This Selected Issues paper and Statistical Appendix examines the channels of monetary policy transmission in Thailand. The main findings are that changes in monetary policy are associated with changes in real output, and that the main channel for transmission is not bank lending but asset prices. The paper takes stock of the performance of the Thai corporate sector emerging from the crisis and discusses remaining challenges and vulnerabilities. An assessment of Thailand’s fiscal vulnerability is also presented.

Abstract

This Selected Issues paper and Statistical Appendix examines the channels of monetary policy transmission in Thailand. The main findings are that changes in monetary policy are associated with changes in real output, and that the main channel for transmission is not bank lending but asset prices. The paper takes stock of the performance of the Thai corporate sector emerging from the crisis and discusses remaining challenges and vulnerabilities. An assessment of Thailand’s fiscal vulnerability is also presented.

IV. An Assessment of Thailand’s Fiscal Vulnerability1

A. Introduction

1. After enjoying a decade of debt consolidation and fiscal surpluses, Thailand’s fiscal trends reversed quickly during the 1997 crisis, which caused a surge in public debt and a sizable widening of the fiscal deficit. The deterioration in the fiscal position was driven by a combination of cyclical and structural factors, including a severe output decline, the steep depreciation of the baht, and large financial sector losses absorbed by the government.

2. The heavy debt burden inherited from the crisis is a source of vulnerability and a constraint on economic management. High indebtedness limits the scope for policy flexibility in the face of a cyclical downturn. Also, aggressive measures to reduce indebtedness can delay a nascent economic recovery. Historical data from other emerging market economies uncover a general association between high public debt and weak economic performance. Moreover, recent crisis episodes corroborate the view that high public indebtedness, if not managed properly, may induce or propagate an external crisis.

3. This paper offers a fresh look at Thailand’s fiscal vulnerability in a cross country perspective. Following Hemming and Petrie (2000), it begins with an assessment of the initial fiscal position and its sustainability, including estimates of contingent liabilities (see Section B). Central to the fiscal vulnerability assessment is the quantitative measurement of the impact of various macro shocks on the medium-term fiscal outlook (Section C). Risks from debt management and other structural fiscal risks are also explored below (Section D), while vulnerabilities arising from ongoing fiscal decentralization are covered in Chapter V.

4. The main findings and policy implications of this paper are as follows:

  • Thailand’s main sources of fiscal vulnerability relate to (i) the presence of sizable contingent liabilities; (ii) the high sensitivity of the debt dynamics to adverse economic scenarios; and (iii) the significant near-term gross financing requirements.

  • Policy efforts are needed to place the medium term debt path on a firmly declining path. The ongoing economic recovery presents a timely opportunity to reorient fiscal policy from stimulus to debt consolidation. Asset recovery and privatization could also play a key role in containing the medium-term debt dynamics.

  • An orderly rollover of near-term maturing public liabilities should be facilitated by Thailand’s high private savings rate, high domestic liquidity, and low interest rates. Moreover, moderate public external indebtedness reduces the chance that domestic fiscal pressures may spill over into an external crisis.

B. Current Fiscal Position

Thailand’s current fiscal position is best described in an historical perspective and against the experience of other emerging market economies—with caveats about data comparability2.

Historical and Cross-country Perspective

5. During the decade prior to the 1997 crisis, Thailand undertook a successful fiscal adjustment. The primary balance rose by some 6 percent of GDP above its previous decade average; and the central government debt ratio was brought down to around 5 percent, from its earlier peak of 35 percent reached during the financial crisis of the mid-1980s. Thailand’s successful fiscal consolidation was facilitated by high output growth (9½ percent a year), well in excess of the real interest rate (4½ percent). These achievements are striking, specially when compared to the broad fiscal trends of other emerging market economies (Figure 1).

Figure 1
Figure 1

Fiscal Developments in Thailand and Other Emerging Markets (1972 – 2001) 1/

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

Source: IMF staff estimates based on GFS, IFS and country authorities’ data.1/ All variables in percent, except for public debt/revenues. The emerging markets sample includes 22 countries (see footnote 2 of main text).2/ Excludes non financial public enterprises.3/ Central Government plus FIDF.4/ g = real GDP growth; r = average real borrowing cost.

6. Thailand’s fiscal position deteriorated rapidly in the wake of the 1997 crisis. Headline public debt tripled in just two years—an increase of exceptional size and speed by Thailand’s own history and that of other countries—and now hovers at around 60 percent of GDP (Text Chart). Over two-thirds of the increase in the headline debt was driven by structural factors, including large banking system losses, and the limited rebound from the initial sharp depreciation of the exchange rate. The cyclical income decline and an accommodative reorientation of fiscal policy also contributed to higher indebtedness. In fact, a comparison of the pre and post-crisis fiscal positions indicates that about 70 percent of the actual deterioration in the central government fiscal balance (excluding the principal costs of financial sector restructuring) was of a cyclical nature (Table 1).3

Table 1.

Thailand’s Fiscal Accounts, in percent of GDP

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Source: IMF staff estimates based on authorities’ data.

Includes non-fiscalized portion of financial sector restructuring (FIDF) interest costs.

Includes the non-fiscalized portion of the funding costs of the “village fund” and the debt suspension for farmers.

7. The budget ending in September 2002 builds a temporary rise in expenditures. The comprehensive public sector deficit is targeted to widen to 5½ percent of GDP (a 1½ of GDP deterioration—most of which is structural—compared to post-crisis average deficit), on account of a pick up in expenditures, including some undertaken outside of the budgetary framework (Box IV.1). The envisaged recourse to quasi-fiscal financing reflects, to some extent, difficulties in using budgetary spending flexibly to support economic activity.4 Based on preliminary information, the budget draft for FY 2003 targets a reduction in the overall deficit of over 1¼ percent of GDP, and is underpinned by significant expenditure cuts.

8. Despite its recent weakening, Thailand’s fiscal position does not compare unfavorably with other emerging market economies (Figure 1). A caveat is in order: cross-country comparisons are hampered by a different coverage of fiscal data in the sample considered. As a result, the evidence presented should be interpreted with caution. This said, a static cross-country comparison indicates that Thailand’s public indebtedness (excluding Non Financial Public Enterprises (NFPE) debt for consistency with other countries debt data) is of the same order of magnitude as that of other emerging market economies (both as share of GDP and revenues). Thailand’s share of external indebtedness—a potentially significant source of vulnerability—is generally smaller than in other countries (Text Chart). However, Thailand’s revenue ratio is significantly lower than in other emerging market economies, and its primary balance weaker. As regards the macroeconomic environment for fiscal sustainability, Thailand enjoys higher private savings, but a less favorable growth-interest rate nexus—a key determinant of debt sustainability (see ¶ 11–12).

9. In the sample of countries under consideration, higher indebtedness tends to be associated with weaker economic performance. Based on data averaged over long time spans, debt ratios tend to be correlated negatively with real output growth and with private savings, and positively correlated with inflation (Figure 2). Moreover, high debt ratios have been historically associated with greater volatility in output, inflation, interest rates and private savings. More rigorous testing would be needed to uncover the causality of these relationships, but regardless of the direction of this causality, once large public debt exists it complicates economic management. Not surprisingly, countries with relatively higher debt ratios appear to receive less favorable long-term sovereign debt ratings.

Figure 2
Figure 2

Public Debt and Long-run Macroeconomic Performance 1/

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

Source: Based on GFS, IFS, and national authorities’ data.1/ Available data is averaged over long time spans (1970–2001). “EM” refers to the median of 22 emerging market countries.2/ End-2001, or earlier available observation.

Is the Current Fiscal Position Sustainable?

10. One central question to the fiscal vulnerability assessment is whether the initial fiscal position is sustainable. The theoretical notion of sustainability refers to a situation where the debt stock does not exceed the present value of all future primary surpluses (a condition for solvency). This notion, however, does not always have immediate policy implications—e.g., it does not rule out large persistent primary deficits, so long as these are reversed in the distant future. The tests of sustainability offered in the literature have instead focused on the requirement that the change in the debt ratio is zero (see Chalk and Hemming, 2000). Three such tests, which are derived from the approximated accounting relation Δd1 = −(gtrt)*dt − 1pbt (where d, pb, g, and r indicate, respectively, the debt ratio, the primary balance ratio to GDP, real growth, and the real interest rate at time t), are used here:

  • The primary gap indicator computes the permanent adjustment in the primary balance needed to stabilize the debt ratio at its current level: pbap = pbt − (gtrt)*dt − j

  • The debt-stabilizing revenue ratio is closely related to the primary gap indicator. It computes the revenue ratio needed for a stable debt: T* − niet − (gtrt)*dt − 1, where T and nie are, respectively, the revenue and the non-interest expenditure ratios to GDP.

  • The debt-stabilizing growth rate computes the real growth rate necessary to stabilize the debt ratio at its current level for an unchanged primary balance: g* = rt (pbt/dt − 1).

Progress in the Implementation of the Government Fiscal Initiatives

Since coming to office in early 2001, the government has implemented a number of fiscal programs, which aim to boost the incomes of the rural population, increase the availability of financing for new enterprises and boost capita] markets. For most of these programs, financing is provided, at least initially, outside of the budgetary framework. The eventual cost to the budget is in some cases uncertain, but given the non-recurring nature of the majority of these programs, their costs should be manageable. A description of each initiative is provided below.1

  • Village Fund. Under this program, each of Thailand’s roughly 75,000 villages and urban communities are provided with a revolving fund facility of B 1 million ($23,000) to finance working capital needs and microcredit programs for small scale enterprises. Although, funding is initially provided by a government-owned specialized financial institution (the Government Savings Bank, GSB), principal and interest costs are reimbursed by the budget over an 8 year period. The interest rate charged to the budget is equivalent to the market deposit rate plus 175 basis points to cover GSB’s operational expenses. The funds are managed independently by village-level committees, with only broad oversight exercised by a national-level committee.

    By February 2002, B 70.4 billion (1.4 percent of GDP) in funds—nearly the whole amount of funds allocated to the initiative—had been disbursed to the villages. Of this, about B 48.6 billion (0.9 percent of GDP) had been on-lent to individuals. Under the program, each borrower’s credit limit is capped at B 20,000 ($460), and the average loan size is estimated at about half of that. Loans to individuals are on a short term basis (less than 1 year) and the interest rate charged ranges from 0 to 12 percent, with an estimated median of around 6 percent. According to a BOT survey, most of the loans (60 percent) are funding purchases of intermediate farm inputs (such as fertilizer), with the rest equally split between investment in small scale projects, and refinancing of high-cost debt. Since this initiative is at an early stage, no reliable information on default rates is yet available.

  • Debt Suspension for Farmers. This program provides debt relief to farmers with outstanding credit from the Bank for Agriculture and Agricultural Cooperatives (BAAC) of less than B 100,000 ($2,300), comprising 84 percent of BAAC debtors. Eligible farmers were given the choice of a three-year suspension of all principal and interest payments, or a 3 percentage point reduction in the interest rate for three years. The total cost of this program is estimated at around B 20 billion (0.4 percent of GDP). Losses resulting to BAAC are compensated by the budget over a three year period (B8 billion has been allocated thus far). By February 2002, 98 percent of the almost 2½ million of eligible farmers, holding B 94 billion in debts, had adhered to the initiative, with broadly equal participation in the debt suspension and interest rate reduction programs.

  • Universal Health Care. The objective of this plan is to make health care available at a fixed fee of 30 baht (S0.66) per visit to families not currently covered by other government-sponsored health insurance schemes. The authorities plan to phase this plan over a three-year period, after initial pilot programs are completed. Thailand has already a fairly extensive public health care system with a consolidated yearly budget of circa B 75 billion. The incremental cost of the universal health care program will ultimately depend on the precise details of the initiative and the cost savings achieved from the consolidation of existing programs. The incremental cost of this program is estimated to be in the order of B 25 billion (½ percent of GDP) yearly.

A number of other initiatives have been launched to stimulate credit and revive key economic sectors:

  • Measures to stimulate the domestic real estate market. The MOF has assigned the Government Housing Bank (GHB) to extend loans to create demand for housing from state officials, state enterprise employees and members of the Government Pension Fund who have sound purchasing power. Under one scheme, the GHB allows eligible individuals to borrow up to the appraised value of the house at below-market interest rates (equivalent to 75 basis points above deposit rates). By April 2002, the GHB had approved B 12 billion in home loans for 1,732 out of 37,600 applications received for loans worth around B 29 billion. Under a second pilot scheme, the National Housing Authority has been charged to coordinate with the GHB, and Krung Thai Bank the funding of the development of stalled (NPL) housing projects for sale to civil servants, state enterprise employees and the general public. By end March 2002, 9 projects worth B 7 billion had been selected.

  • Micro lending under the People’s Bank. The government has entrusted the GSB to establish the People’s Bank program to provide small scale financing (mostly to retail businesses). Funding for this initiative comes from the GSB with no explicit guarantees by the budget. Under the initiative, uncollateralized loans are capped at B 50,000 ($I,200), though the loan size could be higher if collateral is pledged. Interest charges are set at 1 percent per month, with the repayment period not exceeding 3 years. To instill credit discipline, members of the People’s Bank must open a deposit account, and loan repayments are automatically deducted from their savings. The GSB expects to lend over B 8½ billion of funds to 600,000 individuals by 2003. By end 2001, loans for about B 3.8 billion baht had been extended to 280,000 individuals, of which less than 1 percent had turned non-performing. Complementing the People’s Bank project, the BAAC is preparing to extend B 100 million in non-farm micro credits (of up to B 15,000 per applicant). The terms of the loans are similar to those offered by the GSB under the People’s Bank. To encourage good credit discipline, under this initiative borrowers who make repayments on time for six months qualify for reduced interest payments.

  • Lending by state banks and Specialized Financial Institutions (SFIs). The MOF has assigned state banks and SFIs to spearhead credit extensions to key economic sectors and SMEs.

    • The Small Industry Credit Guarantee Corporation (SICGC) established a B 10 billion credit guarantee program covering up to 50 percent of SME loans extended by state financial institutions (the guarantee covers also forgone interest payments). Fees levied by the SICGC range between 1 and 1.8 percent.

    • The EXIM bank and the Small Industry Finance Corporation (SIFC) established a credit program to promote and support exports, with an operating budget of B 12 billion.

    • The role of the SIFC was expanded to allow it to become a special-purpose “SME Bank” with the mandate to extend up to B 10 billion in soft loans and provide financial services to SMEs. Although details are still being worked out, the proposed SME Bank will be allowed to accept deposits from its borrowers, but is not expected to be supervised by the Bank of Thailand.

  • Equity funds. In an effort to support the capital markets and foster corporate restructuring, the government has recently launched four special funds to purchase securities in listed companies. Altogether, these funds can mobilize equity investments for up to $ 1.1 billion, of which less than 40 percent is funded from government-run entities. The investment pool corresponds to less than 3 percent of Thailand’s 2001 stock market capitalization.

    • The Thai Matching Fund will invest $500 million mainly in ailing companies under restructuring with the TAMC, and is contributed for 80 percent by a US-based fund (Cerberus), with the rest provided by state-owned financial institutions (Krung Thai Bank, IFCT and the SET).

    • The smaller Thai Opportunity Fund ($250 million) is instead contributed entirely by state-owned financial institutions and the Government Pension Fund, and will focus its investments on listed companies which are undergoing restructurings.

    • The Thai Equity Fund expects to invest $250 million in medium to large companies in high-growth industries (manufacturing and services). Most of the funding comes from private investors and the International Finance Corporation, with only a small share from the MOF and state-owned banks.

    • The smaller Thai Recovery Fund is fully privately owned (including contributions from ADB, JBIC, and US-based State Street Corp.) and was established to invest $100 million in small and medium sized enterprises and start-up companies.

Table. Cost of Government Fiscal Initiatives

(Estimated Cumulative Financing Need over 2001–2003)

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Source: IMF staff estimates on authorities’ data.

Three-year incremental cost of initiative (annual incremental cost is B 25 million).

Portion financed by state-run entities (additional B29 billion provided by private investors).

Planned credit extension for year 2002.

Estimated subsidized home loans extended by April 2002.

1 A number of tax measures were also implemented in 2001. These measures aimed at promoting the listing of companies in the Thai stock market (by lowering the corporate income tax rate for listed companies from 30 percent to 25 percent), encouraging home purchases (by exempting down-payments from the calculation of the personal income tax), mobilizing revenues and discouraging imports of consumption goods (by increasing selected excise taxes).

11. Based on these sustainability indicators, Thailand’s achievement of a stable debt path depends on a stronger fiscal position and more favorable macro economic environment. Over the past three years, Thailand’s sizable primary deficits, in the face of a real interest rate in excess of the growth rate, have kept the debt ratio on a rising path. In fact, during the same period, other emerging market countries were running fiscal policies leading to higher debt (see Text Chart). However, as suggested by the intertemporal budget constraint, the increase in the debt ratio can be reversed provided offsetting primary surpluses are achieved in the future.

12. The sustainability indicators presented here provide a rough measure of the needed fiscal offset: (Table 2). For example, assuming 2002 growth and interest rates are held constant in the future, the adjustment in the primary balance (or the revenue increase, for unchanged non-interest expenditures) needed to stabilize the debt ratio ranges between 3 percent to 4 percent of GDP. Conversely, if the projected (FY 2002) primary deficit of 2½ percent of GDP at the central government level is not reduced in the future, the economy’s growth rate will have to increase to over 5½ percent to stabilize the debt ratio at its current level. The degree of fiscal adjustment needed to ensuring a stable debt dynamics would therefore be smaller in the event growth picks up and interest rates edge lower, as shown in the alternative “long-run” scenario shown in Table 2 below.

Table 2.

Indicators of Debt Sustainability, in percent of GDP

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Excludes non-fiscalized FIDF interest costs.

Includes non-fiscalized FIDF interest costs and NFPEs.

Indicators based on FY2005–FY2010 average growth and interest rates as per IMF baseline.

13. The policy prescriptions emerging from the sustain ability indicators need to be interpreted with care. First, albeit “sustainable,” an unchanged, but high, debt ratio may not necessarily be desirable, if the ability to mobilize savings and to raise revenues is limited. Moreover, sustainability indicators are not useful in the event the deficit differs from (i.e., is lower than) the change in debt—which has been the case in Thailand, due to the presence of large principal costs of financial sector restructuring which were not recorded under the headlined deficit figures. Finally, the usefulness of the sustainability indicators is limited in the event the fiscal accounts do not capture the full range of the government’s fiscal activities. Under any of the above circumstances, the size of the fiscal adjustment required to stabilize the debt to GDP ratio would be higher than that computed by the simple sustainability indicators (see Section C for a further discussion on sustainability).

Coverage of Fiscal Statistics—Contingent Liabilities

14. The coverage of Thailand’s debt statistics is broad. The headline debt covers not only the direct liabilities of the central government, but also the debt of NFPEs and the on-balance sheet liabilities of the Financial Institutions Development Fund (FIDF)—the arm of the Bank of Thailand, which has financed the bulk of the bank restructuring costs.5 The headline debt figures are consistent with a notion of gross indebtedness, so that neither the assets of NFPEs nor those of the FIDF are netted out from outstanding liabilities.

15. Some analysts and rating agencies contend that, despite their broad coverage, headline debt statistics underestimate the full extent of the government indebtedness, since they exclude a large stock of unfunded contingent liabilities.6 Thailand’s gross contingent liabilities are estimated to be around 22 percent of GDP, with the bulk (19 percent of GDP) connected with the gross costs of financial sector restructuring (Box IV.2 and Text Chart). Including me total stock of contingent liabilities, gross public debt is estimated at around 80 percent of GDP, of which more than half is accounted for by the gross costs of bank restructuring. The net indebtedness is, however, smaller, since most state enterprises have positive net worth, and the FIDF controls a sizable pool of assets, including equity holdings in financial institutions and contingent claims on recoveries from NPLs. After deducting prospective asset recoveries (mostly, FIDF’s contingent claims on NPLs), the net public debt is estimated at around 68 percent of GDP, and could be even lower including privatization receipts—here conservatively neglected.

A04ufig04

Public Debt and Contingent Liabilities

As of end FY 2001. in percent of GDP

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

16. The presence of contingent liabilities clouds the assessment of the fiscal stance and the timing of its impact on the economy. From an economic standpoint, the contraction of a contingent liability (i.e., not its later payout) may impact private agents’ behaviors by, inter alia, affecting actual or perceived private wealth and expectations about future taxation (Lane, 1996). The provision of timely information on the scope of contingent liabilities is therefore key to enable a fuller assessment of their impact on the fiscal stance and, in turn, on the economy. Greater transparency would also reduce uncertainty over the medium-term fiscal sustainability, and could bolster the credibility of the government’s commitment to control the debt dynamics. Finally, transparent reporting of contingent liabilities (as advocated in the IMF Manual on Fiscal Transparency) would improve the cross-country comparability of debt statistics (Box IV.3).

Contingent Liabilities and Financial Sector Restructuring Costs

The bulk of the government’s gross contingent liabilities is linked to the costs of financial sector restructuring, which are recorded as off-balance sheet liabilities of the FIDF—in fact, its on-balance sheet liabilities (which were incurred to fund depositor payouts to honor the general guarantee) are already included in the headline debt figures. The FDDF’s off-balance sheet liabilities, which are estimated at about 19 percent of GDP, have arisen from the issuance of guarantees against losses from (i) NPLs transferred to state-owned AMCs, (ii) NPLs placed under, so-called, Covered Asset Pool (CAP) arrangements, and (iii) private bank NPLs acquired by the Thai Asset Management Corporation (Table A). Additional contingent liabilities, roughly estimated at 4 percent of GDP, are linked to the government’s quasi-fiscal activities (Box IV.1), including spending programs funded outside of the budgetary framework (such as the village fund and the debt suspension for farmers), investments in joint-venture equity funds, and guarantees on loans extended by specialized financial institutions.

Table A.

Thailand: Public Debt and Contingent Liabilities

As of end of FY 2001, in percent of GDP

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Source: IMF staff estimates on authorities data.

Excludes future projected funding costs for the SME Bank (0.2 percent of GDP). subsidized real estate and other credits by stale financial institutions (0.8 percent of GDP), and the incremental costs of the universal health insurance scheme (0.5 percent of GDP yearly).

Transfer value of NPLs acquired from private financial institutions.

It assumes a 40–45 percent average recovery rate from NPLs guaranteed by the FIDF, no losses from SFI loans or investments in equity funds guaranteed by the government. Also, it conservatively neglects receipts from bank privatizations.

The impact of FIDF bank restructuring activities on its balance sheet is best gauged by way of an example. The state-owned Krung Thai Bank (KTB) was initially recapitalized by converting FIDF-provided liquidity support into equity, amounting to about 3.7percent of GDP. Both the initial liquidity injection and its conversion into equity are on-balance sheet items of the FIDF, and therefore increase the headline public debt statistics. At a second stage, KTB was indirectly recapitalized through the transfer of its NPLs to SAM, a newly-established AMC owned by the FIDF, SAM acquired the NPLs by issuing a promissory note to KTB which was, in turn, guaranteed by the FIDF. This explicit guarantee—amounting to about 5.4 percent of GDP—is an off-balance sheet liability of the FIDF, and therefore does not increase the headline public debt statistics. Overtime, however, losses from the NPLs acquired by SAM will eventually be absorbed on-balance sheet by the FIDF and, thus, increase headline public debt. In the same vein, annual interest payments on the promissory notes issued by SAM are borne by the FIDF, affecting its profitability and, indirectly, worsening the government debt position.

The extent to which existing contingent liabilities may give raise to future cash outlays is uncertain. This largely depends on the likelihood that implicit claims (such as guarantees on loans) are called, but also on the success of NPL recovery efforts, and bank privatizations. Assuming a 40–45 percent average recovery rate on NPLs, and conservatively neglecting privatization receipts, the expected future losses from contingent liabilities linked to bank restructuring is estimated at around 10 percent of GDP (Text Chart).

A04ufig05

Contingent Liabilities from Bank Restructuring

As of end FY 2001. In percent of GDP

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

Contingent Liabilities Complicate Cross-Country Comparability of Government Debt Statistics

By way of example, at end-2001, headline public debt stood at 90 percent of GDP in Indonesia, and at 58 percent in Thailand. The different funding structure of the large costs of bank restructuring makes however the two debt ratios not directly comparable. In Indonesia, financing of these costs was largely met by issuing straight government bonds (e.g., the largest state-owned bank was recapitalized through the placement of about 12 percent of GDP in government bonds), resulting in a one-to-one increase in headline public debt. In Thailand, instead, a sizable portion of bank restructuring costs was funded through the issuance of guarantees and promissory notes by quasi-fiscal entities (e.g., state AMCs) and, as such, have not contributed to an increase in headline debt.

17. The recently announced plan to fiscalize the FIDF’s losses offers a transparent and viable solution to finance the bulk of the government contingent liabilities. So far, just less than one-third of the total gross costs of financial sector restructuring (amounting to 44 percent of GDP) have been fully fiscalized through the issuance of government bonds (Text Chart). The residual gross costs (31 percent of GDP) are funded by the FIDF, either explicitly on its balance sheet (12 percent of GDP), or implicitly, in the form of off-balance sheet (contingent) liabilities. The announced fiscalization plan calls for the issuance of about 15½ percent of GDP in government bonds, which after factoring in prospective recoveries from NPLs and bank privatization receipts should provide assurances that the bulk of these costs will eventually be funded directly by the government.

18. The first phase of the fiscalization plan entails the floatation of 5½ percent of GDP in savings bonds to retail investors. (At the time of writing, a large share of these bonds had been successfully underwritten). The interest cost on the bonds will be borne by the budget, while principal repayments will be funded by earmarking Bank of Thailand’s prospective cumulated profits. It is unlikely that the initial bond issuance will have a disruptive impact on financial markets or the banking system, since some of the FIDF liabilities to be refinanced with the savings bonds are already held by retail investors.7 Also, ample bank liquidity should facilitate a switch from deposits to bonds. Moreover, the presence of a large output gap and scant bank lending implies that, in the short term, fiscalization of the FIDF liabilities is unlikely to crowd out private credit. The plan envisages additional bond issuances in the coming years to meet the FIDF’s future financing needs (see¶20 for a discussion of how these will impact debt dynamics).

A04ufig06

Funding of Costs of Bank Restructuring

In percent of GDP

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

C. Sensitivity of Fiscal Outlook to Economic Environment

Uncertainty over the future path of public debt, and its sensitivity to macroeconomic shocks are key sources of fiscal vulnerability.

Medium-term Debt Projections

19. Thailand’s headline debt ratio is expected to continue to rise in the near term, driven by prospective deficits and the realization of contingent costs from financial sector restructuring (Text Charts). In the baseline scenario, headline debt is expected to peak in FY 2005 at roughly 65 percent of GDP, and to be brought down to its current level by the end of the projection period, or 8 years from now. The medium-term consolidation is expected to be driven both by a gradually increasing growth rate (averaging 4½ percent) in excess of the real interest rate, and a steady fiscal adjustment which closes the central government deficit gap by FY 2008.8 Underpinning the fiscal adjustment in the baseline scenario is the assumption that the VAT rate will be increased back to 10 percent by the beginning of FY 2004—a measure which is projected to yield about 1½ percent of GDP in additional revenues a year.9

20. These medium-term debt projections incorporate the financing requirements stemming from the FIDF’s contingent costs of bank restructuring. Following the traditional cash-based accounting framework—according to which the contraction of a contingent liability is not debt-creating insofar as it does not trigger a cash outlay—debt is increased when prospective losses from contingent liabilities are realized. The interest cost of FIDF’s contingent liabilities are made explicit in the projections, since these are added to the comprehensive public sector deficit. These projections are actuarially equivalent to those produced by some analysts, whereby public debt is augmented up-front by the gross stock of contingent liabilities, and reduced over time as assets are recovered.

21. The authorities’ medium-term fiscal framework builds a faster reduction in the debt ratio. Compared with the baseline projections presented above, the Ministry of Finance model assumes (i) higher growth, reaching 7 percent by FY 2008; (ii) slightly lower central government deficits, including by allowing for some compression in the nominal wage bill growth; (iii) significantly lower NFPE yearly borrowing requirements (by about 0.5 percent of GDP); (iv) somewhat lower borrowing requirements to finance the financial sector restructuring costs (Text Chart). Consistent with the IMF baseline projections presented above, in the authorities’ framework the VAT rate is raised in FY 2004.

A04ufig08

Public Debt, percent of GDP

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

Sensitivity Analysis to Public Debt Projections

22. The medium-term debt projections are highly sensitive to the underlying macroeconomic assumptions and the size of the fiscal effort. The sensitivity analysis presented below (see Text Chart and Table 3 below) is illustrative of the likely evolution of the debt ratio under various shocks to the macroeconomic variables (growth, inflation and interest rates).10 To provide a structure to the sensitivity analysis, the size of the shocks was calibrated drawing from Thailand’s own historical data and that of other emerging market economies (Table 4 below). This should preserve the inherent co-movements among macro variables (particularly with respect to growth and interest rates) in the simulated values.

Table 3.

Public Debt Sensitivity Analysis, in percent

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Source: IMF staff estimates based on authorities’ data.

Average over 1991–2001.

Alternative scenarios as follows:

Same as baseline, except that the VAT rate is not raised to 10 percent.

Growth, interest rates, and inflation at Thailand’s long-run average values (see first column of the table). The VAT rate is not raised.

As in B. except that growth and inflation are reduced by 1 standard deviation, and the real interest rate is increased by 25% of 1 standard deviation. The VAT rate is increased to 10 percent as in the baseline.

Thailand’s 1990–2001 average growth, inflation and interest rates are perturbed by 1 standard deviation computed as the median of the growth, inflation and interest rates standard deviations of a group of emerging market economies. The VAT rate is raised as in the baseline.

Uses the median of emerging markets’ 1997–2001 average growth, inflation and interest rates. The VAT rate is raised as in the baseline.

Table 4.

Macroeconomic Variables in Thailand and Other Emerging Market Countries

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Source: IMF staff estimates based on IFS and country authorities data.

The sample of emerging market economies consists of Argentina, Bolivia, Brazil, Chile, Colombia, Czech Republic, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Slovak Republic, South Africa, Thailand, Turkey, Uruguay, Venezuela. Data was not uniformly available for all countries.

A04ufig09

Sensitivity Analysis, Debt/GDP in percent 1/

Includes central government, NFPE and FIDF debt

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

1/ Baseline and alternative scenarios (A, B, C, D, E) are discussed in the text.
  1. Unchanged policies. The first alternative scenario shows the impact on the debt ratio of the failure from raising the VAT rate to 10 percent, with all other variables kept at their baseline values. Lack of fiscal adjustment is expected to slow down the pace of debt consolidation, with the debt ratio projected to be some 7 percent of GDP above baseline by the end of the projection period.

  2. Thailand’s long-run growth. This optimistic scenario mimics the pace of consolidation which would be achieved if all key macroeconomic variables took on their 1970–2001 average values. Here discretionary fiscal measures are not required (i.e., the VAT rate is not raised) to achieve a steady reduction in the debt ratio to below 50 percent of GDP.

  3. Thailand’s low growth. This scenario shows the impact on the debt ratio of a 1 standard deviation reduction in Thailand’s long-run growth. The real interest rate is concurrently raised from its long-run average to preserve the observed historical negative correlation with GDP growth.11 A fiscal adjustment of the magnitude achieved by raising the VAT rate would not be enough to prevent the emergence of a divergent path for the debt ratio.

  4. Emerging market low-growth shock. A uniform negative shock is applied to Thailand’s 1990–2001 average growth, inflation and interest rates. The shock is calibrated to mimic the “median” volatility observed since the Asian crisis among the sampled emerging market countries.12 As in C, the real interest rate is raised concurrently. Despite the increase in the VAT, the debt ratio follows an explosive path reaching over 80 percent by end of the projection period.

  5. Emerging market median growth. This scenario envisages Thailand’s macroeconomic performance to match that exhibited by the “median” emerging market country during the last five years. Lower growth compared to the baseline scenario (2½ percent viz. 4½ percent in the baseline) is partly compensated by lower real interest rates (1 percent viz. 3½ in the baseline) allowing for a stable debt dynamics. Despite the built in increase in the VAT rate, the result is a slowly decreasing debt path, above the baseline scenario.

23. The debt projections are also sensitive to financial sector restructuring costs. For example, if recovery rates on NPLs under state management are as low as 20 percent, or half of what assumed in the baseline, resulting losses would cause the FY 2010 debt ratio to rise by about 5 percent of GDP above baseline. By converse, a faster reduction in the debt ratio is achievable provided asset recoveries exceed those assumed in the baseline scenario, or bank privatization proceeds, which are conservatively neglected in the IMF baseline projections, are realized. In fact, the FIDF expects that the sale of shares in state-owned banks could generate over time around 4 percent of GDP in revenues.

D. Structural Fiscal Vulnerability

Additional sources of potential vulnerability stem from the financial management of public liabilities and other institutional constraints.

Debt Management Risks

24. A key source of fiscal vulnerability stems from the significant near-term gross financing requirement. Despite successful efforts to lengthen the maturity structure of the central government and state enterprise debt, the overall near-term refinancing need, inclusive of FIDF’s explicit and contingent liabilities, remains substantial (Figure 3).13 It is estimated that about 16 percent of GDP in domestic and external public liabilities fall due during 2002 (equivalent to over 40 percent of issued domestic securities) and that roughly half of this amount will fall due next year. Similarly, the gross financing requirement, which is a more comprehensive measure of the government borrowing needs (i.e., it includes borrowings to cover prospective deficits) is estimated at over 20 percent of GDP in 2002 or, equivalently, 100 percent of 2002 public sector revenues.

25. Despite the large nominal amount of debt falling due, an orderly rollover of the near-term maturing debt should be manageable. Various considerations support this statement. First, over 50 percent of the (16 percent in GDP of) debt falling due in 2002 represents very short-term market borrowings by the government and the FIDF (T-bills and repurchase agreements, respectively), which have been successfully rolled over during the last few years (e.g., T-bill auctions are typically fully subscribed). Second, another 20 percent of the debt falling due represents non-market based financing held by FIDF-owned entities, which could be conceivably rolled over on the same terms. Third, about half of the remaining 4½ percent of GDP in debt falling due is financed externally, and has good prospects for being refinanced abroad. Therefore, a market-based rollover of the residual maturing debt (2½ percent of GDP, equivalent to less than 15 percent of central government revenues), which is currently held domestically, should be manageable.14

26. Another risk conies from the large costs of servicing an increasing debt burden. Despite historically low interest rates (currently the yield on a 10-year government bond is below 6 percent), interest payments, including the imputed servicing cost of outstanding contingent liabilities, are estimated at just below 4 percent of GDP in 2002 and 2003 (Text Chart). Although their magnitude does not compare unfavorably to other countries, it is high when measured against the public sector’s ability to generate revenues (total interest payments are roughly equivalent to 1/5 of public sector revenues). In fact, the interest burden of the public sector could have been higher were it not for the fact that a significant share of indebtedness is funded short-term or at below market yields. For example, the FIDF’s liabilities pay on average a 3 percent interest rate, since most of them are currently funded either in the short-term money markets, or at a small premium over deposit rates.15 The interest burden on external debt is also contained (about ¾ percent of GDP) since it is funded at an average rate of 4½ percent.16

Figure 3
Figure 3

Thailand: Financing Structure of Public Debt 1/

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

Source: IMF staff estimates based on country authorities’ data.1/ Debt service figures include the interest component on projected newly-contracted debt.

27. Market risks could be another important source of vulnerability. Movements in interest rates are a potential source of vulnerability, since just less than half of the gross debt (including contingent debt) is financed at variable rates (the ratio is slightly higher if prospective refinancing commitments are included). By way of example, each 100 basis point increase in government borrowing costs (currently averaging 6½ percent for market-based placements of government securities) is estimated to raise up-front the debt servicing costs by about 0.4 percent of GDP (and twice as much after the repricing cycle of the outstanding borrowing is completed). Risks stemming from a depreciation of the baht are lower, in light of the relatively smaller share and longer-term nature of external public debt, and Thailand’s limited recourse to international capital markets as a source of borrowing.17,18

A04ufig10

Interest payments: Central Government + FIDF

(Including FIDF off balance sheet liabilities)

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

Other Structural Sources of Fiscal Vulnerability

28. Fiscal decentralization, the revenue erosion since the crisis, and institutional constraints for debt management are additional latent sources of fiscal vulnerability.

  • The constitutionally-mandated fiscal decentralization could be another potential risk (see the paper on Fiscal Decentralization in Thailand). The main challenge, as shown by international experience, is to ensure that decentralization is implemented in a fiscally neutral way. This risk is tangible in the Thai context, since the transfer of expenditure responsibility has so far lagged behind the devolution of revenues.

  • The erosion of central government revenues observed since the crisis could constrain future policy action. Thailand’s revenue ratio is low by its own recent history and also compared to other emerging market countries (Text Chart). Although the revenue decline during the crisis was for the most part driven by cyclical factors, tax revenues have been slow in responding to the economic recovery (an experience similar to that of the Philippines). One factor at play has been the shrinking contribution of trade taxes (currently accounting for about 12 percent of revenues) as a result of ongoing trade liberalization. Looking forward, increasing budgetary debt servicing costs and further revenue erosion from the ongoing fiscal decentralization process—in the face of only a limited offset by a natural cyclical rebound in revenues—could constrain the government’s ability to adjust its fiscal position in the absence of discretionary measures aiming at broadening tax collections.

  • Institutional constraints for debt management expose the government to additional fiscal risks. Despite the recent establishment of the Public Debt Management Office, the government debt management activity is still fragmented across a number of institutions and lacks the ability to monitor effectively contingent liabilities. Further development of the domestic bond market infrastructure—which was basically non-existent prior to the crisis (Text Chart)—would also facilitate the government’s debt management activities. Despite measures taken so far, investor participation (especially by foreigners) is limited, and liquidity in the secondary bond market remains low. Priority measures in these areas should aim at promoting derivatives trading and hedging, issuance of asset-backed securities, and the establishment of a modern settlement system.

A04ufig11

Revenue Shares in Selected Countries

Excludes nan-financial public Enterprises; percent of GDP

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

A04ufig12

Outstanding Value of Domestic Bonds

(In trillions of baht)

Citation: IMF Staff Country Reports 2002, 195; 10.5089/9781451836783.002.A004

E. Concluding Remarks

29. Thailand’s main source of fiscal vulnerability arises in connection with the management of the large stock of public liabilities. Three related risks are (i) the presence of sizable unfunded contingent liabilities linked to the costs of financial sector restructuring; (ii) the high sensitivity of the debt dynamics to adverse economic scenarios; and (iii) the significant near-term gross financing requirements. Curbing these risks, and managing effectively the ongoing fiscal decentralization process, would lay the basis for extending the recovery currently underway in the periods ahead. In a worst-case scenario, increasing interest rate risk premia driven by large rollover requirements, and higher than expected prospective losses from contingent liabilities (induced by slow progress in NPL recovery) may increase indebtedness, reduce the government’s ability to meet its gross financing requirements, upset confidence and, ultimately, reduce growth.

30. However, favorable external conditions should allow Thailand to contain the near-term fiscal risks. Thailand’s high private savings rate (22 percent of GDP), high domestic liquidity (estimated at over 10 percent of GDP), and current low interest rates should allow an orderly rollover of near-term maturing public liabilities. Moreover, moderate public external indebtedness makes it less likely that domestic fiscal pressures may spill over into a full blown external crisis—as seen in other emerging markets. In fact, Thailand’s external vulnerability has been much reduced in recent years, and the flexibility of the exchange rate is an important safety valve against unforeseen shocks.

31. Policy efforts are needed to place the medium term debt path on a firmly declining path. The ongoing economic recovery presents a timely opportunity to reorient fiscal policy from stimulus to debt consolidation. In the short term, fiscal adjustment can be supported by spending cuts (as envisaged in the draft FY 2003 budget). However, given the limited room for further expenditure compression, sustainable fiscal adjustment may require a structural increase in revenues. Additional efforts are needed in other areas: for example, recovering value from NPLs under state control is paramount to minimizing the ultimate cost of the banking crisis to taxpayers and containing the medium-term debt dynamics. Accelerating privatization of state owned enterprises would also support debt consolidation. Finally, further development of the bond market, greater transparency of budgetary operations, and enhanced institutional capacity for public debt management would increase confidence in the fiscal framework and reduce lingering fiscal risks.

Bibliography

  • Barnett, S. and V. Haksar (2001), “Medium-term Debt Outlook,” in Thailand; Selected Issues, International Monetary Fund, Country Report, No. 01/147, Chapter IV.

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  • Chalk, N. and R. Hemming (2000), “Assessing Fiscal Sustainability in Theory and Practice,” an IMF Working Paper, no. 00/81.

  • Hemming, R and M. Petrie (2000), “A Framework for Assessing Fiscal Vulnerability,” an IMF Working Paper, no. 00/52.

  • Lane, T. (1996), “The First-round Monetary and Fiscal Impact of Bank Recapitalization in Transition Economies,” an IMF Paper on Policy Analysis and Assessments, no. 96/8.

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1

Prepared by Lorenzo Giorgianni. Part of the data was kindly provided by Teresa Dabán.

2

The sample of emerging market economies comprises Argentina, Bolivia, Brazil, Chile, Colombia, Czech Republic, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Slovak Republic, South Africa, Thailand, Turkey, Uruguay, Venezuela. The fiscal data is not necessarily comparable, as country definitions vary. Thus, the cross country evidence presented in this paper is, at best, illustrative of general trends.

3

The size of the structural deterioration broadly matched the observed increase in debt service, with increases in other current expenditures offset by declines in capital spending.

4

Thailand has a tradition of underachieving deficit targets. During 1999–2001, outturns for the comprehensive public sector undershot plans by between 2 and 2½ percent of GDP.

5

The definition of government debt under the 1986 Government Finance Statistics manual excludes FIDF liabilities since they are considered to be part of the financial public sector. The Thai authorities have, however, included such liabilities in the headline definition of public debt, recognizing that the financial sector restructuring activity by the FIDF is of a fiscal nature, and that its liabilities are conceptually interchangeable with government paper—indeed around 14 percent of GDP in FIDF losses have already been fiscalized.

6

Fiscal accounting practices typically neglect contingent liabilities, including those that explicitly commit the government to future cash outlays.

7

Market reception of the plan was positive, and the yield curve flattened on its disclosure.

8

The baseline projections assume a more conservative medium-term macroeconomic framework than what suggested by Thailand’s own long-run history (e.g., growth is assumed at 4½ percent in the baseline, while it averaged 6¼ percent over the last 30 years).

9

In the model, consolidation is also helped by the presence of a modest buoyancy in revenues as the output gap is gradually eliminated. Detailed information on the forecasting model for revenues, expenditures and financial sector costs which underpins the IMF staff debt projections can be found in Barnett and Haksar (2001).

10

The sensitivity analysis takes the end-FY2003 projected debt ratio as starting point.

11

The size of the shock to real interest rates is equal to one standard deviation times a weight of minus 25 percent (equivalent to the historical correlation between growth and interest rates).

12

As in footnote 11, using a minus 37 percent median emerging market correlation between growth and interest rates.

13

The weighted average maturity of central government domestic debt is just over 5 years. However, including NFPE and FIDF (on- and off-balance sheet) domestic liabilities, the weighted average maturity drops to around 3.3 years.

14

The treasury cash reserves, which are maintained at around ½ percent of GDP, provide an additional, albeit limited, buffer.

15

The recently announced fiscalization plans would allow some refinancing of the FIDF’s short-term borrowings with longer-term government bonds. As a result, the average borrowing cost is expected to increase, though the rollover risk would be eased.

16

Currently, over ¾ of gross public indebtedness (including contingent liabilities) is financed domestically, with the rest (roughly $21 billion) externally—of which, about half is in U.S. dollars and the other half in yen. The low borrowing costs on external debt reflects, by and large, the current low interest rates on yen-denominated debt.

17

Specifically, a 10 percent depreciation of the baht increases external interest payments roughly by 0.1 percent of GDP, and raises the domestic currency value of external debt by around 2 percent of GDP.

18

The share of external borrowing from international capital markets is around 14 percent.

Thailand: Selected Issues and Statistical Appendix
Author: International Monetary Fund