 1997 was 4.4 percent, a strong increase from the 2.4 percent rate of growth experienced in 1996. The official government forecast for growth is in the 5 percent range for 1998, fueled by strong investment. Foreign direct investment should continue to be strong, and the government is moving forward with its privatization plans. Quantitative Performance Panama's score in the quantitative section of the Capital Access Index was significantly compassed by the seventh-worst ratio of government debt to GDP. This aside, government spending was about average, but planned spending on infrastructure in excess of $1 billion could deteriorate this quantitative measure in the next Index. Equity-market capitalization as a share of GDP was slightly below average, but recent market gains should bolster performance in this category. Panama's most impressive quantitativemeasure is its debt-market capitalization as a share of GDP, which is sixth among Index countries. Recent expansions in credit and domestic lending should further strengthen this component of quantitative performance. Risk Performance Panama's risk score of 64.1 is more impressive than its quantitative score (50.4), but is outshined by a stellar qualitative score of 89.1. Panama's top-performing variable in the risk component of the Index is interest rate volatility, which was the sixth-best among Index countries. Panama also enjoys one of the lowest short-term interest rates in Latin America. Stock market volatility is relatively low; but in terms of equity market liquidity,

only Bulgaria (the worst-performing Index country) has a more illiquid market. A further burden on Panama's risk performance is an inactive IPO market, which constrains entrepreneurs' access to capital. As investment in Panama's stock market continues to grow and more companies are privatized, the equity components of the risk category should increase. Qualitative Performance Panama's economy ranked well in our measure of qualitative performance. As Panama has for some years been an offshore finance center, its bank-strength rating was high. This score was only modestly diminished by a 22 percent capital gains tax rate.

MALAYSIA Rank: 11 of 31 Score: 70.8 Economic Summary and Outlook Malaysia's government believes the economy will shrink by 1 to 2 percent this year. Private forecasters see a contraction of 5 percent or greater. Malaysia's political leadership, starting with Prime Minister Mahathir Mohamad, remains in determined denial that its policies are to blame. To fight the recession, the government has announced two fiscal stimulus packages totaling 12 billion ringgit ($2.9 million) and such measures as creating an asset management company to take over non-performing bank loans. But since the government denies that there is anything fundamentallywrong with the system-with political loans and bailouts of corporations linked to UMNO and leading cronies-that is the extent of "reform" efforts. Meanwhile, an enormous pile of domestic debt (totaling more than 160 percent of GDP) and bad loans (reported to be 10.6 percent by the central bank but estimated by private analysts to be 25 percent by the year's end) are ticking time bombs. No measures to open the real estate sector to foreigners or deregulate foreign investment appear in the offing. Quantitative Performance Malaysia's strong quantitative score of 75.2 could have been much higher if not for its government spending score, which was the second-worst among Index countries. A correspondingly high ratio of government debt to GDP (the tenth-worst) was another drag on Malaysia's quantitative performance. Malaysia earned the highest Index marks for equity-market capitalization, 259 percent of GDP, despite the crash of the Kuala Lumpur Stock Exchange. Malaysia also earned the highest Index score for its ratio of debt-market capitalization to GDP, indicating a high level of access to capital for the entrepreneurs capable of fueling economic growth. Risk Performance

Malaysia also fared well in the risk category, scoring 65.8. Despite high stock market volatility, Malaysia offers securities investors one of the most liquid Asian markets as well as an active IPO market. Because of the region's currency crisis, Malaysia had one of the worst-performing exchange rate volatility rankings (the sixth-worst), but managed to keep short-term interest rates in check more than some of its peers. The corresponding interest rate volatility, though high, was better than average. However, with pressure remaining on the ringgit, these measures of volatility could be negatively affected. Qualitative Performance With banks that have shunned excessive foreign borrowing but nonetheless have overinvested in busted real estate endeavors and (at the government'sdirection) excess manufacturing capacity, Malaysia is on the verge of a crisis. Although it is unlikely to ask for an IMF bailout on the scale of Korea, Malaysia has made overtures to other multinational agencies for support. Hence, Malaysia's respectable bank rating will probably decline. The country's longer-term fate rests squarely upon the government's ability to balance the different ethnic interests that make up Malay society. This task may prove difficult if the economy is to be opened widely to foreign investment.

TURKEY Rank: 12 of 31 Score: 72.9 Economic Summary and Outlook Turkey has enjoyed strong economic growth since its brief recession in 1994. Real GNP growth should grow more moderately in 1998. Inflation is inthe triple digits. Quantitative Performance Turkey performed rather well in the quantitative section of the Index, earning a score of 70.2. Its ratio of government spending to GDP helped Turkey to achieve this score, but a planned increase in expenditures jeopardizes Turkey's eighth-best ranking for this variable. Its ratio of government debt to GDP helped to pull down its score, though a proposed deficit increase of about 300 percent threatens to weigh down this quantitative performance. Capitalization of the Istanbul Stock Exchange was a relatively strong 42.6 percent of GDP at the end of 1997. Recent strength in the market could alleviate some of the quantitative pressures placed on Turkey by its government spending patterns. Turkey's ratio of debt-market capitalization to GDP, at a weak 10.8 percent, has negative implications for access to capital.

Risk Performance Turkey's risk performance was impaired by the seventh-highest short-term interest rate among Index countries, although this negative impact was offset by relatively low interest rate volatility (the second-lowest in the Index). Also detrimental to Turkey's risk rating was the Istanbul Stock Exchange's high volatility. Despite this, the exchange offers investors relatively strong liquidity (sixth-best) and the second most active IPO market (as a share of total issues). Qualitative Performance With a reasonably well ranked banking sector offset by a 34 percent capital gains rate, Turkey placed within the upper-middle ranks of our qualitative performance measures. Improvement in these areas are possible, but the nation's political volatility may make certain policies difficult to implement. Turkey's rejection from membership to the European Union was also a lost opportunity for speeding the reforms necessary to improve access to capital.

PERU Rank: 13 of 31 Score: 69.2 Economic Summary and Outlook The recent El Niño hit Peru hard; damage estimates are in excess of $600 million. Reduced output in the agriculture sector coupled with a drop in export demand from Asia will cause a slowdown in 1998. The Peruvian government estimates GDP growth of 4 to 5 percent this year. Quantitative Performance Though Peru's quantitative score of 51.2 is not the highest among Index countries, it is poised for significant improvements over the next few quarters. A strong government surplus in 1997 and the potential for anothersurplus in 1998, despite heavy expenditures to offset the effects of El Niño, should significantly bolster the second-worst ratio of government debt to GDP in the Index. Furthermore, with the assistance of the IMF, Peru is taking steps to fund repairs in the wake of El Niño without raising government expenditures. This should help Peru lift the rank of its ratio of government spending to GDP from its current level of third-worst. An average ratio of debt-market capitalization to GDP is showing signs of weakening in 1998, but the Lima Stock Exchange's strong performance in the latter part of this year could compensate for this. Risk Performance

Peru's relatively strong risk score of 68.5 was undermined by a high short-term interest rate, which served as a barrier to capital access. Interest rate volatility was rather low, though, and partially offset the negative affects of the high interest rate. As is the case with several of the Index countries, volatility in the Peruvian stock market may be understated due to the relatively low market liquidity measure. A stable exchange rate further helped dampen negative pressures imparted on the risk score by the tight market liquidity and the high short-term interest rate. Qualitative Performance Peru scored reasonably well in our qualitative assessment of capital access. Persistent political strife is always at the forefront of Peru's economic challenges.

BRAZIL Rank: 14 of 31 Score: 66.5 Economic Summary and Outlook Brazil has been plagued with one of the worst income distributions in the world since the early 1960s. Since the implementation of the Real Plan in 1994-designed to tighten monetary policy, temporarily halt price inflation, and float its new currency, the real-Brazil has witnessed marked improvement in the poverty rate and a more equitable distribution of income. Brazil's Gini coefficient (a widely used measure of income disparity, with 1 being perfect income inequality and 0 being perfect income equality), has decreased from a high of about .6 to about .57 currently. Though this is a positive step, it is still a far cry from the .35 Gini of the United States or the more equitable distribution enjoyed by citizens of Japan, whose Gini is .27. The Real Plan has allowed Brazil to reduce the percentage of its citizens living below the poverty line by about 35 percent. The currency crisis of late 1997 substantially cooled growth in Brazil, temporarily offsetting the positive steps taken by the Real Plan. Though real GDP growth of 3.2 percent for the period exceeded the 1996 growth of 3.0 percent, contraction in the manufacturing sector inhibited a better performance. The Brazilian economy is not expected to perform as well as it has in the past few years, but 1999 could be a turnaround year in terms of real GDP as interest rates return to lower levels after the currency crisis. This should fuel growth in private-sector consumption. Quantitative Performance Brazil's current strength in the Index is primarily attributable to a strong showing in the quantitative section, where it scored consistently above

average. It was the best performer in the government spending category, exemplifying an economy that is not overly dependent on government expenditures. By the end of the first quarter of 1998, the market capitalization of the BOVESPA had increased by 6.4 percent from the end of 1997. There is potential trouble on the horizon for investors, though, as support for the current president has eroded, making the victory of his opponent-who does not support market-oriented reforms-more likely. Interest rates have continued their fall, but a high consumer-credit default rate does not bode well for the debt-market capitalization portion of the Index. The fiscal deficit recently reversed its downward trend, which may also diminish Brazil's Index standing. Risk Performance Brazil scored near the middle of the pack in the risk category, hurt in part by high interest rate volatility and one of the highest short-term interest rates. Its risk ranking could be strengthened by a reduction in exchange rate volatility as the effects of the 1997 currency crises are smoothed over. Though the BOVESPA provides investors with relatively strong liquidity, a rather unremarkable IPO market could continue to hurt Brazil's Index performance. Qualitative Performance Though Brazil placed in the middle of our ranking, the privatization of Telebras (the world's second largest, following Nippon Telephone) bodes very well for continued improvement. The rationalization of the financial sector driven by the acquisition of domestic banks by foreign banks should substantially improve conditions for accessing capital and improve the bank-strength rating. A major barrier to foreign direct investment, tax contingencies buried in the balance sheets, needs to be sorted out. Though debt issuance by Brazilian companies continues, the IPO market is dormant. M&A activity looks set to continue as foreigners remain eager to enter South America's largest economy while Asia muddles through a repression.

MOROCCO Rank: 15 of 31 Score: 65.5 Economic Summary and Outlook Morocco's economic growth has been volatile over the past few years; that volatility could persist. The EIU estimates that real GDP shrank by 2.2 percent in 1997, while the government forecasts 1998 GDP growth of 8 to 11 percent. Foreign direct investment continues to be strong. Quantitative Performance

Morocco scored relatively well in the quantitative section of the Index, led by growth in the Casablanca Stock Exchange that gave the country a ratio of market capitalization to GDP of 37.4 percent. This quantitative measure should increase in the next Index, as Morocco's market capitalization more than doubled during the first quarter of 1998 to a record of $914 million. Morocco earned an average score for its debt-market capitalization ratio anda slightly below-average score for its government spending ratio. The government is taking steps to tighten fiscal policy, which should bolster the latter quantitative measure, though it is still expected to run a deficit in the short-term. This will not help the government debt variable, however, which is already the fifth-worst among Index countries. Risk Performance Morocco's risk score was marginally better than its quantitative score (67.4 versus 60.5). Its strength in this category is attributable in part to a relatively active IPO market. The Casablanca Stock Exchange offers investors liquidity that is well below average (the fourth-worst) and stock market volatility is much higher than desirable, though a market whose valuations are soaring tempers this high volatility risk. Bourse authorities are taking steps to increase liquidity by attempting to persuade more companies to join the market. If these efforts are successful, we expect to see further increases in market capitalization and liquidity. Moroccans enjoyed the third-lowest interest rate among Index countries and the lowest level of interest rate volatility, resulting in strong variable scores for both of these measures. Qualitative Performance Morocco's middle score is surprisingly good considering this nation only recently joined the list of "investable" countries. Continuing reforms in the equity markets and banking system offer the nation a reasonable prospect of improving its place in the rankings of emerging markets. Morocco received its first international credit ratings of just below investment grade from both Moody's and Standard & Poor's.

INDIA Rank: 16 of 31 Score: 64.3 Economic Summary and Outlook Despite the fact that India's Gini coefficient is in the .31 range (with 1 being perfect income inequality and 0 being perfect income equality), the World Bank estimates that more than 300 million, or about one-third of the country's population, live below the poverty line. India is also plagued by social inequalities. More than half of India's children are malnourished, disease is rampant (particularly in the rural areas), and as many as 3 million

people may be infected with the life-threatening HIV. From 1993 to 1996, India enjoyed real economic growth of just under an average of 7 percent per annum. In 1997, following the regional trend, this growth rate is expected to have fallen to the 4 percent range. The government estimates growth in the 5 percent range for 1998. Since the monsoon rains, essential for the region's crop growth, could be disrupted by the La Niña effect, this number cannot be depended on. Quantitative Performance India's performance in the quantitative measures of the Index was fairly average across the board. Government spending and government debt were eleventh-worst and seventh-worst, respectively. The fiscal deficit is expected to increase this year, which bodes badly for India's quantitative performance. India needs to increase its debt-market capitalization and thereby place more capital in the hands of its entrepreneurs. India's market capitalization ratio was the ninth-best in our Index and increased by 11.7 percent by the end of the first quarter of 1998. Risk Performance India performed better than most of its peers in the risk category of the Index, scoring 71.2. Its strength in this category was due largely to low stock volatility, though investors would be better served by greater market liquidity. In terms of IPO activity, India outperformed most countries included in the Index. High exchange rate volatility and therefore greater interest rate volatility risk were also drags on India's score in the risk category. Qualitative Performance India's position at the middle of our Index belies the nation's balanced positive and negative attributes. On the positive side, India has an active equity market and a long history of investment. On the negative side, however, India's ailing banks and meddling rules governing foreign investment are burdensome.

CZECH REPUBLIC Rank: 17 of 31 Score: 64.0 Economic Summary and Outlook It is expected that the Czech Republic's economy will recover slowly as the effects of fiscal and monetary constraints set in. GDP growth for 1998 should recover after a three-year decline. Foreign direct investment declinedfor two years in a row but may improve in the coming year.

Quantitative Performance The Czech Republic's score in the quantitative area of the Index was weighed down by the fourth-worst government spending ratio. An increase of just over 5 percent in approved spending in 1998 should worsen the performance of this variable. Government debt was relatively average, though the plan for a balanced budget this year could alleviate the problem and further growth in this measure. The Czech Republic offers a good measure of access to capital to entrepreneurs as indicated by the seventh-highest measure of debt-market capitalization. Strong equity market performance in 1998 helped improve that variable. As the Czech economy stabilizes and privatization moves forward, equity-market capitalization should continue to mushroom. Risk Performance The Czech Republic earned a relatively strong score of 66.8 in the risk category of the Index. High equity-market liquidity reinforced its score, though relatively high market volatility partially offset the performance of the liquidity variable. IPO activity has not been very robust; but as the economy stabilizes and privatization continues, IPO activity could increase along with total market capitalization. The risk performance score of the Czech Republic was diminished by a highly volatile exchange rate (though the currency became more stable after its devaluation in May 1997) and unstable short-term lending rates. Qualitative Performance Burdened by weak banks but relieved by a low capital gains tax, the Czech Republic fell into our lower-middle ranking.

PHILIPPINES Rank: 18 of 31 Score: 62.2 Economic Summary and Outlook Since 1994, real GDP growth has held steady in the 4 to 5 percent range, but this is unlikely to continue as the Asian crisis cools the economy down. The consensus outlook is for growth to drop to 2 percent this year before returning to 3 percent or better next year. Though a narrow surplus was achieved in last year's budget, this year's target is unlikely to be met. Quantitative Performance The Philippines scored relatively average across the board in the quantitative portion of the Index. Debt-market capitalization was in the middle of the pack, though a tightening of the credit markets could threaten

the stability of this variable. The government spending component of the quantitative category was slightly below average, and a planned increase in excess of 10 percent in government expenditures does not bode well. Strength was provided by the equity capitalization variable, which earned the Philippines an eighth-best rating. The Philippines Stock Exchange has shown further strength in 1998: Market capitalization was up more than 25 percent, to $39.9 billion. Risk Performance For the most part, the Philippines performed slightly below average in the risk category, and its score of 56.0 captures this mediocre performance. ThePhilippines was hurt by a high short-term interest rate, though the central bank is working toward bringing interest rates down in 1998. Also weighing down the Philippines' risk score was the third most inactive IPO market among Index countries. Despite a dry IPO market, the Philippines offers investors an exchange that is less volatile than other Index countries, while market liquidity is about average (that is, not very liquid). The worst-performing risk variable was currency volatility, though the peso appears to be stabilizing in 1998. Qualitative Performance The Philippines fared relatively well during the Asian crisis in spite of a weak banking sector. Though reforms have stopped and started, progress is under way.

HUNGARY Rank: 19 of 31 Score: 60.6 Economic Summary and Outlook After a disappointing downturn in 1995 and 1996 with growth registering in the low-to-middle 1 percent range, growth rose to 4.4 percent last year (thehighest in 20 years) and may exceed 5 percent this year. Assuming exports hold up, the prospects for Hungary to continue on its positive trend are reasonable. Quantitative Performance Hungary was one of the worst performers in the quantitative section of the Index, hurt by government spending patterns; it received the fifth-lowest score in the government expenditure category. Another drag on its score was government debt. Neither measure shows any short-term strength, as the government is increasing spending in 1998 and is expected to run a substantially large deficit. Access to capital was further impaired by low debt-market capitalization, though this variable could improve in 1998.

Hungary's best-performing quantitative variable was its ratio of equity-market capitalization to GDP, and even here Hungary was only slightly above the median. A surge of just over 10 percent in equity-market capitalization during the first quarter of 1998 could have a positive impact on quantitative performance in the next Index provided the exchange does not give back its gains. Risk Performance Whereas Hungary performed poorly in the quantitative category, the country fared surprisingly well in the risk category, earning a score of 73.9. Though the short-term interest rate was not the best, the associated interest rate stability was the third-strongest among Index countries. Additionally, the Budapest Stock Exchange offered investors higher-than-average liquidity, though volatility was near the median. This volatility has increased over the past couple of months, as uncertainty about the upcoming elections has caused severe market fluctuations. IPO market activity in Hungary is also near the median, but a protectionist attitude threatens continued privatization. Currency volatility could improve during 1998, as the crawling peg system will be continued. Qualitative Performance With low quantitative and medium risk scores, Hungary also scored in the lower-middle range of qualitative measures. This rating was driven by capital gains taxes, capital controls, and an average banking sector. A volatile political environment lowers the probability that useful policies will be implemented.

ECUADOR Rank: 20 of 31 Score: 59.7 Economic Summary and Outlook Ecuador's economy has been in the doldrums for the past few years. Real GDP growth has averaged 2.6 percent since 1995. The current view is that growth will slow in 1998. How the government evolves following the elections will probably determine the fate of the economy. Quantitative Performance The performance of Ecuador's quantitative variables varied greatly. The ratio of government spending to GDP was the second-best among Index countries, while the ratio of government debt to GDP was the sixth-worst. The fiscal deficit is expected to swell this year as the costs of repairing the damages wrought by El Niño increase. The debt-market capitalization was low enough to earn the country below-average marks, though strong credit

market growth should bolster this variable in coming months. Finally, an equity-market capitalization rank of sixth-worst leaves much to be desired. Risk Performance Ecuador performed as poorly in the risk category of the Index as it did in thequantitative section. A majority of the deficiencies in this measure are attributable to a poorly developed equity market. Not only is its market capitalization as a share of GDP low, but its liquidity is one of the worst among Index countries and its market volatility is among the highest. The IPO market shows signs of life, however. As the market continues to develop, we expect to see a reduction in volatility and an increase in liquidity. The short-term interest rate in Ecuador was the sixth-best, though high interest rate volatility increases investment risk. High exchange rate volatility further weakened Ecuador's risk score, though recent stabilization in the exchange rate should benefit this measure in future Indexes. Qualitative Performance Ecuador continued to score at the same level in qualitative measures as in the other categories for the same reasons alluded to above.

MEXICO Rank: 21 of 31 Score: 56.0 Economic Summary and Outlook With the best-performing stock market in the world in dollar terms in 1997, Mexico has been a great success story for investors and the IMF. With Asian countries impacted by the crisis exporting aggressively to earn hard money, Mexico's economy should come under pressure from reduced exports. Quantitative Performance Mexico's score in the quantitative section of the Index was hurt by a low ratio of equity-market capitalization to GDP. Strength in the equity markets and slower GDP growth in 1998 will significantly improve this measure in the next version of the Index. A further drag on Mexico's quantitative performance was the lowest debt-market capitalization score in the Index. Quantitative strength was provided by a low government spending ratio (fifth-lowest) and an even better government debt ratio (fourth-lowest). Both of these measures should show further strength, as the government has slashed projected expenditures and has limited the federal deficit to 1.25 percent of GDP. Risk Performance

Mexico's performance in the risk categories of the index was worse than it was in the quantitative categories, largely because of interest rate problems. During 1997, Mexico experienced the ninth-highest short-term interest rate among Index countries, while the related interest rate volatility measure was the sixth-highest. Fluctuations in the exchange rate, which occurred as the Asian crisis's ripples moved outward, caused Mexico's currency volatility to be the tenth-worst. Equity-market volatility and liquidity were near the median, though these measures should improve during 1998 as instability from the Asian crisis calms. On a more positive note, Mexico offered investors one of the most robust IPO markets, giving companies the access to capital required to fuel growth. Qualitative Performance After having staged a remarkably swift recovery following the first major IMF bailout three years ago, Mexico's financial infrastructure remains in poorcondition. The nation's banks are in weak shape and corruption remains a major dilemma at all levels of politics and business. Any weakening of the U.S. economy is likely to have a serious negative impact on Mexico's financial position and would retard the economic reform process.

THAILAND Rank: 21 of 31 Score: 56.0 Economic Summary and Outlook Thailand was the first Asian economy to "hit the wall," in July 1997, and made rapid initial progress after a new government was installed last November. But reform momentum has since slowed. Most ailing finance companies were shut down; four mid-size banks were taken over by the government to be reprivatized this year; foreigners were given the right to own financial institutions outright; and a comprehensive new bankruptcy law was passed in March. Capital markets are open, and a new law allows trading of derivatives. The hard part-setting up a workable bankruptcy system-is yet to come. It takes five to seven years to foreclose on tangible assets, and political opposition to shortening that period is strong. Accordingto a Thai undertaking with the IMF, efficient foreclosure-on-collateral laws are to be enacted in October; but implementation of such a measure is not to be depended on. Quantitative Performance Thailand score of 82.9 earned it fifth place in the quantitative section of the Index. Thailand's strong debt-market capitalization ratio earned it third place in this category, though a liquidity squeeze threatens to hamper further debt-market growth. A low government debt measure further bolstered Thailand's quantitative score, though the government spending

ratio did not perform as well. The worst-performing quantitative variable was the ratio of equity-market capitalization to GDP. Since recovering in the beginning of 1998 after a crash at the end of 1997, the market has given back its gains as fears about corporate debt overhang swell. Risk Performance With a score of 40.8, Thailand was one of the risk category underachievers, offsetting a strong quantitative performance. Though Thailand had the third most active IPO market, liquidity was quite low, and volatility was significantly higher than the median. These results stem from foreign investors' fears about instability in the region and increasing non-performingloan ratios. A tumultuous foreign-exchange rate (the fifth most volatile among Index countries) did not help Thailand's risk rating, while a very unstable, high short-term interest rate in the wake of the currency crisis exerted further downward pressure. Qualitative Performance Widely regarded as one of the hopefuls for an early return to economic health among the Asian crisis economies, Thailand is making progress in spite of its low rating in qualitative performance measures. Elections in November 1997 brought to power a reformist government that immediately set out to implement new policies. The market has signaled its approval of these measures by strengthening the currency since the beginning of the year.

SLOVAK REPUBLIC Rank: 23 of 31 Score: 50.8 Economic Summary and Outlook Since 1995, economic growth has held steady between 6.5 percent and 6.9 percent. Many expect the economy to weaken this year and worry about a koruna depreciation. Elections this September will determine to a large extent the future of the Slovak economy. Quantitative Performance The Slovak Republic did not exhibit great strength in the quantitative section of the Index, with a score of 45.0. The ratio of government spending to GDP was the seventh-highest of Index countries, characteristic of an economy whose government, rather than its consumers, makes a significant share of the production and consumption decisions. A further indicator of reduced capital access is low equity-market capitalization. Here, Slovakia was the third-worst performing country. Recent stock market weakness threatens to do more damage to Slovakia's rankings in the future.

Government debt as a share of GDP was better than average, and if the government meets its budget in 1998 this measure will improve. Access to capital, as measured by its ratio of debt-market capitalization to GDP, was relatively low, and recent tightening in the credit market due to poor repayment records and high interest rates threatens to erode this measure further. Risk Performance In the risk category, Slovakia performed marginally better than it did in the quantitative category, earning a score of 54.9. Strength was provided by theBratislava Stock Exchange, which offered investors a good degree of market liquidity and a somewhat active IPO market. Investing in Slovakia was not for the weak of heart, though, as market volatility was the highest among Index countries. Weakness in the risk category came from a relatively high short-term interest rate, whose volatility was the third-highest. A higher risk-category score could result from recent stabilization in the koruna's exchange rate, which might further boost Slovakia's current ninth-best currency volatility rank. Qualitative Performance The Slovak Republic scored poorly in the qualitative performance measure, principally due to weak banks. With an extremely volatile and small stock market and high rates, the Slovak Republic is in a poor position to foster better conditions for capital access.

NIGERIA Rank: 24 of 31 Score: 49.8 Economic Summary and Outlook Though economic growth improved last year, this trend is unlikely to continue given the liquidity squeeze that is under way. With presidential elections in August and the impending return to a constitutional government in October, the unstable policy environment is likely to inhibit growth until the new government clearly defines its policy program. Quantitative Performance A score of 48.1 placed Nigeria near the bottom in the quantitative portion of the Index. With the exception of government spending, where Nigeria had the fourth-best score, the country's quantitative marks were horrible. Government debt as a portion of GDP was the fourth-worst, though tight fiscal policy could help to improve this capital access measure. The debt-market capitalization measure was the fifth-worst, as was the equity-marketcapitalization score. The downward spiral of the Nigerian Stock Exchange in

1997 has continued into 1998, and this variable shows no signs of improvement in the short term. Risk Performance Nigeria fared worse in the risk category than it did in the quantitative category, earning a score of 40.2. The Nigerian Stock Market is partially to blame for this low score, as it offered investors the third-lowest liquidity level and the fourth-highest volatility. Preliminary results for 1998 indicate that these variables will again perform poorly in the next release of the Index. Further capital access weakness was exhibited by a relatively lofty short-term interest rate that exhibited high volatility. Compounding the weakness in the risk category was exchange rate volatility, the eleventh-worst among Index countries, though the naira recently has shown strength against the dollar. Qualitative Performance With a bank rating that is only higher than those of Russia and Bulgaria, Nigeria's qualitative performance is near the bottom of the scale. Clearly, Nigeria must bolster its banks before its stock exchange can function at a higher level.

VENEZUELA Rank: 25 of 31 Score: 45.2 Economic Summary and Outlook Venezuela's economy rebounded nicely from a contraction in 1996, registering a real GDP growth rate of 5.1 percent. Growth should be more moderate in 1998, however, pressured by a fall in the price of oil. Foreign exchange holdings are down as investors who fear devaluation are selling bolivar. The IMF will be monitoring the economy as part of a shadow agreement reached with Venezuela. Quantitative Performance Venezuela did not perform well in the quantitative section of the Index with the exception of the government spending variable, which was ninth-best. This variable could perform even better in the next Index because of the recent spending cuts the government has had to make in response to lower-than-expected oil revenues. Government debt as a share of GDP was at the median. Venezuela's debt-market capitalization is the third-worst among Index countries, while its equity-market capitalization is eighth-worst. The Venezuelan exchange is stagnating, which could hurt this variable's performance in the next version of the Index.

Risk Performance Venezuela fared even worse in the risk category than it did in the quantitative category. Currency volatility was the third-highest, and devaluation looms in the face of capital flight and fiscal account deficits. Equity market liquidity is below average, as is market volatility. Furthermore, the IPO market is relatively inactive. The short-term interest rates were high and have soared recently, which threatens to lower Venezuela's score in the interest rate volatility measure. Qualitative Performance An oil-rich nation with a historically volatile government structure, Venezuela ranks toward the lower end of our scale, primarily due to its banking system. Until incentives exist for institutional reform, it is unlikely that Venezuela will change and we will see the same problems continue.

POLAND Rank: 26 of 31 Score: 44.3 Economic Summary and Outlook The Polish economy continued to expand last year, growing by 6.9 percent. Recent reductions in the current account deficit have allayed fears of an overheating economy and looming currency depreciation. Inflation remains high, though tight monetary policy should help to ease the situation. A reduction in interest rates is possible as inflation continues to cool. Quantitative Performance Poland earned the second-lowest score in the quantitative section, ahead of only Bulgaria. Helping to lower its score was equity-market capitalization, which was the second-lowest among countries. This is beginning to improve,though: During the first quarter of 1998, Poland's equity-market capitalization has soared by 27.5 percent, to $16.6 billion. Also faring poorly was debt-market capitalization, which was among the lowest. Poland's ratio of government spending to GDP was higher than in a majority of Index countries, while government debt was a median performer. The government's drive to eliminate the fiscal deficit could improve these measures in the future. Risk Performance While Poland earned low marks in the quantitative portion of the Index, its performance in the qualitative section was relatively strong. Poland offered investors the eighth-highest equity market liquidity, and market volatility was lower than it was in most of the other Index countries. One drawback of

Poland's equity market is a rather inactive IPO market, indicating potential for better access to capital. Another weakness in the risk section was the short-term interest rate, which was the sixth-highest among Index countries. Despite this, Poland has one of the lowest interest rate volatilities. Exchange rate volatility in Poland was at the median. Qualitative Performance The combination of weak banks, capital controls, and a poor institutional structure leaves Poland in a weak position.

EGYPT Rank: 27 of 31 Score: 43.1 Economic Summary and Outlook Egypt has enjoyed relatively stable, though not spectacular, economic growth in the 1990s. Real GDP has grown at an average annual rate of morethan 4 percent. The government expects real GDP to grow by 6.2 percent in 1998 while maintaining a budget deficit of no more than 1 percent of GDP. Inflation has been drastically reduced, though savings rates remain low. Quantitative Performance Egypt earned 56.6 points in the quantitative section. Its scores were, for themost part, average across the board. The one variable that stood out was government spending, in which Egypt's score was the sixth-best. Government debt as a share of GDP in Egypt was higher than in most Index countries, and equity-market capitalization was 27.7 percent of GDP-just below the median. Debt-market capitalization as a share of GDP was at the median. Risk Performance Egypt's performance in the risk category was also mediocre across the board. Both market liquidity and stock volatility were underachievers, while IPO activity was the fifth-lowest among Index countries. The short-term interest rate was near the median, while interest rate volatility was slightly better than the norm. Qualitative Performance For a country with a low capital access rating, Egypt's banks are in fair shape. However, it is the mix of capital controls and foreign ownership restrictions that keep Egypt at the bottom of the rankings.

INDONESIA Rank: 28 of 31 Score: 37.8 Economic Summary and Outlook The Asian crisis seems to have had the worst impact on Indonesia. From thecrash of the rupiah and its economy as a whole to the civil unrest and deaths of six students after fuel price hikes, the future of Indonesia, though uncertain, is definitely bleak. The budget deficit is ballooning, the currency has fallen more than 80 percent in the past year, and the economy shrank by 16.5 percent in the second quarter of this year. No foreign capital is flowing in. Indonesia is expecting another $6 billion in assistance from the IMF, but more international aid by itself will not restore confidence in the country. President B.J. Habibie has now been in power since May, longer than many expected, but there is considerable uncertainty as to how long he can remain in power or whether he will be able to push through much-needed economic reforms. Quantitative Performance Given Indonesia's performance over the past year, it is no surprise that the country's capital access marks were low across the board. Not enough capital is getting into the hands of those who might be able to turn the economy around. The rate of privatization needs to increase. Government debt as a percentage of GDP needs to shrink. The recent pounding of the Jakarta Stock Exchange will negatively impact Indonesia's future performance in the Index. Risk Performance If the quantitative performance of Indonesia is bleak, the risk rating of Indonesia is miserable and the outlook is even worse. The high exchange rate volatility gave it the second-lowest risk rating among countries in the Index. Given the recent performance of the rupiah, which bounced off an all-time low of 17,000 rupiah to the U.S. dollar in May, Indonesia could well have the worst currency risk rating in the next Index. The short-term interest rate has shown similar volatility, spiking to more than 25 percent in the wake of the crisis. The Jakarta Stock Exchange has not been immune to the extraordinary volatility. Within a month and a half, the index fell more than 20 percent in response to fears of a rise in interest rates to support the rupiah. Qualitative Performance Indonesia's substantial decline is by far the worst emerging-markets disaster in recent memory. Indonesian banks are in shambles and nearly all means of capital access are in trauma. With the same regime that created the problem still running the country despite the change in official

leadership, it is unlikely that meaningful policy changes needed to reverse the current depression will ensue.

KOREA Rank: 29 of 31 Score: 20.6 Economic Summary and Outlook Driven by massive trade surpluses, the Korean won has gained against the U.S. dollar recently. International reserves reached $42 billion in July. But Korea is still deep in the woods. The trade surpluses are entirely due to collapsing imports; exports were down 5.6 percent in June. The economy is contracting at an annual rate of 4 to 5 percent. Inflation is averaging 8 to 10percent and unemployment will rise to at least 8 percent by October. Political stalemate persists. President Kim Dae-jung has been unable to convince the families who control Korea's chaebol to support his reform program. Trade union leaders are opposed to bank and business closures. But crises often force governments to take radical action; this may finally bestarting to happen in Korea. Following President Kim's U.S. visit in June, important reforms have been implemented. Restrictions on foreign investment are loosening. With the price of land 20 to 40 percent lower thanin 1997 and numerous medium-size companies for sale cheaply, there are now attractive opportunities for foreign investors-but they will need full pockets and ample patience. Talk of transparency aside, it is very difficult to determine realistic valuations of Korean assets. Portfolio investors should be particularly careful until Korea's banking mess has been adequately addressed. They should wait at least until the fourth quarter begins before getting back into the Korean stock market. Quantitative Performance Korea's quantitative performance places it near the bottom of the Index. Government debt was the highest in the Index, and given that the budget is expected to run at a deficit again this year, it would not be surprising to see Korea retain this dubious distinction. Korea's equity-market capitalization is the seventh-worst and shows no signs of improvement, as the country's market capitalization fell by 11 percent between January and April. AlthoughKorea's debt-market capitalization has remained strong, the expectation of continued high interest rates threatens individuals' access to capital. Risk Performance While performing poorly in the quantitative section of the Index, Korea faredeven worse in the risk area, earning a score of 39.1. As expected of countries facing a currency crisis, currency volatility was extremely high, which fostered higher interest rateñrelated risk. Additionally, the aforementioned high interest rate gives Korea a less than desirable interest

rate ranking. Though stock market volatility continues to hurt Korea's risk measure, relatively high equity-market liquidity lends some support. Additionally, an active IPO market keeps Korea from scoring even lower in this component of the Index. Qualitative Performance Korea is in the midst of a terrible banking crisis, second only to Indonesia. As the biggest client of the IMF under a $60 billion bailout program, Korea isin bad shape, and this is reflected in our qualitative performance measures. However, with the won up substantially since the start of the year, complete liberalization to foreign investment in both equity and fixed income, and privatization of state-owned companies, Korea has made more progress than any other crisis country to restructure its troubled economy. The next challenge is labor reform and is probably going to be difficult to resolve.

RUSSIA Rank: 30 of 31 Score: 18.2 Economic Summary and Outlook Russia's economy is stuck in a quagmire of error and accident. Real GDP grew by a mere 0.4 percent in 1997, the first time growth has been positive in years. Pressure on the ruble, stemming in part from the Asian crisis, has led to spikes in the interest rate, though a tight monetary policy has helped reduce inflation. Foreign direct investment in Russia is negligible. Quantitative Performance Russia's performance in the quantitative section of was the third-worst, ahead of Poland and Bulgaria. Government spending and government debt as shares of GDP were both about average. While spending cuts have been announced, the government will still run a deficit in 1998. Debt-market capitalization was the fourth-worst among Index countries, while the equity-market capitalization measure was below average. Risk Performance While Russia's quantitative score was the third-worst in the Index, its risk performance was the second-worst. The Russian Stock Exchange was the seventh most illiquid among Index countries and volatility was the eighth-worst. Russia also has the second-driest market in terms IPO activity, only ahead of Bulgaria. Russian short-term interest rates were the second-highest, and interest rate volatility was the highest. Russia's strongest showing in the risk category was its relatively stable currency, which earned the sixth-best volatility rank.

Qualitative Performance Russian banks are at the bottom of our measures, indicating that the problem of accessing capital is extraordinary in Russia. Contract law, property rights, and other essential ingredients of a market system are not to be found here. Until these basics are put into place, the foundations for a functioning capital market and banking system will remain absent. This will leave Russia near the bottom of rankings such as ours for the next several years.

BULGARIA Rank: 31 of 31 Score: 9.8 Economic Summary and Outlook It may not have been fair to include Bulgaria in this list of so-called emerging-market countries, as its economy is more aptly described as a "frontier" or "not-quite-emerging" economy. Real GDP contracted in both 1996 and 1997 and is not expected to encounter strong growth until 1999. Foreign direct investment is growing, and as access to capital is improved, Bulgaria should improve its rank in the Index. Quantitative Performance Not only was Bulgaria the worst overall performer in the Index, it was also the worst performer in each of the three Index sections. Government spending as a share of GDP was the only category in the quantitative section in which Bulgaria performed better than average. Government debt as a share of GDP fared much worse, ranking as the third-worst. Bulgaria's equity-market capitalization was the lowest in the Index; debt-market capitalization was the second-worst performer among Index countries. Risk Performance Bulgaria had the worst ranking in four of the seven risk categories: IPO activity, equity-market liquidity, short-term interest rates, and currency volatility. Interest rate volatility was the second-worst among Index countries. Bulgaria scored above average in the stock market volatility measure, but this is most likely more of a tribute to low liquidity than to low volatility. Qualitative Performance As with Russia, Bulgaria lacks the basic ingredients for a capital market and banking system. The country is expected to remain at or near the bottom of the Index unless or until this situation changes.