Bangkok
February 24, 1998

1.  In the three months since this government has been in office, we have given paramount importance to establishing market confidence in the economic program. Most importantly, we have adhered strictly to the program, ensuring that all performance criteria for December 31, 1997 related to monetary, fiscal, and external policies as well as financial restructuring have been observed, despite weaker economic activity and generally increased regional market pressures.

2.  In addition, we have taken a number of measures that have ensured cohesion in economic policy and progressively increased market confidence. Transparency has been greatly increased in a number of ways, especially through the full publication of our letters of intent, as well as by the regular release of statistical information (including on the Bank of Thailand’s net forward position). In the financial area, our bold initiatives have included the closure of insolvent finance companies; also, we have intervened in the weakest banks in order to preserve the integrity of the financial system; and remaining banks and finance companies have started to recognize past losses in their financial statements and to recapitalize according to tighter loan classification and provisioning standards. The two-tier foreign exchange market has been effectively abolished. Far-reaching legal reform is under way to facilitate financial and corporate restructuring, market opening, and privatization.

3.  However, at this stage of the Second Review of the program, there is a need to make some modifications to the program to take into account recent developments. In particular, we have to contend with new challenges that have arisen from the regional situation, and which have put additional pressures on the capital account; these have resulted in the further depreciation of the baht, and a much larger-than-anticipated decline in economic activity. The modifications to the program give clear priority to stabilizing quickly the exchange rate, while limiting the magnitude and negative social impact of the economic downturn.

4.  The full economic policy statement of this government is presented in the attachment. We envisage six key modifications to the economic program that adjust it to existing conditions and strengthen the prospects for its success:

• First, in so far as concerns about the financial system lie at the heart of the present crisis, we are resolved to take a more proactive role and accelerate its restructuring; in particular, we intend to phase in as quickly as possible the privatization of intervened banks; best-practice banking standards; and a sound legal, regulatory, and institutional framework for the Bank of Thailand (BOT), banking supervision, commercial banking, and capital market development.
• Second, there is room to adjust fiscal policy in response to weaker economic activity as well as to the larger-than-anticipated external current account adjustment already under way. We will ensure the financing of higher social spending, while maintaining a sound fiscal position over the medium term.
• Third, while we are resolved to maintain a tight monetary stance supportive of exchange rate stabilization, we have taken steps to ensure the adequate availability of credit to priority sectors of the economy that will lead the economic recovery.
• Fourth, we have stepped up efforts, in collaboration with the World Bank, the Asian Development Bank (AsDB), and the Overseas Economic Cooperation Fund (OECF) to strengthen the social safety net, the need for which has become acute in the wake of rising unemployment and falling real wages.
• Fifth, we have adopted bold targets for deepening the role of the private sector in the economy, through privatization, legal reforms, and initiatives to attract foreign capital into the financial and nonfinancial sectors.
• Sixth, based on the above policies, the stage is being set for our timely return to the international financial and capital markets.

Mr. Michel Camdessus
International Monetary Fund
Washington, D.C. 20431
U.S.A.

Asset disposal of the 56 closed finance companies

3.  Following the Financial Sector Restructuring Authority’s (FRA) decisive action to close all but 2 of the 58 suspended finance companies in early December 1997, we have been working toward completing the institutional structure for launching the disposal process of the assets of the closed finance companies. Working closely with World Bank consultants, we have ensured that rules and procedures for this process will be fully in place by mid-March 1998. We expect movable asset sales to start in February and financial asset sales to start in March. A number of safeguards are being developed to ensure competitive market conditions and an acceptable range of payments instruments. The timetable for key steps in the process is summarized in Box 1.

4.  It is the government’s intention to maximize sales to the private sector. At the same time, given presently depressed economic conditions and thin markets, there is a need to ensure that asset values are not unduly eroded by the dumping of assets, which would adversely affect remaining financial institutions. In order to assure bids for each asset, two new government-owned institutions, the Radhanasin Bank (RAB) and the Asset Management Corporation (AMC), will also participate in the auctions. The RAB is expected to bid for the highest quality assets and be guided by the strictest commercial principles. It is our intention to attract as soon as possible a strategic foreign partner in the RAB. The AMC’s focus will be on the lowest-quality assets and will participate effectively as a buyer of last resort; the AMC will be charged with the responsibility of managing these assets and maximizing asset recovery over the medium term. Both institutions will be adequately capitalized by mid-March 1998. Progress in auctioning of FRA assets and, in particular, the roles of the RAB and the AMC will be closely monitored and reassessed at the time of the third program review.

5.  We recognize that for the asset disposal process, in particular, and for broader corporate and financial restructuring, it remains imperative to strengthen the legal and judicial framework for foreclosure and bankruptcy. These steps are presented in paragraphs 27–28 below.

Strengthening the core financial system

6.  Our strategy is to strengthen progressively the capital base of all remaining domestic financial institutions through a combination of more realistic loan loss provisioning and private sector-led recapitalization (Box 2). In a few cases where banks have become severely undercapitalized and unviable, our strategy has been to intervene to preserve public confidence in the banking system. Since the first program review, we have focused on four severely undercapitalized banks (with a deposit share of about 10 percent), which have relied heavily on liquidity support from the Financial Institutions Development Fund (FIDF). Thus:

• We have intervened in three medium-sized banks which were unable to raise private capital, by replacing their managements, writing down (virtually fully) the capital of existing shareholders, and recapitalizing them through debt-equity conversion by the FIDF.
• We have also intervened (for the second time) in another bank that was taken over by the FIDF in 1996, by writing down its capital and recapitalizing it through the FIDF.

7.  These interventions have demonstrated our resolve to strengthen the financial system, while protecting depositors and creditors, and have been very favorably received by the financial markets. In particular, the withdrawals by creditors and depositors at these banks have stopped and their need for further FIDF liquidity support has ceased. Operating procedures for these intervened institutions will be established immediately by the BOT to limit them to low-risk activities, until they can be privatized (see below).

8.  We are fully aware that the state’s share in Thailand’s financial sector has substantially increased as a result of these interventions. It remains the government’s paramount objective to reduce its ownership of the intervened banks as soon as possible. Thus, the government is in the process of developing privatization strategies with advice from outside experts for this purpose. We expect considerable progress to be made during 1998 toward completing negotiations with domestic and foreign private investors. Various modalities will be explored, with a view to catalyzing private investor interest, while maximizing recovery for the public sector. Any decision regarding the Property Loan Management Organization (PLMO) will be taken in consultation with the IMF.

9.  At the same time, we are accelerating our efforts to strengthen the capital base of remaining domestic financial institutions, and particularly the core banking system:

• Based on the stricter rules on loan classification and provisioning that came into effect on December 31, 1997, the BOT has signed Memoranda of Understanding with undercapitalized banks and finance companies with the aim of raising additional capital in early 1998. This process is well under way and several banks and finance companies have already fulfilled the requirement specified in the MOUs; the capital increase of the large majority state-owned commercial bank has been facilitated through a capital subscription by the FIDF.
• This recapitalization effort is a first step toward our goal of bringing capital adequacy ratios to required levels based on loan classification and provisioning rules consistent with best practices internationally by the end of the year 2000. The new rules will be introduced gradually according to new regulations to be issued by end-March 1998. We are encouraging banks, wherever possible, to accelerate the adoption of the ultimate provisioning rules, in order to achieve an early restoration of confidence in Thailand’s financial institutions. The BOT will strengthen its on-site examinations of the asset portfolios of all institutions and will require MOUs with each financial institution to closely monitor their compliance with recapitalization plans. The signing of MOUs by August 15, 1998 with all domestic banks setting forth their recapitalization plans until the end of 1998 will be a performance criterion under the Stand-By Arrangement.
• The encouragement of domestic and foreign private investment into existing domestic financial institutions remains a key part of our strategy. To ensure that such investments lead to a sounder banking system, "fit and proper" rules and licensing requirements have recently been improved. Until the crisis has subsided, we do not expect to license new financial institutions, except where it would facilitate the restructuring process. Given the limited availability of domestic capital and the need to strengthen the management of banks, we expect the recapitalization to come also from foreign investment, which remains welcome without restrictions.

11.  To enhance the standing and effectiveness of the central bank, the government has appointed an independent commission to identify those activities that will require strengthening; based on the findings of this commission, we intend to form a task force including eminent international financial experts to develop specific proposals regarding the independence and institutional strengthening of the central bank. This is expected to result in revisions to the BOT Law by October 1998. Capacity building and improved operating procedures are expected to result from a major effort of streamlining, recruiting, and training; these efforts will be supported with technical assistance from the IMF, the World Bank, and other central banks.

12.  We are committed to establishing sound legal, regulatory, and institutional frameworks for the supervision of financial institutions, in consultation with the IMF and the World Bank:

• The initial focus will be on banks and finance companies. Accordingly, progressively during 1998, we will: (i) review and start implementing necessary reforms of the legal and regulatory framework, including rules for loan classification and provisioning, insider lending and foreign exchange exposures, and accounting and auditing disclosure practices; (ii) review the supervision function and structure with the aim of strengthening the supervisory independence, authority, procedures, and technical capabilities, and developing an action plan for immediate reforms consistent with the overall economic program; and (iii) finalize a plan for a self-financed and limited deposit insurance scheme that eventually would replace the present general guarantee.
• We will also be undertaking a comprehensive review of the roles of various financial institutions and the way they are regulated and supervised. This will involve not only the BOT, but also the Securities and Exchange Commission (SEC), the Fiscal Policy Office of the Ministry of Finance, and the Insurance Office of the Ministry of Commerce. We expect these efforts to result in a modern and efficient supervisory regime that can support the development of a sound and competitive financial system.

13.  Exchange rate stabilization will be the principal objective of monetary policy, recognizing that the baht may remain excessively volatile in an overly depreciated range. Thus, we intend to impart symmetric flexibility to interest rate policy. First, when the exchange rate is under pressure, the repurchase rate will be adjusted upwards to support the exchange rate. Second, when the exchange rate has shown sustained stability in a more realistic range, interest rates will be brought down, as we are mindful of the potential damage that a prolonged period of tight liquidity conditions might do to the corporate sector and to the banking system.

14.  We have also reviewed our targets for key monetary aggregates against the revised macroeconomic framework. Although average inflation will be somewhat higher than previously anticipated, we intend to maintain broadly the monetary program for 1998. The consequent projected reduction in real money balances during 1998 is consistent with the contraction in the real economy during this period. The monetary program anticipates that the recent increasing trend in the velocity of broad money (M2A) will stabilize after mid-1998, with the progressive return of confidence. On this basis, we expect that M2A growth will be about 5 percent in the year to December 1998. In developing the BOT’s reserve money program, it has been assumed that the recent increasing trend in the demand for currency relative to deposits will also stabilize after mid-1998. Thus, the BOT will aim at maintaining reserve money growth at about 6½ percent during 1998. On this basis, we have revised in Annex A the end-March and end-June performance criteria for NDA, and the indicative targets for reserve money.

15.  We are also assuring the adequate availability of credit to the priority nonbank corporate sector, especially exporters (who continue to face difficulties, notwithstanding the positive effects of the exchange rate depreciation), agricultural producers, and small borrowers. Thus, the EXIM Bank of Thailand and the Industrial Finance Corporation of Thailand (IFCT) have negotiated trade finance facilities with the Japan Export-Import Bank and the AsDB (of about US$1.6 billion); these facilities are being supported by the increased refinancing (up to 60 percent) by the BOT at concessional interest rates of commercial bank loans to exporters. In addition, existing facilities provide for the extension of some subsidized credit to agriculture (through the Bank for Agriculture and Agricultural Cooperatives), small business (through the small Industry Finance Corporation), and low-income housing (through the Government Housing Bank). The subsidy element in all these facilities is small and has been taken into account in the financial program.

Fiscal policy

16.  Last year’s decisive steps—trimming expenditure by 3½ percent of GDP from the original budget and undertaking revenue measures of almost 2 percent of GDP—have been instrumental in maintaining a tight fiscal stance during the crisis; as a result, we have been able to meet the end-December quantitative performance criterion for the central government balance. However, because of the further weakening of the economy, and the net effects on revenues of the excessive depreciation of the baht, government revenues are projected to decline by some 2 percent of GDP this fiscal year, compared with estimates made at the time of the first program review. In addition, the further exchange rate depreciation in recent months is expected to raise government spending by about 1 percent of GDP. Without further measures, the result will be a projected central government deficit of 2 percent of GDP, instead of the 1 percent of GDP surplus originally programmed.

17.  At this juncture, a complete offset of the projected deterioration would be unnecessary. This is because current account adjustment is already exceeding substantially our earlier goals. Additional fiscal actions are no longer needed to hasten such adjustment and could risk exacerbating the current recession and delaying the recovery. Nevertheless, we are taking some carefully designed additional measures to underline our commitment to fiscal discipline. These measures will provide the resources to finance a strengthened social safety net (paragraph 25); they will also ensure that revenues will indeed rise with the recovery of output and allow the fiscal position to return to a small surplus over the medium term.

18.  Accordingly, we are taking some additional revenue measures that will allow us to raise tax revenue by about ¼ percent of GDP in FY 1997/98 (½ percent of GDP on a full-year basis). At the same time, we have realized net savings of about ¼ percent of GDP by cutting lesser-priority investment projects and raising spending on the social safety net (discussed further below). The net result of these initiatives will be to limit the projected central government deficit to 1½ percent of GDP in FY 1997/98 (Annex B), partly financed by foreign financing and the remainder through modest domestic financing.

19.  In recognition of adverse economic conditions, we will also allow the state enterprise sector to move from balance into slight deficit of ½ percent of GDP in FY 1997/98, which is necessary to allow the full drawdown on priority projects financed by foreign creditors, including the World Bank, the AsDB, and the OECF. The small deficit will be largely financed by foreign sources. However, even this target will require additional measures on the part of state enterprises and utilities. Thus, we have taken necessary steps to raise prices for goods and services provided by state enterprises, except in specified cases where the move would hurt the poorest members of society (e.g., bus and rail fares). At the same time, further cuts have been made in the investment budgets of the largest state enterprises.

20.  Overall, the consolidated public sector deficit is now targeted at about 2 percent of GDP in FY 1997/98. This excludes the costs of financial sector restructuring, which are being monitored separately and whose interest cost will be brought fully on budget in the coming years (paragraph 10).

External sector

21.  External current account adjustment has proceeded more quickly than envisaged, with the achievement of significant monthly surpluses since September 1997. We now expect to record a surplus of about 4 percent of GDP in 1998. Thus, current account adjustment is providing an important offset to larger-than-anticipated capital outflows and, with the external financing package, is assuring that the reserve objectives of the program can be broadly maintained.

22.  Regarding the capital account, the revised external outlook for 1998 (Table) is based on the following specific assumptions on key components:

• As previously anticipated, we expect an orderly unwinding of the BOT’s outstanding forward and swap obligations to about US$9 billion by end-1998. At this level, they will comprise exclusively of liquidity-related swaps with foreign and Thai commercial banks, and we would normally expect to maintain such swaps at this level as part of domestic liquidity management.
• There has been considerable stability in the rollover of short-term credit lines of foreign banks operating in Thailand. These credit lines, accounting for more than half of private short-term debt falling due in 1998, are linked to the interoffice funding of these banks from their home offices. We expect that the recent stability will be maintained. Although the rollover rate has been less for the foreign-debt exposure of the Thai banks and the corporate sector, this has, to some extent, reflected the reduced need for import financing, associated with the contraction of the real economy and of imports. We expect the rollover rate to improve progressively during the year as the regional crisis abates. We also are confident that voluntary debt restructuring on a bilateral basis is under way in the corporate sector, and this situation will remain under close monitoring.

Social safety net

25.  This government remains acutely sensitive to the impact of the economic crisis on the poorest sections of society. We are determined to do all that we can to cushion the impact on those who would be most affected. In drawing up a strengthened social safety net program, we have coordinated our policies with the staffs of the IMF, the World Bank, the AsDB, and the OECF. The specific elements of the strengthened program are contained in Box 3. This program will be closely reviewed to ensure that it remains well targeted, cost effective, and transparent. Major parts of the program will be supported by sector loans from the World Bank, the AsDB, and the OECF.

Privatization

26.  This government is determined to accelerate privatization as part of the restructuring of Thailand’s economy. Toward this end, by June 30, 1998, and with the assistance of the World Bank, we will establish a privatization secretariat, propose legislative reform (including a Corporatization Law to expedite the process), and develop a regulatory framework (especially for the utilities). Our near-term privatization program involves the following principal components:

• In transportation, we intend to privatize substantially Thai Airways International in 1998, initially through a strategic partnership with a foreign investor, with remaining shares being offered, both, to the domestic market and employees.
• In the energy sector, we will accelerate privatization and competition. As part of our broader strategy of encouraging the entry of independent private generators to enhance competition, the Electricity Generating Authority of Thailand (EGAT) will initiate sales of its stakes in Electricity Generating (Public) Co. Limited and Power Gen 2 during 1998. Over the longer term, we intend to split EGAT into separate generation and transmission companies, which themselves will eventually be privatized.
• In the oil sector, we will relinquish our stake in Bangchak petroleum company, and plan to begin in June 1998. Also, we will sell part of PTT Exploration and Production, with the aim of privatizing PTT itself by the end of 1999.
• In telecommunications, we will amend the Establishing Acts of the Telephone Organization of Thailand (TOT) and The Communication Authority of Thailand (CAT) during 1998, in order to prepare for their corporatization and privatization by the end of 1999.

Corporate restructuring and legal reform

27.  To facilitate corporate and financial sector restructuring, we are determined to put in place the necessary legal framework as soon as possible. In particular, the bankruptcy and foreclosure laws will be amended shortly, in line with recommendations of technical assistance provided by the World Bank and IMF legal experts. The new Bankruptcy Law, expected to be amended by March 31, 1998, will permit corporate reorganizations (as opposed to liquidations); increase the scope for out-of-court workouts (by repealing Section 94(2) of the Bankruptcy Act); and ensure fair treatment of creditors. Early administrative steps are also being taken to allow foreclosure, with comprehensive amendments of the laws relating to foreclosures to be proposed for enactment by October 31, 1998.

28.  In other areas, as part of the modernization of the central banking function (and as foreshadowed in the Letter of Intent for the First Review), we will be modifying the Currency Act to bring it in line with other central banks. In addition, to facilitate foreign investment and capital inflows, we propose to amend legislation substantially liberalizing ownership laws, including amendments to the Alien Business Law.