Thailand’s quiet rebellion against the IMF

25 November 1998

The Thai economy is stabilising in spite of the IMF programme, not because of it.

Of course, the Thai economy was in a hopeless mess when the IMF arrived. Of course if there had been no IMF loan, Thailand would have been forced to declare a debt moratorium, and who knows what that would have led to. But the programme which the IMF imposed made things worse. Any improvement has come about because Thailand was not a good pupil of the IMF, but a good rebel.

The package which the IMF imposed in August 1998 is still a big secret. The first letter of intent (LOI-1) was never published in full. Only a press release appeared after the signing. The data and assumptions were never discussed. The Thais involved gave the impression that they simply conceded to all IMF demands. But because the public had lost faith in the government’s ability to handle the economy, there was little opposition.

The IMF used a package designed to manage the public sector debt crises in Latin America in the 1980s. The two main conditions were those applied to profligate governments, namely a 1 percent budget surplus and caps on public sector borrowing. A third condition demanded a tight monetary policy to deter capital outflow and stabilise the exchange, but it was expected this would be temporary.

In the next two LOIs, the IMF extended the package to open up the Thai economy rapidly to foreign capital. The first stage of this was a bonfire of local capital - closing down finance companies, introducing Basle standards to force the banks to recapitalise, and fast-track privatisation of public enterprises, in some cases "by mid-1998".

This basic package was devised for an economy where the government had borrowed too much and spent too much, provoking capital to flee in fear that the currency would collapse and the government default. In the environment for which it was devised, the package at least had some logic: the profligate government was forced to generate a surplus to pay off its debts.

The IMF was expecting a rapid return of international confidence. In its Latin American experience, this usually took less than 6 months. In late 1997, the IMF officials, their US patrons, and Thai ministers were all saying the same thing: just wait for the return of confidence.

But the IMF was not paying attention to the international bankers and analysts. They looked at the package and made two comments. First, the loan was not enough to cover the possible outflows (the US deputy treasury secretary explained: "Thailand is not on our border"). Second, Thailand’s problem was not a profligate government but a hopelessly over-indebted private sector. The risk was not that the government would collapse, but that banks and private companies would. The IMF package contained nothing to confront this problem. Indeed, its deflationary austerity would make things worse. The financial analysts’ concluded: get your money out fast. Instead of preventing capital flight, the IMF package provoked it. In the year from July 1997, the capital account (net of IMF and other government loans) showed a deficit of 550 billion baht.

At the start, the IMF envisioned a relatively mild recession, with GDP growth of 3.5 percent in 1998. The first LOI did not specify how this would be achieved, but it can be derived from the LOI’s macroeconomic framework (see table). With currency depreciation, exports would grow 8.6 percent while imports would shrink to 1.6 percent. International confidence would rapidly return and the 1998 capital account would show a net inflow of 1.8 percent of GDP. Overall economic activity would suffer only slightly with consumption flat and gross domestic investment running at 35.9 percent of GDP.

 The Thai government followed IMF instructions to cut the budget by 20 percent, raise taxes (VAT and later petrol), hike up interest rates over 20 percent, and close down financial institutions, which led to seizure in the credit market. The net result was a spectacular collapse of demand.

Over the year spanned by the first five LOIs, the projection for the economy in 1998 slid from mild recession to disaster—from a GDP change of +3.5 percent to -7 percent (see table). This 10.5-point swing was driven by two main changes. First, expectations for the capital account went from a small inflow to a huge outflow of around 15 percent of GDP. Second, domestic demand collapsed, with consumption growth dropping from +0.8 percent to -8 percent, and imports from +1.6 percent to an astonishing -35 percent.

Of course, Thailand’s problem was deepened by the contagion across the region. But the capital flight and collapse of demand began before contagion was a factor. And much of the contagion was a replication of the Thai problem by similar IMF actions in Korea and Indonesia.

Despite evidence of the growing disaster, the second (November 1997) and third (February 1998) LOIs insist on no change in the strategy. But with the fourth (May) and fifth (August) LOIs, the tone, content and emphasis totally changed.

Two things happened in mid-year to shape this change. First, the problems which IMF packages were classically supposed to solve (current account deficit, weak reserves) were overcome - but not at all through the mechanisms (export recovery, return of confidence) which the IMF had planned. Rather, the spectacular collapse of demand and of imports resulted in a large current account surplus. Net capital outflow slowed because debtors could not or would not pay. The government was able to buy dollars to restock the reserves. Pressure on the baht eased.

Second, the Thai government came under a lot of political pressure. Businessmen complained that the IMF package ignored the real economy, and the lack of liquidity condemned them to death. Farmers, NGOs and activists argued that IMF programme saved the rich and sacrificed the poor. Some of the businessmen advocated a debt moratorium. Some of the poor threatened to demonstrate. Both these agitations crested in May-June. The problem was no longer a classic IMF-style crisis, but a wrecked economy, looming social disaster, and political disruption.

In mid-May, as negotiations over the fourth LOI approached, something strange happened. The contents of the LOI were leaked to the press in advance. The finance minister, Tarrin Nimmanhaeminda, began a campaign of public lobbying among academics, businessmen, and the press. He appeared to be rallying support for the coming fourth LOI, and at the same time manoeuvring to present the IMF with a fait accompli over its contents.

Recently Tarrin’s deputy, Pisit Lee-ahtam, let slip that "it took a lot of effort to persuade the international institutions" to accept the changes in the fourth LOI. Pisit is a man whose only tone is understatement. What he meant was: we had to fight them like hell.

The fourth LOI junked all the talk about maintaining the austerity programme. Instead, "the immediate priority under the programme is to minimize any further decline of the economy and bring about early recovery". This meant reversing the budget balance for 1998 from a 1 percent surplus to a 3 percent deficit, and bringing down interest rates. The fifth LOI confirmed the same policy for 1999. Deflationary austerity was reversed into a mild Keynesian stimulus.

There were other changes. From the start, the LOIs had talked about installing "social safety nets" but the first three had contained no substantive proposals except protecting certain ministries against budget cuts. The fourth LOI laid down "concrete measures", including a public works spending programme to create employment. The fifth LOI set out a broader plan.

The early LOIs had assumed that Thai banks would mostly have to be sold to foreign interests, and that the banks would cease to play such a dominating role in the capital market. But the 14 August package rejected this approach. Instead, the banking sector was divided into three segments - foreign, private domestic, and nationalised. Subsequently, the Bank of Thailand began to haul down interest rates, and set up machinery for restructuring corporate debts to free up the credit crunch. Tarrin also set about reviving some moribund specialised public-sector banks to use as a channel to inject government-to-government loans into the private sector. These measures signalled the Thai government’s attention to support the banking sector, and use it as a tool to regenerate the economy.

At the same time, the government stepped quietly back from the rapid fire sale of public corporations. The fifth LOI stated that "market opening policies … which aim at increasing the role of the private sector in Thailand’s economy, need to be implemented with great care, and based on an overall social consensus".

Of course it has suited both the Thai government and the IMF that Thailand should appear as the IMF’s good pupil. But in truth, this was a rebellion which overthrew the IMF programme in favour of an alternative plan better tailored to local reality. In the middle of it, Robert Rubin came to Bangkok in July to insist that Thailand stick to the IMF programme. He met with a subtle rebuff. Two leading establishment economists chose this occasion to voice public dissent. The commerce minister, Supachai Panitchapakdi, said "The IMF was wrong… we had to warn them that we would face a severe recession." Virabongsa Ramangkura, an ex-finance minister, stated "I doubt the US has a true understanding of the local economy".

The apostasy of Virabongsa is instructive. Since the early 1980s, he has been one of the strongest supporters of World Bank/IMF liberalisation strategies in Thailand. He worked with the World Bank on the structural adjustment programmes in the 1980s, and he was brought in to act as liaison with the IMF in late 1997. On television recently, he revealed what he had learnt from this crisis: "nobody understands the Thai economy, the culture of our banking practice, and the culture of our business, better than ourselves". In other words, we should not have let the IMF run things. For some of Thailand’s most loyal liberalisers, the IMF’s failure has been a chastening experience, a real test of faith.

The Thai rebellion against the IMF has been delicately subtle. But it should not be overlooked. It is very easy to attribute a Thai recovery to the IMF’s guiding hand. But that conclusion opens the way to future disasters.