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Caught between the IMF and a hard place


Years of living beyond its means has forced Thailand to seek the International Monetary Fund's help. Thanong Khanthong and Vatchara Charoonsantikul report.


Bank of Thailand Governor Chaiyawat Wibulswasdi said yesterday that Thailand has reached a broad agreement with the International Monetary Fund (IMF) over macro-economic targets, although details of the measures will take more time to work out.

The macro-economic targets will largely focus on how Thailand can achieve a sustainable balance of payments, ''with a view to developing a comprehensive package of policy measures necessary to stabilise long-term macro-economic conditions and to lay the basis for a restoration of sustainable growth and financial institution system stability", a joint statement issued by the Finance Ministry and the central bank said.

One of the underlying reasons behind Thailand's forced acceptance of the IMF's painful remedies is its balance of payments crisis. Balance of payments consist of the current account (export, imports and services), investment flows and gold reserves. In the first half of this year, Thailand ran up a balance of payments deficit of Bt155 billion, due largely to an unsustainable current account deficit and to capital outflows.

This forced the Bank of Thailand (BOT) to flout monetary discipline by printing money to offset the heavy outflow, sending the monetary base up at a year-on-year rate of 30 per cent in June. The crisis, further complicated by the insolvency of an as yet undetermined number of financial institutions, reached its peak on July 2 when the banking authorities floated the baht. This amounted to a de facto devaluation of the currency.

The balance of payments crisis poses a threat to economic growth because it affects the flow of financial resources and imports. This can disrupt development.

According to an IMF document, balance of payments difficulties ''undermine confidence in long-term prospects for the economy, discourage investment and can result in a less efficient use of scarce resources. Stability in the balance of payments, on the other hand, provides a sounder basis for growth, and develops confidence in an economy."

Thailand has mismanaged itself into a corner and been forced to adopt programmes of economic adjustment because it has been living beyond its means. For several years, the country has been spending more to buy goods and services from other countries than it has been earning from its exports and investments.

The measure of this bad habit is the current account deficit, which in the case of Thailand reached the world's highest rate of eight per cent of the gross domestic product in 1986. Thailand has required between US$800 million and $1 billion a month in foreign money to finance its domestic investment and consumption demands. In that time, the private sector debt has soared to more than $60 billion.

For a time, Thailand could continue this way by drawing down its foreign exchange reserves and by borrowing from abroad. But when exports bottomed out last year, Thailand's creditors and foreign investors started to panic with fears that the country will not attract enough foreign exchange to repay its huge foreign debts.

Since these sources of foreign capital have been exhausted, there is no choice other than to adjust to what Thailand can afford.

If Thailand insists on taking the easy way out by becoming passive or doing nothing as has been the case in the past the inevitable adjustment will be forced on it. Creditors will be knocking on our doors, disrupting the entire economy at great cost to potential and actual output. The disruption has already thrown trade and financial relations into chaos.

But if Thailand tries to rectify its past mistakes by assuming an active role in adjusting to economic reality, it will survive the trauma. The IMF will be helping the government to work out an economic and financial reform programme that will seek to minimise economic disruption and help re-establish the fundamental conditions for growth.

''Discussions have been going well and the key policy elements of such a package are falling into place," according to the joint statement from the Finance Ministry and the central bank. ''Work will continue to progress and all details of a comprehensive policy programme will be finalised as expeditiously as possible."

The measures the government are discussing with the IMF, can be grouped into four key areas: financial institution system reform, foreign exchange reserves management, fiscal consolidation and fiscal and monetary discipline.

Dealing with the ailing finance companies will be extremely painful and cause disruptions to the financial system in the immediate future. There will not be any more more free lunches for the cash-strapped finance companies they will be allowed to go under. And there will be more bankrupt finance companies than the 16 already suspended.

The government will, however, set up a deposit insurance scheme to protect the Bt5.5 trillion in public deposits in both the finance and banking systems. Repayments to depositors will span a period of five to 10 years, depending on the size of the deposits.

The shareholders and the creditors of the ailing finance companies will not be protected.

A resolution trust corporation will then be set up to absorb the bad debts of the ailing finance companies, whose good assets will be transferred to their stronger peers or foreign partners through mergers and acquisitions. The corporation will be issuing long-term bonds, presumably worth at least Bt100 billion, to finance the bad assets it absorbs.

The bonds may carry a maturity of 20 or 30 years, postponing the pain for future generations. But the government, which still has to adopt fiscal discipline, will have to allocate from its budget money to finance the bonds upon their redemption. This means taxpayers will share equal pain in the finance sector crisis.

The central bank will come under a wholesale restructuring. Its financial institutions supervision department will be transferred to the Finance Ministry. The Financial Institutions Development Fund, which has so far spent Bt320 billion bailing out ailing finance companies, will no longer have any reason to exist, for it will be replaced by a deposit insurance corporation.

In effect, the BOT will reduce its role to specifically managing monetary policy, setting interest rates, controlling money supply and keeping prices under control.

The IMF is advising the BOT on how best to manage its foreign exchange reserves. Defending the baht in mid-May cost the BOT a fortune. Although the BOT said its reserves fell to $32.4 billion in June, analysts are sceptical of that figure.

The baht float has lost more than 25 per cent of its value since it was floated. Managing the floating baht is extremely tough due to Thailand's deteriorating economic fundamentals. The baht may be fixed again, yet with greater flexibility for the BOT to manage its monetary policy.

The IMF would like the Chavalit government to cut its 1997-1998 budget by at least Bt70 billion. The prime minister has signalled his agreement to this target. This is part of fiscal consolidation. The difficult part lies in increasing tax revenue. The IMF would like the value-added tax to increase by at least three percentage points to 10 per cent, yet the government is negotiating for an increase of two percentage points.

All public utility subsidies must be abolished. Oil prices, bus fares, electricity and water bills will have to be floated. These measures will hit the public hard, particularly medium- and low-income families, who are already feeling the pinch of the economic downturn.

Monetary policy will be tightened to prevent inflation from rising above five per cent. There may be measures to reform public enterprises, such as privatisation, or to limit the degree of wage indexation.

Of all these measures, the toughest ones facing the government are allowing the group of 16 suspended finance companies to go bankrupt and raising the VAT to 10 per cent from seven per cent. A failure to deal with the failed finance companies effectively will lead to a breakdown of the Thai financial system. The sharp VAT increase will be a costly political move.

But there is no easy way out. Reckless development over the past 10 years has left the country with only one cure radical economic surgery.



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