ECONOMICS AND FINANCE NO.

3(99)

ISEAS WORKING PAPERS

Thailand: From Financial Crisis to Economic Renewal

George Abonyi Associate Senior Fellow 15 August 1996-June 2000

Project: Portfolio Investment and Structural Adjustment: The Case of Thailand, funded by the International Development Research Centre (IDRC)
1999 Institute of Southeast Asian Studies ISSN 0218-8937

INSTITUTE OF SOUTHEAST ASIAN STUDIES

THAILAND: FROM FINANCIAL CRISIS TO ECONOMIC RENEWAL Abstract Thailands present crisis was seen to originate in the financial sector, which has been devastated by its impact, and as a consequence, became the focus of the IMF-led adjustment strategy. There is reason to believe, however that addressing the problems of financial institutions while critically urgent and necessary, is not likely to be sufficient for Thailands sustainable economic recovery. In particular, the performance of the real (corporate) sector is likely to be a key factor in Thailands effective transition from stabilization to sustainable growth. Analysis of Securities Exchange of Thailand (SET) data, supplemented by a multi-country World Bank study, indicates deterioration in corporate performance well before the crisis (i.e. before mid-1997). The overall picture that emerges is of a corporate sector overwhelmed by rapid growth, characterized by an investment spending spree. This led to poor financial, strategic, and operating performance well before the present crisis. In particular, corporate performance prior to the crisis was characterized by rapid growth in assets, coupled with the erosion of profit margins, reflected in declining and low returns on equity and capital employed. The problems of the corporate sector brought into focus by the present crisis are then, in a way, problems of success: a crisis of growth, in which rapid and sustained growth put overwhelming pressures on corporate management and performance. Given the clear decline in corporate performance prior to the crisis, the problems of the real sector go beyond the extensive, crisis-induced, short-term, financial (solvency) problems: they relate more fundamentally to performance and profitability. Restoring the Thai economys performance is therefore likely to require revitalizing the corporate sector, an especially important and challenging task in an increasingly competitive and difficult international economic environment, characterized by slowing growth and increasing competition for both markets and capital. As a prescription for action this means that particular issues in the context of the present crisis need to be addressed differently. Two such issues are i. corporate debt restructuring; and ii. fiscal stimulation through expenditure on infrastructure. In both cases it is important to link short-term crisis response measures to longer-term restructuring requirements, in order to ensure the Thai economys effective transition from stabilization and crisis management, to sustainable recovery and growth. Thailand has the necessary commitment, capabilities and resources for economic renewal and sustained growth. In that context, the present crisis may serve the constructive purpose of accelerating the emergence of a more robust and balanced economy.

I. INTRODUCTION The Chinese written expression for crisis is a combination of the character signifying danger, and the one signifying opportunity. Thailands economic crisis has both these elements. The implications of the present crisis as danger are all too clear, with a devastated financial sector and a deeply troubled corporate sector. The crisis as an opportunity may be more difficult to recognize, but it is just as a real. After a period of sustained, rapid and relatively unmanaged growth that saw Thailands economy develop and change significantly, the crisis presents an opportunity to strengthen the foundations of both the financial and corporate sectors to prepare for what is likely to be an increasingly competitive world economy. Thailand has all the attributes and resources needed for economic renewal and sustained balanced growth. How this crisis is utilized as an opportunity will have important implications for the transition from stabilization to sustained growth and development. Thailands present crisis was seen to originate in the financial sector, which has been devastated by its impact. Partly as a consequence, the crisis was diagnosed from the outset as a financial crisis. Therefore the crisis management processin terms of policies and programmes within the framework of the IMF-led adjustment strategyhas focused on the financial sector, especially the banking sector. There is reason to believe, however that addressing the problems of financial institutions while critically urgent and necessary, is not likely to be sufficient for sustainable economic recovery. In particular, the performance of the real sector (i.e. corporate sector), and the relationship between financial flows and the corporate sector (e.g. between debt restructuring and corporate restructuring), are likely to be important factors in an effective transition from stabilization to sustainable growth. The implication is that management of the crisis will have to be closely linked to a process of economic restructuring. In particular, Thailands economic recovery will have to be built on the back of a revitalized corporate sector, which will need to generate over the longer term the necessary earnings to finance the recapitalization of the devastated financial system, and fuel economic growth for employment and income generation. This requires responding to the constraints and challenges of the real sector, simultaneously and linked to addressing the problems of a critically weakened financial sector. This is essential: i. to ensure the capacity to generate the necessary earnings (in particular the tax base) over the medium term to finance the onerous debt service obligations arising from the costs of stabilization and recovery (e.g. multilateral, bilateral loans); to minimize as quickly as possible the rising economic and social costs of the crisis that originate directly or indirectly in the real sector, in particular, spreading unemployment; and to ensure the existence of a viable and competitive production base to sustain the transition from stabilization to growth. This point is worth stressing, in that potentially viable enterprisesas distinct from nonviable firms forced out of business by the crisis atmosphere, leave a hole in a network of production relationships that may be costly, time consuming, and diffi-

ii.

iii.

cult to rebuild. Instantaneous, costless, and smooth redeployment of productive assets can be found most easily in textbooks. To put this in context, a review of the diagnosis of the crisis and the resulting policy responses indicates an IMF-led strategy that took a fundamentally different perspective to economic structure from the outset. It may be caricatured as i. assuming a relative separability of the financial sector and financial flows from the real sector; and ii. sequential response. In effect it assumed that addressing the problems of the financial sector, in particular the banks, is both necessary and sufficient for managing the crisis and restoring the Thai economy to a medium term growth path. This IMF-led strategy shaped policies and programmes, with mixed results to date. In the context of the present paper the logic of this approach may be characterized in an admittedly simplified summary fashion as follows: i. ii. Problems of the real sector (corporates) are secondaryin importance and sequenceto the problems of the financial sector, in particular banks. A market-based approach is both necessary and sufficient to address the problems of the financial sector, i.e. to recapitalize the banks, which in turn will then address and restore corporate performance. If the market-based approach is not progressing sufficiently quickly, then a bank-led approach should be taken, where the government assists in accelerating the recapitalization of the banks. The recapitalized banks will then play the lead in corporate (and therefore economic) restructuring, to the extent needed. Therefore policy attention and associated resources should focus on the financial sector first and foremost, since this is sufficient to create conditions for any necessary corporate restructuring and consequent restoration of economic growth. To the extent that corporates emerge as a focus of adjustment strategy, the key issue is debt (financial) restructuring to resolve the debt overhang problem and restore solvencyas distinct from broader and deeper corporate restructuring, and in this a bank-led approach is likely to be sufficient.

iii.

iv. v.

vi.

Within the above framework, the corporate sector has not been an explicit and direct priority of the IMF-facilitated crisis management process, excepting the recent emergence of a focus on corporate debt (financial) restructuring.1 In this context, a fundamental issue relates to the operating performance of the real sector. In particular, if there were clear signs of deterioration in corporate performance well before the crisis (i.e. before mid-1997), then an effective restoration of the Thai economys performance is likely to require not only the removal of short-term financial constraints on corporates, but also a more general and fundamental revitalization of the corporate sector. This will be an especially important and challenging task in an increasingly competitive and difficult international economic environment, characterized by slowing growth and increasing competition for both markets and capital. As will be seen in Section II, an analysis of enterprise-level data does indeed

indicate a clear deterioration of corporate performance prior to the onset of the crisis. It presents a picture of a corporate sector overwhelmed by rapid growth, characterized by an investment spending spree. In particular, this involved a rapid growth in assets, coupled with erosion of profit margins, reflected in declining and low returns on equity and capital employed. This led to significant weakening in financial, operating, and strategic performance well before the crisis. The economic crisis from this perspective may then be characterized, at least in part, as a crisis of growth, in which rapid and sustained growth over an extended period put significant continuing strains on corporate management and performance. The implication is that managing the crisis with a view to transition from stabilization to economic renewal requires addressing structural problems in the real sector simultaneously with rehabilitating the financial sector. This change in perspective has immediate and important implications for how the present crisis is managed, in terms of both the targets and instruments of adjustment policies and programmes. At the macro policy level, this is likely to require an explicit focus on factors that will facilitate industry and corporate performance; otherwise recovery is unlikely to hold. As a prescription for action, this means that particular issues in the context of the present crisis may need to be addressed differently, involving different policy frameworks and programmes. Two examples, involving corporate debt restructuring and fiscal stimulation through expenditure on infrastructure, form the focus of Section III. With respect to the first example, it is suggested that corporate debt restructuring is best approached as a more general corporate restructuring issue, incorporating both financial and operational restructuring measures, with the objective of restoring sustained solvency and profitability. With respect to the second example, it is suggested that well-designed fiscal expenditure programmes going beyond the usual approaches to infrastructure may contribute not only to short-term demand stimulation, but may also be used to strengthen corporate performance and future competitiveness. II. CORPORATE PERFORMANCE PRIOR TO THE CRISIS 1. Introduction As discussed in part I, the present crisis began in the financial sector, which has been devastated by its impact. As a consequence, and given the critical role of this sector in the economy, the focus in the management of the crisis has been on the financial sector and institutions. There is reason to believe, however that addressing the problems of a devastated financial sector (e.g. recapitalization of the banks), while critically necessary and urgent, is unlikely to be sufficient for reviving economic performance. Furthermore, there are indications of problems in the performance of the real economy well before the financial crisis. This is reflected at the macro level (e.g. Incremental Capital-Output Ratio, or ICOR), and in micro or enterprise-level indicators (e.g. Debt/Service, Return On Assets, Return On Equity, Economic Value Added). Attempts to round up the usual suspects (e.g. rising labour costs, overvalued exchange rate), to explain this deterioration in performance, are only partially helpful. These are likely to have contributed to the problems, but do not seem to explain the breadth and depth of the deterioration in performance.

Therefore addressing problems of the financial sector is unlikely to be sufficient for Thailands economic renewalto resolve the problems of financially weakened corporates, whose operating performance is suspect. There are indications of a wider range of constraints at work in the real sector that will need to be addressed, in order to restore the Thai economys performance. To examine this issue, the next section (2) provides a very brief overview of Thailands economic performance, in particular of exports, then looks at the macro level signals of performance relating to the efficiency of investment (i.e. allocation of savings) as reflected in Thailands ICOR. This is followed (section 3) by an assessment of corporate performance, utilizing data on firms listed on the Securities Exchange of Thailand (SET), limited by the aggregated nature of the enterprise data (into 30 industry categories), and by its relatively short time horizon (readily available only from 1994). This is supplemented by the results of a multi-country study by the World Bank focusing on corporate financial performance, that included a sample of Thai firms. 2. Macro Signals: Declining Efficiency of Investment 2.1 Context It may be useful to put the discussion of performance constraints of the Thai economy briefly in perspective. Over the past 2 decades, the Thai economy has been one of the best performing economies in the world, characterized by sustained high growth rates, averaging 10.3% 1985-90, and 8% in the years prior to the crisis (1990-96). This growth was accompanied by a dramatic decline in the incidence of absolute poverty, from 57% in 1962 to 14% in 1992, with per capita income increasing from $700 per annum in the late 1960s, to $2,700 in 19962 . At the same time, rapid growth was accompanied by environmental degradation, resource depletion, and an increasingly unequal distribution of income and wealth. However, on balance, a remarkable record of development. During this period of rapid growth and economic transformation, Thailand became increasingly integrated into the world economy through trade and investment flows, and production linkages.3 As the economy expanded rapidly and became more complex in structure, it posed more and new types of strains and challenges to economic management or governance systems at both the macro (i.e. public policy) and micro (enterprise) levels. As the relative role of the private sector increased in the economy, the importance of enterprise management and performance correspondingly increased. Looking more deeply at Thailands performance, manufactured exports grew by about 23% per year between 1980 and 1995, almost doubling during 1992-1995. However, in 1996 export growth fell practically to 0 per cent, with labour-intensive exports usually identified as the main culprit. Certain factors are generally cited as responsible for this abrupt and dramatic decline4 : External factors cited included the emergence of new competitors, with the coming on stream of new production facilities in lower income/lower wage countries such as China, Indochina, Philippines, further complicated by the

30% devaluation of the Chinese yuen in 1994; Domestic factors cited generally relate to rising wage rates and overvalued exchange rates. Domestic wage rates during 1991-95 rose about 11%, on average, or about 5% increase in real wages per year, cited as the key factor in the slowdown in growth of labour intensive exports. The real effective exchange rate of the baht is estimated to have appreciated by about 15% during 1995-97, primarily because of the linkage to the US$, which appreciated against the yen.

While the above factors suggest that Thailand was losing its edge in low cost, labour intensive exports, these are at best partial explanations for the overall decline in export performance. The impact of rising wages should not have come this suddenly and pervasively, given that wages were rising for some time, with no significant impact on export performance. For example, textiles, gems and jewelry, which are not particularly labour intensive declined significantly in the 1996 crunch, as did many technology intensive products.5 Similarly, the timing and size of the real exchange rate appreciation is not sufficient to explain the sudden, dramatic drop in export performance. If the usual suspects are not sufficient to explain the export slowdown, then could this be primarily a cyclical downturn, e.g. the result of short-term, mainly external, adverse factors? There is some support for this being a factor. There was a global slowdown in world trade in 1996, with the growth rate of world manufactured exports dropping from 8.6% p.a. during 1990-95, to 2.1% in 19966 . All countries in Asia were hit, with Korea and Thailand the worst affected. If the basic problem of export performance could be seen as cyclical, then in terms of the main focus of this paper, the management of the economic crisis perhaps can indeed focus on the financial sector. That is, the real sector will realign itself, as the financial crisis begins to be resolved, and the cycles will at some point, begin their upswingthough the global economic outlook looks less than optimistic at this time. Although cyclical demand factors seem to be relevant, they are only partly helpful in understanding the performance of the Thai (real) economy prior to the crisis. There seems to be more to the story. For example, industry-specific factors may have also been at work: a rapid rise in US sourcing of garments from Western Hemisphere producers such as Mexico, Honduras, and El Salvador, led to a relative loss of US market share by Asian exporters, including Thailand, among others. It is not clear whether this shift in sourcing is a cyclical factor, or a structural shift in the basis of competitive advantage (e.g. relating to NAFTA; relating to the increasing role of time or order cycle as a competitive factor, an issue touched on in section III). A fundamental question that emerges from the perspective of the present economic crisis relates to the performance of the corporate sector prior to the crisis, a performance which was then further aggravated by the financial devastation of corporates by the crisis. In particular, were there clear signs of deterioration in performance, especially at the micro (enterprise) level prior to mid-1997, masked by rapid (export) growth? If yes, then resolving the present crisis in terms of restoring the Thai economys performance is likely to require a focus on the real sector simultaneously with addressing the problems

of the financial sector. This is likely to be especially important for Thailands economic renewal and sustainable growth, given expectations of a global economic environment over the medium term characterized by slow growth and increasing competition for both markets and capital. 2.2 Declining efficiency of investment and rising ICOR7 Thailands very high growth rates, or more precisely, the high growth rates in output of the late 1980s and early 1990s, were driven primarily by very high investment rates. The key issue relates to the efficiency of investment, a function of variables such as rate of return and gestation period of investment, versus the costs and maturity structure of the current account deficit. In general, investment in Thailand, as measured by the Incremental Capital-Output Ratio (ICOR), seems to have been relatively efficient over the long term (e.g. 1975-95) as compared with other middle income countries. Although Thailand has traditionally maintained current account deficits, it was primarily because of high domestic investment rates, rather than low rates of domestic savings. On closer examination, it seems that over the past 20 years Thailands current account deficit has widened, while its ICOR has increased. The efficiency of investment was declining in both relative and absolute terms during this period. In relative terms, investment rates were higher than in some neighbouring countries experiencing similar rates of growth (e.g. China, Indonesia, Malaysia, Singapore). This implied lower relative productivity of investment in Thailand. In absolute terms, Thailands investment increased, as growth rates declined, implying a declining efficiency of investment over time. Therefore in both relative and absolute terms, the efficiency of investment was reflecting problems in the real economy well before the financial crisis hit in mid-97.8 In 1988 the current account deficit changed in nature, becoming privately induced, driven by a rapid expansion of private investment (see Figure 1). During 1986-96 an increase in private investment from 17% to 33% of GDP fuelled an expansion in total investment from 27% to 42% of GDP. The rise in private sector investment was not matched by a rise in private savings, however, leading to a private sector savings-investment gap. This caused the current account deficit to widen from about 3% of GDP in 1988 to 8% of GDP in 1996, financed largely by private capital inflows. The investment boom, as noted above, was accompanied by a decrease in the efficiency of investment. Thailands ICOR rose virtually every year, from a low of 2.5 in 1988 to above 6 in 1996 (see Figure 2). This macro trend is reflected in declining firmlevel performance (see Section 3). From a macro perspective, one general interpretation in the context of the present crisis is that the rise in ICOR is to a large extent the result of speculative investments in the nontradable sector, e.g. real estate. There is support for this as an important factor, in both anecdotal evidence, and from an inspection of available balance sheets indicating the portfolio of loans of financial institutions. However, other factors such as overcapacity in a range of sectors indicates that there may be more to declining corporate performance than real estate speculation. The micro-level corporate performance data in section 3 posits a potentially wider

range of issues for consideration. The significant decline in corporate performance prior to the crisis reflected in the data, may indicate two sets of factors. One set of factors relates to the effectiveness of the allocation of capital, for example, strategic decisions by firms as to what businesses to invest in, including adding capacity in existing core businesses and/or investing in new businessesof which real estate is one, if rather dramatic, example. A second set of factors relates to the efficiency of the use of capital, for example, the management of firm operations in areas such as cost control and logistics. We turn next to an examination of firm-level performance. 3. Performance of Thai Non-Financial Corporations Prior to the Crisis9 3.1 Introduction i. A Note on SET Data on Corporate Performance This section examines the performance of non-financial corporations prior to, and in the early stages of the crisis. Data is available most readily for corporations listed on the Securities Exchange of Thailand (SET), aggregated into 30 sectors (see Table 1). These are then taken as a proxy for corporate Thailand. There are 2 basic qualifications that should be kept in mind, both implying that the SET data may somewhat overstate actual performance of all Thai corporates. The first issue relates to the degree to which the approximately 350-400 SETlisted firms are representative of all Thai non-financial enterprises. In particular, the SETlisted firms are likely to be relatively larger firms, understating the presence, role and performance in the Thai economy of small and medium sized enterprises (SMEs). Partly as a consequence of size, listed firms are likely to have closer links with international corporations, investors and markets, implying easier access to product/market information, technology, management knowledge, and market linkages. It may also be the case that listed corporations have had better access to both domestic and foreign financing, before and during the crisis, including the capacity to renegotiate/roll over existing debt. The second issue relates to the extent to which the publicly provided data represent actual corporate performance. It may be the case that under present accounting practices fixed assets, equity and income may be overstated, leading to an understatement of debt/equity ratios; overstatement of depreciation expenses; and therefore overstating of operating cash flows relative to interest expense. This may lead to an overstatement of performance measures such as those related to interest coverage and profitability.10 ii. A Comparative Look at Corporate Performance The primary analysis of corporate performance based on SET data is complemented by reference to a World Bank multicountry study of corporate financial performance.11 This study looked at the performance of a sample of listed corporations in the precrisis interval 1992-96 in selected countries in Asia, including Hong Kong, Indonesia, Korea, Malaysia, Philippines, Taiwan and Thailand. The performance of Asian corporates is compared to that of corporations in Latin America, France, Germany, Japan and the

USA. The data is from the Financial Times Informations Extel Card database, and covers 173 Thai corporations in the general manufacturing, extractive industries and utilities. The World Bank study presents a very useful addition to the assessment of Thai corporate performance. It extends the analysis back to 1992, and presents a comparative picture of Thai corporate performance relative to both other Asian and non-Asian corporations. Since corporate competitiveness is fundamentally a relative concept, i.e. relative to other competitors, a more complete picture emerges of Thai corporate performance prior to the crisis. It should be noted that as the World Bank study uses a sample of SET corporates, there are some discrepancies on some of the individual indicators with the analysis of full set of SET data, e.g. ROE for 1996. However, the overall analysis of corporate performance, and the conclusions of the two studies are fully consistent and mutually supportive. 3.2 Performance of Non-Financial SET Enterprises i. Growth Assets, Sales and Profits - Refer to Tables 2.1, 2.2 & 3; and Figures 3 & 4 A place to start is to look at changes over time in key variables related to corporate performance: assets, sales and net profits. These are the building blocks of more sophisticated measures of performance that will be considered later. The assets of SET nonfinancial enterprises (excluding mining) grew on average 46.5% in the pre-crisis interval 1994-96, while net profits declined by -19.2%. If the crisis year 1997 is added, the gap is even more pronounced, with assets growing by 74.4% between 1994 and 1997, while net profits declined by 777.2% during the same period. A look at the year-on-year changes in assets and profits highlights the contrast even more. Assets expanded on average at the rate of 27.8%, 1994/95; 13.9%, 1995/96; and 16.2%, 1996/97. During this same period, net profits declined from an average growth of 13.5%, 1994/95; to 17%, 1995/96; and 379.4%, 1996/97. Asset growth, coupled with significant decline in profits during the pre-crisis interval of 1994-96 was especially noticeable for the following sectors, (with the crisis year of 1997 added for comparison): Building and Furnishing Materials: for 1994-96 asset growth of 80.2% vs. net profit decline of 39.9%; for 1994-97, asset growth of 206.2% vs. net profit decline of 1,516.7%; Electrical Products and Computers: for 1994-96, asset growth of 40.9% vs. net profit decline of 10%; for 1994-97, asset growth of 36.1% vs. net profit decline of 499.8%; Household Goods: for 1994-96, 49.8% vs. net profit decline of 314.8%; for 1994-97, asset growth of 47% vs. net profit decline of 978.4%; Pharmaceutical Products: for 1994-96, asset growth of 37.1% vs. net profit decline of 24.5%; for 1994-97, asset growth of 32.8% vs. net profit de-

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cline of 171.0%; Property Development: for 1994-96, asset growth of 45.7% vs. net profit decline of 45.8%; for 1994-97: asset growth of 56.6% vs. net profit decline of 796.2%; Pulp and Paper: for 1994-96, asset growth of 62.4% vs. net profit decline of 201.3%; for 1994-97, asset growth of 185.1% vs. net profit decline of 2,805.3%; Textiles, Clothing and Footwear: for 1994-96, asset growth of 19.4% vs. net profit decline of 124.0%; for 1994-97, asset growth of 52.7% vs. net profit decline of 588.3%.

A number of other sectors show a dramatic plunge in profits in 1997, even as assets continue to grow, i.e. for the interval 1994-97. These include: Chemicals and Plastics (asset growth of 168.3% vs. net profit decline of 3,216.2%); Commerce (asset growth of 67.4% vs. net profit decline of 742.7%); Communication (asset growth of 166.8% vs. net profit decline of 1111.1%); Electronics (asset growth of 132.1% vs. net profit decline of 666.6%); Energy (asset growth of 113.6% vs. net profit decline of -980.8%); Machinery and Equipment (asset growth of 184% vs. net profit decline of -568.4%); Transportation (asset growth of 54.8% vs. net profit decline of 903.0%); and Vehicles and Parts (asset growth of 54.7% vs. net profit decline of 447.1%). The growth in assets was accompanied by a general, if slower, expansion in sales. In particular, during the pre-crisis interval 1994-96 while assets grew on average by 46.5%, sales expanded by 37.4%. The gap between the growth in assets and the lagging growth in sales becomes more pronounced if 1997 is added, with average asset growth increasing to 74.4%, while average sales also grew but lagged significantly at 45.1%, during the interval 1994-97. The year-on-year performance of sales for SET non-financial enterprises shows a continuing and significant decline in average growth from 23.5%, 1994/95; 11%, 1995/96; and 4.9%, 1996/97. However, as always, care must be taken with averages, in that it masks important differences among sectors. For example, for the intervals 1994-96, and 1994-97, some sectors continued to exhibit similar rates of growth in both assets and sales, e.g. Electrical Products and Computer, Entertainment and Recreation. Others were characterized by a significant gap between growth in assets, and lagging growth in sales, e.g. Building and Furnishing Materials, Chemicals and Plastics, Electronics, Machinery and Equipment, and Property Development. Complementing the above analysis of change in assets, sales and profits, the World Bank study looked at change in fixed or capital assets. These grew at an extremely rapid rate of 29% per annum during the period 1992-96 (see Figure 5) for the sample group of Thai corporates. Sustained growth at this rapid rate is likely to put overwhelming pressures on corporate governance systems, management resources, and organizational structures. To put this in perspective, this compares with an average rate of growth in capital assets of 8% for Taiwan, 7% for Latin America, 15% for the industrialized countries; and in terms of other Asian crisis countries, 33% for Indonesia and 17% for Korea. Significant and continuing growth in assets, coupled with lagging and declining growth in sales, and fall in profitability, appear to indicate the buildup of overcapacity in

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key industries. Therefore the earlier noted misallocation of savings may have involved more than the usually cited factor of investment being simply diverted to speculative ventures and nontradables, in particular, real estate. It could relate to more fundamental problems in corporate investment strategy and performance. Although falling net profits are a clear signal of performance problems, an examination of profitability indicators based on operating performance, such as Return on Assets (ROA), and Return on Equity (ROE), should contribute to an understanding of this issue (section iii). Before examining operating performance, it is useful to look at the financial position of Thai corporates. ii. Financial Strength and Leverage In examining leverage-related measures, it is important to keep in mind that there is a general relationship between debt and risk. This arises because when a company raises debt, it takes on a commitment to substantial fixed cash out-flows for some time into the future. However, it is unlikely to have equivalent guaranteed cash in-flow over the same period. Therefore financial risk arises from fixed cash out-flow combined with an uncertain cash in-flow. Fundamentally, an enterprise raises funds through debt because it costs less than equity funds: it provides the owners the benefits of maintaining control over the firm with limited investment. By adding debt to its balance sheet, a company can improve profitability: and if the enterprise earns more on the borrowed funds than it pays in interest, the returns to the owners increase. This is the basic concept of leverage. However, as noted, debt can increase both profit and risk. Firms with high leverage ratios have a chance of gaining high profits when the economy expands, but they also run the risk of large losses in an economic downturn. Therefore management must maintain a proper balance between the two; this balance, in turn, can vary among sectors and economies. For example, sectors with very predictable income streams, e.g. leasing, can incur higher levels of debt; highly volatile sectors rely more on equity. In assessing the financial strength and leverage of Thai corporates, the first measure in this section looks at the Financing of Tangible Fixed Assets to determine the extent to which borrowed funds have been used to finance the rapid expansion of fixed assets, and therefore the implications for financial risk. The Interest Coverage Ratio examines the number of times fixed charges are covered by operating profits. The Debt/Equity (D/E) ratio examines the extent to which borrowed funds have been used to finance the enterprise, relative to the owners investment. Finally, the Maturity Structure of Debt examines level of short-term liabilities as a proportion of total liabilities, signaling the likely pressure on earnings. Financing of Tangible Fixed Assets The World Bank study found that rapid and sustained build up of fixed assets relied primarily on debt financing, as measured by debt raised and repaid as per cent of investments (see Figure 6). During the period 1993-96 Thai reliance on debt financing for fixed asset growth was, on average, 78% per year, as compared with 47% for Taiwan, 19% for Latin America, 8-19% for industrialized countries; and in terms of the other Asian

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crisis countries, 67% for Indonesia, and 69% for Korea. Debt Sustainability: Interest Coverage Ratio Financial strength refers to the ability of an enterprise to withstand operating setbacks. It looks at the long-term position of the company, by relating a companys total borrowings to its cash flow. In principal, rising or relatively high debt need not signal problems, as long as the borrowed money is used productively, and the debt repayment requirements do not overwhelm the cash flow capacity of the enterprise. How productively money is used is reflected in indicators such as Return on Assets (ROA) and Return on Equity (ROE), which will be examined in the next section. The Interest Coverage Ratio looks at the ability of SET non-financial enterprises to service their debt. The Interest Coverage Ratio is calculated as the ratio of the companys operating cash flows (earnings before interest, taxes and depreciation, or EBITDA) to the annual interest payments on loans. If financial leverage is high, that is, interest payment is a significant part of pre-tax profits, a small change in the operating profit will be greatly magnified in its effect on return to shareholders. As noted, a highly leveraged company can do well in times of rapid growth, but could encounter difficulties in a downturn. As a benchmark, in a survey12 of approximately 200 companies in the EU, Japan, UK and US, interest cover of well run companies averaged just under 6 times, ranging between just under 4 times for the EU, to around 7 times for the US. (It should be noted that the focus in the Financial Times survey was specifically on benchmarking performance measures for well run, or first class companies, as distinct from average companies.) Research in the UK13 has shown that few successful companies operate at a value of less than 3.3 times. However, the level of interest rates in an economy will have an important impact on this ratio. For example, low interest economiesnot the case in pre-crisis Thailandseem to accept more highly leveraged balance sheets. The SET non-financial enterprises show a significant decline in debt coverage, as measured by the interest coverage ratio, from an average of 4.70 times in 1994, to 2.74 times in 1996 (pre-crisis), and to 0.92 times in 1997 (see Table4 & Figure 7). The sectors showing significant deterioration in the pre-crisis period of 1994-96 include (for 1994; 1996): Building and Furnishing Materials (2.78; 1.52), Communication (5.79; 2.97), Electrical Products and Computers (3.29; 2.21), Electronics (4.18; 3.34), Health and Services (6.47; 2.65), Machinery and Equipment (8.45; 4.87), and Textiles, Clothing and Footwear (3.67; 0.88). The crisis then brings serious problems to additional sectors (for 1994; 1997), for example Chemicals and Plastics (2.65; -0.49); Commerce (3.57; -0.08) and Packaging (3.02; 0.86). The World Bank study corroborates the significant decline in debt coverage found in the SET data, from 4.6 times in 1992, to 1.92 times in 1996 for its sample of Thai corporates (as compared with 2.74 times for 1996 for the full set of SET data cited above). This compares in 1996 with interest coverage ratio of 4.08 times for Taiwan, 25.36 times for Latin America, a range of 4.31-7.62 for key industrialized countries (for the sample group of companies); and in terms of the other Asian crisis countries, 2.44 times for Indo-

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nesia, and 1.07 times for Korea. (see Figure 8) Leverage: Debt/Equity Ratio The primary measure of leverage is the Debt/Equity ratio, measured by dividing the enterprises debt by shareholder equity. This indicates how much money an enterprise is borrowing relative to its equity, to finance its operations. This ratio is a basic test of the financial strength of the enterprise: the greater the debt the greater the risk. To put this in perspective, well-run companies in the EU, Japan, UK and US averaged debt/equity ratios of under 60%, ranging from just under 40% in the UK, to just over 60% in the EU and Japan.14 The SET non-financial enterprises show high and increasing debt/equity ratios, with the average increasing from 131% in 1994 to 166% in pre-crisis 1996, and jumping to 350% in 1997 (see Table 4 & Figure 9). The sectors showing high and/or significant increases in debt/equity ratios in the pre-crisis period of 1994-1996, then further deterioration in 1997, include (for 1994; 1996; 1997): Building and Furnishing Materials (195%; 274%; 514%); Chemicals and Plastics (107%; 179%; 515%); Communication (103%; 185%; 917% Electrical Products and Computers (192%; 228%; 508%); Health and Services (64%; 126%; 388%); Household Goods (195%; 373%; 362%); Pulp and Paper (178%; 265%; 312%); Transportation (306%; 287%; n.a.). The World Bank sample of Thai corporates confirms the rapidly increasing debt/ equity ratios, from 71% in 1992, to 155% in 1996 (as compared with 166% for 1996 cited earlier for the full SET data set). This compares, in 1996, with 65% for Taiwan, 31% for Latin America, 90% in the US; and in terms of the other Asian crisis countries, 92% for Indonesia, and 132% for Korea (1995). (see Figure 10) Maturity Structure of Debt The usual assumption in corporate finance is that not all debt is the same. In particular, the temporal profile of debt matters. Long-term debt provides, in principle, options and opportunities for generating the necessary revenues for repayment. Shortterm debt, on the other hand, leaves less flexibility, and could threaten to overwhelm the cash generating capacity of the enterprise. Therefore the higher the proportion of shortterm debt, the more pressure this will exert on the revenue generating capacity of the enterprise, in terms of repayment and refinancing needs. The maturity structure of debt of an enterprise can be measured as its total current liabilities divided by its total liabilities. The World Bank study found for the period 1992-96 that the maturity structure of debt for its sample of Thai corporates averaged 62%, with little year-on-year variation, similar to other Asian economies (see Figure 11). This compares with 40% for Latin American and 31%-55% for the industrialized economies; and in terms of the other Asian crisis economies, 52% for Indonesia and Korea. The implication is that there was a consistently significant burden of short-term debt that had to be serviced or repaid prior to the economic crisis.

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iii. Operating Performance: Profitability We now arrive at the core of corporate performance. Earlier, in section 2.2, the discussion focused on the efficiency of investment at the macro level (ICOR). This section focuses on return on investment as measured at the enterprise level.15 The basic concept involves deriving the enterprises return on investment by relating the operating surplus (from the firms income statement) to the value of the underlying assets/funds (from the balance sheet). Two key measures of return on investment that follow are: Return on Assets (ROA) and Return on Equity (ROE). ROA reflects the operating efficiency of the total enterprises by looking at the returns on total assets. ROE reflects the returns generated to the owners (shareholders) from the operating efficiency. The relationship among the measures of operating performance may be summarized as follows. Return on Equity (ROE) may be considered the key driver of company value. Return on Assets (ROA) is the most important driver of ROE. Operating surplus measured as the Net Profit Margin, and Total Asset Turnover, jointly drive ROA. Therefore although Total Asset Turnover is not a profitability indicator, it is a key measure of operating performance, and a key driver of profitability through its impact on ROA. Whereas all these measures take an accounting perspective of performance, Economic Value Added, the last measure included in this section takes an economic perspective, focusing on future cash flows to determine whether the enterprise is creating value for its shareholders. Net Profit Margin The Net Profit Margin on sales is computed by dividing net income after taxes by sales, to derive the profit per dollar of sales. Changes in profit margin generally reflect changes in efficiency, but can also be a function of changes in products or in types of customers; if it is the latter, these are likely to be reflected in corresponding changes in asset turnover. To put this in perspective, the general relationship between Net Profit Margin and Total Asset Turnover may be summarized as follows. An enterprise with very heavy assets such as telecommunications, will typically have very high margins, combined with very low asset turnover. A distribution-type of company will typically have a relatively low margin, combined with high asset turnover. Many manufacturing companies will show average values for both profit margin and asset turnover. The focus here is on the behaviour of these variables over time: in particular, declining profit margin is likely to reflect declining operating performance. (If profit margins are falling primarily due to changes in business focusfor example, in products and/or customerswith no significant negative implications for operating performance, then this is likely to be compensated in the asset turnover measure, and reflected in a relatively stable ROA.) To put these figures in perspective, but keeping in mind the industry variations noted above, well run companies in the EU, Japan, UK and US have an average margin on sales of around 9%, (and average asset turnover of around 1.2-1.3, ranging from 1.0 for the EU and Japan, to 1.5 for the UK).16 The SET non-financial enterprises show clear deterioration in profit margin prior

15

to the crisis, from 8.14% in 1994 to 4.6% in 1996, with significant further deterioration to 31.0% in 1997 (see Table 5 and Figure 12). Focusing on the pre-crisis interval of 19941996, with 1997 included for comparison, the deterioration is especially pronounced (for 1994; 1996; 1997) in Building and Furnishing (7.59%; 2.89%; -62.93%); Communication (16.90%; 10.12%; -75.98%); Electrical Products and Computers (5.29%; 3.38%; -14.23%); Household Goods (7.51%; -12.43%; -38.77%); Jewelry and Ornaments (6.82%; 1.61%; 5.81%); Pharmaceutical Products and Cosmetics (12.33%; 7.45%; -8.57%); Property Development (12.78%; 5.66%; -65.28%); Pulp and Paper (4.39%; -2.64%; -58.85%); and Textiles, Clothing and Footwear (5.39%; -1.08%; -20.26%). In addition, virtually all the remaining sectors show a dramatic plunge in profit margins in 1997, including for example: Chemicals and Plastics (-139.83%); Energy (27.87%); Machinery and Equipment (-27.58%); Packaging (-35.13%); Transportation (31.73%). Return on Assets (ROA) Return on Assets (ROA) is provides the foundations necessary for an enterprise to deliver a good return on equity, and is the key measure of operating efficiency. To calculate the ROA, net income or operating profits are divided by total assets, to yield the rate of return earned by the total assets of the enterprise. Therefore the ROA measures how well the enterprise uses all its assets to generate an operating surplus. To put this in context, well run companies in the EU, Japan, UK and US averaged ROAs just over 10%, ranging from around 7% in Japan, to just under 15% for the US and UK.17 The SET non-financial enterprises show a clear deterioration of performance prior to the crisis, with average ROA declining from 4.99% in 1994, to 3.0% in 1996. The crisis year 1997 sees a dramatic drop in ROA to 14.73% (see Table 6 and Figure 13). Focusing again on the pre-crisis period 1994-96, with 1997 included for comparison, the deterioration in ROA is especially significant for the following sectors (for 1994; 1996; 1997): Building and Furnishing Materials (4.30%; 1.60%; -25.06%); Communication (4.73%; 3.00%;-20.58%); Electrical Products and Computers (5.18%; 3.50%; -14.94%); Household Goods (3.98%; -6.18%; -23.57%); Pharmaceutical Products (9.29%; 5.26%; -4.89%); Property Development (3.63%; 1.45%; -16.73%); Pulp and Paper (1.64%; -1.15%; 19.81%); and Textiles, Clothing and Footwear (3.76%; -0.74%; -13.50%). Most remaining sectors show dramatically low ROAs in 1997, including: Chemicals and Plastics (-41.81%); Commerce (-19.21%); Electronics (-26.94%); Energy (13.14%); Machinery and Equipment (-17.70%); Packaging (-22.53%); Transportation (15.36%). The World Bank study confirms for its sample of Thai corporates a significant decline in Return on Capital Employed (ROCE) from 9% in 1992 to 5% in 1996 (as compared with average ROA of 3% in 1996 for the SET data, cited earlier). This compares with an average of 20% for Hong Kong, 16% for Latin America, 11% for the US, 8% for Taiwan, 4-5% for Germany, France and Japan; and for the Asian crisis countries, 11% in Indonesia and 8% in Korea. (see Figure 14)

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Return on Equity (ROE) Return on Equity (ROE), as a fundamental measure of profitability, indicates how well the equity investors are doing in terms of the ability of the enterprise to generate adequate returns to common shareholders equity, measured by dividing corporate net earnings (after tax), by common shareholders equity. It is a critical performance indicator in a market economy not only at the enterprise (micro) level, but also at the (macro) level of the overall economy. At the level of the enterprise, good returns on equity bring success to the businesscontribute to a higher share price and make it easier to attract new funds, allowing the enterprise to grow, given suitable market conditions, and generate further profits. At the macro level of an economy, return on equity drives industrial/corporate investment and therefore growth in GDP. It should be noted that profitability measures must be viewed in the context of alternative opportunities for investors in the domestic and international markets, an issue we will return to when considering the concept of economic value added. Well run companies in the EU, Japan, UK and US averaged ROEs of just over 15%,. There is, however, a wide range in corporate performance as measured by ROE, ranging from 10% in Japan, to just under 20% in the US.18 The SET non-financial enterprises show clear deterioration in performance prior to the crisis, with average ROE declining from 10.91% in 1994, to 6.19% in 1996. This is followed by, and a drastic plunge in returns to 56.84% in 1997 (see Table 6 & Figure 15). Focusing on the pre-crisis period of 1994-96, with 1997 included for comparison, the decline is especially pronounced (for 1994; 1996; 1997) in Building and Furnishing Materials (13.05%; 5.62% -128.11%); Electronics (25.08; 16.58; -108.89); Household Goods (11.82%; -25.05%; -110.93%); Property Development (10.12%; 4.26%; -64.44%); Pulp and Paper (4.59%; -3.78%; -78.54%); and Textiles, Clothing and Footwear (7.74%; 1.84%; -41.32%). In addition, as with ROA, virtually all remaining sectors show dramatically low returns in 1997, including: Chemicals and Plastics (-172.18%); Commerce (-69.55%); Communication (-103.83%); Energy (-46.39%); Packaging (-81.36%); and Vehicles and Parts (-62.97%). The World Bank confirms for its sample of Thai corporates the significant decline from 13% in 1992 to 5% in 1996 (as compared with 6.19% for 1996 for the full SET data set, cited earlier). There is significant variation in the countries in the sample. For example, over the same period ROE for Hong Kong corporates averaged 25% ROE, for the US 12% Taiwan 11%, for Latin America 9%; and for the Asian crisis countries of Indonesia 13% and Korea 7%. (see Figure 16) Economic Value Added (EVA) The concept of Economic Value Added (EVA) adopts an economic, rather than an accounting perspective. That is, it assumes that value is determined by future cash

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flows, rather than historic profit or balance sheet calculations. EVA uses the notion of opportunity costs to assess whether a company is creating value for its shareholders. It relates profitability, as measured in the Return on Capital Employed (ROCE), to the opportunity cost of capital, technically measured as a weighted average cost of alternative opportunities to generate returns to investors. If profitability exceeds the prevailing cost of capital, then the corporation is creating wealth for the shareholders, and is reflected in a positive EVA. If not, the corporation is in effect destroying shareholder wealth, reflected in a negative EVA. The World Bank study employed a simplified version of EVA, using bank lending rates as a proxy for the weighted average cost of capital. On this measure, Thai corporate performance again was not encouraging. In the period 1992-94 it fluctuated between 9 and 7, averaging 8 (1995 and 1996 data were not available). This compares with positive EVAs only for Hong Kong, Japan, Malaysia, Singapore and the US. In terms of the other Asian crisis countries, Indonesias EVA averaged 9% over the same period, and Korea 2%. (see Figure 17) iv. Financial Fragility: Altmans Z Score An interesting composite measure, Altmans Z Score, is utilized in the World Bank study to assess financial fragility. It is calculated as a weighted sum of 5 ratios: return on total assets; sales to total assets; equity to debt (the inverse of the debt/equity ratio); working capital to total assets; and retained earnings to total assets. The weighted sum of these 5 ratios yields a score for financial fragility ranging from 4 to +8, where companies above 2.99 are considered financially sound; those between 2.99 and 1.81 are considered vulnerable; and those below 1.81 are considered financially distressed and candidates for bankruptcy. The Altman Z Score for Thai corporates declined significantly and dangerously from a healthy 3.115 in 1992, to a distressed 1.5 in 1996, with 1994 and 1995 in the vulnerable category. In 1996 similar signs of distress were evident with respect to the other Asian crisis countries of Indonesia (2.6) and Korea (1.55). (see Figure 18) 4. Conclusions The overall picture that emerges from the above analysis is that of a corporate sector overwhelmed by rapid growth, characterized by an investment spending spree. This led to poor financial, strategic, and operating performance well before the present crisis. In particular, as a consequence of rapid sustained growth and increasing complexity, problems for corporates emerged in the following areas: i. ii. declining effectiveness in the allocation of capital, i.e. strategic management decisions by firms as to what businesses to invest in; declining efficiency in the use of capital, i.e. management of the firms operations in areas such as procurement, cost control, inventory management; and increasing vulnerability in financing growth, i.e. through an overdependence on asset-secured bank lending, with limited attention to earnings performance by both lenders and borrowers.

iii.

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The result was rapid growth in assets, coupled with the erosion of profit margins, reflected in declining and low returns on equity and capital employed. The present problems of the real sector then go beyond the very extensive financial (e.g. solvency) problems of corporates, and relate more fundamentally to performance (e.g. profitability). As a consequence, debt restructuring alone, aimed at short-term financing constraints, and corporate recapitalization, are unlikely to be either effective or sufficient, for corporateand therefore economicrecovery. Thai corporates have massive equity and debt capitalization needs, as indicated by the erosion of equity capital, and maturity structure of debt. Given the limitations of credit extension by a distressed banking system, and insufficiently developed domestic bond markets, the prospects for new debt financing are rather limited at this time. Similarly, recapitalization plans that rely heavily on equity injections might not be realistic in the current market environment, especially for corporates whose earnings performance and prospects are suspect. In this context, the recapitalization of the banksa critical and central focus of crisis managementis unlikely to address the problems of financially devastated corporates. Therefore meeting of the recapitalization needs of Thai corporates is likely to be highly problematic at this time. Furthermore, given the scale of the financing required to recapitalize the financial sectors and to revitalize the real sector, Thailand is unlikely to be able to rely solely on high domestic savings to fuel the transition to growth. For better or for worse, external financing in some form (including bond-related debt) will have to play an important role in recovery and renewal. However, competition for capital is likely to be intense. Japan, Asias chief source of capital, is showing little signs of pulling out of its continuing recession; Europe is likely to be inwardly focused on its own monetary union, as well as beginning to experience problems of its own; and the U.S. is likely to be preoccupied closer to home, both domestically and in the Western Hemisphere. In addition, there is a general decrease in appetite for emerging market risk, constraining available capital. In this environment, corporations will have to demonstrate to investorsdomestic and foreignthat they can sustain solid performance, and create shareholder value. This is likely to be especially importantand challengingin an increasingly difficult global economic environment of slower growth, increasing competition for markets, and therefore downward pressure on prices and profits. The implication is that revitalizing a devastated Thai corporate sector will require extensive and systemic corporate restructuring to attract the fundsand generate the earningsnecessary for sustained recovery. At the macro policy level, this will requireas part of the crisis management processan explicit focus on factors that are likely to facilitate corporate performance, or else recovery is unlikely to hold.

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III. TRANSITION FROM STABILIZATION TO ECONOMIC RENEWAL 1. Introduction The purpose of this section is to explore examples suggestive of alternative ways of approaching Thailands economic crisis management; that may increase the likelihood of economic renewal by strengthening corporate performance. There is no attempt to identify an alternative comprehensive framework for managing the economic crisis. Indeed it is not at all clear at this stage, if such a framework exists, nor what it might look like. The purpose of this section is far more modest: to explore how particular issues may be addressed differently in the context of the present crisis from the perspective of strengthening corporate performance as a key element in economic renewal. In particular, two examples are selected as illustrations: i. corporate debt restructuring; and ii. fiscal stimulation through expenditure on infrastructure. 2. From Debt Restructuring to Corporate Restructuring 2.1 Introduction Debt-servicing costs are threatening the solvency of many corporations. The 1997 performance of SET non-financial enterprises examined in Section II reflects this in low interest coverage, high debt/equity ratios, and excessive short-term debt. Indications are that the situation deteriorated further in 1998. In addition, as noted in Section II, given the nature of listed firms, the SET data most likely understates the full extent of the financial problems for all Thai corporates. For example, there are indications that credit to SMEs is being crowded out, as banks place priority, to the extent that they are lending at all, on the larger borrowers. The debt overhang is self-perpetuating: corporations are unable to address their leverage problems by retaining earnings or issuing equity because of a contracting domestic economy and constraints on export expansion. At the same time, the domestic recession is prolonged by the high level of corporate debt. As corporate solvency problems worsen, the balance sheets of banks deteriorate further: the problems of the financial sector and of the real economy are intertwined. Given deteriorating corporate performance well before the crisis, focusing on short-term financial restructuring to address the corporate debt overhang problems is clearly critically necessary, but far from sufficient for economic recovery. A narrowly focused financial restructuring approach may buy some time with respect to the short-term solvency problems of corporates, but is unlikely to respond to more fundamental problems of corporate performance and restore sustained profitability. It is essential that debt restructuring be based on corporate restructuring that addresses the more difficult, but more fundamental longer-term performance constraints. Unless the basis for future earnings is clear, financial restructuringincluding recapitalizationof the devastated corporate sector is likely to be problematic in the present environment. There has been limited progress to date in addressing the corporate debt-overhang problem. Fundamental issues of corporate performance (corporate restructuring) have

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received limited attention in a financial crisis atmosphere. In general, corporate debt restructuring is likely to be a long, drawn-out, and complex process. The present framework, the IMF-supported voluntary, market-based Bangkok Approach, is likely to require modifications and supporting mechanisms if it is to be effective in addressing the pervasive corporate debt overhang problems, and provide the basis for the recapitalization needed to strengthen corporate performance. 2.2 The Bangkok Approach The Bangkok Approachoutlined in the Royal Thai Governments Memorandum of Economic Policies (MEP) of August 25, 1998 within the framework of the IMFled adjustment strategyreflects a voluntary, market-based and bank-led approach to corporate debt restructuring: debt workouts are to be handled by banks on a case-by-case basis. The focus of Government in facilitating debt restructuring is then twofold: i. creating enabling conditions to support corporate debt restructuring, including developing a monitoring system, and consideration of incentives, penalties and arbitration among creditors; and ii. strengthening the banks so that they can lead the debt workouts. The enabling conditions introduced include: Establishment of a Corporate Debt Restructuring Advisory Committee (CDRAC), chaired by the Bank of Thailand, and including representatives from the financial and corporate sectors, which in turn established a system to monitor the progress of debt restructuring; Establishment (by BOT) of a Credit Bureau to facilitate information exchange among all creditors; Removal of investment limits for financial institutions holdings in companies, in the context of debt restructuring; CDRAC review of possible actions with respect to firms that resist restructuring; Commitment to passing strengthened bankruptcy and foreclosure laws though this is progressing more slowly and with greater difficulty than anticipated.

The key measures to assist in recapitalizing financial institutions were outlined in the August 14, 1998 package of financial sector restructuring, with additional measures introduced in the August 25 MEP. These include: Closing or rehabilitation of a number of finance companies and banks, including recapitalization and provisioning agreements; Amending by emergency decree the Commercial Banking Law to facilitate merger of banks and transfer of assets; Authority to issue up to Baht 300 billion of bonds for capital support schemes; Losses of the Financial Institution Development Fund (FIDF), the lender of last resort to the financial system, converted into government debt; Auctioning of the assets of closed institutions by the Financial Sector Re-

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structuring Agency (FRA); Establishment of an Asset Management Corporation (AMC) to assist in bank loan workouts;

The Bangkok Approach to financial restructuring has had limited success to date. Debt restructuring is progressing very slowly, with banks not willing or not able to play the expected lead role, or to provide the access to new credit (e.g. for working capital, trade finance) required by corporates for continued effective performance. 2.3 Constraints on the Bangkok Approach There are 3 general and related constraints on the effectiveness of the Bangkok Approach to corporate debt restructuring. The first involves operational constraints on implementation. The second set of constraints relates to the appropriate role of government in the debt restructuring process. The third set of constraints relates to the sufficiency of focusing on short-term financing, i.e. solvency, as distinct from more fundamental corporate restructuring as the basis for debt restructuring. i. Constraints on implementation Implementation constraints on the Bangkok Approach include the following: i. constraints on the abilities and incentives of banks to lead corporate debt restructuring efforts appropriate to the nature and scale of the problem; and ii. constraints in the existing institutional and incentive framework necessary for implementing a market-based approach, (e.g. tax system, regulatory environment). The key constraints on a bank-led corporate debt restructuring include the following: There is limited financial capability (i.e. insufficient capital) for banks to underwrite corporate restructuring on the scale required, given the state of their balance sheets and the scale of the corporate debt problem. There is limited incentive for banks to undertake a write-down of corporate debt (haircuts), or to expand credit (and therefore risk) under present conditions, i.e. legal, regulatory and tax environment (see below). There is limited experience and technical capability to undertake the corporate assessmentof present and future operationsnecessary for debt restructuring: to shift from traditional asset based to cash flow/performance based analysis and lending necessary for corporate restructuring. Banks generally feel obliged to place priority on rolling over loans to large, heavily indebted borrowers, with limited attention to SMEs.

The ability of Thai banks and corporates to implement restructuring is also limited by constraints in the institutional environment, including the following:19 Tax regulations discourage equity restructuring (e.g. mergers, asset transfers, share acquisitions). For example, asset transfer or share acquisitions in exchange for shares, and mergers, are treated as taxable transactions.

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There are difficulties in implementing debt-equity conversions. For example, for creditors to acquire shares in a debtor by decreasing the debtors debts requires for the creditors to pay for shares in cash, then receive repayment for their loans. Moreover, this could be opposed by other creditors as a preferential repayment of debt. More generally, current tax laws encourage debt over equity financing by allowing unlimited deductibility of interest expenses. If debt is discharged as part of a voluntary restructuring, the reduction in debt would represent taxable income to the debtor. Losses from discounted sales of bad receivables may not be tax-deductible to the seller, and may in fact be looked on as avoidance of bad debt regulations. Sale of receivables (e.g. factoring, securitization) is subject to VAT, which may make such refinancing expensive.

ii. The Role of Government Given the above constraints on the implementation of the Bangkok Approach, a key issue relates to the appropriate role of government in improving the process of corporate debt restructuring. In this context, governments are faced with the following fundamental policy choices in approaching corporate debt restructuring: i. Market-based approach: This is a private sector-led approach to restore enterprise solvency and profitability, and to restore banks capital. The governments role is to improve the enabling environment, including the tax, legislative, regulatory, and capital market frameworks. The market-based approach limits fiscal costs and reduces the likelihood that government will end up as the primary owner of banks and enterprises. It assumes that the scale of the corporate debt (and bank recapitalization) problem is amenable to market-based (micro) solutions. Bank-led approach: In this approach debt restructuring is still marketbased in that Government does not take a direct role in corporate restructuring. However, it does take a more active if indirect role, focused on assisting the banks as intermediaries. In particular, Government focuses on recapitalizing the banks, who are expected to take the lead in corporate debt workouts, including providing any necessary additional financing (e.g. working capital, trade finance). This approach assumes that banks have the necessary resources, capabilities and incentives to take the lead in corporate debt restructuring. The fiscal costs are a function of the extent of the banking problem, and the scale of Government support to banks. Government-led approach: In this approach Government plays a key role in facilitating corporate debt restructuring, either directly or through government related/induced mechanisms. Governments role can take a variety of forms, including providing financial incentives for debt restructuring, and/or creating special-purpose mechanisms to directly address the corporate debt restructuring problem. In practice, this may entail the government (directly or indirectly) taking shares in distressed enterprises, and

ii.

iii.

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providing additional financing (e.g. working capital, trade finance) during the restructuring process. As discussed earlier, the IMF-supported Bangkok Approach has taken essentially a market-based, bank-led approach to corporate debt restructuring. It is an approach that has had limited success to date. A recent IMF study of international experience with corporate debt restructuring20 implicitly sheds some light on the limitations of the Bangkok Approach, and on possible ways of strengthening the debt restructuring process. The basic lesson of the IMF review is that the tradeoff between the market-based/ bank-led approach, and a more active role for government depends on the systemic (macroeconomic) consequences of the corporate debt problem, and the efficiency of the institutional framework. Market-based, bank-led restructuring has the advantage that the outcome is determined by market forces, but this approach is likely to take time; requires a supportive institutional framework (e.g. efficient markets); and a relatively contained corporate debt problem. Alternatively, a more active government role is likely to entail potentially high fiscal costs, raises potential moral hazard problems, but may eliminate the debt overhang problem more quicklyan important consideration when corporate debt problems are delaying economic recovery. More specifically, governments can take a hands off approach to debt workouts, leaving it to the banking system to handle them on a case-by-case basis if the following conditions exist: the number of corporations involved is small; macroeconomic consequences of corporate debt problems are limited; financial information is readily available and sound; banks and corporations have both the analytical/technical capability and the financial incentive to restructure debt; and the institutional framework (tax, legal, regulatory systems) facilitates the debt restructuring process (e.g. effective bankruptcy and foreclosure laws).

Alternatively, governments are likely to be required to take a more active role if the following conditions exist: corporate debt problems are widespread and pervasive; macroeconomic consequences, or negative externalities, of micro (enterprise-level) debt problems are significant, e.g. squeezing credit to viable borrowers, unsustainably high level of corporate debt constraining capital inflows; microeconomic factors inhibit the debt restructuring process, e.g. lack of corporate capacity and/or willingness to provide reliable financial information institutional failures constrain the process, e.g. appropriate regulatory measures, tax codes, and legal requirements such as adequate bankruptcy and foreclosure laws, are not yet in place; banks are short of capital and expertise to address debt workouts on the

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required scale. Comparing the situation in Thailand with the above 2 sets of conditions, in the context of the limited results to date, it would seem that the Bangkok Approach as presently implemented is not likely to be sufficient to address the scope of the corporate debt restructuring problem. The present framework requires augmentation in some form. An increased government role can take different forms.21 It can involve government mediation to overcome lack of cooperation or incentives for banks and corporations to jointly work out debt. It can take the form of specific financial incentives to facilitate debt restructuring. It can also involve the establishment of a government- linked institutional mechanism that can take an active financial and operational role in corporate debt restructuring. In considering additional government initiatives to support the corporate debt restructuring process, it may be useful to take a closer look at the nature of the corporate debt restructuring problem. As will be discussed, how this problem is framed will have important implications for the type of programs and mechanisms selected, and the results achieved. iii. Corporate Restructuring: Solvency and Sustained Profitability As noted earlier, given deteriorating corporate performance well before the crisis, a focus on short-term financial restructuring to address debt-restructuring and refinancing requirements will not be sufficient for corporate recovery and economic renewal. Unless debt restructuring is anchored in corporate restructuring that addresses fundamental longer-term strategic and operational issues, it will be difficult in the present environment to recapitalize Thai corporates, and to restore sustained performance. Strong support for this view is provided in a recent IMF study22 of the experience of countries that undertook systemic bank restructuring to address severe banking system problems. The sample included 24 countries, reflecting wide coverage across regions and levels of development, analyzing the approaches taken and results achieved. Although this paper focuses on corporates not banks, the IMF study is instructive. Bank performance, similar to performance of non-financial enterprises, involves 2 aspects: solvency, and sustainable profitability. Solvency-improving measures affect banks balance sheets and are therefore stock measures. Profitability-improving measures affect banks income, and are therefore flow measures. Based on this, there are 2 dimensions to bank restructuring: Financial restructuring: tries to resolve solvency (net worth) by improving the banks balance sheets, e.g. by writing down the value of certain debts; raising the recovery value of problem loans and collateral; raising additional capital. Operational restructuring: focuses on improving performance and restoring sustained profitability, e.g. by refocusing business strategy; strengthen-

25

ing operations management; retrenching. The study found that countries were far more successful in addressing solvency problems, which involve primarily shorter-term financial restructuring than profitability problems, which require more complex, longer-term, operational restructuring. It is easier and quicker for governments to show progress through such means as swapping bonds for nonperforming loans, which quickly improve solvency indicators, but do not necessarily affect costs, earnings and profits. As a consequence, governments in restructuring programmes have tended to focus more on shorter-term financial restructuring (immediate solvency), at the expense of operational restructuring (performance and profitability). The result is a potential solvency trap, where success in systemic bank restructuring is equated with addressing immediate solvency problems. The IMF study found that those few countries that were relatively successful in addressing the systemic restructuring problem emphasized operational restructuring. It concluded that unless operational restructuring was undertaken, the original crisis recurred in some form within a relatively short period. Furthermore, the study cautions: The evidence of the relatively disappointing performance with respect to resolving the flow problems [profitability] may have important implications for the future of the banking sector in that it suggests the likelihood of recurrent banking problems and possibly the need for further bank restructuring. Operational restructuring is therefore a necessary condition for banks to return to sustained solvency and profitability. A further important finding of the study points to the critical relationship between the original diagnosis of the problem, and the relative success in addressing the problem. The study found that countries that made significant progress in systemic bank restructuring focused more on the underlying causes of the problems (e.g. performance constraints). The study concluded: It can be presumed from the experience of poorer performers that the failure to diagnose problems effectively leads to the design of restructuring programs that are less than fully comprehensive, and therefore limited in their effectiveness. In other words, the impact of a policy or programme is closely related to the critical assumptions about the nature of the problem imbedded into its design. The IMF study has potentially important lessons for corporate debt restructuring, and lends support to the basic message of this paper: the necessity to address corporate performance as a central focus of the crisis management process, simultaneously and linked to addressing the financial dimensions of the crisis. In particular, the fundamental implication of the IMF study is that the problems of corporates, including the debt overhang, are unlikely to be resolved by short-term financial restructuring measures aimed at addressing the immediate solvency problems. Operational restructuring is likely to be also required to achieve sustained solvency and profitability. Furthermore, unless a performance based approach is taken from the outset (in diagnosis and program design), sustained solvency and profitability will be difficult to achieve. It should be noted that financial restructuring requires an assessment of the value of an enterprise based on an analysis of existing businesses, operations, and assets. This provides the basis for assessing the earning potential of the enterprise, and therefore for

26

valuing its debt, equity and refinancing needs. An in depth analysis of corporate operations provides the value basis for effective financial restructuring by identifying the foundations, if any, for future earnings. 2.4 Implications In summary, it is suggested here that corporate debt restructuring is best approached as a more general corporate restructuring issue, incorporating both financial and operational restructuring measures, with the objective of restoring sustained solvency and profitability. This is supported by experience with systemic debt restructuring elsewhere, as reflected in the IMF studies. Perhaps more important, it also follows from the earlier analysis of the condition of Thai corporates in Section II, which demonstrated that constraints on performance and associated profitability predate the financial crisis. Therefore corporate restructuring is essential not only address the short term, crisis-linked financial problems of enterprises, but to restore corporate performance, essential for sustained recovery and growth. Any proposed augmentation of the Bangkok Approach should keep this perspective in mind. In this context, the establishment of a government-initiated (but independently managed) facility to support corporate debt restructuring based on the perspective presented, especially aimed at small and medium size enterprises (SME), could play an important role in supporting economic recovery. It would need to address the existing debt overhang problem, for example through both equity and debt instruments, (i.e. debt restructuring); and to assist in channeling additional needed financing (e.g. working capital, trade finance) to enterprises whose potential viability is established via a thorough analysis of existing operations and assets, and future earning potential (corporate restructuring). The primary rationale for focusing on SMEs is that they are receiving relatively less attentionand financingfrom banks preoccupied primarily with large borrowers, and at the same time they are a key source of employment and income generation in the Thai economy. In addition, SMEs have more limited analytic/technical capabilities to undertake the kind of analysis essential for providing the foundations necessary for effective corporate restructuring, and which in turn is the basis for access to additional financing.23 3. Investment in Advanced Infrastructure Services: From Demand Stimulation to Improving Corporate Performance24 3.1 Infrastructure and Logistics Management Given the relaxation of the budget constraint under Thailands revised IMF-supported adjustment programme, an important element of the overall crisis management strategy at this stage is fiscal stimulation to create domestic demand. The primary objective is to dampen the undesirable effects of stabilization in the short run, by providing a shock absorber to the income effects of real depreciation and expenditure reduction. A key part of this fiscal stimulation would involve expenditure on infrastructure. Well-designed fiscal expenditure programmes focusing on infrastructure may contribute not only to short-term demand stimulation, but may also be used to strengthen corporate performance and future competitiveness.

27

A central link between infrastructure and corporate performance is logistics management. This concept is emerging as an important strategic tool for enterprises to better manage volatile demand, cut business costs, and improve performance and profits. Logistics is the process of strategically managing the system of movement and storage of materials, parts, and finished inventory from supplier, through the firm, and on to customers. It involves the orchestration of the functions of materials acquisition, production and marketing in order to reduce all inventories to the lowest possible levels through streamlined supply and distribution channels. This process in turn is dependent on advanced infrastructure systems. The concept of advanced infrastructure systems goes beyond the usual approaches to infrastructure such as transport and communication, traditionally thought of as physical systems that move goods and information from one point to another. Advances in technology, services and government regulations have led to the emergence of a new generation of infrastructure as value-added services, referred to as advanced infrastructure (AI). Fundamentally, AI combines basic transportation and communication technology with information technology, and a streamlined institutional environment to create an enhanced service capability. In this way, value-added services become part of the advanced infrastructure systems, supporting production and trade, through more efficient logistics management. In an increasingly difficult international economic environmentcharacterized by slowing growth, increasing competition for capital and markets, and downward pressure on prices and profitsefficiency improvements through improved logistics management can play a key role in strengthening competitive performance and profitability. This is especially important in the context of Thai corporate performance that, as the last section indicated, was declining significantly well before the crisis. Therefore a well-designed fiscal expenditure programme focusing on infrastructure systems that strengthens corporate performance through improved logistics management could help improve the operating efficiency and profitability of Thai corporates by responding to both existing and emerging constraints. 3.2 Logistics Management and Corporate Performance A key competitive factor in international production and trade relates to the value of time. Market volatility and rapidly changing consumer tastes and preferences, are pushing industries and enterprises to i. decrease inventory holdings, both inbound and outbound; and ii. increase the ability to adjust production processes and products to changing demand (e.g. through shorter order cycles). In this environment, investing unnecessarily in raw materials, components, and finished goods inventories can detract significantly from corporate performance, in terms of both costs and market share. Reducing inventory levels, a current asset, can have a significant impact on corporate performanceas reflected in such measures as ROA, ROCE, EVAby reducing carrying costs, as well as total capital employed in the business. This can provide a boost to corporate performance by reducing costs on a lower asset base, and by contributing to improved market share through enhanced customer service.

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To put this in perspective, an IFC survey of 1,500 OECD businesses25 found that inventory holdings was the heaviest burden on corporate performance. A break down of logistics expenditures found that the combined costs of inventory holdingincluding interest payments, losses due to spoilage and obsolescence, warehouse management and depreciation, and administrative overheads amounted, on average, to more than 50% of total logistics costs. Application of logistics management principles, supported by the necessary infrastructure services, allowed many businesses to reduce their inbound and outbound inventories drastically (e.g. to less than 1 week), with significant cost impacts: Expenditures incurred in managing logistics organizations amounted on average to 23% of value added, and 70% of the operating margins in all industries surveyed. By implication, a 10% reduction in logistics costs yielded a 7% improvement in operating margins. Furthermore, a 1% reduction in logistics costs had the same effect on corporate performance as a 10% increase in annual sales. Product channel management led to an up to 80% reduction in order cycle time, reduction of between 30-70% in inventories, between 20-50% increase in productivity, and up to 30% reduction in delivered product costs. The Boston Consulting Group found in review of changes in Eastern Europe that by applying integrated logistics management, some enterprises achieved reductions of up to 25% in the time needed to produce a good, which enabled them to cut overall marketing costs by 20%.

The IFC survey also illustrates the transition from traditional, hardware-centred approaches to infrastructure, to the concept of advanced infrastructure focusing on infrastructure services. For example, the focus within the transportation function shifted from efficiency and cost-effectiveness, to on-time delivery, order fill rates, and order cycle times. There was also clear evidence that effective communication links are a prerequisite for the success of a logistics management system. 3.3 Implications The relevance and importance of improved infrastructure services that strengthen Thai corporate performance through improved logistics management, may be illustrated by the following factors: Market: Over 50% of Thailands domestically produced exports, and around 65% of imports, involve OECD markets. The nature of customer expectations and purchasing behaviour is changing significantly in these markets. For example, there is increasing reliance on new information technologies in buying and selling; and increasing responsiveness and value-added partnerships between customers and vendors, involving continuing service relationships instead of simple transactional exchange. Therefore improved logistics management, and supporting advanced infrastructure services are likely to be key factors in corporate performance in these markets. Relative logistics costs: According to an IFC report26 the logistics costs

29

component in the retail price of goods ranges between 20-25% in countries with well established supporting infrastructure services. By comparison, in Thailand, conservative estimates by local business managers put average logistics costs at about 40% of the retail price of goods. Inventory levels: The recent IFC report found that Thai manufacturers and traders maintain excessive inventories. This is seen largely as a hedge against both supply and demand uncertainty, partly as a reflection of constraints on the existing transport and telecommunication system. An examination of annual inventory turnover for SET non-financial enterprises for the interval 1994-97 reflects this excessive investment in inventory. (See Table 7 and Figure 19).

Given the above, there is significant room for improving the performance of Thai corporates through well-designed fiscal expenditure programmes aimed at strengthening corporate logistics management, through infrastructure services. From this perspective, corporate performance can be strengthened by fiscal expenditures focusing on three related areas: i. Advanced infrastructure: refers to improvements in infrastructurein particular transport and telecommunicationsthat encompass hardware, software, and services, which allow users to move goods and information more rapidly and reliably; Information technology: refers to the set of technologies (hardware and software) that relate to the storage, processing and transfer of information, in particular as related to the corporate logistics functions; Logistics management: refers to management techniques, systems and processes that allow an enterprise to optimize the flows of goods and information that apply to their operations, to improve service and reduce costs, e.g. through reduced inventory.

ii.

iii.

Well-designed fiscal expenditure programmes focusing on the revised concept of infrastructure, may contribute not only to short-term demand stimulation, but may strengthen corporate performance and future competitiveness, through improved logistics management. Operationally, this involves investment in hardware, both traditional (e.g. transport, telecommunications) and non-traditional (e.g. information systems}. However, in focusing on corporate performance, even traditional infrastructure must be approached from a different perspective. For example, production responsive to demand fluctuations, supported by lower average inventories, implies increased utilization of small shipments, in streamlined logistical environments. This involves increased transport intensity of goods, requiring an efficient and diversified intermodal freight transport system. Investment in hardware must be complemented by institutional reforms, or software, such as the harmonization of information/document flows and procedures, which enable efficient electronic transmission of freight bills, payment orders, insurance contracts, and transactions relevant to the movement of goods. This in turn may be supported by assistance to enterprises in acquiring and implementing modern logistics technologies, management concepts and organizational arrangements. (For example, in this,

30

the establishment of a Logistics Management Centreoperating on a cost-recovery, self-sufficiency basiscould make a potentially important contribution.) IV. CONCLUSION: FROM FINANCIAL CRISIS TO ECONOMIC RESTRUCTURING This paper has focused on practical issues of concern: Thai corporate performance and its implications for management of the economic crisis. This conclusion takes a more speculative tone. A conceptual issue is implicit in this paper: Is the present economic crisis in Thailand fundamentally a cyclical problem, albeit an unprecedentedly severe one; a temporary (financial) disturbance around a relatively stable mean of an essentially robust real economy? As discussed, the IMF-led adjustment strategy has implicitly taken this approachassuming a primarily cyclical crisis, requiring at the core, effective stabilization and adjustment measures involving primarily demand management instruments, supplemented by some institutional adjustments of the financial systemto restore stability and growth. The implication is that the existing economic structure and associated management or governance systems at both the macro (public policy) and micro (enterprise) level are sufficientwith some fine- tuningto support economic renewal and growth. An alternative perspective, supported in this paper, sees the present economic crisis as ultimately structural in nature. Sustainable recovery is seen as a function of more fundamental changes in the domestic and international economies, requiring significant adjustment. This implies the need for corporateand economicrestructuring, going beyond traditional stabilization measures supported by strengthening the intermediating role of the financial system. Instead, there is a need to respond effectively, through both short and longer term supply side adjustments, to performance constraints of the real sector, i.e. corporates, as part of the crisis management process. A key element of this not touched on earlier relates to economic institutions. In particular, Thailands economy has experienced sustained rapid growth (quantitative) that has resulted in increased complexity (qualitative) of the economic system. This increased complexity, in turn has stretched the capacities of the economic governance systems at both the macro (public policy) and micro (enterprise) levels. The mismatch between the intermediating role of the financial sector and corporate performance in the allocation of savings/investmentan oft cited factor in the crisisis then but one example of this more fundamental institutional issue. The implication of this approach is the need to reassess key elements of the economic management systems at both the macro (public policy) and micro (enterprise) level in light of changing conditions, an issue not pursued in this paper. From an institutional perspective, the IMF-initiated financial sector-led approach to the crisis and its management reflects a particular conceptual view of economic structure. It implies an approach to corporateand economicrestructuring where the primary institutional role is assigned to financial institutions. More generally, it assumes that capital market efficiencies will impose the necessary discipline and technical capacity to bring about corporate restructuring and real economic renewal. It is the view of this

31

paper that this may be an overly optimistic assessment of the relative role and capabilities of the financial sector in an economy littered with the debris of devastated financial institutions and corporates, whose micro problems have macro consequences. Relying on the financial sector and capital market efficiencies in the present environment may be a rather indirect and uncertain way of dealing with structural problems of the real sector. This is especially important in the case of SMEs, given the history of the client structure and operations of the banking system. The deeper challenges of economic restructuring and the associated institutional adjustments should therefore be explicitly linked to the crisis management process, to support Thailands effective transition to economic renewal and sustained recovery. The Thai economy has a demonstrated historical record of outstanding achievements over the years. As this paper suggests, problems brought into focus by the present crisis are, in a way, problems of success: a crisis of growth. Thailand has the necessary commitment, capabilities and resources for economic renewal and sustained growth. In that context, the present crisis may serve the constructive purpose of accelerating the emergence of a more robust and balanced economy.

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ANNEX I. IMF FINANCIAL PROGRAMMING AND REAL SECTOR RESTRUCTURING 1. Introduction The IMF-led approach to stabilization, generally referred to as financial programming, typically assigns primary role to the instruments of demand management, monetary and fiscal policy, to influence macroeconomic performance. These may be supplemented by other measures, such as exchange rate policy. At a deeper conceptual level, there is in fact no unified and unique theory underlying Fund-supported adjustment programmes. It is not clear what the interactions among various policy measures are in achieving the ultimate objectives, in particular, the restoration of growth. Multiple interpretations may be given of the theoretical basis of adjustment, and therefore a variety of conceptual models may be used as the framework for constructing a given adjustment programme. The good news is that this accommodates, in principle, flexibility in tailoring adjustment programmes to specific circumstances. The bad news is that the link between the intent and outcomes of IMF-supported adjustment programmes in certain key areas are uncertain in theory, as well as in practice. In particular, the conceptual basis of the transition from stabilization to the resumption of growth is by no means clear. Therefore the practical issue of the policy and programming basis of ensuring the resumption of growth from stabilization is also uncertain. The Thai experience provides a clear, though far from unique example. 2. The IMF Financial Programming Approach The fundamental objective of traditional IMF-supported programmes is to provide for orderly adjustment of both macroeconomic and structural imbalances, so as to foster economic growth, while bringing about a balance of payments position that is sustainable in the medium term. Basic policy instruments associated with stabilization and adjustment include: i. expenditure reduction: to curtail domestic demand (domestic resource use) by bringing domestic demand and monetary expansion in line with current account deficit and inflation targets; financial sector institutional and policy reform: financial sector restructuring to address and prevent build up of bad debt and improve system efficiency; expenditure switching (e.g. through devaluation): shifting productive resources (labour and capital) from the non-tradeable to the tradeable goods sector, and from consumption to investment; and shift in domestic demand away from imports to domestically produced goods.

ii.

iii.

Traditional stabilization programmes implicitly assume that conditions for a re-

33

sumption of growth will be provided by fiscal austerity, competitive real exchange rates, sound financial markets, and deregulation. However, although stabilization is a critical necessary condition, it is not sufficient for the resumption of growth. The transition from stabilization to growth is neither automatic, nor easy to accomplish. For example, unless the export sector rapidly becomes a strong driving force, growth is unlikely to follow, especially with severe domestic demand contraction under stabilization. In fact the risk that stagnation will follow stabilization is very serious. On closer inspection, the IMF solves the stabilization-to-growth transition problem by assumption: investment is assumed to rise spontaneously in response to stabilization/adjustment; real depreciation drives growth immediately; and whenever the economy deviates from full employment, the growth rate is assumed to respond positively to the gap. 3. The Role of the Real Sector: Supply-Side Adjustment Key stabilization measures are critical elements in restoring the health of the economy. However, it is generally recognized in principleif not in practicethat additional complementary initiatives are likely to be necessary to create conditions for sustainable growth, focusing on the real sector, termed supply-side adjustment. In the medium term, an adequate rate of growth of domestic output, and especially of (competitive) exports, is a crucial element in reducing the burden of external debt and achieving a viable external position. The difficulty in restoring growth with traditional adjustment programmes involves 3 sets of issues:27 i. Fiscal austerity reduces real wages and therefore internal demand. Without internal demand, firms do not invest. Resources that are freed by fiscal austerity are not automatically and instantaneously re-deployed into export production or import substitution. Strongly competitive real exchange rates support strong export growth, but with a lag. In the short run, real depreciation exerts a contractionary effect on demand, by putting downward pressure on real wages. Firms willingness to invest in export expansion or in import substitution depends on their confidence in the sustainability of what they perceive to be sound economic policies. However, unless there are strong incentives provided at the outset for investmentwhich involves significant redistributional impact, e.g. from labour to capitalthe investors may choose to wait and see before undertaking investment expansion.

ii.

iii.

If the private sector does notor cannotrespond with investment and capacity expansion, and if public sector expansion is not possible because of fiscal restraint, then there is likely to be neither growth nor equity. Since an adjustment programme is intended to lead to the restoration of growth, the IMF programming approach recognises, in principle if often not in practice, the role of

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real sector adjustment. That is, it recognises that supply-side components have a key role to play in the transition from stabilization to growth. This involves the need for measures designed to increase directly the incentive or ability of the domestic producers to supply real goods and services at a given level of domestic and external demand. In general, supply-side adjustment involves 2 dimensions or phases: i. ii. Phase I (shorter term): efficiency improvements, involving increasing output and revenues from existing productive capacity; Phase II (longer term): production restructuring, involving increasing the rate of growth of productive capacity and shift in the composition of output (i.e. intra- and inter-industry restructuring).

A key issue in the transition to growth involves dynamics and lags that constrain the supply-side adjustment process, i.e. the transition from stabilization to growth. Fundamentally, demand-side policies are likely to take more rapid effect (and are more certain in their impact), then supply-side adjustments. This in turn may involve the necessity of obtaining additional external financing to avoid overshooting the targeted demand-side reductions until the supply-side adjustment brings the expected results. Enabling conditions for economic restructuring over the longer term, involving growth in productive capacity and change in its composition (production restructuring) need to be fostered while the increases in output from existing capacity are being achieved. In the case of Thailand, relative competitiveness of the export sector is only partly influenced by devaluation, since Thailands neighbours and competitors have also devalued their currencies, e.g. Indonesia, Malaysia, Philippines, and China. Furthermore, industries are increasingly characterized by overcapacity, slowing demand, and downward pressure on prices and profits. Therefore additional (e.g supply side) adjustments are necessary for export revenue generation, involving efficiency improvements in the short term and production restructuring over the longer term. Continued competitiveness of Thailands exports requires diversification in output and improvements in product (and service) quality. This in turn requires more efficient resource utilization, improvements in the management of operations, transition to more efficient production processes, and higher skill levels in the labour force. Over the longer term, production restructuring involves in two dimensions: i. intra-industry restructuring, meaning shifts within existing industries to more efficient production processes and higher value outputs; and ii. intra-sectoral restructuring meaning transition from low productivity to higher productivity industries. At the same time, there is roomand a needto dampen the undesirable effects of stabilization in the short run, while undertaking supply-side adjustment and building confidence for the return of capital flows. In particular, a cushion in the short run can be provided by well-designed public investment programmes that finance local projects. If well focused, these can simultaneously stimulate domestic demand (income effect), and support the real sector adjustment process (supply side adjustment). This can provide a

35

shock absorber to income effects of real depreciation and expenditure reduction, and address supply-side constraints, i.e. support the structural adjustment process. Given the above, it is evident that even within the context of the traditional IMF programming approach there is a clear recognition of the need for supply-side (i.e. real sector) adjustment to ensure the transition from stabilization to growth. There is no a priori reason why a policy focus on demand side adjustment and on the financial sector could or should not go hand-in-hand with a focus on real sector (supply-side) adjustment. 4. Institutional Implications Institutionally, supply-side adjustment has not been the focus of the IMFs programmes, and traditionally institutions such as the World Bank have played this role, e.g. through structural adjustment programmes. This was the case in Thailand in the early 1980s, with the World Banks structural adjustment loans (SALs). Therefore in the context of the present crisis in Thailandwhich is far from the traditional IMF financial programming contexta real sector or supply side adjustment strategy as a part of the crisis management process is entirely consistent with, and essential, even within the original framework of the IMF programming approach. In practice, it is institutions such as the World Bank and the Asian Development Bank that could and should play an important role in facilitating real sector restructuring (supply side adjustment) to ensure the transition from stabilization to growth.

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REFERENCES [1] Abonyi, G., A Mechanism to Facilitate SME Corporate Restructuring in Thailand (forthcoming). [2] Abonyi, G., and M. Thant, Globalization and Regional Integration in Asia, Theme Paper 6, Asian Development Bank. [3] Colaco, F., Thailands International Competitiveness: A Framework for Increased Productivity, in J. Witte and S. Koeberle, Competitiveness and Sustainable Recovery in Thailand, Vol. II, A Joint Publication of the Office of the National Economic and Social Development Board and the World Bank Thailand Office, Bangkok, May 1998. [4] Corsetti, G., P. Presenti, and N. Roubini, What Caused the Asian Currency and Financial Crisis? Part II: The Policy Debate, September 1998. [5] Dornbusch, R., Stabilization, Debt and Reform, Harvester Wheatsheaf, New York, 1993. [6] Dwor-Frecault, D., Vee Mallikamas, and Kobsak Poontrakoo, Thailands Balance of Payments and Financial Crisis: Export Competitiveness, Investment Efficiency, and Financial Fragility, in J. Witte and S. Koeberle. [7] Dziobek, C. and Ceyla Pazarbasioglu, Lessons from Systemic Bank Restructuring: A Survey of 24 Countries, International Monetary Fund, Monetary and Exchange Affairs Department, December 1997. [8] Krugman, P., What Happened in Asia?, January 1998. [9] Lall, S., Thailands Manufacturing Competitiveness: An Overview, in J. Witte and S. Koeberle. [10] Peters, H., Thailands Trade and Infrastructure, in J. Witte and S. Koeberle. [11] Peters, H., Service: The New Focus in International Manufacturing and Trade, Policy Research Working Papers, WPS 0950, Trade and Transport, Infrastructure and Urban Development Department, World Bank, August 1992. [12] Pomerleano, M., Corporate Finance Lessons from the East Asian Crisis, Public Policy for the Private Sector, The World Bank Group, Note No. 155, October 1998. [13] Pomerleano, M., The East Asia Crisis and Corporate Finances, Development Prospects Group, Office of the Senior Vice President, Development Economics, World Bank, October 1998. [14] Radelet, S. and J. Sachs, The Onset of the East Asian Financial Crisis, Harvard Institute for International Development, March, 1998 [15] Stone, M., Corporate Debt Restructuring in East Asia: Some Lessons from International Experience, International Monetary Fund, Asia and Pacific Department, October 1998. [16] Wade, R. and F. Veneroso, The Asian Crisis: The High Debt Model vs. the Wall Street-Treasury-IMF Cmoplex, New Left Review 228, March-April, 1998. [17] Walsh, C., Key Management Ratios, Financial Times/Pitman Publishing, London, 1996. [18] Witte, J. and S. Koeberle, Competitiveness and Sustainable Recovery in Thailand, Vol. II, A Joint Publication of the Office of the National Economic and Social Development Board and the World Bank Thailand Office, Bangkok, May 1998. [19] World Bank, East Asia: The Road to Recovery, Washington, September 1998. [20] World Bank, Thai Corporate: Origins of Financial Distress and Measures Promoting Voluntary Restructuring, April 1998.

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ABOUT THE AUTHOR Dr. George Abonyi is an Associate Senior Fellow at the Institute of Southeast Asian Studies and is Project Director, of the IDRC funded project, Portfolio Investment and Structural Adjustment: The Case of Thailand. He may be contacted on e-mail at: abonyi@loxinfo.co.th

ACKNOWLEDGMENTS The author wishes to thank members of the Project Team, for their valuable contributions to the Project, and their many helpful comments related to this paper; in particular: Ms. Ai Gek Beh, Dr. Nicholas Freeman, and especially Mr. Christopher Lee who made the invaluable contribution of preparing the tables and figures. Dr. Randy Spence, Director, Asia, International Development Research Centre (IDRC) has played a key role in the initiation of this Project, and made many very useful comments both on the work of the Project and earlier drafts of this paper. Mr. M. Pomerleano kindly allowed the referencing of his work on corporate financial performance related to the East Asian crisis (ref. [13]). The author in his capacity as Project Director, also wishes to thank the International Development Research Centre (IDRC) for its financial support for the Project, and the Institute of Southeast Asian Studies (ISEAS) for providing a supportive administrative and intellectual home for the work, including the publication of this paper. The author wishes to recognize the critical role in this Project of the participating financial institutions and associated key individuals who are providing their very scarce time to discuss, on an on-going basis issues related to portfolio investment and structural adjustment as the Project unfolds.

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There is no a priori reason why an IMF-led adjustment programme should exclude a focus on the real sector, even if the IMF itself focuses elsewhere. See Annex 1 for a brief summary of the logic of the IMF programming approach, and its relationship to real sector adjustment. 2 See Colaco [3] 3 See Abonyi and Thant [2] for a discussion of regional integration and its implications. 4 See Dwor-Frecault et al [6] 5 See Lal [9] 6 op cit 7 This section draws on detailed development of this issue by Dwor-Frecault et al [6]. 8 op cit 9 Christopher Lee assisted in the preparation of the tables and figures in this section from SET data. 10 See World Bank [20] 11 See Pomerleano [12], [13] 12 See Walsh [17] 13 op cit 14 op cit 15 See Walsh [17] for a discussion of key management ratios, their meanings and implications. 16 Walsh [17] 17 op cit 18 op cit 19 World Bank [20] 20 See Stone [15] 21 See Stone [15] 22 Dziobek et al [7] 23 See Abonyi [1] for the outline of such a facility focused on SMEs. 24 This section draws on Peters [10], [11] 25 Peters [11] 26 See Peters [10] 27 See Dornbusch [5]

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Figure 1: Public, Private and Total Investment to GDP

45

40

35 Total Investment 30

25 Private Investment 20

15

10

Public Investment

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Source: from Dwor-Frecault et al [6]

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Figure 2: Thailand: ICOR (19975-96)

7.0

6.0

5.0

4.0

3.0

2.0

1.0

0.0 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Source: from Dwor-Frecault et al [6]

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Table 1: Sectoral Sample of SET Companies. 1994 Agribusiness Banking Building & Furnishing Materials Chemicals & Plastics Commerce Communication Electrical products & computer Electronics Energy Enetrtainment & Recreation Finance & Securities Food & Beverages Health & Services Hotel & Travel Services Household Goods Insurance Jewelry & Ornaments Machinery & Equipment Mining Packaging Pharmaceutical Products & Cosmetics Printing & Publishing Professional Services Property Development Pulp & Paper Textiles, Clothing & Footwear Transportation Vehicles & Parts Silo & Warehouse Others Total Of which non-financial enterprisesa 39 16 26 9 12 6 10 5 5 2 38 11 9 13 8 21 5 2 3 15 2 9 2 27 3 32 4 6 4 3 347 272 1995 46 16 28 10 14 10 12 6 7 2 41 11 11 13 11 21 5 3 3 17 2 9 2 33 3 32 5 8 4 4 389 311 1996 30 16 30 13 14 10 13 8 8 5 45 27 11 13 11 22 5 4 3 17 2 9 2 38 3 32 7 9 4 5 416 333 1997 29 16 35 15 15 11 14 10 9 7 52 29 13 13 13 23 5 6 3 17 2 11 2 44 5 29 8 10 4 6 456 365 1998 25 14 29 14 14 10 11 8 9 8 27 25 13 12 8 22 3 6 1 14 2 10 2 40 5 25 8 10 4 6 385 322

a) excludes, Banking, Finance & Securities and Insurance. Source: Based on Stock Exchange of Thailand (SET) data.

42

Table 2.1: Asset and Sales: Value & Growth, for SET Non-Financial Enterprises.

ASSETS ASSETS ASSETS ASSETS ASSETS Value - baht million % CHANGE 1994 1995 1996 Agribusiness 2,209 2,707 2,865 Building & Furnishing Materials 6,636 9,457 11,958 Chemicals & Plastics 7,246 10,230 13,660 Commerce 4,852 6,405 7,034 Communication 15,791 23,266 31,252 Electrical products & computer 3,056 3,824 4,305 Electronics 2,219 3,099 4,147 Energy 9,999 11,321 15,882 Enetrtainment & Recreation 1,772 2,562 3,319 Food & Beverages 1,775 1,947 2,022 Health & Services 1,210 1,803 2,133 Hotel & Travel Services 3,854 4,333 4,081 Household Goods 2,004 2,548 3,001 Jewelry & Ornaments 1,524 1,655 1,802 Machinery & Equipment 832 1,211 1,557 Packaging 1,413 1,688 1,780 Pharmaceutical Products & Cosmetics 613 792 -18.2 Printing & Publishing 1,825 2,407 2,511 Professional Services 582 634 704 Property Development 7,594 9,512 11,067 Pulp & Paper 7,498 9,536 12,175 Textiles, Clothing & Footwear 2,876 3,547 3,434 Transportation 20,883 26,601 26,870 Vehicles & Parts 2,401 3,354 3,506 Silo & Warehouse 492 561 616 Others 3,163 3,662 2,936 Average for non-financial sector 4,397 5,718 6,748 % CHANGE 1997 94-95 3,120 22.5 20,318 42.5 19,439 41.2 8,122 32.0 42,132 47.3 4,160 25.1 5,149 39.7 21,360 13.2 3,841 44.6 2,185 9.7 2,501 49.0 4,090 12.5 2,945 27.2 2,675 8.5 2,364 45.5 1,824 19.5 840 813 1,552 31.9 592 9.0 11,891 25.3 21,378 27.2 4,392 23.3 32,324 27.4 3,715 39.7 566 13.9 2,368 15.7 8,685 27.8 4.3 11.1 16.3 27.7 -3.2 1.0 4.5 9.8 -19.8 13.9 95-96 5.9 26.4 33.5 9.8 34.3 12.6 33.8 40.3 29.5 3.9 18.3 -5.8 17.8 8.9 28.6 5.4 29.3 96-97 8.9 69.9 42.3 15.5 34.8 -3.4 24.2 34.5 15.7 8.1 17.3 0.2 -1.9 48.4 51.8 2.5 6.0 -38.2 -15.9 7.4 75.6 27.9 20.3 6.0 -8.0 -19.3 16.2 Exclude because of outlier effect Mining Source: Based on SET data. 3,109 3,141 2,989 7,294 1.1 -4.8 144.0

SALES SALES SALES SALES SALES

Value - Baht million 1994 3,321 3,761 2,974 5,022 4,420 2,992 2,749 5,321 1,027 2,127 615 931 1,063 942 658 894 -3.2 1995 3,759 4,863 3,885 6,165 6,697 3,536 3,686 6,065 1,269 2,473 711 1,051 1,176 1,012 928 1,153 461 881 1,062 380 416 2,158 2,594 2,797 4,234 2,006 2,366 10,092 13,332 2,486 3,120 151 177 1,048 1,343 2,357 2,985

1996 3,894 5,942 4,357 7,385 8,069 4,213 4,524 7,139 1,963 2,661 822 1,149 1,378 997 1,166 1,197 543

1997 4,445 6,426 4,949 7,448 9,938 4,444 5,006 8,781 2,052 3,018 793 1,156 1,807 1,210 1,258 1,156 577

94-95 13.2 29.3 30.6 22.8 51.5 18.2 34.1 14.0 23.6 16.3 15.6 13.0 10.6 7.4 40.9 29.0 472

95-96 3.6 22.2 12.2 19.8 20.5 19.1 22.7 17.7 54.6 7.6 15.5 9.3 17.2 -1.5 25.7 3.8 17.8

96-97 14.1 8.1 13.6 0.8 23.2 5.5 10.7 23.0 4.5 13.4 -3.5 0.6 31.1 21.3 7.9 -3.5 6.1

1,077 433 2,640 4,718 2,395 12,543 3,540 177 1,121 3,311

841 368 2,941 5,648 2,607 14,327 3,206 150 910 3,668

20.6 9.6 20.2 51.4 17.9 32.1 25.5 16.8 28.2 23.5

1.4 4.1 1.8 11.4 1.2 -5.9 13.5 0.1 -16.5 11.0

-21.9 -15.0 11.4 19.7 8.9 14.2 -9.4 -15.1 -18.8 4.9

1,298

1,425

1,291

4,533

9.8

-9.4

251.2

43

Table 2.2: Profits: Value & Growth, for SET Non-Financial Enterprises.

Agribusiness Building & Furnishing Materials Chemicals & Plastics Commerce Communication Electrical products & computer Electronics Energy Enetrtainment & Recreation Food & Beverages Health & Services Hotel & Travel Services Household Goods Jewelry & Ornaments Machinery & Equipment Packaging Pharmaceutical Products & Cosmetics Printing & Publishing Professional Services Property Development Pulp & Paper Textiles, Clothing & Footwear Transportation Vehicles & Parts Silo & Warehouse Others Average for non-financial sector Exclude because of outlier effect Mining Source: Based on SET data.

NET PROFITS NET PROFITS NET PROFITS NET PROFITS Value - Baht million 1994 1995 125 105 285 306 222 407 226 256 747 1,255 158 107 221 279 278 467 137 107 33 34 59 57 32 19 80 52 64 31 74 92 54 84 57 45 71 30 64 81 276 222 123 401 108 98 566 850 177 207 49 52 130 108 170 221 1996 88 171 356 232 817 142 260 616 340 -20 68 77 -171 16 121 67 43 73 62 149 -124 -26 620 186 45 25 163 1997 -268 -4,043 -6,920 -1,456 -7,551 -632 -1,252 -2,447 -16 6 -458 -379 -701 70 -347 -406 -40 -205 36 -1,920 -3,324 -528 -4,545 -614 22 -157 -1,464

94-95 -16.3 7.3 83.4 13.1 68.0 -32.4 26.2 68.2 -21.8 5.4 -2.8 -41.7 -35.2 -51.0 24.7 54.9 -21.1 -58.0 27.3 -19.7 226.3 -9.7 50.2 16.9 6.1 -17.0 13.5

% CHANGE 95-96 -16.0 -44.0 -12.5 -9.4 -34.9 33.2 -6.8 31.9 217.6 -157.8 19.9 310.8 -431.6 -49.1 31.0 -20.1 -4.3 141.8 -23.9 -32.5 -131.1 -126.6 -27.0 -10.2 -13.7 -76.8 -17.0

96-97 -404.9 -2458.4 -2042.5 -727.6 -1024.3 -544.1 -581.8 -496.9 -104.6 -130.9 -771.6 -592.0 308.9 339.1 -386.8 -703.6 -194.1 -382.8 -42.2 -1384.7 2569.9 1936.2 -833.0 -430.8 -50.8 -729.9 -379.4

27

-170

-151

-2,218

-717.0

-10.6

1364.4

44

Table 3: Changes in Assets, Sales, Net Profits (1994-96; 1994-97) for SET Non-Financial Enterprises. Table 3: Changes in Assets, Sales, Net Profits (1994-96; 1994-97) for SET Non-Financial Enterprises.

percentage change Agribusiness Building & Furnishing Materials Chemicals & Plastics Commerce Communication Electrical products & computer Electronics Energy Enetrtainment & Recreation Food & Beverages Health & Services Hotel & Travel Services Household Goods Jewelry & Ornaments Machinery & Equipment Packaging Pharmaceutical Products & Cosmetics Printing & Publishing Professional Services Property Development Pulp & Paper Textiles, Clothing & Footwear Transportation Vehicles & Parts Silo & Warehouse Others Average for non-financial sector Exclude because of outlier effect Mining Source: Based on SET data. 94-97 41.3 206.2 168.3 67.4 166.8 36.1 132.1 113.6 116.7 23.1 106.6 6.1 47.0 75.4 184.0 29.1 32.8 -14.9 1.9 56.6 185.1 52.7 54.8 54.7 15.0 -25.1 74.4 94-97 33.8 70.9 66.4 48.3 124.8 48.6 82.1 65.0 99.7 41.8 28.9 24.2 70.1 28.4 91.1 29.2 2.3 -4.6 -3.0 36.3 101.9 30.0 42.0 29.0 -0.8 -13.1 45.1

Assets 94-96 29.7 80.2 88.5 45.0 97.9 40.9 86.9 58.8 87.3 13.9 76.2 5.9 49.8 18.2 87.1 26.0 37.1 37.6 21.1 45.7 62.4 19.4 28.7 46.0 25.0 -7.2 46.5

Sales 94-96 17.3 58.0 46.5 47.1 82.6 40.8 64.6 34.2 91.1 25.1 33.6 23.5 29.7 5.9 77.1 33.9 25.0 22.3 14.1 22.3 68.7 19.4 24.3 42.4 16.9 7.0 37.4

Net-Profits 94-96 -29.6 -39.9 60.4 2.4 9.4 -10.0 17.6 121.9 148.4 -160.9 16.6 139.6 -314.8 -75.1 63.3 23.8 -24.5 1.7 -3.1 -45.8 -201.3 -124.0 9.6 4.9 -8.4 -80.7 -19.2

94-97 -314.5 -1,516.7 -3,216.2 -742.7 -1,111.1 -499.8 -666.6 -980.8 -111.3 -81.2 -882.9 -1,279.0 -978.4 9.5 -568.4 -847.3 -171.0 -387.5 -44.0 -796.2 -2,805.3 -588.3 -903.0 -447.1 -55.0 -221.3 -777.2

-3.8

134.7

-0.6

249.2

-651.3

-8172.8

45

Figure 3: Change in Assets, Sales & Net Profits (intervals 1994-96; 1994-97)
100.0

80.0

60.0

40.0

20.0

0.0

Assets

Sales -20.0

Net Profits

-40.0

-60.0

-80.0 -777.2 -100.0 94-96 Source: Based on SET data. 94-97

46

Figure 4: Change in Assets, Sales & Net Profits: Selected Sectors (intervals 1994-96; 1994-97)
100.0 206.2 80.0

60.0

40.0

Assets 94-96

20.0

Assets 94-97

Sales 94-96

Sales 94-97

Net-Profits 94-96

-20.0

Net-Profits 94-97

-40.0

-60.0

-80.0 -1516.7 -100.0

Building & Furnishing Materials

-314.8 -499.8 -978.4

Electrical products Household Goods & computer Pharmaceutical Products & Cosmetics

-124.0 -171.0
Property Development

-796.2

-588.3
Textiles, Clothing & Footwear

Average

Source: Based on SET data.

47

0.0

Figure 5: Average Percent Change in Tangible Fixed Assets, 1993-1996

35

30

25

20

15

10

* average for 1992 - 1995 Source: from Pomerleano [13]

48

Figure 6: Average Percent Debt Financing of New Investment, 1993-1996

100

80

60

40

20

-20
Thailand Korea Indonesia Taiwan Malaysia Hong Kong Singapore Philippines Latin America Japan

USA

Germany

France

Source: from Pomerleano [13]

49

Table 4: Leverage or Financial Risk for SET Non-Financial Enterprises; Debt/Equity (D/E) Ratio and Interest Coverage Table 4: Leverage or Financial Risk for SET Non-Financial Enterprises; Debt/Equity (D/E) Ratio and Interest Coverage Table 4: Leverage or Financial Risk for SET Non-Financial Enterprises; Debt/Equity (D/E) Ratio and Interest Coverage Table 4: Leverage or Financial Risk for SET Non-Financial Enterprises; Debt/Equity (D/E) Ratio and Interest Coverage

Agribusiness Building & Furnishing Materials Chemicals & Plastics Commerce Communication Electrical products & computer Electronics Energy Enetrtainment & Recreation Food & Beverages Health & Services Hotel & Travel Services Household Goods Jewelry & Ornaments Machinery & Equipment Mining Packaging Pharmaceutical Products & Cosmetics Printing & Publishing Property Development Pulp & Paper Textiles, Clothing & Footwear Transportation Vehicles & Parts Silo & Warehouse Others Total non-financial sectors - average Exclude because of outlier effect Professional Services Source: Based on SET data.

Debt/Equity Ratio 1994 1995 1.12 1.49 1.95 2.10 1.07 1.32 1.44 1.65 1.03 1.28 1.92 2.38 1.52 1.07 1.24 1.40 0.30 0.53 1.85 2.07 0.64 1.08 0.90 0.85 1.95 2.44 1.25 1.41 1.11 0.99 0.80 0.98 1.27 1.43 0.27 0.54 0.95 1.52 1.75 1.81 1.78 1.90 1.00 1.36 3.06 2.67 1.94 2.45 0.40 0.47 1.59 1.88 1.31 1.50 1996 1.60 2.74 1.79 1.50 1.85 2.28 1.53 1.51 0.29 2.18 1.26 0.79 3.73 1.62 1.02 0.86 1.45 0.60 1.53 1.92 2.65 1.46 2.87 1.64 0.58 1.98 1.66 1997 2.56 5.14 5.15 4.53 9.17 5.08 6.72 3.90 0.49 1.69 3.88 0.99 3.62 1.91 3.80 4.36 5.47 0.74 2.34 4.13 3.12 2.53 N.M. 4.12 0.48 1.46 3.50 1994 3.51 2.78 2.65 3.57 5.79 3.29 4.18 3.36 10.66 1.81 6.47 1.66 2.56 2.71 8.45 2.94 3.02 18.32 3.54 5.55 1.87 3.67 1.82 4.62 11.16 2.31 4.70

Interest Coverage 1995 1996 2.52 1.98 2.07 1.52 3.47 2.62 3.03 2.77 5.13 2.97 2.11 2.21 4.00 3.34 2.62 2.65 7.66 13.85 1.83 1.25 3.80 2.65 1.34 1.82 1.72 0.06 1.45 1.21 4.90 4.87 -0.89 -0.45 3.20 2.75 7.72 3.49 1.73 1.96 3.26 2.23 2.48 0.73 2.38 0.88 2.10 1.89 3.78 3.75 10.93 7.12 1.64 1.21 3.31 2.74

1997 2.01 0.62 -0.49 -0.08 1.00 0.82 -2.63 2.06 5.90 3.16 0.52 0.60 1.33 0.47 0.84 1.18 0.86 0.92 -0.66 -0.28 1.60 0.84 -1.30 0.83 3.17 0.56 0.92

0.63

0.56

0.68

0.42

466.06

98.67

37.30

28.59

50

Figure 7: Change in Interest Coverage for Selected Sectors (1994-96; 1997)

10.0

8.0

6.0

1994 4.0

1996

1997 2.0

0.0

-2.0

-4.0
Average Building & Furnishing Materials Commerce Communication Electrical products & computer Electronics Health & Services

Machinery & Equipment

Textiles & Clothing

Source: Based on SET data

51

Figure 8: Interest Coverage, 1996

30

25

20

15

10

0
Latin America Hong Kong Singapore USA Germany Malaysia France Japan Taiwan Philippines

Indonesia

Thailand

Korea

Source: from Pomerleano [13]

52

Figure 9: Change in Debt/Equity Ratio for Selected Sectors (1994-96; 1997)

10.0 9.0

8.0 7.0 6.0 5.0

1994 4.0 3.0 2.0

1996

1997

1.0 0.0 Average Building & Furnishing Materials Chemicals Communication Electrical products & computer Health & Services

Household Goods

Pulp & Paper

Source: Based on SET data.

53

Figure 10: Increase in Leverage, 1992 vs 1996

180

160

140

120

100

80

1992

1996 60

40

20

0 Hong Kong * Data for 1992 vs 1995 Source: from Pomerleano [13] Indonesia Korea* Malaysia Philippines Singapore

Taiwan

Thailand

54

Figure
90

11:

Current

Liabilities/Total

Liabilities,

1992-1996

Average

80

70

60

50

40

30

20

10

0
Singapore Taiwan Malaysia Thailand Hong Kong Japan Philippines Korea* Indonesia France

Latin America

USA

Germany

Source: from Pomerleano [13]

55

Table 5: Profitability of SET Non-Financial Enterprises: Net Profit Margin (%), Total Asset Turnover (times). Table 5: Profitability of SET Non-Financial Enterprises: Net Profit Margin (%), Total Asset Turnover (times).

Net Profit Margin 1994 3.77 7.59 7.47 4.51 16.90 5.29 8.04 5.22 13.33 1.54 9.51 3.45 7.51 6.82 11.25 2.12 6.07 12.33 8.10 16.81 12.78 4.39 5.39 5.61 7.12 14.38 12.36 8.14 1995 2.79 6.30 10.48 4.15 18.74 3.02 7.57 7.70 8.44 1.39 8.00 1.78 4.40 3.11 9.96 -11.89 7.29 8.25 2.82 19.53 8.54 9.47 4.13 6.37 6.63 14.62 8.01 6.73 1996 2.26 2.89 8.18 3.14 10.12 3.38 5.74 8.63 17.33 -0.75 8.30 6.70 -12.43 1.61 10.38 -11.74 5.62 7.45 6.73 14.28 5.66 -2.64 -1.08 4.94 5.25 11.95 2.22 4.60 1997 -6.04 -62.93 -139.83 -19.54 -75.98 -14.23 -25.01 -27.87 -0.76 0.20 -57.79 -32.74 -38.77 5.81 -27.58 -48.94 -35.13 -8.57 -24.39 9.71 -65.28 -58.85 -20.26 -31.73 -19.16 5.85 -17.26 -31.00 1994 1.48 0.55 0.39 0.99 0.23 0.96 1.21 0.51 0.55 1.17 0.49 0.22 0.51 0.61 0.75 0.40 0.61 0.71 0.44 0.61 0.26 0.36 0.66 0.47 0.96 14.38 0.26 1.14

Total Asset Turnover 1995 1.49 0.58 0.41 1.03 0.29 1.00 1.36 0.53 0.56 1.29 0.45 0.23 0.49 0.61 0.87 0.43 0.72 0.74 0.46 0.59 0.28 0.48 0.70 0.55 1.01 14.62 0.31 1.19

Agribusiness Building & Furnishing Materials Chemicals & Plastics Commerce Communication Electrical products & computer Electronics Energy Enetrtainment & Recreation Food & Beverages Health & Services Hotel & Travel Services Household Goods Jewelry & Ornaments Machinery & Equipment Mining Packaging Pharmaceutical Products & Cosmetics Printing & Publishing Professional Services Property Development Pulp & Paper Textiles, Clothing & Footwear Transportation Vehicles & Parts Silo & Warehouse Others Total non-financial sectors - average Source: Based on SET data.

1996 1.35 0.53 0.34 1.03 0.27 1.01 1.23 0.49 0.61 1.30 0.39 0.24 0.47 0.55 0.82 0.40 0.66 0.66 0.39 0.59 0.23 0.43 0.65 0.45 0.97 11.95 0.28 1.05

1997 1.46 0.39 0.34 0.97 0.26 0.99 1.05 0.45 0.54 1.43 0.34 0.27 0.60 0.51 0.62 0.81 0.64 0.58 0.37 0.51 0.25 0.33 0.65 0.47 0.87 5.85 0.32 0.81

56

40

Figure 12: Change in Net Profit Margin for Selected Sectors (1994-96; 1997)

20

-20

1994

1996

1997 -40

-60

-80
Average Communication Household Goods Pharmaceutical Products

Pulp & Paper

Source: Based on SET data.

57

Table 6: Profitability of SET Non-Financial Enterprises: Return on Equity (ROE, %) and Return on Assets (ROA, %)

Return on Equity 1994 12.43 13.05 6.39 11.64 9.96 15.27 25.08 6.26 10.05 5.29 8.30 1.63 11.82 9.58 18.98 1.59 8.82 11.78 7.64 17.91 10.12 4.59 7.74 11.01 22.67 14.38 10.59 10.91 1995 10.18 11.83 10.36 11.88 14.58 9.87 23.48 10.26 7.07 5.52 7.41 0.88 7.32 4.67 18.64 -10.37 12.93 9.09 3.19 21.40 7.33 13.47 6.85 13.72 24.24 14.62 8.68 10.34 1996 8.28 5.62 7.69 9.08 8.09 11.66 16.58 11.31 16.09 -3.16 7.83 3.45 -25.05 2.36 17.76 -9.68 9.58 8.44 7.48 15.09 4.26 -3.78 -1.84 8.74 17.07 11.95 2.24 6.19 1997 -27.83 -128.11 -172.18 -69.55 -103.83 -63.39 -108.89 -46.39 -0.61 0.86 -64.67 -18.04 -110.93 8.85 -55.41 -150.81 -81.36 -8.28 -28.16 8.59 -64.44 -78.54 -41.32 N.M. -62.97 5.85 -16.25 -56.84 1994 5.67 4.30 3.06 4.67 4.73 5.18 9.96 2.78 7.73 1.84 4.83 0.83 3.98 4.21 8.90 0.88 3.84 9.29 3.91 10.98 3.63 1.64 3.76 2.71 7.37 10.01 4.09 4.99

Return on Assets 1995 4.26 3.81 4.66 4.55 6.43 3.11 10.49 4.38 4.94 1.85 3.78 0.46 2.27 1.98 9.04 -5.43 5.43 6.39 1.42 13.38 2.59 4.71 3.04 3.58 7.19 9.93 3.15 4.50

Agribusiness Building & Furnishing Materials Chemicals & Plastics Commerce Communication Electrical products & computer Electronics Energy Enetrtainment & Recreation Food & Beverages Health & Services Hotel & Travel Services Household Goods Jewelry & Ornaments Machinery & Equipment Mining Packaging Pharmaceutical Products & Cosmetics Printing & Publishing Professional Services Property Development Pulp & Paper Textiles, Clothing & Footwear Transportation Vehicles & Parts Silo & Warehouse Others Total non-financial sectors - average Source: Based on SET data.

1996 3.16 1.60 2.98 3.45 3.00 3.50 7.17 4.53 11.57 -1.00 3.47 1.83 -6.18 0.93 8.74 -4.94 3.88 5.26 2.95 9.25 1.45 -1.15 -0.74 2.32 5.42 7.67 0.76 3.00

1997 -8.97 -25.06 -41.81 -19.21 -20.58 -14.94 -26.94 -13.14 -0.43 0.29 -19.78 -9.27 -23.57 3.14 -17.70 -43.14 -22.53 -4.89 -10.10 5.52 -16.73 -19.81 -13.50 -15.36 -17.02 3.75 -5.93 -14.73

58

Figure 13: Change in ROA for Selected Sectors (1994-96; 1997)

15.0

10.0

5.0

0.0

-5.0

-10.0

1994 -15.0

1996

1997 -20.0

-25.0

-30.0
Average Building & Furnishing Materials Communication Electrical products & computer Household Goods Pharmaceutical Products Property Development

Pulp & Paper

Textiles & Clothing

Source: Based on SET data.

59

Figure 14: Average ROCE Before Tax, 1992-1996

25

20

15

10

* average for 1992 - 1995 Source: from Pomerleano [13]

60

Figure 15: Change in ROE for Selected Sectors (1994-96; 1997)

40.0

20.0

0.0

-20.0

-40.0

1994

-60.0

1997

-80.0

-100.0

-120.0

-140.0 Average Building & Furnishing Materials Electronics Household Goods Property Development

Pulp & Paper

Textiles & Clothing

Source: Based on SET data.

61

1996

Figure 16: Comparative Return on Equity, 1992-1996 Average

30

25

20

15

10

0
Hong Kong Malaysia Indonesia USA Taiwan Philippines Thailand Singapore Latin America Korea*

Germany

France

Japan

* average for 1992 - 1995 Source: from Pomerleano [13]

62

Figure 17: Average Economic Value Added, 1992-1996

Philippines Indonesia Thailand* Germany France Korea* Japan Singapore Malaysia USA Hong Kong -15 -10 -5 0 5

10

15

Source: from Pomerleano [13]

* Korea average 92-95, Thailand average 92-94

63

Figure 18: Financial Fragility, 1996

8

0
Hong Kong Malaysia USA Germany Philippines Taiwan Singapore Indonesia Japan Latin America

France

Korea*

Thailand

* data for 1995 Source: from Pomerleano [13]

64

Table 7: Inventory Turnover for SET Non-Financial Enterprises

Agribusiness Building & Furnishing Materials Chemicals & Plastics Commerce Communication Electrical products & computer Electronics Energy Enetrtainment & Recreation Food & Beverages Health & Services Hotel & Travel Services Household Goods Jewelry & Ornaments Machinery & Equipment Mining Packaging Pharmaceutical Products & Cosmetics Printing & Publishing Property Development Pulp & Paper Textiles, Clothing & Footwear Transportation Vehicles & Parts Silo & Warehouse Others Total non-financial sectors - average Exclude because of outlier effect Professional Services Source: Based on SET data.

1994 7.9 3.0 3.0 5.9 7.1 4.6 5.2 7.1 4.2 4.8 20.4 10.6 2.2 1.6 2.5 1.6 3.2 3.0 4.8 0.6 2.8 3.7 11.8 6.0 0.0 1.6 5.0

1995 7.6 3.3 3.5 6.3 6.3 4.4 5.9 7.7 4.4 5.3 20.9 11.3 2.3 1.4 2.9 2.7 3.8 3.3 5.4 0.6 3.0 3.7 14.6 5.5 0.0 1.9 5.3

1996 6.7 3.3 3.4 6.3 5.9 4.2 6.2 7.5 4.3 5.4 21.5 10.7 2.6 1.3 2.8 3.4 3.8 3.3 5.1 0.5 2.8 3.6 11.1 4.4 0.0 1.6 5.1

1997 6.6 3.0 4.0 6.0 6.0 4.8 6.5 7.5 4.4 5.8 20.5 10.2 2.9 1.6 2.0 3.9 3.7 3.4 5.1 0.6 2.8 3.8 8.8 3.5 0.0 1.8 5.0

Average 94-96 7.4 3.2 3.3 6.2 6.4 4.4 5.8 7.4 4.3 5.2 20.9 10.8 2.4 1.4 2.7 2.6 3.6 3.2 5.1 0.6 2.8 3.7 12.5 5.3 0.0 1.7 5.1

94-97 7.2 3.2 3.5 6.1 6.3 4.5 6.0 7.4 4.3 5.3 20.8 10.7 2.5 1.5 2.5 2.9 3.6 3.2 5.1 0.6 2.8 3.7 11.6 4.8 0.0 1.7 5.1

74.9

96.0

183.1

84.8

144.4

13.2

65

Figure 19: Inventory Turnover (average 1994-97)

8.0

7.0

6.0

5.0

4.0

3.0

2.0

1.0

0.0 Building & Furnishing Materials Source: Based on SET data. Chemicals & Plastics Household Goods Machinery & Equipment Packaging Pharmaceutical Products & Cosmetics

Pulp & Paper

Textiles, Clothing & Footwear

66

ISEAS WORKING PAPERS I. ISEAS Working Papers on Economics and Finance (ISSN 0218-8937)
1(96): Nick J. Freeman, Portfolio Investment in Vietnam: Coping Without a Bourse, February 1996 2(96): Reza Y. Siregar, Inflows of Portfolio Investment to Indonesia: Anticipating the Challenges Facing the Management of Macroeconomy, March 1996 3(96): Helen Hughes, Perspectives for an Integrating World Economy: Implications for Reform and Development, May 1996 4(96): Carolyn L. Gates, Enterprise Adjustment and Economic Transformation: Industrial Enterprise Behaviour and Performance in Vietnam during Stabilization and Liberalization, June 1996 5(96): Mya Than, The Golden Quadrangle of Mainland Southeast Asia: A Myanmar Perspective, July 1996 1(99): Myat Thein, Improving Resource Mobilization in Myanmar, January 1999 2(99): Anita G. Doraisami, The Malaysian Currency Crisis: Causes, Policy Response and Future Implications, February 1999 3(99): George Abonyi, Thailand: From Financial Crisis to Economic Renewal, March 1999

II. ISEAS Working Papers on International Politics and Security Issues (ISSN 0218-8953)
1(96): Derek da Cunha, The Need for Weapons Upgrading in Southeast Asia: Present and Future, March 1996 1(97): Simon J. Hay, ASEANs Regional Security Dialogue Process: From Expectation to Reality?, March 1997 1(99): Sorpong Peou, The ASEAN Regional Forum and Post-Cold War IR Theories: A Case for Constructive Realism?, January 1999 2(99): Sheng Li Jun, China and the United States as Strategic Partners into the Next Century, February 1999 3(99): Jrgen Haacke, Flexible Engagement: On the Significance, Origins and Prospects of a Spurned Policy Proposal, February 1999

III. ISEAS Working Papers on Social and Cultural Issues (ISSN 0218-8961)
1(96): Federico V. Magdalena, Ethnicity, Identity and Conflict: The Case of the Philippine Moros, April 1996 1(98): Patricia Lim, Myth and Reality: Researching the Huang Genealogies, June 1998 2(98): M. Thien Do, Charity and Charisma: The Dual Path of the Tinh D Cu Si, a Popular Buddhist Group in Southern Vietnam, September 1998

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Editorial Committee Carolyn L. Gates Derek da Cunha Leonard Sebastian Naimah S. Talib

Papers in this series are preliminary in nature and are intended to stimulate discussion and critical comments. The Editorial Committee accepts no responsibility for facts presented and views expressed, which rests exclusively with the individual author. No part of this publication may be produced in any form without permission. Comments are welcomed and may be sent to the author at the Institute of Southeast Asian Studies.

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