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IMF provided the wrong prescription


February 26, 1999 -- The IMF's prescription for Thailand to tighten its belt in the initial stabilisation programme led to a meltdown of the Thai economy, Vatchara Charoonsantikul and Thanong Khanthong report in the second of a series.

The fiscal-tightening to tackle Thailand's crisis, hastily drawn up in August 1997 under the tutelage of the International Monetary Fund, was unwittingly a double blow to an economy which had already plunged into a severe recession.

On Aug 2, 1997, Hubert Neiss, the director of the IMF's Asia-Pacific Department, sent a letter to Dr Chaiyawat Wibulswasdi, the then governor of the Bank of Thailand, outlining a preliminary assessment of the Thai crisis and the accompanying remedies. One of the bitter pills the IMF suggested was that Thailand must tighten its belt so that the economy is adequately financed domestically. Thailand had been living beyond its means by running a current-account deficit of 8 per cent of the gross domestic product (GDP), financed largely by foreign borrowings. Fiscal tightening was also designed to address the cost of financial restructuring.

Then Neiss wrote: ''Fiscal measures of about 3 per cent of the gross domestic product are needed to ensure that the adjustment to a reduced current-account deficit can be achieved. This would help the central government in 1997-98 have a small surplus necessary to absorb the costs of the financial restructuring. These costs are real and cannot be avoided through extra-budgetary accounting.''

The IMF team, under Neiss' leadership, assessed the Thai financial system's grave situation and pointed out that half of all finance companies were insolvent and were kept operating through massive liquidity injections by the Financial Institution Development Fund. Then the liquidity injection had already reached Bt400 billion, reaching almost half of the country's annual tax revenue. Finance companies were bleeding badly, suffering from an outflow to the tune of Bt15 billion to Bt20 billion a week. In the end, the taxpayers would have to foot these bills.

But the fiscal tightening, resulting in a surplus of 1 per cent of GDP in the first letter of intent, was a blatantly wrong prescription. For, the Thai current-account deficit of about 8 per cent of GDP was due to the over-investment of the private sector -- not from the weak base of domestic savings, which reached one of the world's highest rates at about 35 per cent of GDP, and not from the government's overspending, like most Latin American economies the IMF had dealt with.

By tightening the government's belt, the IMF programme handcuffed the public sector from spending in the economy to keep growth going at a time when the private sector was crumbling. The economy, which grew 6 to 7 per cent in the previous year, was immediately pushed into recession by registering a contraction by 1.2 per cent in 1997.

Misreading of the actual economic growth by the Bank of Thailand also led to a flawed IMF programme design, which aimed to keep economic growth at between 2 and 3 per cent. Not until Feb 15, 1999, did the government attempt to provide a quarterly review of the economy. The National Economic and Social Development Board has found that the Thai economy was already contracted in the second quarter of 1997 (see table). In the second quarter of 1998, real economic growth contracted sharply by a double-digit figure of 11.1 per cent. Given the trend, it is more likely that the economy would contract by at least 10 per cent in 1998, not 8 per cent as projected.

The IMF programme was based on a completely wrong assumption of economic growth. It was not until the third letter of intent in February 1998 that the IMF started to shift course by relaxing Thailand's fiscal policy. But that was too late, for the tightening in the first two letters of intent resulted in a contraction by 7 per cent of government spending into the GDP. This could be quantified as a disappearance by Bt370 billion from the economy.

It was not a surprise, then, that the current-account deficit, targeted by the IMF in the initial programme to fall to 5 per cent of GDP in 1997, made a sudden reverse, because of the fiscal tightening, to punish the economy. The current-account deficit turned out to be 2 per cent of GDP in 1997 before registering a surplus by 11 per cent of GDP in the following year. The surplus means that there is less money than before to finance the economy.

Moreover, the value-added tax had been forced to rise from 7 per cent to 10 per cent, another shock treatment that dampened domestic consumption and investment.

By the time the IMF began to relax its fiscal conditions on Thailand in the third letter of intent, it was too late. Everything was beyond repair.

 Next: IMF not worthy of rates praise



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