Bangkok
December 1, 1998

Dear Mr. Camdessus:

1.  This letter marks the completion of one year of Prime Minister Chuan’s government. In this relatively short period, Thailand has made great strides toward overcoming the economic and financial crisis, restoring Thailand’s external strength, keeping inflation under control, and laying a strong basis for the resumption of growth in 1999. These achievements have been reflected in growing market confidence in our program despite successive shocks in emerging markets since our letter of August 25, 1998.

2.  We recognize, however, that the larger challenge of moving from successful stabilization to sustainable growth still lies ahead. All our efforts are now firmly focused toward that end. Thus, at this fifth quarterly review of the program, we have adapted further the program’s policy framework as follows:

• First, direct measures to facilitate recovery of the real economy are being deepened to help increase corporate liquidity and provide carefully targeted support to key sectors, consistent with the overall program.

• Second, within the macroeconomic framework, fiscal policy has been made even more supportive of domestic demand. The overall public sector deficit for 1998/99 is now targeted at about 5 percent of GDP, higher than our previous target by about 2 percent of GDP. (In addition, the interest costs of financial restructuring are estimated at 3 percent of GDP of which, as indicated in our Memorandum on Economic Policies (MEP) of August 25, 1998, we will fiscalize up to 1½ percent of GDP of interest costs in 1998/99.) The additional fiscal measures are designed to ensure the maintenance of a well targeted fiscal stimulus, focused on maximizing the impact on demand and on the social safety net. We are confident that this deficit can be quickly scaled back, once growth resumes, thus preserving the medium-term strength of Thailand’s fiscal position. 

• Third, rising market confidence and a strengthening baht have allowed money market interest rates to decline further, to levels below those prevailing prior to the crisis. As such, monetary policy is now fully supportive of recovery. In response, banks’ lending rates have been falling and liquidity conditions have improved. As this process takes root, with the recapitalization of the core banking system, we can expect credit crunch conditions to recede.

• Fourth, we can confidently assess that financial restructuring is now at an advanced stage. In particular, the August 14 comprehensive policy package is being implemented steadily. However, its complexity has led to some delays in resolving the status of the intervened institutions—by integration or sales—and slightly modified timetables have been adopted for implementation. Recapitalization of remaining financial institutions remains at the center of the agenda. The recently introduced Tier 1 and Tier 2 capital support facilities underline the government’s determination to enable the banking system to recapitalize and resume normal lending operations. Several banks have already indicated their intentions to utilize these facilities.
  

• Fifth, regarding corporate debt restructuring, we had outlined a voluntary, market-based approach in our letter of August 25. We are currently augmenting this strategy by developing an effective monitoring system, and reviewing options for introducing a carefully balanced system of incentives, penalties, and arbitration among creditors. These initiatives, being developed with the World Bank, should give greater momentum to the process. Some notable restructuring agreements have recently been concluded or are in prospect.

• Sixth, we have taken additional measures to augment the social safety net in the context of a revised fiscal target for 1998/99, as mentioned above. These measures remain consistent with our approach to support priority areas in rural and urban sectors, through carefully designed and targeted expenditure programs, while avoiding the kind of benefits schemes that could distort Thailand’s labor market.

• Finally, the legislative agenda of the government’s economic program has been considerable. Helped by a continued strong consensus in favor of reform, we are confident that all necessary amendments to key legislation essential to financial and corporate restructuring will be in place shortly. With these achievements, Thailand would have made very considerable strides toward creating an environment fully responsive to new domestic and foreign investment and prepared to deal with future challenges.

3.  Our economic program has continued to be supported strongly by the international financial institutions (including the World Bank, and the AsDB), as well as the bilateral agencies (including Japan EXIM and OECF) and other contributors to the financing package. Nevertheless, regional and other uncertainties make it imperative that we keep the financing of the program under review to assure that, with IMF support, the program remains fully financed.

4.  Thus, Thailand is establishing a firm basis for recovery. Of course, the government stands ready to take, in consultation with the Fund, whatever additional measures may be necessary to ensure the continued success of the program.

Attachments

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431

MEMORANDUM ON ECONOMIC POLICIES
OF THE ROYAL THAI GOVERNMENT

December 1, 1998

1.  Financial conditions have continued to improve in Thailand, and the strengthening of market confidence has extended beyond the exchange rate to declining interest rates, a rise in the stock market, and a leveling off in indicators of production and demand. Nevertheless, broader recovery has yet to be achieved. Under the stimulus of financial stabilization and a succession of direct measures, we are confident of accelerating corporate debt and financial restructuring and, thereby, advancing recovery.

2.  Financial and corporate restructuring has been the cornerstone of our program, and a number of direct measures have also been taken to revive the real economy. These include:(i) raising the public sector deficit through carefully targeted expenditures on the social safety net, infrastructure, state enterprise investment, and accelerating project implementation; (ii) expediting tax refunds due to exporters and corporations, and temporarily postponing the payment of corporate income tax; (iii) providing externally-financed credit facilities, especially for small industries, and exporters; (iv) expanding rural infrastructure projects and supporting credit flows to the agricultural sector; (v) removing tax disincentives to corporate debt restructuring; and (vi) restructuring the borrowing operations of the Financial Institutions Development Fund (FIDF), thereby helping extend maturities and reduce distortions in the money market.

I.  MACROECONOMIC FRAMEWORK AND POLICIES FOR 1998-99

3.  The macroeconomic framework to guide policies for the remainder of 1998 and for the year ahead is presented below. The framework provides for modest recovery during 1999.

Indeed, there are already tentative signs that the fall in domestic demand has started to level off so that, under the momentum of the policy initiatives set out below, output could begin rising steadily during 1999. Although growth for the year as a whole is likely to be about 1 percent, this implies a fairly vigorous rebound, reaching 3-4 percent by the fourth quarter of 1999 relative to the fourth quarter of 1998. The external reserve position will be further strengthened, while inflation will be further reduced.

Fiscal Policy

4.  Given the continuing weakness in external and private domestic demand, it is appropriate for the public sector to provide greater support to demand than previously envisaged. Accordingly, it is our intention to raise the 1998/99 central government deficit target by about 2 percent of GDP to 3 percent of GDP. This has been built in to the quarterly targets and limits for the central government deficit and net bank credit to government in Annex A. The main elements of the higher deficit are as follows:

• First, we have identified specific spending projects in the central government, totaling about 1 percent of GDP, directed toward the social safety net and related labor-intensive investment projects (¶ 20). As far as possible, this will be foreign financed.
• Second, we will raise cash spending by another 0.5 percent of GDP by ensuring full implementation of the approved expenditure program and by preparing additional social sector projects for rapid implementation, to be identified and supported in the context of expected new foreign financing.
• Third, the fiscal target accommodates a reduction in revenue of about 0.5 percent of GDP from the impact of lower nominal GDP and possible revenue measures.

5.  Additional components of the public sector deficit include: (i) the deficit of local governments and state enterprises, which is still projected to be 2 percent of GDP; and (ii) the total interest costs of financial restructuring, which are now estimated at 3 percent of GDP in 1998/99, somewhat less than previous projections because of falling domestic interest rates. Of these, about 1½ percent of GDP are due to be fiscalized in 1998/99; 1 percent has already been budgeted, and an additional ½ percent is earmarked for the initial interest costs of the August 14 financial package and for possibly higher than budgeted interest payment on bonds for FIDF.

Monetary and Exchange Rate Policy

6.  Monetary policy has so far delivered very positive outcomes in terms of a strengthened and stable exchange rate, significantly lower money market rates, and falling inflation. The flexible use of interest rate policy to maintain baht stability is reaffirmed. Money market rates are now in the 4–6 percent range, thus making the monetary stance as supportive as possible of emerging recovery. Bank lending rates too have started to decline, although a decisive reduction—including in bank spreads—will hinge crucially on bank recapitalization.

7.  The BOT’s quantitative monetary program has been reviewed and extended through the first quarter of 1999, and constitutes an additional guide for monetary policy. The modified targets and limits for reserve money and the net domestic assets of the BOT, set out in Annex B, continue to be viewed as upper bounds rather than precise targets. They accommodate a further recovery in the demand for broad money, as well as the positive impact on the money multiplier of growing confidence in the financial system, which has kept reserve money below previous projections.

8.  With banks still hesitant to make loans, we are moving across a number of fronts to facilitate the extension of credit to viable firms. The terms and mechanisms underlying the existing AsDB syndicated loan for export financing have been improved to remove bottlenecks to its utilization. In cooperation with the World Bank, we have adopted a program to recapitalize and strengthen the operations of the specialized financial institutions, thereby preparing them for expanded operations, especially to sectors such as low income housing and small borrowers (¶ 14).

9.  The overall balance of payments outcome in 1998 is expected to be somewhat better than previously envisaged. A higher current account surplus, reflecting weak domestic demand, carries over into higher projected reserves of about $28 billion by end year.

10.  There is cautious optimism that Thailand’s external situation will strengthen further in 1999, despite continued risks in global financial markets and to partner country growth. Although the current account surplus is likely to shrink as output recovers, this will likely be more than offset by a reduction in the capital account deficit. Most importantly, the process of unwinding offshore swaps (totaling about $20 billion since mid-1997) was completed last month, and will no longer encumber the capital account. With additional support from expected new official financing, gross official reserves are likely to rise to at least $32 billion by end-1999, at the same time as we expect to reduce further onshore swaps held by the Bank of Thailand. Modified floors for the further rise in NIR are given in Annex C.

II. Financial Sector Restructuring

11.  The government has reviewed the progress in implementing the August 14 package on financial sector restructuring as well as the other financial reforms specified in the August 25 MEP. This review has benefited from the recommendations of the Steering Committee of international experts on BOT restructuring, as well as of our Financial Restructuring Advisory Committee (FRAC).

12.  Based on this review, we are confident that the overall strategy is essentially on track, although the process of resolving the status of the intervened institutions has taken more time than anticipated, reflecting a number of complex issues. We have now fully clarified the authority of the FIDF to complete the envisaged integrations and sales of the intervened institutions. The revised timetables are in Box A.

13.  Implementation of the strategy to strengthen the core banking system is entering a decisive stage:

• By January 31, 1999, as anticipated, the BOT will complete the next round of negotiations with all banks and finance companies to ensure that they remain fully capitalized during the six-month period through June 1999. Based on established norms, MOUs will be signed with all institutions needing to raise additional capital in this period. Individual institutions can make use of public resources under the newly established Tier 1 and Tier 2 capital support facilities.
• The ongoing comprehensive review of the legal and regulatory framework will be completed by March 31, 1999, after allowing time for a process of review with the industry. Parliamentary approval of amended commercial bank and finance company laws is expected by about mid-1999. On this basis, a strengthening of BOT’s framework for financial supervision will be fully in place by the third quarter of 1999.

Details of the updated strategy in these areas are contained in Box B.

14.  The government expects to complete an assessment of the specialized financial institutions by December 31, 1998, on the basis of on-site examinations by the BOT and technical assistance from the World Bank. The objective is to improve their financial condition, assess their long-term goals, and recapitalize them in 1999.

15.  The FRA process has proceeded according to schedule and we expect a major auction of the assets of the 56 closed finance companies to be held in mid-December. An independent third party review of the overall process is currently under way.

16.  We expect that this comprehensive strategy will restore the soundness of Thailand’s financial sector, increase competition and efficiency, attract new investments, and ensure that financial sector problems do not arise again.

17.  At the last review, we put in place a voluntary, market-based approach to corporate debt restructuring, as set out in the Bangkok Approach. In addition, the government removed various obstacles to restructuring (such as tax disincentives) and put in place institutions and incentives for restructuring (most importantly, the strengthened bankruptcy law that is expected to be passed shortly).

18.  These efforts have begun to produce results. The Corporate Debt Restructuring Advisory Committee (CDRAC) is closely monitoring a first target group of 200 key debt restructuring cases, involving some 353 companies and approximately B 674 billion in debt. Of these, about half have formally begun the process of debt restructuring in line with the Bangkok Approach, and the BOT is paying particular attention to the process. There is also evidence of successful restructuring taking place outside of the CDRAC process, and a large number of mills in the sugar sector have recently signed debt restructuring agreements valued at B 33 billion with their domestic bank creditors. Also, some very large and complex debt restructuring and rescheduling cases are at an advanced stage.

19.  Despite these successes, it is clear that the scale of the debt problem warrants consideration of additional measures to give greater momentum to debt restructuring. Thus, as foreshadowed at the last review, we have comprehensively reassessed the strategy set out in the Bangkok Approach, and are in the process of making important changes to ensure that it is as supportive as possible of a broad-based recovery of the private sector (Box C). This is being done in close collaboration with the World Bank in the context of a second Economic and Financial Assistance Loan (EFAL). The Bangkok Approach is being extended in the following main ways, with concrete steps to be adopted by end-December 1998.

• First, financial institutions are being encouraged to adopt contractual arrangements among themselves for arbitrating inter-creditor disputes.
• Second, on the basis of much strengthened and more specific oversight and monitoring mechanisms, CDRAC/BOT will be better placed to track debt workouts.
• Third, CDRAC is reviewing possible options for actions against firms that willfully neglect to resolve or restructure seriously delinquent debt obligations.
• Fourth, we will introduce shortly a Credit Bureau Bill allowing the establishment of credit bureaus to facilitate the exchange of information among creditors.
• Fifth, the BOT will be prepared to bear the costs of technical assistance, such as for debt workout training in debtor institutions, enhanced monitoring by the CDRAC, legal and accounting expertise, and for public education of the strategy.

IV. Social Safety Net

20.  As noted above, the bulk of the additional fiscal spending in 1998/99 focuses on the social safety net, including job training and labor-intensive projects. This program, designed in collaboration with the World Bank and the AsDB, has the following principal objectives:

• First, the program aims to provide additional public sector employment, consistent with regional poverty and unemployment patterns, for at least 200 thousand unemployed. By limiting such employment to two years, we will avoid raising the structural deficit.
• Second, we will upgrade skills of a targeted group of new entrants into the labor market.
• Third, coverage will be substantially increased of the existing means-tested cash transfer programs aimed at needy families and the elderly.
• Fourth, in view of the sharp rise in the dropout rate of students, we have increased the budgetary allocation for the secondary education loan program, which will supplement an existing grant program for primary education financed by the AsDB; the school lunch program is also being expanded significantly.
• Fifth, we are enhancing opportunities for the unemployed to become entrepreneurs through expanded small loan facilities and training programs.
• Finally, all of the above will lay the foundation for a new Social Sector Investment Program (SIP II) to be financed externally.

In addition, by end year, we will implement the provisions of the Labor Protection Act to establish a public compensation fund for unpaid severance payments to be financed by fines from violations of the Labor Protection Act.

V. Legal reform, Privatization, and Market Opening

21.  The government remains committed to implementing a number of crucial legal initiatives to accelerate corporate and financial restructuring and support the recovery. These include amendments to the Bankruptcy Law, the Code of Civil Procedure, and the Alien Business Law (and related legislation to liberalize ownership of land and buildings). The process has taken longer than anticipated because of the large volume of bills pending in Parliament. Nevertheless, we are confident that the lower house will soon pass amendments relating to bankruptcy and foreclosure. After that, we will continue to cooperate with the Senate to secure full passage of all these laws during the current session of Parliament. Amendment of the Bankruptcy Law was a performance criterion for October 31, 1998 and a waiver is, therefore, requested. It remains our intention to move to the next phase of foreclosure reform (amendments to the Civil and Commercial Code), with Parliamentary approval expected as soon as possible after Cabinet consideration of the draft law in mid-1999.

22.  Further progress has been made in the government’s privatization plan, the major aspects of which were set out in the Master Plan for state enterprise reform. Most importantly, the work on defining a regulatory framework to increase competition in key sectors such as telecommunications and energy is now well advanced, and Cabinet approval is expected by the first quarter of 1999, after which Parliamentary approval will be sought. A draft Corporatization Law has been cleared by the Cabinet and we will be seeking its early enactment by Parliament, together with amendment of the Aviation Act. Accordingly, we do not anticipate any significant slippages in the timetable for privatization set out in the August 25 MEP. These market opening initiatives are underpinned by our resolve to maintain a liberal trade regime, consistent with our commitments to the WTO and AFTA.

ANNEX A

The definitions of all variables and sectors are unchanged from the previous Review and the same adjustments apply for FIDF operations. The adjuster on excess balance of payments support, which has not been operational since the start of the program, has been eliminated. Principal and interest pay-ments arising from financial sector restructuring, including from fiscalization of FIDF obligations, continue to be excluded.

1. Indicative limits on the cumulative balance of the central government

The cash balance of the central government is defined as in the treasury accounts (which exclude amortization and foreign-financed expenditures). The coverage of these accounts was described in the MEP of May 26, 1998. Privatization receipts are excluded.

2. Performance criterion on banking system net credit to the public sector

ANNEX B

MONETARY TARGETS

The definitions of all performance criteria and indicative limits are unchanged from the previous Review, and the same adjustments apply¹. For the purposes of program monitoring, the baht value of NFA of the BOT will be calculated using the exchange rates given in the previous MEPs.

1. Performance criterion on net domestic assets of the BOT

2. Indicative limits for reserve money

¹ The NFA baseline path is B 501 billion for December 1998, and B 517 billion for March 1999. The NDA ceiling will be adjusted downwards to the extent that NFA exceeds the baseline projection. Changes in reserve regulations will modify the NDA ceiling and the indicative limit on reserve money, as described in the MEP of May 26, 1998.

ANNEX C

EXTERNAL SECTOR TARGETS

The definitions of all performance criteria, as well as the exchange rates used, are unchanged from the previous Review.

1. Performance criterion on net international reserves of the BOT

The program definition of NIR of the BOT is as described in the May 26 MEP.

2. Performance criterion on contracting or guaranteeing of new external debt

The limit applies to the contracting or guaranteeing by the public sector of new nonconcessional external debt with an original maturity of more than one year, as defined in the MEP of May 26, 1998.

3. Performance criterion on the stock of short-term debt outstanding

The public sector will not contract or guarantee any new debt of maturity up to one year. Excluded from these limits are guarantees associated with the financial system restructuring, the balance of payments financing package envisaged under the program, normal import-related credits, forward contracts, swaps, and other futures market contracts.