UN Resident Coordinator ResCor Thailand

A paper prepared for the United Nations Development Programme (UNDP / Thailand)

presented at the High-Level Consultative Meeting
"Policy Response to the Economic Crisis and Social Impact in Thailand"
22 May 1998, Bangkok

UN/UNDP’s Roles and Support to National Response
Framework for Future UN System Cooperation

ANNEX - High-Level Consultative Meeting "Policy Response to the Economic Crisis and Social Impact in Thailand". Organized by the United Nations Development Programme, Friday, 22 May 1998, The Siam City Hotel, Bangkok.

Figure 1 Incidence of Poverty in Thailand, 1975-1996
Figure 2 Baht/Dollar Exchange Rate 2^nd June 1997 to 11^th August 1998
Figure 3 Pathways from Economic Crisis to Social Impact
Figure 4 Sources of Income by Income Deciles, Rural Thailand 1996

Table 1 Key Macroeconomic Variables for Thailand in 1998 as Expected in the Various Letters of Intent between the Thai Government and the IMF
Table 2 Employment and Unemployment of persons who are 13 or older in February 1995-1998
Table 3 Distribution and Incidence of the Unemployed and Underemployed, February 1997 and February 1998
Table 4 Changes in Government Revenues
Table 5 Cuts in Government Expenditures, 1997/98
Table 6 Money and Quasi-Money (M2)/GNP Ratios in Selected Countries, End of 1996
Table 7 Secondary School Enrolment in Selected Countries in Asia, 1993

Until the crash of 1997, the Thai economy had performed exceptionally well. Economic growth had been averaging 7.6 per cent over the two decades from 1977-1996. While the fruits of that growth were unequally distributed, with income disparities widening, there is no doubt that the benefits of that growth have trickled down. Consequently, (except for a pause in the mid-1980s), the incidence of poverty has been steadily declining. This decline can be observed regardless of the poverty line used (see Figure 1). There is little doubt that the decline has occurred because the rapid rise in average incomes has smothered the impact of increasing income disparities.

Source: Calculated from National Statistical Office, Socio-economic Surveys,[data tapes] various years, 1975- 1996.

The high economic growth was achieved mostly by a development strategy that emphasized the role of the private sector, backed by prudent macroeconomic management at least until about 1993. As a result, inflation was low, averaging 4.7 per cent per annum between 1980 and 1996.

Because of its market-oriented policies, the Thai economic structure has reflected more or less faithfully its comparative advantage and has evolved over time in response to the shifts in that advantage (as well as the shifts in world agricultural prices). Thus, until about 1980 its major exports were agricultural products. This reflects the relative land abundance that was then the main feature of its resource endowment. However, after 1980, that comparative advantage in agriculture became less pronounced for two reasons.

Consequently, Thailand had to find alternatives to survive within the world economy. It turned out that because of land surplus in the 1960s and the 1970s, Thailand had a very large share of its labor force within the agricultural sector. The agricultural depression of the 1980s meant that this labor force would become available for labor-intensive manufacturing. Thus were created the conditions which led to the export-led manufacturing boom beginning in the second half of the 1980s and which continued until 1996.

The basis of the boom in its earlier and middle stages, that is until about 1993, was sound, with rapid investments in manufacturing capacity brought about by the relocation of industry from East Asia following the appreciation of the yen. As a result economic growth accelerated sharply, reaching double-digit rates towards the end of the 1980s. Such high growth rates naturally led to severe pressures on the capacity of the infrastructure. Consequently, major investments had to be made, mostly in telecommunications and electric power. Together with the investments in manufacturing, there was a sharp acceleration in the country's gross capital formation.

This growth in demand for investment funds coincided with the decision of the Bank of Thailand to liberalize Thailand's financial system, particularly in its relationship to the rest of the world. There were two important milestones in this opening up of the financial system. The first was Thailand's acceptance of the obligations under Article VIII of the International Monetary Fund in 1990. This required the lifting of all controls on all foreign-exchange transactions on the current account, most of which had already been removed. The second was the opening of the Bangkok International Banking Facility (BIBF) in 1993, designed to make Bangkok a center for financial services by encouraging foreign financial institutions to set up operations in Thailand. These financial institutions were to make loans both to domestic borrowers and to those in other countries in the region.

Following the logic of these two milestone decisions, most remaining foreign-exchange control measures were removed. Although Thai residents who wished to acquire assets abroad had to obtain the central bank's approval, it was readily granted. Similarly it became easier for foreigners to hold non-resident baht accounts.

On the domestic front, all ceilings on interest rates were removed in 1992, and the requirement for banks to direct a certain proportion of their loans to the agricultural sector was gradually loosened until it became almost meaningless. The rules relating to non-performing assets were changed to conform to those defined by the Bank for International Settlements (BIS). But the Bank of Thailand chose to use the loosest of the rules. For example, a loan was deemed to be non-performing only if both principal and interest were unpaid for twelve months.

At the same time, the regulatory regime of the stock exchange was strengthened by new comprehensive legislation in 1992. However, this strengthening was insufficient to limit the speculative fever from 1993 to 1995 that resulted from other factors. Among these other factors was very poor corporate governance prevailing among the listed companies, a fault not remedied by the reform of 1992. Essentially, the families controlling the enterprises found it very easy to exploit minority shareholders, mostly punters who entered the stock exchange for speculative purposes. The following are examples of malfeasance on the part of the managers/owners of some of the companies.

These are not small fly-by-night operations; they are some of the foremost firms in their industries. While the bubble lasted, everyone profited, or at least nobody noticed the danger. But this system encouraged the bubble to grow much larger that it would have otherwise and thus made the fall when it came in 1996-1997 much more severe. Worse, since some of the malfeasance affected the firms' ability to repay their loans to financial institutions, depositors in the latter were put at risk.

Financial liberalization at a time when the country was growing rapidly and had major capital requirements fueled an investment boom, and later an asset price bubble which grew out of control. With foreign money available at the low rates prevailing in the developed world, and with an exchange rate which was perceived to be fixed forever, borrowers perceived their cost of capital to be considerably reduced. This first stimulated the investment boom, which in turn nurtured a high growth rate. Side by side with the investment boom, the high growth rate of the economy, and the low perceived cost of capital, there arose an asset price bubble. The speculative fever surrounding the stock exchange has already been mentioned. But the bubble in property prices was to have wider repercussions.

The property boom went back to the late 1980s, when Thailand was enjoying double-digit growth. With that kind of growth rate, there was indeed a shortage of office and residential space, particularly in Bangkok. The resulting construction spree was only to be expected and in the beginning, justified by demand. But by 1994 it was becoming obvious that supply was overshooting requirements. There was an Indian summer of construction activity, when everyone raced to complete their projects before the impending crash, helped along by the cheap money that was becoming available at that time.

The property sector has a special place in the Thai financial system. The majority of Thai bank loans are based on collateral, with property as the asset of choice. With rapidly rising prices, the property placed as collateral can be used to raise more loans, whose proceeds can in turn be used to purchase yet more property, fueling asset price rises even further. Thus was born a classic bubble. More seriously, the financial institutions were inevitably drawn in. The travails that Thai banks and finance companies are currently going through are in no small measure due to the close nexus between property and bank loans.

However, while the bubble arose in large part out of private decisions, there were major policy and regulatory failures also. One should not fault the Bank of Thailand simply for having liberalized the financial regime, a decision which set in train the events which caused the bubble to grow and then to burst. Liberalization under the right circumstances can be beneficial. The fault was the failure to follow through that liberalization with strict prudential measures, and to take firm action when it was needed.

First of all, the central bank should not have continued with an essentially fixed exchange-rate regime. An open capital account has repeatedly been shown to be incompatible with such a regime (unless there is a very strong currency board that strictly eschews the use of monetary policy). The crises of Chile in 1982, Sweden in 1990 and Mexico in 1994 can be cited as examples of the failure to heed this rule. The reason is that the insurance against exchange-rate movements offered by the central bank tended to encourage excessive movements of capital, both inwards and outwards. The outward movement would also be bound to be more violent if associated with a fear of devaluation, which is what happened in the first half of 1997.

Second, even granted the central bank's decision to keep the exchange rate fixed, the authorities can be faulted for not taking appropriate action to control excessive demand. True, the Bank of Thailand began to apply monetary brakes starting from mid-1994 onwards. But under a fixed exchange-rate regime with an open capital account, monetary policy is not very effective, as was soon shown to be the case. As the central bank's policy pushed domestic interest rates upwards, there was an acceleration of the inward flow of foreign money. The current account deficit rose to 8 per cent of the gross national product in 1995 and 1996. This high current-account deficit was primarily due to the capital inflow which fueled the high domestic investment. The investment rate eventually reached 42 per cent of GNP in 1996.

With monetary policy ineffective, fiscal policy should have become the central instrument to limit aggregate demand. While Thai fiscal policy appeared conservative, with a string of budget surpluses going back almost a decade, it was not so by design. Rather it was an outcome of the strong growth, combined with an excessive caution in the estimate of revenues. In any case the surplus as a per cent of GNP was steadily declining, turning into a small deficit in 1996. The 1996 deficit was in fact a conscious decision to loosen fiscal policy, at a time when monetary policy was already quite tight. But given the overheated economy, this was definitely a wrong move.

If the Thai bubble is to be characterized, then one has to assign the high growth rate and expectations of a perpetuation of that growth rate as a primary cause of the excesses that followed. For with a high growth rate of the economy, asset prices continued to appreciate, revenues continued to grow, and the burden of any debt incurred then could be expected to decline relative to income in the future. With an open capital account, and with the Thai economy performing miraculous feats of continued high growth, debt could be increased seemingly without limit. As foreign money continued to pour in, the growth of the economy continued, confirming the expectations of high growth that generated the state of euphoria in the first place.

By 1996, the assumptions on which growth was premised were being exposed to be false one by one. In the middle of that year, export growth rates that until that point were in the upper teens, sank suddenly to negative or very low levels. The cause of this collapse is still shrouded in some mystery. A part of it can be attributed to the rise in real effective exchange rate, which in turn was caused by the higher inflation rate in Thailand relative to its trading partners. But this is probably only a small part of the story. A larger explanation has to be sought in something which affected not only Thailand, but also other Asian countries, where a similar phenomenon can be observed.

Whatever the cause of this decline in export growth rate, it portended a serious problem for the economy, for it was (and is) widely believed that a high growth rate in exports is a sine qua non of the continued high growth of the economy. Without a high growth rate in exports, there cannot be a growth of the overall economy, and without the high growth rate of the economy, many of the investments that were made on the expectation of perpetual high growth would turn out to be unprofitable. The huge foreign debt of close to 80 billion dollars to finance all these investments now loomed much larger, because there was no longer any hope of future growth to lessen its burden. Not to be forgotten are the debts owed to domestic financial institutions. The question of whether they would be repaid had become a burning issue. Unsurprisingly, questions began to be raised as to how viable these financial institutions were.

Imagine now a foreign speculator as he surveyed the problems of the Thai economy at the end of 1996. It did not require particular astuteness for him to realize that asset prices in Thailand were considerably misaligned. The prices of land, property, and stocks were well above what was justified by their future returns, particularly now that growth was no longer automatic. Even the value of deposits in some of the Thai financial institutions would be less than their face value, if proper consideration were given to the assets backing these deposits. For the speculator, such expectations, verging on certain knowledge, could in theory be converted into profit.

But there is a problem in the working of the asset markets. When an asset price is expected to rise, profit can be made by buying the asset and waiting until the price actually rose. On the other hand, when the asset price is falling, the matter is more complicated. For here, profit can only be made by short-selling the asset, i.e. promising to deliver the asset to the buyer in the future at a price to be agreed upon now. Now, short sales are possible only in very few markets. The one important market where short sales can be easily made is the currency market.

Thus the only way our foreign speculator could make a profit on Thailand in Thailand was to short-sell the baht. It is thus not surprising that beginning in November 1996, waves of attacks were made against the baht, hoping that the central bank would be forced to devalue it. Each wave was met by a stout defense by the Bank of Thailand, but each such defense cost the Bank considerable foreign exchange reserves. The fiercest attacks came in May 1997, and by the middle of the month, the Bank had almost run out of net reserves which had stood at 33.8 billion dollars at the beginning of that year. It barely avoided devaluing the baht then, but only by sharply reversing the policy of opening the foreign exchange market that it had been conscientiously following for the last decade. What it did was to sharply curtail the flow of baht overseas to catch those who short-sold the baht in a squeeze and also to prevent it being used for speculative purposes. A gap arose in the baht exchange rates on-shore and offshore with the latter commanding a premium at times of as much as 10 per cent.

This closing-off of the flow of baht overseas was undertaken too late, and extended the life of the old baht exchange rate by only six weeks. In June, the problems of the baht worsened. This time it was a run away from it by the Thais themselves, not by outside speculators. Finally, on July 2, the baht was floated, whereupon its value sharply deteriorated.

The fall of the baht, dramatic though it was, was accompanied by another event that was to prove more painful for Thais in the end, that is, the implosion of Thailand's financial system. It was becoming clear to many depositors that the balance sheets of many financial institutions were extremely shaky, with some being near insolvent already at the beginning of the year. Many of the loans, particularly to the property sector, were already non-performing. But with the economy spiraling downwards and, after the flotation, with the baht rapidly depreciating, the total size of the non-performing loans was becoming larger. Often in the past, the government has bailed out the depositors of insolvent banks, but there was no automatic guarantee. Considerable uncertainty existed, which led to a mild run in the beginning in the first and second quarters of 1997, but which later gathered momentum in response to misguided policies by the central bank.

The Bank of Thailand, as the supervisor of these institutions, began to move on some of the worst cases, first asking them to increase their capital, and then encouraging them to merge. These actions were actually too weak as these worst cases were already technically bankrupt. Under such a circumstance, the existing shareholders and the management should have been ejected, and the firms taken over by the central bank to eventually dispose of the assets, without closing down their doors for a single day. The Bank of Thailand chose not to do this. Rather, when the first lot of ten companies could find neither the capital nor any partner to merge with, they were "suspended" together with six more.

Suspension meant the doors of these companies were closed for the time being until the central bank decided what to do. Their fate was to be decided within three months. But meanwhile, depositors could withdraw money only from another (government-owned) bank after three years - immediate withdrawal would entail discounting at 12 per cent per annum.

The central bank stated that these companies were suspended in order to separate the really sick ones from the remainder, which, the central bank assured the public, were perfectly safe. Nobody believed it. What had been a gradual bleeding of deposits developed into a run on all the finance companies and later, on some of the banks as well. These heavy withdrawals were made up by the central bank acting as a lender of last resort, all the while working under the assumption that these companies were illiquid rather than insolvent.

Despite the earlier assurances of good health, on 5^th August 1997, forty-two finance companies were also suspended. This sparked the biggest run, which continued for the rest of the year. It is not clear how much the International Monetary Fund shared in this decision. The closure was prior to Thailand's entry into the IMF program, and it was said at the time that this was the entry price into the program. The first letter of intent did indicate this as one of the measures that was already implemented. According to the summary of that letter issued by the Bank of Thailand,

At the very least, this statement reflected the failure of the decision-makers, regardless of whether they were the Thai authorities or the Fund or both together, to learn the lesson from the closure only a few months earlier. A very heavy run on all remaining financial institutions was the natural consequence.

The depleting funds at these institutions were made up by loans from the central bank. To stem the flow, the government assured both depositors and creditors who had lent to these institutions that they would get both principal and interest back. All of these actions led in effect to the transfer of a very large chunk of the financial institutions' assets to the central bank - assets which were of highly dubious value. To finance these transfers, the Financial Institution Development Fund - FIDF (which is a part of the central bank, although it is a distinct legal entity) began to issue notes which ballooned in size, so that eventually they totaled nearly a trillion baht. Worse than that, during the period when there was a severe run and a big demand for FIDF loans by the finance companies, the Bank of Thailand took up many of the notes that could not be sold in the money market. This meant that there was a major issuance of high-powered money.

Plaguing the Thai economy to this day is this overhang of debt owed by the FIDF - debt owed on the basis of assets yielding negative returns, as their quality deteriorated at an accelerating pace.

The above presentation interpreted the Thai crisis of 1997 as a financial crisis, caused by excessive private borrowing. As the economy unraveled, and already before the collapse in value of the baht, in the first and second quarters of 1997, many financial institutions were illiquid, as an increasing share of their loans became non-performing. Over 1997, many became insolvent. Hit at home by these problems, abroad by a sudden unwillingness of foreign lenders to lend or even to roll over old, mostly short-term debt, and required by the central bank to increase their capital base, they became much less willing to lend to their customers. The sudden withdrawal of credit led in turn to a severe deflation and a contraction of the economy.

The collapse of the baht led, as is well known, to widespread contagion throughout East Asia, which fed back to the foreign exchange market for the baht. With the collapse the Indonesian rupiah and the Korean won, the baht went into free fall. The consequences can be seen in Figure 2. The value of the baht at some point sank to levels that were unimaginable before it was floated on July 1997, and even now (August 1998) stands at a level that implies a depreciation of more than a third.

To shore up the currency therefore, extremely tight monetary policies were imposed. The already tight credit market thereby tightened further, with obvious effects on the economy. The deterioration in the economy began to have a serious effect on employment from about the third quarter onward. Sectors hit hardest in the beginning were financial services and that part of the manufacturing and services that catered to the domestic market, although some firms began to switch their efforts to export markets. However, aside from agriculture, the beneficial impact of the baht's collapse on export dollar values was not as large as expected, because of the simultaneous collapse of many other Asian currencies and the severe shortage of working capital occasioned by the credit contraction.

In assessing the impact of the crisis on the rest of the economy, we run into the difficulties caused by the nature of Thai statistical system, such as it is. Where they exist, they are late, and in many cases they do not exist at all. What is worse, different sources collect different statistics on ad hoc, contradictory bases. At this juncture, the impact of the crisis on savings and investment cannot be discerned, as national accounts data are available only on an annual basis, and figures for 1997 as a whole are still preliminary, showing a growth rate of -0.4 per cent.⁽¹⁾ This was the first time since 1951 (when national accounts data were first officially compiled) that the economy contracted.

In lieu of objective data, we can sense the changes by looking at what the authorities claimed or forecast to be the case. A record of their expectations can be discerned from the four letters of intent written by the Minister of Finance to the IMF, which officially began its Thai program in August 1997. Attached to these letters are the memoranda prepared jointly by the IMF and the Thai authorities. Table 1 shows the estimates of the various economic variables, all for the same year, 1998, but as expected at different times by the authorities. The figures clearly indicate a rapidly deteriorating situation, except for the current account surplus.

Even for the current account, the apparent improvement was really a mirror image of the very large deterioration in the capital account in the balance of payments. The central bank could not cushion the effects of the capital outflow by drawing down the reserves since these had already been exhausted. Since exports were not expanding sufficiently rapidly - performance in this area has been extremely disappointing - the only way the market mechanism could cope was to ration imports through an increase in the price of dollars.

The depreciation of the baht played havoc with the balance sheets of the corporate sector, many of which had large loans denominated in foreign currency. The deterioration of their balance sheets in turn made them poor credit risks. Even the banks had been awash in money, they would have been reluctant to lend. But, of course, banks were very illiquid from the second quarter of 1997 onwards. All of these factors led to a severe credit crunch. The credit crunch was partly responsible for the severe contraction of the economy.

The one positive outcome has been the relatively low rate of inflation in the face of such severe depreciation of the currency. With an increase of more than 50 per cent in the price of the dollar, and with such an open economy, a ten-percent rate of inflation is surprising. On the other hand, with a real depreciation of the local currency of such an order of magnitude, the failure of exports to perform is all the more disappointing.

As the financial crisis began to hit the real economic sector and then to the society below, the ripples began to widen and to affect the poor. Three major pathways can be discerned. One is through the impact of exchange-rate changes, another through the fall in production and employment, and the final one through the decline in the government revenue (see Figure 3).

Table 1
Key Macroeconomic Variables for Thailand in 1998
as Expected in the Various Letters of Intent
between the Thai Government and the IMF

Variable	LOI-1 Aug.97	LOI-2 Nov.97	LOI-3 Feb.98	LOI-4 May98
Real GDP growth (percent)	3.5	0 to 1	-3 to -3.5	-4 to -5.5
Consumption growth	0.8	-1.1	-5.0	-8.0
Growth in Gross Fixed Investment	-0.8	-6.5	-21.0	-24.0

CPI Inflation (end period, per cent)	5.0	6.0	10.6	10.0
CPI Inflation (period average, per cent)	8.0	10.0	11.6	10.5

Saving and investment (percent of GDP)
Gross domestic investment	35.9	34.3	29.1	28.2
Private, including stocks	26.1	24.7	17.6	16.4
Public	9.8	9.6	11.5	11.8
Gross national saving	32.9	32.5	33.0	35.0
Private, including stocks	21.5	21.7	23.0	25.6
Public	11.5	10.8	10.0	9.5
Foreign saving	3.0	1.8	-3.9	-6.9

Fiscal accounts (percent of GDP) 1/
Central government balance	1.0	1.0	-1.6	-2.4
Revenue and grants	17.8	16.6	15.8	15.5
Expenditure and net lending	16.8	15.6	17.4	17.9
Overall public sector balance	1.0	1.0	-2.0	-3.0

Balance of payments (billions of US$)
Exports, f.o.b.	61.0	60.9	60.1	57.5
Growth rate (in dollar terms)	8.6	7.9	6.2	1.4
Growth rate (volume terms)	n.a.	n.a.	10.6	8.8
Import, c.i.f.	67.6	64.3	56.8	50.5
Growth rate (in dollar terms)	1.6	0.2	-7.7	-17.7
Growth rate (volume terms)	n.a.	n.a.	-5.2	-13.6
Current account balance	-5.3	-2.5	4.4	8.5
(percent of GDP)	-3.0	-1.8	3.9	6.9
Capital account balance	1.8	0.3	-12 to -14	-14 to -16
Medium-and long-term	5.3	8.5	2 to 3	4 to 6
Short-term 2/	-3.5	-8.2	-15 to -16	-18 to -20
Overall balance	-3.5	-2.2	-8 to -10	-6 to -8
Gross official reserves (end year)	24.5	24.8	23 to 25	26 to 28
(Month of imports)	4.3	4.6	4.9 to 5.3	6.2 to 6.7
(Percent of short-term external debt)	74	87.	109 to 118	114 to 123
Forward position of BOT (end year) 3/	n.a.	n.a.	-9.0	-9.0

Source: International Monetary Fund, based on information provided by the Thai authorities; and staff estimates

The Exchange-Rate Pathway: Normally, a depreciation of the currency would be expected to have an expansionary impact on the economy, as the tradable sector would receive a higher baht income from its sales. In Thailand, farmers in general appear to have benefited directly from the currency depreciation.

Even though rice output was slightly down from the low rainfall induced by El Nino, its price and the prices of most other agricultural products turned sharply upwards in direct response to the rise in exchange rate, as well as the increased demand arising from the impact of El Nino on other countries. There is one important exception. Rubber growers who produce Thailand's second most important crop (after rice), saw the baht price of their product rise only temporarily before coming down to the same level as before. This lack of response of the rubber price to the depreciation reflected the simultaneous depreciation in the currencies of Indonesia and Malaysia, the other major suppliers to the world market.

Countering the benefits of agricultural price increases for farmers is the fact that there are other poor who are food buyers. Food prices have risen sharply in response to the devaluation of the baht (food in Thailand comprises mostly traded goods). Rice prices more than doubled at one point.

Those familiar with most Asian countries (where there are large numbers of landless laborers) would tend to conclude that such large increases in the staple food price cannot but hurt the poorer households, as they would tend to have a higher share of their incomes from employment than from farming. However, the evidence in Thailand indicates the opposite. Figure 4 provides data on sources of income in 1996 for rural households (75.2 per cent of the poor in Thailand lived in rural areas in 1996). It can be seen that among the bottom decile, a greater share of income is
derived from farming than from wage labor. And since the discussion centers on rice and the price of rice, as much as a third of the poor households are headed by rice farmers, while their share among all households is only one-sixth.

Source: Calculated from National Statistical Office's 1975-1996 Socio-economic Survey.

The Employment Pathway: Thus far the discussion has concentrated on the direct impact of the exchange rate on the incomes of the farmers. The indirect impact is quite different. With the contraction of the economy, demand for labor fell. The consequent fall in employment is the second pathway by which the crisis reached the poor.

How large has the fall in employment been? Here we come to the most hotly contested area in Thai public policy. Much of the debate has resulted from late statistics and unclear definitions of unemployment. Data from the Labor Force Survey⁽²⁾ for February of 1998 have just recently (July 1998) been made available, which allows a more detailed analysis of the changes in unemployment between the beginning of the dry season of 1997 (and a few earlier years) and the corresponding period in 1998.

Table 2
Employment and Unemployment of persons who are 13 or older in February
1995-1998 (In Million Baht)

Source : Labor Force Survey [ROUND 1]1995, 1996, 1997, 1998, National Statistical Office, data tapes

Table 2 provides employment data for February from 1995 to 1998, from which the following conclusions may be drawn.

Table 3 analyses further where the unemployed and underemployed workers were. While unemployment increased everywhere, the rural Northeast stands out with its exceptionally high incidence (Part A of Table 3). During the bubble, this particular region was probably the last one that had surplus labor to export to other regions. With demand drying up, the workers that had gone elsewhere returned to their villages. That the incidence was high particularly for them suggests that they were among the first fired.

Distribution and Incidence of the Unemployed and Underemployed
February 1997 and February 1998

Notes: Rural defined as villages; Urban defined as municipalities and sanitary districts.
Source: National Statistical Office, Labor Force Surveys, Round 1, 1997 and 1998 (data tapes).

The distribution of the underemployed (i.e. those working less than 20 hours) gives a totally different picture. Here the exceptional regions were Bangkok and the rural South. Further analysis (not tabulated here) of the sectoral distribution of those who were thus under-employed adds a further surprise. They are not in the informal sectors as would be expected. In Bangkok, three quarters were in the industrial sector (industrial as defined here excludes the construction sector), and women were more at risk than men. In the rural South, four-fifths were in agriculture, probably a consequence of the low prices for rubber.

The greater prevalence of short-time employment in the industrial sector in Bangkok suggests the following further hypotheses (currently available data do not allow substantiation). In the industrial sector, employers were putting workers on short time in order to avoid paying their workers their severance pay. The spate of layoffs that is now (August 1998) being observed is mostly a consequence of a change in the law that increases the size of the severance pay. Employers who have been putting their workers on short time have rushed to lay them off before the new law comes into effect on August 19.

Together with this rise in unemployment, another phenomenon of the labor market cannot be denied, even if the data are (as usual) missing: wage rates have come down even in nominal terms. That it has widely occurred among the salaried in Bangkok is widely reported. By how much is unknown. Still less is known about what is happening to rural wage rates. It is natural to conjecture that the backward flow of labor from urban to rural areas would press down wages. Given the 10% annual inflation rate expected this year, real wages everywhere would have sharply deteriorated. The real gain in wages that occurred during the boom years, which were estimated at around 6-6.5 % per year between 1989 to 1995 appears to have been sharply eroded.

The Fiscal Pathway: The next pathway by which the economic crisis will have an impact on the poor is through the fall in government expenditures, occasioned by the fall in government revenues. Table 4 shows the decline in government revenues relative to the same quarter in the previous year. In reading this table, it should be borne in mind that the figures for the last two quarters of 1997 were affected by the sharp increases in the value-added tax (from seven to ten per cent) and in the gasoline and diesel excise taxes in August.

Table 4
Changes in Government Revenues
(per cent relative to same quarter of previous year)

Given the severe constraints on the size of the budget surplus/deficit imposed by the IMF, the fall in revenues has occasioned recurrent cuts in expenditures. In cutting expenditures the government acted under the advice of the IMF, and used the following criteria to target programs slated for cuts:

These criteria were applied both for the mid-year budget cuts in 1997 and for the budget cuts introduced in 1998. In addition, programs that aimed to improve Thai competitiveness, in the areas of health and education, and that aimed to lessen the social impact of the crisis and to improve the economy of the provinces were to be protected from cuts.

The application of these criteria led to the cuts in the 1997/98⁽⁵⁾ budget as described in Table 5.

A quick perusal of the figures indicates that, broadly speaking, there was an attempt to follow those criteria, but this was not consistently done. Thus, the sharpest cuts were in transport and communications, but balanced against that were equally severe cuts in environment and in social services. Education and health were somewhat protected, but balanced against that is the slow decline in general administration. It is possible that these outcomes reflect some additional considerations in addition to the criteria listed above. Thus, as civil service pay was protected, and there was no attempt to redeploy government employees across programs, those programs that were "civil-servant-intensive" (e.g. general administration) had an automatic protection from cuts. Also, as capital expenditures were easy to cut, investment programs (e.g. transport) were more readily curtailed.

The cuts in education and public health have inevitably affected a number of programs, such as those related to the AIDS epidemic, for example. But as far as providing support to those that were directly affected by the crisis, it is fair to say that the real problem is more a dearth of ideas as to what can be done, than an unwillingness to spend the money. However, in one area, where there is already an institutional framework, the government decided to save money by cutting down its payment into a social insurance fund (currently being used to provide health insurance for those employed, and still substantially in surplus).

In a sense, the poor in Thailand have been somewhat "fortunate". By not benefiting from any major transfer programs or subsidies that target the poor (such as food subsidies) during normal times, there was relatively little for them to lose through the fiscal cutbacks during the hard times.

The crisis of 1997 severely tested the major political institutions of the country. Surprisingly, what was considered the weakest among these, namely the parliamentary system, emerged with some credit. In the past, such a stress would have led to a major crisis, during which calls for an army intervention would quickly gain momentum and end in a coup d'etat. But during 1997, the institution that most Thais like to disparage made two moves.

Throughout the period, the armed forces stayed firmly in the sidelines, except in the constitutional debate, and then only because the current Senate still has among its members a sizable representation from the armed forces.

To be sure, the constitutional reform was possible only because the crisis brought to the surface so much dissatisfaction with the existing political system that the civil society was mobilized to push for constitutional reform. Nevertheless, the parliament has to be given credit for heeding these demands, even though for many of its members, to accept the new constitution was an act of near suicide. In looking over the history of constitutional changes in Thailand, of which there had been more than a dozen within the last sixty-five years, the reform of 1997 was the first that was passed by constitutional means with popular participation.

The prime minister ruling Thailand for most of 1997 resigned in November as the economic crisis deepened, and as the feeling became widespread that his Cabinet could not cope with the myriad problems. A new prime minister who had a more competent team of potential economic ministers within his party was voted into office by Parliament. This peaceful and constitutional transition during a time of severe stress indicated a certain maturing of Thailand's democratic traditions.

It was another important political institution that failed the test badly, namely the economic technocracy. This was surprising, inasmuch as this institution had in the past been considered a tower of strength, particularly in times of crisis. The biggest disappointment was of course the Bank of Thailand, which now badly needed extensive reforms.

But the central bank is not the only institution that failed the test. The other economic agencies - the Ministry of Finance, the Budget Bureau and the National Economic and Social Development Board - were all found wanting. Their central task in the past was to formulate an annual macroeconomic strategy centered on the budget. Unfortunately, this task had become moribund during the bubble, as there was a tendency for revenue to run ahead of expenditure, leaving these agencies with little to do. Just as important, their lackluster performance was part and parcel of the general decline in the quality of Thai bureaucracy, as the abler civil servants were siphoned off to the private sector.

It appears that the days of the economic technocracy, as we know it, are numbered, and they are unlikely to be revived. Without the technocrats or able economic technicians in the ministries and with the central bank demoralized, the elected politicians had to fashion a strategy on their own. They were eminently unfit for this task. Nor did they have any infrastructure, within their own political parties or elsewhere in the civil society, to help them in their task. For that reason when the IMF was brought in, most Thais were relieved.

Nonetheless, elected politicians are bound to be more assertive than they had been in the past in macroeconomic matters. A new design for the whole macroeconomic decision-making machinery is most urgently needed.

Because of the collapse of the economic technocracy, there was no clear macroeconomic strategy formulated on the Thai side throughout most of 1997. The International Monetary Fund had to enter the picture in August. The Fund provided credit lines amounting to $4 billion, which together with other contributions totaled $17 billion. However, just as important was their input and authority in fashioning a response to the crisis. From this point on, with the strong input from the IMF, it is difficult to speak of a Thai government response to the economic crisis, as most key strategies were and still are formulated under the guidance and authority of the Fund.

Among the most serious problems that the Fund faced in Thailand was the bloated balance sheet of the Bank of Thailand, which resulted from pouring funds into a financial system bled dry by the runs that occurred throughout most of 1997. The panic peaked in August, caused by the above-mentioned shutting down of the 42 finance companies at the behest of the Fund. A second problem was the low level of international reserves, depleted almost to zero by the futile attempt to defend the baht. The Fund perceived its and the Thai authorities' central problem to be the restoration of confidence in the Thai currency and the Thai economy. For this objective to be achieved, it arranged loans of 17 billion dollars from myriad sources,⁽⁶⁾ not to be spent, but to be used to rebuild reserves. It then attached stringent monetary and fiscal policy conditions. The more important elements of the Fund's program as outlined in the first letter of intent (August 21, 1997)⁽⁷⁾ included:

The second letter of intent was dated 25^th November 1997, in the immediate aftermath of the outbreak of the Korean crisis. The writer in this case was the new Finance Minister in a cabinet which had came into office only a few weeks previously. The program admitted that the new framework was under a worse short-term macroeconomic outlook than anticipated. In other words, the attempt to convince the markets by measures taken in the intervening period had been unsuccessful. Capital continued to flow out, and the baht continued to depreciate, no doubt helped by the spread of the crisis to other Asian countries.

Nonetheless, in the face of "slower pace of the economy", the second letter of intent continued with the same firm fiscal policy stance as before. The government would maintain a fiscal surplus in the consolidated public sector of 1 per cent of GDP for 1997/98. The monetary policy, written during a period when the baht had depreciated to the high thirties to the dollar (see Figure 2), was to remain extremely tight. But "once the foreign exchange rate has stabilized, the program envisages the … ranges for the overnight repurchase rate [to be] 15-20 per cent."⁽⁸⁾ [Italics added].

But of course the foreign exchange rate did not stabilize. The period between the second and third (dated 24^th February 1998) letters of intent saw the value of baht to the dollar sink further, from the high 30s to the mid 50s, as both the Indonesian and the Korean currencies went through major upheavals of their own. Further, the Thai economy was sinking further into recession.

Consequently, in preparing the third letter of intent, both the Thai government and the Fund recognized that a softening of the policy stance had become necessary. Although a central government deficit equal to 2 per cent of GDP was projected for the fiscal year 1997/98 in the absence of any government action, only some minor tax and expenditure adjustments were undertaken. A final figure of 1½ per cent deficit was deemed satisfactory. In addition, the state enterprises were allowed to incur a ½ per cent financial deficit. Unlike in the first letter, the cost of financial restructuring was taken out of consideration in the above calculations.

Since the third letter was written during a period when the baht had sunk to its lowest level, a strict monetary policy was maintained.

It is only in the fourth letter of intent (dated 26^th May 1998) that the Thai authorities and the Fund could look back with some satisfaction at the results of their efforts. The baht bounced back from the mid-50s to the high 30s again, and remained in the low 40s, despite the Indonesian convulsion in May 1998 and the continued depreciation of the yen. Consequently, the overall public sector deficit was allowed to widen to 3 per cent of GDP, and for the first time, a monetary easing was being proposed.

This first piece of good news must be considered against a backdrop of continued decline of the economy. As a consequence, the financial sector's balance sheets were showing increasing deterioration as the size of non-performing loans mounted. At this point the macroeconomic stabilization policies can no longer be separated from the travails of the banks and the finance companies.

This account indicates that the policy response of the Thai authorities and the IMF was mainly reactive to surprising developments. The runs on financial institutions were not the only surprise to the Thai government and the Fund. Specifically, over the first year of the IMF program, they were also surprised by:

Should the Fund and the Thai government have been thus surprised? It is difficult not to sympathize with them regarding the first of these two. Very few analysts could or did predict the contagion effect until it began. With hindsight, one could reasonably have expected at least the two Bretton Woods institutions to catch on early, because of the fuss that was to be made about corporate and political misgovernance as an explanatory factor for the crisis which eventually engulfed much of East Asia. As Thailand was not uniquely (or even outstandingly) deficient in this respect, the failure of the two institutions to predict that other countries would be as vulnerable as Thailand was surprising.

Less excusable has been the Thai government's and the Fund's inability to forecast the severity of the decline of the Thai economy. In perusing the letters of intent, it is difficult to avoid the impression that neither the Thai authorities nor the Fund had the tools to predict properly the consequences of their own actions. GDP growth forecasts provided the amount of fiscal resources and the constraints on money supply. From this exercise, policy prescriptions were drawn without examining the feedback effects from the very same policies or posing clearly the counter-factual of what would happen if the prescriptions were not adopted. This was a source of considerable weakness in estimating the effects of their actions.

Forecasting GDP without looking at the impact of demand-side management is of course consonant with classical (i.e. pre-Keynesian) economic theory. As unemployment developed, the authorities' use of this theoretical position in framing policy became increasingly inappropriate. Admittedly, they have become somewhat more pragmatic over time, as can be seen in the increased willingness to allow an expansionary fiscal policy since the beginning of 1998.

The problems of Thai financial institutions seem to be unending. The runs that followed the suspension of the forty-two finance companies began to abate at the end of the year. Together with the sixteen suspended earlier, the total number of finance companies whose doors were supposed to be temporarily closed came to fifty-eight. In the meantime, the companies themselves were to come up with a recapitalization plan. On 8^th December, a decision was made that the submitted plans were inadequate for all but two of the companies, and so 56 of the 58 finance companies were closed down permanently.

Several weeks later, at the very end of 1997, one small bank was taken over by the government, followed by three more in February 1998. Their management was removed, the existing equity reduced to a nominal amount, and the debt owed to the FIDF converted to equity. These banks were in effect nationalized. This time around, the banks were allowed to continue their operations, so that no panic resulted.

Nonetheless, even though these banks were taken over, or perhaps because of it, their figures for non-performing loans (NPLs) went steadily up, as the economy continued to sink. Worse, healthy banks were also facing the same problems, and their recapitalization needs began to pose a serious problem. For a while, it looked as though this could be done, as the Bank of Thailand was reducing its rules against foreign ownership, and foreign buyers were expressing interest in many Thai banks.

Indeed, in March 1998, two of the largest banks, Bangkok Bank and Thai Farmers' Bank successfully raised capital overseas. Unfortunately, their success was the undoing for the other banks in the system. It turned out that they luckily floated their new shares during a very narrow window of opportunity. Soon after, the yen was facing severe problems, and Asia went out of fashion once more. The NPL figure in the Thai banking system continued to move relentlessly ahead, pulling banking share prices down further. Those who put their money in the two banks lost a great deal of money. After that, it became impossible for any other bank to raise capital in the markets.

Eventually, the government had to step in and announced on 14^th August 1998 a series of measures to facilitate the recapitalization of banks, if necessary by means of public funds. Two more banks were taken over by the government, and were to be merged into two government banks, together with two of the banks that had been taken over earlier in the year. Two other banks that had then been taken over had their FIDF debts converted into equity, to the point where their NPLs are now adequately covered with reserves up to the year 2000. These are to be sold to investors, most likely foreign. One bank, the Bangkok Bank of Commerce (BBC), was to be closed down altogether.

The more important part among the 14^th August measures eases the recapitalization burden by shifting the proportions of tier-1 and tier-2 capital in favor of the latter. It also provides government funding through issuance of bonds in exchange for bank debentures to beef up Tier-2 capital or equity to increase Tier-1 capital. To get Tier-1 capital, banks must show plans to bring forward their capital base deadline from 2000 to the present.

These restructuring and recapitalization measures do not in any way involve the separation of good and bad assets, as has become the standard practice in other countries' restructuring of their banking system. The Minister of Finance who designed these measures believed that to separate out the non-performing loans would preclude their getting further liquidity to help them become good debtors again. There was also concern about the problem of valuation of these problem loans.

The attempt to fiscalize the cost of the massive financial bailout has proven and will continue to be the most intractable. Not least among the problems is that the eventual net cost to the taxpayers remains unknown, at least with any precision. The amount lent out by the FIDF, including the finance companies' notes taken up by the Krung Thai Bank at the request of the central bank totaled more than a trillion baht. The current interest cost on this sum alone is in excess of 100 billion baht. In addition the FIDF notes overhanging the money market have been keeping an upward pressure on interest rates. With high interest rates, economic recovery remains stunted.

Eventually, some of this money will be recovered, but most estimates put the figure at around fifty percent of the total. The disposal of the assets has proven agonizingly slow, although the Financial Sector Restructuring Agency (FRA), charged with this task, is speeding up and on course to meet its deadline of December 1998 to complete it. Meanwhile the interest burden for the FIDF has been accumulating. In March 1998, the government began to attack the problem by issuing a decree, later ratified by the parliament, to enable it to float a bond issue up to 500 billion baht to retire the short-term notes issued by the FIDF. To this cost must be added the amount to be used in the recapitalization of banks which are still in operation.

Together, it is estimated that the cleaning up of the FIDF problem and the recapitalization of the remaining banks will cost the taxpayers annually some 100-200 billion baht, a non-marginal addition to the Thai budget, the total size of which is currently 800 billion baht. Such a discrete jump requires two programs: privatization of State assets and a restructuring of the tax system.

Privatization: A privatization program has been incorporated into the various letters of intent almost from the beginning. Given the cost of rescuing the financial system, this seems to be the obvious way to recoup it and thus reduce the amount of new taxes that would otherwise be necessary. Two not entirely unconnected problems will make this process of recouping the cost much more time-consuming than is normally realized.

The first is that many of these enterprises are monopolistic and therefore earn a great deal of monopoly rent. Even the international component of the national airline has valuable landing rights. The rights to earn the monopoly rent were written into the acts of parliament that chartered the enterprises. If these enterprises are to be sold off, these acts will have to be rewritten to remove the monopoly rights. Given the snail's pace at which Thai legislatures work, these changes will take a great deal of time to enact.

Worse, in many instances, the monopoly rights have been divided up, and "sublet" to private companies. To take an example, cellular phone companies are privately operating under concessions granted by the two State telephone monopolies.⁽⁹⁾ These concessions divided up the profits (or in some cases revenues) between the monopolies and the concessionaires, under certain rules concerning pricing - rules which assumed continued monopoly in telephony. Any dilution of that monopoly would require renegotiations of all these contracts, which involve bargaining over the said monopoly rents. Such bargaining is unlikely to yield quick results, as some, perhaps even all, parties have an interest in prolonging the negotiations as long as possible. Every delay implies a longer period during which to earn the monopoly rent.

There is also a second reason for delay. Public enterprise unions have traditionally been very strong, even though their power was clipped when the last military government banned them in 1991. Their power was revived with the return of the civilian government in 1992. Many state enterprises are also overstaffed, and known by all to be overstaffed. Since privatization would clearly lead to the elimination of many jobs, union resistance to privatization is understandable, if difficult to overcome.

For these reasons, it is expected that the use of privatization as a means of paying for the rescue of the financial system will, at the very best, take place over a much longer term, during which tax money will have to be found.

Tax Restructuring: While it is possible to craft a tax package to raise the amounts required, the political problem is bound to be enormous. A point worth noting is that the beneficiaries of the financial bailout, namely depositors in the finance companies, do not belong to the poorer sections of the country. Additionally, some of the owners of the finance companies have now been shown to have engaged in many shady practices that brought their companies down. To impose additional taxes collected from the economy at large, and from the poor in particular, would not go down very well.

Yet the deed has been done. Depositors have received their guarantees. Some owners of finance companies have taken their money and run, while others cannot be made to come up with the sums involved. Fiscalization remains the only option to close the chapter on the bubble and the crisis of the 1990s. How then to persuade the Thai taxpayers to accept this new burden, manifestly unfair though it is?

A proper approach should eschew marginal tax changes here and there, but rather use the opportunity to engage in a radical tax reform, employing a process that assures the population that a serious attempt is being made to restore some fairness to the system. In doing so, the process is as important as the outcome. The question is who will formulate a tax reform strategy. Tax reform is an inherently complex task at the best of times. In the present circumstances it is so charged with political complications that this "who" question demands attention.

Constitutionally of course, this role belongs to Parliament, and it will have the final stamp of authority. The next question is who will submit a politically credible tax reform strategy to the Parliament. Again, constitutionally, the government is charged with that duty. But in designing the package, all sorts of details will have to be worked out, each of which will have considerable impact on various sections of the population. Normally the economic technocrats within the Ministry of Finance could have been trusted to engage in the task; but that trust has been forfeited during this crisis.

Furthermore, to meet the demands for greater fairness in the tax system, new forms of taxation will have to be devised, such as property taxes or inheritance taxes, both of which have been much discussed but never implemented. These new taxes should not be considered in isolation however, but rather in the context of overall fiscal needs as well as of the impact on the entire economy.

To have broad-based acceptance, a new mechanism has to be devised to engage in a hardheaded dialogue with the population. A possible mechanism would be an appointment of a commission that will engage in the task of revising the entire tax and expenditure system of the Thai central government, and that will conduct pubic hearings and to solicit as wide an opinion as possible. But the commission must be equipped with the means to do the staff work necessary to acquire the information and to do the research for the dialogue not to degenerate into emotional confrontations.

Clearly, such a task would take at least a year, if not more, to complete. In the meantime, taxes would still have to be raised to finance the mounting interest cost of the bailout package. A package will therefore have to be devised in Parliament, incorporating both short-term tax increases and long-term reform.

Almost all Thai enterprises, including those listed in the stock exchange, are basically family enterprises. In such a situation, the only moral hazard problem arises from limited liability, which is of concern only to the creditors. Among these of course are the financial institutions whose solution to the problem in the past was to rely on devices such as a very extensive use of collateral. But the use of collateral is as good as the efficiency with which foreclosure procedures are followed. In Thailand, foreclosures can take three to five years between initiation of the proceedings to the time when lenders actually see the cash. It is not surprising that in settling debts, banks and finance companies are finding it exceedingly difficult to collect.

But if companies can continue to hold banks hostage because of inefficient foreclosure procedures, the public has a great deal to lose because of the blanket guarantee of deposits and credits to financial institutions granted in 1997. The authorities therefore, have moved reform of foreclosure to near the top of their agenda.

The reform of foreclosure follows an earlier reform of bankruptcy. Until 1998, Thailand's company bankruptcy law provided only for its liquidation. There was no Chapter-11-type procedure to keep a company going until all its debts were worked out. Such a procedure was introduced in the first stab at bankruptcy reform introduced in 1998, only to be watered down substantially in the Senate by a group of senators who are owners of near-bankrupt corporations. A second attempt is currently being made.

Without these reforms, the mountain of internal debt will not be resolved quickly. And without quick resolution, the economy will take a very long time to recover.

The bankruptcy and foreclosure reforms are merely those that require immediate attention as a consequence of the dire state of the financial system. More fundamental problems loom over the horizon and these problems are at the heart of Thai-style capitalism.

Essentially this capitalism rests on a close relationship of trust between banks and their clients, to the point where banking families have acquired equity interest in many of their clients' businesses, and where insider lending has been quite widespread. Over time, the very close inter-connection between banks and their clients had loosened, but by and large less formal relationships still stand. At the same time, banks had performed important tasks of coordinating investment by firms. In this function, their importance substantially overshadowed that of government agencies. The sole exception to this last statement was the development of industries around the Eastern Seaboard, where the government took a proactive role, and the banks were followers rather than the leaders.

On the other hand, by relying on these more traditional methods, Thai banks tended to eschew modern (i.e. Western) methods of relying heavily on financial analysis and risk management. It must also be said that, while growth was going strong, such alien techniques appeared unnecessary. Throughout the last three decades, the tried and tested methods of mobilizing capital had worked. Above all, Thai savers had voted confidence by putting most of their savings into banks. As Table 6 shows, Thailand's M2/GNP ratio is among the highest in developing countries.

Table 6
Money and Quasi-Money (M2)/GNP Ratios
in Selected Countries, End of 1996

Note: ¹ Turkey's figure is for 1995.
Source: International Monetary Fund, International Financial Statistics, 1997.

Banks had thus on-lent this money, companies had expanded, and the economy had grown at more than seven percent through the three decades. It was when foreign money began pouring in in large quantities that the delicate nexus joining lenders and borrowers began to unravel, as described in Section A above. Interestingly, foreign financial institutions and analysts for all their wisdom ex post and for all their vaunted techniques available ex ante, did not perform significantly better. It was only the guarantee given under duress by the Thai government in 1997 that saved them from being punished.

It is not that the Thai authorities have ignored the market for long-term risk capital. The equity market was developed and encouraged to grow during the 1980s and the 1990s with that segment in view. The fruit of that development has been to draw in individual investors, mostly from the growing Thai middle classes, rather than the institutional investors, based on life insurance companies or pension funds for example. The problem with relying on individual investors to power the equity market is that the monitoring of corporate officers has been less than satisfactory, a problem compounded by the lack of protection afforded to minority shareholders against the majority family interests.

The crisis probably means the end of traditional Thai-style capitalism. Resuscitating the past is not among the options available, for with the devastation wreaked on the Thai capitalist class as a whole, it is clear that the banks, at the very least, will begin to look distinctly different from now on. The multinational presence will be much more strongly felt, together with their different methods and culture. And with a different banking culture, practices among borrowing corporations that were once taken for granted will have to give way to something different. What shape or form that will be no-one can foretell. What can be predicted is that, because the changes required will be institutional and even cultural, the process will take time. Meanwhile the saving-investment nexus will remain somewhat frayed and growth will therefore be stunted.

A few public actions can be taken to pave the way, however. First of all, the crisis has shown that the almost exclusive reliance on bank capital is fraught with greater risks for the country than most Thais had thought. But, as the matter stands, they are mostly social risks and not private risks. At the system level, the current blanket guarantee on bank deposits removes the private risks altogether and provides exactly the wrong incentive. That guarantee must be removed, gradually, cautiously but firmly, as conditions return to normality.

More positively, measures should be taken to nudge Thai savers toward longer-term risk capital market. After what had happened to the stock market, their movement is likely in fact to be in the reverse direction. If a voluntary move toward that outcome cannot be expected, then perhaps an involuntary approach may be the next best possibility. For this, the traditional role of the State has been in the area of pensions.

The government has on the books a social insurance law, which when fully implemented will have three components: medical insurance for those employed, unemployment insurance and old age pensions. We are here interested in the old age pension provisions, which have not yet been implemented yet.

It is not yet clear whether the plan, under consideration, will be fully funded or pay-as-you-earn. If the latter, the government would be foregoing an opportunity to raise long-term capital, particularly if it is remembered that the majority of workers in the formal sector, who would contribute to and benefit from the program are still overwhelmingly young.

Regardless of the funding mechanism, the government still envisages basically a State run system. If the system is to be fully funded, it would likely invest in government bonds and other safe securities, and again would limit the growth of long-term risk capital.

It is recommended that the government examine the system in place in Chile, which combines the compulsion on the saving side with a more voluntary approach on the investment side by allowing the amount saved to be invested in pension funds chosen by the savers.

Business cycles are not unknown in Thailand - there was a slowdown in growth in the early 1980s, for example. However, the recent slump has been orders of magnitude stronger than anything experienced previously. The question that has arisen is whether Thailand has any safety net for the poorer members of society that would, if not shield them from being affected, but would at least help them if they were.

The strongest safety net has been the rather steep severance pay required if employers were to lay off workers. Before 19^th August 1998, it was six months for those who have worked at least three years. Since that date, the severance pay has been changed so that the maximum rate is now ten months.

This reliance on severance pay in lieu of unemployment insurance has worked well thus far for employees in the formal sector, although research is needed to find out whether the workers have actually benefited from it to the full extent laid down by the law. One obvious problem area arises when the company that is laying off the workers is closing down its operations permanently, or going bankrupt.

Meanwhile, the government has set up a 10 billion baht fund called Fund to Aid the Unemployed Workers. It is too early to say yet how this fund will be disbursed.

Because of the severity of the current crisis, and also because of a desire to pumpprime purchasing power back into the economy, the government has obtained loans from the Asian Development Bank ($500 Million) and the World Bank and OECF ($300 million and $120 million respectively) for a Social Sector Programme and Social Investment Project, respectively. The programme will be implemented over the four year period and the government is committed to three social policy areas: labor market and social welfare, education and health.⁽¹⁰⁾

The Ministry of Labor and Social Welfare (MOL) and the Ministry of Interior have been implementing programs to help laid-off workers. The MOL launched the Centre for Assistance to Laid-off Workers in August 1997 as a one-stop service that includes assistance in the areas of severance pay, social security card, placement and counseling, low-interest loans, and training courses. The government has recently established a committee chaired by the Prime Minister himself to address the short and medium term unemployment situation. Another committee is to formulate a comprehensive program of skill training and employment creation for the unemployed and the newly graduated, including access to credit, land, marketing, and technological resources. Minimum wage increases have been limited to improve the competitiveness in labor force. Line ministries were told to target their help to the poor in rural areas by disaggregating to the provincial level and to vary their assistance according to the incidence of poverty in each province. The procedure by which private enterprises can receive tax deduction for investing in the vocational training of their workforce has also been simplified.

These measures are largely mitigative in response to the crisis. The enormity of the crisis has led many to rethink the entire social development approach. In fact, a new social development program has to be constructed from the ground up, because in the past, there was widespread belief that economic growth was sufficient to generate social development. The turmoil has highlighted how Thai society has not constructed an immune system, while the capacity of the pre-existing immune systems within families and communities were being seriously eroded by economic growth. The aim of the new approach is to reestablish the strength of the ties within families and communities to enable them to support those affected by the crisis.

With the cuts in the government budget, social development projects cannot and should not be implemented through the central government agencies alone because it may not serve the needed target groups around the country. It is important to utilize community organizations, civil society organizations, private business to provide needed services directly to the following target groups. Local and private organization should be trained or encouraged to adopt good management procedure, and they should be allowed to design and choose their own activities to achieve the overall objective of reducing the hardships caused by the crisis.

In this respect it is encouraging that the Social Investment Project loan from the World Bank requires the setting up of a Social Investment Fund to provide grants to community-based organizations to undertake activities designed and implemented by them.

In the analysis of the impact of the crisis, it has been indicated that through the exchange-rate pathway farmers have been favored, but this happy outcome is somewhat negated by the fall in wages and/or the unemployment that resulted from the same crisis. Nevertheless, a very tentative conclusion was drawn above that the crisis may have helped the rural poor somewhat, through the increase in agricultural income. Can this be the basis from which to advance the further conclusion that Thailand should revert back to an agrarian development strategy? The response to this question has to be cautious.

First, an agrarian strategy has to be a long-term strategy, because of the very nature of agricultural investments in areas such as irrigation, agricultural research and so on. Consequently, to turn around and argue for an agrarian strategy at this point is also to accept one of two views: either the present crisis has revealed that Thailand's industrialization of the last decade has been a mistake tout court; or the working out of the crisis will take place over a period much longer than the two or three years currently expected. Both of these are unlikely premises. If so, then a temporary reversal back to an agrarian strategy would be inappropriate.

Having said that, there is no question that during the last years of the bubble, because of the artificially low price of capital, Thailand had hurried along to the capital-intensive and high-technology phase of development at too rapid a pace. Wages have gone up much more rapidly than is appropriate for the level of skills that Thai workers currently have. These high wages have made the labor-intensive sectors in industry (such as textiles, garment and footwear) less competitive in the world markets. The labor scarcity caused by the bubble meant that both Thai farmers and producers of labor-intensive products faced a classic cost-price squeeze - while their labor costs have gone up, they had to sell their products at world market prices.

The real devaluation of the baht that has occurred since July 2, 1997 has given all these sectors a breather. As already suggested, the farmers have partly benefited from it. The next question to be asked is: how long will this real devaluation last, or will inflation eventually catch up and erode the competitive gains that were made during the last ten months? To place the answer to this question in context, the reader needs to be reminded that the level of foreign debt of this country after the devaluation now stands at a very high level. Thailand now has a foreign debt level standing at close to $80 billion, compared to a GNP level of $110 billion at the new exchange rate of 40 baht to the dollar. Clearly, further expansion in the size of this debt cannot take place, although the public sector may be partially replacing the private sector as debtor to foreign lenders. This implies that the next several years will see net outflow of capital rather than an inflow. With a continued outflow, one can reasonably expect the real exchange value of the baht to remain low.

With a depreciated value for the baht (in real terms) continuing for the medium term (say, up to five years), it is possible to see Thailand reemphasizing even more vigorously the export oriented strategy that it had pursued in the past. In the short to medium term, it may even revive some of the unfashionable sunset industries such as agriculture, textiles and footwear.

Banking on labor-intensive and agricultural exports based on a depreciated exchange rate for the long term means that Thailand is staking out this area as being within its competitive sphere. But to continue to play in this arena means that it will be facing stiff competition from lower-wage countries. This would clearly limit the ability of Thais to obtain a continued higher standard of living, at least in the medium term.

While considerable scope exists to move upscale within each of these sectors (Italy, for example, remains one of the world's largest textile exporters to this day), one has to search elsewhere for a long run solution. For Thais to be able to obtain a higher standard of living, their earning capacity must be enhanced, and the only way to achieve that is by technological upgrading of the industries, and for that to happen in turn requires a continued expansion in Thailand's human resources. No "industrial policy" of picking winners will replace the policy of upgrading the skills and knowledge at the disposal of every Thai man or woman.

A long-term development strategy for Thailand is difficult to conceive without human resource development as a major component. The inadequacy of Thailand's educational attainments can be seen in Table 7.

Table 7
Secondary School Enrolment in Selected Countries in Asia 1993
(Per cent of age group)

This table shows the main quantitative shortcoming of Thai education. Qualitatively, the inadequacies are even greater, as of course would be the task of overcoming them. Additionally, the country's output of scientists and engineers has to be substantially accelerated.

The following summarizes the recommendations made above in order of priority for consideration and implementation. Included are only those that tackle problems arising directly out of the crisis. The first group of recommendations pertains only to issues which arose directly in connection with the crisis.

In addition, as far as ongoing programs are concerned, the following should be shielded from budgetary cutbacks:

For the past five decades, the UN system has played crucial roles in supporting Thailand's economic and social development and launched programmes and projects in partnership with government agencies and the civil society. Increasingly, joint programmes and collaborative undertakings have enhanced collaboration both within the UN system and with all sectors of the Thai society. The Thailand-United Nations Collaborative Action Plan (Thai-UNCAP) launched in March 1997 to pilot a holistic people-centred development at the community level as envisaged in the Eighth Plan represents the most recent example of this partnership approach.

Since the onset of the crisis, all UN agencies have expressed concerns about Thailand's financial and economic problems, especially their social impact. In response, the UN agencies have undertaken several short-term and long-term measures.

Firstly, a number of studies and cross-sectional discussion sessions have been organized by the UN agencies such as ILO, UNDP, UNICEF, WHO and the World Bank to gather information and brainstorm an appropriate action agenda. These fora range from small brainstorming session, high-level consultation, broad-based national consultation and regional meetings. Outputs from these studies and consultations have constituted an important data base on the crisis, raised awareness of the magnitude of the problem, stimulated responses from all parties concerned, as well as served as need assessment for the UN system's technical assistance.

Aside from situational analyses, policy studies, and technical inputs, almost all UN agencies have allocated a portion of their budget for project responses to the crisis. Regular programmes of FAO, ILO, UNFPA, UNICEF, UNDP, WHO and others have been adjusted in terms of objectives, target groups and scope of work to provide better response to the new situation.

For example, ILO, having played an important role in facilitating tripartite dialogue among workers, employers and the Government, now plans to expand the dialogue to include international financial institutions. It is also mobilizing resources for labour-intensive public works, labour market monitoring and skill development, social security programmes.

UNIDO is planning and mobilizing funds for several programmes that range from support to agro-industries and SMEs to enhancement of competitiveness and total quality management.

UNIFEM, in cooperation with the Department of Industrial Promotion, initiated a pilot project to strengthen women's business network.

UNDP's Country Cooperation Framework (1997-2001) was approved prior to the crisis. But the scopes of the programmes - especially the Poverty Alleviation programme, the Emerging Issues programme that includes decentralization and good governance projects - are broad and flexible enough to provide immediate and long-term responses to the new challenge. Early activities under the programmes including skills training, and micro credit for the poor, are being carried out in the North and the Northeast. In this regard, UNDP benefits from the expertise and cooperation from many specialized agencies.

Thai-UNCAP is another vehicle through which the UN agencies have provided a collective response to the crisis. In this regard, FAO, UNESCO, UNFPA, UNICEF and UNDP have undertaken community-led activities in the Thai-UNCAP pilot areas with special attention to the impact of the crisis. In addition, the "Poverty Strategies Initiatives", a Thai-UNCAP programme, a collaboration between FAO, ILO and UNDP on one hand, and NESDB on the other, is expected to provide appropriate intermediate and long-term policy measures.

The largest financial resource to address the social impact of the crisis has come in the form of the US$ 420 million Social Investment Project (SIP) Loan from the World Bank and OECF, to which UNDP will contribute technical assistance for the project's management, monitoring and evaluation. SIP will fund short-term job creation and social service projects as well as address long-term empowerment and decentralization objectives.

In the context of overall economic and social adjustment, the World Bank's Country Strategy (1998- 2000) has estimated US$ 2,900 lending and non-lending assistance that focuses on renewing competitiveness, strengthening governance and sharing growth and ensuring quality of life.

The Asian Development Bank's US$ 500 million Social Sector Loan is another major funding source that focuses on cushioning the short-term impact and fostering long-term policy reform in education, health and labour sectors. The UN system has also been engaged in continued dialogues with ADB to ensure consistency and compatibility in policy response and technical assistance.

Other agencies such as the UNDCP, UPU and UNHCR do not have a mandate to address the current crisis, but their activities have indirectly contributed to the mitigation effort. For example, UNHCR's purchase of relief supplies in particular provides additional stimulant to the local economy.

The national policy priorities and action agenda described above are intended to support implementation of painful but necessary economic adjustments as well as mitigation of immediate and short-term social impact of the economic crisis, particularly the loss or reduction of livelihood opportunities. In the context of this broad national agenda and priorities, actions directed towards some of the underlying causes of the economic crisis such as the country's weak human resource base, increasing disparities between the rich and the poor and inadequate decentralization and transparency in governance could also be taken now.

A review and possible reorientation and augmentation of external assistance, including from UNDP and the entire UN system would be necessary, in order to effectively complement national efforts for the implementation of the new national agenda. The new agenda should provide a basis for the Royal Thai Government and civil society, on the one hand, and the UN system, on the other, to jointly identify new directions for UN assistance through appropriate collaboration and interactive mechanisms.

In this connection, the Thailand-United Nations Collaborative Action Plan (Thai-UNCAP) has proved to be an effective approach to exchanging views and forming a broad partnership for action. It has already demonstrated in five pilot areas the feasibility and effectiveness of a participatory process that enable communities to:

The UN system would do well to expand this partnership as a mechanism for providing support to the Thai Government and civil society in the implementation of the new national action agenda.

In addition, UN assistance should also be programmed and implemented in a more coordinated fashion and with common focus. For this purpose, the UN system should accelerate the process of preparing a common country assessment (CCA), using a common set of indicators, and highlighting the development issues that have become more critical as a consequence of the economic crisis. These issues include the need to:

Based on the CCA, a UN development assistance framework should also be prepared as basis for joint programming, to ensure coherence and mutual reinforcement among programmes of various UN agencies, and to maximize the overall contribution and impact of UN assistance on the achievement of the new national agenda.

High-Level Consultative Meeting
"Policy Response to the Economic Crisis and
Social Impact in Thailand"

Organized by the United Nations Development Programme
Friday, 22 May 1998
The Siam City Hotel, Bangkok

1. This figure is obtained from the third and fourth letters of intent submitted by the Thai government to the International Monetary Fund in February and May 1998.

2. The National Statistical Office conducts three surveys every year, the first being in February, the second in May and the third in August.

3. It should be noted that the surveys sampled all Thai households, so that "urban" or "rural" signifies the residential location of a surveyed household and not a given household member's workplace. "Urban" here includes Bangkok Metropolitan Area, municipalities and sanitary districts. The last is sometimes, (but not in this paper) considered rural, particularly in most publications from the National Statistical Office.

4. International Labor Organization, The Social Impact of the Asian Financial Crisis, Technical Report for discussion at the High-Level Tripartite Meeting on Social Responses to the Financial Crisis in East and South -East Asian Countries, April 22-24, 1998, Bangkok, p. 18
5. The Thai fiscal year runs from October to September.

6. The lenders were Japan $4 billion; the central banks of Australia, China, Hong Kong, Malaysia and Singapore $1 billion each; the central banks of South Korea and Indonesia $0.5 billion each; the World Bank $1.5 billion and the Asian Development Bank $1.2 billion. Since then, Japan has taken up the contributions of South Korea and Indonesia.
7. Unlike the succeeding letters of intent, only a summary of the first one has been released. This limits analysis of the policies included in it.

9. One has the monopoly over domestic telephony (both local and long-distance), and the other over international telephony.

10. International Labor Organization, The Social Impact of the Asian Financial Crisis, Technical Report for discussion at the High-Level Tripartite Meeting on Social Responses to the Financial Crisis in East and South -East Asian Countries, April 22-24, 1998, Bangkok.

	Male				Female
	1995	1996	1997	1998	1995	1996	1997	1998
A. Employed Persons by Hours Worked
Rural	*11.66*	*12.01*	*12.03*	*11.65*	*8.26*	*8.60*	*8.56*	*8.13*
Less than 20 hours	0.18	0.26	0.21	0.42	0.21	0.28	0.24	0.40
Between 20 and 39 hours	1.70	1.68	1.63	1.97	1.57	1.67	1.63	1.67
More than 40 hours	9.77	10.08	10.19	9.26	6.48	6.65	6.69	6.06
*Urban*	*5.07*	*5.24*	*5.33*	*5.23*	*4.07*	*4.25*	*4.35*	*4.40*
Less than 20 hours	0.05	0.05	0.05	0.27	0.05	0.05	0.05	0.38
Between 20 and 39 hours	0.79	0.74	0.76	1.14	0.74	0.70	0.72	1.09
More than 40 hours	4.23	4.45	4.52	3.82	3.28	3.49	3.58	2.93
B. Employed Persons by Industry
Rural	*11.66*	*12.01*	*12.03*	*11.65*	*8.26*	*8.60*	*8.56*	*8.13*
Agriculture	6.39	6.46	6.33	6.47	4.65	4.83	4.76	4.33
Industry (excl. Construction)	1.37	1.47	1.45	1.38	1.40	1.48	1.42	1.39
Construction	1.54	1.81	1.84	1.24	0.32	0.41	0.45	0.24
Services	2.35	2.27	2.41	2.56	1.90	1.87	1.93	2.17
*Urban*	*5.07*	*5.24*	*5.33*	*5.23*	*4.07*	*4.25*	*4.35*	*4.40*
Agriculture	0.48	0.51	0.50	0.51	0.32	0.35	0.34	0.33
Industry (excl. Construction)	1.26	1.21	1.30	1.27	1.07	1.03	1.06	1.12
Construction	0.63	0.70	0.56	0.48	0.16	0.20	0.13	0.08
Services	2.70	2.83	2.96	2.97	2.51	2.67	2.81	2.86
C. Employed Persons by Status
Rural	*11.66*	*12.01*	*12.03*	*11.65*	*8.26*	*8.60*	*8.56*	*8.13*
Employees	4.83	5.12	5.12	4.56	2.76	2.94	2.94	2.81
Self-employed	5.36	5.46	5.33	5.53	2.32	2.33	2.25	2.25
Unpaid family workers	1.47	1.43	1.58	1.56	3.18	3.33	3.38	3.07
*Urban*	*5.07*	*5.24*	*5.33*	*5.23*	*4.07*	*4.25*	*4.35*	*4.40*
Employees	3.21	3.40	3.37	3.29	2.36	2.54	2.63	2.69
Self-employed	1.55	1.50	1.60	1.59	0.92	0.91	0.89	0.91
Unpaid family workers	0.31	0.34	0.36	0.36	0.79	0.80	0.83	0.81
Total Employment	16.72	17.25	17.36	16.88	12.33	12.84	12.91	12.53

	Male				Female
	1995	1996	1997	1998	1995	1996	1997	1998
D. Unemployed persons
Rural	*0.70*	*0.49*	*0.49*	*1.04*	*1.35*	*1.09*	*1.01*	*1.32*
Actively seeking work	0.06	0.04	0.07	0.18	0.04	0.02	0.03	0.08
Ready to work	0.22	0.20	0.18	0.51	0.25	0.24	0.24	0.40
Seasonal	0.42	0.25	0.23	0.35	1.06	0.83	0.73	0.83
*Urban*	*0.11*	*0.10*	*0.10*	*0.18*	*0.14*	*0.12*	*0.13*	*0.20*
Actively seeking work	0.04	0.04	0.04	0.08	0.02	0.02	0.03	0.06
Ready to work	0.04	0.04	0.04	0.08	0.05	0.04	0.05	0.09
Seasonal	0.03	0.02	0.02	0.02	0.07	0.06	0.05	0.05
Total Unemployed	0.80	0.59	0.59	1.22	1.49	1.21	1.14	1.51
E. Not in the Labour Force
Rural	*3.10*	*3.14*	*3.32*	*3.34*	*5.70*	*5.82*	*6.12*	*6.42*
Housework	0.04	0.06	0.07	0.06	2.49	2.50	2.67	2.90
Studying	1.73	1.77	1.90	1.89	1.57	1.72	1.83	1.91
Too young of old	1.08	1.03	1.07	1.12	1.36	1.28	1.31	1.39
Others	0.26	0.29	0.29	0.28	0.29	0.32	0.30	0.22
*Urban*	*1.72*	*1.71*	*1.76*	*1.92*	*3.06*	*3.08*	*3.14*	*3.20*
Housework	0.02	0.04	0.03	0.03	1.42	1.41	1.42	1.36
Studying	1.06	0.99	1.04	1.13	0.91	0.99	1.05	1.16
Too young of old	0.47	0.50	0.52	0.56	0.61	0.57	0.57	0.59
Others	0.17	0.18	0.17	0.20	0.11	0.11	0.11	0.10
Total outside the Labour Force	4.82	4.85	5.08	5.26	8.77	8.89	9.26	9.63

Quarter	% Change
1996 Q1	14.01
1996 Q2	13.89
1996 Q3	9.27
1996 Q4	4.27
1997 Q1	-0.13
1997 Q2	-3.45
1997 Q3	-6.37
1997 Q4	-0.78

Country	Female	Male
Bangladesh	12	26
China	51	60
Indonesia	39	48
Malaysia	61	56
Sri Lanka	78	71
Thailand	37	38

Responding to the Thai Economic Crisis

by Ammar Siamwalla and Orapin Sobchokchai
Thailand Development Research Institute (TDRI)

Dated: 16May1999

Responding to the Thai Economic Crisis

by Ammar Siamwalla and Orapin Sobchokchai Thailand Development Research Institute (TDRI)

Dated: 16May1999

by Ammar Siamwalla and Orapin Sobchokchai
Thailand Development Research Institute (TDRI)