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Thailand: Light at the End of the Tunnel?

by Dr Pasuk Phongpaichit
and
Mr Chris Baker

ASIALINK - April 1999

PP [2] On 30 March, the Thai government announced the most dramatic and radical crisis package since the start of the crisis nearly two years ago. [3] The package included tax cuts (especially VAT from 10 to 7 percent), and the injection of US$1.54 billion, mostly from the Miyazawa Scheme. The government told the world to expect a turnaround in 4-6 months. The IMF echoed the estimate of 6 months. Some financial analysts in HK have been equally upbeat.

Groping around, there are some signs of increased confidence. [4] Imports edged up in February for the first time in almost 2 years, raising hopes of some return in consumer demand. Sales at the recent Bangkok Motor Show exceeded expectations. Department stores say they can detect a little consumer pull. A business cycle index edged up slightly.

But. But. [5] The stockmarket greeted the government's new package by falling. Sceptics pointed out that both government and IMF have been predicting recovery 'within 6 months' ever since August 1997. They have been very consistent. They are not yet right. The government's index of investment is still going downwards. Exports lurched down by another 5.6% over the first two months of the year. Despite the excitement over the Bangkok Motor Show, total car sales in the first quarter fell 4 percent over last year.

So is there light at the end of the tunnel? A lot depends on how you picture the tunnel. If you imagine it like a tunnel through a mountain (the Mont Blanc tunnel, for instance), then at some point you turn a corner and the light is visible. But the Thai crisis is more like a mineshaft Ü a steep drop almost straight down. Just levelling out is not enough. You have to really turn upwards before the light becomes visible. And then what you have ahead of you is a very steep climb.

Why a mineshaft? [6] The Thai economy has been knocked backwards by about 6-10 years. The per-capita GDP dropped 19 percent last year. In baht terms, it now stands roughly where it was in 1993. In dollar terms, it is back around 1990-1. [7] The temporary euphoria over the motor show sales won't change the fact that car sales are below a third of the level of two years ago. Thousands of firms have been bankrupted. Probably 1-in-5 of everyone working outside agriculture has lost their job.

Whatever the longer-term and deeper causes of the crisis, the immediate cause was the massive inflow and outflow of money. [8] The total net private inflow over 1993 to 1996 was equivalent to around one-third of Thailand's GDP. [9] After the baht float in July 1997, nearly all of that amount flowed out within 18 months. No economy can cope with flows of that size, and a reversal so sharp. The equivalent in Australian terms would be an inflow of 18 billion Aus dollars over 4 years, followed by an exit of 15 billion over 18 months.

On the inward phase, it creates a bubble economy of over-priced real estate, crazy loans, profligate consumption. On the way out, it wrecks balance sheets, seizes up the banking system, destroys jobs, and leaves a trail of collapsed companies.

The fault, of course, lies on both sides. Thailand was certainly at fault for encouraging the inflows (by liberalising the financial sector but holding the baht to a dollar peg), and failing to police its financial system. But international finance was at fault for stuffing money in, ramping up Thailand as a new eldorado until weeks before the crash, ignoring (and even enjoying) the lax state of government regulation.

CB This is a new type of crisis. Since the baht was floated in July 1997, and the IMF came in a month later, the crisis has gone through three distinct phases.

[10] In the first phase, the IMF treated it like an old type of crisis, and so made things much worse. The IMF had been used to managing crises in Latin America where governments had overspent and got hopelessly into debt. The solution was to squeeze the government down by higher taxes and spending curbs. These strictures made international investors happier, and usually confidence returned in 6 months.

In Thailand the problem was quite different Ü a private debt bubble Ü but the IMF's solution was the same. The result was disastrous. International financiers could not see how the IMF's plan was supposed to work, so they got their money out as fast as possible. The deflationary macro policy added to the problem of capital flight. Demand in the economy disappeared faster than anyone could imagine.

[11] The innovation in the IMF scheme was to launch a programme of financial restructuring. This programme of course makes a lot of sense Ü the Thai banking system was not designed to function in a liberalised world. But beginning such restructuring when the economy is in shock, is very dangerous. The IMF began by closing down banks and finance companies which were sliding towards bankruptcy. At first, it promised to sort out the good and bad debtors of these institutions and treat them differently. But it quickly gave up this idea. So, if you were a client of one of these institutions, it did not matter whether you were a good debtor or a bad debtor, a profitable company or a disaster. Your banker had disappeared.

[12] The result of the IMF package was a total collapse in demand; capital flight; and seizure in the banking system.

[13] At the start of the bailout, the IMF projected the Thai economy would still grow in 1998 by 3.5 percent. [14] This figure slid down and down and down until it ended up at -8.5 percent. This swing of 12 percentage points is a measure of the failure and inappropriateness of the IMF plan. It dragged the baht value down from 25/US$ to 56/US$ at the worst. Thousands of companies found that their customers disappeared, then their credit disappeared Ü and then they disappeared.

The second phase of the crisis began in mid-1998. In short, the Thai government rebelled against the IMF programme. This was done ever so discreetly. The IMF desperately wanted a 'good pupil', and Thailand was happy to be a 'good pupil'. But behind the scenes there was a big fight. Two things changed.

[15] First, the external economy had stabilised and the baht recovered. This stabilisation had nothing to do with the 'return of confidence' which the IMF was waiting for. Rather, it was a consequence of the economy's disastrous decline. Imports dropped by almost half. This put the current account into surplus which made the currency strengthen, and gave the government cash to replenish the reserves.

[16] Second, the steepness of the economic decline made the government rightly worried about the social impact. There was a rising threat of social disorder. And big pressures from the business lobby being devastated by the programme.

[17] In the middle of last year, the IMF macroeconomic programme was totally reversed out. Instead of a budget surplus, a deficit. Instead of tax rises, tax cuts. Instead of high interest rates, a dramatic drop by about 9 points over two months.

Since then, the IMF programme in Thailand has been about financial restructuring alone. This has included new laws, new banking regulations, and a scheme to restructure bank capital. In both Indonesia and Korea, the equivalent programmes have followed a certain pattern. Bad and bankrupt financial institutions were closed down. But then for the remainder, government bought up their bad debts so the banks' balance sheets would improve and they could start operating again.

[18] In the banking package of August 14 last year, Tarrin, the Thai finance minister chose a different route. He left it to the individual banks to deal with their own bad debts, and provided a set of carrots and sticks to encourage them to do it quickly by negotiating with their debtors. If they succeeded, they would get government help with recapitalisation. If they failed, they would be wiped out.

[19] It hasn't worked. Probably simply because there is neither the law nor the experience to make debt restructuring work. Instead, the banks have tried to survive by stopping lending, downsizing their business, and raising extra capital by creative means.

This led to a further downward spiral. Interest rates came down, but banks refused to lend. Firms in the real economy still could get no credit, still were going bankrupt, and increasingly felt government was neglecting them and lavishing all its attention on the financial sector. Many reacted by stopping paying interest to their bankers. A steel magnate encouraged his colleagues to adopt the 'Three Don'ts' Ü don't pay interest, don't negotiate, don't run away. NPLs are now officially 46% of all bank credit Ü and probably more. Towards the end of last year, bankers started to get frightened about the spread of a 'non-payment culture'. Relations between bankers and their debtors Ü between the financial sector and the real economy Ü have grown steadily worse.

[20]Further, late last year, people began to question where the stimulus would come from to make the economy grow again. The prospect of any growth in exports was getting worse as the recession spread around the world. The prospect of any significant capital inflow was no better. The only route left was to stimulate domestic demand.

PP [21] So now we are entering the third phase where the government's main plan is to stimulate domestic demand. The government has just announced the large package, equivalent in value to 2.6% of GDP, to stimulate domestic demand. The Miyazawa money is mostly to be spent on local projects of job creation in the hope that these will kill two birds with one stone Ü firstly, creating a large multiplier effect to stimulate the economy, and second relieving the increasing social stress of the crisis. Sceptics believe there is also a third bird: increasing the governing parties' chance of being re-elected.

[22] Will this work? Who knows. Thai governments have almost always managed the economy by managing external demand (exports and capital flows). They have almost no experience with stimulating domestic demand. Hence they have little of the machinery for doing so. Some fear all this money will be wasted. Some fear a lot will be lost in corruption, creating a terrible political backlash. Some fear this will leave Thailand with a heavy weight of debt.

Moreover, some say this spending could still come to nothing if the banking system is still in the ICU. Hence there have been calls to Tarrin to do something about his failed August 14 banking package. So far he has slightly eased the conditions, to give the banks a little more breathing space. And he has promised to revise the package. Some others have urged him to go back to the Korea-Indonesia strategy, and just buy up the NPLs.

So, Thailand is now at a very delicate stage. The economy does seem to have levelled out. This time last year, it was shrinking at an annualised rate of over 12 percent. That stage has passed. But whether it will really perk up Ü and how quickly Ü still depends on many factors.

The critical point is whether the government can unfreeze the credit system and get banks to lend again. This depends on two things. First, whether the banks can restructure their deadweight of debt. [23] Government has now completed most of the legal changes needed to facilitate this. And it is pushing the banks and big debtors hard to reach some landmark agreements which will encourage others to follow suit. This process began very slowly. It is now gathering momentum.

[24] Second, the major banks are just about above water Ü through a mix of recapitalisation, government help and foreign partners.

But: the banks will only begin lending again when they are convinced they are no simply throwing good money after bad Ü in other words, when they have some confidence that a recovery has arrived. This conviction depends on both real changes and psychological changes. The government is trying to induce real changes on three fronts.

[25] The first and main front is stimulating domestic demand through the budget deficit and Miyazawa money. This package is ambitious. It certainly makes some sense, where the original IMF strategy never did. But it is also experimental, and risky.

[26] The second front is exports. In the last month, government has at last begun to pay some attention to this area. It met with big exporters who asked for a weaker baht and more credit. Hey presto, the baht has started weakening (who believes this currency is not still managed?). And new schemes are being worked out for export credit. This should at least stop the continued decline and may bring some mild growth.

[27] The third front is capital inflows. The government is completing the legal changes to facilitate foreign investment in real estate. It is preparing to sell off three dead banks. And it has plans to privatise a power plant, oil refinery, some of Thai Airways, and some waterworks and waste management projects.

[28-blank] One way or another, these efforts should work. I think we can conclude that, economically, the glimmer at the end of the tunnel really is light and not (as the song ran) nothing but a burglar's torch. But remember, this tunnel is a mineshaft. It is a long, steep climb back to the surface.

CB This crisis has not only been economic. It is a political event too. Few doubt that the rough-and-ready state of Thai politics contributed to the crisis

In the past, foreign observers (and businessmen) tended to ignore Thai politics. This was not a bad idea, because it really is very confusing. There used to be lots of coups, but now there are lots of cabinets. Leaders don't last long enough to remember those long and difficult names. Until recently, many observers excused their failure to understand Thai politics by saying it didn't matter: the bureaucrats and technocrats ran the economy anyway.

That view had some truth. But in the mid-1990s, it clearly no longer held. [29] As Thailand slipped into the crisis, politics seemed to be making matters worse. Thailand had two prime ministers in 1995-7, who did not know much about the economy, and who did not know it was important.

Worse, they disliked or distrusted technocrats. For many key economic management jobs, they picked very mediocre people Ü sometimes because the good people simply wouldn't work for them, sometimes because they wanted people who were dependent rather than good. The severity of the crisis has resulted in large measure from the failure of the technocrats, which in turn has been a function of bad political management.

On top of this, the inability to react to the gathering crisis came about partly because so many Thai politicians were involved in the bubble economy. They were punting on the stock market, investing in finance firms, building condos. They did not want the government to do anything which might bring the bubble economy to an end. In fact when the bubble started to leak and pucker, they got the government to blow into it Ü with massive bailouts for the stockmarket, finance firms, and property speculators. These of course made the bust much worse when the bubble finally burst.

The international observers and businessmen became only too aware of this Ü not so much before the float, but certainly after it, once the crisis gathered momentum. One of the supplementary reasons for the sudden loss of confidence in Thailand and the capital flight was the loss of confidence in Thai politics.

[30] This loss was not just shared by international observers. There was quite simply in late 1997 an urban revolt against the government in power. White-collar workers came out on the streets and held meetings in the centre of the business district. Public figures and socialites gathered outside government house and chanted slogans. The press cartoonists portrayed the current political line-up as dinosaurs, monkeys, robbers, rhinos and clowns. For a short time, it looked as if this might drive Thailand back to the age of the coup. But in the end, it was managed within the frame of democratic parliamentary politics. The prime minister quit, and then three parties split, enabling a new coalition to be formed.

Moreover, in the same period, the parliament passed a new constitution. This is a quite remarkable document. It had taken over five years of pressure to create the draft. It attempts to engineer a complete change in politics. The draft was opposed by almost everyone in power Ü the army, most of the political parties, judges, police, senators, village officers. It probably had a slim chance of being passed if it had not been caught up in the same urban revolt. Lots of people Ü who may not have understood the content of the constitution very well Ü demanded that parliament pass the constitution just because they felt any change was better than the current mess. In the face of this pressure, the opponents had to back down.

The Democrat party is now in power. The constitution is gradually being implemented. The question is: what happens next? Is this period just unusual because of the crisis? Will things slide backwards afterwards? Or is there a real change under way?

PP The short answer is: yes, it's a real change. But there are too many unknowns, too many innovations to be very clear in prediction. And don't expect Thai politics to become suddenly like, say, Australian politics.

First, what about the fate of the current government led by the Democrat party's, Chuan Leekpai?

[31] This government has three things going for it, and these were the reasons the 'urban revolt' pushed this government into power. First, it had the only credible economic team, when that was the one thing obviously missing. Tarrin, the finance minister, has been able to deal with the IMF. He has won some foreign confidence. He got to Japan as first in the queue for the Miyazawa money. He managed to command popular support through one very difficult year, though that is crumbling now. He has brought back the smarter technocrats to the important jobs.

Second, the prime minister is obviously clean. Third, he has also brought in some appealing younger political figures Ü particularly the foreign minister, Surin Pitsuwan.

Some foreign observers have convinced themselves that if this government goes, disaster will return: Tarrin and Chuan are all that stand between Thailand and a return to the incompetence, mismanagement and greed of 1995-7. They cannot understand why Chuan and Tarrin are beginning to face increasing criticism.

[32] This needs to be got into some kind of perspective. First, while Chuan is as clean as a whistle, and his young team is very appealing, this government is still studded with some of the worst figures in Thai politics over recent years. For instance, there is one very senior minister who is reckoned to be one of Thailand's biggest oil smugglers, a major investor in casinos (which are illegal in Thailand), and with links in drug dealing. Last year a judge found that 20,000 votes had been stuffed into the ballot boxes in his constituency. Such people are in the government because of parliamentary arithmetic. Chuan needs them for his majority. So far, he has kept them fairly well under control. But they are there.

Second, monopolies are difficult to maintain. Two years ago, the Democrat party had a monopoly on credible economic managers, and attractive young politicians. The other parties are now trying to copy this formula. None yet maybe can match the Democrat team. But it is no longer a question of black-and-white.

The Chuan government had a long honeymoon. For a year it was pretty much immune to criticism. But since the beginning of the year, the criticism has been rising. Why should this be?

First, Thailand is a democracy. It has a remarkably free press. The government cannot just stamp on criticism, accuse rivals of sodomy, lock them up for 6 years, close down papers. Criticism is part of the system.

Second, a crisis such as this is bound to create splits and divisions. Two such divisions have become more and more politically important over recent months.

CB [33] The first we have already noted Ü the growing divide between banker and debtor, between the financial sector and the real economy. This Democrat government has concentrated its attention on finance and has stated it believes that financial restructuring is a prerequisite for recovery. But as time goes by, and as the financial solution fails to deliver, more and more people dissent. Many see this financial strategy as 'subservience to the IMF'. Many in the real economy feel neglected. Some feel they are being 'sacrificed' to a foreign-made strategy. At present, there are probably still more businessmen supporting the Democrats than those opposing. But there is a definite drift. A few weeks ago, some of Thailand's most conservative and mainstream economists came out to criticise the IMF. Last week, the major mainstream economic think-tank joined in too. These are the kind of people and institutions who normally believe in the IMF, liberalisation, restructuring. But they are rapidly losing their faith.

This opposition to the Democrats and to the IMF makes many overseas friends of Thailand become concerned about a growth of 'nationalism'. [34] In truth, there has been a bit of nationalist rhetoric. The government has been accused of 'selling the country'. But I think this has to be held in perspective. [35] Most of those peddling this rhetoric are highly indebted and threatened businessmen. Their speeches are not really political nationalism, but simple business strategy. They will try anything to survive. It would begin to count as nationalism if they got serious popular support. But they haven't. One of the leaders was promptly voted out of his business association for being too extreme. There has been no serious nationalist demonstration, not even a tiny pebble tossed at a McDonalds.

In truth there has been one big nationalist event during the crisis. And that was rather shocking. But you have to remember that Thailand has nothing like the European heritage of nationalism. It has never fought a nationalist war, never had a real nationalist movement, has no real historical nationalist hero (unless you can count a king). The one shocking event which raised popular nationalist feeling since the start of the crisis was this: [36] six Thai elephants which had been lent to Indonesia were found to be being mistreated (because of the crisis). There was an emotional campaign to 'bring these Thai elephants home'.

Second, there is an urban-rural rich-poor divide. [37] The Democrats did not create it. It has been widening over a long time. Thailand is one of the world's more unequal societies. But over the past two years this divide has gathered more political meaning. The present government is seen as very 'urban'. It has been focused on saving the urban economy. It has not done very much for the villages, which increasingly are suffering too. What's more, there has been a growing trend of rural protest over the past decade. The previous government tried to deal with this by negotiation. The Democrat-led government has taken a much more high-handed and paternalist attitude. It won't negotiate with protest leaders. It tells the farmers to go home and let the bureaucrats look after them. But the farmers won't take this any more. They want to participate more. They see the Democrats as examples of urban superiority and domination. They appreciate that Chuan is clean. But they don't find him warm.

These two divisions are giving Thai politics a new flavour. [38] There is a big opportunity now to build a political party with core support among domestic businessmen in the real economy who feel neglected during this crisis. There are two candidates looking to seize this opportunity. The first is the Chat Phatthana Party, which has long represented important interests in Bangkok and provincial business. However, the party has just gone through a leadership change with the death of the founder, Chatichai, and the succession of his nephew, Korn. Also, the party is now part of the Democrat-led coalition, and cannot so easily distinguish itself from the general government position.

The second candidate is Taksin Shinawatra Ü the telecoms billionaire who has been flirting with politics for the past few years. He recently founded a party Ü Thai Rak Thai (Thai loves Thai), which is bidding for the support of small and medium businessmen. He has managed to get the support of some talented people as the party core. Polls show he could be popular in Bangkok, where the electorate is very fickle and is likely to turn against the Democrats.

[39] The second big new opportunity is to build a party which appeals to the rural mass. The New Aspiration Party of General Chavalit is being gradually drawn towards this position. When he was in power two years ago, Chavalit projected his party as a centrist conservative party Ü rather like the LDP in Japan. But his biggest base of support is in the rural northeast. Since losing power to the Democrats, he and his followers have gradually more and more been projecting themselves as the leaders of the poor and the rural against the rich and the city. This kind of populism makes many Bangkokians quite horrified. But it is undeniably a growing force.

[40] According to the constitution, the final deadline for the next election is November next year (2000). The Democrats have said they don't want to hold an election until after polls for the senate which are scheduled for March. Although opposition to the government is now rising, in reality this government can probably hang on. To bring the government down earlier, the opposition parties have to induce one of the coalition partners to break ranks. But at the moment they are unlikely to do so. So the likely schedule for the next election is some time between April and November 2000 Ü probably more towards the end of that period.

[41] And what then? That is very difficult to say. The election will be the first under the new constitution passed in 1997. This constitution was written in an attempt to improve and clean-up Thai politics. Will it work?

PP This new constitution does three main things.

[42] First, it sets out a list of human rights and prescribes an agenda of reform to implement these rights, thereby making Thai society more just and more transparent. This agenda of reforms include decentralisation, liberalisation of the media, freedom of information.

[43] Second, it re-engineers parliamentary politics. This is very complex, but the main innovations are: a new election commission and electoral laws which should drastically reduce vote-buying; addition of 150 new seats elected on a 'party-list' system Ü a national vote by party Ü this is hoped to bring new blood into the parliament; and a 'separation of powers' which means MPs have to resign their seats when they become ministers. This is intended to make both ministers and legislators more professional and responsive.

[44] Third, the constitution creates a lot of new judicial and quasi-judicial institutions including a powerful counter-corruption body, a human rights commission, an administrative court and so on. These are mainly meant to provide much better public monitoring and control of both politicians and bureaucrats. There is no doubt that this constitution will drastically change Thai political life over the long term. In the shorter term, it is difficult to predict. At the last (1996) elections, one third of all seats changed hands, and overall the MPs became younger, better educated, and generally more attractive. This signifies a transition of political generations. It does not show so well yet, because many old leaders are still in place, and because seniority is very important. But I think this process will continue. Many of the old guard may well withdraw before the next poll because the new system is too new to predict, and they don't want to lose face. How the party contest turns out is even more difficult to predict. But the three major players are likely to be the Democrats in favour of Thailand's open economy; a business-led grouping, possibly behind Taksin's Thai Rak Thai; and a more populist rural voice behind Chavalit's NAP.

CB [45-blank] So, let us briefly sum up. The economy is still very fragile. But at least it is not going fast in the wrong direction, as it was for much of last year. It may indeed be perking up. But the recovery will take some time. There is a lot of blood on the floor.

On the political front too, things are looking cautiously better. The current government is likely to stay the course. The constitution Ü and the new popular attention to politics Ü are likely to do away with some of the abuses of the past.

To end on an upbeat note, we want to show just a couple of last charts on the economy.

[46] The first shows exports. The thing to look at is the magenta-red bit. This shows 'medium-tech exports' which mostly means electronics, electrical goods, and automotive. While exports as a whole have stalled over the last two years, this segment is still growing. Thailand appears to have some comparative advantage.

[47] Lastly, there is one index, which was growing before the crisis, and has gone on growing. And we hope this makes you pleased. [48] It is 'Beer Sales'.

Thank you [49]