ASIAN DEVELOPMENT BANK SES:THA 99020

SPECIAL EVALUATION STUDY

INTERIM ASSESSMENT OF ADB’S LENDING

TO THAILAND

DURING THE ECONOMIC CRISIS

December 1999

CURRENCY EQUIVALENTS

Currency Unit – Baht (B)

ABBREVIATIONS

ADB – Asian Development Bank APFM – Association of Provident Fund Managers BAAC – Bank of Agriculture and Agricultural Cooperatives BIBF – Bangkok International Banking Facilities BOP – balance-of-payments BOT – Bank of Thailand BSDC – Bangkok Stock Dealing Center CDD – Child Development Department DOSRI – directors, officers, stockholders and related interests EFF – Export Financing Facility EM – exploratory mission EXIM – Export-Import Bank of Thailand FMRPL – Financial Markets Reform Program Loan FPO – Fiscal Policy Office FSRA – Financial Sector Regulating Authority IMF ? International Monetary Fund JEXIM ? Export-Import Bank of Japan LOI – letter of intent MOE – Ministry of Education MOF ? Ministry of Finance MOI – Ministry of Interior MOLSW – Ministry of Labor and Social Welfare NESDB – National Economic and Social Development Board OAG – Office of the Auditor General of Thailand OEO – Operations Evaluation Office PCI – participating credit institutions PCMC – Program Coordinating and Monitoring Committee PPR – program/project performance report RRP – report and recommendation of the president RECP – Rural Enterprise Credit Project SEC – Securities and Exchange Commission SEM – special evaluation mission SET – Stock Exchange of Thailand SES – special evaluation study SME – small- and medium-scale enterprise SSPL – Social Sector Program Loan TA – technical assistance TAO – Tambon Administrative Office

NOTES

(i) The fiscal year (FY) of the Government ends on 30 September. (ii) In this report, “$” refers to US dollars.

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Operations Evaluation Office, SS-39

CONTENTS

Page

BASIC DATA ii EXECUTIVE SUMMARY vi

I. INTRODUCTION 1

A. Background 1 B. SES Objectives and Scope 2 C. Overview of ADB’s Crisis Operations in Thailand 2

II. RURAL ENTERPRISE CREDIT PROJECT 6

A. Background 6 B. Rural Credit Market Conditions 7 C. Funding Conditions 8 D. Performance of Subprojects 9 E. Key Findings 11

III. FINANCIAL MARKETS REFORM PROGRAM LOAN 13

A. Background 13 B. Program Implementation and Scope of SES 13 C. Key Findings 15

IV. SOCIAL SECTOR PROGRAM LOAN 17

A. Background 17 B. Program Implementation 17 C. Scope and Approach of the SES 18 D. Key Findings 19

V. EXPORT FINANCING FACILITY 21

A. Background 21 B. Project Implementation 22 C. Financial Market Environment 23 D. Project Design, Deal Structure and Administration 25 E. Financial Implications for EXIM 25 F. Key Findings 26

VI. CONCLUSION 28

APPENDIXES 27

BASIC PROJECT/PROGRAM DATA

Rural Enterprise Credit Project (Loan 1540-THA)

TECHNICAL ASSISTANCE ACTIVITIES: none Major Objectives and Scope The Project aims to (i) finance about 54,000 profitable rural enterprises

owned and operated by farm families, and (ii) strengthen BAAC's processing and supervision capacity, and improve services to clients for rural enterprises. The Project will cover 44 provinces identified as economically depressed.

Purpose of Loan For BAAC's relending to eligible subborrowers KEY DATES Appraisal 10-20 Jul 1997 Board Approval 18 Sep 1997 Loan Signing 29 Sep 1997 Loan Effectiveness 26 Nov 1997 Estimated Completion 31 Aug 2002 (Undisbursed balance of the loan was cancelled in Oct 1999) Latest Review Mission Mar 1999 Next Review Mission Feb 2000 KEY PROJECT DATA Total Project Cost $440 million Foreign Exchange Cost $200 million Local Currency Cost $240 million Bank Loan Amount $200 million Bank Loan Disbursed $94 million No. of Review Missions 2 (completed) Project Performance Report Project Rating (as of 31 Oct 1999) Implementation Satisfactory Development Objectives Satisfactory EXECUTING AGENCY Bank of Agriculture and Agricultural Cooperatives (BAAC)

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Financial Markets Reform Program Loan (FMRPL) (Loan 1600-THA) TECHNICAL ASSISTANCE ACTIVITIES AS PART OF THE PROGRAM TA No. TA Project Name Type1 Amount Approval Date TA 2955 Pension and Provident Funds Reform Activities A&O $1,150,000 19 Dec

1997 TA 2956 Strengthening Information Disclosure and Compliance A&O $ 440,000 19 Dec 1997 TA 2957 Asset Securitization A&O $ 410,000 19 Dec 1997 Major Objectives & Scope The FMRPL aims to (i) strengthen market regulation and supervision,

(ii) improve risk management, (iii) diversify the means of intermediating funds within the economy and develop the securities market, and (iv) develop long-term institutional sources of funds.

Purpose of Loan To finance a broad range of imports required during Program

implementation. The counterpart funds to be generated out of the loan will be used to meet the costs of adjustment, program expenditures, related costs of financial markets reform, and high priority needs of the private sector.

KEY DATES Appraisal 27 Oct-7 Nov 1997 Board Approval 19 Dec 97 Loan Signing 19 Dec 97 Loan Effectiveness 22 Dec 97 Estimated Completion Dec 99 Latest Review Mission Oct 99 Next Review Mission To be determined

KEY PROJECT DATA Bank Loan Amount $300 million Bank Loan Disbursed $300 million No. of Review Missions 4 (completed) Program Performance Report Project Rating (as of 31 Oct 1999) Implementation Satisfactory Development Objectives Satisfactory

EXECUTING AGENCY: Ministry of Finance (MOF)

1 A&O = advisory and operational

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Social Sector Program Loan (SSPL) (Loan 1611-THA)

TECHNICAL ASSISTANCE ACTIVITIES AS PART OF THE PROGRAM TA No. TA Project Name Type2 Amount Approval Date TA 2995 Capacity Building for Social Activities Sector Reform A&O $700,000 12 Mar 1998 TA 2996 Education Management and Financing Study A&O $700,000 12 Mar 1998 TA 2997 Health Management and Financing Study A&O $700,000 12 Mar 1998 Major Objectives and Scope The SSPL's objectives are (i) mitigating the short-term adverse impact of

the current crisis on society, (ii) adopting structural reforms to enhance competitiveness, and (iii) reducing inefficiencies in the provision of social services.

Purpose of Loan To finance a broad range of imports required during Program

implementation. Local currency proceeds of the loan will be used by the Government to support the social sector in general, and its reforms to be initiated or implemented under the program in particular.

KEY DATES Appraisal 12-16 Jan 1998 Board Approval 12 Mar 1998 Loan Signing 13 Mar 1998 Loan Effectiveness 17 Mar 1998 Estimated Completion 01 Sep 1999 Latest Review Mission Sep 1999 Next Review Mission To be determined

KEY PROJECT DATA Bank Loan Amount $500 million Bank Loan Disbursed $500 million No. of Review Missions 5 Program Performance Report Project Rating (as of 31 Oct 1999) Implementation Satisfactory Development Objectives Satisfactory

EXECUTING AGENCY Ministry of Finance (MOF)

2 A&O = advisory and operational

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Export Financing Facility Project (Loan 1612-THA)

Technical Assistance None Major Objectives and Scope The Project aims to provide credit to the private enterprise export sector

and assist the Government and the banking system to allocate appropriate resources to this sector.

Purpose of Loan For direct lending to export-related enterprises (25 percent of the loan)

and the balance for lending to eligible participating credit institutions. KEY DATES Appraisal 26-30 Jan 1998 Board Approval 26 Mar 1998 Loan Signing 01 Apr 1998 Loan Effectiveness 30 Jun 1998 Estimated Completion Prepaid on 17 Sep 99 Latest Review Mission Sep 1998 Next Review Mission To be determined

KEY PROJECT DATA Total Project Cost $1 billion ($950 million is syndicated loan) Bank Loan Amount $50 million Bank Loan Disbursed $50 million

$200 million (including the syndicated loan) No. of Review Missions 1 (completed)

Project Peformance Report Project Rating (as of 31 Oct 1999) Implementation Satisfactory Development Objectives Satisfactory

EXECUTING AGENCY Export-Import Bank of Thailand (EXIM)

EXECUTIVE SUMMARY

More than two years have passed since the onset of the Asian financial crisis. The crisis was triggered by the abandonment of a peg to a currency basket in Thailand, reflecting the country’s growing external imbalances and financial sector weaknesses. With international support, including that from the Asian Development Bank (ADB), the Thai Government has made significant progress in laying the foundation for the resurgence of sustained economic growth. In the eighth Letter of Intent (LOI) of 21 September 1999, the Finance Minister of Thailand informed the International Monetary Fund (IMF) that he did not expect to make further drawdown from the official financing package, although the country would retain the option to do so. The latest LOI implies the Thai economy’s entrance to a new stage, where structural issues still remain but full recovery from the economic crisis is in sight. For its part, ADB’s cumulative loan disbursements to Thailand beginning in September 1997 (the Tokyo Pledging Meeting was in August 1997) reached the pledged amount of $1.2 billion in October 1999. This report is the first independent internal review of ADB’s response to the Asian financial crisis. It focuses on the experience of Thailand, the first crisis-hit country, so as to draw tentative lessons from the ongoing operations for future practice. The assistance consisting of projects and programs had to be formulated in the shortest time possible, at the same time ensuring that much-needed reforms are put in place. Considering such circumstances, both the Government and the Operations Evaluation Office (OEO) view the overall contributions of ADB to Thailand during the crisis as adequate, timely, and appropriate. Given the interim status of the projects/programs, the report takes an issue-oriented approach, examining inputs and tentative outputs instead of impacts. Therefore, a performance rating for each loan and for the lending package as a whole cannot be provided. Instead, this report focuses largely on the specific performance aspects of the core crisis lending operations, i.e., Rural Enterprise Credit Project (RECP), Financial Markets Reform Program Loan (FMRPL), Social Sector Program Loan (SSPL), and Export Financing Facility (EFF). A collaborative arrangement was made with the Office of the Auditor General of Thailand on this study, reflecting the growing emphasis on governance and participation, both in the country and in ADB.

In defining the scope of the study, the objectives of the respective loans, implementation status, and particular issues raised by the executing agencies were considered. As regards the EFF and the RECP, the issues that the executing agencies encountered during implementation, and reasons for underutilization of loans are looked into. The relevance of the program outputs and issues regarding some conditionalities are covered in the chapter on the FMRPL. The efficacy and efficiency of public sector spending, especially the performance of SSPL-funded subprojects, are assessed in light of its first objective, i.e., mitigation of the short-term adverse impact of the crisis on the most vulnerable groups and the unemployed. RECP was conceptualized in response to the existing resource gap in the rural credit market before the crisis. Towards the final stage of formulation, the loan amount was raised in consideration of the crisis factors. The initial impact of the crisis on the Bank of Agriculture and Agricultural Cooperatives (BAAC), the executing agency of the RECP, was the rise in funding costs and a lower growth rate of deposits. By mid-1998, domestic interest rates started to decline and deposits started coming in. Domestic credit then declined and the portfolio quality started to deteriorate. The risk, associated with the currency mismatch between assets and liabilities, significantly increased with the floating of the baht. These factors contributed to underutilization of the RECP. The experience with the RECP highlights the risk of underutilization associated with volatile domestic financial markets during a crisis, particularly

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for projects with dual purposes, e.g., balance-of-payment support for a country and funding support for a financial institution.

EFF, as one of the largest syndicated loans to an Asian borrower, signaled Thailand’s

return to the international financial market. This demonstrated that the partial guarantee scheme of ADB could be an effective instrument under certain market conditions. However, the factors causing the underutilization of the RECP also applied to the EFF. Both projects were to meet a portion of the resource gap and involved onlending activities. Nonetheless, some major differences in the structure of these two loans existed. First, BAAC played a dominant role, and thus was a price setter in the rural credit market, in contrast to the limited role of the Export-Import Bank of Thailand (EXIM), functioning as a price taker in the trade finance market. Thus, the lending rates of EXIM are more sensitive than those of BAAC. These differences together with the difference in the timing of the loan approval and effectiveness, were reflected in the varying utilization of the two loans. Second, the risk factors associated with the ADB loans were different. Risks associated with currency mismatches were BAAC’s main concern, while the financial costs of underutilization were the risk for EXIM, due to the size of the arrangement fee, which had to be paid up-front. Third, the impact of the downtrend in commercial credits, accelerated by the introduction of strict asset classification and provisioning norms for banks, was apparently more significant for the EFF. Lastly, being a large-scale syndication deal, difficulty in prompt consensus building when adjusted arrangements were needed during implementation, was a specific issue for the EFF.

Achievements in capital market reforms over the past two years were remarkable and went beyond the scope of the FMRPL due to the strong authorship and the implementation capacity of the Securities and Exchange Commission (SEC). The program outputs were relevant and laid the foundations for the far-reaching reforms. However, without specific performance indicators to monitor, ADB’s program reviews tended to focus narrowly on the status of compliance with the program measures, rather than on the implications (and further progress) of these measures. Meanwhile, the delay in amending the SEC Act hindered full compliance with several other related program requirements under the component for market regulation and supervision. The experience with the SSPL demonstrates that policy-based lending in the social sector can be an effective instrument during a crisis. Among the key factors for the successful implementation to date are: (i) effective combinations of short- and medium-term measures; (ii) provision of extensive support for program implementation; and (iii) the Government’s keen attention to the effective use of counterpart funds generated under the loan. More efficient implementation of social sector projects, which aim to mitigate the impacts of the crisis on a vulnerable group, would require consideration of the following: (i) beneficiary targeting and identification, (ii) timely distribution of funds, (iii) beneficiary participation, (iv) clarity in the mandate of a targeted institution and terms of reference of expected project participants, (v) implementing agencies' capacity for project management and monitoring, and (vi) availability of performance benchmarks to measure the achievement of project objectives. The study draws some tentative lessons learned on crisis lending operations in general. High volatility in financial variables is one of the key risks in project lending through financial intermediaries, as in the cases of RECP and EFF. When a banking crisis is involved, a credit crunch and excess liquidity in a banking system are potential impediments in the utilization of a loan. In addition, when an abandonment of a currency peg is involved, there is change in risk profile due to currency mismatches between banks’ assets and liabilities. Meanwhile, the experience with the EFF highlighted the need for a review of the business processes in dealing with a large syndication deal, to ensure swift consensus building internally and among lenders in responding to changing circumstances. Policy-based lending can be an effective instrument not only in the financial and other economic sectors but also in the social sector. In supporting

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social safety nets through a program loan, the Government’s keen attention to the effective and efficient use of counterpart funds is critical.

It is noted that most of the issues identified in this SES were discussed—at the very least, mentioned—during formulation of the loans reviewed. However, some of them were not fully resolved partly because the formulation process for most loans had to be streamlined. This was understandable in the light of the emergency situation brought about by the crisis. Nevertheless, the discussion of unsolved issues could have been continued during the implementation of these loans. In this regard, establishment of an enhanced monitoring framework, which considers all the issues raised at formulation and the volatile economic environment, is essential to crisis lending operations. The experience of the four loans also highlighted the need for performance indicators (which should be clearly defined, and monitored by both the executing agencies and ADB). In addition, the importance of (i) conducting economic and sector studies, generating timely and reliable socioeconomic data, and (ii) timely monitoring of key financial variables, were also highlighted.

I. INTRODUCTION

A. Background

1. In July 1997, Thailand was hit by a severe crisis that initially emanated from the foreign exchange market. The rapid withdrawal of substantial amounts of short-term liabilities created balance-of-payments (BOP) difficulties and forced the abandonment of a peg to a currency basket, mainly the US dollar. Despite efforts to stem the crisis, it quickly spread to engulf the entire financial sector, where a tight monetary policy (to defend the baht) pricked a lending bubble and pushed many finance companies and banks toward insolvency. What followed was a deep recession that spread to virtually all sectors of the economy (Box 1). 2. At the early stage of the economic crisis, the Thai Government committed itself to a stabilization and far-reaching reform program while seeking significant external assistance. This resulted in the Tokyo Pledging Meeting in August 1997, which was coordinated by the International Monetary Fund (IMF). The total support package of $17.2 billion, consisting of IMF’s standby arrangement and assistance from other multilateral and bilateral sources, was announced during the Tokyo meeting. The responsibility for overseeing the policy support aspects of the Program was divided among IMF, World Bank, and the Asian Development Bank (ADB). IMF was responsible for macroeconomic policy and bank restructuring, the World Bank for preparing the resolution framework for finance companies and corporate debt restructuring, and ADB for the capital market reform and the social sector. 3. Despite the Government’s strict adherence to the stabilization program since August 1997, the economy continued to be fragile. By early 1998, the recession became one of the major concerns, as exemplified by the exchange rate bottoming out at B53-B54 to the dollar in January 1998, and the growth projection being adjusted downward in the second and third Letters of Intent (LOIs) of November 1997 and February 1998, respectively. The economy began to restabilize in the second quarter of 1998. Since then, measures to accelerate the restructuring of the financial sector have moved to center stage, complemented by measures to cushion vulnerable groups against the impact of recession and to revitalize the real sector. The Government’s economic policies gradually moved from stabilization to easing some of the tight fiscal and monetary targets so as to bring about early recovery. These policies started to bear fruit, with a range of indicators showing that the economy has been moving upward since early 1999. 4. In the eighth LOI of 21 September 1999, the Finance Minister of Thailand informed the IMF that he did not expect to make further drawdown from the official financing package, although the country would retain the option to do so. That official statement indicated strong confidence that the country’s financial stability and growth prospects were reaching a comfortable level and that the Government no longer required liquidity support. But as the risks remain—especially in terms of slow progress in reducing the nonperforming loans—the Finance Minister also noted that the Government, in consultation with IMF, would adopt the necessary additional measures to ensure the continued success of the reform program. An apparent message of the eighth LOI was the Thai economy’s entry to a new stage, where structural issues still remain but full recovery is in sight (Table 1 and Appendix 1). For its part, ADB’s cumulative loan disbursements to Thailand since September 1997 (Tokyo pledge was in August

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1997) have reached the pledged amount of $1.2 billion in October 1999 (Box 2). In this regard, ADB’s lending operations in Thailand are entering a new phase.

B. SES Objectives and Scope

5. The special evaluation study (SES) is the first independent internal review of ADB’s response to the Asian economic crisis. It aims primarily to draw lessons from the ongoing operations in Thailand. It was expected that SES’ real-time feedback will offer relevant inputs for the (i) ongoing crisis-related projects/programs in Thailand and other developing member countries, and (ii) formulation of future operational strategy and assistance programs for Thailand. The SES also aims to draw tentative lessons for ADB’s future practice in general. 6. The SES focuses on the core crisis lending operations, i.e., Rural Enterprise Credit Project (RECP), Financial Markets Reform Program Loan (FMRPL), Social Sector Program Loan (SSPL), and Export Financing Facility (EFF). The scope was broadly defined during an Exploratory Mission (EM)3 in July 1999, when collaborative arrangements with the Office of the Auditor General of Thailand (OAG) were made, reflecting a growing emphasis on governance and participation, both in the country and ADB. The major contribution of OAG included an independent survey assessment on the SSPL. The evaluation of RECP and SSPL was mainly based on field assessments (including OAG’s survey) conducted during August-September 1999. The FMRPL and the EFF were assessed during the Special Evaluation Mission (SEM)4 from end-September to early October 1999. Feedback from beneficiaries, executing agencies, consultants, ADB and other aid agencies’ staff, and some quantitative information gathered during the course of the study were major inputs. 7. In line with discussions with the Government during the EM and SEM, the focus of the report is on the performance of the individual projects/programs rather than the country assistance program or the rescue package as a whole. In defining the study scope of the respective projects/programs, their objectives, implementation status, and particular issues raised by the executing agencies (EAs) during the EM were considered. Given the interim status of the projects’/programs’ implementation, the report takes an issue-oriented approach rather than a comprehensive assessment. Inputs and tentative outputs rather than impacts are the main topics.

C. Overview of ADB’s Crisis Operations in Thailand

8. Compared with the ADB’s total loan disbursements to Thailand of merely $286 million during 1995-1996, its disbursement performance during the economic crisis was remarkable. After the Tokyo meeting, ADB’s immediate response was an increase in the loan amount for the RECP, from $100 million to $200 million reflecting its concern about the likely impact of the crisis. Nonetheless, as this loan was conceptualized before the crisis, the project design and monitoring framework did not reflect crisis factors. The core crisis-related loans, namely the

3 The Exploratory Mission (EM) was undertaken by T. Ito, Evaluation Specialist/Mission Leader. 4 The Special Evaluation Mission (SEM) comprised T. Ito; Evaluation Specialist/Mission Leader; A. Tadle, Evaluation

Analyst; A. Pongsapich, Social Sector Specialist/Local Expert; N. Poapongsakorn, Economist/Local Expert; D. Nikomborick, Economist/Local Expert, and R. Werner, Capital Market Specialist/InternationalExpert. T. Peterson, Director, OEO later joined the Mission as Advisor.

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FMRPL, SSPL, and EFF, were then approved between December 1997 and April 1998, the period when the economy was most fragile. The approval of the three loans totaling $850 million and a partial credit guarantee of $950 million during this period were timely and perhaps contributed significantly to the economic stabilization that subsequently began. Meanwhile, the $50 million disbursed under the EFF was prepaid in September 1999, and the undisbursed portion of $106 under the RECP was cancelled in October 1999. The implications of the underutilization of these loans are discussed in later sections of the SES. 9. The FMRPL addressed part of the structural problem faced by the country’s financial sector. As stated in para 2, the idea of assisting capital market development under the FMRPL reflected coordination among the major aid institutions in their policy support operations. Given the delay in the banking sector restructuring and consequent credit contraction, the significance of capital market development has been further emphasized. The SSPL addressed both medium-term policy issues and short-term budgetary allocation matters. In this connection, the second LOI of November 1997 noted that ADB was expected to move speedily and announce a social sector support program by early 1998. The need for higher social sector spending was reiterated as one of the six key policy objectives newly identified in the third LOI of February 1998. The EFF also represented ADB’s timely response to the country’s evolving policy agenda. Allocation of adequate funds to the priority nonbank corporate sector, especially exporters, was another newly identified objective in the third LOI. 10. Based on these observations and positive feedback from the Government, ADB’s program of assistance, as an integral part of the economic stabilization and structural reform program led by the IMF, can be considered adequate, timely, and appropriate. Apparently, such an international effort had substantial announcement effects in gaining the investors’ confidence on early resurgence of the Thai economy. Nonetheless, quantification of such effects either of total rescue package or the ADB’s assistance program was difficult, and not the objective of this study. Instead, the study examined the specific issues of the individual projects/programs as discussed in para. 7. As regards the RECP and EFF, the issues that the Executing Agencies (EAs) encountered during implementation are the central topics. The relevance of the program outputs and the issues in the pending program measures are discussed in the chapter on the FMRPL. The chapter on the SSPL focuses on the performance of the social sector subprojects in light of its first objective, i.e., mitigation of the short-term adverse impacts of the crisis on the most vulnerable groups and the unemployed. The policy issues related to the SSPL were reviewed adequately in a recent progress report supporting the release of the second tranche.5 Key issues, lessons learned, and recommendations specific to the concerned projects/programs are discussed under key findings in each chapter. Meanwhile, lessons that are applicable to crisis operations and/or Thai operation in general are further highlighted in the last chapter.

5 Doc. In. 250-99: Progress Report on the Social Sector Program Loan (Loan 1611-THA) to the Kingdom of

Thailand, 14 October 1999.

Box 1. Thailand: Crisis, Stabilization and Recovery

Indicators Apr May June Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May June Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul

26.0 25.8 25.8 30.2 32.4 36.2 37.5 39.2 45.2 53.7 46.2 41.3 39.4 39.1 42.3 41.1 41.5 40.4 38.1 36.4 36.2 36.5 37.0 37.5 37.5 37.0 36.9 37.1Official Reserves ($ billion) (end of period)a 37.3 33.3 32.4 30.4 25.9 29.6 31.3 21.3 27.0 26.7 26.2 27.7 29.5 27.5 26.6 26.8 26.7 27.3 28.5 28.9 29.5 29.0 28.7 29.9 36.2 30.6 31.4 31.9Consumer Price Index (1994 = 100) 115.7 116.2 116.4 117.2 120.3 120.8 121.8 122.8 122.8 124.2 125.1 126.5 127.4 128.1 128.8 128.9 129.4 129.2 129.0 128.6 128.1 128.6 128.7 128.5 127.9 127.4 127.3 127.5Interbank Overnight InterestRate (period average) (%) 8.8 12.1 15.1 18.7 15.4 23.9 18.7 20.0 21.7 21.5 19.8 20.6 19.1 16.4 18.6 11.7 9.8 7.1 5.4 3.6 2.6 2.7 3.1 2.3 1.7 1.5 1.3 1.5Current Account Balance ($ million) (1,402) (872) (860) (413) (391) 58 712 1,016 1,142 1,292 1,458 1,460 937 1,020 853 1,184 1,122 1,103 1,275 1,136 1,450 1,204 1,330 905 930 1,124 500 976Purchase from IMF ($ million) - - - - 1,200 - - - 600 - - 200 - - 100 - - 100 - - 100 - - - 100 - 100 - Manufacturers Producers Index (not seasonally adjusted) 7.2 7.2 7.2 (4.0) (4.0) (4.0) (11.4) (11.4) (11.4) (15.8) (13.2) (21.3) (16.0) (17.3) (12.3) (14.1) (8.6) (8.3) (3.1) (5.3) (2.6) 0.4 2.6 11.2 10.5 9.1 11.7 13.7Capacity Utilization 69.1 69.1 69.1 64.1 64.1 64.1 57.8 57.8 57.8 50.1 52.0 55.2 50.9 51.5 53.0 50.9 50.9 50.9 54.5 51.0 55.3 52.5 54.3 62.0 55.8 57.9 61.5 60.7 This excludes swap and forward obligation of the country which reportedly peaked in July 1997.

Source: Bank of Thailand.

Table 1: Key Economic Indicators

Foreign Exchange Rate (period average)

(April 1997 - July 1999)

1997 1998 1999

Box 2: Donor’s Response to the Economic Crisis in Thailand

IMF ADB IBRD Japan Australia Brunei Canada

People's Republic of China

Republic of Korea

Hong Kong, China Malaysia Singapore

Amount 4.00 1.20 1.50 4.00 1.00 0.50 0.50 1.00 0.50 1.00 1.00 1.00

Bilateral Creditors

Table 2: Official Financing Package for Thailand as of August 1997($ billion)

Multilateral Creditors

Program Loan Amount Date Amount Date Amount Date

Rural Enterprise Credit – 200.0 Sep 97 94.0 – 106.0 Oct 99Financial Markets Reform Program Loan 300.0 300.0 Dec 97 300.0 – –Social Sector Program Loan 300.0 500.0 Mar 98 500.0 – –Export Financing Facility a – 50.0 Apr 98 50.0 50.0 Sep 99 –Agriculture Sector Program Loan – 300.0 Sep 99 – – –Higher Education Development – 59.3 Sep 99 – – –Disbursement of ongoing loans approved before August 1997 600.0 – – 362.5 – –

Total 1,200.00 1,409.30 1,306.46 50.0 106.0ADB = Asian Development Bank, IMF = International Monetary Fund.a In addition to $50 million from ADB, $950 was pledged through syndicated commercial cofinancing. Of the latter, the full disbursed amount of $150 million was also prepaid in September 1999.

Table 3: Crisis Operation of ADB in Thailand, September 1997 - October 1999

Loan Approval PrepaymentCancellation of

Undisbursed PortionPledged in Aug 97 under IMF Package

($ million)

Cumulative Disbursements

Month 1995 1996 1997 1998 1999January 7,548 12,885 11,619 25,231 10,675February 13,045 5,863 12,168 10,514 9,130March 16,578 5,926 22,684 320,178 12,878April 3,733 5,251 10,366 11,062 5,122May 7,575 11,035 14,846 13,151 7,244June 32,556 10,829 18,315 17,459 9,510July 20,123 9,178 36,515 37,527 10,486August 19,170 10,056 20,920 39,923 7,738September 7,402 8,051 77,214 36,490 18,660October 13,358 8,155 18,352 12,195 205,862November 9,519 18,351 19,020 29,633 –December 11,830 17,725 330,920 10,302 – Total 162,437 123,305 592,939 563,665 297,305a Ordinary capital resources only.

Table 4: Gross Disbursements to Thailand,a 1995-1999($ thousand)

Social Implications of the Crisis

The latest National Economic and Social Development Board (NESDB) estimates based on the Socioeconomic Survey of 1998a and the redefined poverty lines,b indicated that the percentage of population in poverty increased from 11.4 percent in 1996 to 13.0 percent in 1998.c The same 1998 survey indicated that the level of income inequality in 1998 (Gini coefficient of 0.51) was almost equivalent to that in 1994 (Gini coefficient of 0.52). Little improvement in income inequality was explained by the widening income gap in urban areas especially after the crisis. The number of unemployed persons increased from 0.64 million in February 1996 to 0.70 million in February 1997,d to 1.48 million in February 1998 (according to Labor Force Survey by National Statistical Office), and to 1.72 million in February 1999 (5.2 percent of the current labor force). Several early indicators from various studiese showed that the crisis has had no immediate negative effects on school enrolments, indicating a sense of commitment to education from families, government, and schools.f Most recent studiesg also indicated that the health impacts of the crisis were relatively minor, with the reduced household expenditures on medical services being partly offset by self-medication expenses. ________

a The study was conducted in 1998 under the ADB’s Technical Assistance (TA) 2744-THA:Institutional Strengthening of the Development Evaluation Division of the NESDB, for $470,000 approved in December 1996.

b Kakawani and Krongkae developed the concept in 1997, under TA 2744-THA. c In contrast, a recent study by Isara (1999) using a different definition of poverty, indicated the poverty incidents to have

declined from 5.83 percent in 1996 to 5.02 percent in 1998 (based on second quarter figures). d Data were not available for May 1997. e See (i) Poverty and Inequality during the Economic Crisis, NESDB Newsletter, Vol. 3, No. 1, Jan. 1999; (ii) A Survey Study on

the Impact of the Economic Crisis conducted by TDRI from Dec 1998 to Feb. 1999; and (iii) Thailand Social Monitor, World Bank, July 1999.

Macroeconomic Update

In its eighth Letter of Intent of September 1999 to the IMF, the Government adjusted upwards the projection of gross domestic product (GDP) growth for 1999 to 3-4 percent. The growth has been so far supported by a steady recovery in private consumption, while capacity utilization and private investment have been slowly recovering. On the fiscal front, the Government formulated the second stimulus package in early August 1999, comprising (i) deferral of corporate income taxes, (ii) equity investment measures, (iii) stimulus measures for the recovery of real estate sector, and (iv) enhancement measures for small and medium-sized enterprises (SMEs). Nonetheless, the projected 1998/99 public sector deficit has slightly declined to 5.5 percent of GDP, reflecting delays in some types of spending. Monetary policy has been eased to the point that money market rates are at their lowest levels in over a decade. However, commercial banks’ credit has continued to decline while real interest rate has been rising. This was reportedly due to the debt write-off by some banks in the first half of the accounting year and a decline in Bangkok International Banking Facility credits, which was caused by debt repayments. Apparently, the nonperforming loan issue is the structural constraint in this regard. On the external front, the

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II. RURAL ENTERPRISE CREDIT PROJECT

A. Background

11. Following the successful implementation of the Small Farmer Credit Project, 6 the Government requested ADB’s Country Portfolio Review Mission in December 1996 for another credit line of $100 million to the Bank of Agriculture and Agricultural Cooperatives (BAAC). This reflected the resource gap existing in the rural credit market and funding conditions of BAAC at that time. The amount was subsequently included in ADB’s Country Assistance Plan for 1997. An Appraisal Mission was fielded on 10-20 July 1997 to confirm the scope of this Project during the initial phase of the financial crisis. With a growing concern about the likely impact of the crisis, ADB’s management proposed increasing the loan amount from $100 million to $200 million (during an internal meeting on 1 August 1997), if requested by the Government. This proposal was also discussed during the Tokyo Meeting on 13-15 August 19977 between the Thai and ADB delegations. The Government requested a greater loan amount on 22 August 1997. The Board approved the RECP for $200 million in September 1997 and the loan became effective in November 1997. 12. The Project aimed to (i) finance about 54,000 profitable rural enterprises owned and operated by farm families; and (ii) strengthen BAAC's processing and supervision capacity for rural enterprises, and improve its services to clients. In addition, aforementioned increase of the loan amount from $100 million to $200 million reflected the severe BOP conditions of the country. The Project covered 44 provinces identified as economically depressed. The Loan Agreement was amended in October 1998 to include subprojects in additional provinces that the National Economic and Social Development Board (NESDB) newly classified as poverty areas. 13. BAAC disbursed B5,559 million to fund 65,193 subprojects under the loan by March 1999.8 In supporting these subloans, ADB disbursed a total of $94 million, of which $44 million was liquidated from the imprest account between March and November 1998, and $50 million was liquidated in June and July 1999 (Table 5). The slow pace of loan utilization had been an issue from the early stage of implementation. Expansion of the project scope in October 1998 did not effectively promote loan utilization. During the EM of the Operation Evaluation Office (OEO) in July 1999, BAAC explained that declining credit demand for eligible farm-related projects, coupled with declining domestic funding costs, resulted in slower-than-expected utilization of ADB loan. During the SEM in September 1999, BAAC also indicated its decision to cancel the undisbursed portion of the loan.9

6 Loan 1423-THA: Small Farmer Credit Project, for $50.0 million, approved on 16 January 1996. 7 Loan negotiation was held on 13-15 August 1997 in Manila, but the size of the Loan was not finalized during the

negotiation. 8 See Project Performance Report, Rural Enterprise Credit Project, 30 September 1999. 9 The remaining balance of the loan was cancelled in October 1999.

7

Table 5: Disbursement and Drawdown from the Rural Enterprise Credit Project ($ million)

Disbursement

Drawdown Date Amount Date Amount

1997 November December

9.0 21.0

1998 January March August October November

20.0 0.6 23.6 3.5 16.3

1998 March August October November

0.6 23.6 3.5 16.3

1999 June July

26.2 23.8

Total 94.0 94.0 14. As agreed upon with the Government and BAAC during the EM, the SES assessed the issues that BAAC encountered during implementation, with a focus on the rural credit market and BAAC’s funding conditions, and the subprojects’ performance under RECP. The following sections summarize OEO’s findings.10 Appendix 2 shows key data on BAAC and the RECP.

B. Rural Credit Market Conditions

15. By end of March 1999, the total BAAC loans outstanding of the farm-related projects targeted under the RECP amounted to B13.7 billion, compared with B1.6 billion at end-FY1994/95, B5.0 billion at end-FY1995/96, B10.6 billion at end-FY1996/97, and B12.3 billion at end-FY1997/98.11 Although the pace slowed in 1998/99, the figures can be considered relatively healthy as loans outstanding of commercial banks has been declining (Table A2.1, Appendix 2). Nonetheless, disbursements during 1997/98 and 1998/99 dropped (Figure 1).

Figure 1: Lending Operations for Farm-Related Activities (FY1994-FY1998)

10 The base study was conducted by the Thailand Development Research Institute during August-September 1999. 11 BAAC’s total loans outstanding increased by 9.3 percent in 1997/98 and 8.2 percent in 1998/99, as against the

annual average growth of more than 25 percent during 1993/94-1996/97. The share of the farm-related loans outstanding against total loans outstanding was about 2.5 percent as of end-1998/99.

0

2 , 0 0 0

4 , 0 0 0

6 , 0 0 0

8 , 0 0 0

1 0 , 0 0 0

1 2 , 0 0 0

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F Y 1 9 9 4 F Y 1 9 9 6 F Y 1 9 9 8

Bah

t m

illio

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T o t a l O u t s t a n d i n g

D is b u rs e m e n t

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8

16. On credit demand for farm-related activities, the Report and Recommendation of the President (RRP) noted that “BAAC expects the demand to grow rapidly by at least 20 percent.” Neither specific assumptions nor a time frame was provided to support this figure. Assuming a 20 percent growth in demand would increase loan disbursements by 20 percent for five years, total disbursements during the period would be B41.1 billion (Table A2.2). The RRP, however, also noted: “in the next five years, BAAC is expected to disburse B62.5 billion for rural enterprises alone.” This assumed that BAAC’s disbursements would increase by more than 35 percent every year. Meanwhile, the internal report at the time of the Appraisal Mission merely noted that BAAC had an active pipeline of subprojects and anticipated no difficulty in committing $100 million in three years. Apparently, these different estimates of the credit demand were not clarified. In retrospect, the initial pent-up demand of 70,000 farms was significantly met during the initial two years after BAAC’s lending to farm-related activities commenced in 1994. Hence, the RRP overestimated the credit demand; moreover, it did not sufficiently assess the crisis-related implications for credit demand.12

C. Funding Conditions

17. BAAC indicated that one of the major reasons for its reluctance in using the RECP was their existing excess liquidity due to increased deposits (Table A2.3). However, the actual amount of deposits was not far above the projected amount at appraisal.13 What was not anticipated was the lower growth rate of deposits in 1997/98, the quick recovery a year later, and the prolonged slump in credit extension. Drastic changes in the domestic interest rates and risk profile in foreign currency borrowings were the other key factors that affected the funding situation faced by BAAC. 18. BAAC’s major funding sources were deposits, external borrowing, domestic bonds, and other borrowings (Table A2.4). Reflecting the steady growth of BAAC’s deposits, the shares of domestic bond issuance and other borrowings had been declining since before the crisis. The temporary rise in borrowing from the Government in 1997/98, which was to offset the slow growth of deposits, was subsequently converted to equity in 1998/99. The main sources of external borrowings were Overseas Economic Cooperation Fund (OECF), ADB, and World Bank loans, as well as Yankee bonds issued by the Government. Increases in external borrowings in 1996/97 and 1997/98 partly reflected ADB’s Small Farmer Credit Project and RECP loans. 19. The interest rate on domestic bonds averaged 8.6 percent in FY1998/99 against BAAC’s deposit rates of 3-5 percent. The interest rates applicable to external financing varied widely. The interest rate of OECF’s yen loan was around 2.7 percent to 3.5 percent. The interest rate on RECP, which was based on a 6-month floating rate, was within the range of 6.2 percent and 7 percent. The World Bank charged 8.25 percent (floating rate), which was slightly higher than the Yankee bonds’ 7.75 percent. Figure 2 shows domestic benchmark interest rates, while Table A2.6 in Appendix 2 shows BAAC’s lending rates for farm-related activities.

12 Internal discussions before Board approval highlighted the weaknesses in the analysis of the credit demand. Yet, in

view of overall macroeconomic considerations, the loan amount was raised before the Board discussion as noted earlier.

13 The RRP projected a total deposit of B154,595 million and B173,458 million as of end-1999 and 2000, respectively.

9

Figure 2: Domestic Interest Rate

a Daily average of overnight rate in the interbank market. b Maximum rate offered by commercial banks for Government time deposits. c Minimum lending rate offered by commercial banks. Source: International Financial Statistics, IMF. 20. Although the ADB loan is relatively costly now, it can be argued that this may not be so in the medium-term. Financial implications of the ADB loan would naturally vary reflecting the market conditions at times. On the other hand, a rise in foreign exchange risk, associated with the floating of the baht, is a more fundamental issue. During the past two financial years, BAAC incurred a huge exchange rate loss totaling approximately B550 million14 each year, against such a loss of B151 million15 in FY1996/97 (Table A2.5). This was apparently because BAAC did not entirely hedge its foreign exchange rate risk. A swap arrangement offered by Bank of Thailand (BOT), for hedging the foreign exchange risk of the BAAC’s external borrowing, was suspended after the crisis. Against the high premium and fees offered by commercial financial institutions, BAAC decided to hedge its own risk by putting aside 2 percent of the RECP loan outstanding as reserve funds for possible exchange rate loss. It should be noted that with little demand for foreign currency loans in rural areas, foreign currency borrowing causes a currency mismatch in the balance sheet. Overall, a falling domestic interest rate and the floating of the baht have rendered foreign funds relatively expensive and risky.

D. Performance of Subprojects

21. Data on the subborrowers’ cash flow pattern, including detailed data on their drawdown from BAAC’s loan facility, were not fully managed by its computerized database. 16 Thus, it was difficult to fully capture the performance of the subprojects. Meanwhile, the slower-than-

14 It should be noted that the method by which the BAAC accounts for exchange rate losses is different from

the standard accounting practice. The loss is amortized according to the repayment period in accordance with the criteria set by the Ministry of Finance. The Office of the Auditor General pointed out that had the BAAC followed the general accounting standard, the recorded exchange rate loss as of 31 March 1999 would have declined to B909.41 million. This would have the effect of boosting the BAAC’s profit by the same amount according to the BAAC Annual Report FY1998/99.

15 The exchange rate loss before the crisis does not reflect losses arising from exchange rate movements, but rather, the cost of swap arrangements.

16 The branches are expected to be fully on-line by March 2000, according to BAAC.

0

5

10

15

20

25

30

Aug-97 Nov-97 Feb-98 M ay-98 Aug-98 Nov-98 Feb-99 M ay-99

per

cen

t

Discount RateM o ney M arket Rate aDeposit Rate bLending Rate c

10

expected pace of the loan utilization did not necessarily indicate delays in the implementation of subprojects, as the timing of reimbursement by the loan varied and utilization of the RECP was not mandatory when BAAC made the disbursements. Out of BAAC’s total disbursed amount of B5,559 million ($139 million),17 $94 million was funded by the RECP. Box 3 summarizes the characteristics of 65,193 subprojects approved under the RECP.

Box 3: Profile of the Subloans of the RECP

Type of Business and Purpose. The purpose of the loans for farm-related activities is twofold: a) short-term loans for production with maturity of one year for working capital to pay for operating expenses for activities related to agriculture; and b) medium- to long- term loans for investment in asset procurement used in farm-related activities. About 59 percent of the total subloans were for working capital and the rest for capital investment, with 6 percent for purchase of tractor/land preparation and 5 percent for building/warehouse, respectively.

Geographical Distribution and Size. The subloans under the RECP were dispersed across regions, reflecting the general trend of BAAC’s lending. They ranged from B72,272 to B118,259, with an overall average of B85,269. In the initial stage of the RECP, BAAC set the minimum size of the subloan at B60,000. This was not an explicit RECP loan condition. However, a condition for relending was that the interest rate must cover the cost of funding. Since the interest rate for small-size loans had been subsidized, such loans did not qualify. With the restructuring of the lending rates that abolished the subsidy, loans less than B60,000 became eligible under the RECP.

22. Data on the repayment performance of the subprojects under the RECP were also not available. Thus, the repayment rate on loans for farm-related activities were looked into as a proxy for the repayment performance. Total disbursements/utilization of $94 million under the RECP corresponded to more than 70 percent of BAAC’s total disbursements of B5,222 million (about $130 million) for farm-related activities during 1998/99. Table A2.7 depicts the rate of repayment for various lending facilities of BAAC. It shows a degree of deterioration in the collection ratio of farm-related activities, being slightly higher than that of conventional agricultural lending. This is consistent with the key observations of the field assessment, which highlighted (i) the tendency of excessive lending to farm-related activities;18 (ii) inadequate skills of many BAAC credit officers in appraising farm-related projects; 19 and (iii) inappropriate management information system, especially in farm-related portfolios.20

17 Assuming the rate of B40 to $1.00. 18 First, as subloans of sizes smaller than B60,000 were originally not eligible under RECP as stated in Box 3 (per

BAAC internal guidelines), there was an incentive for the BAAC staff to set the minimum loan requirement at the threshold level, which would have been excessive for some subborrowers. Second, supply pressure from the headquarters to district office to meet the disbursement rate especially of the farm-related activities could have easily led to excessive lending. The first issue had been subsequently solved with the restructuring of the lending rates and the admittance of small-size loans into the RECP.

19 BAAC has many credit officers who are generally knowledgeable on agricultural products. The field assessment, however, indicated few experts in specific farm-related industries who understood the nature of production and were able to conduct relevant market analysis.

20 Classification and codification currently used have been tailored specifically for agricultural loans. Thus, farm-related activities to which the RECP subloans are directed do not fit the existing classification. Consequently, most subprojects are classified simply as either “activities related to agriculture” or “other activities,” which offers minimal information on the type of activities undertaken. However, a written description of the activity to be pursued appears in the individual contracts. Based on this information, BAAC headquarters reclassifies the various types of activities into 16 groups upon obtaining information from the branches. To be able to analyze the loan's performance, it is thus essential that subloans are properly classified and that such information is computerized at the branch level.

11

23. BAAC primarily targeted existing rural enterprises rather than funding new enterprises under its farm-related loan facility. While this certainly reduced the business risks involved, it did not necessarily promote new activities. Moreover, as the types of rural enterprises were likely limited, the simultaneous expansion of the scale of these operations may have led to a glut of some goods in the market, thus depressing prices. 21 Also, it seemed that the funding of established business ventures did not necessarily generate additional investment (similar to the idea of redundant investment incentives), but simply "replaced" equity financing with debt financing. The relative cost of debt and equity financing, and the change in the income and expenditure flows need to be assessed to determine whether such a replacement generates net gains or losses for the borrowers.

24. Under the circumstance, BAAC decided to limit the share of nonagricultural lending at 20 percent of its total lending and targeted loans amounting to B2 billion for the FY1999/2000. In adapting to this new task, many credit officers recently underwent training in risk assessment and market analysis.22 Moreover, new organizational structure, and lending procedures and guidelines were put in place, while the information network system is being improved.23

E. Key Findings

25. The initial impact of the crisis on BAAC was the rise in funding costs and lower growth rate of deposits. By the time interest rates started to decline and deposits started coming in, a decline in credit demand from eligible subprojects and deterioration of the portfolio quality set in. The risk associated with a currency mismatch, which significantly increased with the abandonment of the peg to a currency basket, was another matter of concern. There is little question about the critical need of the economy for hard currency during the crisis; however, all the above caused the underutilization of the loan. This assessment highlighted the risk in a project that deals with dual purposes, e.g., BOP support for a country, and liquidity support for a financial institution. 26. Under the circumstances, cancellation of the loan could be considered reasonable. Issues on underutilization could have been discussed with ADB even at an earlier stage.24 In this regard, a question remains on the efficacy of risk analysis at formulation and of the monitoring framework of the RECP. Projections of loan utilization should have been drawn under several different scenarios, responding to a foreseeable rise in volatility in the key financial variables. Performance indicators should have been identified to monitor not only the interim impact but also the degree of deviation from what was assumed, as well as its financial implications to the recipient agency. It should also be noted that a disbursed amount does not ensure actual utilization, especially when the size of an imprest account is relatively large.

21 For example, in Ayutthaya, data showed that 30 percent of the subloans involved brick making, and another 12.5

percent involved fish grilling. The consultant team suspected that the discouraging subloans’ performance in these two sectors was partly related to the excessive supply of the products.

22 A small-scale pilot project involving nonagricultural lending called the Micro-finance Linkage Project was undertaken jointly by BAAC and the German Agency for Technical Cooperation early in 1999 in two provinces, Kalasin and Surin. TA 2524-THA: Institutional Strengthening of BAAC, for $600,000, approved on 16 January 1996, also provided general training for BAAC staff.

23 TA 2953-THA: Strengthening Project Loan Appraisal and Risk Management for BAAC, for $600,000, approved on 19 December 1997 supported such institutional strengthening effort with particular focus on risk management.

24 The back-to-office-report of the project review mission of March 1999 did not adequately discuss this matter.

12

27. The pace of expansion of farm-related loans could have been determined based on a more solid assessment of the credit demand, as well as BAAC’s institutional capacity in adapting to the new task, especially in terms of the skills of credit officers and the quality of its data management system.

13

III. Financial Markets Reform Program Loan

A. Background

28. As part of Thailand’s economic and financial recovery program coordinated by IMF, a $300 million Financial Markets Reform Program Loan from ADB’s ordinary capital resources was approved on 19 December 1997. The FMRPL aimed to (i) strengthen market regulation and supervision, (ii) improve risk management, (iii) facilitate the access of investors and issuers to the domestic financial markets, and (iv) develop institutional sources of funds by promoting the system of pension and provident funds. 29. The program measures were to be implemented over two years starting December 1997, while loan disbursement was to be made in a single tranche up-front. The Program has two major components: (i) a program of policy reforms to strengthen, broaden, and deepen the financial markets; and (ii) a package of technical assistance (TAs) vital to the reforms. The TAs dealt with pension and provident funds reforms,25 information disclosure and compliance,26 and asset securitization.27 The Loan Agreement stated that the counterpart funds to be generated out of the loan proceeds will be used to finance the cost of structural adjustment and high priority needs in the private sector, and not for the financial restructuring of distressed financial institutions.

B. Program Implementation and Scope of SES

30. The loan became effective soon after approval, and disbursement was promptly made. Implementation of the program measures has been broadly satisfactory according to the back-to-office-reports of the review missions. Feedback from the Fiscal Policy Office (FPO) and Security Exchange Commission (SEC) highlighted the relevance of the FMRPL in terms of its (i) BOP contributions, and (ii) policy enhancement effects. The former reflected recovery in foreign reserves and foreign exchange performance to date. On the other hand, the degree of the latter remained in question as the performance indicators were not specified in the RRP. Considering the above, it was decided during the EM that the SES would assess the relevance of key program outputs and the implications of some delayed program measures. Box 4 gives an overview of the capital market performance from 1997 to date, and Appendix 3 updates the status of the policy matrix.

25 TA 2955-THA:Pension and Provident Funds Reform Activities, for $1.15 million, approved on 19 December 1997. 26 TA 2956-THA: Strengthening Information Disclosure and Compliance, for $440,000, approved on 19 December

1997. 27 TA 2957-THA: Asset Securitization, for $410,000, approved on 19 December 1997.

14

Box 4: Performance of the Stock Exchange Index and Traded Volume of

Stock Exchange of Thailand, 1997-1999 Source: Bloomberg

15

Box 4: Continuation

C. Key Findings

31. Appendix 4 assesses the 12 key program outputs under FMRPL, including: (i) Bankruptcy Act; (ii) criteria of the self-regulatory organizations; (iii) mark-to-market rules for margin lending; (iv) directorship, officership, stockholder, and related interest rule; (v) regulatory framework for short-selling of borrowing and lending of securities; (vi) bonds’ issuance in the market; (vii) regulatory framework for repurchase agreements; (viii) promotion of SMEs’ capitalization; (ix) Corporatization Law, (x) master plan for state enterprise reform; (xi) institutional framework of social security and pension and provident fund systems; and (xii) mark-to-market rule for all existing pension and provident funds. The assessment also covers the implications of the delay in key legislative measures, such as the SEC Act, Alien Business Law, and the Derivatives Market Bill. 32. The detailed assessments of the above program outputs indicated that achievements in the capital market reforms over the past two years were remarkable, and went beyond the scope of FMRPL. The strong authorship and implementation capacity of the SEC were among the key factors for the achievements. The program outputs were relevant and laid the foundations for far-reaching reforms. However, the policy dialogue and technical discussions with ADB during program implementation were not as active as SEC had initially expected. Without specific performance indicators to monitor, ADB’s review missions tended to focus somewhat narrowly on the status of compliance with program measures, rather than the implications (and further progress) of these measures. Since the capital market studies were

Primary Market Update

The primary market shrank considerably in the crisis-affected year of 1997. The total value of securities issued dropped by 72 percent over the previous year to only B57 billion. Equity issuance dropped by 76 percent, while debt issuance fell by 59 percent. Initial public offering dried up entirely (after B10 billion in 1996) and B55 billion of the total new issuance of B56 billion was accounted for by private placement. In 1998, the total volume of issuance in the primary market more than tripled over the previous year, to reach B174 billion in 1998. The majority of new issuance was in the equity market, where volume rose

Secondary Market Update

Total turnover in the equity market bottomed in 1998 at B855 billion, less than half of the volumes seen in the early 1990s. It has since recovered in 1999. A similar picture was seen in the bond market. According to the Thai Bond Dealers Club (TBDC), the total turnover value of bonds fell to B72 billion in 1998. Like equities, it bounced back sharply in 1999. While the number of listed securities dropped to 466 by June 1999 (down from 579 in 1996), the number of securities registered with the TBDC jumped from 131 in 1997 to 288 in 1998, reaching 320 in June 1999. This was a reflection of the recession, which depressed equity values, but boosted the bond market due to declining interest rates. It was especially noticeable that foreign participation fell in 1999 compared with 1998.

16

undertaken under a regional TA28 in 1998, the key findings of the study could have been considered by the review missions. To maximize the value added offered by the FMRPL, the momentum of the policy dialogue should have been maintained over the implementation period. 33. Compliance with the program measures was largely satisfactory. However, the importance of delay in the amendment to the SEC Act could not be understated. It hindered full compliance with several other related program requirements under the component on market regulation and supervision. Feedback from the concerned agencies implied that more technical inputs from ADB as well as a stronger policy coordination would have been helpful for the Government.29 In this regard, implementation support, probably through an accompanying TA, should have been directed to core program measures such as the SEC Act.30 There was also the issue of including legislation (enactment of laws) as part of program measures. In view of the required democratic procedure for legislation, drafting a law for cabinet approval rather than enactment might have been more appropriate.

28 See R. A. Werner, Capital Markets in Thailand: Issues and Opportunities. This report was prepared in September

1998, under RETA 5770:Study of Financial Markets in Selected Member Countries. 29 According to the concerned project division of ADB, however, such concerns were not raised by the Government

and executing agency during the Program review missions. 30 The concerned division of ADB noted that assistance was earlier offered by ADB, which SEC declined as they did

not see any need for further assistance, except under the TAs already being processed.

17

IV. SOCIAL SECTOR PROGRAM LOAN

A. Background

34. At the Tokyo Meeting in August 1997, it was agreed that ADB would provide $800 million for two program loans, one each in the financial and social sectors. In conceptualizing the SSPL, the social sector was defined as comprising the labor market, social welfare, and the education and health sectors. Responding to the growing emphasis on the need for an effective social protection scheme as stated in the second LOI of November 1997, a social impact study was conducted under an ADB small-scale TA. 31 The study provided relevant inputs in formulating the SSPL, and for the Government’s intention to address various systematic inefficiencies and improve the provision of social sector services. Reflecting the above needs, the SSPL was designed to address the social consequences of the current financial and economic crises and assist the Government to make its social sector policies more effective and efficient. 35. The major objectives were to (i) mitigate the short-term adverse impact of the current crisis on society, in particular on the most vulnerable groups and the unemployed; (ii) help initiate structural reforms to enhance the competitiveness of the Thai economy through the development of human resources; and (iii) reduce inefficiencies in the provision of social services. The SSPL was to be released in two tranches supporting social sector policy reforms, while the local currency proceeds of the loan (counterpart funds) were to support part of the social sector spending of the Government. To ensure the successful implementation of the SSPL, the Government created a ministerial-level Program Coordinating and Monitoring Committee (PCMC) headed by a deputy prime minister. At the working level, the Fiscal Policy Office (FPO) with the assistance of the NESDB set up a steering committee to monitor the progress of the line ministries carrying out the operational plans for meeting the policy conditions of the SSPL. The first tranche of $300 million was disbursed soon after loan approval in March 1998, while the remaining $200 million was disbursed in October 1999.

B. Program Implementation

36. As stated in the recently submitted progress report,32 implementation of the program measures under the SSPL has been largely satisfactory. All the concerned Government agencies gave positive feedback on the SSPL in terms of its contribution in enhancing the needed policy reforms and maintaining social sector spending. The first tranche conditions mainly comprised short-term measures for mitigating of the crisis impacts, while the second tranche conditions consisted of structural reform measures. The former corresponded to the Program’s first objective while the latter corresponded to the second and third objectives. Part of the counterpart funds generated by the first tranche of the SSPL, amounting to $100 million,

31 TA 2920-THA: Social Impact Analysis of the Economic Crisis, for $50,000, approved on 26 November 1997. 32 Education, Health and Population Division West, 1999. Progress Report on the Social Sector Program Loan (Loan

1611-THA).

18

supported 11 social sector subprojects.33 These subprojects corresponded to “policy priorities” specified in the policy matrix, such as: (i) “protect the poor in the formal sector and rural areas by making poverty programs more effective” under the market and social welfare component; (ii) “reduce the incidence of dropouts” under the education component; and (iii) “protect the poor” under the health component. Recently, the PCMC identified three more subprojects to be backed up by the second tranche of the SSPL, and another one is under consideration. 37. Among the key features of the SSPL were its broad coverage of both short- and medium-term measures. Another notable feature was Government’s keen attention to the effective use of the counterpart funds of the loan, as it is closely related to the first objective of the SSPL. Information on the implementation status of these subprojects is regularly featured in NESDB’s homepage 34 “SSPL Quarterly News Letter,” under the section of “SSPL Project Update.” By explicitly linking the funds to the ADB loan, the line ministries were expected to be more conscious of ensuring the cost-effectiveness of the subprojects. The OEO is of the view that such consideration, reflecting the growing concern with governance and disclosure of the country’s public finance, should be received positively. For its part, ADB identified the SSPL-funded subprojects as the investment component of the loan and discussed their implementation performance in its program performance reports (PPRs).

C. Scope and Approach of the SES

38. In consultation with concerned government agencies and the OAG during the EM, it was deemed timely to assess the performance of selected SSPL-funded subprojects mainly along the first objective of the Program—mitigation of the short-term adverse impact of the crisis on vulnerable groups and the unemployed. While the implementation of program measures was progressing well, it was too early to assess the impacts of medium-term policy measures. The performance indicators specified in the RRP were not effectively monitored by line ministries, although the establishment of solid social sector monitoring framework is one of the key agenda under the TAs accompanying SSPL. Through this review of the SSPL-funded subprojects, early results regarding the efficacy and efficiency of social sector spending and achievement of the Program’s first objective could be deduced. More importantly, an independent assessment of the SSPL-funded subprojects at this stage of implementation would provide the Government with real-time feedback helpful in formulating a second round of subprojects. 39. During the EM, three subprojects were selected: (i) Subproject to Employ University Graduates to Strengthen Village Welfare Centers, (ii) Scholarship Fund to Assist Students Affected by Crisis, and (iii) Subproject to Provide Lunch and Milk to Disadvantaged Children in Child Development Centers. These subprojects were selected because they specifically targeted the vulnerable and the unemployed, were being implemented by different line ministries, and were either completed or to be completed soon. The OAG’s survey assessments 33 These are (i) Scholarship Fund to Assist Students Affected by the Crisis (Ministry of Education); (ii) Voluntary

Health Card Project (Ministry of Public Health); (iii) Computer Training Program (handled by the Ministry of Labor and Social Welfare [MOLSW]); (iv) Project to Improve Labor Force Information (MOLSW); (v) Project to Support Disadvantaged Pre-School Children in Urban Areas (Ministry of Interior [MOI]); (vi) Subproject to Provide Lunch and Milk to Disadvantaged Children in Child Development Centers (MOI); (vii) Project to Develop a Community Unemployment Register (MOI); and (viii) Employment Creation Project for Community Strengthening, consisting of (a) Rubber Harvesting Training Project (MOLSW), (b) Subproject to Employ University Graduates to Strengthen Village Welfare Centers (MOLSW), (c) Project to Support Home-based Production Networks through Management Skills Center for Group Leaders (MOLSW), and (d) New Theory Agricultural Project.

34 Refer to www.sspl.org.

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and the independent performance review of a local expert, 35 conducted during August-September 1999, formed the basis of the SES. Table 6 summarizes the scope and achievements of the three selected subprojects. Appendix 5 provides details on implementation performance and results of the individual subprojects. Table 6: Profiles of the Selected SSPL-Funded Subprojects

Item Employment of University

Graduates to Strengthen Village Welfare Centers

Scholarship Fund to Assist Students Affected by the Crisis

Provision of Lunch and Milk to Disadvantaged Children in Child

Development Centers

Objectives

(i) Give employment opportunities

(i) Improve welfare conditions of

(i) Improve welfare conditions of

for university graduates poor students poor children (ii) strengthen village welfare centers (ii) Prevent poor students from (ii) Replace government dropping out of schools budgetary cuts

Ministry of Labor & Social Welfare (MOLSW)

Ministry of Education (MOE) Ministry of Interior (MOI) Implementing Agencies

Village welfare centers Primary and secondary schools, 7,119 child development and Buddhist novices centers in 41 provinces Implementation January 1999 to date. July 1998 to date December 1998- Period December 1999

Project Costs (in baht)

852 million (allocated) 835 million (allocated and actual) 27.5 million (allocated)

12.6 million (actual expense to date)

D. Key Findings

40. The evaluations found that all three implementing agencies, i.e., MOLSW, MOE, and MOI, demonstrated a strong sense of ownership and were conscious of cost-effectiveness in the subprojects. In particular, MOLSW and MOE considered the implementation of the concerned subprojects together with other medium-term policy measures as integral to the SSPL. In contrast, MOI noted that it had no specific policy measures addressed under the SSPL, and that the financial assistance provided by the SSPL covered only a small portion of the ministry’s existing routine projects. 41. The SES largely confirmed the positive welfare implications of all three subprojects. Quantifiable subproject achievements obtained during the SES, such as the number of

35 This local expert has been actively involved in conducting research/studies in the social sector, particularly, on the

impact of the economic and financial crisis in Thailand. She is currently working on the World Bank’s Social Investment Fund Monitoring Framework.

20

beneficiaries and the amount of transferred resources, support a conclusion that these subprojects used funds effectively. The conceptualization of these subprojects was commendable for its reliance on domestically available inputs such as human resources, and utilization of existing institutions such as village welfare centers, schools, and child development centers. Formulation of the subproject on employment of university graduates was especially innovative because of its dual objectives and the focus on community-based initiatives. The concepts of the two other subprojects were simple and straightforward. 42. Nonetheless, several weaknesses were noted in the design of the Employment of University Graduates and Scholarship subprojects. These were formulated only during the crisis, and given the time constraints, the designs reflected inadequate preparation of feasibility studies and appraisals. Consequently, the implementation of the subprojects was not as efficient as would have been possible. 43. Lack of clarity in the objectives of the targeted institutions and in the terms of reference for the human inputs has been raised against the Employment of University Graduates subproject. Lack of beneficiary (villagers) participation in project formulation was a critical factor in not achieving the second objective, i.e., to strengthen the village welfare centers. However, the subproject did improve employment opportunities for university graduates. Meanwhile, the experience with the Scholarship Project highlighted the difficulties in targeting poor students, and the importance of timely funds distribution especially relating to school activities. Incorrect beneficiary identification and the complicated resource distribution system hindered subproject implementation. 44. Weak monitoring, another important issue raised in connection with these two subprojects, could be traced to the following: (i) the social sector’s lack of reliable and updated information (at the micro level) on institutional indicators; (ii) a weak monitoring framework defined at subproject formulation, especially the lack of a mechanism for obtaining immediate feedback from the beneficiaries; and (iii) lack of capacity in line ministries to monitor projects. 45. The sustainability of these subprojects apparently depends on future budgetary allocations. Similarly, the sustainability of the recipient institutions such as village welfare centers and child development centers, especially in the case of Employment of University Graduates and Milk and Lunch Projects, would depend on receiving an adequate budget.

21

V. Export Financing Facility

A. Background

46. During the meeting between the Finance Minister of Thailand and ADB’s President in September 1997, the possibility of formulating an export financing facility (EFF) with international commercial banks’ cofinancing of $1 billion was discussed. The primary concern behind the discussion was that monetary compression, under the tight demand control policy, would lead to severe contraction of banks’ credit, which might in turn affect Thai exporters adversely. In March 1998, the Board approved (i) a loan of $50 million to the Export-Import Bank of Thailand (EXIM), guaranteed by the Thai Government; (ii) a partial credit guarantee of the syndicated loan of $950 million to EXIM, counter-guaranteed by the Thai Government; and (iii) a limited waiver of the negative pledge in existing and future loan and guarantee agreements between ADB and the Government for the limited purpose of enabling the commercial cofinanciers under the cofinancing loan to take security in the export receivable trust account. The signing of the EFF on 1 April 1998, as one of the largest syndicated loans to an Asian borrower, signaled Thailand’s return to the international financial market.36 47. The major objectives of the Project were to (i) provide credit to the private enterprise export sector to fill a portion of the resource gap for export credit; and (ii) assist the Government and the banking system to allocate appropriate resources to this sector. The RRP indicated that the size of the facility was based on the projected export-related funding requirement of $160 billion from 1998 to 2000. Although not discussed explicitly in the RRP, the aforementioned “signaling effect” of the facility, was apparently the other key agenda. 48. Slow utilization of the facility had been an issue from the early stage of implementation. With little prospect for further utilization after the drawdown of $200 million, EXIM decided it would not request an extension of the availability period for the facility in March 1999. During the EM in July 1999, EXIM explained that the unexpected sudden drop in the domestic interest rate beginning mid-1998 was the major reason for this decision. EXIM highlighted the seemingly narrow subproject scope and eligibility criteria as the secondary reason. It was expected that prepayment of the disbursed amount under the facility was to result in a net loss (for the first time since the EXIM’s establishment in 1994), reflecting the up-front payment of the arrangement fee in full on its income statement for 1999. 49. The SES assessed the key constraints that hindered the utilization of EFF by reviewing its implementation, financial market conditions, Project design, and the financial implications of the facility for the EXIM. Appendix 6 gives the key data on EXIM and EFF.

36 “While players in the market argue that the deal was not a pure Thai risk, the ability to raise funds in such a hostile

climate was commendable. The bold move was repaid by a successful deal which showed that appetite for Thai risk could be tapped by the right structure and timing.” Cited from “Review of the Year,” International Finance Review, December 1998.

22

B. Project Implementation

50. It took three months for the ADB portion to become effective after loan signing; and legal issues37 further delayed by two and a half months the availability of the cofinanced portion.38 By the time the legal issues were solved, the subloan terms under the EFF became unattractive, reflecting the downtrend in domestic interest rates. 51. Table 7 shows that the peak of facility utilization by participating credit institutions (PCIs) and EXIM, amounting to about $137 million, was during October-November 1998. After that, utilization by the PCIs sharply dropped from $109 million by end of October 1998 to $37 million by end of December 1998, and further to $2 million by end of August 1999. Meanwhile, EXIM’s outstanding direct lending was maintained between $30 to $40 million from January to August 1999. Appendix 7 shows a chronology of events during EFF implementation.

Table 7: EFF Position Sheet

Date

Total

Disbursed Amount from

Facility ($)

Lending through PCIs

($)

Number

of PCIs

Number

of Subloans

Direct Loan Outstanding from EXIM ($)

Number of Subloans

30/6/98 - - - - - - 31/7/98 25,000,000 287,111 2 2 - - 31/8/98 25,000,000 31,044,175 4 33 - - 30/9/98 100,000,000 64,929,935 6 51 10,025,000 na 30/10/98 200,000,000 108,653,774 7 62 28,287,944 na 30/11/98 200,000,000 94,102,359 8 55 42,683,520 na 30/12/98 200,000,000 37,472,391 7 37 46,799,669 84 31/1/1999 200,000,000 28,000,793 6 37 38,996,341 66 28/2/1999 200,000,000 25,768,418 4 33 32,146,025 60 31/3/1999 200,000,000 23,132,876 4 28 37,652,263 58 30/4/1999 200,000,000 16,107,921 4 29 32,838,445 58 31/5/1999 200,000,000 9,379,356 2 26 34,312,232 57 30/6/1999 200,000,000 5,773,085 2 24 34,238,678 61 31/7/1999 200,000,000 3,243,892 2 18 35,701,217 58 31/8/1999 200,000,000 2,104,588 2 15 32,151,681 51

na = not available, EFF = Export Financing Facility, EXIM = Export-Import Bank of Thailand, PCIs = participating credit institutions. Source: EXIM’s Quarterly Status Reports, various issues. 52. With little scope for further utilization of the original facility, EXIM requested ADB and the cofinanciers to approve (i) extension of the loan utilization period and loan availability period; (ii) EXIM’s taking over of a line of credit of eligible borrowers where the PCIs were unable to increase the line of credit; (iii) expansion of the subproject scope to include import substitution

37 The Loan Agreement specified eight conditions for loan effectiveness. All the conditions were fulfilled soon after

loan signing except one, i.e., an Export Receivable Trust Account had to be established to meet the collateral requirements of the syndicated loan.

38 The offices responsible for legal and cofinancing matters in ADB noted that the delay was caused partly by factors on the borrower’s side. They especially highlighted the EXIM’s reluctance, at the early stage of processing, to engage outside counsel in connection with the cofinancing loan transaction, despite the size and complexity of the facility.

23

or business that leads to foreign currency earnings such as tourist hotels or purchase of airplanes; and (iv) utilization of the facility by other specialized financial institutions. ADB consented immediately to the extension of the loan utilization and availability period, and within a month agreed to EXIM’s takeover of a line of credit. In March 1999, after several rounds of internal discussions and discussions with EXIM, ADB finally decided not to agree with the request for expansion of the project scope and utilization by other specialized financial institutions. This triggered EXIM’s decision to withdraw the request for the extension of the loan availability period and to prepay the disbursed amount at the earliest possible interest payment date.

C. Financial Market Environment

53. The Thai commercial banks’ reluctance to extend credit despite the recovery in deposit mobilization resulted in excess liquidity in the market. This caused a drastic decline in the money market interest rate in the second half of 1998 and a more gradual but prolonged decline in commercial bank’s lending rates offered to the exporters (Figure 3).

Figure 3: Domestic and International Interest Rates

54. Credit and Liquidity. On a year-on-year basis, commercial bank credit has continued to decline since September 1998, reflecting the Bangkok International Banking Facilities’ (BIBF’s) contraction in credit (Figure 4) while the baht strengthened. The decrease in BIBF credits corresponded to a downtrend in commercial banks’ foreign liabilities since June 1998 (Figure 5). Consequently, the existing currency mismatch in the banks’ balance sheets was reduced. New loan classification rules and the associated provisioning requirements, which were announced in March 1998, also discouraged banks’ credit expansion in general. In contrast, commercial bank deposits have been growing as a natural result of a drop in private consumption from the second quarter of 1997 to the third quarter of 1998. The outcome was excess liquidity in the banking system.

0.0

5.0

10.0

15.0

20.0

25.0

30.0A

ug 9

7

Oct

97

Dec

97

Feb

98

Apr

98

Jun

98

Aug

98

Oct

98

Dec

98

Feb

99

Aor

99

Jun

99

per

cen

t

Average in terest ra te charged toexpo rters (period average)Overn ight m o n e y m arket rate (per io daverage)Six-m o nth LIB O R (period average)

LIBOR = London interbank offered rate.

24

Figure 4: Commercial Banks’ Credit and Deposit Growth

Figure 5: Commercial Banks’ Foreign Assets and Liabilities

55. Export and Export Credit. Despite the overall credit contraction and sharp decline in import volume, the export volume has been broadly unchanged from the beginning of the crisis to date (Figure 6). This implies that the key imports required for the production of export goods, and the associated financing requirements for exporters have been secured or effectively replaced. Clarification of this matter would require further assessment of the micro aspects of the export industries, their funding mechanism, and specific Government support to exporters. In retrospect, the resource gap for export finance did not seem as obvious during the crisis period as earlier anticipated during project formulation.

Figure 6: Export and Import Performance

0

20

40

60

80

100

120

140

Jun-

97

Aug

-97

Oct

-97

Dec

-97

Feb

-98

Apr

-98

Jun-

98

Aug

-98

Oct

-98

Dec

-98

Feb

-99

Apr

-99

Jun-

99

Ind

ex:

1995

= 1

00

Export ValueExport VolumeImport V alueImport V olume

-15-10

-505

1015202530

Oct

97

Dec

97

Feb

98

Apr

98

Jun

98

Aug

98

Oct

98

Dec

98

Feb

99

Apr

99

Jun

99

% C

han

ge,

Yea

r-o

n-Y

ear

Commercial B ank Credit

Excluding B IB F

Commercial B ank Deposits

0

500

1000

1500

2000

2500

Jun-

97

Aug

-97

Oct

-97

Dec

-97

Feb

-98

Apr

-98

Jun-

98

Aug

-98

Oct

-98

Dec

-98

Feb

-99

Apr

-99

Jun-

99

Bah

t m

illio

n

Foreign Assets

Foreign Liabilities

25

D. Project Design, Deal Structure and Administration

56. The Export-Import Bank of Japan (JEXIM)39 facility of Y30 billion for the promotion of exports, which EXIM availed of in March 1998, has been well utilized mainly because (i) it became effective soon after loan signing, (ii) the on-lending rate was lower, 40 and (iii) its subproject eligibility criteria were more flexible. In relation to the third factor, EXIM highlighted a particular constraint in utilizing the EFF, i.e., the requirement that exporters be without losses for the past three fiscal years (or in case there is a negative operating profit, additional collateral up to a minimum of 30 percent of the credit line must be secured). 57. Due to the large number of cofinanciers, the facility could not be adjusted swiftly to respond to changing circumstances. For instance, EXIM’s request for an extension of the availability period from 300 to 540 days could not be approved due to reluctance of only one cofinancier. Meanwhile, the confusion arising in the exchange of communication between EXIM and ADB was another factor occasionally hindering the timely response of ADB to EXIM’s requests.41 Under the circumstances, EXIM indicated at times it had to deal with several ADB officers and offices, who asked for more or less the same information. As a remedial step, ADB requested EXIM to address all EFF related communications to the project division. According to EXIM, however, this did not necessarily result in quicker response from ADB. Considering this experience, project administration of such a large syndication deal, especially during the crisis, could have been tailored to address the difficulty in consensus building as well as volatile external conditions. Such a tailored approach might have resulted in a quicker response from ADB and other lenders to EXIM’s requests, probably including the one on expansion of project scope.42 Similarly, this would have resulted in EXIM deciding earlier to prepay the disbursed portion to minimize the interest payment under the facility.

E. Financial Implications for EXIM

58. While the EFF most likely contributed to restoring investor confidence in Thailand (Box 5), it turned out to be a financial burden for EXIM. The balance sheet of EXIM showed a rapid increase in liquid assets and a decrease in loans outstanding against a sharp increase in long-term foreign liabilities in 1998 (Table A6.1, Appendix 6). These indicated the growing maturity and currency mismatches between its assets and liabilities. On the income statement, these resulted in a loss of net interest income in 1998 (Table A6.2). Meanwhile, the gross interest payment by EXIM under the EFF amounted to about $12 million. Furthermore, there were sharp increases in fees and services expenses in 1998 and 1999. The expenses just for fees under the EFF were substantial, amounting to about $16.8 million (Table A6.3). The arrangement fee,

39 On 1 October 1999, JEXIM was merged with Overseas Economic Cooperation Fund of Japan, and became Japan

Bank for International Cooperation. 40 The intermediation cost of JEXIM’s facility was lower because (i) EXIM lent directly to end-borrowers, and (ii) its

fees and other expenses were lower. JEXIM insisted on the direct lending of EXIM with anticipation of credit crunch in the commercial banking system.

41 The concerned project division views that this was attributable to EXIM’s inexperience in dealing with ADB. 42 The concerned project division raised a question as to the validity of this argument. It views that the careful

assessment of the Government’s requests especially on expansion of the project scope naturally took time. On the other hand, the offices concerned with cofinancing operations and legal matters agreed with the observations and addressed the need to form an interdepartmental deal team to handle complex projects in the future.

26

which had to be paid up-front, turned out to be costly43 to EXIM, especially because only a small portion of the facility was utilized and within a short period, too.

Box 5: BOP Implications –Announcement Effects – of the EFF Several public companies did return to the international capital market following the EFF

(Table A6.4, Appendix 6). Hence, it can be said that, at the very least, EFF played a role in indicating a benchmark rate to issuers and in impressing upon international investors Thailand’s return to the market. Nonetheless, quantification of the “announcement effect” of the EFF, or the estimation of the “without-EFF” scenario is still difficult. Meanwhile, Figure 7 showed declining trends of foreign direct investments and banking flows during April-June 1998. After the sharp increase in March-May 1998, other private capital flows also declined from May to November 1998. These indicators did not necessarily show the immediate impact of the EFF on private foreign capital flows to the country.

Figure 7: Private Foreign Capital Flows

F. Key Findings

59. The EFF demonstrated the efficacy of the ADB’s partial guarantee scheme in arranging syndication in certain market conditions. Nevertheless, the preceding assessment revealed that the issues raised in para. 25 (RECP chapter) also largely applied to the EFF. Nonetheless, there are some major differences in the structure of these two loans. First, BAAC played a dominant role, and thus was a price setter in the rural credit market, in contrast to the limited role of EXIM, functioning as a price taker in the trade finance market. Thus, the lending rates of EXIM are more sensitive than those of BAAC. These, together with the difference in the timing of the loan approval, reflected varying degrees of utilization of the two loans. Second, the risk factors associated with ADB loans were not the same. Risks associated with currency mismatches were BAAC’s concern, while the financial costs of underutilization were the risks for EXIM, due to the size of the arrangement fee which had to be paid up-front. Third, the impacts of structural issues such as credit crunch, accelerated by introduction of the strict asset

43 EXIM’s view on the financial terms of the cofinancing portion of the facility was not fully reflected in the negotiation

between the Government and the lenders, due to the country’s urgent need for the facility at that time.

-3000

-2000

-1000

0

1000

2000Ja

n-98

Feb

-98

Mar

-98

Apr

-98

May

-98

Jun-

98

Jul-9

8

Aug

-98

Sep

-98

Oct

-98

Nov

-98

Dec

-98

Jan-

99

Feb

-99

Mar

-99

Apr

-99

May

-99

$ m

illio

n

Foreign Direct InvestmentsBanking FlowsOther Private Capital Flows

27

classification and provisioning norms for commercial banks, were apparently more significant in the EFF. Lastly, difficulty in swift consensus building, among cofinanciers, and the complicated legal arrangement were specific issues for the EFF, being a large scale syndication deal. They caused critical delay in the initial stage, precluded a quick response to the change in market conditions, and limited the options for adjusting the project scope and arrangements. 60. Inadequate linkage between loan operations and a sector study, an issue highlighted in para. 32 of the FMRPL chapter, could also apply to the EFF. The banking sector study conducted under regional TA 577044 could have more effectively linked to the EFF.45 It is also noted the final report of the consultant, who monitored the ADB’s financial sector operations in Thailand, did not adequately assess the impediments for the utilization of the EFF.46 61. In view of a number of cofinanciers and volatile market conditions, project administration of a large syndication deal, especially during a crisis, should be tailored so as to enable swift consensus building internally and among lenders in responding to changing circumstances.

44 See M. Kawai and K. Takayasu, The Banking and Financial System in Thailand. This report was prepared in July

1998, under RETA 5770:Study of Financial Markets in Selected Member Countries. 45 In contrast, JEXIM conducted the comprehensive credit market study in the second half of 1998, as the basis of its

second credit line to Thailand after the crisis. This is referred to in T. Ito and A. Pereira da Silva, The Credit Crunch in Thailand during 1997-98 Crisis:Theoretical and Operational Issues.

46 The consultant’s final report was submitted to ADB in November 1998.

28

VI. CONCLUSION

62. This report is an initial assessment of some key aspects of ADB’s lending operations in Thailand during the economic crisis. Of the assessed four loans, the two program loans are still ongoing, while the other two project loans have been terminated only recently. Events and the impacts of the crisis are apparently still unfolding. Thus, any conclusion drawn at this stage should be considered preliminary. Nonetheless, examining some general lessons from the experience of the individual projects and programs so far would still be meaningful. 63. Project lending through financial intermediaries. During the financial crisis, the risk involved in project lending through financial institutions, such as under RECP and EFF, seemed higher than that for such lending under normal economic conditions. The common objectives of these loans were to fill the existing resource gaps confronting the recipient banks. Mitigating BOP difficulties was another implicit objective of these loans. These objectives, though different, are not necessarily conflicting, especially at the initial stage of a crisis. But higher volatility than usual in the key financial variables would be inherent concerns during a crisis. Especially in the case where a banking crisis was involved, a credit crunch could eventually appear, while recession and excess liquidity in a banking system could be another outcome. This situation apparently caused a mismatch between the funding needs of recipient banks and the BOP support needed. 64. Early warning mechanism. The risk highlighted (para. 63) does not necessarily undermine this type of lending, through which ADB supports private sector activities in targeted sectors. What is needed is a clear understanding of market risks for recipient intermediaries and prompt responses to their signals. In this regard, some early warning mechanisms and effective safeguard measures should be considered at formulation. 65. Large syndication deal. The experience with the EFF highlighted the need for a review of the ADB’s business processes in dealing with a large syndication deal, to ensure swift consensus building internally and among lenders in responding to changing circumstances. In this regard, it would be helpful to form interdepartmental teams/groups during not only formulation but also implementation of complex projects in crisis situations. 66. Policy-based lending in a social sector. The experience with the SSPL demonstrated that policy-based lending in the social sectors can provide effective and efficient safety nets when the executive agency takes strong ownership. Combinations of short- and medium-term policy measures, ADB’s provision of extensive TA support for program implementation, and a keen attention of an executing agency to the effective use of counterpart funds generated under a loan are some key factors. 67. Beneficiary targeting and participation, and resource distribution. The experience with the SSPL-funded subprojects also highlighted that appropriate beneficiary targeting, effective beneficiary participation and timely distribution of funds are among the key factors in efficiently implementing social sector projects, especially those addressing social safety nets. 68. Ownership, policy dialogue, and implementation support. The experience of the FMRPL showed that the EA’s ownership and implementation capacity are essential to program lending. The experience of the SSPL highlighted the efficacy of an inter-ministerial committee,

29

headed by a high government authority, for managing a multi-objective program. Meanwhile, the assessment of the two program loans, especially the contrasting feedback from the respective concerned agencies, highlighted the relevance of in-depth policy dialogues and implementation support for key reform measures. 69. Performance indicators and sector studies. The experience of the four loans highlighted the critical need for performance indicators, which should be monitored by both EAs and ADB. As any crisis will impact largely on the poor, a comprehensive examination of the poverty situation across the country, based on reliable socioeconomic data, is needed. Timely monitoring of key financial variables is also essential. In addition, this assessment highlighted the importance of conducting economic and sector studies, which should be effectively linked to ADB’s lending operations. 70. Enhanced monitoring framework. It should be noted that most of the issues identified in this SES were discussed—at the very least, mentioned—during project/program preparation. However, some of them were not fully resolved partly because the formulation process for most loans had to be streamlined. This was understandable in the light of the emergency situation brought about by the crisis. Nevertheless, discussion of the unsolved issues should have continued during project/program implementation. In this regard, they should have been effectively incorporated in establishing an enhanced monitoring system for each of the loans.

30

APPENDIX

Cited on

Number Title Page (page, para.) 1 Evolution of Government Policies and Progress in Reforms (July 1997 to Date) 28 1, 4 2 Key Data on BAAC and RECP 32 7, 14 3 Policy Matrix under FMRPL 35 12, 30 4 Assessment of the FMRPL Outputs 49 14, 31 5 Assessment of Selected Subprojects Funded by SSPL 54 17, 39 6 Key Data on EXIM and EFF 59 19, 49 7 Chronology of Events during the Implementation of EFF 61 20, 51