Lessons learned must be applied

Parista Yuthamanop and Wichit Sirithaveeporn

July 2, 1997 is a date that few Thai people can forget, and five years later the impact of the events set in place that day is still being felt as well as debated.

ECONOMY After five years digesting the impact of July 1997, policymakers and citizens alike are more aware of the importance of reform ... and of neverending vigilance

It was the date that the government decided to abandon the pegged foreign exchange regime in place since the end of World War II and opted for a new system under which the baht would float in line with market forces, with only token efforts to defend it.

The adoption of the new regime was a tacit acknowledgement of flaws in the policies and structures implemented during the early 1990s to fulfill the ambition of becoming a developed economy and a regional financial centre.

Thailand at the time had been reaping the gains of a relatively cheap labour and had shifted away from agriculture. The result was rapid industrialisation and an export boom during the second half of the 1980s, which continued until 1996.

The relocation of East Asian manufacturers to Thailand in search of a cheaper production base in the light of strengthening yen was a major stimulus of rapidly expanding investment.

The Bank of Thailand's response was to remove restrictions on foreign exchange transactions and promote the Bangkok for International Banking Facilities (BIBF) in 1993, with an aim to make Bangkok a centre for international financial institutions to offer services in the country.

BIBF loans in foreign currencies soon became the financing vehicle of choice but not, it later emerged, for the right kinds of businesses. A lot of the funds were lent to local property companies that had placed their bets on continuing spectacular economic growth.

A worker climbs on an iron scaffolding platform next to a garuda statue under renovation in front of a bank in Bangkok.

The central bank's liberalisation of the capital account spurred an inflow of short-term money to the stock and money markets to arbitrage against higher interest rates and the soaring prices of Thai shares.

Few people realised or were willing to accept that economic growth had been too fast and expectations too unrealistic. A few lonely economists warned that the unsustainable nature of such growth would lead the whole system to a bust if the short-term foreign inflows suddenly dried up.

For example, while exports were a major engine of growth, their benefit in the current account was debatable as so many export industries relied on high import content.

By 1996, overinvestment and overspending by Thais had sent the current account deficit as high as 7.9% of gross domestic product _ anything over 5% is generally held to set off alarms, even in developed countries.

A subsequent down cycle of global trade in electronic products played a role in the decline of export to zero growth only few months before investors began to openly question the sustainability of the prevailing baht exchange rate.

The Bank of Thailand struggled to defend the baht's value and lost almost all of the country's foreign reserves in the fight against speculators.

Finally the defence was abandoned, the baht was floated, and in August 1997 the government entered a financial rescue programme worth $17.2 billion, brokered by the International Monetary Fund.

But the severe depreciation of the baht and the tight monetary and fiscal policy the economy adopted in the immediate aftermath of the crisis _ a prescription the IMF later admitted was wrong _ led countless firms into bankruptcy and left the banking system with staggering non-performing loans.

The immediate lesson for businesses was that they would have to live with currency fluctuations from now on, and the more astute executives responded by making sure they had hedges against their transactions.

A vendor arranges local cosmetics at a market in Bangkok. Locals are being encouraged to use Thai products to help reduce the country's bill for luxury imported products.

The government, meanwhile, acknowledged that reform of economic fundamentals, both in the financial and the real sectors, was the way forward, though the road ahead would be arduous.

Chalongphob Sussangkarn, president of the Thailand Development Research Institute, said the country's macro-economy actually became more stable after the baht was floated, as the risks created from the misalignment of currency lessened.

Five years later, the country's economy had become considerably more stable as a result, agreed Sompop Manarungsan, an associate professor of economics at Chulalongkorn University. External debt, particularly short-term, is down sharply and the country's foreign reserves have been steady at around $33 billion.

But the impact of the economic crisis that began in Thailand and spread throughout Asia also pointed up the need for more regional interdependence to guard against future aberrations. Responses have included the Chiang Mai initiative, under which Asean countries have entered currency-swap agreements _ to be used in emergencies _ with economic superpowers such as Japan, Korea and China.

In Dr Chalongphob's view, the most important thing Thais learned from the economic crisis was simply the cause that led us to it.

In its haste to tap the growing volume of global financial market transactions, policymakers neglected to consider the consequences of higher risk and how to deal with it, he said.

"The financial sector still has considerable problems. But there are improvements in terms of risk controls, which were lacking before the crisis."
Still, the crisis carried a high cost as substantial sums of taxpayers' money would be used to revive the banking industry and companies.

The most painful event in the financial system came with the closure of 56 finance companies that became insolvent as a result of high foreign-currency debt and their inability to recall loans or seize assets from delinquent debtors.

The suspension came with increasing liabilities for the central bank's Financial Institutions Development Fund, which was utilised by the government as a bailout tool for ailing financial institutions, both in terms of extending credit lines and capital increases.

Cleaning the pavement is a lot easier than sweeping away the mountain of debt created by the property boom of a decade ago.

The central bank has estimated that the FIDF would book an estimated 886 billion baht in losses from its assistance given to ailing banks and finance companies over the next three years to 2005.

Total state money injected into the Fund would run to around 1.3 trillion baht, when one adds the bonds issued to refinance its short-term debt worth 500 billion baht.

The FIDF's liabilities and the abolition of full guarantees for financial institutions were left as "unfinished homework" from the crisis, Dr Chalongphob said.

Fundamental problems in the real sector also came under a glaring spotlight in the 1997-98 period. It became clear that many businesses had wasted time and resources on reckless expansion into non-core, speculative ventures. At the same time, few had done much to establish credible accounting systems, risk management, or research and development that would keep them competitive.

While the country continues to struggle to clear the consequences of the crisis, it also needs to develop a strategy for future development, given stiffer competition in global trade and its changing structure.

The most important factor is China, whose large, cheap workforce and huge consumer base are expected to sap foreign direct investment from other developing economies, according to Dr Sompop.

The government could do only so much, he said, because of constraints on the management of both fiscal and monetary policy.

Expansionary fiscal policy would have the consequence of high public debt and would threaten economic stability. The central bank, meanwhile, has insufficient tools to serve as intermediaries for its monetary policy, as the money market is glutted with excess liquidity.

Dr Sompop also believes that reforms by commercial banks to date have been largely superficial, compared with the overhauls that followed the savings-and-loan bust in the United States in the late 1980s, or reforms undertaken more recently in Korea.

"There are some remaining problems within the banking system, such as high non-performing loans, and the fact that banks normally seek to cut costs by reducing deposit interest rates," he said.

Another reason cited for the magnitude of the crisis was the undeveloped bond market, which resulted in the real sector relying mainly on the banking system for credit.

The development of the bond market as an alternative funding source had not been effective as the majority of bonds were traded within a limited circle of investors.

Reforms at the Stock Exchange of Thailand were also inadequate, as redundancies persisted among agencies overseeing the market. Efforts to improve transparency and corporate governance had also gone slowly, which created a credibility issue for the SET and for listed companies
"The stock market does not yet reflect economic fundamentals very well. Several companies are operating as family-run but under the cover of public companies," he said.

The corporate sector also lacked proper production and cost management, he said, which exacerbated the problems caused by high excess capacity.

Kanit Sangsubhan, director of Policy Research Institute of the Fiscal Policy Office, said the crisis had made the country question the degree of which it should open its market to the global financial system. A balance had to be struck between economic stability and fair competition within the country.

As well, he said, the economic crisis had reduced the role of bureaucrats in administering the country, due to the decline in their credibility after the crisis.

"Civil servants, who used to be policy initiators, had turned to be only the executors of the economic policies drafted by politicians," Dr Kanit said.

He believes the government must improve the benefits of civil servants in order to attract more talent to strengthen the bureacracy and raise it to the standard of more developed countries.

And while political parties such as Thai Rak Thai, now in government, had started to do a better job at proposing and selling economic policies, rigorous examination of the best ways to implement policy was lacking, he said.

A senior official at the Finance Ministry said the crisis had also highlighted the fact that the economy needed a system to more efficiently monitor the movement of foreign capital.

On the domestic front, meanwhile, a feeling that the worst is over has set in. The Thaksin Shinawatra government has made the revival of domestic consumption one of the centrepieces of its economic policy. Government stimulus programmes have improved confidence and created a mini-boom in consumer credit in recent months.

Concerns have been raised, however, that a consumer credit is also unsustainable, though the risks are different by nature from those that triggered the events of 1997.
The bad loans then were the result of defaults by large companies rather than small ones or individuals, the economist said.

In the five years since July 2, 1997, many lessons have been absorbed. The acknowledgement of the need for economic reform also led to a successful push for political reforms, including a new constitution that greatly increases public participation in the way the country is run.

The main lesson, though, is that only with stronger foundations can Thailand build an economic structure capable of withstanding whatever future storms may arise.

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© The Post Publishing Public Co., Ltd. 2002
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