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A lay person's guide to IMF bail-out deal

 

Thanong Khanthong and Vatchara Charoonsantikul offer a simple guide to the International Monetary Fund aid package.

 

Thailand has agreed to embrace the International Monetary Fund-led aid package to stabilise its macro-economic conditions and undertake drastic financial and economic reform. But does it guarantee Thailand is safe from insolvency?

Thailand will almost certainly be reincarnated through this IMF package. Stand-by credit from the IMF and other financing packages put together by Tokyo to the tune of US$18 billion will restore foreign investors' confidence in Thailand.

The financial aid will be kept at the Bank of Thailand in the form of foreign exchange reserves to assure foreign investors that Thailand is not insolvent because it will have enough US dollars to cope with capital outflows. Part of the money will be used to tackle the finance sector's problems.

In a way, Thailand is following a tactic practised by the beleaguered Bangkok Metropolitan Bank, which is obliged to play a poker game. BMB is putting stacks of money on the table to assure panicking depositors that it has enough cash to meet any withdrawals. BMB, which faced a run of Bt7 billion in a single day on Wednesday, will certainly get recycled money from other member banks or the central bank afterwards to cope with the withdrawals.

The Thai central bank will be playing exactly the same game by displaying its reserves obtained from the IMF and other organisations so that any foreign investors wishing to leave Thailand with their money can exchange their baht for dollars.

Yet the Bank of Thailand said it had US$32.4 billion in reserves at the end of June. Isn't that enough to show the world that we're not all that poor?

Don't be too complacent with this semi-fictitious figure. The exotic nature of foreign-exchange accounting makes it possible to cook the books. The BOT might have had only $17 billion left in reserves at the end of June after the costly baht defence in mid-May. It could theoretically have borrowed $15 billion overnight from neighbouring central banks on June 30 and returned the money the following day. If the reserves had been $32.4 billion, the BOT would not have had reason to float, or devalue, the baht on July 2.

The central bank said it will try to maintain its reserves at $25 billion to manage foreign exchange stability. This means the BOT now must have less than $25 billion in reserves.

In reality, the central bank's reserves are ''borrowed" because Thailand is a capital-deficit country. Thailand's reserves are formed by the net capital inflows that exceed the current account deficit. So if these borrowed reserves flow out of the country, Thailand will be in serious trouble.

Earlier there were fears that Thailand might be forced into insolvency because, without additional inflows of fresh capital, it would not have had sufficient reserves to back up the outflow of about $40 billion over the coming months.

Why were IMF managing director Michel Camdessus, US Treasury Secretary Robert Rubin and Japanese Finance Minister Hiroshi Mitsuzuka so excited about Thailand's decision to adopt the IMF's economic stabilisation programme?

Their support for the Thai government's tough decision was premeditated a collective exercise to inform the global financial markets that Thailand is moving in the right direction towards mending its structural imbalances. This will also have far-reaching implications for other regional economies, which have also come under currency turmoil following the baht devaluation.

Thailand has overcome the crucial external hurdle necessary to correct its macro-economic imbalances. The question is whether the government will be able to overcome the domestic or political constraints to undertake the painful economic and financial reforms. It is now purely a domestic business to rectify the structural imbalances.

What are some of the bitter pills in the IMF package?

Turmoil and runs on deposits have already been seen in the financial system since the Chavalit government decided to shut down another 42 finance companies. The ''death toll" in the finance sector has now risen to 58 finance companies. A weak financial system prevents any chance of a fundamental improvement in the economic conditions or a stabilisation of the foreign exchange and interest rates.

The IMF must have told the Thai regulators that they, through the Financial Institutions Development Fund, could not continue to throw money behind all the unsalvageable finance firms. Yet somehow they must stop the bleeding in the finance sector, which has been facing a deposit run of between Bt15 billion and Bt20 billion a week.

However, the IMF must have been shocked to learn that the BOT spent Bt450 billion in its futile exercise to prolong the death of the ''zombie-like" finance companies. This is the largest bailout in world banking history.

About Bt200 billion of this amount went to the group of 16 finance companies shut down earlier. Another Bt230 billion went to the other 42 ailing firms. Enough must be enough. The BOT must decisively draw the line between the ''bad" and the ''good" finance companies so that the public and investors can clearly distinguish between them.

The Thai regulators ended up with the tough decision to keep the remaining 33 finance companies and 15 banks. However, some of the 33 finance companies are not that healthy because they have borrowed a total of Bt20 billion from the Financial Institutions Development Fund.

What about the three per cent increase in VAT?

The Thai government has decided to raise the value-added tax from seven per cent to 10 per cent, which would broaden the government's tax base and increase its revenue by Bt70 billion in fiscal 1998. The hike will be effective from Aug 16.

The opposition has sharply criticised the government, saying it should not have transferred the burden onto the public by raising the VAT because it could have drastically cut spending to balance the budget. However, the government said it will cut spending by at least Bt60 billion in the 1998 budget.

Lawyers have warned that a 10 per cent VAT is likely to create a tax revolt, followed by upward price pressure which the VAT will build into the costs not to mention the inflationary effect of the baht devaluation.

The IMF would like Thailand to bring its current account deficit down to a more sustainable level. What does it mean and how will it affect economic growth?

The IMF package spells out clearly that Thailand must bring its current account deficit the gap between savings and investment demand down from eight per cent of gross domestic product in 1996 to five per cent in 1997 and to three per cent in 1998. It has also set the ceiling for economic growth at three to four per cent in 1997 and 1998 before fundamental conditions may improve in 1999. In short, this is a three-year surgery programme for Thailand.

Bringing down the current account deficit amounts to an attempt to contract the economy and bring the balance of payments crisis under control. Thailand has depended too heavily on foreign capital, as measured by the current account deficit, to finance its economic growth. Between $800 million and $1 billion a month in foreign capital was needed to keep the over-leveraged economy going.

The loss of confidence as a result of the export slowdown and the financial crisis has triggered capital outflows baht sold for US dollars resulting in a balance of payments crisis. The central bank has been printing money since the beginning of the year to offset shrinking liquidity.

The foreign debt creation in the past has not been matched by net export earnings. The shrinking current account deficit will signal that Thailand is willing to live within its means. Contracting the economy will create economic dislocations corporate bankruptcies, factory shutdowns and unemployment over the next two years before the economy comes to terms with its domestic capacity.

 

 

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