Internationalization problems in Moodle:
1) XML import and export uses standard PHP functions utf8_decode and utf8_encode that are suitable ONLY for iso-8859-1; other encodings are not converted correctly
2) character encoding is specified in lang/xx/moodle.php - it is used only in hmtl headers of generated pages = encoding of generated pages depends on user selected language. For example I can not display Czech language course content after setting English for interface language.
1) instead of utf8_decode and utf8_encode use mb_convert_encoding($content, "UTF-8", "iso-8859-2") (again Czech example, use your own encoding such as iso-8859-1) and opposite - it needs "extension=php_mbstring.dll" in php.ini
2) make encoding independent of the selected interface language, add site content encoding to the main configuration page and use it in mb_convert_encoding() and all page headers
1) Server admins would have to enable new extension php_mbstring.dll (and similar in *nix), it should not be generally problem during transition to 1.3. There could be some ifs specially for iso-8859-1 sites that could use old conversion without mbstring extension..
2) Now you can switch to any language and the Moodle menu is displayed correctly, BUT the content with non-ASCII encoding is usually crippled. After this change course content would be always correct, but some foreign interface languages could be messed up. This should not cause much trouble I think, bacause most sites use the same encoding for content and interface.