This Selected Issues paper on Thailand reviews public investment and investment recovery from financial crises. Thailand is a country with a moderate tax effort, which indicates that increases in public saving should be achieved through a mixture of tax and expenditure measures. Future budgets should accommodate the megaprojects without putting excessive pressures on public finances, inflation, and the external balance. Least present value of revenue (LPVR) auctions alleviate the demand risk inherent in the fixed-term contracts and thus eliminate a key driver for renegotiations and the provision of minimum income guarantees.

Abstract

This Selected Issues paper on Thailand reviews public investment and investment recovery from financial crises. Thailand is a country with a moderate tax effort, which indicates that increases in public saving should be achieved through a mixture of tax and expenditure measures. Future budgets should accommodate the megaprojects without putting excessive pressures on public finances, inflation, and the external balance. Least present value of revenue (LPVR) auctions alleviate the demand risk inherent in the fixed-term contracts and thus eliminate a key driver for renegotiations and the provision of minimum income guarantees.

II. Investment Recovery from Financial Crises: A View from Cross–Country Experiences 1

Lower investment in emerging Asia compared with the pre–crisis period is a puzzle. This paper examines the post–crisis behavior of investment in Asia. Based on cross–country historical experiences we argue, first, that the investment slump after the Asian crisis is exceptional. Second, the paper shows that the investment slump can be characterized as a reaction to pre–crisis overinvestment. However, the overinvestment cannot be a full explanation of the still low investment. Third, the paper examines reasons that might account for the slow investment recovery. Explanations discussed include: (i) a riskier investment environment, (ii) weaknesses in the financial and corporate sectors, and (iii) sluggish nontradable sectors. We show these explanations are loosely consistent with the observed patterns of investment, though none of them are strong enough to fully explain the slow investment recovery on their own.

A. Introduction

1. Since the 1997 financial crisis, the saving–investment balance in emerging Asian countries has shifted from a deficit to a significant surplus. While there has been an active debate over whether the large surpluses in emerging Asia reflect an “investment drought” or a “saving glut,” the data point to the former. In contrast to the relatively stable savings, investment declined almost simultaneously with the crisis and has only partially recovered. Thus, the limited contribution of investment to output growth and the resulting large current account surpluses have focused much interest on the factors driving the recent stagnation of investment in Asia.2

uA02fig01

Saving and Investment Balance in the Asian Crisis 5 Countries 1/

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: World Bank, World Development Indicators; and IMF staff calculations.1/ Weighted average of Thailand, Malaysia, Indonesia, Philippines, and Korea.

2. Although the roots of the investment slump are complex and may differ across countries, the simultaneous investment decline in Asia could have regional explanations. Using a cross–country panel of 85 countries, this paper attempts to study the effects of financial crises on investment. Like other recent studies (e.g., WEO, 2005), the investment regression in this paper is not very successful in tracking recent developments, especially those after the Asian crisis. However, the deviations from the standard model themselves may contain important messages, as described in the following sections. By examining the residuals from the investment regressions, this paper tries to explain the post–crisis investment slump and propose policies to remedy the situation.

3. Based on cross–country historical experiences, this paper, first, argues that the contraction of investment after the Asian crisis is exceptional. Pre–crisis investment was far beyond the level suggested by economic fundamentals, and the post–crisis investment fall has been exceptionally severe and prolonged. Excluding the Asian crisis episodes in 1997, only 9 out of more than 100 independent currency crisis events identified in this paper could be categorized as investment slump crises like the Asian crisis.

4. Then, by comparing the investment slump crisis with the others, the paper shows that the investment slump can be broadly characterized as a reaction to pre–crisis overinvestment. In general, there was rapid credit growth during the period leading up to the investment slump crisis, allowing economies to expand beyond fundamentals. Overinvestment took place largely due to overtly optimistic market expectations. Therefore, we cannot expect investment in emerging Asia to recover its pre–crisis level. On the other hand, we might well expect investment to pick up eventually, so long as the current investment is still below its normal level.

5. Finally, this paper turns to why investment has yet to recover, by focusing on five crisis–affected Asian countries.3 A riskier investment environment, weaknesses in the financial and corporate sector, and sluggish nontradable sectors are the likely factors that are examined. We show that explanations based on these three factors are loosely consistent with the observed patterns of investment in the Asian–crisis countries, though none of them are strong enough to explain all the slow investment recoveries on their own.

6. The paper is organized as follows: Section B briefly looks back at investment developments in Thailand before and after the Asian crisis, and argues that the after–crisis investment slump is a regional phenomenon that warrants cross–country study. Section C runs cross–country investment regressions as references to evaluate the “right” level of investment. Using deviations from the regressions as our source of information, we try to highlight the features of the investment slump crisis including the Asian crisis. Section D turns to the causes of the deviations, and Section E concludes.

B. Background Facts

7. The investment decline in Thailand since the Asian crisis has been sizable and prolonged. Investment dropped from over 40 percent of GDP during 1990–96 to about 20 percent in 1999. While investment has grown since then, it remains well below pre–crisis levels and only regained its pre–1990 average (29 percent of GDP) in 2005, eight years after from the crisis. While the initial drop in investment was largely due to a decline in private investment, public investment has contributed to the slowness of recovery. Despite the very negative contribution of investment during the crisis, the contribution of investment to output recovery after 1999 was smaller than that of a typical expansion.

uA02fig02

Thailand Gross Fixed Capital Formation

(in percent of GDP, nominal ratios)

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: National Economic and Social Development Board; and IMF staff calculations.

Relative Contribution to Real Output Growth 1/

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Unweighted average.

Average of three expansionary cycles: 1966–69, 1976–78, and 1987–96

Average of two contractionary cycles: 1970–75, and 1979–86.

Contributions add up to–1 to reflect negative output growth during this period.

8. The investment slump after the crisis had an international dimension. For example, comparing 1990–96 with 2000–04, investment declined by between 4 and 17 percentage points of GDP in the Asian–crisis countries. On the other hand, effects on the other six Asian countries/economies were relatively minor at least in the 1990s.4 Given relatively stable saving rates in the region, albeit at higher levels than in other regions, the collapse of investment and subsequent sluggish investment recovery led to a sustained external surplus in the crisis countries.

uA02fig03

Asian Fixed Investment

(in percent of GDP, nominal)

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

1/ Weighted average of Indonesia, Korea, Malaysia, and the Philippines.2/ Weighted average of China, Hong Kong SAR, India, Japan, Singapore, and Taiwan Province of China.
uA02fig04

Asian Net Exports

(in percent of GDP, nominal)

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

1/ Weighted average of Indonesia, Korea, Malaysia, and the Philippines.2/ Weighted average of China, Hong Kong SAR, India, Japan, Singapore, and Taiwan Province of China.

9. The broad–based decline in investment relative to GDP in the Asian–crisis countries warrants a regional study on the effects of financial crises on investment. To be sure, the extent and nature of the investment slump, as well as factors underlying it, may differ across countries. However, the drastic turn of events after the crisis and the observed impact, which was centered on the crisis–affected countries, suggest that there are some underlying factors that were affected by the crisis and caused the emerging Asia’ investment slump. In the next section, we adopt a cross–country historical perspective to find out what factors may explain the investment slump.

C. Econometric Evaluation

Reference regressions as a measure of the normal investment

10. Though controversial, projections from econometric models provide us with a yardstick to determine whether investment is now at the “right” level. While current investment rates in emerging Asia are apparently lower than pre–crisis levels, this might just reflect a pruning of pre–crisis overinvestment. At least investment has been, and still is, higher than that in other regions. However, recent empirical studies that tackled the question of the “right” level have generally found that recent investment in emerging Asia (excluding China) is lower than predicted by fundamental factors.5 Drawing on these earlier studies, we run cross–country regressions of the determinants of the ratio of investment to nominal GDP, to obtain a measure of normal investment.

11. The specification broadly follows that by Barro and Lee (2003), which used lagged GDP, government size, trade openness, demographics, and a democracy index as control variables. We supplement it with other variables—real per capita GDP growth, population growth, inflation rate, share of agriculture/industry in GDP, dependency ratio, etc.—that are likely to account for the normal level of investment. We adopt specifications without lagged dependent variables and generalized 2 stage least squares (G2SLS) random–effects estimations6 so that we may use projections (fitted values) from the regressions as our reference investment.7

12. The sample used in our study consists of 85 countries over the period 1975–2004. Data series were taken from a variety of sources, including the World Bank’ World Development Indicators, the IMF’ International Financial Statistics and the World Economic Outlook, and national authorities. Countries were selected based on data availability, although we excluded some small countries, for which data appeared unreliable, from our sample.8

13. Our results confirm the findings by earlier studies, such as WEO (2005) and Barro and Lee (2003). We tried four combinations of specification by including and excluding two key independent variables, that is, public investment ratio and domestic saving ratio. The results are robust irrespective of the combinations (Table 1). The initial level of per capita GDP negatively affects the investment ratio. Higher output/population growth boosts investment significantly. Inflation and trade openness are positively related to investment, while the increases in dependency ratio result in lower investment regardless of age. The investment ratio is affected also by industrial structures, though they are not always statistically significant. The nonlinear relationship between democracy and investment, as found by Barro and Lee, is confirmed. Significant coefficients on the public investment, roughly 0.5, indicate that public investment is only partially offset by adjustments in private behavior. Significant positive coefficients on saving ratio reconfirm the strong relationship between saving and investment, which was originally reported by Feldstein and Horioka (1980).

Table 1.

Investment Ratio Reference Models: Panel Regression

(G2SLS random–effects IV regression)

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Notes:

Numbers in parentheses are standard errors. Significance level are * 10%; ** 5%; *** 1%.

All regressions are estimated by G2SLS random–effects IV regression and include time dummies and a constant.

14. As the regressions above do not control for the impact of financial crises, any effect of crises would show up as deviations from the estimated models. Obviously, the most straightforward and conventional way to evaluate the impact is to use crisis dummy variables, which take on the value one if a crisis occurred for each country in that year, in the regressions.9 Table 2 reports the coefficients on dummy variables, which we obtained by adding the currency and banking crisis dummies to our system.10 To capture persistent impact, we included crisis dummies with lags up to five years. Estimated coefficients show that a currency crisis is significantly associated with a decrease in the investment ratio by about 1 percentage point, and the negative impact persists at least for a few years. A banking crisis is also associated with a 1 percent reduction in the investment ratio, though the impact eases up relatively quickly.

Table 2.

Coefficients on Financial Crisis Dummies in the Reference Models

(G2SLS random–effects IV regression)

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Notes:

Numbers in parentheses are standard errors. Significance level are * 10%; ** 5%; *** 1%.

All regressions are estimated by G2SLS random–effects IV regression and include the same explanatory variables as those in the regressions in Table 1.

15. Though the estimated negative impacts are consistent with previous studies, they cannot satisfactorily account for the investment slump after the Asian crisis. A combined currency and banking crisis is accompanied by a contraction of the investment ratio of about 2 percentage points. While this finding is in line with earlier studies (see Barro and Lee, 2003; Schindler, 2005), it is by far smaller than the 10–20 percentage point investment decline after the Asian crisis. In that respect, the sharp contraction of investment in the Asian–crisis countries was really exceptional.11

Deviations from the reference regression

16. The large difference between the investment collapse after the Asian–crisis and the estimated 2 percent damage from financial crises suggests that the effects of financial crises on investment are highly diverse. To shed light on the diversity, the sections below focus on crisis events only rather than all observations as was done in the regressions, and they consider in more detail the economic adjustment before and after the crises. To maximize our observations, we focused on currency crises, for which more observations are available; contemporaneous banking crises are examined only as cases of twin crises. After applying a window of three years to isolate independent crises, we identify 106 independent crisis events in 85 countries over the period from 1980–2004.

17. The changes in investment ratios before and after the crisis events and average deviations from the estimated reference model are reported in Table 3 (see also the figure below. 12 Row (a), which tabulates the average of all 106 events, shows that a currency crisis results in a 1–2 percentage point fall in the investment ratio on average, and roughly half of the fall can be traced by our reference model (without the financial crisis dummies). While the average pre–crisis investment ratio is slightly higher (by 0.3 percentage points) than the model prediction, it falls below the prediction by about 0.5 percentage points to GDP on and after the crisis. However, investment ratios recover the model prediction levels relatively quickly in almost all countries (2.2 years on average).

uA02fig05

Share of Investment Relative to GDP: Actual vs. Reference Model Prediction

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Table 3.

Investment Ratios Before and After Financial Crises and Deviations from the Reference Model

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Notes:

Numbers in column [1] (outside of parentheses) are investment to GDP ratios averaged over 3 years before the crises. Taking an example of the row of Thailand, 41.4 means the averaged ratio for the period from 1994 (=T–3=1997–3) to 1996 (=1997–1) was 41.4 percent.

Numbers in column [1] in parentheses are the same period averages of the fitted values (estimated investment ratios) from our reference regressions. Again taking a Thai example, the averaged fitted value for Thailand from 1994 to 1996 is 34.1 percent.

Numbers in columns [2]–[4] (outside of parentheses) report changes in the investment to GDP ratio from the pre–crisis average in the column [1]. For example, –14.3 for Thailand and column [2] means the ratio decreased by 14.3 percent to 27.1 percent (1997–98 average) from the pre–crisis 41.4 percent (1994–96 average). Similarly, –18.9 for Thailand and column [3] means the investment ratio decreased by 18.9 percent from 41.4 to 22.5 percent (1999–2001 average).

Numbers in columns [2]–[4] (inside of the parentheses) report changes in the estimated investment ratios (averaged fitted values) from their pre–crisis average in the column [1]. For example, (–2.6) for Thailand and column [2] means the estimated ratio decreased by 2.6 percent to 31.5 percent (1997–98 average) from the pre–crisis 34.1percent (1994–96 average). Similarly, (–5.8) for Thailand and column [4] means the averaged fitted value decreased by 4.1 percent from 34.1 to 30 percent (2002–04 average).

Numbers in columns [5]–[8] are residuals from the reference regressions averaged over the designated period. For example, –5.9 for Thailand and column [7] means averaged actual investment ratio for 1999 (=T+2=1997+2)–2001(=1997+4) period is higher than the averaged model prediction for the same period by 5.9 percent. Following relations hold among the columns as long as there is no dropout of samples. (a) Degree of Pre–Crisis Overinvestment = Figures in column [5] = Outside–Parenthesis figures in column [1] –Inside–Parenthesis figures in column [1]. For example, 7.3 = 41.4 – 34.1. (b) Degree of Post–Crisis Investment Slump = Figures in columns [6]/[7]/[8] = Outside–Parenthesis figures in columns [2]/[3]/[4] – Inside–Parenthesis figures in columns [2]/[3]/[4] + Degree of Pre–Crisis Overinvestment. For example, –4.4 = –14.3 – (–2.6) + 7.3.

Numbers outside of brackets report (averaged) years to recover the targeted band levels of investment, i.e., reference model predictions ±1 percent point for column [9] and pre–crisis investment ratios ±1 percent point for column [10], respectively. "Not yet" means the investment has not yet reached the targeted level as of 2004. For example, Korea recovered its model prediction level three years after the crisis. None of the Asian–Crisis 5 countries have recovered the pre–crisis levels as of 2004.

Fractions in brackets in columns [9] and [10] are ratios of the number of episodes which recovered the targeted band levels to total number of episodes in the groups. For example, [ 94/101 ] for row (a) and column [9] means, 94 out of 101 observations examined eventually recovered the model prediction levels of investment in our sample.

Nine episodes in (e), i.e., Argentina (1989), Bulgaria (1994), Cameroon (1994), Colombia (1997), Finland (1991), Iran (1993), Russia (1998), Sweden (1992), and South Africa (1984), were selected based on the following four conditions: (i) [2]<0, (ii) [5]>[6], (iii) [7]<–1, and (iv) [8] <0.

18. Investment performance before and after the Asian crisis (row (b) of Table 3) is more extreme than that of the average crisis. The crisis started from overinvestment of roughly 5 percentage points of GDP, and underwent a nose dive in investment of 12 percentage points on average. Thailand and Malaysia experienced a nearly 20 percent drop. And the post–crisis investment ratio is about 5 percentage points lower than our model predictions, as only one–fourth of the fall can be traced by our model. Four out of five crisis–affected countries (Korea is the exception) have not yet recovered to their model–predicted levels, let alone their pre–crisis levels.

19. The investment slump after the Asian crisis is remarkable even if compared with the similar investment decline in Latin America during the 1980s debt crisis (row (c)). While the initial fall in Latin America was comparable to that of the Asian crisis countries, more than half of the decline could be traced by the model, and all Latin American countries recovered to model–predicted investment levels in three years or less. Another distinctive feature that differentiates the Latin American crisis from the Asian crisis is its pre–crisis level of investment. As column [1] or [5] clearly shows, pre–crisis investment before the Latin American crisis was close to the model predicted levels. The investment slump for the Asian–crisis countries also stands out when compared with the other economies in emerging Asia. Although these other economies also faced investment declines in the 2000s (with the exception of China and India), most of the declines can be explained by the model.

20. Scrutiny of the 106 crisis events reveals the investment slump after the Asian crisis to be exceptional. In order to find similar examples, we set four criteria to be satisfied by the investment slump crises: (i) the investment rate drops immediately after the crisis (the number in column [2] is negative), (ii) the investment rate relative to its model prediction also drops right after the crisis (the number in column [5] is larger than that in column [6]), (iii) the investment rate two to four years after the crisis is lower than the model prediction by at least 1 percentage point (the number in column [7] is less than –1), and (iv) the investment rate remains below the prediction after five to seven years from the crisis (the number in column [8] is negative). Four of the five Asian–crisis countries satisfy these criteria (Korean investment fails to meet criterion (iii)). Other than the Asian–crisis countries, only 9 out of more than 100 currency crisis episodes could satisfy the criteria.13 In that sense, the investment decline after the Asian crisis is not just another currency crisis.

Characteristics of the investment slump crisis

21. The investment slump crisis was preceded by a period of overinvestment. The nine episodes selected were characterized by a sizable and prolonged investment slump as previously defined (see row (e) of Table 3), though the severity of the slump was not as great as in the Asian crisis. Another point that should be noted is the evidence of pre–crisis overinvestment (see column [5] of row (e)). This evidence, which appeared independently of our criteria, supports the conventional belief that a high run–up before the crisis leads to a harder crash.

22. The investment slump crisis hit seemingly well–performing economies (see Table 4). Pre–crisis investment rates are generally higher in the investment slump crises, and moreover, there appears to be a run–up phase just before the investment crash (column [1]). Columns [2] to [5] report the differences in four fundamental variables that are often considered to be grounds for financial crisis. Perhaps surprisingly, the saving rate is higher and the fiscal condition appears healthier in the investment slump crises. On the other hand, there appears to be a pre–crisis escalation of the current account deficit before the investment slump, probably due to an exuberant private sector, followed by a strong reaction after the crisis. We could not detect systematic differences regarding inflation.

Table 4.

Comparison Between Investment Slump Crises vs. Non–Investment Slump Crises

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Notes:

Reported figures in columns (a)–(e) are the averages of crisis episodes included in each categories. Since some data are not always available for all episodes, number of observations in each calculation does not necessarily equal to the reported total observations.

Figures in the brackets in the rows of "Level" are medians to see the effects of abnormal observations.

Row (f) reports the result of hypothesis testing to see whether the averages of selected categories are significantly different. Figures in column [1]–[10] are T–statistics for Welch’ Test, and figures in column [11] are normal st ***, **, and * in row (f) indicate statistical significance at 1, 5, and 10%, respectively.

23. The pre–crisis overinvestment appears to be fueled by an overly optimistic public mood and lax financing. Shares of short–term debt to total external debt are higher for the investment slump crises, though the difference is not statistically significant. Then again, we notice pre–crisis inflows of short–term capital in the slump episodes. The domestic credit to GDP ratio is also higher, and we can observe rapid pre–crisis expansion of credit in the investment slump countries. That is to say, there seem to be fast growing credit markets during the period leading up to the investment slump crises, allowing economies to expand far beyond market fundamentals. Optimistic pre–crisis evaluations by country risk rating institutions14 corroborate the overly optimistic mood before the investment slump crises. The degree of currency devaluation after the crises is not very different between the two groups, despite the clear difference observed in their current account outcomes. The ratio of twin crises, or contemporaneous currency and banking crises, is significantly higher for the investment slump crises, suggesting that the banking sector had a role in the investment slump.

D. What Might Explain the Deviation?

24. Several factors, certainly more than those examined in our regressions, contributed to the investment slump after the Asian crisis. A buildup of excess capacity in the run–up to the crisis and corporate overleveraging, which resulted partly from excess reliance on foreign currency loans, look consistent with our findings (except for the Philippines). However, nearly a decade has passed since the crisis, and capacity utilization has generally returned to its pre–crisis level, so overinvestment cannot be a full explanation of the still low investment. Although lack of comprehensive cross–country data keeps us from further formal testing, this section examines possible reasons for lower Asian investment than expected, by focusing only on the Asian–crisis countries. In particular, it considers three possible explanations: (i) a riskier investment environment, (ii) weakness in the financial and corporate sectors, and (iii) sluggish nontradable sectors.15

uA02fig06

Pre–Crisis Overinvestment and Post–Crisis Investment Slump

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: IMF staff calculations.
uA02fig07

Capacity Utilization Rate for the Asian–Crisis countries

(normalized to make 2000=1.00)

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Riskier investment environment

25. Heightened risk of investment after the crisis could have depressed investment. Modern investment theories predict that greater uncertainty will lead agents to put off investment (Dixit and Pindyck, 1994). Evidence for higher risk is the standard deviation in the consensus forecast of GDP growth for the Asian countries, which increased sharply after the crisis. Both the higher investment risk and the pessimistic growth expectation, which has been more depressed than actual growth, could have pushed down post–crisis Asian investment, as is argued in REO (May 2006).

uA02fig08

GDP Growth Consensus Forecast 1/

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Source: Consensus Economics.Note: 1/ Forecasts are as of January of subsequent year.2/ Simple average of Indonesia, Korea, Malaysia and Philippines.
uA02fig09

Error of Consensus Forecast

(Forecast Mean–Actual GDP Growth)

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Source: Consensus Economics.

26. However, measures of macroeconomic volatility have lately returned to their pre–crisis level.16 The standard deviations of macroeconomic variables, that is, industrial production, wholesale/producer price, and stock price, have generally returned to their precrisis levels in the Asian–crisis countries. Therefore, this casts doubt on explanations that rely on actual volatility as an indication of increased risk.

Fluctuations of Macro Indicators Before and After the Crisis

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Sources: CEIC Data Company, Ltd.; and IMF staff calculations.

27. Nonetheless, despite the waning actual volatility, the perceived investment environment continues to be weak compared with the pre–crisis period. Worldwide Governance Indicators by the World Bank Institute evaluate the governance environment of countries along six dimensions—voice and accountability, political stability, government effectiveness, regulatory quality, the rule of law, and control of corruption. The indicators for the Asian–crisis countries generally deteriorated after the crisis, and have not yet recovered, except those for Korea. Relatively sound investment in Korea (see the residuals in the column [8] of Table 3) may indicate the importance of these perceptions on investment.

uA02fig10

Worldwide Governance Indicators for the Asian Crisis Countries

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: World Bank, Worldwide Governance Indicators; and the Fund staff calculations.1. Voice and Accountability,2. Political Stability/No Violence,3. Government Effectiveness,4. Regulatory Quality,5. Rule of Law, and6. Control of Corruption. Index lies in the range between minus 2.5 and plus 2.5, with higher values denoting better governance environments.

Weakness in financial and corporate sectors

28. While financial and corporate sector restructuring has progressed, financing may be a constraint on investment. In the aftermath of the Asian crisis, the sharp deterioration in banking–system solvency and liquidity caused banks to rein in credit, with a sizable impact on investment. This was exacerbated by bank–dominated financial systems. Credit to the private sector as a share of GDP fell drastically and has not yet recovered. While significant progress in restructuring has mitigated the impact of the financial crises,17 still high nonperforming loan (NPL) ratios for four out of five crisis countries18 remains an issue. This may be particularly true for small and medium enterprises (SMEs) that do not have access to capital markets (see table below). As a sign of the severe lending climate, the share of claims on the private sector in total bank assets continued to fall until 2005 in three crisis countries including Thailand (see figure below). The relatively better performance of Korea in this regard again seems to suggest some role of financial factors in the lingering investment slump.

uA02fig11

Credit to Private Sector Relative to GDP

(1990–97 average=1.0)

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: IMF, International Financial Statistics; and IMF staff calculations.
uA02fig12

Banking Sector Bank Restructuring: Nonperforming Loans to Total Loans

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: Bank of Thailand; and Global Financial Stability Report.1/ Figure for Philippines is 2001–2002 average.2/ Simple average of Australia, Japan and the U.S.A.
uA02fig13

Progress in Corporate Sector Restructuring

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: Corporate Vulnerability Utility; and IMF staff calculations.1/ Capital weighted mean.2/ Simple average of Australia, Japan, and the U.S.

Share of Firms that Regard Financing as an Obstacle

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Source: World Bank, World Business Environment Survey, 2000.
uA02fig14

Credit to Private Sector Relative to Total Bank Assets

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: International Financial Statistics; and IMF staff calculations.

Sluggish nontradable sector

29. The difference in performance between tradable (T) and nontradable (N) sectors may also explain the low investment in the Asian–crisis countries. REO (September 2006) argues that a source of the post–crisis investment decline is financially starved N sector producers.19 Firms in the T sector, typically large and able to pledge export receivables as collateral, have better access to international capital markets. Firms in the N sector, which are generally smaller, rely predominantly on domestic bank credit. In the face of cautious banks after the crisis, the smaller N firms were hit especially hard and benefited little from subsequent exchange rate depreciation due to their domestic nature. As the capacity utilization only covers mining and manufacturing industries, which largely overlap with the T sector, the sluggish N sector may fill the gap between the capacity utilization recovery and the investment slump.

30. While corroboration is needed, casual observation from the World Business Environment Survey is loosely consistent with the premise of the sluggish N sector hypothesis. First, firms in the T sector tend to be larger than those in the N sector, if we identify exporters with T sector firms and nonexporters with N sector firms. Second, the share of firms that regard financing as a major obstacle to their business is generally higher for the N sector firms. These findings agree well with our inference of a credit–constrained N sector, though the observed differences between the two sectors are very slight, and the number of observations for individual countries is not sufficient to be conclusive.20

Size and Sectoral Distribution

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Sources: Tornell and Westermann (2003) that bases on World Business Environment Survey (WEBS, 2000).Notes:1. Small denotes small and medium firms up to 200 employees.2. Large firms have more than 200.

Share of Firms that Regard Financing as a Major Obstacle in Their Business Environment

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Sources: World Bank, World Business Environment Survey (WBES, 2000) Interactive Dataset.

Others include construction, service, and other.

31. The sluggish N sector may partially explain the investment slump for a few countries including Thailand. In the aftermath of the crisis, N sector output dropped relative to that of the T sector in three emerging–Asian countries, that is, Indonesia, Malaysia, and Thailand. Unfortunately, the lack of data on sectoral investment prevents us from region–wide examination; however, the progress of the capital–output ratio by sector in Thailand, that is, still high N sector capital–output ratio, seems to indicate N sector problems in the country. Our tentative estimates of Thai sectoral investment21 reveal that the recent pace of investment recovery in the N sector is slightly slower than that in the T sector. As the N sector investment represents roughly seventy percent of total private investment, even the slight difference may be one of the contributing factors to the prolonged investment slump.

uA02fig15

Production Ration between N–sector and T–sector

(nominal ratio, N–sector/T–sector)

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: CEIC Data Company, Ltd; and IMF staff calculations.Note: T–sector includes agriculture, mining and quarrying, and manufacturing. N–sector covers all the others.
uA02fig16

Capital Stock to GDP Ratio: T–sector Vs. N–sector

(real ratio, normalized to make 1993–96 average=1.0)

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: CIEC Data Company, Ltd; and IMF staff calculations.Notes: 1. The T–Sector includes agriculture, mining and quarrying, and manufacturing industries.2. The N–Sector covers all other industries.
uA02fig17

Investment Recovery : T–sector Vs. N–sector

(Real investment relative to 1993–1996 average)

Citation: IMF Staff Country Reports 2007, 231; 10.5089/9781451969368.002.A002

Sources: CEIC Data Company, Ltd.; and IMF staff calculations.Notes: 1. The T–Sector includes agriculture, mining and quarrying, and manufacturing industries.2. The N–Sector covers all other industries.3. Investment by industry derived from the gross private capital stock data.

E. Summary and Policy Implications

32. This paper first argued the Asian investment slump is related to pre–crisis overinvestment. Since the overinvestment leading to the Asian crisis was exceptionally high, it is natural to see a sizable and prolonged investment slump in the crisis–hit countries. As overinvestment took place largely due to optimistic market expectations, we cannot expect investment in emerging Asia to recover its pre–crisis level. On the other hand, we might well expect investment to be an important contributor to output growth, as long as the factors hindering investment fade away over time.

33. Three factors (other than overinvestment) were examined that may explain the slow investment recovery from the Asian crisis. These are (i) a riskier investment environment, (ii) weakness of the financial and corporate sectors, and (iii) a sluggish nontradable sector. Perceived investment risks continued to be high compared with the pre–crisis period, while actual macroeconomic volatility has lately returned to its pre–crisis levels. Financing still seems to restrain investment, though significant progress in restructuring has certainly mitigated this factor. The sluggish N sector is a constituent of the investment slump at least for a few countries including Thailand.

34. However, none of the factors above can by themselves explain the investment slump in the Asian–crisis countries. Indeed, the sluggish N sector holds true only for a few selected countries. The uncertainty and restructuring are convincing as an explanation of regional development as a whole; however, they may not be as useful in explaining cross–sectional diversity among countries in the region (except in the case of Korea’ relatively better performance). Even overinvestment, the core account of this paper, does not apply to the Philippines episode. Various combinations of factors rather than one single factor, therefore, seem to account for emerging Asia’ investment slumps.

35. These findings suggest several policy implications:

  • In view of the cost of overinvestment, it is crucial that policies help foster balanced growth in investment. What is needed is private investment that is justified by economic fundamentals, as investment growth that is too high can jeopardize economic stability.

  • Prudent macroeconomic policies, along with clear communication about the policy framework, will help to contain any increase in perceived macroeconomic risks. From this standpoint, the recent monetary policy stance of inflation targeting with a flexible exchange rate seems to be serving Thailand well.

  • Efforts to remove obstacles to private investment, such as reducing red tape, improving governance, and establishing political stability, also would be helpful to deal with uncertainty and the investment climate.

  • Addressing the legacies of the Asian crisis in financial and corporate sectors could help to stimulate investment. For example, the ratio of NPLs to total loans and the level of distressed assets while declining are still high. Further progress on this front remains a priority.

  • Taking steps to expand the potential sources of financing, especially by encouraging the development of bond markets, would improve the efficiency of financial intermediation and provide backstops for banking systems in the crisis. Policies to reduce small firms’ excessive reliance on bank credit and/or those to encourage bank lending to small firms might be a key to ameliorate the present situation.

36. Given the complicated roots of the post–crisis investment slump in emerging Asia, a policy package that takes into account all of the necessary measures above is needed. Going forward, productivity should be raised over the long run to further boost returns on investment, since that is the only way to maintain steady investment given an increasingly competitive international business environment.

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