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Bangkok
August 25, 1998

Dear Mr. Camdessus:

1.  We have continued to make considerable progress in implementing the program, and all performance criteria have been met. This has helped consolidate Thailand’s external situation, increase further net international reserves, and maintain broad stability in the baht. These are significant achievements given the deepening of the recession in Asia.

2.  However, Thailand has been deeply affected by the regional crisis, and domestic output has fallen further. Although an export recovery is emerging, with volumes having increased by about 10 percent during the first half of 1998, there are severe constraints from the decline in commodity prices and depressed regional demand. Domestically, consumer and investor confidence has been slow to recover, and unemployment is rising.

3.  Against this background, we are resolved to intensify restructuring efforts in crucial sectors of the economy, and further adapt the program’s policy framework. These modifications are designed to be as supportive as possible of an early recovery, and as protective as possible of social conditions. At this fourth quarterly review of the program, the focus of policies will therefore be in the following six areas:

• First, within the macroeconomic framework, fiscal policy will continue to aim at supporting domestic demand. Therefore, the overall public sector deficit for 1998/99 is targeted to remain at about 3 percent of GDP. This excludes 1½ percent of GDP in interest costs related to the ongoing fiscalization of bonds for FIDF and other financial restructuring costs. Of these costs, 1 percent had already been budgeted; an additional ½ percent is earmarked for the initial interest costs of the August 14 financial package, and for possibly higher than budgeted interest payments on bonds for FIDF. Expanded government spending through the central government and the public enterprises is being carefully designed to maximize the impact on the real economy and on the social safety net.
   
• Second, on monetary policy, money market interest rates have already declined substantially, from over 20 percent earlier this year to the 10-12 percent range. As the effects of these reductions work themselves through and financial institutions are recapitalized, banks’ lending rates should fall further, and liquidity conditions improve. This process will be helped by the ongoing decline in inflation.
   
• Third, financial and corporate debt restructuring—crucial to the timing and strength of the recovery—are being carried to a decisive stage. Through a comprehensive announcement on August 14, remaining weaknesses in the financial system have been addressed, further consolidation achieved, and conditions established for the use of public resources in recapitalizing banks and facilitating corporate debt restructuring.
   
• Fourth, the strategy for corporate debt restructuring includes, in addition, the removal of institutional obstacles and tax disincentives, and the elaboration of a comprehensive framework to guide market-based debt workouts under the Corporate Debt Restructuring Advisory Committee (CDRAC).
   
• Fifth, additional measures have been taken to cushion the impact of the recession. We have augmented and better targeted the social safety net, while avoiding entrenching new costly schemes that could introduce distortions into the labor market. Infrastructure spending is to be increased to support priority areas in rural and urban sectors in order to augment broader agricultural production and industrial restructuring. We will also accelerate the social investment program targeted at addressing many dimensions of unemployment.
   
• We are committed to further market opening of Thailand’s economy. Many sectors have been sheltered from foreign investment, and thus denied both new liquidity flows as well as international expertise. In response, the Alien Business Law will be converted into a new and more liberal Foreign Investment Law, taking care to balance the need for new foreign investment flows with domestic sensitivities. Privatization of Thailand’s utilities is also to be launched. The privatization process will generate resources that will be used to protect the situation of workers while also contributing to reducing the public debt.

4.  We will continue to keep the financing of the program under close review to assure that, with IMF support, the program remains fully financed at all times.

5.  Significant progress has been made in rebuilding confidence and paving the way for a sustainable and strong economic recovery. Were new pressures to arise, the government stands ready to take, in consultation with the Fund, whatever additional measures may be necessary to ensure the continued success of the program.

Attachments

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431

MEMORANDUM ON ECONOMIC POLICIES
OF THE ROYAL THAI GOVERNMENT

August 25, 1998

I.  MACROECONOMIC FRAMEWORK AND POLICIES

1.  Steady progress in implementing the program has restored net international reserves to comfortable levels and helped stabilize the baht. Nevertheless, the economic recovery has been delayed, partly reflecting the deepening recession in Japan and elsewhere in the region. Against this background, the main focus of this review has been to address key obstacles—corporate indebtedness and inadequate bank capitalization—to economic recovery, within a supportive macroeconomic policy framework.

2.  While the government remains committed to the overall macroeconomic framework developed at the last review, some modifications are necessary in light of the developments in the first half of 1998. Key elements of the modified framework are presented below.

3.  In recent months, manufacturing production (seasonally adjusted) has stabilized, and the agricultural sector is beginning to respond to much improved relative prices. Thus, the modified macroeconomic framework anticipates that the economy will bottom out toward the end of the year, setting the stage for a modest recovery of growth in 1999. A supportive regional environment will be important to this prospect. Reflecting the deeper recession, we now expect inflation to be lower and the external current account surplus higher than previously forecast. Within the overall framework, fiscal policy will continue to be assigned the task of offsetting the recessionary impulse from falling domestic demand, while monetary policy will aim at maintaining broad exchange rate stability and ensuring adequate liquidity in the economy.

Fiscal policy

4.  The larger fiscal deficit target for 1997/98 (3 percent of GDP on a GFS basis for the overall public sector, excluding the cost of financial sector restructuring) agreed at the last review remains appropriate. It is our intention to fully utilize the increased margin in the fiscal program to support domestic demand. The performance criterion on net bank credit to the public sector (Annex A) has been modified, consistent with changes in the composition of the financing of the overall public sector deficit.

5.  Given the continued weakness in domestic demand, we will defer any contraction of the fiscal stance in 1998/99. Thus, we will aim at an unchanged overall public sector deficit of 3 percent of GDP, of which the central government component is 1 percent of GDP. This excludes 1½ percent of GDP in interest costs related to the ongoing fiscalization of bonds for FIDF and other financial restructuring costs. Of these costs, 1 percent had already been budgeted; an additional ½ percent is earmarked for the initial interest costs of the August 14 financial package and for possibly higher than budgeted interest payments on bonds for FIDF. Within this framework, the government will channel an additional B 12 billion for the Social Investment Program (SIP) and expand the scope of the Social Security Fund (SSF), as part of the broader effort to strengthen the social safety net (paragraph 26).

6.  The deficit of the state enterprise sector is now projected to rise from ½ percent of GDP in 1997/98 to 2 percent of GDP in 1998/99. Some part of the increased deficit is explained by lower earnings forecasts. However, the larger state enterprise deficit target importantly also reflects a strengthened and better targeted expenditure program, the composition of which has been discussed with World Bank staff. In particular, infrastructure projects, aimed at alleviating bottlenecks and supporting employment in both urban and rural areas, are part of the revised expenditure program of the state enterprises. They constitute an integral part of the government’s efforts to cushion the impact of the recession on employment.

7.  The 1998/99 budget framework contains a number of structural measures. Most importantly, we have either eliminated or temporarily suspended taxes that could hinder debt restructuring efforts and mergers and acquisitions, whose costs in terms of foregone revenues are negligible (Section III). As part of future tax reform, aimed at restoring fiscal strength and improving the efficiency of the tax system, we are considering a package of measures that would phase out tax exemptions, introduce capitalization rules limiting interest deductibility, and streamline VAT collection and refund procedures. In the meantime, we have appointed a customs advisor to implement a program for institutional and procedural improvements in customs administration.

8.  Based on the August 14 comprehensive announcement on financial sector restructuring (Attachment I), we are reassessing the ultimate fiscal costs of such restructuring. Our preliminary estimates suggest that the interest costs associated with all restructuring operations could average 3–4 percent of GDP on an annual basis in the next few years, before declining gradually. Of this amount, as indicated above, we will fiscalize 1½ percent of GDP of interest costs in 1998/99. The remainder will be phased into the budget over the two fiscal years 1999/2000 and 2000/2001. These estimates include a preliminary assessment of the possible access to public funds for the recapitalization of financial institutions (paragraphs 17–18).

Monetary and exchange rate policy

9.  The monetary policy framework under the program, which has emphasized broad exchange rate stability, has delivered important results. It has helped stabilize the baht, given credibility to the BOT’s willingness to respond to exchange market pressures, and allowed financial sector restructuring to be implemented without disturbing monetary stability. It is now allowing for a very substantial reduction in short-term money market rates (presently about 10–12 percent, compared with over 20 percent earlier this year). This policy framework will be maintained. Beyond that, as inflation declines, there will be increased focus on restoring liquidity and bringing down the broader structure of bank lending and deposit rates.

10.  Regarding the conduct of monetary policy, we have begun to give greater prominence to interest rates with 1–3 month maturities in the repurchase market. This is aimed at providing the market with a somewhat longer-term benchmark than the overnight repurchase rate. However, were foreign exchange market pressures to arise, short-term interest rates of all maturities, including the overnight repurchase rate, would be promptly raised to counteract speculative pressures.

11.  Within this framework, the BOT has prepared a monetary program as an additional guide for monetary policy, based on the latest outlook for inflation and output. At this stage, the reserve money program sets upper limits (B 495 billion for reserve money for end-December 1998), rather than precise targets, for reserve money and NDA of the BOT (Annex B). Over time, as money demand stabilizes, greater prominence will be given to quantitative targeting, and the BOT has begun to strengthen the institutional capacity for monetary analysis and control.

12.  In the context of the recessionary environment, a major bottleneck to renewed credit expansion has been the reluctance of inadequately capitalized banks to lend to over-indebted corporations. It is for this reason that the overall strategy now focuses on accelerating corporate and financial sector restructuring (Sections II and III). Meanwhile, the government has supported the targeted extension of credit to the export sector through trade-financed facilities with the Export-Import Bank of Japan and the AsDB. With the cooperation of the World Bank and the AsDB, we are assessing the capacity of the specialized financial institutions and their regulatory framework, in order to support their operations.

External sector

13.  The 1998 balance of payments outlook remains broadly unchanged. While adjustment of the external current account continues to be greater than envisaged, developments in Japan and the region, as well as those in Russia, have added offsetting pressures, reducing export demand and making the rollover rate of maturing obligations more volatile. Based on developments in the first half of 1998, we now expect the current account surplus in 1998 to reach $11–12 billion or about 10 percent of GDP. With falling export prices offsetting relatively buoyant growth in export volumes, dollar exports are projected to decline by about 3 percent this year. Consequently, the shift in the current account is being driven by the continuing compression of imports. The capital account is now expected to record a larger deficit, despite higher foreign direct investment, on account of more volatility in the debt rollover rate.

14.  Based on these projections, the BOT’s gross reserves are expected to remain within the $26–28 billion range by end-December 1998, as anticipated at the time of the last review. However, reflecting the revised phasing of some official financing disbursements, the net international reserve floor for end-December 1998 has been slightly modified (Annex C). Reserves will continue to provide more than full coverage of short-term debt. We will monitor closely future capital account developments, and were pressures to intensify, we would take appropriate measures to ensure that the economic program remains adequately financed.

15.  Regarding the 1999 outlook, the capital account deficit is likely to narrow sharply, as the large stock of offshore forward and swap obligations will have been settled by end-1998. The current account is expected to record a surplus of about $9 billion or 7 percent of GDP in 1999, based on continued strength in export volumes and a possible rebound in import demand. On this basis, and assuming some recovery in the regional situation, the BOT’s reserves could rise further in 1999. This should increase room for maneuver and facilitate the process of lowering external debt that is already under way.

II.  FINANCIAL SECTOR RESTRUCTURING

16.  A comprehensive announcement on financial sector restructuring was made on August 14 (attached). This announcement focuses on a wide range of immediate measures to resolve Thailand’s banking crisis, stabilize banks’ deposit base, and resume lending. There are four major aspects of the financial restructuring program. First, the consolidation of the banks and the finance companies has been accelerated through additional BOT interventions and proposed mergers. Second, private investment and entry (domestic and foreign) into the banking system is to be encouraged through the early sale of two intervened institutions, as well as the preparation of other state banks for eventual privatization. Third, public funds are to be provided for recapitalizing all remaining financial institutions, with appropriate safeguards and conditions, and linked to progress in corporate debt restructuring. Fourth, a framework has been developed for the creation of private asset management companies. A timetable for key implementation targets and dates for this agenda is contained in Box A.

17.  The priority in using public funds is to facilitate the restructuring and consolidation of the core banking system while, at the same time, balancing the need for safeguarding the economy from further weakening. The banks are expected to use the public capital injections, with new private capital, to increase their capital positions above the current minimum. This should provide banks with the room necessary for adequate provisioning, new lending, and advancing the implementation of the year 2000 LCP standards. The new windows for the use of public resources involve the provision of Tier 1 and Tier 2 capital, with the latter linked to progress in restructuring corporate debt. We are confident that the newly announced mechanisms for recapitalizing banks with public resources are flexible enough to address the different financial needs of individual banks, and provide sufficient incentives for banks to access these facilities. The modalities envisaged minimize moral hazard concerns, through the write-down of the old shareholders and the adoption of new restructuring plans (involving changes in management) in all institutions receiving public equity support.

18.  We have also reaffirmed our commitment to on-going and longer-term initiatives designed to ensure that financial sector problems do not arise again in the future. These initiatives, which have been part of previous letters of intent, are summarized in Box B.

19.  As indicated in the last Memorandum of Economic Policies (May 26, 1998), the government has initiated a broad review of financial sector legislation and regulation, as well as of the information systems of the BOT. The review is being conducted with the help of a Steering Committee of international experts on BOT restructuring, as well as a Working Group on Financial Sector Policies. The review should be completed by end-October 1998, after which we will finalize proposals for legal, regulatory, and institutional reforms, including that of bank supervision, consistent with international best practices.

III.  CORPORATE DEBT RESTRUCTURING

20.  Corporate debt restructuring is closely intertwined with financial restructuring. Both are essential to reestablish normal market relations, allow the resumption of credit flows, and support a recovery of the private sector. A key focus is to reduce the debt burden of the corporate sector which has risen sharply. Thus, restructuring of corporate debt is a key focus of the strategy, essential for Thailand to restore sustained growth over the medium term.

21.  The government is committed to facilitating this process through legal, tax, and other institutional reforms. The recently established Corporate Debt Restructuring Advisory Committee (CDRAC) seeks to promote market-based corporate debt restructuring with a view to supporting the economy and employment. Toward this end, we have developed a detailed framework for restructuring and, in addition, have sought to eliminate impediments and strengthen the broader incentive framework for restructuring. Details of this approach are summarized in Box C, and include the elimination of tax disincentives for debt restructuring; revised BOT regulations for loan classification and collateral appraisal in line with best international practice; and an increased involvement of the BOT to monitor and supervise the debt restructuring carried out by financial institutions under its regulations. A detailed timetable for moving ahead with actual restructuring has been recommended as part of the agreed principles; however, in larger and more complex cases, the lead institution or steering committee may set a different timetable. At present, based on the financial institutions’ reports of debt restructuring to the BOT, approximately 800 debtors (with total indebtedness of over B 200 billion) have begun the process of debt restructuring. Based on the restructuring cases proposed by its five member associations, the CDRAC is targeting 200 restructuring cases for early resolution.

22.  We recognize that the market-based strategy can only succeed if the incentive structure drives both debtors and creditors to accelerated negotiation and resolution. Thus, it remains crucial to strengthen bankruptcy legislation and to reform judicial foreclosure proceedings and secured lending legislation as much as possible. Our strategy in this area is contained in Box D. Additional amendments to the bankruptcy law have been approved by the Cabinet and are expected to be enacted by the current session of Parliament (by October 31, 1998). Regarding foreclosure and the enforcement of security rights, the Cabinet has approved amendments to the Code of Civil Procedure which should significantly accelerate judicial proceedings applicable to the enforcement of mortgages. These amendments are also expected to be enacted by Parliament by October 31, 1998. We are keeping under review the need for additional modifications, particularly to the current regime of security rights, seeking to broaden the range of assets that could serve as collateral, and introduce a regime of centralized registration. We will finalize the additional changes by end-1998.

23.  Incentives for financial institutions to accelerate debt restructuring with their corporate clients have also been increased by the scheme to provide Tier 2 capital, with appropriate safeguards, to financial institutions undertaking such restructuring. (Details are contained in the attached August 14 announcement.) Corporate restructuring will also be facilitated by envisaged market opening policies which should increase the role of foreign investment in the economy (summarized in paragraph 27 below).

24.  We will not hesitate to strengthen this strategy for corporate debt restructuring if warranted by circumstances. In particular, in the event that protracted deadlocks develop, the CDRAC may intervene to aid negotiations—in addition to its role of reviewing existing legislation and regulations—with the aim of facilitating debt restructuring in Thailand. Progress in corporate debt restructuring will be a key focus of the next quarterly review under the program.

IV.  SOCIAL SAFETY NET

25.  As recognized in previous letters of intent, the government has a vital role to play in supporting the recovery of the real sector and, in the meantime, minimizing the social impact of the recession. With the depth of the recession more severe and prolonged than previously anticipated, we are renewing our efforts in this regard.

26.  Development of an adequate social safety net to cushion the impact of the recession on the most vulnerable, remains a key priority of the government. Our strategy has been developed in consultation with major nongovernmental organizations and labor leaders, and is being implemented with the support of the World Bank (a social investment project loan was approved on July 9), the Asian Development Bank (a social sector loan was approved on March 12), and the Overseas Economic Cooperation Fund. Key elements of the strengthened social safety net are contained in Box E. In designing the social safety net, we have avoided introducing distortions into Thailand’s relatively free and well functioning labor market.

V.  MARKET OPENING POLICIES

27.  The government recognizes that market opening policies can make a significant contribution to ending the recession, accelerating the economic recovery, and restoring sustained medium-term growth. However, these policies, which aim at increasing the role of the private sector in Thailand’s economy, need to be implemented with great care, and based on an overall social consensus. In particular, these policies need to be justified by the contribution they will make to reducing liquidity shortages in the economy, increasing efficiency, supporting employment, and restoring output. On this basis, we have drawn up a framework for privatization of key sectors (Box F). In addition, we are encouraging new inflows of foreign direct investment by converting the Alien Business Law into a new and more liberal Foreign Investment Law, and by liberalizing land leasing and sales (Box G) of the LOI.

ATTACHMENT I

JOINT STATEMENT BY THE MINISTRY OF FINANCE AND
THE BANK OF THAILAND

August 14, 1998

Financial Restructuring for Economic Recovery

I. Introduction

1.  Structural weaknesses in Thailand’s financial system have been at the heart of the current crisis. Over the past year, a succession of measures have been introduced to address these weaknesses and restructure the financial sector. These have included: (i) requiring all financial institutions to raise capital according to MOU’s with the Bank of Thailand (BOT); (ii) BOT intervention in all institutions that could not succeed in raising new capital (six banks and 12 finance companies, including today’s actions) and closing 56 unviable finance companies last December; (iii) gradually tightening loan classification and provisioning (LCP) standards to increase recognition by all institutions of their true financial condition, as well as to bring these standards in line with international practice; (iv) liberalizing the limit on foreign equity in financial institutions; and (v) establishing institutions for the disposition of the assets of the closed finance companies. These are only some of the measures that we have taken in our efforts to restore and maintain confidence in the Thai financial system. Moreover, through them, we have consistently demonstrated that financial restructuring, and the restoration of viability to Thailand’s financial system, is an essential precondition to economic recovery.

2.  However, the deteriorating domestic and regional economic environment has now become a key obstacle to the task of restructuring Thailand’s financial system. The deepening economic recession has caused asset quality of all financial institutions to deteriorate further. While several private banks, including the two largest, have been able to secure injections of private capital, their success has not been widely shared. Sharply declining credit quality and falling earnings, because of the economic downturn, are now impeding efforts of all financial institutions to raise capital. These difficulties have contributed to tight credit conditions and further complicated the task of economic recovery.

3.  Therefore, comprehensive and forceful actions are needed to address all the outstanding weaknesses in the financial sector. This is the objective of today’s announcement. The augmented restructuring strategy is focused on the following elements: (i) the commitment of funds to assist in the restructuring efforts of viable banks and finance companies; (ii) incentives for accelerating corporate debt restructuring pari passu with recapitalization; (iii) the efficient management of nonperforming assets; (iv) the exit, merger, or sale of nonviable banks and finance companies; (v) equitable loss-sharing arrangements, containment of public sector costs, and the avoidance of moral hazard; (vi) the strengthening of prudential supervision and the accelerated adoption of international best practice; and (vii) operational restructuring of state banks and their preparation for eventual privatization.

4.  Such a comprehensive approach will require a high-level Financial Restructuring Advisory Committee (FRAC) to oversee its implementation. This body is being established and will advise the Minister of Finance and the Governor of BOT regarding all aspects of the strategy. The composition of FRAC will be finalized next week.

II. Capital Support Facilities

5.  Against the above background, and recognizing that the continuing uncertainties about the macroeconomic outlook impede injections of new private capital, the government has designed two capital support facilities. Technical details of these facilities are contained in Annexes 1 and 2. The objective is to restore and maintain the solvency and credibility of the Thai financial system and, most importantly, to enable the financial institutions to perform effectively their role in supporting economic growth.

6.  The government recognizes fully that the terms and conditions of any public support facility should be transparent and subject to the strongest possible safeguards, while facilitating the restructuring and consolidation of financial institutions and protecting the economy from further weakness.

7.  With the above aims in mind, we have developed two schemes to provide funds to assist with the recapitalization of the viable financial institutions (henceforth, "institutions" will refer to banks and finance companies incorporated in Thailand), and to resume normal but prudent lending. One scheme is aimed at catalyzing entry of private capital. The other scheme provides financial resources and incentives to accelerate corporate debt restructuring and encourage new lending. Both schemes build in appropriate safeguards.

8.  Objectives: Under this scheme, the government essentially helps to recapitalize the good assets of the institutions. As a first step, they will be required to adopt up-front the end-2000 LCP rules. Although this will bring forward provisioning requirements, it will remove uncertainties associated with bad loans, and provide the basis for resumption of normal lending practices.

9.  Safeguards: This facility includes the following safeguards: First, the costs associated with bringing forward the end-2000 LCP rules will be borne by existing shareholders. Second, the new injections of public and private capital will have preferred status over existing shareholders, thus ensuring that the existing shareholders will be the first to bear losses on the old portfolio. Third, the government or the new investor will have the right to change existing management. Fourth, resources will be made available to these institutions provided their restructuring plans have been approved by the BOT.

10.  Capital injections: The capital injections under this facility will take the form of the placement of tradeable government bonds, and subject to the following conditions: (i) after full provisioning and up-front write-off , if the Tier 1 capital adequacy ratio (CAR) falls below 2 ½ percent, the government would be prepared to recapitalize the institution up to this level; (ii) beyond this level, the government would inject Tier 1 capital up to the amount provided by private investors. We will be supportive of institutions’ efforts to recapitalize above the regulatory minima, thus providing them with room necessary for adequate provisioning and new lending.

Tier 2 capital support facility

11.  Objectives: This facility provides additional incentives to facilitate corporate recovery through the provision of Tier 2 capital.

12.  Safeguards: The safeguards include the requirement that eligibility is dependent upon a legally binding debt restructuring agreement between the financial institution and the debtor. In addition, the institutions will need to satisfy the BOT that the debtor has been able to service the loan according to BOT regulations on corporate debt restructuring (which require that borrowers meet their obligations for three consecutive payment periods or at least three months). The BOT will regularly conduct ex-post audits of the restructuring agreements.

13.  Capital injections: Capital injections under this facility will take the form of the exchange of nontradeable government bonds for bank’s debentures, subject to the following terms and conditions: (i) the total amount eligible for Tier 2 capital injection would comprise write-offs, net of amounts provisioned, as well as 20 percent of the net increase in outstanding loans to the private sector; (ii) while each institution would be eligible to receive a maximum amount equal to 2 percent of risk weighted assets, total Tier 2 support for increase in net lending will be capped at 1 percent of risk weighted assets; (iii) no single debt restructuring agreement would be eligible for more than 10 percent of the amount available to the institution; and (iv) as an additional incentive to stimulate early corporate debt restructuring and to increase net lending, the injection of Tier 2 capital will be graduated. Since drawdowns under this facility would be in the form of Tier 2 capital, based on commercial terms, this facility would not impose a burden on public finances.

14.  Additional incentives: Financial institutions which adopt up-front the end-2000 LCP rules will be allowed to phase write-offs for debt restructuring over a five year period, hence providing some additional, temporary relief to capitalizing banks.

III. Regulatory Changes

15.  In order to allow institutions to use this facility, the BOT will issue a new regulation regarding the composition of the capital base in line with recommendations under the Basle Concordat. The overall CAR ratio will remain 8.5 percent for banks (slightly above Basle standards) and 8 percent for finance companies; however, the Tier 2 component will be allowed to increase up to 50 percent of the capital base, in line with Basle standards. Moreover, the one percent provisioning for performing loans will also qualify for Tier 2 capital, also in line with Basle standards.

IV. Facilitating the Establishment of Private AMCs

16.  We recognize that additional modalities need to be made available to financial institutions to provide maximum flexibility to deal with their bad assets, while allowing institutions to restructure their balance sheets. Thus, we are encouraging institutions to set up, capitalize, and fund private Asset Management Companies (AMCs). The AMCs will be defined as financial institutions to allow them to borrow (excluding deposits) and re-lend funds (only to existing customers); and allow them full flexibility in setting their interest rates. Thus, the government will propose amendments to necessary legislation. Institutions will be able to transfer assets to AMCs without legal impediments. All taxes and fees incurred in transferring assets to the AMCs will be exempt. AMCs will be fully consolidated into the institutions’ balance sheet provided they own more than 50 percent of the shares. BOT will shortly issue regulations regarding the operation of AMCs.

V. Resolution of the Four Intervened Banks

17.  The four intervened banks are severely undercapitalized and have a large proportion of nonperforming loans. Given the potential costs to the state, we believe that any resolution strategy for the intervened banks must adhere to the following key principles:

• Be cost efficient
• Facilitate consolidation of the banking sector
• Allow for new domestic and foreign investment
• Be credible and transparent
• Enhance confidence in the whole banking system
• Be consistent with the capital support facilities

With the above objectives, and with the assistance of an international investment bank, we have developed the following resolution strategies:

18.  Bangkok Metropolitan Bank (BMB) and Siam City Bank (SCIB): It is proposed to privatize these banks. In preparations for this, the end-2000 LCP rules will be brought forward and the banks recapitalized through a debt to equity conversion of outstanding FIDF lending. The new investors could bid for up to 100 percent of the entire bank, and absorb all assets and liabilities, including the nonperforming assets. However, the government will be prepared to provide a loss-sharing or stop-loss guarantee on nonperforming assets, as well as a guaranteed annual yield to service the liabilities. Potential investors will have to specify in their bids the type of stop-loss and yield guarantee they require. It is expected that the privatization process will be completed and the banks taken over by new investors before end 1998.

19.  First Bangkok City Bank (FBCB): FBCB will be absorbed by KTB under the same loss sharing arrangement as the privatization of the above two mentioned banks. The integration of FBCB with KTB has been proposed because FBCB’s branch network complements that of KTB. KTB will take over the staff and all the FBCB branches and will have the right to later rationalize staffing and the branch network.

20.  Bangkok Bank of Commerce (BBC): All performing assets and liabilities of BBC will be transferred to KTB. The staff, branches and nonperforming assets will remain in BBC, which will be turned into a special financial institution owned by FIDF. FIDF will determine the process of winding down BBC (by end-1999) with the aim: (i) to maximize loan recoveries; (ii) to rationalize the staff; and (iii) to wind down and sell off branches.

VI. Operational Restructuring of KTB

21.  While KTB will play a key role in the consolidation of FBCB and BBC, the government recognizes that KTB also needs to be restructured and recapitalized, with the ultimate intention of preparing KTB for privatization. With this objective, KTB will implement a comprehensive restructuring plan. A new KTB Board will be appointed on end-August 1998, with all but one member of the Board from outside the public sector. KTB will also establish a new full-time Executive Board. A comprehensive plan for the operational restructuring of KTB will be developed by outside experts by end-November 1998. This plan has to be approved by the BOT and the MOF before KTB is capitalized according to the end-2000 LCP rules.

VII. Resolution Strategy for the Two Banks and 5 Finance
Companies Intervened Today

22.  To ensure that public resources would not be available to unviable institutions, the BOT has today intervened in two weak banks and 5 unviable finance companies. These institutions were deemed unviable according to BOT standards and had failed to raise new capital. Intervention had become necessary to protect the public interest. BOT has ordered these institutions to write down capital and to reduce their value per share to one satang.

23.  We have developed a resolution strategy for all of the newly intervened institutions, leading to further consolidation of the financial sector. Union Bank (UBB) and the newly intervened finance companies will be managed and eventually integrated with KTT. Laem Thong Bank (LTB) will be integrated with Radhanasin Bank. While this will further raise the share of the state in the banking system, it remains our intention to seek a strategic investor for Radhanasin Bank and, as indicated above, to prepare KTB and KTT for privatization.

VIII. Financing the Costs of Financial Restructuring

24.  Thus far, the burden of supporting financial restructuring has fallen on the FIDF. Some of the FIDF exposure will be converted into equity as part of the recapitalization of the restructured financial institutions. The government has already declared that it is prepared to take full financial responsibility for the losses of the FIDF, by converting them into government debt. This has been a key plank of Thailand’s overall economic program supported by the IMF and other members of the international community. It is also common to the experiences of virtually all other countries that have been faced with systemic crisis in their financial system. This conversion has already begun with the issuance of government bonds in recent months.

25.  The ultimate costs of financial restructuring will be offset, to some extent, by asset recovery, dividend and interest payments from institutions, privatization receipts and, ultimately, by the recovery of the economy. Nevertheless, it is recognized that there could be substantial remaining costs which will be borne by the government. As a first step toward meeting these costs, the government has already agreed to issue B 500 billion of government bonds. Additional losses will be fiscalized by the government over the next two years.

26.  Also in consultation with the IMF, we have assessed the implications of these costs for the public debt burden over the medium term. Thailand’s public debt has been relatively low by international standards. At this stage, it is impossible to precisely estimate the additional costs of the financial restructuring. After incorporating possible ranges for the total costs of financial restructuring, Thailand’s central government domestic debt will rise substantially in the next two years, while leaving total public indebtedness below that of many other developing and middle-income countries. As such, it should be sustainable, given its present low level, and the anticipated contribution of future privatization receipts as well as asset recoveries.

IX. Enabling Legal Changes and Key Benchmarks for Implementation

27.  The following enabling legal amendments will be proposed to parliament:

• Authorization to issue up to B 300 billion of government bonds for the Tier 1 and Tier 2 capital support schemes. In addition, when additional losses to FIDF are identified, the government will stand ready to fiscalize them by seeking authority to issue more bonds.
• Amendment of the Commercial Banking Law to enable establishment of AMCs.
• Amendment of the Commercial Banking Law to facilitate the merger of the banks; and the necessary changes in the associated tax and SET regulations.

28.  Key benchmarks for the implementation of today’s announcement are provided in the attached table.¹