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31 Seiten, Note: 1.8
1.0 CHRONOLOGICAL OVERVIEW: What happened when?
1.1 Fifties till Seventies.
1.2 Seventies till Eighties.
1.3 1985: the boom starts.
1.4 Beginning Nineties: Foundation of crisis.
1.5 1996/1997 The crisis starts.
2.0 THE FINANCIAL CRISIS.
2.1 No need to reform.
2.1 A structural problem.
2.2 The structural financial solution, a vision.
2.3 The FDI problem and solution.
3.0 BACK TO BUSINESS AS USUAL?
3.1 Corporate structure
3.2 Composition of companies
3.3 What to do? Three approaches.
3.4 What’s been done? What’s yet to be done?
3.5 On corporate governance.
3.6 6 Points for corporate governance improvement.
4.0 ON PREDICTABILITY AND IMF OBJECTIVES
4.1 The misjudgement.
4.2 Three models for predictability.
4.3 Kaminsky, Lizondo and Reinhart (KLR).
4.4 Pros and Cons.
4.5 Frankel and Rose (FR).
4.6 Pros and Cons
4.7 Sachs, Tornell and Velasco (STV).
4.8 Pros and Cons
4.9 The problem with predictability.
5.0 BIBLIOGRAPHY AND REFERENCE.
5.1 Internet sites for research
5.2 Working papers for research
5.3 Articles for research
De foundation for the transformation of Thailand to fifth tiger was laid by the industrial sector, despite all the successes of the farming industry. It was in the fifties that the government of Thailand started to boost production of the farming sector primarily for export purposes. The government had two instruments to reach its goals. First, it stimulated the formation and the existence of co-operation between state-owned and private companies. Second, improvement of the irrigation-system should boost the production per squared meter and thus making the sector more productive and ready for export. In the end of the fifties and beginning of sixties came the first growth-impulse for the industrialisation of Thailand.
Under the Sarit-dictatorship (1958-1963) the Thai industry, which up to then had been on a low level, experienced a number of improvements. The introduction of the "Open Door Politic" created opportunities for the Thai economy to finally integrate with world-economy. This integration was more a forced one, as a radical break had to be made with the traditional State-capital development. Through the Open Door Politic the FDI were stimulated and the start of the creation of a widely spread infrastructure should improve efficiency. Above all foundations of Import-substituting industries were stimulated.
Thailand was not only profiting from it's own efforts, there are a number of exogenous factors that assisted Thailand in it's tremendous growth, it profited from the "weltwirtschaftliche Rahmenbedingungen" that were set out in the sixties and the relocation of production-sites by the main Industrial countries but above all Japan and the USA. Another factor was the engagement of the USA in the Korea war, which resulted in an increase of the production in the service sector (Rest and Recreation Program) as the US-troops were stationed in Thailand as of 1962.
1 The period from the beginning of the seventies until the mid eighties brought some changes to world economy which did not fail to hit Thailand. The retreat of US-troops from Vietnam and hence from the basis in Thailand. The Oil-crises in 1973 an 1979 and the collapse of the world- market-price of rise, tapioca, kautschuk, sugar and zinn in the late eighties. Not only exogenous but also a number of endogenous aspects had their influence on the Thai economy; growing dependence on the import- substituting industries and a too small domestic market, which was not able to sustain the growth-rates, assisted the setback of the Thai economy. To some extend this setback is regarded as a classic setback after a period of growth based on a strategy of import-substitution like happened in many other third world and south-Asian countries. It was in this last recession (setback) that the government decided to exchange the import-substitution for a strategy of export-industrialising and herewith it followed Taiwan, Singapore and Malaysia who had already adopted similar strategies in the late sixties, this strategy was called the "Flying Geese Model". With General Prem Tinsulanonda as prime-minister (1980) Thailand engaged in a strict export focussed strategy and "Thus Thailand became a prime exemplar of export-led growth, which emerged as the central theme of government's development rhetoric in the early 1980`s" (Lewis/Kapur 1990: 1363). The change of strategy showed its result in a wave of liberalisation that crossed the country. Privatisation of state-owned companies was forced, regions that for long had been solely accessible for Thai companies were opened up for foreign investors. Taxes were being lowered, a step-wise dividends control mechanism was developed and investment-incentives-packages were introduced for both foreign- and domestic companies.
All these measurements did not find its effects until 1986. Before that time Thailand was still busy with a deep recession. 1984 and 1985 were tough years for the Thai economy as a result of the collapse of the Thai export. The economy experienced a rising inflation and many banks were on the edge of bankruptcy, added to this was a 15% devaluation of the Thai bath in November 1984. Growth-rates averaged 4.2% for the first half of the eighties with a minimum of 3.5% in 1985, with rates like these, Thailand was among the slowest-growing economies of Asia.
2 With the Plaza-agreement (1985) between USA and Japan, Thailand's boom was sealed. The devaluation of the Japanese Yen to the US Dollar from 260 Yen to 140/150 Yen to the dollar increased the prices of Japanese products overnight with 70%. With Japanese companies now seeking more relocation of their labour intensive industry in order to remain competitive on the world market, Thailand was prime target with their recently reformed strategy and low labour costs. Driving force behind the immense growth- rates of the second half of the eighties, 4.5% growth in 1986 to 13.2% in 1988 were then FDI. Japan's share in Thailand's FDI is in this context very important as it is the initiator of the economical prosperity and huge growth that followed in Thailand; Japan's share rose from 31% in 1960 to 53% in 1990. After Japan other countries like Taiwan and Hong Kong followed. The sectors that were focussed on were predominantly textile, electronic- components, electronic machines, food-sector, jewellery and plastic- products. Had the USA and the EU once been among the most important investors in FDI, it were now Japan, Taiwan and South Korea claiming these positions. It was not only the private sector benefiting a growth in investments, private investments rose 18.5% in 1989, but also the public investments showed a huge increase with 15.4%. The public spenditures were, as a result of increasing purchasing power, becoming more and more relevant for the economic growth. Spin-off from the Plaza agreement, and the price-increase in Japanese products, was the gain in demand for Thai products, the 70% increase in Japanese prices made other countries, among which Thailand, extremely competitive. Added to all the positive factors contributing to Thailand's boom should also be the deleting of South Korea, Taiwan, Hong Kong and Singapore from the list of GSP (General System of Preferences) by the USA, which gave Thailand another competitive advantage over the other South East Asian countries.
Asked for the main characteristics which made Thailand so attractive, many investors also replied with items like high political stability of the country, lack of racial-ethnical conflicts (in many countries such as Indonesia or Malaysia their is an aversion against Chinese investors) and also the relatively large labour-population (60 million in 1996).
In this period of economic growth the BIBF (Bangkok International Banking Facility) was founded, which was to play a major role in the Asia crises, as it is believed that one of the key issues in the crisis is a fragile and uncontrolled banking and financial sector, which is to be discussed in more detail. The BIBF was founded under the Chuan Leekpai-government (1992- 1995) which followed the, with military action overtaken, allegedly corrupted, Chatichai-regime. Although the Thai economy was really taking off here at this point the foundation of the economic crisis was being laid out here. The BIBF was specially designed for investments in the newly opened markets, Vietnam, Laos Cambodia. Through the BIBF banks could get cheap dollar loans, from abroad (offshore), against better interest rates then in Thailand and then pass them on to customers in Thailand (onshore). Rather then passing loans on for project outside Thailand (out-out), the BIBF developed itself from the start as a source for cheap dollar-loans for investments in Thailand self (out-in). Credit lines were given to institutions that had no rights to such means at all. The existing fixed Baht-Dollar exchange rate made it all so much easier to abuse these cheap dollar loans, especially for Thailand banks who, due to liberalisation and opening up of financial markets, now had to compete on a global level with foreign banks. This competition was one of the reasons behind the fact that a lot of Thailand banks were investing more and more in high-risk and speculative areas, the fragile Thailand financial system had to compete with firmly established foreign financial institutions.
The Thai financial system was developing itself in a very unbalanced manner, without adequate supervision the financial system developed without the presence of a bond market. If there was one, banks would generally guarantee the lending of bonds and other corporate securities. With the control of corporate governance in the hands of primarily financial institutions and lack of lending regulations banks were more and more getting involved in non-performing loans or investment-projects in high risk sector. The previous combined with the rapid growing number of NBFI’s (Non Banking Financial Institutions) results in a reduced franchise-value of banks which resulted again in riskier lending and investing, and with this last step the reinforcing circle was completed. The crisis that was at hand lies predominantly in the vulnerability of the financial sector and its unbalance, thus without risk-diversification. Moreover was there a large mismatching between long-term foreign deficit and short-term deficit. All this was covered by an economy that was growing at full speed and there was thus no pressure for the authorities to speed up reform policies. The situation at the end 1996 can be more or less described as having the following characteristics;
- Increased vulnerability and fragility of the banking system
- Increased overexposure to risky sectors and non-performing loans
- Unbalanced ratio between short term foreign currency borrowing and long term domestic lending.
A detailed description of the financial system can be found in the corresponding chapter of this paper. The loans that banks received went for a significant part into real-estate and it was finally the massive oversupply in real-state and the realisation that many finance institutions borrowed heavily off-shore that made investors reassess their positions in the country in the beginning of 1997. The move out of Thailand began when investors saw the real-estate oversupply and the weakened macro-economic situation, a current account deficit of 8.2%, an export growth rate of zero and foreign debt up to $89 billion, half of which in short term. This move to get out of Thailand meant unloading trillions of baht for dollars, and with too many baht chasing too few dollars, naturally the result was a tremendous downward pressure on the value of the baht. This attracted the speculators, who sought to make profits from the well-timed purchases and unloading of baht and dollars. The Bank of Thailand tried to defend the baht at around 25 bath to one dollar, but the foreign investors' stampede that speculators rode on was simply too strong, with the result that the central bank lost $9 billion of its $39 billion reserves before it threw in the towel and let the baht float "to seek its own value" on July 2.
This was, in a nutshell, the Asia crisis with the emphasis on Thailand, more or less in chronological order.
As stated in the previous chapter the Southeast Asian financial sector developed without the presence of a bond market. On top of this development there was a lack of supervision and al large role for government. In Thailand the banking system denominated the financial intermediation and this resulted in a highly unbalanced financial system. Equity markets were rapidly developing, bonds and other security-markets stayed behind. All this was leading to misallocation of resources, overexposure to risky sectors, risky liability structures and poor institutional development. In a fast changing environment in the economy a restructuring of corporate governance of security market dependent companies is also necessary. The absence of developed security markets meant that the monitoring of firms was in the hands of banks primarily and was not assisted by other financial companies, which resulted in an absence of risk- diversification. A relative large amount of lending and financing went to projects and companies that had no rights to such means whatsoever. The unbalance of this financial system was not a cause, rather than an amplifier for the crisis. In regard to the problems in the Southeast Asian banking system the problem can be summarized as having a low capital-adequacy ratio, badly designed, weakly enforced lending regulations, poor disclosure and transparency and weak supervision. The weak supervision added to the poor performance which, in its turn, stimulated banks to engage more and more in higher risk projects. Much of the lending was done on a collateral basis rather than on cash-flow analysis or profitability basis or similar method.
3 Although countries did realize the need to reform their financial systems, efforts were clearly made; the pressure to do so was apparently to low. The need to reform was overshadowed by the high growth. Because banks
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appeared sound, were official there few or public demands on the government for greater reform. While overall intermediation costs measured by interest margins were relatively high, costs to income ratios did not suggest inefficiencies. It were these measurements that biased the information. Still finance companies in Thailand were performing poorly. Also, the restriction of classes of financial companies to operate in different markets ensured a fragmented financial system, where there was less competition of these different classes (e.g. finance companies in Thailand were not allowed to raise deposits which stimulated them to rely on higher cost funds, this created incentives for riskier lending). All this weakened stability of the financial sector and added more risk. All these weaknesses were not enough to push the financial system straight into a crash; it was the high economic growth and high domestic savings that saved most of the Southeast Asian banks of immediate stress. It were these high savings of the public in the form of bank deposits that enabled these banks to remain engaging in bad loans without any liquidity problems. And of course a government that was foolishness more or less implicitly backing up this banking system and assuring the fixed currency rate (which is another big issue in this respect).
4By this time (mid 90`s) the in 1992 founded BIBF (Bangkok International Banking Facility) was doing its work. Through the BIBF financial institutions could get dollar-loans from abroad at cheap dollar-rates to channel these to finance projects in Thailand, this institution developed however from start as a source for financing projects outside Thailand. The
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rapidly growing amount of NBFI`s were eager to use the licenses they had obtained. These NBFI`s were generally less regulated and subject to weaker supervision than banks, their growth and numbers is a direct measurement for the financial systems growing fragility. The tables clearly show the large amount of these non-banking institutions that were relying heavily on foreign exchange borrowing.
Also the previous rescue of the last financial crisis (83-87) by the government reinforced the perception that the government implicitly guaranteed the banks deposits and liabilities. Not only this guarantee, but also the perceived exchange rate guarantee suppressed incentives to hedge external borrowing and moreover, created a bias towards short-term foreign currency borrowing. To be clear; the exchange rate policy increased the incentives for unhedged external borrowing, this is very clearly shown in the sharp rise of short term liabilities in Thailand in the period 94-96. The financial system was doing a lousy job in intermediating capital; it relied more on banks rather than foreign investments. The high and rising investments, large private capital inflows and asset booms in the period 94- 96 led to a number vulnerabilities; increased banking fragility, increased exposure to risky sectors and increased borrowing short in foreign currency and lending long in domestic currency, all these effects reinforced eachother. The increasing fragility was not detected during the lending boom because the growth was accompanied by rising measured profits as these profits were measured relative to income. Largest amount of exposure of the banking sector was to the real-estate sector; it is believed by some investors that the factual numbers were twice as much as the official ones. As late as end of 1996 there was still huge construction while there was already a significant oversupply for the years ahead (97-99) and vacancy rates for that year already 14% and increasing.
The foreign exchange exposure (lending) in combination with the huge mismatching created the next vulnerable factor. During the period 91-96 short term external liabilities accumulated rapidly and most of this borrowing was unhedged. Short term debt as a percentage of gross reserves was 150% prior to the crisis. This high ratio of short-term obligations to liquid foreign exchange assets made Thailand much more vulnerable to a possible run on
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its currency, which could arise from a lost in investors confidence or a reassessment of positions. Riskier investments together with the banking sector’s growing fragility and the rise of the short-term external liabilities resulted in increasing macro and financial vulnerability. Once again it should be stated that the source for the crisis lies not within the financial vulnerability rather this vulnerability was the amplifying factor in the crisis. The fact that few observers predicted the crisis is a proof of this argument. Even an institution like the IMF failed to predict or foresee trouble, as late 1996 the IMF was still praising Thai authorities with their “consistent record of sound macroeconomic management policies”. Not having predicted the crisis does not exclude the fact that the established institutions have solutions. It might come clear now that Thailand is by far the hardest hit by the asiacrisis; the wordpuns are numerous (thai-phoon, thai-tanic).
Unemployment rises radically (1998: between 2 and 3 million persons), poverty is entering society as an issue again, the fall of the Baht melted the, during the last decade accumulated, profits and private investors lost their money either on the stockmarket or in real estate. Even the low-level of the Baht is not helping the once so glorious export sector, companies are lacking the necessary capital due to high interest rates, capital they need to buy raw materials or pre-produced in order to raise productivity. It is difficult for companies to determine the value of import-products with an exchange rate that is running up and down. Are all these problems temporarily and a result of highly necessary restructuring of a once vulnerable financial system? Or, are these signals signs of an economic crisis that started as a financial crisis. Up to now a number of actions have been taken or are in progress:
- The restrictions connected to the over US$ 17 million IMF infusion (securing the currency, tight savings-regulations for public spending, reducing foreign deficits, cleaning up bad debts) have so far been implemented.
- The highly necessary restructuring of the financial- and banking sector has started.
- Stimulation of foreign capital input (more and more can foreign companies achieve majority ownership in Thai companies).
- The structural transformation of the Thai industry from cheap labor and assembly focussed to advanced technical production.
Most important actions that have been undertaken are by far the restructuring of the financial system. More than 91 finance companies have been closed, several commercial banks have received infusions of new capital and a few find themselves involved in foreign equity-investment participation. The Thai government on the solvency of their financial system has issued formal guarantees in order to restore confidence. The crisis has brought about a consciousness that not only the financial system needs restructuring, very few corporations have been restructured up to now. All East Asian countries have recently tried to facilitate enterprise restructuring by creating an environment, which includes better accounting and disclosure standards, bankruptcy and foreclosure processes, and taxation and accounting rules. In March 1998 Thailand revised its bankruptcy law and other countries have done so too. Still the mechanisms through which new laws and regulations should find its applications are badly designed. Furthermore is there a low level of experience when it comes to restructuring. The government has encouraged the development of a capital market by removing regulation and tax obstructions and enhancing the institutional framework for primary and secondary markets. Government bonds have been issued and these bonds will be placed at financial institutions to strengthen their income and asset portfolios. It is expected that these government bonds will become a benchmark for future corporate bonds and thus fulfilling a function that was missing before.
5 The true objective in order to become a global player again, once the financial structure is in place and sound, is to get the Foreign Direct Investments flowing in again, but this time getting them where they should be. The idea is very basic; start the Asian miracle again once the economical structure is capable of handling the foreign surge. Of worthwhile consideration is the construction of a system that protects the immediate outflow of capital as a crisis is due or profits can be maximized at other regions. The so-called "Tobin Tax" (named after its proponent, the US economist Jame Tobin), a transactions tax imposed on all cross-border flows of capital that are not clearly earmarked as direct investment would help slow down the frenzied and increasingly irrational movements of finance capital6. A slowing down of the movements of speculative capital would also be accomplished by a measure advocated by University of the Philippines Professor Solita Monsod: require portfolio investors to make an interest-free deposit of an amount equal to 30 per cent of their investment that they would not be able to withdraw for one or more years. This would make them think twice before pulling out at the scent of higher yields elsewhere. The aim would not be to discourage foreign direct investments, this would be foolish. The aim would be to reduce the unproductive daily turnovers in currencies and other assets, resulted from swift movements of large amounts of capital, and thus increasing stability in money values. Foreign direct investment, of course, brings with it its own problems, and it must be managed by a related system of incentives based on, among other considerations, the strategic objective of acquiring technology. When it comes to portfolio investments it pays of to be critical as can be concluded from an article from the Singapore’s Business Times: “Long-term flows can be of greater benefit but it is questionable whether all of the money that goes into so-called foreign direct investment (FDI) in manufacturing and service industries is as long-term as it purports to be. The moment one country is perceived to be becoming less competitive than an emergent neighbour, FDI can prove to be highly footloose and fancy free, as some ASEAN nations have already found. And the benefits it confers by way of technology transfer and productivity gains can be exaggerated.”7
8 Twenty-five percent of the companies in Thailand suffered losses that exceeded their equity. High leverage, short-term loans, unhedged foreign borrowing has had its effect on the price of capital. High prices of capital are manageable as long as corporations are backed by an increasing growth rate, but it was this growth rate that stucked. Many companies continued to borrow during the mid 90’s even with the prospect of declining profitability. When the exchange rate finally depreciated with roughly 30 to 40 percent and interest rates rose from 5 to 10 percent, high-performing, healthy companies suddenly found themselves on the verges of brake-down. The aggressive export focussed strategy of the last decades had left its marks in the form of high leverage ratios, which left corporations vulnerable to shocks. Incentives such as directed credits, subsidized loans and tax breaks should have ensured companies to have sufficient resources to continuously upgrade and grow. The retained earnings were not enough, equity markets hardly present or developed, and as a result companies borrowed heavily. After the restrictions on foreign borrowing were loosened up (see previous chapter), companies found eager foreign investors willing to lend, mostly short term, as both lender and borrower assumed the fast economic growth to remain and exchange rate backed up by the government, as a result, foreign short-term debt rose and unhedged positions developed. Also was there the problem of the nontradables (real estate and infrastructure), their prices were increasing as to the prices of tradables who could not rise due to import competition, this made corporations more vulnerable to cyclical downturns. Thai corporations performances deteriorated sharply, especially after 1995, this can be seen by the fast downfall of the return on assets ratio which fell from 8 to 1 percent between 1991 and 1996. In the same period leveraged doubled. There was a strong correlation in Thailand between bad performance and high leverage demonstrating that far too much bad performing corporations had access to too much financing. The corporate sector’s excessive borrowing compared with its earnings shows that an increasing share of profit went to cover interest costs, by 1997 more than 33 percent of the companies in Thailand had interest costs exceeding their profits. The most highly leveraged firms in Thailand by the end of 1996 were construction companies with 406 percent, as this sector experienced high investment fuelled by real appreciation and necessary large borrowing. Banks typically dominated Thailand’s corporate finance market; this was probably the best way for Thailand because securities markets normally require a more sophisticated institutional and regulatory framework. Bank dominance in the corporate finance market can work provided that they are not subject to unjustified state influence, are exposed to competition, and are prudently regulated; the Thai market failed to meet these criteria and suffered. Corporate governance was of a very low quality and can be explained by the following five points:
- The existing relations between government and bank and between bank and clients were based on unofficial relations rather than professional cooperation. There was political pressure to make loans to favored firms and credits to private sector were being guaranteed by government, conflicts of interests due to interlocking of ownership reduced marketdiscipline.
- Low and underdeveloped system of domestic institutional investors. Institutional investors would have helped to establish private markets incentives and corporate governance (e.g.managing pension funds). The mutual fund industry only represented 7% of the SET (Stock Exchange of Thailand) in 1996. Up to now provident funds are still for a relatively large amount restricted.
- The integration of foreign banks into funding Asian firms was limited and avoided the implementation of international standards of governance; east-Asian banks have low level of foreign ownership due to protecting policy of the limited amount of licenses. If foreign banks do get any they are often limited to lend only under the safest restrictions.
- Foreign investors have not been insistent on corporate governance and disclosure, as they were convinced of the critical mass of the market. Fast real growth rates and upward movements created a euphoria that, as happens a lot, biased judgements of investors.
- Market and regulatory institutions that play an important that do play an important role in industrial countries facilitating and creating incentives for market discipline were not yet fully developed.
9 Crosscompany ownership would probably be the best way to describe the form of ownership in Thailand, the most found organizational form is the diversified conglomerate, which are closely held and managed by family. The ownership is generally not a direct one but is hold through membercompanies, so called interlocking of ownership can in this way add up to more than 50%. The benefit of this form of ownership is that firms enhance their efficiency of operations and investments. On the other hand it might lead to a higher ratio of corruption, in the form of controlling owners to expropriate other investors and stakeholders and pursue personal nonprofit maximizing objectives, and it may impede the development of professional managers who are required as economies and firms mature and become more complex. The combination of these forms of ownership combined with the relation between banks and companies and the ones between banks and government were dangerous. The relationship increased the possibility of easy borrowing, thus leading to higher leverage without a direct link to performance and to a slower response to changing market conditions. After the crisis, several shocks hit Thai firms. First, international investors lost confidence and retrieved their capital from the country. Second, unprecedented exchange rate devaluation aggravated the debt service burden and created extensive losses. Corporate foreign debt was largely unhedged, as firms believed in a secured exchange rate. Third, tight monetary policies implemented to prevent further devaluation created sharp increases in interest rates, this was damaging to highly leveraged companies. A survey in 1997 revealed that less than 4 percent of firms wit foreign currency debt were fully hedged and only 17 percent were partially hedged. However, the problem of unhedged borrowing was not as extensive as might be suggested. The large majority of firms borrowed only in baht and those that did borrow in foreign currency were generally the more efficient firms (predominantly large exporters with ties to foreign companies), and they have better adjusted to the crisis with higher capital utilization and employment cuts. The issue was more important in the banking sector than in the manufacturing sector, especially with financial institutions heavily borrowing from foreign investors and passing them on to domestic companies and assuming the constant exchange rate themselves.
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After the crisis, bankruptcies and corporate distress spread through the region in a way that is unprecedented in recent economic history.
10 Restructuring the corporate economy will be a challenge; financial recourses are scarce banking system is a mess and stock markets are depressed thus limiting the option of a quick restore of financial flows to enterprises. Solving this crisis requires the co-operation of enterprises, financial institutions and governments. In seeking for solutions these parties will have to determine who is going to bear the costs of the restructuring? How fast can solutions be implemented? How can survival chances be maximised? In general can be stated that any solution should contribute to improved enterprise governance. History has shown us that in general solutions work best if the costs to taxpayers were minimised, shareholders paid the largest part, banks managed the restructuring and governments did not found themselves owning large amounts of financial institutions and enterprises. According to the World Bank the Thai government have three distinctive strategies they could consider.
The market based approach aims to use mainly market forces to restore profitability and bank capital. Items like operational restructuring of enterprises, debt restructuring should lead to higher profitability and efficiency, new inflow of foreign and domestic investments, asset sales, equity issuance. The market-based solution limits the burden to taxpayers and reduces the likelihood that governments end up as primary owners of banks and enterprises. It is however very unlikely that the marketbased solution is able to reduce the debt to manageable levels.
The second approach, which can be described as the recaptalized bank-led approach recapitalizes banks that then take the lead in corporate restructuring. This way the government recaps the banks on an ex-ante assessment of their losses. Financial institutions then resolve the debt issue and lead the operational restructuring, optionally providing working capital during restructuring. Government intervention into corporate restructuring is indirect in this manner. This approach can be relatively fast and can create the idea that problems are being resolved. Downside of this approach is the risk involved that governments could be injecting financial aid into insolvent institutions without creating sufficient change in the banks governance and operations. History teaches us that most of these approaches have been unsuccessful so far. The dilemma in this approach is the balance between maintaining confidence and preserving incentives for good banking.
The government-led approach describes a solution whereby a government agency takes over a large share of the distressed assets from the banks and replaces these assets with government bonds. The government then tries to restructure the claims and force corporate restructuring. This approach is fast and crates clarity (bad loans are concentrated into a new agency) it can also shift the balance of power to creditors in case of large corporations. Downside of this approach is that it brakes the links that exist between banks and corporations, these links can have various functions. Second disadvantage is that non-banking entities could lack the working capital lending that is often required during debt restructuring. Last but not least would be the fact that government organisations would have poor motivation to restructure corporations.
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So far the Thai government has closed down 56 financial institutions in order to resolve problems. The Thai authorities adopted in this case a hand off approach by encouraging debtors and creditors to negotiate obligations through voluntary arrangements. The Thai sector is mainly hit in the commercial bank loan sector through bank loans from the BIBF. Where necessary the Thai government did intervene depending on the type of financial institute and trouble. For insolvent finance companies, closure and disposal of their assets; for distressed banks nationalisation and eventually privatisation. The Thai government is improving the role of foreign investments in the corporate sector, reviewing tax rules that may discourage debt restructuring, debt-equity swaps, mergers and acquisitions; reviewing bankruptcy legislation. According to the World Bank the Thai government should do so through the implementation of six steps:
- Elimination of tax disincentives to equity restructuring (mergers and acquisitions) should imply that asset transfers or share acquisitions in the course of corporate reorganisation should not be treated as a taxable event if no cash is exchanged (shares are exchanged), also mergers should not be taxable.
- Temporarily reduction or elimination of tax disincentives to debt restructuring because this is likely to be a crucial element of the restructuring processes in Thailand. The Thai government should develop criteria for providing tax relief for debt restructuring to discourage tax evasion and avoid providing tax relief for corporations that do not need such relief or that are candidates for liquidation or supervised reorganisation.
- Eliminate interest deductibility on excessive debt. Current tax laws could encourage firms to borrow too much; it would be useful for the Thai government to develop a capitalisation rule that would prohibit the interest deduction above a certain threshold. On determining this threshold the cyclicality and characteristics of the different businesses should be taken into account.
- Allow conversions of debt to equity for both public limited and private limited companies.
- Liberalize the legal framework for the foreign investments should increase transparency of the market and ensure that foreign direct investors are not bypassing legislation through shell companies which decrease transparency and increase costs.
- Liberalize the legal framework for property ownership. Restrictions on property ownership were a great impediment to foreign ownership. Had there been additional opportunities during the crisis then there would have been a better balance in supply and demand of for instance real estate.
Important in the case of Thailand is that it takes an integrated approach on the issue of corporate governance and financing. The poor system up to now has contributed to the crisis by keeping banks and corporation away from market discipline. Corporate governance has been characterized by ineffective board of directors, weak internal control, unreliable financial reporting, lack of adequate disclosure, tax enforcement to ensure compliance, and poor audits. Improving the framework of corporate governance and financing will require behavioral changes. Improving corporate governance should focus on the following six areas in order to be effective.
Enhancement of enterprise monitoring, especially between banks and corporations, banks should establish close relations with their customers whilst at the same time stricter enforcement of limits on lending. Financial institutions are key players in enterprise monitoring and corporate governance, more transparency and stricter rules are issue here. Improved disclosure and accounting to make sure that up to date and reliable reports can be summoned at any given time. New GAAP`s should of course be consistent with western countries. Improved reliability and integrity of financial reporting and disclosure is the prerequisite for reforming the corporate sector and restoring market confidence. Strengthen the enforcement of corporate governance regulations. Changes in capital market and judicial system are needed so that minority shareholders’ rights are better protected. Improvement of the corporate governance framework, the issue of corporate governance concerns the distribution of economic power and should be made more accessible to a broader public. Facilitate equity institutions as external financing needs are going to be very high, new investors will be very important. To facilitate the process of new equity, it will be necessary to provide investors with a more direct role in governance and monitoring, the shareholders’ voting power is an issue here as in terms of proportional or perhaps overproportional to ensure such a more direct role. Strengthening institutions should then actually be the end result of these issues, but should be an objective at itself, as the Thai government should distinguish between size and type of business.
11 Indeed, as late as 1996, while expressing some concern with the huge capital flows, the IMF was still praising Thai authorities for their "consistent record of sound macroeconomic management policies." While the IMF "recommended a greater degree of exchange rate flexibility," there was certainly no advice to let the baht float freely12. The complacency of the Bretton Woods institutions when it came to Thailand--indeed, their failure to fully appreciate the danger signals--is traced by some analysts to the fact that it was not incurred and financed by government but by the private sector. Indeed, the high current account deficits of the early 1990's coincided with the government running budget surpluses. As a group of perceptive Indian analysts noted, "[p]art of the reason for this silence was the perception that an external account deficit is acceptable so long as it does not reflect a deficit on the government's budget but 'merely' an excess of private investment over private domestic savings." In this view, countries with significant budget deficits, such as India in 1991, were regarded as profligate even when their current account deficit was lower than Thailand's. The latter's deficit, because it was not incurred by government and not financed by public expenditures was simply reflecting "the appropriate environment for foreign private investment rather than public or private profligacy."
13Only months after the crisis and two years after their “all is well” statement the IMF published a working paper on predictability and modelling. In the paper three models are discussed in depth and their applicability tested; Kaminsky, Lizondo and Reinhart (KLR), Frankel and Rose (FR) and Sachs, Tornell and Velasco.
KLR monitor a large set of monthly indicators that signal a crisis whenever they cross a certain threshold beyond which a crisis is more likely. This brings with it the practise of establishing certain thresholds, which can be monitored easily such as current account deficits beyond 5 percent of GDP or reserves less then three months of import. A currency crisis would be defined according to them when a weighted average of monthly percentage deprecations in the exchange rate and monthly percentage declines in reserves exceeds its mean y more than three standard deviations. KLR chose the following 15 indicators based on theoretical priors and on the availability of monthly data: (1) International reserves; (2) imports; (3) exports; (4) terms of trade; (5) deviations of exchange rate from a deterministic time trend; (6) the differential between foreign and domestic real interest rates on deposits; (7) excess real M1 balances, where excess is defined as the residuals from a regression of real M1 balances on real GDP, inflation, and a deterministic time trend; (8) the money multiplier of M2; (9) the ratio of domestic credit to GDP; (10) the real interest rate on deposits; (11) the ratio of nominal lending to deposit rates; (12) the stock of commercial bank deposits; (13) the ratio of broad money to gross international reserves; (14) an index of output; and (15) an index of equity prices. When one or more of these indicators issues a signal (crossing of threshold) the signal would be defined as being good if a crisis follows within 24 months. The reduction of the ratio false to good signals is called determining the optimal set of thresholds also known as the reduction of the noise to signal ratio.
Given the non-statistical nature of the KLR methods it is somewhat difficult to evaluate the success of this approach. KLR conclude that the signal approach can be useful as the basis for an early warning system of currency crises. Their grounds are that most of the signals have a low noise to signal ratio, most indicators signal ahead of the most crises, and most crises are preceded by multiple signals. Nonetheless, most crises are still missed and most alarms are false. This may sound like poor performance. It worth noting however that these forecasts are significantly better than random guesses, both economically and statistically.
Frankel and Rose (FR) try to estimate the probability of currency crashes using annual data for more than 100 developing countries from 1971-1992, which is much broader then KLR or STV use. The use of annual data may restrict the applicability of the approach as an early warning system, but it permits the analysis of variables such as the composition of external debt for which higher frequency data are rarely available. FR bases their prediction on positive relations that exist between certain characteristics of capital inflows and currency crashes: low shares of FDI; low shares of concessional debt or debt from multilateral development banks; and high shares of public sector, variable rate, short-term and commercial bank debt. FR define a currency crash as a depreciation of the nominal exchange rate of at least 25% that also exceeds the previous years exchange rate by at least 10%. This type of analysis does therefor not regard speculative attacks warded of by the authorities through reserve sales or interest rate increases. After applying the data of 1996 for the prediction of the 1997 crash the model was analyzed and its predictability awarded. The FR models can easily generate out of sample predictions for 1997.
Using the FR models whilst forecasting presents a new problem; some pre- crisis explanatory variables are still unavailable. The forecasts were found at best moderately successful, with correlation ranging from 18 to 24 percent. The predictions were not statistically significant, with a lowest p-value at 11 percent. This model predicted for Thailand a 10 percent probability of a crisis. The IMF paper concludes: “In sum, the FR model and extensions fail to provide much useful guidance on crisis probabilities in 1997”.
Where the KLR and FR encounter two problems. First, the use of a panel relies on the assumption that all crises can be explained in the same way. Second, the analysis of a large number of possible explanatory variables means that, even with a large panel of variables, it is not possible to consider all the non-linearities and interaction effects that may be important. This is where STV takes over. STV tries to examine the magnitude of a crisis over a cross-section of countries. This approach does not shed light on timing of crisis. Rather it answers the question of vulnerability in the light of a change in the global environment. This approach takes into account that timing is much harder to predict than the incidence of a crisis across countries. Also, the determinants of crisis episodes may have varied importantly over time. STV define a crisis index as the weighted sum of the percent decrease in reserves, and the percent depreciation of the exchange rate, from November 1994 to April 1995. The argument here is that the occurrence of the crisis and timing is clearly a result of contagion; the variation however is explicable.
The application of the STV model is not as straightforward as the other two approaches, because it is formulated and estimated over a cross section of countries, it is not clear how to update figures for 1997. The paper describes two approaches none of them perform very well. The most successful explanations predict crises for Malaysia and Thailand but also for Brazil and to a lesser extend Argentina. It misses Korea and Indonesia.
The results are mixed. The most successful pre-1997 forecast that comes from the study is by the use of the KLR-based probabilities of crisis derived from the weighted sum of signaling indicators. When the model issued an alarm during the 1995/5 to 1996/12 period, a crisis would actually have followed in 1997 at 37 percent of the time. This compared to a 27 percent unconditional probability crisis in 1997. The other two methods examined provide forecasts that would have been of little use. These forecasts were described as insignificant predictors of actual outcomes and explain very little of the variance of the actual countries’ experience.
The answer to the question whether currency crises are predictable would be according to the examiners; yes, but not very well. They say yes because the forecasts are clearly better then a naive benchmark of pure guesswork. They say not very well because none of the models reliably predicts the timing of the crises. False alarms always outnumber appropriate warnings14. Moreover, the statistically significant results imply that some of the models clearly outperform pure guesswork, not that they do better than the analysis of informed observers. All three models did however demonstrated that the probability of a currency crisis does increase when domestic credit growth is high, the bilateral exchange rate is overvalued relative to trend, and the ratio of M2 to reserve is high. All models except STV also suggests that a large current account deficit is an important risk factor. Some evidence was also found for the importance of variables such as export growth and the amount of FDI in the external debt.
- http://www1.worldbank.org/wbiep/decentralization/courses/manila%201 0.11.99/weist/index.htm
- IMF working paper; “are currency crises predictable?” 1998
- Asia Point Network; “Thailand and the IMF”
- Walden Bello, Asia House Essen and the Heinrich Boell Foundation; “Asia-Europe Relations In The Light Of The Southeast Asian Financial Crisis”
- Karl Husa and Helmut Wohlschlägl; “Vom “emerging market” zum “emrgency market” Thailands wirtschaftsentwicklung und die “Asienkrise””
- world bank report; “East Asia, the road to recovery” 1998
- The Nissan institute of Japanes studies (Jenny Corbett) and Institute of economics and statistics (David Vines); “The Asian crisis: Competing explanations” 1998
- Observer no. 217/218 summer 1999; “Asia’s industrial crisis: what really hapened”
- “The Asian miracle, the Asian contagion & the USA”; paper by Theodore Field 1998.
- Informationsbrief Weltwirtschaft & entwicklung nr 5/98; “Von der boomwirtschaft zum sozialen Niedergang”
- Economist August 21st 1999; “Asia’s bounce back”.
- Economist August 21st 1999; “On their feet again”.
- Economist September 26th 1999; “A Thai silk purse?”
- Prentice hall international editions (George W. Gallinger and Jerry B. Poe); “Essentials of finance” 1995.
1 Data from Asia-Europe Relations In The Light Of The Southeast Asian Financial Crisis by Walden Bello, Asia House Essen and the Heinrich Boell Foundation.
2 Data from Asia-Europe Relations In The Light Of The Southeast Asian Financial Crisis by Walden Bello, Asia House Essen and the Heinrich Boell Foundation
3 Source of data in table from the World bank paper (see bibliography)
4 Source of data in table from the World bank paper (see bibliography).
5 Data from the Husa and Wohlschlägl paper (see bibliography).
6 The Asian miracle, the Asian contagion & the USA; paper by Theodore Field (see bibliography).
7 "Time for Less Hectic Growth," Business Times, Aug. 20, 1997
8 Numbers and figures from the IMF working paper and World Bank Paper (see bibliography).
9 Numbers and figures from the IMF working paper and World Bank Paper (see bibliography).
10 Approaches as proposed by World Bank (see World bank paper)
11 Data from Asia-Europe Relations In The Light Of The Southeast Asian Financial Crisis by Walden Bello, Asia House Essen and the Heinrich Boell Foundation
12 Quoted in Robert Chote, "Thai Crisis Highlights Lessons of Mexico,"Survey, Financial Times, Sept. 191, 1997, p. 16.
13 Models are presented by IMF paper (see bibliography).
14 IMF working paper (see bibliography).
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