The Crisis

build-up in non-performing loans and decapitalization throughout the whole fragile financial system.

was strengthened at the first quarterly review (on Decem-ber 8, 1997). The new government was determined to take a number of additional measures to support the policy pack-age. With weakening economic activity, constraining rev-enues, additional fiscal measures were introduced to achieve the original fiscal target for 1997/98. Reserve money and net domestic assets of the Bank of Thailand were to be kept below the original program limits. As a result, indicative interest rates were raised and a specific timetable for financial sector restructuring was announced.

In early February 1998, the baht began to strengthen against the U.S. dollar as improvements in the policy setting revived market confidence. Growth projections, however, were marked down further. Contracting domestic demand helped to keep inflation under control and contributed to a larger-than-expected adjustment in the current account.

The stabilization program was revised significantly at the time of the second quarterly review (on March 4, 1998).

Under the revised program, monetary policy continued to focus on the exchange rate, with interest rates to be main-tained at high levels until evidence of susmain-tained stabilization emerged. Fiscal policy shifted to a more accommodating stance. In addition, the program included measures to strengthen the social safety net, and broaden the scope of structural reforms to strengthen the core banking system and promote corporate restructuring.

The third quarterly review took place on June 10, 1998 and a marked strengthening of the baht during February-May 1998 was noticed (some 35 percent vis-a-vis the U.S.

dollar from the low in January). The revised program was on track, but with real GDP projected to decline 4–5 per-cent in 1998 and inflation subdued, further adjustments were made to allow for an increase in the fiscal deficit tar-get for 1997/98 from 2 percent to 3 percent of GDP. Mon-etary policy continued to focus on maintaining the stability of the baht. While the reductions of interest rates since late March 1998 was viewed as consistent with exchange mar-ket developments, it was understood that interest rates would be raised again if necessary. Additional measures to strengthen the social safety net were planned, and the pro-gram for financial sector and corporate restructuring was further specified.

The exchange rate weakened during June-July 1998 amid growing concerns about the growth outlook, and renewed signs of strains in the financial sector, where grow-ing difficulties in the corporate sector complicated restruc-turing of financial institutions. Fiscal and monetary policies had been tighter than programmed, economic activity was weaker than expected, and exports had failed to pick up.

The large adjustment in the current account (projected to amount to over 10 percent of GDP) reflected a sharp con-traction of imports.

The fourth quarterly review (on September 11, 1998) focused on adapting the policy framework to support the

recovery without sacrificing stabilization gains. With output now projected to decline by 6–8 percent in 1998, efforts were stepped up to utilize the scope of fiscal easing provid-ed under the program. Foreign exchange market conditions were relatively stable (in spite of the Russian crisis), provid-ing room for further lowerprovid-ing of interest rates. The pro-gram for financial and corporate sector restructuring was broadened significantly, and the structural reform agenda in other areas (privatization, foreign ownership, and social safety net) was strengthened.

As of October 19, 1998, 12.2 billion U.S. dollars from the total financing package for Thailand (17.2 billion U.S.

dollars) had been disbursed, including 3 billion U.S. dollars from the IMF and 9.2 billion U.S. dollars from other multi-lateral (World Bank and Asian Development Bank) and bilat-eral sources.

During 1999 there were several additional quarterly reviews of the stabilization program. All of them were focused on revitalizing of domestic demand and on the social safety net. The overall public sector deficit was grad-ually set at the higher level (5 percent of GDP in the fiscal year 1998/99 and 7 percent in the fiscal year 1999/00.

These fiscal targets accommodated reductions in revenues (of about 0.5 percent of GDP in 1998/99 and in 1999/00) from the impact of lower-than-expected nominal GDP. The flexible use of interest rate policy to maintain baht stability was reaffirmed, monthly interest rates were lowered and inflation was falling. Growing confidence has allowed inter-est rates to fall below pre-crisis levels without compromis-ing exchange rate stability. The overall balance of payments outcome was stronger than expected, as a higher current account surplus, reflecting weak domestic demand, carried over to higher than projected reserves.

On May 8, 2000 the Executive Board of the IMF com-pleted the ninth, and final review under Thailand's Stand-By Arrangement. To date, under 17.2 billion U.S. dollars official financing package, Thailand has drawn 14.3 billion U.S. dol-lars from bilateral and multilateral contributors, including 3.4 billion U.S. dollars from the Fund.

3.3.2. Macroeconomic Environment after the Crisis

The persistence and widening of the current account deficit, over-investment, declining rates of return on capital, and the over-expansion of the non-tradable sector pointed on macroeconomic reasons of the crisis and the need for deep adjustment in exchange rate. In the aftermath of the crisis, Thailand's real effective exchange rate depreciated by 35 percent in the second half of 1997, but subsequently recovered. As of end-1999, the cumulative real exchange rate depreciation was 25 percent. After depreciation Thai-land's external current account balance shifted from a deficit

of eight percent of GDP in 1996 to a surplus of more than 12 percent of GDP in 1998. Due to the fall in Thailand's terms of trade and falling dollar export prices, export vol-ume growth exceeded 8 percent per annum in 1997–98.

Conversely, import volumes fell dramatically by more than 40 percent from 1996 to 1998, reflecting the weakness in domestic demand and the relative price effect of the deval-uation.

Once the full extent of the weaknesses in Thailand's economy became known, including the underlying problems in the financial sector and the collapse of Thailand's interna-tional position, financial market confidence vanished. Thai-land's pre-crisis problem of persistent and excessive capital inflows was transformed into one of managing major capital outflows, with creditors refusing to rollover short-term debt. As indicated before, investment was falling sharply [6]

in the first quarter of 1997 what influenced output contrac-tion. In 1998, the recession widened and real GDP declined by 10 percent. Private consumption also fell markedly. Con-sumer durables were particularly hard hit, with car sales falling to around one quarter of their pre-crisis levels. As a result of high interest rates and the reduced availability of credit, consumption fell by 13 percent in 1997 and 1998.

Another factor responsible for decline in consumption was lowering personal incomes. With the general collapse in domestic demand, unemployment increased and wages declined.

Since January 1998, the rate of private credit growth (adjusted after correcting for changes in valuation due to exchange rate fluctuations) declined steadily (Figure 3-4).

Later the growth of credit continued to decrease and was even negative at the rate of 10 percent per annum in Janu-ary 1999. In 1999 the situation started to improve. And in the end of 1999, the credit started to grow at the rate of 5 percent per annum. However, the volume of credit was still 20 percent below the peak reached in late 1997. This sug-gests two possibilities. First, that credit-intensity of firms has fallen as firms started to rely increasingly on retained

earn-ings and other sources of non-bank financing or, second, that there has been a shift in the allocation of credit [7].

After the sharp contraction in 1998, the recovery start-ed in 1999. Manufacturing production, which had already bottomed out by the middle of 1998, grew at double-digit rates through much of 1999, and by September 1999 it had surpassed its pre-crisis peak. On the demand side, lower interest rates and improving recovery prospects have stim-ulated private consumption. This trend was supported by a temporary VAT reduction, which took effect in early 1999.

In 1999, Thailand's economy reached the growth rate of 4 percent, which was much more modest than in the past. In 2000, the recovery was strengthened and real GDP was expected to increase by 4–5 percent. If 2000 trends con-tinue, Thailand will recover pre-crisis levels of output and consumption per-capita by the end of 2002 (the IMF esti-mates). The major contributors to growth continued to be exports (6.3 percentage points) and private consumption (3.4 percentage points).

Total factor productivity (TFP), which began to decrease well before the crisis, became negative in 1996, and bot-tomed out in 1998. However, since 1999 TFP appeared to start to grow again, helped by structural reforms and cycli-cal bounce back, and was estimated to grow from 1 to 1.4 percent in 2000 (the IMF estimates).

Exports have done well and have been a key driver of the recovery. In 1999, they grew by close to 9 percent, and were set to grow by 6.8 percent in 2000 (IMF estimates).

The U.S. and EU markets contributed to the pick-up in Thai exports. More recently, the exports to Japan and ASEAN countries recovered, and accounted for over 30 percent of total exports in 1999. Nonetheless, there were concerns regarding the competitive weakness of the Thai industry.

Skill-intensive activities complained of shortages of high level skilled manpower, and technology-intensive activities remained largely confined to the final assembly stage of operations. More recently, technology intensive exports have increased. Recent data suggest that the growth in

[6] While investment fell across the board, investment in construction was especially badly hit, its share fell to 35 percent of the total investment from 50 percent before the crisis.

[7] Some firms have suspended servicing their loans, thereby "obtaining credit" by generating NPLs.

Table 3-7. Contribution to economic growth in the year 2000 (percent)

Growth Contribution to Growth

Real GDP growth (%) 4.5 4.5

Private consumption 6.4 3.4

Public consumption 4.9 0.5

Private investment 11.0 1.2

Public investment 4.5 0.5

Exports 11.0 6.3

Imports 17.0 -7.5

Source: World Bank. Thailand Economic Monitor. June 2000

imports has started to slow down. Imports fell by 17 per-cent between December 1999 and January 2000 (IMF esti-mates).

Given projected growth rates of imports and exports, the current account balance was expected to generate a surplus of 7.7 billion U.S. dollars in 2000 (5.3 billion US$ of the trade balance surplus). On the capital account side, repayments by the private sector were expected to fall from 15.5 billion in 1999 to 9.5 billion U.S. dollars in 2000.

This created a cushion to support potential weakness in portfolio flows and foreign direct investment. Gross official reserves increased to 34 billion U.S. dollars at the end of 1999. But in the middle of 2000, the country's foreign reserves stagnated at around 32 billion U.S. dollars [8]. This level was sufficient to cover more than three times the cash in circulation at that time (which approximated 9 billion U.S.

dollars and about 400 billion Thai bahts). This level of reserves was an equivalent to 200 percent of debt maturing in the next 12 months, and 6 months of imports.

A second key driver of recovery was private consump-tion. In 1999, total private consumption grew by 3.5 cent, recovering from sharp contraction in 1998 (-12.3 per-cent). This growth was broadly consistent with a return of consumer confidence, reflected in an increase in aggregate disposable income resulting from rising wages and higher levels of employment. Inflation remained under control in 1999 and did not create a risk for the economy. The gov-ernment set an inflation ceiling of 3.5 percent for the year 2000, what was possible to reach.

However, employment data show that the recovery is still fragile. The crisis did not appear to have affected the trend in a significant way. After the onset of the crisis employment was expanding gradually but the unemploy-ment rate was falling at a very slow pace. The February unemployment rate fell from 5.4 percent in 1999 to 4.8 per-cent in 2000. While the unemployment rate appeared to be modest when compared to European countries, Thailand

has no unemployment insurance system and welfare impact can be severe. However, a review of the adjustments in the labor market showed that wage reductions among less edu-cated workers were less severe compared to the eduedu-cated workers, suggesting that labor markets protected the less well off (WB Monitor).

Looking back over the two and half years under the Fund-supported program, the successful implementation of macroeconomic policies can be observed. All above-men-tioned indicators show that the main objectives of the pro-gram have been met. Over the medium term, the key chal-lenge will be to sustain economic recovery in the context of a heavily indebted corporate sector and continued weak-ness of financial system. The results of corporate debt restructuring are not satisfactory and this process still has some way to go. In order to complete reforms in the finan-cial sector, the speeding up of corporate debt restructuring process is also necessary.