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1. Very significant progress has been made in implementing the economic program since the second program review. The last three months have witnessed an important turnaround in market confidence. The exchange rate has appreciated by about 35 percent since early this year, and has stabilized since mid-March, allowing a steady lowering of short-term interest rates. The Bank of Thailand (BOT), taking advantage of improved market conditions, has been able to rebuild its foreign exchange reserves. Thailand’s first sovereign bond issue since the onset of the crisis is planned in the coming months.
2. These favorable developments have followed from the government’s strict adherence to the economic program. All quantitative and structural performance criteria for March 31, 1998 related to macroeconomic policies and financial restructuring have been observed.
3. We draw special attention to the progress being made in financial restructuring. We have announced the phased implementation of tighter loan classification and provisioning rules, which will be gradually brought up to full observance of international best practice over the next two years. Banks have made considerable progress in recapitalization: two large banks have just completed major international share issues, and another two have developed strategic partnerships with foreign banks. Tighter loan classification and provisioning standards are contributing to increased confidence and investor interest in bank recapitalization. To facilitate financial restructuring, five emergency decrees have been approved by the Cabinet, four of which have been ratified by an extraordinary session of Parliament on May 25, 1998, and the remaining one shall be considered shortly during the same extraordinary session.
4. Nevertheless, while important progress has been made in the financial sector, conditions in the real economy are still deteriorating as the economic decline during the first half of 1998 is proving to be deeper than previously anticipated. Both domestic and external factors have contributed to the revised economic outlook, some of them directly associated with prolonged contagion from developments in the region. Domestically, there has been more pronounced weakness in private consumption and investment demand, and continued liquidity shortages.
5. Against the background of considerable progress in stabilization, the immediate priority under the program is to minimize any further decline of the economy and bring about early recovery, while sustaining the stabilization gains. Thus, the focus of policies will shift to adapting macroeconomic settings, strengthening structural policies, and ensuring the adequacy of the social safety net.
6. An updated economic policy memorandum of this government is presented in the attachment. We draw attention to six key areas where strengthened understandings have been developed in order to alleviate liquidity shortages in the economy, accelerate restructuring, protect the disadvantaged, and prepare the ground for an early recovery:
8. The immediate period ahead will continue to be very difficult in Thailand, but the country is becoming much better placed to overcome the remaining challenges and to prepare for a sustainable recovery. Were new pressures to arise, the government stands ready to take whatever additional measures are necessary to ensure the success of the program, and will consult with the Fund, as indicated earlier.
Mr. Michel Camdessus
OF THE ROYAL THAI GOVERNMENT
May 26, 1998
I. Macroeconomic Framework and Policies for 1998
2. The weaker economy during the first-half of 1998 lies behind the revision in the economic outlook for the year as a whole, a decline in real GDP of about 4–5½ percent. A number of external and domestic factors are contributing to this outlook. The continued unsettled conditions in the region are a key factor, reducing export demand below previous projections, and delaying the recovery in private capital flows. Domestically, consumption and investment demand have both been weaker than previously expected. The modified policy framework adopted at this review (Table 1), aims at accelerating structural reforms and offsetting some of the weakness in private demand, and should help the economy bottom out by about midyear, and begin to recover during the latter part of 1998. Inflation is now expected to peak at just over 12 percent, during the second quarter of 1998, and should be contained at 10.5 percent for the year as a whole, restrained by the weaknesses in the real economy. The BOT’s foreign exchange reserves have remained well above the program floor, reflecting a larger current account surplus and a slightly smaller deficit in the capital account. These inflows, together with other initiatives summarized below, will contribute to easing progressively liquidity shortages in the economy.
Monetary and Exchange Rate Policy
3. Stabilization of the exchange rate will remain the primary objective of monetary policy, but there is now room to adapt the monetary program to better assure the liquidity needs of the private sector. However, against the background of a significant strengthening of the currency since January, the recent stability of the baht within a more realistic range, and the substantial restoration of the BOT’s reserves, there is room for further cautious reductions in the overnight repurchase rate. Correspondingly, the monetary program for 1998 is being adapted to take account of improved market confidence and a stronger outlook for money demand, and M2A growth in 1998 is now projected at 9 percent. The December 1998 target for reserve money growth will be kept closely under review, within a target range of about 6½–8 percent, and we will use the increased room provided exchange rate stability is maintained. However, if there is increased pressure on the exchange rate, we will raise interest rates and tighten the monetary program as necessary. Annex A contains the revised NDA performance criteria through September 1998 and the new indicative targets for reserve money.
4. The monetary program allows the proceeds of the anticipated sovereign bond issue to be used to strengthen the four specialized banks. For this purpose, the policy framework of the specialized banks will be reviewed and strengthened ahead of their recapitalization (paragraph 15 below). On this basis, we expect that the specialized banks will be able to expand their lending operations at market rates, especially to the export sector, building on the recently negotiated trade finance facilities with the Export Import Bank of Japan ($600 million) and the AsDB ($1 billion).
5. Although recent revenue and expenditure developments have been well within established program targets, the deeper-than-anticipated recession makes it likely that there will be further revenue shortfalls later in the fiscal year, especially in corporate income taxes as well as with respect to the earnings of state enterprises. In addition, we have concluded that existing arrangements for social safety net spending need to be strengthened more rapidly than previously anticipated to provide greater relief to displaced workers. Therefore, we propose to revise the target for the 1997/98 overall public sector balance from minus 2 percent of GDP to minus 3 percent of GDP (defined under the program on a GFS basis and excluding the costs of financial restructuring. See Annex B). This will also help offset the greater deflationary impulse from contracting private consumption and investment. Within this total the central government deficit will rise from 1.6 percent of GDP to 2.4 percent of GDP. Roughly one-half of this revision will reflect higher social safety net spending, while the remainder will comprise the effect of lower revenues as we allow automatic stabilizers to take effect.
6. Regarding the state enterprise sector, we expect that the small deficit will rise somewhat, from 0.4 percent to 0.6 percent of GDP, during 1997/98, reflecting lower earnings. Adjustments have been made to prices for goods and services provided by state enterprises, including for electricity, air-conditioned buses and trains, and for water use. However, bus and rail fares for the poorest members of society have been maintained as part of our social safety net, and we will ensure that emerging arrears in the State Railways and in the Bangkok Metropolitan Transport Authority are cleared by the end of June 1998 by budgetary transfers within the fiscal framework.
7. We have also formulated the preliminary fiscal framework for 1998/99. Against the expectation of a small economic recovery during 1999, there will be room to reduce the fiscal deficit from that currently projected for 1997/98. Thus, we expect to contain the overall public sector deficit to no more than 2½ percent of GDP in 1998/99, signaling the continued structural strength of Thailand’s public sector despite the economic crisis. The central government deficit will be about 1½ percent of GDP. This target includes the costs of financial sector restructuring. Toward this end, the government has set itself the ambitious objective of issuing about B 500 billion of government bonds by the end of the 1998/99 fiscal year (paragraph 18). About 1 percent of GDP will be the deficit of the public enterprises. The 1998/99 fiscal framework will be reassessed during the next quarterly review, ahead of its formal adoption in September 1998.
8. External current account adjustment is also proceeding more quickly than envisaged just a few months ago, mainly reflecting the deep recession, and we now expect to record a current account surplus of about $8.5 billion or about 7 percent of GDP in 1998. Export performance has been weaker than expected, partly because of declining agricultural and manufactured good prices, as well as lower external demand; therefore, import compression remains, for now, the principal source of external adjustment. However, progressively during 1998, we expect the balance between import compression and export growth to shift, and the current account surplus to narrow.
9. The capital account is developing broadly as envisaged in key areas. Most of the offshore forward and swap obligations incurred in 1997 have now been settled, and we are confident that the total stock of such obligations will be reduced to about $9 billion by end-1998, comprising only domestic obligations related to liquidity management. Also, there has been greater stability in recent months of short-term credit lines. In particular, the rollover rate for the Thai banks and the corporate sector has recently risen. Moreover, foreign direct investment recovered somewhat in recent months owing to share issues associated with commercial banks’ recapitalization (see below). Against this, there were some outflows from nonresident baht accounts earlier in the year.
10. We have been encouraged by the entry of Canada into the financing package, which will offset some erosion in the package from other sources. In addition, we intend to place a sovereign bond issue in international markets in the coming months. Overall, we expect that more ambitious external targets can be set for the 1998 program. The modification of the June 30 performance criterion on net international reserves and the data for the September 30 external performance criteria are specified in Annex C. In addition, the envisaged amendment of the Currency Act allows for greater flexibility in reserve management. For all these reasons, we are confident that the economic program remains comfortably financed.
Strengthening the Core Banking System
12. Our strategy continues to be targeted at augmenting the capital base of all domestic financial institutions, and this process is being facilitated by the tighter loan classification and provisioning standards. Major commercial banks have succeeded in raising private capital, and many smaller banks continue discussions with foreign strategic partners. About $3 billion of new private capital has been raised since last November, most of it from foreign investors. This process has been driven by the introduction at the end of March 1998 of new loan classification and loan loss provisioning rules consistent with international best practices. The new loan classification rules will take effect on July 1, and the associated provisioning requirements—to be implemented gradually—will be the driving force behind future bank recapitalization.
13. The four intervened banks continue to operate subject to strict supervision by the BOT. Their funding has been regularized by converting most of their short-term liabilities to the FIDF into long-term obligations at funding rates closer to those of core banks. We are developing a strategy for their resolution and privatization, and have accordingly contracted an investment bank to develop least-cost proposals by midyear. We expect to have adopted a strategy for these banks by end-July.
Strategy for Remaining Financial Institutions
14. The 35 remaining finance companies are subject to the same recapitalization requirements and loan classification and provision rules as banks. Some finance companies have been recapitalized and have found viable market niches, but many others are very small and will need to be consolidated. Consistent with this strategy, and following the modalities of previous interventions in banks, on May 18, 1998, we have intervened in seven finance companies that were unable to raise capital. A majority state-owned finance company (KTT) is leading the consolidation effort. This consolidation strategy shall apply to other finance companies which do not comply with their Memoranda of Understanding with the BOT.
15. Regarding specialized financial institutions, it is our intention to make increased use of these institutions to make credit available to the economy. Therefore, it is vital to ensure that they are financially sound, properly regulated and supervised, and adequately capitalized. Accordingly, these institutions and their overall policy framework will be assessed promptly with the assistance of the World Bank, with the view to identifying any problems by June 30, 1998.
Asset Disposal of the 56 Closed Finance Companies
16. The Financial Sector Restructuring Agency (FRA), working closely with World Bank consultants, has completed the rules and procedures for auctioning the assets of the closed companies. The FRA has successfully auctioned a substantial amount of physical assets since March. The next stage is to auction more complex hire-purchase and loan portfolios, and this is scheduled to begin shortly with a first auction comprising $1.2 billion of hire-purchase loan portfolios. The FRA has contracted an investment bank to professionally market the assets in order to stimulate bidder interest. All financial institutions in Thailand, including BIBF, are eligible to participate in the auctions. An important precondition to these next auctions is to remove the major impediments to asset transfers; it is our intention to address these problems through an emergency decree by the end of May.
17. The organization and procedures of the Asset Management Corporation (AMC) are broadly in place, and an increase of its capital to B 10 billion has been authorized. It is expected that the AMC as well as the Radanasin Bank (RAB) will shortly fully define their own bidding procedures and funding policies in order to bid for the financial assets offered by the FRA. To assure the efficiency and integrity of the process, a third party review of FRA/AMC/RAB procedures will be completed by September 1998. It is not envisaged that other state agencies would participate in the auctions.
FIDF Policies and Operations
18. As previously declared, the government has decided to take full financial responsibility for the losses of the Financial Institutions Development Fund (FIDF) by converting FIDF debt into government debt. This conversion will start with a government bond issue of B 500 billion in FY 1998-99; the interest costs of these bonds will be met by the Budget, with their amortization being met partly by 90 percent of the future realized profits of the BOT, and partly by privatization proceeds. The Ministry of Finance is working out the terms and conditions, as well as the institutional framework, for issuing these bonds with the aim of separating the mechanism for FIDF’s borrowing needs from the BOT’s management of short-term interest rates. In its capacity as lender of last resort for the financial system, the FIDF will charge a lending rate that will be the highest in the system for new lending. Finally, and perhaps most importantly, we will continue to move toward devising, by the end of the year, a deposit insurance scheme to replace the comprehensive guarantee of the financial system presently provided via the FIDF.
Strengthen Supervision and Regulation
19. The BOT’s supervision of financial institutions is focussing on loan portfolio values and capital adequacy. This effort has taken the form of a set of Memoranda of Understanding (MOUs) with undercapitalized banks and all finance companies, supported by targeted on-site examinations. The BOT intends to continue this process by entering by mid-August into a new set of MOUs with all financial institutions; new MOUs will be signed subsequently, until the new year 2000 provisioning rules have been met.
20. Given that problem loans in Thailand will need to be restructured, it is essential to develop detailed operational guidelines to make the new loan classification and provisioning rules fully effective, and to provide banks with incentive to restructure their loans. These guidelines, which are crucial for a restoration of normal credit flows in the financial system, will need to be consistent with international best practices to be credible, while also taking into account the deep systemic difficulties facing Thai borrowers. We envisage that these new guidelines will be fully in effect by mid-June 1998. The operational guidelines on collateral valuation will also be introduced by mid-June 1998.
21. The government is conducting a broad review of banking and financial sector legislation and regulation with the view to identifying the need for changes and finalizing proposals for legal and regulatory reforms to be taken later in 1998. We are in the process of bringing in experts from G-7 central banks to provide support for a High-Level Commission which is being established to develop concrete recommendations on how to strengthen central banking and supervision in Thailand. Finally, the BOT will strengthen the capacity of its supervisory staff through recruitment and retraining.
Corporate Restructuring and Legal Reform
23. Corporate restructuring with external and domestic creditors is crucial to the recovery of the private sector. We are encouraged that such restructuring is under way, and is being pursued on a voluntary and market-oriented basis. The government is committed to facilitating this process through legal and tax reform that would establish the appropriate enabling framework; the key steps toward this end are summarized in Box C. The government will encourage banks and corporate bodies to create voluntary creditor committees and debt-workout units. A consultative committee drawing together domestic creditors, mainly banks, and corporate debtors has already been set up. One of its first recommendations—to clarify the accounting and provisioning rules for restructured loans—has been acted on and it is hoped that, in this way, the government can contribute to removing the institutional obstacles to debt restructuring, especially facilitating debt workouts outside of formal bankruptcy court. The government has already announced that public funds will not be used to bail out corporate units, and this basic principle is reaffirmed.
24. To improve corporate governance, the SEC has embarked on a review of accounting principles and practices to bring them in line with international best practices by end-1998. This will result in enhanced transparency and disclosure standards on the part of all listed companies. Companies listed on the Stock Exchange of Thailand will be required to disclose all liabilities (including external liabilities and off-balance sheet liabilities). Other steps are also being taken to increase accountability to shareholders. These measures to improve corporate governance should be finalized by June 30, 1998.
Privatization and Competition
25. The government has now drawn up a concrete agenda to implement the restructuring and privatization program that was presented in the February Memorandum on Economic Policies, and these are elaborated in Box D. To ensure an adequate consensus for the government’s privatization program, we are embarking on an increased dialogue with workers and other affected parties. The program presented in the last Letter of Intent is reaffirmed, and a specific timetable for individual enterprises will be developed by the time of the next quarterly review.
26. The government also places considerable importance in deepening the external openness of Thailand’s economy, and increasing foreign direct investment flows into the economy. Such increased investment flows will contribute directly to relieving the liquidity shortages in many sectors. As such, the government will shortly propose to Parliament amendments to the Alien Business Law, as well as to other associated laws, aimed at liberalizing foreign investment limits in selected sectors during the second half of the year.
Social Safety Net
27. A social safety net adequate to the task of protecting those left vulnerable by the economic crisis is a key priority of the government. In consultation with the major nongovernmental organizations and labor leaders, we have further elaborated on the design of the social safety net. These have allowed greater specification of the social safety net measures anticipated at the last program review, and the strengthened program is presented in Box E. This program is being implemented in close collaboration with the AsDB (a social sector loan was approved on March 12), the World Bank (approval of the social investment project loan is planned for July 1998), and the Overseas Economic Cooperation Fund. In addition, it is expected that the government will accelerate public employment creation in small infrastructure programs in the agricultural sector, and increase funds for retraining programs and lending to the unemployed to facilitate self-employment activities within the increased margin provided by the fiscal program.