The crisis of the Thai economy and the IMF

Narong Petprasert

The period of the bubble economy

From 1988 until the recent crisis, the Thai economy was prosperous, creating a large class of newly rich people. The price of land increased by 100% to 200% in a year. The stock market boom encouraged a large number of middle-class Thais to become investors; many became rich within days. This condition is termed by academics a "bubble economy", a condition in which asset prices increase rapidly because of speculation.

What were the main factors in the Thai bubble economy?

1. In 1984, Thailand faced serious economic problems: 25 finance companies were closed; the current account deficit was 9% of gross domestic product (GDP); foreign debt was 19.5% of the total value of exports. Finally these problems brought about the devaluation of the baht [the Thai currency].

Nobody could forecast that the depression of 1984 would become the bubble economy of 1988. Global changes in the world economy generated luck for Thailand.

In the 1980s, Japan became an unbeatable giant in the economic world, building up a huge trade surplus. This led to a very strong yen and a relative depreciation of the US dollar. Hence the dollar prices of Japanese exports were very high, undermining their competitiveness. Associated with this was US pressure on Japan to liberalize its trade.

In order to maintain competitiveness in the world market, Japanese producers needed to cut costs and to face the difficulties caused by the strong yen. Therefore, they shifted their investments to ASEAN [Association of Southeast Asian Nations] countries like Thailand with cheap labour and low-valued currencies.

The following table shows direct investment from abroad.

From the table, it can be seen that Japan is the largest external direct investor in Thai businesses. In 1987, Japanese investment was only 4,711.5 million baht, but it increased to 14,607.6 million baht in 1988 and reached a peak of 27,931 million baht in 1990. Also apparent in the table is the later influx of Hong Kong capital, due to fear of the consequences of the return of Hong Kong to Chinese rule in 1997.

Unit: million baht
Source: Bank of Thailand

The rise in Japanese investment pushed up the price of land in Bangkok and its hinterland. Rocketing land prices led in turn to a stock market boom, stimulated by the real-estate business. In the mainstream economic perspective, this boom was the result of the rapid increase in asset prices generated by speculation. In other words, it was a bubble economy.

2. In 1993 Thailand set up the Bangkok International Banking Facility (BIBF), to allow the free movement of financial capital in and out of Thailand. The consequence was an influx of short-term loans, due to the very low interest rates in foreign countries (3-4%) compared to the high interest rate in Thailand (14-18%).

Thailand's foreign debt at the end of June 1990 was about $92,000 million, of which about $76,000 million was private-sector debt and about $16,000 million was government-sector debt. Over 60% of the private debt was short-term debt (to be repaid within one year).

The influx of loans from abroad increased the money supply and the need to invest in order to repay these loans. This led to speculation in the stock market and in real-estate businesses, and the second wave of the bubble economy.

During the period from 1988 to 1995 Thailand, like other ASEAN countries, experienced extremely rapid economic development. The mainstream economists appreciated the way in which the ASEAN countries used export-oriented growth to fuel an economic boom. More radically-minded "political economists" warned the governments and business communities of the dark side of the bubble economy and the dangers of the free movement of money capital.

They also criticized the structural weakness of the Thai economy, in that it is based on industries with a high import content. The import content of the main export commodities can amount to 60-80%. The import content of Thailand's number one export, computer parts, is 80%. So more exports require more imports.

Dazzled by rapid industrial growth, the Thai economists and economic planners forgot the comparative advantage of agriculture and agro-industries, in which Thailand can produce low import-content products. The rapid growth rate in GDP at the end of the 80s (1988: 13.3%; 1989: 12.3%; 1990: 11.6%) led them to believe that its economic development model was successful. Thailand was hailed as a new Asian tiger, along with Malaysia.

The Thai tiger becomes the disabled Siamese cat

In 1997 the "Thai tiger" became the "disabled Siamese cat". There was a serious trade deficit. The current account deficit was about 9% of GDP.¹ The international reserves quickly ran down, from about $35,000 million in 1995 to $24,000 million in the second quarter of 1997. On June 27 1997, 16 finance companies were closed, and on August 5, another 42. The stock market index dropped to 500, from 1700 in 1994. Commercial banks ceased giving credit for housing. Real-estate businesses could not sell their products, while their total indebtedness was about 800,000 million baht or $30,769 million. The businesses were stuck. Borrowers could not repay. Lenders had no liquidity. This was associated with the collapse of the stock market. Foreign investors withdrew their investments. Thai investors suffered serious losses. The volume of selling and buying on the stock market decreased drastically and the income of the brokers (finance companies) became statistically insignificant. This caused the collapse of 58 finance companies, and finally the devaluation of the baht.

Why did this happen? It happened for three reasons.

Source: Krung Thai Bank annual report, 1996

Thailand is proud of her success in industrial development and export-oriented industries in which she employs a Promotion Protection Policy (PPP) to encourage the growth of industries and the export of industrial goods. The table on the previous page shows the high percentage of industrial exports.

Source: calculated from the figures of the Bank of Thailand

1. The dark side of Thai industrial exports is the high import content. This is associated with a lack of capital goods and technology. The weak structure of Thai industry led to growing trade and current account deficits. Thailand had to import capital goods, raw materials, fuel, and chemical products for manufacturing production. These account for 85% of the total imports as seen in the table above.

Unit: million baht
Source: Bank of Thailand

In fact since 1985 Thailand has had a trade deficit every year. Moreover, Thailand also has a deficit in services. Therefore at present the current account deficit (trade deficit + service deficit) is greater than the trade deficit. However up to 1997 Thailand had a surplus in its balance of payments.²

Direct investment in Thailand is attracted largely by cheap labour. At present, Thailand cannot keep wages as low as China and Vietnam because of its higher degree of capitalism in which every thing has a market price and must be paid for. Hence the cost of living in Thailand is higher than in those countries. Consequently, labour-intensive industries are moving elsewhere for cheaper wages. Thailand then faces the problem of capital flight and diminishing investment from abroad.

Moreover, under globalization and the requirements of the World Trade Organization, Thailand is obliged to adopt a free-trade policy and allow imports in with low import duties. This encourages imports. The industrialized countries set non-tariff barriers (eg, compliance with ISO international standards, or human rights and environmental criteria) to protect their domestic markets. This undermines the competitiveness of Thai exports.

The serious current account deficit and the drop in foreign investment means a decrease in the inflow of funds from abroad and in the international reserves, which underpin the value of the baht. The depletion of the reserves makes it impossible to defend the baht and leads inevitably to depreciation.

2. The rapid growth of the Thai economy from 1988 marked the great leap forward in Thai capitalism. Businesses earned high profits. Professionals and middle-class people became newly rich. But the immaturity of the businesses and the instant wealth generated by the bubble economy blinded them to the dangers of their situation. Businesses borrowed large amounts of money from abroad and never thought about how to make a profit in foreign currencies. Making profits in the domestic market didn't help with the foreign debt because the repayment had to be in foreign currencies, in particular, in US dollars. Without a return in dollars, the borrowers have to use the international reserves for the repayment. The rapid fall in the reserves and the rapid depreciation of the baht led to the baht crisis. The government was forced to float the baht on July 2 1997.

Since 1988, foreign finance capital stimulated the bubble economy. In 1993 foreign loans further stimulated it. Unfortunately, over half of the total loans were short-term private-sector loans. They were invested in speculative sectors, particularly in the stock market and in real estate. A part was also invested in the real sector (in production). The key problem was that a number of the borrowers had to repay within one year. But they could not get enough return in time, on the one hand, because of the collapse of the stock market and speculative businesses and, on the other hand, because investment in the real sector has a long-term payoff. This forced borrowers to postpone their repayments. This unreliability prompted the foreign lenders to call in their loans and to call for repayment in full, undermining the credibility of the Thai businesses. The government was forced to step in. The crisis escalated from private sector to public sector. Government institutions had to raise funds to support the finance companies, which lacked liquidity: because of the collapse of the stock market, their assets were overvalued, and their loans were not performing because their customers were in trouble.

3. Government mismanagement is a third reason. Before the crisis, no mainstream economist sounded the warning. Some political economists gave a serious warning about the possibility of a monetary crisis, but it was ignored. The warning signs were already there, eg, the serious current account deficit, the high proportion of short-term loans, the bubble prices of many assets. But the economists and the government academic institutions gave no analysis to counter optimistic projections for 1997. Not seeing the crisis coming, they gave no thought to preventing it.

Before the BIBF was set up, there was no regulation to prevent non-performing loans and to limit short-term loans.

During the crisis, the government also did the wrong thing by using the reserves to protect the value of the baht in foreign markets, using dollars to buy baht and incurring a loss.

The bankruptcy of many finance companies stemmed from mismanagement and over-investment in speculative businesses. Their licenses should have been quickly withdrawn, but the government did not do this. It wanted to reconstruct them. Eventually, on December 8 1997, 56 finance companies were closed permanently.

How to cure the disabled Siamese cat?

These were the conditions that changed the Thai tiger to a disabled Siamese cat. To my mind, it is not fair that the people should suffer because of the immaturity of Thai capitalism and the mismanagement of businesses.

What is the way out? Mainstream economists propose three solutions.

1. Increase exports. But this faces the fundamental problem we have already noticed, ie, the more exports, the more imports. As long as there exists the old industrial structure, with a high import content, Thailand cannot solve the problem of its trade deficit by increasing exports. However, there is some scope to increase foreign income from tourism. In my view, Thailand needs to restructure its industries and exports. It needs to support industries with a low import content and to pay more attention to the agricultural and agro-industrial sectors, because these are our strong bases. They have better comparative advantage i.e. better quality, lower cost and low import content.
2. Privatize public enterprises. This means selling all or part of the shares to the private sector. This is not easy, because the employees do not agree to it. Nonetheless, the government is trying to implement this strategy.
3. Take out loans. This is the easiest path. So Thailand asked for help from the International Monetary Fund. She thus became the "disabled Siamese cat" that lies down at the foot of the IMF.

In fact the direct loan from IMF was only $4,000 million, with $13,200 million from countries which are IMF members. See the figures below.

The IMF imposed the following conditions on the Thai administration.

1. To maintain a rate of growth of 3-4% in 1997-98, and 6-7% in the following years.
2. To keep the inflation rate below 7-8% in the first period, and below 4-5% in the next period.
3. To reduce the current account deficit of government spending to 5% of GDP.
4. To keep the level of the international reserves at $23,000 million in 1997 and $25,000 million in 1998.

To comply with these IMF conditions the government had to cut the budget and stop some projects. It also had to increase VAT in order to control national expenditure and to allow for a budget surplus of 1% of GDP. Result: a decrease in government investment and an increase in unemployment.

The IMF frame of thought contrasts with Keynesian theory, which insists on increasing aggregate demand to recover from economic depression. The great depression in the USA during 1929-1940 was overcome by this method. In December 1997, Japan applied Keynesian theory in reducing income tax in order to increase aggregate demand to stimulate the economy.

Now there is a wide-ranging debate about IMF conditionality and why Thailand has to accept its rule. Is the IMF Satan or Santa Claus?

What is the IMF?

During the second world war, monetary cooperation expanded among allied countries through various agreements and through monetary planning for the peace to follow. American policy-makers concluded that one of the chief causes of the economic and political disaster of the previous decades had been the failure of American leadership. They decided that America would have to assume primary responsibility for establishing a post-war economic order, which would be designed to prevent economic nationalism by fostering free trade and a high level of international interaction. The conference in Bretton Woods (New Hampshire, USA) organized in 1944 by the USA, the UK and Canada led to the creation of the new post-war system of international monetary control and the establishment of the International Monetary Fund (IMF) and International Bank for Reconstruction and Development (IBRD) or World Bank.

The IMF came into operation in 1947, with headquarters in Washington. Its aims are the promotion of international monetary cooperation, the expansion of world trade through the removal of exchange controls, and making funds available to countries experiencing short-term balance-of-payments difficulties to enable them to maintain their exchange rates. The resources of the fund come from capital subscribed by member states, quotas for which are decided upon and reviewed every five years. Voting rights on almost all issues are related to the size of the quota. The USA holds the largest quota (17.82%), hence it is able to exert a preponderant influence in the body. Other quotas include Germany 5.5%, Japan 5.5%, France 4.99% and the UK 4.99%. Between them, the G10 (the USA, the UK, Germany, Italy, Canada, Japan, the Netherlands, Belgium, Norway and Sweden) control over 50% of IMF resources. This means that the IMF is absolutely under their control. ASEAN and other countries are powerless. They are not able to change the IMF rules in accordance with their needs. The IMF becomes an instrument of the G10 to control the monetary system of the world.

What rules does the IMF impose on borrowers? The general rules are:

1. To have free exchange rates and free trade in currencies.
2. To devalue.
3. To control inflation through:
   1. control of bank credit,
   2. the government budget, ie to increase tax and reduce expenditure,
   3. a wage freeze
   4. to float the prices of commodities
4. To stimulate foreign investment and foreign ownership.

Consequently, it is very hard for developing countries to manage their monetary system. Local currencies are exposed to the attacks of the "robber barons" of finance. IMF rules bring suffering to the people, particularly to the workers and the poor. Why? First, because floating prices mean increased prices, and these, together with increased taxes - especially regressive consumer taxes - push up the cost of living. If at the same time wages are frozen, the real incomes of the workers are reduced. (Note in passing that allowing prices to float upwards does not assist in the goal of controlling inflation.)

Secondly, the reduction in government expenditure and the decrease in purchasing power due to increased consumer taxes leads to a decrease in investment in both government and private sectors, bringing about increased unemployment. A vicious spiral is created. Unemployment leads not only to the suffering of workers, but also to a decrease in national purchasing power or aggregate demand. Finally, this undermines economic growth. The downward spiral disrupts the national economy. Many businesses collapse, paving the way for foreign take-overs.

It seems to many that the IMF rules are good for lenders, but not for borrowers. The IMF never takes the unemployment and the suffering of the workers and the plight of other poor into account. That is why academic communities in the south wonder whether the IMF is Santa Claus or Satan.

The cold war ended in 1989, but it has been replaced by a new economic war. Western nations build up their strongholds, Nafta and the EU, setting up free trade and free capital movement in their regions. At the same time, they set up many non-tariff barriers to protect their economies and prevent exports from Asia's newly industrializing countries.

From 1987 to 1996 was the period of "miracle" economic growth in the ASEAN 4 (Thailand, Malaysia, Indonesia and the Philippines). They became formidable competitors in the world market. As a result, some people are inclined to think that the IMF, under the control of the G10, is not likely to be too quick to cure the economic crisis in Southeast Asia. The longer the crisis, the better the competitiveness of the G10 in the world market. Thus, I appreciate the prime minister of Malaysia, who dares to challenge the big powers of the west and does not bring Malaysia into the IMF programmes. He is the only Asian leader who dares to attack the financial "robber barons" openly.

What is the way out for Asian countries?

There are three levels to the crisis, so three levels of response are needed to counter it.

1. To counter unemployment in Thailand, Indonesia, Philippines and Korea, the workers and unions in each country needs to ask their governments to set up a budget for job creation. This budget is available from the World Bank and Asian Development Bank, which provide loans for structural adjustment of production and economic institutions.
2. In negotiating with the IMF each government must act in accordance with its national interest and on the basis of the best solution for the nation in order to preserve appropriate economic growth and appropriate conditions of life for the people at large.
3. Thirdly, at the regional level, three needs can be seen:
   1. The need to increase trade among the countries in the Asian region;
   2. The need for regional agreement on currencies and international payments, so that each country can use its local currency to pay for imports and accept the currency of its counterparts in payment for its exports. However, the countries in the region may base the par value of their currencies on the Japanese yen. This means that the prices of imports and exports may be set in yen and converted into local currencies;
   3. Asian countries need to set up an independent Asian Monetary Fund (AMF) to be a mutual help organization for Asian countries. Japan and China should be the core of the organization. The huge reserves of Japan and China would be able to protect the other Asian currencies from predatory attack. However, how can we ask Japan and China to be the core of the Asian fund? There is the historical problem between China and Japan. Moreover, it seems to me that Japan is reluctant to say where it stands.

We need the unity of the east. An economic war is going on. Asian countries must dare to win.

Narong Petprasert is a professor of economics at Chulalongkorn University, Thailand

Notes

1. The balance of trade deals with merchandise (or visible) imports or exports. When "invisibles", or services, are included, the total accounting for imports and exports of goods and services is called the balance on current account.

2. The balance of payments includes both the current and capital accounts.