• Marking 25 years since an economic crisis that shook a region

By Sumudu Chamara Recovering from an economic crisis is not just a matter of obtaining financial assistance, turning losses into profits, or cutting down on expenses. A great deal of this process involves managing available resources judiciously, having in place a proper political, policy, and legal environment, and designing and executing a country’s recovery plans in a credible manner. This is one of the lessons Sri Lanka can learn from Thailand, a country that successfully recovered from a massive economic crisis, nicknamed the “Tom Yum Kung Crisis”, after Thailand's famous hot-and-sour soup, which took place 25 years ago. The steps Thailand took to recover from this crisis – which was massive enough to pose a threat to the whole of East and Southeast Asia – was explained by former Bank of Thailand Governor Dr. Veerathai Santiprabhop in a discussion with Advocata Institute Chairman Murtaza Jafferjee, during the ReformNow conference organised by think tank Advocata Institute.   What led to the 1997 crisis? The 1997 Asian financial crisis, which started as the 1997 Thai financial crisis, was a combination of several economic issues that posed short-term to medium-term economic impacts on Thailand and several surrounding countries. In the 1996/97 era, Thailand faced a massive foreign currency shortage due to several reasons, and in July 1997, that country’s Government had to float the Thai baht (THB). Before that, the exchange rate was THB 25 per US dollar. However, within six months, the value of the currency dropped to its lowest, at about THB 57 per US dollar. This led to several firms going bankrupt, and many others at risk of following suit.  Within two years after the crisis broke out, Thailand’s Gross Domestic Product (GDP) contracted by close to 12%. The closure of a large number of finance companies, non-performing loans (loans that are subject to late repayment or highly unlikely to be repaid by the borrower) in the banking system rising to about 47% of balance sheets, and massive number of lay-offs by companies that went bankrupt, are some of the other challenges this crisis led to. According to Dr. Santiprabhop, this crisis could be described as a combination of a currency crisis and a banking crisis.  He noted that one of the reasons for the currency aspect of this crisis was the large amount of short-term debt Thailand had to pay in the 1996/97 era, which, he noted, affected the country’s international reserves, as they were insufficient to settle the said debts.  He explained another aspect of the 1997 financial crisis: “China entered the World Trade Organisation (WTO) in the early 1990s. Until then, Thailand had good export growth all along. Then, in the early 1990s, our exports started to come down. We had large current accent deficits – our current account deficit stayed in the range of about 7% of the GDP for five years – leading to the crisis. The current account deficit also reflected the fact that we had overinvested in a number of sectors, particularly sectors that do not generate foreign exchange. But we used a lot of foreign borrowings – particularly in the private sector, which had borrowed substantially to invest in real estate – and those were not generating foreign exchange.” On top of these issues, he said, Thailand had a fixed exchange rate regime, which he said was a major policy mistake. He explained: “The Bank of Thailand, at that time, was trying to defend the fixed exchange rate by basically using up all its international reserves. We had international reserves of about $ 30 billion at the end of 1996. When we had to float the exchange rate in July 1997, we had zero international reserves.” He emphasised that the currency crisis was a result of these three issues. Adding that the other part of the crisis was a banking crisis, Dr. Santiprabhop explained: “We had a number of small finance companies. These were not banks, but were operating as if they were banks. We had about 91 of them in 1996, if I recall correctly. They had a very poor risk management network, with a fixed exchange rate regime and the policies of the Bank of Thailand, which was trying to control the overheating economy. There was a huge interest rate spread between the domestic interest rate and international interest rate.” Another aspect of the banking crisis that led to the 1997 financial crisis, he pointed out, was the attempts by the Government of Thailand to promote the nation as an international financial centre.  “The Thai Government and the Central Bank were trying to encourage local banks to provide international banking facilities, mainly by taking out all the regulations for what we call out-in transactions, borrowing from abroad for domestic investments. There was a big mismatch of currencies, due to borrowing US dollars for domestic currency (Thai baht)-generating projects, and also a mismatch of maturity, due to borrowing on a short-term basis for long-term investments. So the balance sheets of the banks were very weak.” Adding that this currency crisis and the banking crisis originated through policy mismanagement, Dr. Santiprabhop said that on its Central Bank’s part, Thailand attempted to maintain what is called the impossible trinity – a regime with free capital mobility, independent monetary policies, and fixed exchange rates – at that time, and that certain other reasons also worsened the economic crisis.  “We had that system before the 1997 crisis. The Finance Ministry did not want to support the change of exchange rates. No politician would like to see devaluation during their term, and that is a fact of life. It was not clear which organisation had full authority over the exchange rate regime. At that time, it was a joint responsibility between the Central Bank and the Finance Ministry.  “The Government also did not want to slow down on the overheating economy, and they all thought that having higher investments is always good. We did not pay sufficient attention to the types and quality of investment coming in.” In addition, the fact that Thailand had a coalition Government consisting of small parties was noted as an issue. Dr. Santiprabhop said it was, in his opinion, a weak political system, because these numerous small parties made it difficult to make big decisions. Another factor he highlighted was the lack of good governance in the private sector. In this regard, he said that large corporations and banks made a lot of transactions between the market, company, and subsidiaries that were not transparent, or failed to accurately disclose their financial positions. He added that the stock exchange was also a problem at that time due to stock price manipulation and not being up to standards for publicly listed companies. Recovering from the crisis Dr. Santiprabhop spoke extensively of the nature of the solutions that were employed to revive the crisis-hit Thai economy. He noted that for a crisis of that magnitude, there was no single panacea, and that the solution had to be a combination of measures. The first type of measures was aimed at stabilising money markets/the banking system.  He explained: “A stabilisation package was very important when the exchange rate was free-falling, and we had to stabilise that. When the people had no confidence in the banking system, customers were taking their deposits out of the banks. Money markets became non-functional. When interest rates in money markets went up to about 25%, no business would be able to survive. So we had to improve confidence in and stabilise the functioning of the banking system/money markets. Providing confidence in the foreign exchange market was also part of this.” The other category of measures was related to fiscal stimuli, regarding which Dr. Santiprabhop said that fortunately, Thailand did not have large physical deficits in the lead up to the crisis. With regard to the International Monetary Fund’s (IMF) concerns regarding this, he said that Thailand managed to negotiate with the IMF and substantially relax the fiscal conditions so that the Government would be able to use fiscal policy to stimulate the economy. The third category was related to economic restructuring, particularly restructuring of the banking sector. Adding that Thailand had to come up with a series of measures with regard to such restructuring, he explained that the country liberalised foreign investment regulatory frameworks. He said that although Thailand had opened up its Foreign Direct Investment (FDI) framework leading to the crisis, the service sector was very much protected. With regard to the steps under this category, he said that Thailand had to amend the foreign business law in order to allow foreign participation in the service sector, and that privatisation of State-owned Enterprises (SEOs) also received attention. The fourth category of measures pertains to protecting the most vulnerable groups, which Dr. Santiprabhop said is very important. He stressed: “The people at the bottom of the pyramid get hit the most when a crisis like that hits. So we have to come up with a number of programmes to safeguard the livelihood of these people.” The last set of steps focused on institutional reform, and this led to a major amendment to Thailand’s Central Bank Act, capacity improvements in the Finance Ministry, and establishment of a new public debt management office and an SOE policy office. In addition, pointing out the importance of strengthening the export sector to support the recovery process, Dr. Santiprabhop said: “When the exchange rate devalued from THB 25 to THB 57 (against the US dollar) and stabilised at about THB 40-45, the export, tourism, and agriculture sectors benefitted substantially. The people who went back to rural areas (due to the crisis) could produce agricultural products and generate a good amount of income because the prices of agricultural products went up when the currency devalued. The exports and tourism sectors led to relatively quick turnaround in some segments of the economy.” Stabilising the political environment too played an important role in this process, according to Dr. Santiprabhop. He noted that a few months after the floating of the exchange rate, Thailand’s Constitution was changed, and that everyone had high hopes that it would change the political system of Thailand, which it did. With regard to the changes the Constitutional amendments led to, Dr. Santiprabhop said: “One change was promoting decentralisation. Having a central Government commanding so much authority was not helpful. So with the new Constitution in 1997, we promoted decentralisation. Another aim was trying to address the issues of small parties in coalition governments. Everyone was fed up with having weak coalition governments that were unable to address reforms for the country. Another result of that Constitution was creating independent entities like the anti-corruption entity, which would not be under political influence. Learning from the crisis During the discussion, Dr. Santiprabhop pointed out that the crisis pointed out several key lessons that should be adopted as policies. He underscored that credibility of any stabilisation or reform programme is of utmost importance, and that such a programme has to be credible in the eyes of the local people as well as the international community.  “You have to ensure strong credibility in the design and execution of the programme. If you have a stabilisation or a reform programme that is not sufficiently credible, there is a high likelihood that the programme will not succeed, and you will end up having to implement an even stronger programme, causing more pain in the transition process.” He further said it is a necessary principle to accept the reality of the situation: “The Government that was in charge before 1997 (in Thailand) was in denial. They thought that the conditions of the macroeconomy were basically narratives of the Opposition parties. They were disconnected from reality, and they underestimated the magnitude of the crisis.  “They did not accept that the causes of the crisis were structural. They thought that some of the problems could be dealt with through transitory measures and by kicking the can along the road, which created a much larger burden for everyone in society. In a crisis, there are a lot of things at hand that need to be done immediately. One also needs to have forward-looking views of what could go wrong.” Another lesson he said the crisis taught was that macroeconomic problems need to be tackled first by macroeconomic policies.  He noted that often, politicians may not be sufficiently aware of matters such as macroeconomic policies, the way exchange rates work, and monetary policies, and may come up with something they are quite familiar with, such as microeconomic policies. He expressed concerns that when there is a large foreign account deficit or an inaccurate exchange rate regime in place, it is impossible to solve that problem by having an import license alone. It is thus necessary to ensure that key macroeconomic problems are taken care of by proper macroeconomic policies in the stabilisation package, not by microeconomic measures, reiterated Dr. Santiprabhop. Describing the fourth lesson/principal, he said: “In a crisis of this magnitude, it is impossible to help everyone. The most important thing is to safeguard the functioning of the core system. It is important to separate the banks that have the potential to stay on and serve as the core of the banking system to facilitate economic recovery, from the banks that do not have the same potential. “Obviously, the public would also be calling for help. We have to be very specific and targeted about groups of vulnerable people we have to deal with and assist because of the limited sources. If we tried to help everyone, there is a high chance that no one would survive. Prioritisation is very important. This prioritisation is based on the economic justification that the core functioning of the economy could continue to carry on its duty.” The last point he presented was that the direction of the stabilisation programme and the restructuring liberalisation programme need to be aligned and consistent. Adding that co-ordination failure is magnified during a crisis, he said that even though different parties work within their own limits, during a crisis, there needs to be strong co-ordination and proper incentive for different parties. In Sri Lanka’s quest for economic recovery, several parties have come forward to offer support. However, one thing most of them note is that Sri Lanka should have a proper plan to revive its economy, and that this plan should include several long overdue economic and policy reforms to which the country has not given adequate attention. As was noted during the discussion, the perceived credibility of Sri Lanka’s plan will provide a definite advantage, and the Government has a massive responsibility in that regard if it truly hopes to overcome this seemingly insurmountable challenge.