Reforming the International Monetary and Financial System

Comments: The Case of Thailand

Alexander Swoboda, and Peter Kenen
Published Date:
December 2000
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Thailand received financial assistance from the IMF following its severe economic and financial crisis, with the belief that strict adherence to the IMF advice would eventually steer the country out of the crisis. The IMF gave Thailand technical advice and financial assistance in good faith, with the aim of bringing about a sustained recovery. The extent of the crisis was unexpectedly severe, however, and the international financial market grew turbulent following the swift diffusion of Thailand’s crisis to other countries. Investors thus became risk averse and engaged in a flight to quality.

In the initial stages of the crisis, market perception usually focused on the darkest aspect of the developments, that is, extreme pessimism. Given these self-fulfilling expectations and the vicious circle they created, harsh austerity measures were necessary. Policy recommendations by the IMF, and their subsequent implementation by the Thai authorities were, therefore, sound and justified by the prevailing conditions and necessarily took a longer time than in normal circumstances before showing positive results.

In the first stage of the IMF Stand-By Arrangement, both the IMF and the Thai authorities had to race against time as the situation progressively worsened and confidence rapidly deteriorated. The primary objective of any of the policies undertaken—monetary, fiscal, or financial sector restructuring—was to restore investor confidence. Nevertheless, it was very difficult to change the one-sided and mostly pessimistic market perception into a somewhat positive one.

IMF policy recommendations focused on exchange rate policy. In the run-up to the crisis, Thailand followed the IMF’s recommendation to change the exchange rate system from a basket peg to a managed float regime, which has proven successful so far. Since this milestone development, the authorities have been able to gauge effectively the status of the economy, as well as to attain a certain degree of stability. However, both the IMF and the Thai authorities have learned from this experience that monetary measures that might be effective in normal times may not be as effective when facing a confidence crisis.

Thailand had experienced a bubble economy for many years, so it was natural for the policy prescription to be reduced and disciplined government expenditure in order to moderate economic growth to a level consistent with the underlying fundamentals. At the same time, restructuring measures were required across all areas of the economy. The severity of the financial sector problems, however, far exceeded anyone’s expectations and the economic downturn unexpectedly became deeper and more prolonged.

The policy dilemma of pursuing exchange rate stability versus economic recovery has ignited controversial debates worldwide. In Thailand’s experience, the most important concern was to strike the right balance between the two. Attaining exchange rate stability was an important concern initially, especially during a crisis of confidence, but once external pressures subsided, the authorities were able to concentrate on reviving economic activity. This strategy was firmly supported by the IMF.

Without policy advice and financial assistance from the IMF, Thailand would have been in a weaker position. The IMF’s role in giving professional and experienced policy advice is a crucially important function, especially to countries undergoing crises. Contrary to perception, the IMF’s policy recommendations are flexible and adaptable to the changing macroeconomic environment. Moreover, with the benefit of hindsight, generally, strict adherence to IMF policy by authorities has significantly contributed to renewed confidence in the economy and the authorities’ resolve.

As of May 1999, both the IMF and Thai authorities have agreed that Thailand has passed the trough of the crisis. Throughout its latest quarterly reviews, the IMF team gave the Thai authorities increased flexibility or room to operate, in terms of both policy framework and performance criteria. For the past two years, we have had a good and productive working relationship. There may have been disagreements or differences in opinions but these were minor issues. The principle we adopted was to follow the majority consensus. The experience has provided valuable lessons that will help avert any recurrence of the crisis in the future.

Recommendations on financial system reform are highly appreciated as they will make Thailand fundamentally stronger in the future. It is usually difficult for any nation’s authorities to implement reform measures under normal economic conditions; but the crisis has provided the opportunity to make sweeping structural changes to the financial system landscape. Policy recommendations by the IMF have provided important impetus and many have already been translated into concrete outcomes. Most notable was the IMF’s key role in pushing for Thailand’s legislative changes, particularly the bankruptcy law that, despite receiving fierce criticisms from the parliament, has been approved by both the house and the senate, enabling quicker liquidation or reorganization, thus easing considerably financial sector problems.

Making structural changes in the midst of sharp economic contraction, although necessary, may add to turbulence in the economy. Under these abnormal conditions, the Thai authorities and the IMF have learned that the transmission effects of monetary policy will take longer than usual before effective outcomes can be seen. Thailand also needs a corporate sector whose working culture is transparent, is bounded by standard rules, and has good corporate governance. IMF recommendations have thus induced the corporate sector to reconsider its priorities and to restructure so as to become stronger and more competitive.

Having passed the trough of the downturn, Thailand is now beginning to see the light at the end of the tunnel. This light is evidenced by the stable currency, low interest rates and low inflation, accommodative monetary and fiscal policy, and stable trends in many leading indicators. Supported by the stable political system underpinned by democratic principles, investors are now confident that Thailand is heading in the right direction.

Nevertheless, there remain some downside risks. First, monetary tightening by the U.S. Federal Reserve could induce an interest rate differential in favor of the U.S. dollar. If regional currencies depreciate against the U.S. dollar, it may no longer be possible to maintain low interest rates to stimulate growth. Furthermore, if the growth in the U.S. economy slows down following the tightening, export performance in Thailand and other countries in the region will be directly affected. Second, China may not be able to maintain its currency value and may be compelled to devalue the renminbi against the dollar, which will inevitably affect the whole region. As Southeast Asian exports compete directly with China, there will be widespread competitive devaluations.

Despite the considerable progress made, Thailand needs to continue its restructuring efforts to provide the foundation for sustainable economic growth. Thai authorities cannot afford to be complacent but need to be consistent in their policy implementation.

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