Ministry of Finance
Press Release Regarding
Fourth Letter of Intent

No. 45/1998 May 26, 1998

The Thai government has already made three withdrawals from the IMF Financial Package amounting to US$ 10.232 billion since the government and the Bank of Thailand had first requested for the financial and technical assistance from the International Monetary Fund. The first disbursement of US$ 6.103 billion was undertaken in August 1997, of which 1.629 billion was channeled from the IMF and US$ 4.5 billion from bilateral creditors of friendly Central Banks and international financial institutions. The second withdrawal of US$ 3.211 billion was done in December 1997, of which US$ 0.809 billion was disbursed from the IMF and US$ 2.402 billion from bilateral creditors. The third withdrawal of US$ 0.968 billion was done in March 1998, of which US$ 0.278 billion was disbursed from the IMF and US$ 0.698 billion from bilateral creditors. Subsequent withdrawals can only be made after the Thai government meets all the performance criteria set in the Memorandum of Economic Policy. The evaluations will be conducted every three months.

During May 4-18, 1998, the IMF mission completed the third review of the performance criteria for the end of March 1998, which the Thai government has met in its entirety. In addition, the IMF mission, together with the Bank of Thailand and the Ministry of Finance have drafted the Fourth Letter of Intent.

On May 26,1998, the cabinet entrusted the Minister of Finance and the Governor of the Bank of Thailand to co-sign the Fourth Letter of Intent to be submitted to the IMF to consider the approval of the fourth disbursement from the stand-by arrangement. In the Fourth Letter of Intent, the Ministry of Finance, the Bank of Thailand and the IMF have agreed to revise six aspects of the economic program which the Thai government will continue to implement. The details can be summarized as follows:

• First, regarding our macroeconomic policies, there is room for further cautious reductions in interest rates and somewhat higher monetary growth rates in line with recovering money demand. Distortions in the money market created by FIDF financing are also to be reduced by raising more long-term funds to substitute for its short-term borrowing. All of this should greatly improve liquidity conditions. In addition, we will use the proceeds of the sovereign bond issue to strengthen the specialized banks and increase their capacity to meet the credit needs of key sectors; the policy framework of the specialized banks is to be strengthened for this purpose.

• Second, in light of the larger current account surplus, there is room to adjust the fiscal target and, thereby, contribute directly to minimizing any further decline of the economy. Thus, the overall public sector deficit target under the program for 1997/98 is proposed to be changed from 2 percent of GDP to 3 percent of GDP.

• Third, the government have developed concrete measures to strengthen the social safety net and increase well-targeted public works programs, and have allocated an additional ½ percent of GDP in the 1997/98 Budget for this purpose.

• Fourth, with the recovery contingent on effective corporate debt restructuring, important steps are being taken in this area. The legal and institutional framework is being strengthened and made more supportive through reform of the bankruptcy act, foreclosure procedures, and other laws. In addition, we are liberalizing further foreign investment restrictions in key sectors in order to increase resources for restructuring.

• Fifth, financial sector reforms continue to focus on the need for the core banking system to continuously strengthen its capital, based on international best practices for loan loss provisioning that have already been introduced; implementation guidelines will be developed by midyear.

• Sixth, the coming months will see the auction of more complex assets by the FRA, and the government will be developing a strategy to strengthen the finance company sector, as well as to resolve the status of the four intervened banks. This is essential to minimize the need for any future FIDF support for these institutions.

Each of these aspects is discussed in further detail below.

I Macroeconomic Framework and Policies

The government has re-estimated the current economic condition due to the sharper than expected economic contraction. The macroeconomic framework of 1998 has been reassessed. Real output growth has been adjusted from negative 3 percent to negative 4-5.5 percent. Inflation has been adjusted from 11.6 percent to 10.5 percent. The current account has been adjusted from a surplus of US$ 4.4 billion equivalent to 5.9 percent of GDP, to a surplus of US$ 8.5 billion or 6.9 percent of GDP. Gross official reserves have also been adjusted from US$ 23-25 billion to US$ 26-28 billion.

1.1 Monetary and Exchange Rate Policy

Stabilization of the exchange rate will remain the primary objective of monetary policy, but there is now room to adapt the monetary program to better assure the liquidity needs of the private sector. However, against the background of a significant strengthening of the currency since January, the recent stability of the baht within a more realistic range, and the substantial restoration of the BOT’s reserves, there is room for further cautious reductions in the overnight repurchase rate. However, if there is increased pressure on the exchange rate, the government will raise interest rates and tighten the monetary program as necessary.

The monetary program allows the proceeds of the anticipated sovereign bond issue to be used to strengthen the four specialized banks. On this basis, we expect that the specialized banks will be able to expand their lending operations at market rates, especially to the export sector.

1.2 Fiscal Policy

Even though the government has been following tight fiscal policies, the deeper-than-anticipated recession makes it likely that there will be further revenue shortfalls later in the fiscal year. The government recognizes the negative social impact of the economic crisis and the need to strengthen social safety nets to provide relief to displaced workers. Therefore, the target for the 1997/98 overall public sector balance has been revised from minus 2 percent of GDP to minus 3 percent of GDP. Within this total the central government deficit will rise to 2.4 percent of GDP, and the state enterprise deficit will increase to 0.6 percent.

The government has also formulated the preliminary fiscal framework for 1998/99. Against the expectation of a small economic recovery during 1999, there will be room to reduce the fiscal deficit from that currently projected for 1997/98. Thus, we expect to contain the overall public sector deficit to no more than 2.5 percent of GDP in 1998/99, of which the central government deficit will be about 1.5 percent of GDP and the deficit of public enterprises will be about 1 percent of GDP. This target includes the costs of financial sector restructuring. The 1998/99 fiscal framework will be reassessed by August 1998 before the next quarterly review.

1.3 External Sector

As a result of the deep recession, external current account adjustment is also proceeding more quickly than envisaged just a few months ago, and the government now expects to record a current account surplus of about $8.5 billion, equivalent to 6.9 percent of GDP by the end of the 1998, which will be higher than that previously projected. In addition, the government is planning to issue government bonds domestically in the near future.

II Financial Sector Restructuring

2.1 Strengthening the Core Banking System

The strategy of the government continues to be targeted at augmenting the capital base of all domestic financial institutions, and this process is being facilitated by the tighter loan classification and provisioning standards which have been introduced at the end of March 1998. Major commercial banks have succeeded in raising private capital, and many smaller banks continue discussions with foreign strategic partners. About $3 billion of new private capital has been raised since last November, most of it from foreign investors.

The four intervened banks continue to operate subject to strict supervision by the BOT. The government is developing a strategy for their resolution and privatization, and has accordingly contracted an investment bank to develop least-cost proposals by midyear. The government expects to have adopted a strategy for these banks by end-July.

2.2 Strategy for Remaining Financial Institutions

The 35 remaining finance companies are subject to the same recapitalization requirements and loan classification and provisioning rules as banks. Some finance companies have been recapitalized and have found viable market niches, but many others are very small and will need to be consolidated. Consistent with this strategy, and following the modalities of previous interventions in banks, on May 18, 1998, the government has intervened in seven finance companies that were unable to raise capital. A majority state-owned finance company (KTT) is leading the consolidation effort. This consolidation strategy shall apply to other finance companies which do not comply with their Memoranda of Understanding with the BOT.

Regarding specialized financial institutions, it is the government’s intention to make increased use of these institutions to make credit available to the economy. Therefore, it is vital to ensure that they are financially sound, properly regulated and supervised, and adequately capitalized. Accordingly, these institutions and their overall policy framework will be assessed promptly with the assistance of the World Bank.

2.3 Asset Disposal of the 56 Closed Finance Companies

The Financial Sector Restructuring Agency (FRA), working closely with World Bank consultants, has completed the rules and procedures for auctioning the assets of the closed companies. The FRA has successfully auctioned a substantial amount of physical assets since March. The next stage is to auction more complex hire-purchase and loan portfolios, and this is scheduled to begin shortly with a first auction comprising $1.2 billion of hire-purchase loan portfolios. The FRA has contracted an investment bank to professionally market the assets in order to stimulate bidder interest. All financial institutions in Thailand, including BIBF, are eligible to participate in the auctions. An important precondition to these next auctions is to remove the major impediments to asset transfers, which the government will address through an emergency decree by the end of May.

The organization and procedures of the Asset Management Corporation (AMC) are broadly in place, and an increase of its capital to B 10 billion has been authorized. It is expected that the AMC as well as the Radanasin Bank (RAB) will shortly fully define their own bidding procedures and funding policies in order to bid for the financial assets offered by the FRA. To assure the efficiency and integrity of the process, a third party review of FRA/AMC/RAB procedures will be completed by September 1998.

2.4 FIDF Policies and Operations

As previously declared, the government has decided to take full financial responsibility for the losses of the Financial Institutions Development Fund (FIDF) by converting FIDF debt into government debt. This conversion will start with a government bond issue of B 500 billion in FY 1998/99, the interest costs of these bonds will be met by the Budget, with their amortization being met partly by 90 percent of the future realized profits of the BOT, and partly by privatization proceeds. The Ministry of Finance is working out the terms and conditions, as well as the institutional framework, for issuing these bonds with the aim of separating the mechanism for FIDF’s borrowing needs from the BOT’s management of short-term interest rates. In its capacity as lender of last resort for the financial system, the FIDF will charge a lending rate that will be the highest in the system for new lending. Finally, and perhaps most importantly, we will continue to move toward devising, by the end of the year, a deposit insurance scheme to replace the comprehensive guarantee of the financial system presently provided via the FIDF.

2.5 Strengthen Supervision and Regulation

The BOT’s supervision of financial instutitions is focussing on loan portfolio values and capital adequacy. This effort has taken the form of a set of Memoranda of Understanding (MOUs) with undercapitalized banks and all finance companies, supported by targeted on-site examinations. The BOT intends to continue this process by entering by mid-August into a new set of MOUs with all financial institutions, new MOUs will be signed subsequently, until the new year 2000 provisioning rules have been met.

Given that problem loans in Thailand will need to be restructured, it is essential to develop detailed operational guidelines to make the new loan classification and provisioning rules fully effective, and to provide banks with incentive to restructure their loans. These guidelines, which are crucial for a restoration of normal credit flows in the financial system, will need to be consistent with international best practices to be credible, while also taking into account the deep systemic difficulties facing Thai borrowers. The government envisages that these new guidelines will be fully in effect by end-June 1998. The operational guidelines on collateral valuation will also be introduced by end-June 1998.

The government is conducting a broad review of banking and financial sector legislation and regulation with the view to identifying the need for changes and finalizing proposals for legal and regulatory reforms to be taken later in 1998. We are in the process of bringing in experts from G-7 central banks to provide support for a High-Level Commission which is being established to develop concrete recommendations on how to strengthen central banking and supervision in Thailand. Finally, the BOT will strengthen the capacity of its supervisory staff through recruitment and retraining.

III Supporting and Revitalizing the Real Sector

A major strengthening in economic and legal institutions is needed to help the large number of financially distressed firms and displaced workers cope with the challenge of adjusting to the new economic environment. Thus, the government is accelerating many of the initiatives in this area that were foreshadowed at the time of the last review of the program.

3.1 Corporate Restructuring and Legal Reform

The government is currently playing a supportive role in corporate restructuring with external and domestic creditors among the private sector by committing to facilitating this process through legal and tax reform that would establish the appropriate enabling framework. The government will encourage banks and corporate bodies to create voluntary creditor committees and debt-workout units. A consultative committee drawing together domestic creditors, mainly banks, and corporate debtors has already been set up. One of its first recommendations—to clarify the accounting and provisioning rules for restructured loans—has been acted on and it is hoped that, in this way, the government can contribute to removing the institutional obstacles to debt restructuring, especially facilitating debt workouts outside of formal bankruptcy court. The government has already announced that public funds will not be used to bail out corporate units, and this basic principle is reaffirmed.

To improve corporate governance, the SEC has embarked on a review of accounting principles and practices to bring them in line with international best practices by end-1998. This will result in enhanced transparency and disclosure standards on the part of all listed companies. Companies listed on the Stock Exchange of Thailand will be required to disclose all liabilities. Other steps are also being taken to increase accountability to shareholders. These measures to improve corporate governance should be finalized by June 30, 1998.

3.2 Privatization and Competition

The government has now drawn up a concrete agenda to implement the restructuring and privatization program that was presented in the Third Letter of Intent. To ensure an adequate consensus for the government’s privatization program, we are embarking on an increased dialogue with workers and other affected parties. A specific timetable for individual enterprises will be developed by the time of the next quarterly review.

The government also places considerable importance in deepening the external openness of Thailand’s economy, and increasing foreign direct investment flows into many sectors that were previously shielded from such investment flows. Such increased investment flows will contribute directly to relieving the liquidity shortages in many sectors, especially in the property sector. As such, the government will shortly propose to Parliament amendments to the Alien Business Law, as well as to other associated laws, aimed at liberalizing foreign investment limits in selected sectors, such as securities and brokerage services, condominiums and land-leasing arrangements.

3.3 Social Safety Net

A social safety net adequate to the task of protecting those left vulnerable by the economic crisis is a key priority of the government. Greater specification of the social safety net measures which were anticipated at the last program review have been included in the Fourth Letter of Intent. This program is being implemented in close collaboration with the AsDB, the World Bank and the Overseas Economic Cooperation Fund. In addition, the government will accelerate public employment creation in small infrastructure programs in the agricultural sector, and increase funds for retraining programs and lending to the umemployed to facilitate self-employment activities within the increased margin provided by the fiscal program.

IV Disclosure and Transparency in Economic Policy

The dissemination of timely and accurate economic information is essential in bolstering market confidence and ensuring a stable recovery. The government has already subscribed to the special data dissemination standards (SDDS), and the government expects to be in full compliance with it by the end of the year. The government has also steadily increased the quantity, scope, and timeliness of economic data in the Bank of Thailand’s monthly press release and on the Worldwide Web. Additional plans to improve the transparency and timeliness of data reporting are underway.

Fourth Letter of Intent

Memorandum on Economic Policies of The Royal Thai government

Table & Box

Monetary Targets

Fiscal Targets

External Sector Targets

Program Assumptions and Conversion Rates

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Last Updated: May 27,1998