A S IAN CO R PO RAT E R EC OV ERY FINDINGS FROM FIRM-LEVEL SURVEYS IN FIVE COUNTRIES 20381 Apr'I 2000 Edited by Dominique Dwor-Fr6caut, Francis Cola~o, and Mary Hallward-Driemeier ~~ TH E WO RLD BAN K * WASH IN GTO N D. C. i i I AS -IAN CSORPO loRATE RECO)VERY Findings from ]Firm-Level Surveys in iFive Countries E{dited by Dominique l)wor-Frecaut, Francis Cola,co, and Mary IHrallward-Driemeier * ~T HE W O RLD B AN K W AS HI NG T ON D .C. Copyright ( 2000 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W., Washington, D.C. 20433 All rights reserved Manufactured in the United States of America First Printing April 2000 The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. 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Colaco, Mary Hallward-Driemeier. p. cm. "Regional conference based on firm-level surveys in Indonesia, Korea, Malaysia, the Philippines and Thailand, Bangkok, March 31-April 2, 1999."--CIP gallery. ISBN 0-8213-4634-2 1. Financial crises--Asian, Southeastern--Congresses. 2. Asia, Southeastern--Economnic conditions--Congresses. 3. Industrial management--Asia, Southeastern--Congresses. I. Dwor-Fr&aut, Dominique, 1962- II. Colaco, Francis X. III. Hallward-Driemeier, Mary, 1966- IV. World Bank. HB3808 .A853 2000 338.095--dc2l 00-024442 Contents Abbreviations and Acronyms vii Abstract ix Acknowledgments xi Foreword xiii Editors' Notes xv Chapter 1 Asian ManLifacturing Recovery: A Firm-Level Analysis 1 Data 2 Impact of the Crisis 3 Conclusion 17 Chapter 2 Corporates" Views of the Constraints to Recovery 21 Impact of the crisis on the surveyed firms' performance 22 Reasons for declining performance and constraints to corporate recovery 25 Constraints to recovery and policy recommendations 32 Conclusions 34 Chapter 3 MacroeconoDmic Views of the East Asian Crisis: A Comparison 37 Macroeconomic development 38 Monetary and fiscal policies in the adjustment process 44 Assessment of the adjustment process 49 Policy implications and concluding remarks 50 Chapter 4 The New Miyazawa Initiative and Response to the Corporate Debt Problem 55 Basic perspectives 55 Issues for the promotion of debt restructuring 56 iii Approaches to the corporate debt problem under the Miyazawa Initiative 57 The Asian Growth and Recovery Initiative (AGRI) 59 Transparency in markets and stockholder-oriented corporate governance 59 Transparency in markets 59 Conclusion 59 Chapter 5 Asian Corporate Credit Needs and Governance 61 Structure of corporate finance prior to the crisis and in mid-1998 63 Determining whether credit availability is a constraint to corporate recovery in Asia 69 The firms' views on loan repayment prospects 75 Issues in corporate financial governance 77 Concluding comments 80 Chapter 6 Financial Sector Restructuring: Progress and Issues 83 The genesis of the crisis 83 Restructuring and recapitalization 85 Strengthening prudential standards and the legal frameworks 89 Interest rates and loan growth 90 Conclusions and lessons 91 Annex 6.A Financial restructuring in East Asia at a glance 93 Chapter 7 Publicly Listed East Asian Corporates: Growth, Financing, and Risks 97 The data 98 Performance measures 99 Financial structures 103 Summary 108 Chapter 8 Corporate Foreign Debt in East Asia: Too Much or Too Little? 111 Introduction 111 The survey data 112 Foreign debt financing 114 Short-term versus long-term debt 116 Unhedged short-term foreign debt: too much or too little? 118 Profitable versus less profitable firms 118 Conclusions 119 Chapter 9 Corporate Employment and Public Policy 123 Background information 124 Employment performance across countries, sectors, and the export status of the firms 126 Causes of employment changes 128 The characteristics of workers leaving the firms 131 The firms' reactions to the loss of human capital 135 Summary and policy implications 137 Annex 9.A The frequency of use of formal training programs during the crisis 139 iv Chapter 10 Indonesia: The Impact of the Economic Crisis on Industry Performance 141 The economic crisis 142 Overview of the competitiveness study 143 Impact of the crisis on firm performance 146 The financial position of the firms 150 Financial characteristics and impact of the crisis 153 The government's response to the crisis 154 The firms' expectations for the next six months 155 Summary and conclusion 155 Chapter 11 A Study on the Crisis, Recovery, and Industrial Upgrading in the Republic of Korea 159 The survey 160 Analysis of the impact of the crisis on the firms 161 Financial position of the firms before and after the crisis and its impact on the firms' responses to the crisis 166 Concluding remarks and recommendations 172 Annex 11.A Government support programs listed in the questionnaire 175 Chapter 12 The Asian FinanciaL Crisis: Impact at the Firm Level- The Malaysian Case 177 Framework of the survey 179 Impact of the crisis on the firms 180 Impact of the crisis on the financial position of the firms 184 The policy response 188 Conclusion 191 Chapter 13 The Impact of the Southeast Asian Financial Crisis on the PhiLippine Manufacturing Sector 195 Description of the survey 196 Analysis of the impact of the crisis on the firms 198 Financial position of the firms before and after the crisis 206 Transparency 212 Short-run prospects 214 Conclusions and recommendations 215 Chapter 14 Thailand: The Road to Recovery 219 Description of the survey 220 Corporate adjustments to the crisis 221 Constraints on corporate recovery and policy implications 227 Prospects for the first half of 1999 and policy recommendations 232 Annex 14.A Macroeconomic data 235 Annex 14.B Methodology 237 References 239 v Abbreviations and Acronyms ADB Asian Development Bank AGRI Asian Growth and Recovery Initiative AGRP Asian Growth and Recovery Program AMC Asset Management Corporation (Thailand) APEC Asia-Pacific Economic Cooperation ASEAN Association of South East Asian Nations ASEM Asia-Europe Meeting BAAC Bank for Agriculture and Agricultural Cooperatives BIR Bureau of Internal Revenues BIS Bank for Int,ernational Settlements BMA Bangkok Metropolitan Administration BNM Bank Negara Malaysia BOI Board of Incustry (Thailand) CIF Cost, Insurance, and Freight CRPP Currency Rate Protection Program (The Philippines) CDRC Corporate Debt Restructuring Committee (Malaysia) CPI Consumer Price Index DOLE Department of Labor and Employment (The Philippines) EBIT Earnings Before Interest and Taxes EBITDA Earnings Before Interest and Taxes (but adding back depreciation) EFAL II Economic a:-d Financial Adjustment II program, World Bank EIU Economist Intelligence Unit ESCL Exchangeable Subordinated Capital Loans EXIM Export Import Bank of Thailand FIDF Financial Institutions Development Fund (Thailand) FDI Foreign Dir2ct Investment FOB Free On Board FRA Financial Restructuring Agency (Indonesia) FSC Financial Supervisory Commission GAAP Generally Accepted Accounting Principles GDP Gross Dom estic Product GHB Government Housing Bank HRDF Human Res,ource Development Fund (Malaysia) IBRA Indonesian Bank Restructuring Agency IFCT Industrial Finance Corporation of Thailand vii ILTD Linkages and Technology Development Study (Malaysia) IMF International Monetary Fund ISIC International Standard Industrial Classification ISIS Institute of Strategic and International Studies (Malaysia) JEXIM Export-Import Bank of Japan KAMCO Korean Asset Management Company KDIC Korean Deposit Insurance Company LE List of Establishments (The Philippines) M&As Mergers and Acquisitions MATRADE Malaysia External Trade Development Corporation MDB Multilateral Development Bank NAFTA North American Free Trade Agreement NCR National Capital Region (The Philippines) NERP National Economic Recovery Plan NICs Newly Industrialized Countries NPLs Nonperforming Loans NSO National Statistics Office OECD Organization for Economic Cooperation and Development OECF Overseas Economic Cooperation Fund RA Republic Act (The Philippines) ROA Return On Assets SAL Structural Adjustment Loan SBGFC Small Business Guarantee and Finance Corporation (The Philippines) SBI Sertifikat Bank Indonesia SCB Siam Commercial Bank SEC Securities and Exchange Commission SFIs Specialized Financial Institutions SITC Standard Industrial Trade Classification SIFC Small Industry Finance Corporation SIP Social Investment Program (Thailand) SMEs Small and Medium Enterprises SPVs Special Purpose Vehicles (Thailand) SSN Social Safety Net SSS Social Security System (The Philippines) TFB Thai Farmer's Bank UNDP United Nations Development Program viii Abstract This volume presents the main findings of surveys of 3,700 manufacturing firms in Indonesia, The Republic of Korea, Malaysia, the Philippines, and Thailand, conducted by the governments of these countries from November 1998 to February 1999. The resulting papers were prepared for a conference on Asian corporate recovery, hield in Bangkok in March and April of 1999, and are collected in this book. The papers compare the effect of the 1997-99 crisis on various countries, sectors., and types of firms, in terms of output, exports, and employment. They analyze the causes of corporate decline and assess the policy options to foster corporate recovery. The impact of the financial sector crisis on the corporate sector is discussed through an analysis of corporates' financial structure and credit needs. The extent of foreign corporate indebted- ness is reviewed, as well as the role debt played in the propagation of the crisis. Each of the five survey countries prepared a report; these reports are also included in this volume. ix Acknowledgments The World Bank wishes to thiank the governments of Indonesia, the Republic of Korea, Malaysia, the Phili ppines, and Thailand for their undertaking of the survey work. Financial support was provided by Japan's Policy and Human Resource Development Fund and by the Asia-Europe Meeting Trust Fund, as well as by regional private sector organizations. The surveys were coordinated and the conference organized by a team led by Dominique Dwor-Frecaut arnd consisting of Francis Colaco, Mary Hallward- Driemeier, and Charu Adesnik. Flavia Fernandes provided secretarial assis- tance. The team wishes to thank Kyle Peters, without whose support this work could not have been carried out. xi :~~~~~~~~~~~~. J Forewordi Asian corporate recovery frcm the devastating effects of the financial crisis of 1997 is in its initial stages in some economic sectors and some companies in cer- tain parts of Asia. For sustained recovery, the region needs to adopt a balanced response that combines expansion of domestic demand with accelerated cor- porate and financial restructuring. This was the key conclusion reached by par- ticipants at the Conference on Asian Corporate Recovery: Corporate Governance, Government 7:olicy, organized by the World Bank in Bangkok, Thailand, from March 31 to April 2, 1999. New data emerged at the conference showing that economic revival pro- grams in Indonesia, the Republic of Korea, Malaysia, the Philippines, and Thailand are beginning to pay off in certain sectors. The participants acknowl- edged, however, that much riemains to be done to stimulate a wider and fuller recovery. The participants were responding to extensive new surveys of nearly 4,000 firms in the five crisis countries mentioned above. Substantial information on how small and medium-sized firms and those listed on stock exchanges are far- ing is now available for the ,irst time. This important information, in addition to the standard macroeconomic data, is pointing the way to the kind of policy and institutional reforms most likely to engender sustained recovery. After two days of discussions on the survey results, the participants agreed on the following points: * Stimulation of domestic demand alone is not enough, since the crisis was caused primarily by structural problems. Stimulation of domestic demand is, however, necessary to facilitate the accelerated restructuring of banks and other financial institutions and corporate restructuring; * Corporate and financial restructuring must take place simultaneously for both to succeed; * The institutional framework for corporate finance needs urgent strength- ening to improve the efficiency of credit allocation. Laws to regulate bank- xiii ruptcies, foreclosures, and mergers and acquisitions economic policies and restructuring in the financial and are needed to facilitate the transfer of resources from corporate sectors. less to more viable activities; The five countries that participated in the collection * Financial transactions need greater transparency and analysis of the survey information are to be com- through improved reporting, accounting, and audit- mended. The World Bank is also to be commended for ing; having organized this unique conference with entirely * According to business responses to the survey, the new firm-level information and for having brought demand for credit has declined as sales have fallen. together such an impressive group of individuals from However, many firms reported difficulties in secur- business, government, academia, and research institutes ing adequate credit. As demand grows, credit avail- from Asian countries. It is to be hoped that efforts to col- ability will become a bigger issue; lect firm-level information will continue, since this a * Excess capacity has both a cyclical and structural valuable additional element that can give policymakers nature, so macroeconomic policies need to be sup- confidence in making recommendations. plemented with measures to improve corporate Recent events indicate that Asia constitutes a distinct competitiveness; region in the global context. They have also highlighted * The development of longer-term instruments and the linkages between countries. Asia's successes have bond markets needs urgent attention; spread from one country to the next, and recently so * More discussion is required to design competitive- have difficulties. Further effort is thus needed to con- ness strategies; tinue similar regional discussions on key issues of inter- * The speed of adjustment must be balanced with the est, based on good and timely data and systematic social costs and the need for social safety nets. analysis. Asia has been through a dramatic adjustment in a very short period. The task, however, is not complete. Dr. Il Sakong Incipient recovery should not deter continuing efforts at Former Minister of Finance corporate and financial restructuring. The key to sus- CEO, Institute for Global Economics tained recovery is to balance accommodative macro- Seoul, Korea xiv Editors' Notes This volume contains papers presented at a regional conference on "Asian Corporate Recovery: Corporate Governance, Government Policy," organized by the World Bank with the financial support of the Policy and Human Resource Development Fund (Japan) and the Asia-Europe Meeting (ASEM) Trust Fund, and cosponsored by regional private sector organizations. The regional conference--based on firm-level surveys in Indonesia, the Republic of Korea, Malaysia, the Philippines, and Thailand-was held in Bangkok from March 31 to April 2, 1999. The surveys covered some 3,700 firms in seven manufacturing sectors: electronics, textiles, garments, food pro- cessing, chemicals, machinery, and auto parts. They were conducted between December 1998 and Februaiy 1999 by the respective governments, with tech- nical assistance from the World Bank. Two-thirds of the companies were small and medium-size enterprises with fewer than 150 workers while the rest were large companies. About 20 percent of the firms were publicly listed. The conference brought together 60 senior government officials, business people, academics, and researchers in a roundtable format to examine the prospects for Asian corporate recovery based on the unique and new data made available by firm-level surveys. The chairperson of each session was a senior Asian policymaker: Dr. II SaKong, a former Minister of Finance of Korea and currently Chairman and CEO of the Institute for Global Economics Institute; Dr. Zeti Akhtar Aziz, Deputv Governor of Bank Negara Malaysia; M.R. Chatu Mongol Sonakul, Governor of the Bank of Thailand; Secretary Benjamin Diokno, of the Department of Budget and Management of the Philippines; and Dr. Mari Pangestu, Executive Director of the Center for Strategic and International Studies of Indonesia. Each session consisted of paper presenta- tions, followed by designated lead commentators and a general discussion by the participants. The conference had five sessions: * Macroeconomic Constraints to Corporate Recovery, and Country Presentations on Thailand and Korea; xv * Corporate Domestic Credit 'and Financial Fragility, ified, allowing for the rational behavior of financial and Country Presentations on Indonesia, Malaysia, institutions in limiting the allocation of credit only to and the Philippines; viable firms. Differences across countries (for example, * Corporates and Foreign Financing; Korea and the Philippines) and between firms * Corporate Employment and Public Policy; and (exporters versus nonexporters) must be kept in mind. * Summing Up. It was acknowledged that "survival bias" was an The principal issues taken up in the lively exchange of unavoidable feature of such surveys. While it called for views among the participants in this roundtable and caution in interpreting the results, the fact was that in closed-door regional conference were (a) corporate two consecutive firm-level surveys undertaken in recovery's current status and the major constraints it Thailand following the crisis, only 10 percent of the faced, observed from macroeconomic and firm-level firms in the sample had not survived. The large size of perspectives-and (b) a number of interrelated financ- the sample also reduced the impact of this bias. ing questions: Is there a "credit crunch?" Is firm-level The firm-level surveys indicated that the collapse of indebtedness a major constraint? What is the role of domestic demand was a critical factor hindering corpo- short-term indebtedness? What is the role of foreign rate recovery. They stressed the importance of stimulat- financing? Is there "labor hoarding" and what is its ing consumption demand, without further damaging a impact on corporate restructuring and on the nature of country's creditworthiness. They also underlined the government social policies? What are the policy options importance of improving competitiveness to take advan- for accelerated corporate recovery on a regional basis? tage of buoyant foreign markets. Others indicated that a The regional conference took place against the back- lesson Asian countries could learn from the crisis was drop of an incipient corporate recovery in some sectors avoiding the kind of rapid contraction that had taken and in some, but not all, countries. A general point place. It was also pointed out that demand stimulation emphasized in the discussions was that the crisis had nei- had to be accompanied by required corporate and finan- ther affected all five countries at the same time, nor had cial restructuring for international competitiveness. its intensity been of the same magnitude. Accordingly, The discussion on foreign financing raised the issues the constraints to recovery also varied by country, as did of excessive borrowing and the availability of hedging the policy options. Caution had to be exercised, there- instruments. Grenville noted that the crisis had high- fore, in making generalizations. (See the Foreword for lighted the prominent issue of how to open an economy the principal conclusions of the conference.) without excessive capital inflows, an overappreciation The issues of macroeconomic demand stimulation of the exchange rate, and a vulnerability to changes in and the so-called "credit crunch" were at the center of investor sentiment. He stressed the difference between discussions during the first two sessions. Ito, comment- perceived and real profits. According to Grenville, the ing on the papers by Atchana Waiqwamdee and Dwor- perception of high profits in the region was overblown. Frecaut, Hallward-Driemeier and Colaco, drawing on a As these economies opened, there was a huge in flow of study that he had undertaken of Thai financial institu- capital. Hedging alone would have provided insuffi- tions immediately after the onset of the July 1997 crisis cient protection. Many firms decided not to hedge not in Thailand, indicated that he had found there was because of the insufficient development of such instru- indeed evidence of a credit crunch. He also cautioned ments, but because the cost of hedging was high. Other that there might be a "survival bias" in the firm survey participants of the foreign financing roundtable noted it results (since only those firms in existence at the time of was not surprising that the more profitable firms were the survey could be interviewed). Other discussants those that had not borrowed in foreign currenci.qs; they noted that it was important to distinguish between the also expressed caution regarding the quality of financial early postcrisis period when there had been a major data, stressed the importance of further development of spike in domestic interest rates following the initiation corporate legal systems, and indicated the importance of stabilization programs, and the period covered by the of resumed capital inflows for corporate recovery. survey when interest rates had returned to precrisis lev- The discussion on corporate employment ancd public els. The definition of "credit crunch" must also be clar- policy elicited a wide range of comments. Siamwalla xvi cautioned that official unemployment numbers might academics, and researchers to exchange views on Asian be underestimating the number of unemployed, as there corpo:ate recovery on the basis of a unique set of sys- had been a substantial move to nonparticipation in the tematically collected and analyzed firm-level data. labor force, particularly by women. He made a plea for Some lessons on crisis management were drawn. The compulsory severance pay and an employment insur- incipient signs of recovery, even though they were ance system. Choi argued that the degree of labor mar- uneven- between countries and sectors, have led to ket flexibility was inversely related to firm size and increased attention being paid to issues of corporate degree of unionization. Others noted that there was sig- restructuring for international competitiveness. There nificant evidence of labor hoarding in Indonesia, are indications that the five countries, and possibly oth- Malaysia, and Thailand; that with wages not having ers in che region, will undertake further such surveys as adjusted fully, significant labor restructuring might still a basis for returning Asian countries to strong interna- be ahead; that the human costs of the crisis and of tional competitiveness in the next few years of the new restructuring needed to be given adequate attention; millennium. and that the social cost of the crisis had been unevenly distributed and mitigated since the bulk of the redun- dancies was among younger and less skilled workers. Dominique Dwor-Frecaut This regional conference provided an opportunity for Francis X. Colaco senior Asian policymakers, business representatives, Mary Hallward-Driemeier xvii C4kate*r oo y Asian MAnufacturing Recovery: A Firm-Level Analysis Mary Hallward-Driemeier Dominique Dwor-Frecaut Francis X. Colafo -IL AW- acroeconomic studies investigating the causes of the crisis in East f~J3 Asia abound. However, until now, there have been little systematic A4= v ^or comparable data across the crisis-hit countries to provide a microeconomic explanation of the last two years' events. Recognizing the importance of filling this information gap, the governments of Indonesia, the Republic of Korea, Malaysia, the Philippines, and Thailand, with the technical assistance of the World Bank, undertook an extensive survey of 4,000 firms between November 1998 and February 1999. The surveys have two areas of focus. The first is understanding the extent of the impact of the crisis on firms and identifying their constraints to recovery. The second is looking at the determinants of productivity and longer-run issues of structural impediments to growth. This paper provides the overview to the first of these topics. It is based on the survey results and the conclusions of a regional dialogue attended by senior policymakers and private sector repre- sentatives from across Asia.' The paper explores the impact of the crisis by looking at changes in capacity utilization, export performance, and employment practices. The causes for the decline are then examined from the perspective of the surveyed firms. Given the attention paid to issues of credit availability, this issue is discussed at length. One of the contributions of the data set is that it provides information on the financial position of small ar d medium enterprises (SMEs) and unlisted large companies. It relates the extent of the firms' leverage and their reliance on dif- ferent sources of capital to their reported access to credit. One of the principal findings of the survey is that the nature of the firms' cash flow position is the I key to understanding their response to the crisis. These principal manufacturing sectors in each country: elec- firms had been relying heavily on internal funds-and tronics, textiles, garments, food processing, chemicals, as sales fell with the slump in demand, the costs of machinery, and auto parts. The sectoral composition imported inputs rose and nominal interest rates differs somewhat across countries, with each country increased, severely hampering cash flow position. One selecting five of the seven sectors. Each sector was cho- of the policy messages is that the lack of demand was the sen by at least three countries, enabling regional com- main constraint reported by the firms. Stimulating parison (see table 1.1). demand is a priority, but the survey also demonstrates The sample was designed in conjunction with the sta- other structural problems, and that any stimulation tistical agency in each country. Rather than focus on the must be complemented by simultaneous restructuring largest firms, a random sample of surveyed firms was of the financial and corporate sectors. drawn so that the results would be significant for the larger population of firms in the economy. Par-icipating Data firms were drawn from the population of firms with 20 or more employees in the selected sectors. Approximately Close to 4,000 firms were individually interviewed as two-thirds of the resulting sample consists of SMEs the basis of the survey. The firms were selected from the (firms with fewer than 150 workers), and one-third is TABLE 1.1 Characteristics of the sample Size (%) Export orientation (%/D) Fflfirm (%/.) Sector (%) Total Small Large Nonexporters Exporters No Yes Food Text. andgarm. Elec. mach. Chem. Auto. Country Indonesia 56 44 64 36 82 18 32 26 12 30 -- 816 Korea, Rep. of 65 35 25 75 83 17 - 23 35 28 14 857 MaLaysia 74 26 53 47 74 26 26 31 20 20 4 693 PhiLippines 48 52 48 52 64 36 26 37 21 16 -- 564 Thailand 63 37 43 57 70 30 10 54 16 20 659 Sector Food 66 34 64 36 84 16- - - - -- 649 TextiLes and garments 63 37 48 52 82 18 - - - - -- 1194 ELectronics, eLectr. mach. 58 42 29 71 61 39 - - - - -- 752 ChemicaLs 61 39 44 56 73 27 - - - - -- 717 Auto parts 63 37 44 56 75 25 - - - - -- 277 Size Small - - 60 40 85 15 19 34 20 20 8 2077 Large - - 24 76 62 38 16 33 23 21 8 1257 Export orientation Nonexporters 80 20 - - 90 10 25 35 14 19 8 1629 Exporters 46 54 - - 64 36 12 33 28 20 8 1923 FDlfirms No 69 31 54 46 - 20 36 17 20 8 2792 Yes 38 62 19 81 - 12 25 33 22 8 889 Indebtedness Low 63 37 49 51 73 27 17 33 22 20 8 1204 High 55 45 36 64 76 24 12 35 24 19 9 772 Foreign borrowing No 67 33 49 51 80 20 16 36 21 20 8 1911 Yes 37 63 13 87 58 42 6 29 30 21 13 700 Total 2000 1221 1570 1861 2688 872 649 1194 752 717 277 3589 Note: Percentages represent the share of the row variabLe that has the corresponding column characteristic. Source: WorLd Bank, Firm-LeveL Survey. 2 Asian Corporate Recovery: Findings fron Firm-Level Surveys in Five Countries made up of large companies. The ownership structure the crisis (see figure 1.1).3 Since the onset of the crisis in of these firms varies across countries, but on average 20 July 1997, 71 percent of the firms have reported declin- percent are publicly listed companies, 55 percent are ing levels of capacity utilization. With investment plans private corporations, and the remainder are partner- virtua] ly halted, this decline corresponds very closely to ships, single proprietorships, cooperatives, or other decreases in output. The proportion was highest in forms of business. Indonesia, followed by Thailand, Malaysia, the While the chosen sectors represent tradable goods Philippines, and Korea. Indonesia also experienced the industries, just over one-half of the firms export some of largest magnitude in the decline, with declines averag- their output. The extent to which the firms export also ing about 20 percent. The lowest average decline was in varies, with less than 20 percent exporting the majority the Philippines, at 9 percent. This is consistent with of their products. A significant number have a relation- other evidence that the Philippines was less affected and ship with a foreign partner; about a quarter are classi- felt the impact at a later date. Korea saw its largest drop fied as foreign direct investment, with a foreign partner in the first half of 1998, again corresponding to the later holding at least a 10 percent ownership stake. date of the onset of its financial crisis. The firms were asked two kinds of questions. The Conmparing exporting and nonexporting firms, the first are quantitative questions regarding production, capacity utilization of the former remained less affected employment, and balance sheet information. The ques- than nonexporters. While levels were comparable in tions cover the period from 1996 through the first half 1996, by 1998 the exporters' capacity utilization was of 1998. The second part of the questionnaire asked nine percentage points higher than the nonexporters'. qualitative questions that were answered by the owner The hardest hit sector was auto parts, with 90 percent or senior manager during an interview. These questions of the firms experiencing a decline. The average decline referred to the time of the interview-between for auto parts was almost 22 percent, followed by November 1998 and February 1999. decline s for electronics (13 percent), chemicals (10.7 Some important caveats need to be kept in mind in percerLt), garments and textiles (9.3 percent), and finally interpreting the data. First, while the survey was food processing (8.4 percent). endorsed by the governments, the firms' compliance was voluntary. Verification of responses can be scruti- nized using internal consistency checks, but it was not possible to obtain external confirmation of responses. FIGURE 1.1 This caveat is particularly relevant with regard to the Capacity utilization financial data. Second, this survey, as with any other, suffers from a survival bias. Only firms that were still in 90 existence were available for interviewing. To gain some 80 measure of the extent of the problem, the statistical 70 *. agencies kept track of the nonresponse rate owing to 60 bankruptcies or closures. On average, 10 percent of the 50 firms selected for the sample were no longer in opera- 40 tion at the time of the interview.2 30 20 10 h:ndonesia Rep. of Malaysia PhiLippines ThaiLand Capacity utilization Korea E1 1996 El Second half 1997 The firms were asked to report their capacity utilization U First half 1997 U First half 1998 in 1996, the first half of 1997, the second half of 1997, Source: WorLd Bank, Firm-LeveL Survey. and the first half of 1998 as a measure of the impact of Asian M-anufacturing Recovery: A Firm-Level Analysis 3 The exporting firms in Korea, Malaysia, and a loose correlation between the firms' expectations and Thailand were also asked to report on changes in their their actual performance in the prior year. export performance. Just over half of the firms in these countries export some of their output, with the highest Employment proportion found in Korea. The surveyed firms were more likely to report an improvement from 1996 to The survey data provides information on the extent to 1997 than from 1997 to 1998-despite the continued which the crisis has affected employment and the causes devaluation. However, one-third of the firms reported for employment reductions.4 These data have implica- that their export performance had declined, on average tions for the social costs associated with the crisis and 10-25 percent. As discussed below, with a significant for the likely extent of human capital loss for firms, and share of exports sold to neighboring countries, the they provide an indication of the extent to which firms regional recession has created an impact on the demand are undertaking restructuring. One of the principal for exports. Coupled with falling dollar prices in many findings is that employment changes are only loosely sectors, it is not surprising that the export performance correlated with changes in capacity utilization; there is of firms after the devaluation was mixed. evidence of labor hoarding in Indonesia, Thailand, and It is clear from the data that the fall in capacity is not Malaysia. Thus, while the data indicate that bKorea has just a cyclical story associated with the financial crisis. made the most progress in adjusting its labor force to Particularly noticeable in Thailand is that capacity uti- the new market conditions, significant labor reductions lization was already falling prior to the devaluation in could still be on the horizon.' July 1997. Data are available on inputs and outputs Almost half the firms in the survey currently employ from 1996 to 1998 that will allow this to be investi- fewer workers than they had prior to the crisis (see fig- gated further in a separate paper. In certain sectors, part ure 1.3). The rate is highest in Korea, where 60 percent of the explanation is the worldwide overcapacity, such have fewer workers. Korea and Thailand are also the as in electronics and auto parts. countries where the proportion of redundancies are greatest, with over a quarter of the firms reporting a Prospects for capacity utilization decline in employment of over 25 percent. In Korea, the reduction in total employment was close to 20 per- Firms in Korea are the most optimistic that recovery is cent. Malaysia is the country where the impact on likely in the first half of 1999 (see figure 1.2). Approximately 70 percent of the sample firms in Korea and the Philippines believe that they will maintain or increase their capacity utilization. In contrast, more Prospects for recovery: firm expectations than 35 percent of the firms in Indonesia, Malaysia, and of changes in capacity utilization in the Thailand believe that their capacity utilization will next six months decrease in the next six months. The financial position Rep of Korea of the firms gives insights into these differences that will MaLaysia be addressed further below. Among the sectors, auto PhiPippinese parts firms are the most optimistic. Having suffered the ThaiLande VWorsen greatest declines in capacity utilization, many believe that OveralL m their position will improve as demand picks up again. F Food 1011ENE _ Imnprove Table 1.2 provides information on which firms have Textites _N _ 1 _ in fact experienced some recovery, with either capacity ELectricaL _ utilization or export performance having improved in Auto parts *_I__ l__ 1998 relative to the end of 1997. It is clear in this infor- -jO -40 -30 -r0 -10 0 10 20 30 40 S0 mation too that Korean firms, particularly exporting Percent firms, have been able to increase their output in recent Source: WorLd Bank, Firm-Leve[ Survey. months. However, it should be noted that there is only 4 Asian Corporare Recovery: Findings fron Firm-Level Surveys in Five Countries TABLE 1.2 Who is recovering: characteristics of the firms that expanded in 1!398 relative to the end of 1997 Reported as percent (by country) of firms that have expanded By size By export orientation FDlfirm Sector Small Large Non- Text. and exporters Exporters No Yes Food garm. Elec. mach. Chem. Auto Total % Sample Increase in capacity utilization Indonesia 43.1 56.9 40.1 59.6 79.4 20.6 47.6 7.9 17.5 26.9 - 51 6.3 Korea 70.1 29.1 21.9 78.1 81.9 18.1 - 31.4 25.0 32.4 1.0 103 12.0 MaLaysia 65.1 34.9 39.3 60.7 68.5 31.5 31.5 19.1 20.2 27.0 2.3 86 10.6 Philippines 43.9 56.3 33.8 66.2 59.8 40.2 25.6 40.2 19.5 14.1 - 71 12.6 ThaiLand 56.0 44.0 25.9 74.1 67.0 33.0 12.1 66.4 12.9 - 8.6 100 15.2 TotaL 57.9 42.1 30.8 69.2 71.2 28.8 20.4 36.3 21.3 19.1 2.9 - - Increase in exports Percentage of exporters Korea 50.0 50.0 - 55.1 77.6 22.4 - 21.8 38.2 27.9 12.1 348 40.6 Malaysia 39.9 60.1 - 59.2 52.4 47.6 14.0 22.6 25.6 33.5 4.3 164 29.1 Thailand 41.3 58.7 - 40.3 56.6 43.4 10.1 61.1 16.1 - 12.8 149 22.6 TotaL 45.7 54.3 - - 66.7 33.3 12.1 30.86 30.1 29.7 10.3 - - Total sample Indonesia 47.9 37.1 55.1 31.4 82.5 17.5 32.1 26.2 11.8 29.9 - 816 - Korea 62.7 33.4 24.9 73.7 83.0 17.0 - 23.2 34.5 28.4 13.9 857 - Malaysia 68.1 24.8 52.3 47.7 73.8 26.2 21.9 26.0 17.0 17.0 3.3 814 - Philippines 42.6 45.9 45.4 49.1 63.3 34.9 25.7 37.2 20.7 16.3 - 564 - ThaiLand 53.9 31.4 43.1 56.1 68.3 28.8 9.7 54.5 15.9 - 19.9 659 - Total 62.3 37.7 45.9 54.1 75.9 24.1 17.5 32.2 20.3 22.6 7.4 - - Source: WorLd Bank, Firm-LeveL Survey. employment has been mildest. Across sectors, auto Conmparing the declines in employment with capacity parts experienced the largest reductions with 73 percent utilization changes, there are stark differences across of the firms reducing their work forces, followed by countries (see figure 1.4). In Indonesia and Thailand, the electronics and machinery. countries with the largest declines in capacity utilization, FIGURE 1.3 FIGURE 1.4 Percent of firms with employment change Changes in capacity utilization by categories of employment response Employment Changes by Country Percent change in capacity utilization 70 Decrease between June 1997 and June 1998 * Same 10 60 D_ IncreaseRe.o 60 | g Increase 5 Indonesia Korea MaLaysia PhiLippines Thailand 0 40 -5 30 -10 20 -15 10 Dcesdepomn 0 -20 U Same employment Level Indonesia Rep. of Malaysia Philippines Thailand El Increased employment Korea -25 Source: World Bank, Firm-Level Survey. Source: NorLd Bank, Firm-LeveLSurvey. Asian Manufacturing Recovery: A Firm-Level Analysis 5 there are also large declines in employment. However, Minimizing the loss of human capital is consistent with there are also a significant number of firms that have rational behavior on the part of the firms. Looking at it maintained their employment levels despite declines in from the social perspective, younger people are less capacity utilization averaging 5-10 percent. A similar likely to have family responsibilities and likely co be eas- phenomenon is discernible in Malaysia. This is consis- ier to train, thus lessening the social cost dimension of tent with labor hoarding.6 the lost employment. Labor hoarding could be the result of inflexible labor The one exception to this pattern is Korea. In Korea, markets. A high cost of firing workers can lead firms to almost half of the lost jobs had been held by workers in maintain higher than optimal levels of employment. their 30s. Korean firms also had a lower share of pro- Further investigation is needed to examine the specific duction job losses, consistent with the lower overall labor market institutions in each country and to ascribe share of production jobs in Korea, but this category still to them the cross-country differences in the data. What bore a disproportionate share of the lost jobs. Like is particularly striking, however, is that Korea, the firms in the Philippines, those in Korea lost a higher country with the strongest union movement is also the share of workers with six to ten years tenure. This could country with the highest redundancies and the least represent a significant loss of human capital. llowever, labor hoarding. One explanation is that with the crisis bearing in mind the loosening of inflexible labor mar- there has been an introduction of measures that have kets, this is consistent with Korean firms' using the loosened the restrictions on firing workers. Further- opportunity to substantially restructure their work- more, union activism seems to have been curbed by forces. This explanation is consistent with the fact that workers' worries about job security in the face of rising Korean firms are also the most liKely to be filling vacan- unemployment. Many firms may have taken advantage cies; a sign that they are reacting to meet changes in of this to undertake desired restructuring. Such a line of labor demand. reasoning is most consistent with the chaebols, the con- That only firms in Korea show substantial signs of glomerates with large labor forces. This explanation is restructuring their work force does not bode well for also consistent with further evidence on the types of the extent of labor adjustment that could be on the hori- workers that were made redundant. zon. If demand does pick up soon, the labor haoarding From another perspective, labor hoarding can be optimal if real wages have fallen or if the firms wish to maintain firm-specific human capital and the shock is 0 perceived to be short-term. Research on the changes in \ 4 real wages continues, with preliminary indications that Age profiLe of workers who have left firms real wages have fallen-in some cases, substantially. Percent The age, tenure, and position of workers who have been 90 * Under 20 made redundant do indicate that the firms are trying to m Age 20-30 minimize the loss of human capital. 80 E Age 31-40 Younger workers were disproportionately made 70 X Age 41-50 redundant in all countries but Korea (see figure 1.5). 60 U Age over 51 Most of the lost jobs had formerly been held by 21-30 50 year-old workers. Likewise the job losses were concen- 40 trated in the production jobs rather than managerial or 30 technical staff. Production jobs represent close to two- thirds of the jobs, but represent three-quarters of the 20 lost jobs. This is most striking in Malaysia and 10 Thailand. The average tenure of those made redundant 0 i P s Indonesia Rep. of MaLaysia Philippines i'hailand was one to three years. The implication of these pat- Korea terns is that younger workers with less firm-specific Source: WorLd Bank, Firm-LeveL Survey. human capital have been those that are let go. 6 Asian Corporate Recovery: Findings fron Firm-Level Surveys in Five Countries FIGURE 1.6a FIGURE 1.6b Sources of output decLine Sources of export decline Importance to output decline (1=not important, 5=important) Imporlance to export decline (1=not important, 5=important) 5 5 4 4 3 3 2 .~~~~~~~~~~~4 0151 11|0 mav have been j'ustified, but only if there is little sub- decline in investment and consumption. As emphasized stantial shift in the skills needed by the firms in the post- by Cho and Rhee,1° the withdrawal in capital flows that crisis period. If significant labor shedding develops in took place in 1997 translated more into a sharp rise in the upcoming months, the need will grow for continued interest rates than into a contraction of money supply improvements in the expansion of social safety nets and as gove-rnments continued to extend liquidity support a further balancing of the speed of adjustment with to theilr fledgling financial sectors (see figure 1.7). social costs. Clearly this is an area that justifies careful Nomirnal and real interest rates jumped to historical monitoring in the months ahead. highs. Because East Asian firms were highly leveraged, the rise in interest rates translated to a sharp decline in Corporate views of the causes of the output the firms' investment demand. The collapse of this decline demand had a large impact on aggregate demand because before the crisis, investment in these countries The firms were asked to list and rank the causes of out- accournted for 40 percent of gross domestic product put decline.7 The responses are shown in figure 1.6a (GDP), with the exception of the Philippines where and table 1.3.8 The first four causes were, in order of investraent represents only about 20 percent of GDP. decreasing importance, domestic demand, the rise in The restrictive fiscal policies initially adopted in imported input costs caused by the depreciation, high response to the withdrawal of capital flows further con- interest rates, and labor cost. It should be kept in mind tributed to the collapse of domestic demand. that the answers to this qualitative question were based The second cause of the output collapse reported by on the firms' position and the economic environment the firms was the rise in the cost of imported inputs prevailing in the time period from the end of 1998 to caused by the devaluation. (Filipino firms reported this early 1999.9 as the most important cause of output decline.) This The main complaint of the firms in all countries, with complaint can be expected in countries that have deval- the exception of the Philippines, was the collapse of ued their currency. The rise in input costs caused by the domestic de-mand for their products. This complaint is devaluation reduces the profit margins of nonexporting mirrored by the macroeconomic data showing a sharp firms a~nd provides them with the incentive to redirect Asian Manufacturing Recovery: A Firm-Level Analysis 7 NominaL and reaL interest rates, March 1997-December 1998 (percent) Indonesia Rep. of Korea 90 40 60 30 30 20 0 10 -30 -60 0 -90 -10 Mar. 1997 Aug. 1997 Jan. 1998 June 1998 Nov. 1998 Mar. 1997 Aug. 1997 Jan. 1998 June 1998 Ncv. 1998 Malaysia Philippines 15/ 20 lt ' 1o 15 .10 5 5 0 -5 -5 Mar. 1997 Aug. 1997 Jan. 1998 June 1998 Nov. 1998 Mar. 1997 Aug. 1997 Jan. 1998 June 1998 Nov. 1998 Thailand 25 20 15 10/N 5 0 -5 Mar. 1997 Aug. 1997 Jan. 1998 June 1998 Nov. 1998 ReaL interest rate NominaL interest rate Source: World Bank, Firm-LeveL Survey. their production to the tradable sector, which eventu- for the causes for the decline in export performance (see ally results in an increase in the volume of exports and figure 1.6b and table 1.4). The most important one in the restoration of the firms' profits. Indeed, in 1997 given was the lack of foreign demand and the lack of the expectation was for a rapid recovery led by exports. stability in foreign markets. The collapse of domestic However, the export-led recovery did not materialize. demand in the five countries and the recessiorL in Japan The survey results shed some light on the reasons. also hurt exporters, because of the importance of Exporters in Korea, Malaysia, and Thailand were asked intraregional trade. Including Japan, about half of the 8 Asian Corporate Recovery: Findings fron Firm-Level Surveys in Five Countries exports of the five countries go to the region (the excep- following the devaluation of the Thai baht, export vol- tion is the Philippines, which sells a greater share of its umes in the five countries rose by about 20 percent, but exports to the United States). The firms have reported nominal export values in U.S. dollars remained flat, fewer complaints about the impact of the decline in for- with the exception of the Philippines where nominal eign demand on overall output, not so much because export values continued to grow at a 20 percent clip. the decline in foreign demand has been less pro- Thus, exporters and domestic producers trying to reori- nounced, but rather because the firms sell a smaller ent their production to the export markets were hit share of their output abroad. simultaneously by shrinking markets and declining The second main reason given by exporters as the prices. cause of their decline was exchange volatility and the The third cause of output decline reported by the lack of price competitiveness. Export prices in the five firms tvas the high level of interest rates. At the time countries had started to decline before the crisis hit."1 when the question was asked (late 1998 to early 1999), And after the crisis, they declined sharply: in the year nominal interest rates were back to their precrisis levels. TABLE 1.3. Change in leveL of output after the crisis and source of outpiut decline By change in B_v source of level of output (%) output decline (%) ,'eavy Not Increose Dom. Costly Labor debt Wk. Fgn. Raw Expans. Suppl. deliver or some Decrease demand Depreciation loans costs tlurden capital demand materials credit credit goods Country Indonesia 24 76 3.5 3.6 3.1 2.6 2.1 1.8 2.5 2.1 1.8 2.1 Korea 33 67 4.3 2.9 3.1 2.0 2.3 2.6 2.8 2.3 2.2 2.1 2.1 Malaysia 33 67 4.0 3.6 2.8 2.5 2.5 2.3 2.4 2.1 2.2 2.1 2.0 Philippines 31 69 3.2 3.9 3.4 3.3 2.7 2.4 2.6 2.4 2.3 2.3 ThaiLand 27 73 4.0 4.0 3.3 3.4 2.9 2.7 2.8 2.3 2.2 2.4 2.1 Sector Food 34 66 3.4 3.6 3.0 2.7 2.3 2.2 1.8 2.7 2.0 1.9 2.1 TextiLes and Garments 32 68 3.7 3.7 3.2 3.0 2.7 2.6 2.5 2.3 2.3 2.3 2.2 Electronics and elect. mach. 26 74 3.9 3.3 2.9 2.5 2.4 2.3 2.9 2.1 2.1 2.0 1.9 Chemicals 33 67 3.9 3.6 3.2 2.6 2.5 2.5 2.2 2.4 2.3 2.2 2.0 Auto parts 7 93 4.6 3.6 3.3 2.7 2.8 2.7 2.6 2.3 2.2 2.2 2.1 Size SmaLL 26 74 4.0 3.5 3.0 2.7 2.5 2.4 2.2 2.3 2.1 2.1 2.1 Large 34 66 3.6 3.6 3.2 2.7 2.6 2.5 2.8 2.3 2.3 2.1 2.0 Export orientation Nonexporters 21 79 4.1 3.6 3.0 2.7 2.5 2.3 1.7 2.3 2.0 2.1 2.1 Exporters 37 63 3.6 3.6 3.3 2.7 2.6 2.6 3.2 2.4 2.4 2.2 2.1 FDIfirms No 28 72 3.9 3.6 3.2 2.7 2.6 2.5 2.2 2.4 2.2 2.1 2.1 Yes 34 66 3.5 3.6 2.9 2.8 2.4 2.3 3.0 2.1 2.1 2.0 1.9 Indebtedness Low 28 72 3.9 3.6 3.0 2.8 2.4 2.2 2.4 2.3 2.1 2.0 2.0 High 27 73 3.9 3.6 3.4 2.8 2.8 2.6 2.6 2.4 2.3 2.3 2.1 Foreign borrowing No 26 74 3.9 3.6 3.2 2.8 2.7 2.5 2.4 2.4 2.3 2.2 2.1 Yes 35 65 4.0 3.3 3.2 2.4 2.5 2.6 3.0 2.2 2.2 2.1 1.9 Capocity utilization Increase 3.4 3.7 3.3 3.1 3.3 2.7 2.6 2.7 2.5 2.4 2.4 Same 3.5 3.5 2.9 2.8 2.5 2.3 2.4 2.3 2.1 2.0 2.0 Decrease 4.0 3.6 3.2 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.1 Total 29 71 3.8 3.6 3.1 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.1 Soarce: World Bank, Firm-Level Survey. Asian Ms nufacturing Recovery: A Firm-Level Analysis 9 TABLE 1.4 Source of export decline by firm characteristics By change in export (%/.) By source of export decline (%) Exchange High Poor rate Unstable Price import Credit Decrease Same Increase demand volatility markets competitiveness cost constraints Design Country Indonesia - - - - - - - - - Korea 29 11 60 3.68 2.94 3.55 3.28 2.71 2.30 1.97 Malaysia 38 15 46 4.24 3.64 3.22 3.48 3.76 - 2.82 PhiLippines - - - - - - - - - - Thailand 36 20 44 3.93 3.96 3.96 3.76 3.84 3.12 - Sector Food 40 21 39 3.79 3.85 3.26 3.55 3.57 3.17 2.63 TextiLes and garments 31 15 54 3.85 3.89 3.70 3.60 3.43 2.81 2.36 ELectronics and elect. mach. 34 14 52 3.97 3.45 3.49 3.36 3.30 2.19 2.32 Chemicals 32 14 55 3.99 3.45 3.45 3.52 3.12 2.44 2.40 Auto parts 38 10 52 4.02 3.79 3.73 3.20 3.48 2.82 2.14 Size SmaLL 38 17 45 3.98 3.66 3.67 3.49 3.31 2.48 2.35 Large 27 11 62 3.85 3.71 3.35 3.46 3.32 2.68 2.36 Export orientation Nonexporters - - - - - - - - - - Exporters 33 14 52 3.93 3.68 3.55 3.47 3.34 2.58 2.36 FDI firms No 33 13 53 3.79 3.59 3.53 3.42 3.18 2.48 2.26 Yes 34 16 50 4.18 3.79 3.56 3.54 3.62 2.82 2.56 Indebtedness Low 35 15 50 4.03 3.66 3.84 3.43 3.34 2.31 2.39 High 33 15 52 3.94 3.63 3.76 3.44 3.34 3.01 2.31 Foreign Borrowing No 35 15 50 3.84 3.67 3.65 3.43 3.28 2.49 2.20 Yes 31 12 58 3.96 3.67 6.47 3.47 3.20 2.55 2.40 Total 33 14 52 3.93 3.68 3.55 3.47 3.34 2.58 2.36 Source: WorLd Bank, Firm-LeveL Survey. Real interest rates, measured by the consumer price months of each other. As the countries, particularly index (CPI) were also below their precrisis level. Indonesia, Malaysia, the Philippines, and Thailand However, because of producer price deflation, real have fairly similar exports, their overall competitive- interest rates measured by the producer price index ness has not increased by much. Finally some of the (PPI) were above their precrisis level.12 Furthermore, countries, particularly Korea and Thailand had experi- with the decline in output prices, precrisis real interest enced several years of real wage growth that was higher rates were likely to be perceived by firms as "too high." than productivity growth in the manufacturing sectors. The fourth cause of output decline reported by the As mentioned previously, the decline in the rate of firms was the high level of labor costs. This is a surpris- capacity utilization prior to the crisis suggests that ing finding in view of the nominal depreciation of about structural problems were at play before the crisis hit. 40 percent in nominal terms betwveen mid-1997 and the To sum up, the firms in Indonesia, Korea, Malaysia, end of 1998. This particular complaint has to be put in and Thailand, were hit by a collapse in domestic the context of declining output prices. Moreover, the demand and a decline in profitability caused by sharply currencies in the five countries were devalued within higher imported costs but could not successfully switch 10 Asian Corporate Recovery: Findings fron Firm-Level Surveys in Five Countries their production to exports because of shrinking export The crisis has greatly curtailed the availability of markets, declining export prices, and competitiveness credit. Bank liquidity and capital have been severely problems that predated the crisis. affected by mounting stocks of nonperforming loans. The firms in the Philippines seem to have had a some- Estimates of peak nonperforming loans vary from 30 what different experience. First, as mentioned above, of perceni: of the total loan portfolio of banks in Korea to the five countries, Filipino firms had the lowest rate of 75 percent in Indonesia,14 while the Filipino banking capacity utilization in 1996 but the smallest decline in sector has not so far suffered from systemic difficulties capacity utilization as a result of the crisis. Second, (see table 1.5). Second, many countries had initially Filipino firms ranked costs-imported inputs, high adopted policies that tightened capital adequacy and interest rates, and labor costs-as more important loan classification rules. These policies have further causes of output decline than a lack of domestic or for- reduced the availability of credit because banks have eign demand. found it more difficult than expected to mobilize capi- This is likely to reflect a different macroeconomic and tal from private sources, especially foreign ones. In view international environment. The international environ- of the lack of interest on the part of foreign investors, ment for Filipino firms seems to have been more favor- governnents have had to intervene and provide dis- able, with firmer export prices and a greater reliance on tressed banks with liquidity and capital. However, with the U.S. market, in which import demand has been sus- perhaps the exception of Korea, governments have gen- tained throughout the crisis. Furthermore, the contrac- erally been slow in restructuring and recapitalizing the tion of GDP in 1998 was much smaller than in the other banking sector. Eventually, the tightening of capital ade- countries. The Philippines has not been hit by a collapse quacy ratios had to be reversed or phased in over a in investment demand comparable to that of other longer period of time. A third reason for the decline in countries. The rise in real interest rates was much less credit availability has been an increased degree of risk pronounced than in Korea and Thailand,13 and as men- aversion on the part of banks, a phenomenon that has tioned above, the ratio of investment to GDP in the been observed in most banking crises. Figure 1.8 shows Philippines is smaller than in other countries. Rather, that, on aggregate, real credit to the private sector has the Philippines has been hit by a supply shock: the 1998 declined since mid-1997 in Indonesia, the Philippines, drought led to a contraction of output in the agricul- and Thailand. In the case of Thailand, the decline in the tural sector, as well as to higher costs of foodstuffs that supply of credit is also well documented in a paper by fed into higher inflation. Professor Takatoshi Ito and Luis Pereira da Silva.15 The low level of capacity utilization in 1996, the Compared with the sharp output declines that decline in capacity utilization prior to the crisis, and occurred, and reduced demand for credit, these aggre- Filipino firms' complaints about costs despite a more gate numbers do not indicate that there were large favorable international environment suggest that the aggregate shortfalls in credit availability. Despite the decline of output of Filipino firms and the recent slow- decline in banks' capability to extend credit, the surveyed down in export growth have been caused more by structural competitiveness problems than by the col- TABLE 1.5 lapse in domestic and foreign demand. Peak n Dnperforming loans and losses Credit availability, corporate credit needs, (percentsge of percentNge of Losses/capital and governance loan portfolio) GDP percent Indonesia 75 30 474 By the end of 1998, the firms did not report credit avail- Malaysia 35 20 120 . , . Kre .........Kor......a. 30 16 126 ability as a major source of output decline, despite the Thailand 50 34 248 systemic problems experienced by the financial sectors of many countries. The surveys shed some light on this Note. Assuniptions on recovery rates: Indonesia 25 percent; Thailand 30 percent; M~aLaysia anni Korea, 50percent. Net loss is defined as the deterioration in bank capitol surprising finding by providing information on the rela- resulting from the implied write-down of loans. June 1997 baLance sheet data on Loans and capital are used as a base. tionship between the banking sector and the firms. Source: Deutsche Bank Research. Asian Manufacturing Recovery: A Firm-Level Analysis 11 FIGURE 1.8 Real domestic private credit and industrial production, three-month moving average 1996-98 (Index July 1997=100) Indonesia Rep. of Korea 110 110 100 ~~~~~~~~~~~~~~105 100~~~~~~~~~~~~~~~0 90 0 95 80 90 70 85 60 _______________________80 JuLy 1997 Dec. 1997 May 1998 Oct. 1998 JuLy 1997 Dec. 1997 May 1998 Oct. 1998 Malaysia Philippines 115 90 75 July 1997 Dec. 1997 May 1998 Oct. 1998 JuLy 1997 Dec. 1997 May 1998 Ot. 1998 Thailand 110 100 90 80 July 1997 Dec. 1997 May 1998 Oct. 1998 IndustriaL production index Private domestic credit index Note: Industrial production index for Indonesia refers to quarterLy data (1997 Q2=100). Source: WorLd Bank, Firm-LeveL Survey. 12 Asian Corporate Recovery: Findings fron Firm-Level Surveys in Five Countries firms did not report credit availability as a major source The firm-level data shows that caution needs to be of output decline-and exporters reported that the top exercised against drawing broad generalizations causes of decline were a fall in demand and a lack of regarding the issue of credit availability. Clearly the sup- price competitiveness. With the decline in the demand ply of credit has been reduced, but so too has the for their products, the firms' credit demand is likely to demand for credit. First, distinctions between the time have declined as well so that credit availability is not an period, after the onset of the crisis need to be taken into immediate constraint to corporate recovery. However, account. During the stabilization phase when interest as countries implement expansionary fiscal policies, the rates were raised significantly, the demand for credit demand for the firms' product and the firms' demand was obviously lower. With output down, the demand for credit are likely to increase. Financial sector restruc- turing and recapitalization have to proceed in step with FIGURIE 1.9 fiscal expansion. fiscal~~~~~~~~~ expnson Share of firms reporting inadequate liquidity Furthermore, credit aggregates do not indicate whether there were deficiencies in the way credit was Percent allocated. The survey data indicate that despite overall 60 credit availability, many firms felt severely constrained 50 in undertaking viable projects. In part this is due to the distinction between credit and liquidity. Liquidity is a 40 broader concept, including the important financing 30 provided by internal funds. About 40 percent of the firms overall reported experiencing inadequate liquid- 20 ity to finance production (see figure 1.9). Thailand and Korea were the two countries in which liquidity prob- lems were the most acute, and, in general, exporters 0 R Inidonesia Rep. of Malaysia Phi[ippines Thailand found it easier than nonexporters to secure adequate Korea liquidity. When the firms were asked about the causes Source: WorLd Bank, Firm-Level Survey. of inadequate liquidity, they listed as the main causes lower revenues and higher input costs caused by the devaluation. The burden of servicing their debts and insufficient working capital ranked much lower (see fig- FIGURE 1.10 ure 1.10). In other words, factors affecting cash flow Sources of inadequate liquidity received more attention than credit. Contribution to inadequote liquidity The importance of cash flow over credit reflects the (1=no conitribution, 5=mojor contribution) structure of working capital of firms in the sample, two- 4.5 thirds of which are small and medium. Only about 20 4 percent (in Indonesia and Malaysia) to 35 percent (in 3.5 Thailand) of working capital requirements of surveyed 2.5 firms comes from loans; the bulk (between 50 and 65 2 percent) comes from retained earnings (see figure 1.11). 1.5 Also, Thai and Indonesian firms get about one-third 1 and Korean, Malaysian, and Filipino firms about one- 0.5 tenth of their working capital from informal sources of 0 financing-family, partners, and informal money C'# ° >& . . z, lenders. Thus Thailand, the country with the highest .- 9 reliance on loans to finance working capital, is also the ',o\ country where surveyed firms complained the most Source: WorLd Bank, Firm-LeveL Survey. about the lack of loans for working capital. Asian Manufacturing Recovery: A Firm-Level Analysis 13 FIGURE 1.11 trate that for the manufacturing firms, foreign borrow- ing was concentrated in a small number of firms.16 Sources of working capital, 1996-98 Based on the survey results, the manufacturing sector Share of working capital (percent) Ci 1996 does not seem to have been a major player, particularly 50 U 1997 Hl relative to the real estate and financial services sectors. 40 U 1998 H2 With the exception of Korea, less than 10 percent of 30 _ 1 financing was in foreign currency (see figure 1.12). 20 r g ' W Korea is notable for its greater reliance on foreign bor- 10 rowing, with a quarter of the surveyed firms engaging o _ _ g * W l l t in this practice. That there are more listed companies in Retained earnings Loans Other the Korean sample is one explanation for this. Of the share of financing that is in foreign currency, only in Korea and Malaysia is the majority of it not short-term. Sources of working capital by country, 1998 HI However, it remains true that most of the effect of the Share of working capital (percent) 1 Retained earnings depreciation would have been transmitted through \ 70 U Loans alternative channels (for example, the impact on banks) 60 1 Other than through the balance sheets of manufacturing firms. 50 However, one finding does indicate a more worri- 40 some pattern. The firms that qualified for for-eign cur- 30 rency loans were more likely to be the unprofitable lo I}}§l 000 * 9\\0000 f000 s firms (see figure 1.13). Conversely, more profitable 0 firms had a lower share of their financing denominated I Indonesia Rep. of MaLaysia Phi Li ppi nes Thai Land | ndonesa R ofKorea in foreign exchange. It is certainly possible that the Source: WorLd Bank, Firm-LeveL Survey more profitable firms had less need to borrow, but this Scarce: Wur[d Bunk, Firm-Luve[ SurveyIprovides further evidence that the financial sector needs to scrutinize its clients carefully in deciding whether or not to extend loans. for credit has remained lower. However, since interest rates have been lowered, as recovery picks up, the demand for credit could well rise, increasing the diffi- culty of obtaining adequate financing if banks remain FIGURE 1.12 cautious about extending new loans. Second, there are Foreign debt (percentage of total plus ecjuity), important differences between the firms depending on 1996-98 Hi their initial level of credit in their total financing, their Percentage offoreign debt C Short-term recourse to bank lending for working capital and for 25 U Long-term longer-term investments, and the sectors in which they 20 operate. Another factor is whether the firms export or are oriented toward the domestic market. The new 15 microeconomic data available here complements the 10 more aggregate analysis that has so far been undertaken. Foreign indebtedness 0 L ., AI¾L Se S$St Se SSt SiN leSe SSe 0t@ Short-term borrowing in foreign currency and the sud- Indonesia Korea Malaysia PhiLippines ThaiLand den reversal of capital flows are often cited as important Source: WorLd Bank, Firm-Level Survey. causes of the financial crisis. However, these data illus- 14 Asian Corporate Recovery: Findings fron Firm-Level Surveys in Five Countries A policy implication of the surveys is that even The Firms'responses to this question are shown in fig- though there is no evidence of an overall shortfall of ure 1. 1 4. In the five countries, a first category of firms credit availability, credit allocation from domestic and that indicate that they do not expect to have problems foreign sources is not always efficient. Some firms have in serv:.cing their loan repayments range from over two- seen their working capital needs increase as their source thirds i n Korea, Malaysia, and Thailand, to one-half in of liquidity decreased; they could benefit from addi- Indonesia and the Philippines. A second category of tional credit. At the same time, exporters attribute their firms indicating that they expect to be able to meet loan decline to a lack of competitiveness, which suggests that payments for the following twelve months but not additional credit would have to be extended in the con- beyond that period is populated by 10-15 percent of the text of improvements in competitiveness. These latter firms in Thailand and Malaysia, and 20-25 percent in improvements require a combination of government Indonesia, Korea, and the Philippines. A third category competition policies and corporate restructuring to of firms indicated that they are currently having diffi- increase productivity. culties in meeting loan repayments, or expect to be able to meer. loan repayments only for the next three months The firms' views on loan repayment and nDt beyond: about 20 percent in Indonesia, prospects Thailand, the Philippines, and Malaysia, and 10 per- cent in Korea. The questionnaire, as noted earlier, in addition to seek- Table 1.6 shows the characteristics of firms in the ing quantitative information from the firms, sought three categories. A comparison of the firms in the first their qualitative views on their ability to meet required and third categories indicates that those not reporting loan payments, if interest rates remained at current-in loan repayment difficulties, on average: other words, end-of-1998 through early 1999-levels. * Have experienced smaller declines in capacity uti- The firms were asked to indicate their perceived ability to lization (a significant exception is Korean firms); meet required loan payments, by three-month intervals, * Are exporting more (exceptions are Korean and over the next twelve months and beyond. About 2,000 Thai firms); firms in the five countries responded to this question. * Are financing a greater portion of their working cap- ital with retained earnings (Filipino firms are an exception); and FIGURE 1.13 * Have experienced much less difficulty in securing adequate amounts of liquidity for production. Short-term foreign debt by profitable and less The above information indicates that surveyed firms profitable exporters, 1996-98 Hl in the five countries see themselves at various stages in Short-termforeign debt/totalforeign debt El ProfitabLe the recovery process, as well as in their access to liquid- exporter ity required for production. The bulk of the firms in 5 Less profitable Korea, Malaysia, and Thailand consider themselves to 50 be in good financial condition. This is less the case in Indonesia and the Philippines. There remain, however, 45 a signilicant number of firms in all five countries that were either experiencing loan repayment difficulties at 40 the time of the survey, or thought that they would find themselves in that situation in the near future, if eco- 35 nomic conditions (in particular, demand and interest rate levels) were to persist. This financial fragility of a 30 1996 1997 1998, Hi significant proportion of the firms is linked both to Source: World Bank, Firrn-Level Survey. macroeconomic conditions and the pace of bank and corporate restructuring. Asian Manufacturing Recovery: A Firm-Level Analysis 15 FIGUREd1.14W I I X M EXw i Ability to meet loan payments, by country Indonesia Rep. of Korea MaLaysia 2101 15%I 5 D o /~~~~2 67 680,5l Philippines Thailand Overall 1 40/a020 j8 0 h~~~~8 65 62 %8 Y Expect to pay Expect to pay Expect to pay MW for up to 3 months for 3 to 12 months fo r over 1 year Source: World Bank, Firm-LeveL Survey. Governance A central issue of corporate governance is the relation- S ship between the firm and its financial institution(s), for ban uires ty dere of Lvage The disclosure and transparency of information is of particular interest. The firms were asked whether they Percent 1 Highty leveraged were required to provide audited statements to receive 80 * Low Leverage a loan. Of those with 20 percent or more of their financ- 70 ing provided by bank or financial company loans, the 60 share that are so required ranged from 40 percent in 50 Indonesia and Thailand to 70 percent in Korea, 40 Malaysia, and the Philippines (see figure 1.15). If the 30 firms are only interested in securing a letter of credit for 20 trade finance, the issue of transparency is not so impor- 10 I tant. But to the extent that many of the firms' only 0 source of finance is short-term trade credit-which they Indonesia Korea MaLaysia Philippines ThaiLand in fact use to finance investment or other long-term Source: World Bank, Firm-Level Survey. activities-the issue is still pressing. 16 Asian Corporate Recovery: Findings fron Firm-Level Surveys in Five Countries While the survey provides evidence in favor of accel- and im proved allocation of credit should see the replace- erating standard accounting methods and disclosure ment of relationship-based loans with more market- requirements, there is another side to the story. It is true based criteria. This is a long-term endeavor. In the short that more highly leveraged firms are more likely to be term, wvhat is needed is a clear set of prudential regula- required to provide audited statements. The ones least tions and disclosure requirements that should be likely to be required to present them are small firms, imposed on banks and financial institutions with regard which tend to have long-standing relationships with to thei loans-including those extended to SMEs. their financial institutions. On average, these firms have done business with the same primary financial institu- ConcLusion tion for over half of the life of the firm. Informal rela- tionships can be an efficient way of learning about a The main conclusions of the survey results and the con- firm and having needed credit extended. In credit mar- ference discussions, as outlined by the five senior Asian kets that discriminate against SMEs, such relationships- policyrnakers who chaired the sessions, are summarized based financing may indeed be efficient. However, the below:17 development of more transparent financial institutions TABLE 1.6 Profile of firms with different expectations on remaining current on debt payments (Percentage of firms in each category) Firms that expected to remain currentfor more than a year Indonesia Korea MalaYsia Philippines Thailand Average Experienced output decLine 80 70 71 77 73 74 Capacity utiLizationa 59 71 69 70 64 66 SmaLL size 51 67 63 54 64 57 Exporter 45 63 51 55 42 49 Low indebtedness 67 37 75 47 63 60 Foreign debt 17 44 2C 14 28 27 Liquidity is a problem 36 60 23 28 55 42 Firms that expected to remain current for more than 3 months and less than 1 year Indonesia Korea Malaysia Philippines Thailand Average Experienced output decLine 76 72 86 81 73 77 Capacity utilizationa 63 67 64 61 60 63 SmaLL size 55 77 76 53 68 64 Exporter 38 65 48 41 69 51 Low indebtedness 71 54 91 40 66 62 Foreign debt 10 40 20 11 28 22 Liquidity is a probLem 30 58 46 36 69 44 Firms that were not current or did not expect to remain currentfor more than 3 monrhs Indonesia Korea Malaysia Philippines Thailand Average Experienced output decLine 80 73 73 81 88 81 Capacity utiLizationa 56 69 58 62 52 57 Small size 62 42 71 49 62 57 Exporter 38 85 52 50 52 51 Low indebtedness 62 42 72 57 45 55 Foreign debt 21 54 12 23 28 26 Liquidity is a problem 45 70 62 43 85 61 a. Average capacity utilization. Source: WorLd Bank, Firm-Level Survey. Asian Manufacturing Recovery: A Firm-Level Analysis 17 * The stimulation of demand alone is not enough. It authors and do not necessarily represent the views of the WorLd Bank, needs to be combined with accelerated restructuring its Executive Directors, or the countries they represent. of banks and other financial institutions if corporate 1. The surveys provide the basis for regional conferences on these recovery is to be robust. issues of corporate recovery and the determinants of productivity. The * Corporate and financial restructuring must take first was heLd in Bangkok from March 31 to April 2 and was attended place simultaneously for both to succeed. by 150 senior policymakers and private sector representatives from * The institutional framework for corporate finance around the region. The second conference is pLanned fo- November needs urgent strengthening to improve the efficiency 1999. A research conference is aLso under discussion for thie spring of of credit allocation. Laws to regulate bankruptcies, 2000. foreclosures, and mergers and acquisitions, are 2. ThaiLand provides a speciaL case as this was the second such sur- needed to facilitate the transfer of assets of failed vey it had carried out. Twelve hundred firms had been interviewed by companies to viable ones. the end of 1997. These same firms were then contacted a year later, * Financial transactions need greater transparency and again, cLose to 10 percent had gone out of business. A foLLow-up through improved reporting, accounting, and paper will examine the characteristics of the firms that cl)sed during auditing. 1998 to gain insights into the most vuLnerabLe firms and as a predic- * According to business responses to the survey, the tor for the Likely extent of future bankruptcies. demand for credit has declined as sales have fallen. 3. See Waiquamdee, Krairiksh, and PhongsanarakuL, 1999, "Corpo- However, many firms reported difficulties in secur- rates' Views of the Constraints to Recovery," paper prepared for the ing adequate credit. As demand grows, availability conference on Asian Corporate Recovery, Bangkok March 31-April 2. will become a bigger issue. 4. Care has been taken not to cLassify aLL the redundarcies as Lay- * Excess capacity has both a cyclical and a structural offs or fired workers. Many of the countries have restrictions on fir- nature; therefore, macroeconomic policies need to ing, incLuding Large severance packages. Thus, many firms have found be supplemented with measures to improve corpo- aLternative ways to reduce the number of workers, and the number of rate competitiveness. layoffs is significantLy Lower than the overall reductions in empLoyment. * The development of a bond market needs to be 5. See Xin Meng and RonaLd Duncan, 1999, "Corporate lEmpLoyment started now because it is a long-term endeavor. and PubLic PoLicy," paper prepared for the conference on Asian • More discussion is required to design competitive- Corporate Recovery, Bangkok March 31-ApriL 2. ness strategies. 6. In ThaiLand, and to a Lesser extent Indonesia, firms with * The speed of adjustment must be balanced with the increased empLoyment aLso increased capacity utilization, implying social costs and the need for social safety nets. that their markets were expanding. In contrast, in MaLaysia, firms with greater empLoyment were stiLL experiencing Lower LeveLs of capacity Notes utiLization. Further investigation, particuLarLy regarding movements in wages, is underway to explain this pattern. Mary Hallward-Driemeier and Dominique Dwor-Frecaut are with the 7. See Waiquamdee, Krairiksh, and PhongsanarakuL, 1999, WorLd Bank. Francis CoLaco is with Asia-Pacific Management "Corporates' Views of the Constraints to Recovery," paper srepared for ConsuLtants, Inc. The authors wouLd Like to thank Giuseppe Iarossi, the conference on Asian Corporate Recovery, Bangkok Match 31-April Stacy Nemeroff, Dennis Tao, Hairong Yu, and Hosook Hwang for invaLu- 2, and presented in this voLume. abLe heLp in assembLing the data set and for exceLLent research assis- 8. There is considerabLe variation in the responses of individuaL tance. They have aLso benefited from the comments of the participants firms to this question, indicating that managers did differentiate of the Asian Corporate Recovery Conference heLd in Bangkok, March between the severity of different sources of probLems. The reported 31-ApriL 2, 1999 and from the seminars heLd at the WorLd Bank and resuLts are the mean responses, but if percentile ranks ae used, the in Kuala Lumpur, Jakarta, Singapore, ManiLa, Hong Kong, Tokyo, Seoul, ordering is the same. and at the meeting of the Association of Southeast Asian Nations 9. Care must aLso be taken in interpreting these quaLitative resuLts, (ASEAN) Chambers of Commerce and Industry. The findings, interpre- as the firms report their partiaL equiLibrium view of the world. Thus is tations, and concLusions expressed in this paper are those of the it is possibLe that the decLine in domestic demand is "overreported" 18 Asian Corporate Recovery: Findings fron Firm-Level Surveys in Five Countries as a problem, since many suppliers to a large credit-constrained firm conference on Asian Corporate Recovery, Bangkok March 31-April 2, will report that a decLine in demand is the main constraint, when the and presented in this volume. root cause is the Large buyers access to credit. However, one piece 15. Ito and Pereira da SiLva (1998). The paper anaLyzes aggregate of evidence that mitigates this concern is that there is no statisti- data on the Thai financial sector and the responses from 17 banks (7 calLy significant difference between the responses of firms that pro- Thai anc 10 foreign) that returned questionnaires in ApriL and May of duce intermediate goods and those that produce final goods. l998. 10. Cho and Rhee, 1999, "Macroeconomic Views of the East Asian 16. See Masahiro Kawai, Hongjoo Hahm, and Giuseppe Iarossi, Crisis: A Comparison," paper prepared for the conference on Asian 1999, (Corporate Foreign Debt in East Asia: Too Much or Too Little?" Corporate Recovery, Bangkok March 31-ApriL 2, and presented in this paper prepared for the conference on Asian Corporate Recovery, volume. Bangkok March 31-ApriL 2, and presented in this voLume. 11. See Dasgupta and Imai (1998). 17. These concLusions are taken from the press conference written 12. There is some controversyabout how bestto calculate reaLinter- by the five chairs of the Asian Corporate Recovery conference, est rates in a period of rapidLy changing expectations as the ex ante Bangkok, March 31-April 2: Dr. IL Sakong (former Finance Minister of expected infLation and ex post infLation can differ substantiaLLy. Korea arid President of the Institute for GLobaL Economics), Dr Zeti 13. See Dwor-Frecaut, HaLLward-Driemeier, and CoLaco, 1999, "Asian Akthar Aziz (Deputy Governor of Bank Negara Malaysia), M.R. Chatu Corporates' Credit Needs and Governance," paper prepared for the con- MongoL Sonakul (Governor of the Bank of ThaiLand), Secretary ference on Asian Corporate Recovery, Bangkok March 31-April 2, and Benjamii Diokno (Secretary of Budget and Management, the presented in this voLume. PhiLippines), and Dr. Mari Pangestu (Executive Director, Center for 14. See Javad K. Shirazi, 1999, "The East Asian Crisis: Financial Strategic: and International Studies, Indonesia). Sector Restructuring-Progress and Issues," paper prepared for the Asian Marnufacturing Recovery: A Firm-Level Analysis 19 C-kAptewr j177o Corporates' Views of the Constraijnits to Recovery Economic Research Department, Bank of Thailand he economic and financial crisis that has swiftly and devastatingly swept through Asia is undoubtedly the steepest and most prolonged downturn witnessed in recent decades. It has wiped out the economic gains that have been laboriously accumulated over the years-inevitably result- ing in widespread social suffering. More than one year after it first struck Thailand and its contagion effect was felt throughout Asia, the crisis has now brought to the fore a number of widely debated issues, especially with regard to the suitability of competing prescrip- tions for crisis management. Thus far, policy response by most countries has been characterized by austeriliy measures commonly in the form of fiscal disci- pline, interest rate hikes, and strengthening financial supervision (although there have also been alternative approaches, most notably the imposition of capital controls combined with the easing of positions regarding fiscal and monetary policy). What is often overlooked in these discussions, however, is that policy implementation, regardless of methods, has only been based on the top-down macroeconomic approach. Indeed, while conventional macroeco- nomic indicators have shown the relative extent to which the crisis has affected the different countries, a common comparison among the countries in terms of the microeconomic impacts is yet to be done. Therefore, the surveys conducted by the national authorities in collaboration with the World Bank are timely and appropriate, in that they have enabled us for the first time to step back and gauge the extent of the crisis and its impact on the real sector of the economy. More important, this bottom-up approach allows us to formulate or fine-tune policies-though not necessarily implying a preference of one macroeconomic approach over the other-that could support an early economic recovery. In this paper, the aim is to identify the impact of the crisis on surveyed firms in Indonesia, the Republic of Korea, Malaysia, the Philippines, and Thailand and assess the relative contributions of the different factors to economic con- traction. In so doing, it will be possible to identify the major constraints that 21 these firms perceive to be hampering their recovery, and declines since the onset of the regional crisis in 1997. draw policy recommendations accordingly. The proportion was highest in Indonesia (76.3 percent), As the details collected from the surveys are quite followed by Thailand (73.1 percent), Malaysia (69.6 extensive and voluminous, and have many combina- percent), the Philippines (68.7 percent), and Korea tions of dimensions and breakdowns, this paper will (67.3 percent) (see table 2.1). attempt to highlight only the salient points and features In terms of the magnitude of the decline in capacity of the firms in the five countries. It is structured to utilization, it was observed that the decline during answer three basic questions: what happened, why it 1996-1998 was most severe in Indonesia (reduction of happened, and how it can be solved. Specifically, the capacity utilization by 20.8 percentage points), fol- paper is structured as follows: The next section looks at lowed by Thailand (17.6 percentage points), Malaysia the impact of the crisis on the firms' performance, par- (15.6 percentage points), Korea (12.7 percentage ticularly in terms of capacity utilization, export perfor- points), and the Philippines (9 percentage points). The mance, and expansion plans. This is followed by a lowest level of capacity utilization in the first half of section that will identify the reasons for the worsened 1998 was found in Indonesia (at 59.2 percent) and performance, and another section that outlines the fac- highest in Korea (at 72.1 percent). Corresponding to tors perceived to be the major constraints to the firms' the fact that Thailand was the first country to experi- recovery, and collates and synthesizes the entire paper ence the crisis, Thai firms experienced a sharp decline with the relevant policy recommendations. The final during the first and second half of 1997. Interestingly, section provides concluding remarks. Indonesia suffered a marginally greater fall in 1997. For the first half of 1998, Korea saw the highest drop in Impact of the crisis on the surveyed capacity utilization rate, followed by Indonesia, firms' performance Malaysia, the Philippines, and Thailand (see table 2.2). The largest drop appeared most common in the auto Prior to identifying the relative importance of the vari- parts and electronics industries (see table 2.3). ous causes of the economic downturn, it is necessary to As for the capacity utilization levels of exporters, it is illustrate the impact of the crisis on the firms' perfor- not surprising to note that they were generally higher mance. In this regard, issues relating to capacity utiliza- than those of nonexporters (see table 2.4). Slectors in tion, export performance, and expansion plans will be which exporters experienced the smallest decline in assessed. capacity utilization were found in the garment and tex- tiles, and food industries. Alternatively, output decline Capacity utilization of exporters-a concept that is different Irom but related to capacity utilization-appeared most com- It was observed that about 71 percent of all the firms mon in the auto parts sector, with over 90 percent of surveyed in the five countries had experienced output both exporters and nonexporters of auto parts in TABLE 2.1 The firms: a profile (percent) Output since July 1997 Export status Liquidity Partnership Country Decline Not decline Exporter Nonexporter Problems No problem Foreign Domestic None Indonesia 76.3 23.7 36.0 64.0 34.8 65.2 11.9 25.6 62.5 Korea 67.3 32.7 74.8 25.2 48.2 51.8 13.2 4.5 82.3 MaLaysia 69.6 30.4 47.6 52.4 25.3 74.7 1.5 3.4 95.2 Philippines 68.7 31.3 52.0 48.0 23.3 76.7 5.5 2.8 91.7 Thailand 73.1 27.0 56.8 43.3 55.8 44.2 7.6 5.4 87.0 Total 71.0 29.0 54.0 46.0 37.9 62.1 8.2 8.9 82.9 Source: World Bank, Firm-Level Survey. 22 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 2.2 Capacity utilization levels of the five countries (percent) Capacity utilization 1996 1997 1998 1996-1998 HI Country First half Second half First half Indonesia 80.0 74.5 66.2 59.2 20.8 Korea 84.8 84.3 30.9 72.2 12.7 Malaysia 81.9 78.5 72.9 66.3 15.6 PhiLippines 77.7 75.1 73.3 68.8 8.9 ThaiLand 79.4 71.4 66.0 61.8 17.6 Average 81.1 77.2 72.1 65.7 15.4 Source: World Bank, Firm-Level Survey. TABLE 2.3 increasing rate of utilization (see table 2.5). Exporters SectoraL breakdown of capacity utiLization: particularly seemed to have a more positive view than 1997-1998 Hi domestic producers. The most pessimistic seemed to be (percentage points) the Malaysian corporates, with as high as 41.4 percent Capacity utilization expecting a decline, followed by Indonesia, Thailand, Sectors decline during 1997-98 HI and thte Philippines. In terms of sectoral breakdown, Auto parts -21.7 electronics and electrical machinery, particularly in ELectronics -13.0 Indonesia and Malaysia, were exceptionally pes- Chemical -10.7 Garment and textiLes -9.3 simistic, with 45 percent and 50 percent, respectively, Food -8.4 predicting that their capacity utilization would fall. Source: WorLd Bank, Firm-Level Survey. This contrasts with Korea, where more electronics firms were optimistic than pessimistic. The auto parts indus- try, having suffered the most dramatic decline, is now Korea, Malaysia, and Thailand experiencing output the sector that is most optimistic about reversing its declines. The smallest proportion of exporters facing position and increasing capacity utilization. Overall, output declines were again exporters of garments, tex- firms in Korea and the Philippines seemed to be the tiles, and food. most optimistic, with over 70 percent of all firms As regards prospects for capacity utilization over the expecting stable or increasing capacity utilization rates next six months, one-quarter of the firms expected an over the next six months. TABLE 2.4 Capacity utilization Levels of exporters and nonexporters (percent) 1996 1997: First half 1997: Second half 1998: First half Country Nonexporter Exporter Nonexporter Exporter Nonexporter Exporter Nonexporter Exporter Indonesia 80.8 79.3 75.2 74.9 65.0 68.5 56.6 65.1 Korea 85.1 84.8 84.2 84.5 79.6 81.3 68.5 73.7 Malaysia 81.8 82.0 77.7 79.4 70.6 75.5 63.9 68.9 PhiLippines 76.6 78.8 73.3 76.8 70.0 76.2 64.8 72.4 ThaiLand 79.3 79.7 68.5 73.8 60.7 70.0 54.9 66.7 Average 80.7 81.6 75.6 79.0 68.4 75.5 61.0 70.0 Source: World Bank, Firm-Level Survey. Corporates' Views of the Constraints to Recovery 23 TABLE 2.5 the most commonly cited magnitude for both the Expectations of capacity utiUization over the next improved and worsened performance was in the range six months of 10-25 percent. (percent of firms) As for sectoral breakdown, a number of respondents Expectations of capacity utilization in the Thai auto parts industry noted that their exports over the next 6 months had dropped from 47 percent in 1997 to only 37 per- Country Worsened Same Improved cent in 1998. The garment and textiles sector in Indonesia 36.9 47.3 15.9 Thailand reported improved export performance (47 Korea 28.7 35.5 35.9 percent claimed an increase during 1996-97 and 49 MaPaysia [425. 47.9 27.0 percent claimed an increase during 1997-98), while Thailand 36.2 41.5 22.3 those in Malaysia experienced quite a sharp (Irop (66 Average 34.1 41.5 24.4 percent claimed an increase during 1996-97 but only Source: WorLd Bank, Firm-Level Survey. 56 percent claimed an increase during 1997-9 8). In terms of prospects for export performanrce this Export performance year, proportionately more exporters expected their exports to increase (43 percent of exporters) than Approximately 54 percent of the firms surveyed were decrease (24 percent) or remain the same in 1999 (33 exporters but questions on export performance were percent). The average for Korean exporters was some- only provided to firms in Korea, Malaysia, and what higher at about 50 percent for those with high Thailand. For these countries, about half of the expectations, but lower at only 39 percent and 37 per- exporters claimed that their exports had increased dur- cent for Malaysian and Thai exporters. Overall, auto ing 1996-97 and 1997-98, although slightly larger pro- parts exporters were most optimistic about their future portions claimed improved performance during prospects. 1996-97 than 1997-98 (54.8 percent against 50.7 per- In the questionnaires, all exporters were also asked to cent of exporters for the two respective periods). report the reasons for both their improved and declined Improved performance was most common for Korean export performance in volume terms in 1998 as com- exporters. Interestingly, a significant proportion of pared with 1997. The exporters in Korea, Malaysia, exporters remained (28.9 percent and 34.7 percent for and Thailand thus cited the different reasons both for the two periods) who noted that their performance had their improved and worsened performance, not neces- declined during 1996-97 and 1997-98, respectively, sarily claiming that their overall performance had fallen with Thai exporters having the most common instances into one or the other category. of worsened performance for 1996-97 (32.2 percent) For those with worsened export performance, the and Malaysia for 1997-98 (41.7 percent) (see table most relevant contributing factor to the decline was 2.6). In terms of the magnitude of export performance, poor demand. Unstable conditions in the export market, TABLE 2.6 Export performance (percent of exporters) Performance in 1997 Performance in the first half of 1998 Expected performance in '999 Country Improved Worsened Some Improved Worsened Same Improved Worsened Some Korea 64.0 25.9 10.1 59.9 29.4 10.7 49.7 21.6 28.8 MaLaysia 47.4 30.4 22.2 42.5 41.7 15.8 38.6 25.4 36.0 ThaiLand 47.9 32.2 19.9 44.3 35.6 20.1 37.4 26.4 36.2 Average 54.8 28.9 16.3 50.7 34.7 14.7 43.0 24.0 33.0 Source: World Bank, Firm-LeveL Survey. 24 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries lack of price competitiveness, and exchange rate volatil- By analyzing the impact of the crisis on the firms' per- ity were also cited as significant contributing factors. formance in terms of capacity utilization, export per- Meanwhile, inferior product design, and to a lesser formance, and expansion plans, two important findings extent, credit constraints, were regarded as the least rel- have been illustrated. First, in line with the general evant (details also shown later in table 2.13). expectations, there is consistent evidence throughout all As regards improved export performance, the five countries that the crisis has severely affected capac- exchange rate effect and price competitiveness were ity utilization levels. The most depressed sectors seemed universally cited as the most important factors con- to be auto parts and electronics. The former particu- tributing to the improvement, while low dependence on larly seemed to be a serious concern for exporters in imported inputs was the least relevant. It should be Korea, Malaysia, and Thailand, as it probably reflected noted that the average rating (on a scale from 1 to 5, the limited capacity of the export markets to absorb the with 5 being an extremely important factor) was highest excess domestic supply, as well as the regional slump in for Malaysia (3.91) and lowest for Thailand (2.98). This demand for automobiles. Secondly, a notable number implied that the mentioned factors were most relevant of firrms have indeed reported improved export perfor- for Malaysian firms and least relevant for Thai firms. mance. Even in the auto parts industry in which capac- It should also be noted that with questions on capac- ity utilization declined most, a third of the exporters in ity utilization and export performance being separately Thailand reported having improved export perfor- asked in the questionnaires, firms with lower capacity mance. Nevertheless, there are two important features utilization could still give reasons for improved export questioning the widespread perception that exporters performance if the volume of their exports, not output, represent the major stimulus to economic recovery. The had increased, thus reflecting their increasing reliance first is that only half of all exporters noted improved on the export market. export performance despite large currency deprecia- tions in 1997. In addition, poor demand (the reason Expansion plans cited as the most relevant for the worsened perfor- mance) is likely to persist given the regional turmoil- The last impact of the crisis to be addressed concerns while the exchange rate effect and price competitiveness expansion plans: How have plans for expansion (the factors previously driving export performance) are changed with the onset of the crisis and what are the likely to be less supportive as currencies stabilize and expectations over the next six months? strengthen. Therefore, the outlook for export perfor- As expected, plans for expansion have been continu- mance does not necessarily support optimistic expecta- ously scaled back since the crisis, but the outlook for tions regarding an export-led economic recovery. A 1999 is generally better than 1998. In 1997, 44 percent slight counter-argument to this view is that several of surveyed firms had said that they considered expan- firms, in fact, thought that they had already turned the sion, but by 1998 this figure had dropped to 15.4 per- corner This is not to say that some firms had already cent. It rebounded to 22.2 percent for 1999. Also, most recovered from the crisis, but rather that they had of the firms without expansion plans before the crisis imprcved expectations of the future direction of the did not have plans to expand in 1998 or 1999 either. economy-a somewhat positive sign. Conversely, only half of those firms that planned to expand before the crisis actually did expand. Reasons for declining performance and Interestingly, despite the many uncertainties, Indo- constraints to corporate recovery nesian firms seemed to be the most optimistic compared with other countries, with 27.2 percent of Indonesian The previous section illustrated that apart from some corporates expecting to expand in 1999, compared exporters, the performance of the surveyed firms across with 18.9 percent in Korea, 23.6 percent in Malaysia, countries and sectors has deteriorated since the onset of 25.9 percent in the Philippines, and 15.5 percent in the crisis, while prospects for an export-led recovery Thailand. remains somewhat questionable. Among the many fac- Corporates' Views of the Constraints to Recovery 25 tors, the major reasons cited for the declined perfor- extent to which this had been affected by poor external mance were reduced demand, credit constraints, and demand. In this regard, the majority of those exporters other cost- and supply-related factors. Each of these whose exports suffered (79.5 percent in Malaysia, 68.3 will be carefully analyzed in this section to determine percent in Thailand, and 61.8 percent in Korea) which elements are seen by the firms as constraints to believed that poor demand had significantly affected their recovery. their export performance. In addition to looking directly at the role of reduced Reduced demand and revenue demand on capacity utilization and export: perfor- mance, it would also be useful to see whether -he firms The firms' responses confirmed that contraction in were seeking foreign partners as a means of expanding demand had played a very important role in lowering market access to compensate for the reduced demand. capacity utilization and export performance. On the whole, however, it appeared that the majority For domestic demand, the data show that its decline (62.8 percent in Indonesia, 79.3 percent in Korea, 94.8 significantly contributed to a reduction in output for the percent in Malaysia, 92.1 percent in the Philippines, majority of surveyed firms-but to a much lesser extent and 90.0 percent in Thailand) did not seek foreign part- in the Philippines than in the other four countries. ners. This finding, therefore, rejects the notion that the When the firms are further divided into exporters and firms were compelled to seek foreign partners as a nonexporters, the data indicate that proportionately means to expand overseas market access. Nevertheless, more nonexporters than exporters considered the for those actually seeking foreign partnership, securing reduction in domestic demand to be an important rea- access to a foreign market was deemed as the most son for output decline. important consideration (as expressed by 61.3 percent In contrast, changes in foreign demand were largely of Indonesian firms, 52.0 percent of Korean firms, 85.7 perceived to have less influence on the firms' output percent of Malaysian firms, 83.3 percent of Philippine level, particularly in Indonesia (see table 2.7). As firms, and 77.3 percent of Thai firms). expected, however, a notable proportion of exporters- Apart from having direct and adverse imnacts on 24.3 percent in Korea, 33.8 percent in Malaysia, 37.5 capacity utilization and export performance, the prob- percent in the Philippines, and 39.9 percent in lem of reduced demand also affected revenue. This Thailand-regarded the decline in foreign demand to would inevitably have important implications on liqui- have significantly contributed to lowering their capac- dity and a host of other factors. To confirm this point, ity utilization. of those firms experiencing inadequate licquidity- In terms of export performance, responses from which surprisingly amounted to only 37.9 percent of all Korea, Malaysia, and Thailand elaborated on the firms-about three-quarters (74.5 percent) cited lower TABLE 2.7 Impact of reduced demand on output (percent of firms with reduction in output) Reduction in domestic demand Reduction in foreign demand Country None Limited Significant None Limited Significant Indonesia 12.3 27.8 60.0 66.4 18.8 14.8 Korea 5.0 11.4 83.7 28.2 37.1 34.7 MaLaysia 9.9 19.5 70.6 48.4 21.2 30.4 Philippines 27.6 23.4 49.0 52.9 16.1 31.0 Thaitand 11.5 17.9 70.5 35.4 27.0 37.6 Average 12.1 19.9 67.9 46.4 24.4 29.2 Note: The surveyed firms were asked in the questionnaires to give ratings on a scale from 1 to 5. "None" refers to a rating of 1, meaning that the factor had no relevance to the question being asked. "Limited" refers to the ratings of 2 and 3, meaning that the factor had some, but limited, relevance. "Significant" refers to the rating.; of 4 and 5, at which point the factor's degree of reLevancy was highest. Source: Wortd Bank, Firm-LeveL Survey. 26 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 2.8 than exporters throughout, and most exporters (over Impact of lower revenue on liquidity 70 percent, except in Korea and Thailand) on average (percent of firms with liquidity probLems) had adequate liquidity to finance production. The Impact of lower revenue major departure from this trend was observed in Korea Country None Limited Significant and Thailand, where a much smaller proportion of Indonesia 12.5 25.0 62.5 exporters had adequate liquidity (54.6 percent and 47.2 Korea 5.0 17.6 77.4 percent, respectively). If exporters are taken to be the MaLaysia 10.2 12.6 77.2 engine of economic recovery, then this finding high- Philippines 15.4 17.1 67.5 Thailand 5.8 13.2 81.0 lights the urgent need to address their liquidity prob- Average 8.4 17.2 74.5 lems. This does not necessarily mean that nonexporters Source: World Bank, Firm-Level Survey. were better off than exporters in absolute terms, how- ever. Instead, the lack of liquidity for exporters can be revenue as a significant contributing factor. The aver- interpreted such that they had demand but not enough age was even higher for respondents in Thailand (81.0 cash flow to produce, while nonexporters faced much percent) and surprisingly lowest in Indonesia (62.5 per- more pressing concerns, for example, from the reduced cent) (see table 2.8). Meanwhile, lower sales were more demand than inadequate liquidity (see table 2.9). likely to cause a liquidity shortage among nonexporters Alternatively, in terms of country and sector break- than exporters, apart from the Philippines. downs, the most common instances of liquidity-con- In all, therefore, it appeared that demand, and thus strained firms in Indonesia were domestic producers of revenue considerations, were the overriding factors in garments and textiles. In Korea and Malaysia, domestic driving down capacitv utilization and export perfor- producers of auto parts consistently reported the prob- mance, as well as contributing to liquidity problems. lem, while the most common instances in the Philip pines were reported by domestic producers of tex- Liquidity and the credit crunch tiles, and in Thailand by producers of garments, tex- tiles, and auto parts. The second major reason for the decline in capacity uti- Having determined that liquidity problems existed, lization is associated with liquidity and credit consider- the remaining issue to be evaluated is the conventional ations. Liquidity and credit are two different perception that liquidity and credit shortages are both notions-the former generally refers to a firm's cash reasons for the decline in performance and a constraint flow, which is partially but not completely influenced to recovery. Specifically, there are four questions to be by credit. In this section we will first determine, based addressed-to what extent credit shortage has affected on exporting status, the extent of the liquidity problems capacity utilization, how the liquidity shortage was dri- in different countries and in different sectors of indus- ven by a credit crunch, why the problem with credit tries. Then we will discuss the degree to which the lack access has prompted the search for partners, and how of credit contributed to liquidity problems and other credit constraints have affected export performance. related issues. Although there is certain evidence of inadequate liq- - uidity among firms in the five countries, the extent of TABLE 2.9 Problems of inadequate liquidity the problem may not be as severe or widespread as (percent of exportirg firms, or of nonexporting firms) some might have expected. As commented above, a lit- tle over one-third (37.9 percent) of the surveyed firms Exporters Nonexporters reported experiencing inadequate liquidity. Thailand Country Problem No problem Problem No problem was the country with the largest proportion of firms Indonesia 27.2 72.8 40.4 59.7 facing the problem (56.8 percent), followed by Korea Korea 45.4 54.6 56.8 43.2 (48.2 percent), Indonesia (34.8 percent), Malaysia Malaysiai 20.4 79.6 29.7 70.3 Philippines 19.7 80.3 27.2 72.8 (25.3 percent), and the Philippines (23.2 percent). In ThaiLand 52.9 47.2 59.9 40.1 addition, this was more common among nonexporters Source: World Bank, Firm-Level Survey. Corporates' Views of the Constraints to Recovery 27 Cost and availability of credit as causes of the decline than nonexporters, thus confining the economic recov- in capacity utilization. The surveyed firms were asked ery prospects. to give ratings to the various factors that they perceived High interest rates per se were not unanimously per- to have contributed to the decline in their capacity uti- ceived to be a significant cause of the decline: about 30 lization. Among the factors relating to the cost and percent of all respondents rejected it as a factor. The availability of credit are supplier credit, credit for work- finding here, though not rejecting the general wisdom, ing capital, credit for expansion, high interest rates, and is far less conclusive about the problem of high interest heavy debt burden. rates. The country-wide differences also bring out some First of all, based on the empirical cvidence, the quite interesting features. A large proportion of notion that insufficient credit extension by suppliers Malaysian (39.1 percent) and Indonesian (34.2 percent) had any contribution to the decline in capacity utiliza- firms reported that high interest rates had nc adverse tion was rejected. consequences on their capacity utilization, while con- Likewise, insufficient credit for working capital at versely, almost half (48.9 percent) of all respondents prevailing interest rates was largely rejected as the rea- suggested that high interest rates had significantly con- son. However, there remained a notable proportion of tributed to it. This proportion was over one-half for the firms in the Philippines (35.8 percent) and Thailand Philippines (55.5 percent), Thailand (53.7 percent), and (36.0 percent), suggesting that this factor had signifi- Indonesia (51.3 percent)-but merely 40.5 percent in cantly contributed to the decline of capacity utilization. Malaysia. Unfortunately, there was again a consistent, A more worrying feature is the breakdown in exports- disturbing pattern among exporters: a higher propor- as there was a higher proportion of exporters than non- tion of exporters than nonexporters observed that high exporters in Malaysia, Indonesia, and Thailand that interest rates had caused their capacity utilization to regarded the lack of working credit as a significant fall, and the reverse proportion was observed for those cause of the drop. This meant that those few firms in noting that high interest rates had no contribution. A Malaysia, Indonesia, and Thailand facing significant comfort that could be derived from this finding is that problems associated with access to working credit were interest rate levels have come down significartly from largely exporters. their previous levels, thus the recovery prospects, espe- There was also little evidence that the insufficiency of cially for exporters, should be somewhat more favorable. credit for expansion had contributed to the decline in Finally, with regard to debt burden, there is again no capacity utilization or output. (It should be noted that conclusive evidence that this is an influence in the technically an increase in credit for expansion would decline by way of leaving insufficient internal funds. initially raise capacity, thus lowering capacity utiliza- Responses to this question were only available in tion-defined as output per capacitv. Therefore, had Korea, Malaysia, and Thailand. Over one-third (36.9 there been insufficient credit for expansion, we would percent) of the firms whose output had declined have been able to explain the decline in capacity utiliza- rejected the notion that heavy debt burden had left tion entirely by the reduction in output.) Only 13.1 per- insufficient internal funds and thus caused capacity uti- cent of the firms said that credit for expansion was a lization to fall, while almost another third (32.1 per- severe constraint. This observation implies that the sup- cent) regarded it as having some relevance. Definite ply of credit at prevailing interest rates was not really a affirmation was highest from Thai firms at 40.5 percent concern. The relevancy of this factor in determining and lowest from Indonesian firms at 21.4 percent. capacity utilization was highest in the Philippines and Again, relatively more exporters were affected by the lowest in Korea. Interestingly, however, in all countries debt burden than nonexporters. proportionately more exporters than nonexporters In summary, only certain aspects of cost and avail- regarded availability of expansion credit as a significant ability of credit were regarded as important factors in contributing factor. This finding supports the previous determining the level of capacity utilization, and the most view that the lack of expansion credit was unfortu- relevant was deemed to be high interest rates. Through- nately a more relevant contributing factor for exporters out these breakdowns, Indonesian firms consistently 28 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries regarded the various credit considerations as unimpor- lation of any kind, while another 36.9 percent said that tant, while those affected by credit considerations in all it had had only a limited or moderate impact. As with countries were proportionately more often exporters the previous findings, it appeared that Indonesia was than nonexporters. However, it should be emphasized only partially affected by supplier credit, while Thailand that these observations only illustrate the link between and the Philippines were most affected. Moreover, there credit and capacity utilization. Therefore, firms having is a consistent pattern emerging in Indonesia, Malaysia, lower capacity utilization may not necessarily be driven and the Philippines that exporters were proportionately by credit considerations and, vice versa, firms with more affected in terms of being liquidity-constrained by insufficient credit may not have lower capacity utiliza- insufficient supplier credit than nonexporters. This is tion. In other words, problems associated with credit- indeed a worrying finding although it does not neces- whether high interest rates or availability of sarily mean that the absolute magnitude of the problem credit-extend far beyond the realms of capacity utiliza- is greater for exporters. tion; for example, there are also profitability and liquid- Finally, there is significant evidence that the burden of ity dimensions, which this section alone cannot cover, debt servicing had left the firms with insufficient inter- Insufficient credit as a cause of inadequate liquidity. nal funds and was deemed as a major cause of liquidity The next issue to be discussed is whether inadequate liq- constraint. On average, only 17.0 percent of firms with uidity was caused by insufficient credit and whether or inadecuate liquidity said that the burden of debt servic- not there existed a credit crunch; that is, at current ing had no meaningful significance, while over one-half interest rates, whether credit is being rationed and (52.1 xercent) confirmed that it had had a notable or viable projects go unfunded. A reduction in the supply major impact on liquidity. Surveyed firms from of credit alone is not sufficient evidence of a credit Indonesia and the Philippines did not provide responses crunch. In the questionnaires, credit considerations for this question. The problem was most severe among included loans for working capital, supplier credit, and Thai firms as over half of those with inadequate liquid- the burden of servicing outstanding debt as it is affected ity (56.3 percent) regarded the burden of debt servicing by interest rate levels. as an extremely important factor in contributing to Although a decline in internal revenue that is attrib- their liquidity problems. The breakdown of exporting utable to depressed demand was the primary source of status once again reveals that those affected by the bur- inadequate liquidity reported by the firms, there is suf- den of debt servicing in Malaysia, Korea, and Thailand ficient evidence that the shortage of loans for working were more likely to be exporters. One point to note here capital was also a contributing factor, as about half is that the high burden of debt servicing is either caused (50.9 percent) of them considered it important. When by the high level of indebtedness or interest rates. It surveyed firms regarded insufficient loans for working would have, therefore, been interesting to see the capital as an important factor for their inadequate liq- responses from the firms on their ability to service loan uidity, Indonesian firms ranked lowest (39.0 percent), payments at current interest rates, as this would have implying that Indonesia was least affected, and Thailand determined the extent to which the high burden of debt highest at 61.7 percent. Meanwhile, proportionately servicing was driven by high interest rates. more exporters than nonexporters in all countries Overall, there is supportive evidence of inadequate except Thailand attributed insufficient loans for work- liquidity and insufficient supply of credit. In particular, ing capital as a cause of their liquidity problems, thus there is evidently a close association between inade- reinforcing the views expressed in the previous findings. quate liquidity, and the burden of debt servicing and In terms of supplier credit, there is no conclusive evi- loans for working capital. Thus, the first criterion for a dence that this had significantly contributed to the credit crunch has been met, that there is insufficient firms' liquidity problems. Although about one-third supply of credit. Concerning the second and most (33.2 percent) of the firms confirmed that it had had a important criterion, however, it is not possible to notable or maj or impact on liquidity, over a quarter deduce from the survey results that credit is being (29.9 percent) conversely said that there was no corre- rationed at the prevailing interest rates. Corporates' Views of the Constraints to Recovery 29 Problems with credit access as a cause of the firms' Although there is little accuracy in these numbers- seeking partners. In this subsection, the question of since relatively few firms were seeking foreign part- why firms wanted to seek partnership will be addressed. ners-it should be noted that Indonesia, despite being If evidence suggests that firms were compelled to follow the country with the largest proportion of firms seeking this path in order to secure alternative access to credit, partners, consistently did not consider access to credit then it further supports the view that there is inadequate an important reason. In general, however, it appeared supply of domestic credit. that credit considerations played a significant role in Overall, firms seeking partners were most common inducing firms to seek partnership, thus supporting fur- among Indonesian firms (38.1 percent) and least com- ther the view that there was insufficient domestic mon in Malaysia (6.1 percent), and were proportionately credit-though the evidence is still not strong enough to more common among exporters than nonexporters. conclude that thcre was a credit crunch. When analyzed by sector, the most common instances The role of credit constraints in hampering export of the search for partners were reported by the performance. The last issue to be addressed concerning exporters of food (57.1 percent) and garments and tex- credit constraints is how these have affected export per- tiles (42.3 percent) in Indonesia. Meanwhile, the least formance. This is a different issue from inadequate liq- common instances varied among sectors of different uidity that was discussed earlier; this question specifically countries. In terms of the perceived contributing fac- addresses the issue of credit constraints. In this regard, tors, foreign market, technology, supplier relationship, there appears to be no conclusive evidence to suggest and access to working and expansion credit, were that credit constraint was the reason for any decline in regarded as the most important considerations for the export performance in Korea and Thailand during firms in their search for partners, while equity partici- 1997-98 (only Korean and Thai firms provided pation was the least relevant. answers to this question). While about a quarter (23.7 More specifically, for those firms seeking foreign percent) of the firms confirmed that it had had a notable partners, it appeared that access to credit for working or major influence on their export performance, almost capital was an important consideration. On average, one-third (29.7 percent) said that it had had no contri- about 60 percent of those looking for foreign partners bution and the rest (46.6 percent) said that it had had confirmed that this had had a notable or major influ- only a limited or moderate influence. Nevertheless, ence on their search. Interestingly, a large proportion of quite a large number of Thai firms (40 percenrt) with the firms in Indonesia (26.1 percent) said that their worsened export performance suggested that the prob- search was not driven by this consideration, while the lem was significantly driven by the problem of credit issue was most important for the firms in Malaysia constraint. (83.3 percent), followed by the Philippines (72.0 per- By looking at the various aspects of credit, it has been cent), Thailand (68.9 percent), Korea (62.4 percent), demonstrated that there was indeed an insufficient sup- and Indonesia (45.5 percent). ply of credit, which contributed to liquidity problems Meanwhile, there was also supportive evidence to and subsequently compelled the firms to seek part- suggest that access to credit for expansion was a signif- ners-though evidently the issue was not regarded as a icant cause for the firms' search for foreign partners. On major cause of the decline in capacity utilization. The average, 57.2 percent of the firms confirmed that it had widely perceived problem of a credit crunch, which can had a notable or major influence on their search. Again, neither be confirmed nor rejected by the survey, may in Indonesia alone was the home country for half (21 out fact have been just a problem caused by the firrns' being of 42) of those firms saying that their search was not unable or unqualified to secure financing in the first driven by expansion credit considerations. place; this is different from the concept of a credit The evidence is far less conclusive for equity partici- crunch in which viable firms go unfunded. Had a direct pation, since 25.9 percent said that it had had no con- question been asked about the nature of creclit avail- tribution, and the remaining was equally divided ability at current interest rates and not merely about its between those saying that it had had either a moderate impact, the notion of a credit crunch could t'hen have influence, or significant influence. been clearly identified. Alternatively, given that the 30 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries firms' viability concept cannot be readily identified exporters than nonexporters in Korea and Malaysia from the survey results-as responses were only pro- said that the problem of increased labor costs was a vided by firms whose output had declined-it would cause Df the decline, implying that these exporters were have also been interesting to see the same responses of affected more than a proportional distribution between firms whose output had increased, since this would them and nonexporters would have dictated. The prob- have represented a proxy for the firms' viability. If the eim may not merely be a new factor, but one that has in firms complained that they had been constrained from fact p rsisted unidentified long before the crisis, and obtaining credit despite their increased output, the story that was only seriously felt by the firms when economic of a credit crunch would then have been confirmed. activities contracted. Thiud, there was significant evidence to suggest that Costs and supply considerations shortages of raw materials were not a cause of the decline in the firms' capacity utilization. The majority It is generally perceived that among many factors, high of the firms (40.7 percent) confirmed that the issue had costs associated with currency depreciation and interest no relevance to the decline and only 12.0 percent said rates have lowered the firms' performance. This section, that it was a severe constraint. therefore, attempts to evaluate this supposition by look- As with shortage of raw materials, disruption of sup- ing at the various aspects of costs. plies was not generally perceived to be a cause, as almost The contribution of increased costs to the decline in half (47.9 percent) of the represented firms revealed output. In addition to the many factors mentioned ear- that it had no relevance and only 7.8 percent said that lier, this subsection attempts to evaluate the extent to it was a severe constraint. which the decline in capacity utilization was caused by On the whole, therefore, it appeared that only cur- the different aspects of costs-namely, currency depre- rency depreciation and, to a somewhat lesser extent, ciation, labor costs, raw material shortage, and disrup- labor costs, were contributing factors in the decline of tion in supplies. capacity utilization. First, increased costs of imported inputs arising from Input costs as a cause of inadequate liquidity. For currency depreciation seems to have played a major role those firms that experienced liquidity problems, in curtailing capacity utilization. On average, almost increased input costs seem to have played a significant two-thirds (60.4 percent) of the firms confirmed that contributing role (firms in the Philippines did not pro- the issue had had a notable or major impact and vide answers to this question). While very few firms (7.2 another 23.5 percent said that it had had a limited or percent) said that the issue had no relevance, about two- moderate impact. In fact, over two-thirds of the sur- thirds (66.4 percent) believed that increased input costs veyed firms in Indonesia (67.6 percent), Philippines had notably affected their liquidity. Thailand appeared (70.8 percent), and Thailand (71.5 percent) named the to be hardest-hit by the problem as two-thirds of the problem as a contributing factor. A breakdown in surveyed firms (66.2 percent) complained that exporting status also reveals that exporters in Malaysia increa;ed input costs had severely hampered their liq- experienced proportionately greater difficulties from uidity, while only 16.2 percent in Korea, 24.7 percent in currency depreciation than nonexporters. This may be Indonesia, and 52.9 percent in Malaysia agreed. attributable to the fact that exporters in Malaysia are Access to foreign inputs as a cause of the search for relatively more dependent on imported inputs than foreign partners. In an uncertain economic environ- exporters elsewhere. ment, forming a foreign partnership can help a great Second, with regard to increased labor costs, although deal in securing the much-needed foreign inputs. This the firms did not unanimously perceive this issue to be supply consideration is one way of reducing uncertainty a cause of the decline in their capacity utilization, a and costs. notable 35.4 percent of Thai firms responded that it had Indeed, there was some supporting evidence that the had very significant implications on their capacity uti- reasor for seeking foreign partners was attributable to lization. In addition, a slightly higher proportion of supplier relationship. Over half (57.0 percent) of the Corporates' Views of the Constraints to Recovery 31 respondents commented that the supplier relationship to output decline, worsened export performance, inad- was a notable or serious reason driving their search for equate liquidity, and the search for foreign partners. a foreign partner. There was much more evidence in support of new Constraints to recovery and poLicy technology as the reason behind the search for foreign recommendations partners-only 6.5 percent (18 of the 278 firms) that were seeking foreign partners said that it had no rele- This paper has been structured so as to identify the rea- vance. Large percentages of the firms seeking foreign sons for the decline in capacity utilization and export partners in the Philippines (84.6 percent), Malaysia performance, which are inevitably related to three con- (83.3 percent), and Thailand (82.2 percent) cited access siderations-(a) the reduction in demand and revenue; to new technology as the overriding motivation. (b) problems associated with liquidity and credit con- Management expertise appears to have been another straints; and (c) other cost and supply factors. In so important consideration in the search for foreign part- doing, bottom-up policy formulations can be devised to ners-only 13.4 percent of the firms seeking foreign address specific areas that the firms regard as the major partners rejected that it had any relevance. Again, a constraints to corporate recovery. great majority of the firms seeking foreign partners in This section will first attempt to identify these major Malaysia (75.0 percent) and Thailand (73.3 percent) constraints by reexamining the previous findings look- cited access to management expertise as the overriding ing from a slightly different perspective. Specifically, we reason, while, as expected, Korean firms ranked lowest will rank the reasons cited for the firms' output decline, at 33.7 percent. problems with liquidity, search for partnership, and Overall, therefore, access to foreign inputs seems to worsened export performance, and based on the out- have played an important role among Thai and come give policy recommendations. Malaysian firms in establishing foreign partnership. Input costs as possible factors hampering export per- Constraints to recovery formance. In addition to demand and credit considera- tions, which we looked at earlier, cost and supply The firms were asked in the questionnaires to give rat- considerations may have also contributed to the wors- ings to the eleven factors that might have contributed to ened export performance in 1998. their decline in capacity utilization. The most irmportant Price competitiveness seems to have been a factor, constraints can, therefore, be interpreted as thc se press- although only firms in Korea, Malaysia, and Thailand ing factors with average ratings of above 3 (on a scale provided responses to this question. A large proportion from 1 to 5), which were domestic demand (3.9), of Thai exporters that experienced poor export perfor- increased input costs arising from currency deprecia- mance (61 out of 96 firms, or 63.5 percent) cited price tion (3.6), and high interest rates (3.1). (See table 2.10.) competitiveness as a notable or significant reason. Regarding problems with liquidity, lower revenue Likewise, there is evidence in support of high costs of (4.1), high input costs (3.8), burden of servicing debt imported inputs and unstable conditions in export (3.4), and insufficient loans for working capital (3.3) market as reasons for poor export performance. were regarded as the most significant contributing fac- Interestingly, almost three-quarters of those exporters tors (see table 2.11). experiencing poor export performance in Thailand As regards the search for a new partner, the most (70.1 percent) cited unstable conditions as a notable or important factors (those exceeding 3.5) driving firms to significant reason. seek a new partner appeared to be foreign market (3.6), The only area in which there appears to be no con- technology (3.5), supplier relationship (3.5), and work- nection with poor export performance was inferior ing credit (3.5) considerations (see table 2.12). product design, although only firms in Korea and Finally, the most important factors (those exceeding Malaysia provided responses to this question. 3.0) that contributed to the worsened export perfor- Suffice it to say that in line with general expectations, mance were poor demand (4.0), unstable markets (3.6), the various elements of costs have evidently contributed 32 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 2.10 Ratings of factors perceived by the firms as causes of output decline Indonesia 3.5 3.6 3.1 2.6 - 2.1 1.8 2.5 2.2 1.8 2.1 Korea 4.4 2.9 3.1 2.1 2.3 2.6 2.8 2.3 2.1 2.1 2.1 MaLaysia 4.0 3.5 2.8 2.5 2.6 2.4 2.5 2.2 2.2 2.2 2.0 PhiLippines 3.2 3.9 3.4 3.3 - 2.7 2.4 2.6 2.4 2.3 2.3 Thailand 4.0 4.0 3.4 3.4 2.9 2.7 2.8 2.3 2.2 2.4 2.1 Average 3.9 3.6 3.1 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.1 -. Not availabLe. Source: WorLd Bank, Firm-Level Survey. TABLE 2.11 Ratings of factors perceived by the firms as causes of inadeiquate liquidity Country Burden oF Insufficient Insufficient Lower revenue Input costs servicing debt working credit supplier credit Indonesia 3.5 3.7 - 2.9 2.5 Korea 4.2 3.4 3.1 3.3 2.5 Malaysia 4.2 4.1 3.3 3.4 3.0 PhiLippines 3.8 - - 3.3 2.8 ThaiLand 4.4 4.3 3.9 3.7 3.2 Average 4.1 3.8 3.4 3.3 2.8 -. Not availabLe. Source: WorLd Bank, Firm-Level Survey. TABLE 2.12 Ratings of factors for the search of a new partner Country Foreign Suppdier Working Lpcal Expansion Equity market Technology relationship credit market credit Monogement participation Indonesia 3.2 3.1 3.3 3.0 3.5 3.0 3.1 2.8 Korea 4.0 3.9 3.9 3.7 - 3.3 2.9 2.5 Malaysia 4.0 3.9 3.5 4.3 - 4.3 3.3 3.8 PhiLippines 3.9 4.0 3.3 4.1 3.0 4.1 - 3.7 ThaiLand 4.0 4.0 3.8 4.0 - 3.3 3.7 3.3 Average 3.6 3.5 3.5 3.5 3.4 3.3 3.1 3.0 -. Not avaiLabLe. Source: World Bank, Firm-Level Survey. lack of price competitiveness (3.5) and high cost of Pokiy Recommendations imported inputs (3.3) (see table 2.13). These simple illustrations show that the perceived Based on the above findings, general policy recommen- major constraints to recovery, in order of importance, dations can be deduced as follows. First and foremost, were invariably associated with (a) the lower demand it is most crucial to boost domestic demand in order to for their products; (b) higher costs; (c) insufficient help kick-start the revival process. The austerity mea- credit; and (d) other supply considerations. sures t aat have severely depressed demand and squeezed Corporates' Views of the Constraints to Recovery 33 TABLE 2.13 Ratings of factors for the worsened export performance Country Poor demand Unstable markets Price competitiveness Imported inputs Credit constraints Design Korea 3.7 3.6 3.3 2.7 2.3 2.0 MaLaysia 4.3 3.3 3.5 3.6 0.0 2.7 ThaiLand 3.9 4.0 3.8 3.8 3.1 0.0 Average 4.0 3.6 3.5 3.3 2.6 2.3 Source: WorTd Bank, Firm-LeveL Survey. credit should be adjusted. Lower interest rates, though Conclusions necessary, may be futile on their own, as consumer demand is also influenced by other factors such as This paper has both confirmed and rejected the many employment and income uncertainties, while new bank perceptions surrounding the "whys" and "whzrefores" lending is likely to be limited by the weak capital bases of the economic crisis. On the one hand, there is clear and low asset quality. A combination of increased mon- evidence that capacity utilization declined across all etary and fiscal stimuli, and a relaxation of certain rules countries and sectors of industries, driven largely by the and regulations relating to consumer expenditure contraction of domestic demand. In addition, the firms' should significantly help raise domestic demand. export performance was generally in line with the sub- In terms of credit and liquidity dimensions, additional dued macroeconomic export numbers, with only about credit facilities should be urgently provided to exporters half of the exporters claiming that their performance in to help relieve their liquidity positions. This could be volume terms had improved. On the other hand, how- done through government-owned financial institutions ever, inadequate liquidity was not generally perceived to such as export-import banks and development banks. be a major problem, and its cause was heavily weighted The authorities should also actively support the small on the side of the demand for goods rather than the sup- and medium enterprises as they represent a large part of ply of credit-which indicates an urgent need to boost the industrial sector. In relation to this, the process of domestic demand. Indeed, there was an insufficient sup- corporate debt restructuring should be promoted and ply of credit, but it cannot be confirmed that there was supported by the necessary legal infrastructure, as there technically a credit crunch. Finally, while several of the appeared to be some evidence that high interest rates surveyed firms held the view that the worst of the crisis and burden of debt servicing had affected capacity uti- is over, there is also an implied notion that e xporters lization. may not be able to provide an immediate engine for eco- Finally, in response to the complaints on cost and sup- nomic recovery, unless certain constraints are removed. ply factors, the authorities should strive to maintain It must be made clear, though, that views expressed in currency stability, since this would provide confidence the surveys and the conclusions reached cannot in any and predictability in the computation of cost and rev- way be interpreted as a judgment of the authorities' pol- enue-a vital consideration for businesspeople and icy response to the crisis. One must be particularly care- entrepreneurs. As for longer-term considerations, the ful not to merely draw conclusions from a subjective authorities should undertake to facilitate the firms' perspective. In other words, it cannot simply be con- access to management expertise and technology by cluded that the stabilization policy of high interest rates, increasing investment in education, training, and for example, has failed or even that it has inflicted more research and development in order to enhance compet- harm than good on the economy by depressing domes- itiveness and truly reflect labor costs. tic demand, making loans more costly, and increasing These general recommendations are broadly in line debt servicing costs. In principle, the time dimension with the current policy directions, but each should be must also be considered and, in doing so, will alter this further fine-tuned and tailored according to the circum- conclusion considerably. Specifically, as the currencies stances in each country. have now stabilized and confidence somewhat 34 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries resumed, the authorities should take a proactive role in Note relieving the painful pressure faced by corporates, brought on by the abrupt adjustment process. Demand This paper was the resuLt of a joint colLaboration effort undertaken stimulus and continued restructuring of the economy by Dr. Atchana Waiquamdee, Mr. Soravis Krairiksh, and Dr. Wasana are necessary measures to promote a recovery. Phongsanarakul of the Economic Research Department, Bank of ThaiLand. Corporates' Views of the Constraints to Recovery 35 Macroeconomic Views of the East Asian Crisis: A Comparison Yoon Je Cho Changyong Rhee T The financial crisis has brought unprecedented economic and social distress to the Asian economies. The average growth rates in Indonesia, the Republic of Korea, and Thailand had been well above 7 percent during the early 1990s but they dropped dramatically to -13.7, -5.7 and -6.5 percent, respectively in 1998. No one had expected such a severe con- traction of the Asian economies. Only in the second half of 1998 did the East Asian countries start to move from the free fall to stabilization. But the recov- ery has been quite moderate and uneven across countries. The purpose of this paper is to examine the role of the macroeconomic envi- ronment in the adjustment prccesses of the East Asian crisis. We first document the macroeconomic adjustment in the five East Asian countries (Indonesia, Korea, Malaysia, Thailand, and the Philippines) and contrast the degree to which each country has been affected by macroeconomic constraints. Based on the observation of what has occurred so far, we attempt to identify which fac- tors contributed most to such a severe contraction and uneven recovery. Our findings can be sumrmarized as follows. The severe downturn was caused mainly by the precipitous drop in investment and, to a lesser degree, consumption. Many factors contributed to the sharp fall. The magnitude of capital flow reversal was remarkable and the concurrent huge depreciation of the currencies worsened the balance sheets of financial institutions and cor- porations that had large unhedged foreign-currency liabilities. To prevent depreciation-inflation spirals, some period of tight monetary policy was 37 inevitable but the resulting high interest rates had a process. Based on the developments so far, the subse- profound effect on the credit crunch and corporate quent section attempts to make preliminary assess- bankruptcies. The negative effect was exacerbated ments on what caused such a severe economic because the stabilization policy was imposed in con- contraction and recent recovery in this region. The final junction with rapid financial restructuring. section concludes and draws some policy implications. Ironically, it was the sharp economic downturn that contributed to the stabilization of the exchange rates Macroeconomic development and interest rates in the second half of 1998, and thereby laid the ground for recovery. The sharp fall in InitiaL conditions demand and the resulting decline in imports brought about a drastic reversal of current account positions The East Asian crisis has many common features- and in turn helped to build up a substantial increase in weak financial systems, excessive unhedged short-term foreign reserves. This speedy adjustment to stabiliza- foreign borrowing, lack of transparency in business tion was possible since the East Asian countries were practices, and so on. Nonetheless, there exist significant more open and private sector-oriented. This was taken differences between the countries regarding the origins into account in the design of the International and the preconditions.2 Among these countries, the Monetary Fund (IMF) adjustment program. The signs of deteriorating economic conditions and over- essence of the IMF adjustment program is to stabilize heating pressures were most visible in Thailand. Key the exchange market in the short run through belt-tight- macroeconomic indicators were stronger in Korea, but ening-and the private sector's belt is easier to tighten the country could not sidestep the crisis because of its than the government's. Also the recession in the domes- serious liquidity problem: the ratio of short-term exter- tic market could generate a larger improvement in cur- nal debt to official foreign reserves in Korea exceeded rent account balances since these economies were more 100 percent from the mid-1990s onward. Recently, the open and export-oriented.1 Philippines has been recovering from its decade-long Despite the common characteristic of a sharp initial economic crisis after gaining political stabilitv in 1992. downturn, the adjustment process varied widely across Indonesia's macroeconomic performance was also the countries. The example of Indonesia shows that a strong until mid-1997. But it had its own structural policy for stabilization cannot be effective if structural weakness, which exposed Indonesia to the contagion problems remain unsolved. Uncontrolled monetary from the Thai and Korean crises in the latter half of expansion in bailing out troubled financial institutions 1997. Short-term external debt had been rising rapidly not only delayed recovery but also brought Indonesia to and the country's weak financial system cast cLoubts on the verge of hyperinflation. The Malaysian case also the government's ability to defend the currency peg. In shows that the belt-tightening policy alone is not suffi- addition, political uncertainty arising from the elec- cient in stabilizing the exchange rate market and that tions in late 1997 and the presidential election in the resumption of foreign capital inflows is essential for March 1998 compounded economic problems. El recovery. Until mid-1998, Malaysia adopted a "virtual Nino's effects included forest fires and caused a long- IMF" policy package of austerity but, unlike Korea and lasting drought, inflicting serious damage on the Thailand, it failed to stabilize the foreign exchange mar- forestry and agricultural sector, reducing exports, and ket. This may be a reflection of the difference in the raising food prices. availability of external financing opportunities through Prior to the crisis, the Malaysian economy had official program loans or private capital inflows. showed the strongest macroeconomic pernormance The paper is organized as follows. In the following among the five East Asian countries. It had enjoyed the section we briefly review the macroeconomic develop- highest growth rates of 8-9 percent with the lowest ment after the crisis and the recovery prospects for the inflation of around 3 percent, and virtually ful. employ- region. Next comes a section in which we discuss the ment. Only the widening current account deficits in the role of monetary and fiscal policy in the adjustment mid-1990s showed signs of imbalance, but these were 38 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries regarded as inevitable and sustainable considering the Capital flows, exchange rates, and stock markets. In country's high levels of growth and investment. Also, the 1990s, almost two-thirds of all private capital flows unlike Korea and Thailand, the current account deficit to developing countries flowed into East Asia. Table 3.2 was covered mostly by long-term capital (primarily for- summarizes capital flows as a percentage of each coun- eign direct investment) rather than short-term capital. try's GDP during the 1990s.4 The reversal of the foreign Moreover, the financial system in Malaysia was known capital flows in 1997 was remarkable. The most extreme to be in better shape than those of other Southeast Asian cases were seen in Thailand and Malaysia. Annual capi- countries, even though the belief must be questionable tal inflows into these two countries averaged over 10 per- in hindsight.3 cent of GDP during the 1990s, and at one point they reached 13 percent and 17 percent of GDP. However, Sharp economic contraction and the reversal capital inflows abruptly changed direction in 1997. For of the current account position examp]e, in Thailand, capital outflows reached 11 per- cent of GDP in 1997 alone. Therefore, between 1996 Reflecting these differences in preconditions, the adjust- and 1997, Thailand experienced a sudden reversal of ment processes also were uneven in these Fast Asian private capital inflows amounting to about 20 percent of countries. Nevertheless, there were substantial com- GDP. T'he other countries faced a similar fate. mon trends in the adjustment processes. First, they all The large capital outflows depreciated the currencies experienced severe economic contraction and a drastic precipi:-ously and the stock markets in the region plum- reversal of current account balances. Second, they all meted. Between January and December 1997, the geared their macroeconomic policy stance toward Korear won was depreciated by 121 percent and its expansion starting in the middle of 1998, cutting inter- composite stock price index declined by 50 percent. The est rates and expanding fiscal deficits. Third, the signs value of Thailand's baht and composite stock price of recovery have been evident (starting late in 1998), index cleclined by 139 and 52 percent respectively dur- but it is still premature to judge whether they will ing a similar period. In Indonesia, Malaysia, and the become a trend. Philippines, the exchange rate depreciated by 85, 40, Economic contraction. As can be seen in table 3.1, and 44 percent, respectively, against the dollar between the economic slowdown in these countries was histori- mid-1997 and 1998. Their stock markets fell by more cally unprecedented. The average growth rates in these than 53, 50, and 40 percent, respectively, during a sim- countries had been well above 7 percent prior to the cri- ilar period. sis. But in 1998, the rcal gross domestic product (GDP) Inflation and interest rates. The sharp depreciation declined by 15, 6, 6, and 7 percent in Indonesia, Korea, provided inflationary pressure. Together with the Malaysia, and Thailand, respectively. These drops con- increase of import prices, expected inflation soared, stitute the countries' worst postwar economic records. since the market participants anticipated that the cen- The growth rate dropped from 5 percent in 1997 to -0.4 tral banks of these countries would inject massive liq- percent in 1998 in the Philippines. The fall of industrial uidity 5upport to save the banking system. The inflation production was even more dramatic. In the first quarter rates irn Thailand, Korea, and the Philippines increased of 1998, industrial production indexes in Thailand and swiftly almost twofold by the first half of 1998, reach- Korea declined by 18 and 8 percent, respectively, com- ing 10, 9, and 10 percent, respectively. The inflation pared with those of the same period in 1997. rate in Indonesia soared to 58 percent in 1998 from 6 The financial meltdown in these countries resulted in percenie in 1997. In Malaysia, the inflation rates soared more people losing their jobs and being forced into to 5.3 percent from 2.7 percent during the same period, poverty. The unemployment rates in Indonesia, Korea, even though expansionary monetary policies now being and Thailand reached 8-10, 8, and 4.4 percent, respec- pursued could accelerate inflation to a much higher tively, at the end of 1998. Prior to the crisis, these coun- level (see table 3.3). tries, except for the Philippines, enjoyed virtually full Owing to higher inflation and tight monetary poli- employment. cies, nominal interest rates drastically increased. At its Macroeconomic Views of the East Asian Crisis: A Comparison 39 TABLE 3.1 Growth and unemployment I Real GDP growth rates (percent change over the same perod of the previous year) 1996 1997 1998 1Q 2Q 30 40 AVG 1Q 2Q 3Q 40 AVG 1Q 2Q 3Q 4Q AVG Indonesia 5.7 6.7 8.4 10.3 7.8 7.7 6.6 3.3 2.4 5.0 -6.4 -16.8 -17.4 -19.5 -15.0 Korea 7.6 6.7 6.6 7.4 7.1 5.7 6.6 6.1 3.9 5.6 -3.9 -6.8 -6.8 -- -5.8 Malaysia 8.3 8.4 8.1 8.2 8.3 8.5 8.4 7.4 6.9 7.8 -2.8 -6.8 -8.6 -- -6.1 Philippines 5.3 6.1 6.9 4.9 5.8 5.5 5.6 4.9 4.8 5.2 1.6 -0.8 -0.7 -1.9 -0.4 Thailand - - - - 5.5 - - - - -0.4 - - - II IndustriaL production index growth rates (percent change over the same period of the previous year) 1996 1997 1998 1Q 2Q 3Q 4Q AVG IQ 20 3Q 4Q AVG IQ 20 30 ZQ AVG Indonesia - - - - - - - - - - - - - - Korea 9.2 9.6 8.0 8.3 8.8 4.4 6.2 7.2 3.4 5.3 -6.1 -12.1 -10.9 -0.1 -7.3 Malaysia 11.6 9.8 10.7 12.0 11.0 11.5 11.6 9.7 10.1 10.7 -0.8 -6.0 -10.5 -5.6 -5.7 Philippines 11.5 2.5 4.9 -1.9 4.2 -3.2 3.6 6.5 13.9 5.2 -3.0 -9.3 -13.0 -- -8.4 Thailand 8.0 6.0 9.7 9.3 8.3 7.0 7.6 -4.1 -11.3 -0.2 -17.0 -15.4 -9.9 -- -14.1 Note: Indexes of ThaiLand and Philippines are manufacturing production indexes. III Unemployment rate (percent) 1996 1997 1998 1Q 2Q 3Q 4Q AVG 1Q 2Q 3Q 4Q AVG 1Q 20 3Q 4Q AVG Indonesia - - - - - - - - - - - - - -- - Korea 1.8 2.0 2.0 2.2 2.0 2.5 2.6 2.4 2.6 2.5 4.7 6.9 8.4 -- 6.7 Malaysia - - - - 2.9 - - - - 3.0 - - - -- PhiLippines 8.3 10.9 7.7 - 9.0 7.7 10.4 - 7.9 8.7 - 7.3 8.9 9.6 8.6 Thailand - - - - 1.5 - - - - 1.9 - - - -- 4.4 Note: Existing monthly value is used as the data for that quarter. Sources: International FinanciaL Statistics, IMF JP Morgan 1999. Bank Indonesia, Indonesian CentraL Bureau of Statistics. Bask Negara Malaysia (Central Bank of Malaysia). Bank of Korea, Korea National StatisticaL Office. Bank of Thailand. Banko Sentral ng Pilipinas (Central Bank of Philippines). highest, the benchmark corporate bond yield rates in and robust otherwise. Bankruptcy and unemployment Korea rose to above 30 percent from their precrisis rates skyrocketed. average of 12 percent. In Thailand, Malaysia, and the Current account. The magnitude of the economic Philippines, the interbank lending rates increased to 24, slowdown during the crisis was most visible in the dra- 11, and 19 percent from their precrisis level of 10, 7, matic responses of current account adjustment. In and 11 percent, respectively. Indonesia's interest rates Malaysia, the current account surplus is expected to be rose to above 70 percent from their precrisis level of 12 about 7 percent of GDP in 1998, increasing from its percent. The punitive level of interest rates strangled 1997 value of -5 percent. The surplus is likely to reach businesses, including those that would have been viable 14 and 9 percent of GDP in Korea and Thailand, 40 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries respectively (see table 3.4).5 The sharp improvement of in 199?, the private investment demand declined by 28 the current account was forced by harsh recessions. It percent, whereas consumption declined by 12 percent was mainly due to the decrease in imports rather than in the first half of 1998 in Korea. the increase in exports. In Korea, imports declined by In Inionesia, despite the sharp recession, export per- more than 23 percent in the first half of 1998 while formance did not significantly improve, and the current export growth remained stagnant.6 The decline of accouni: surplus in 1998 is expected to be only 5 percent imports was mainly attributable to the precipitous fall of GD]', which is significantly lower than those in of investment demand. Compared with the same period Thailan d and Korea. The poor performance shows that TABLE 3.2 Capital flows, exchange rates, and stock prices I Capital fLows (percent of GDP) 1997 1998 1993 1994 1995 1996 1997 Ql 02 Q3 04 Q1 Q2 Indonesia Capital fLows 3.6 2.2 5.1 5.1 -0.3 7.2 4.1 3.3 -15.8 -29.5 1.0 Use of fund credit - - - - 1.4 - - - 5.6 - 4.7 Change in reserves -0.4 -0.4 -0.8 -2.0 2.3 -1.4 -4.2 2.4 12.2 23.2 -9.7 Korea Capital flows 1.0 2.8 8.5 5.0 -2.1 3.8 6.1 0.7 -18.9 -6.5 -0.3 Use of fund credit - - - - 2.5 - - - 10.0 5.3 2.5 Change in reserves -0.9 -1.2 -1.5 -0.3 2.7 3.0 -3.6 2.3 9.0 -12.2 -14.7 Malaysia Capital flows 16.8 1.8 8.5 9.5 2.8 - - - - - - Use of fund credit - - - - - - - - - - - Change in reserves -17.7 4.4 2.0 -2.5 3.9 - - - - - - Philippines Capital flows 6.0 8.0 7.2 11.5 6.1 9.4 14.6 7.5 -6.9 5.0 - Use of fund credit 0.2 -0.3 -0.5 -0.4 0.6 -0.2 -0.3 3.2 -0.3 -0.1 - Change in reserves -0.8 -3.3 -1.2 -4.8 3.1 -2.0 3.4 1.3 9.8 -3.6 - Thailand Capital flows 8.4 8.4 13.0 10.7 -10.3 6.5 -10.3 -15.1 -22.1 -17.5 -12.0 Use of fund credit - - - - 5.4 - - 12.4 9.3 8.1 1.8 Change in reserves -3.1 -2.9 -4.3 -1.2 6.4 0.3 15.3 5.1 5.1 -1.7 3.0 Note: 1. QuarterLy figures are the ratios of capitaL fLows to one-fourth of annuaL GDP. 2. Use of Fund Credit incLudes exceptionaL financing. 3. Minus sign in change in reserves signifies the increase of foreign reserves. II Exchange rate (period average, national currency unit per dollar) 1996 1997 1998 10 2Q 3Q 4Q AVG 1Q 2Q 3Q 4Q AVG 1Q 2Q 3Q 4Q AVG Indonesia 2318.2 2344.0 2350.0 2357.0 2342.0 2403.0 2437.2 2791.3 4005.7 2909.0 9433 10460 12252 - 10715 Korea 782.9 786.2 817.1 831.6 804.5 869.4 8917 899.6 1143.9 949.9 1612.0 1395.0 1324.9 1281.5 1403.2 Malaysia 2.5480 2.5012 2.4952 2.5193 2.5159 2.4898 2.5081 2.7771 3.4818 2.8132 3.9960 3.8451 4.0570 - 3.9660 Philippines 26.190 26.187 26.212 26.276 26.216 26.330 26.371 29.798 35.384 29.471 40.693 39.379 42.865 - 40.979 Thailand 25.25 25.31 25.33 29.54 25.36 25.91 25.90 34.31 42.37 32.12 45.56 40.31 40.63 36.48 40.75 III Stock market index 1996 1997 1998 10 20 30 40 AVG 1Q 20 3Q 40 AVG 1Q 2Q 3Q 40 AVG Indonesia - - - - - 686.2 690.9 597.3 434.6 599.9 503.2 442.2 366.8 361.7 418.5 Korea 868.6 900.5 797.6 711.8 819.6 679.9 735.1 699.5 418.3 630.7 535.8 350.4 321.3 472.6 420.0 MaLaysia 1096.3 1155.6 1107.4 1210.9 1142.6 1230.2 1087.4 877 601.5 949.1 687.1 540.0 359.7 497.6 521.1 PhiLippines - - - - - 3320.1 2755.6 2231.8 1819.8 2531.8 2150.9 1984.3 1353.2 1899.7 1847.0 Thailard - - - - - 740.3 595.0 570.0 405.1 575.3 494.3 335.0 245.0 350.0 356.1 Sources: International FinanciaL Statistics, IMF; JP Morgan 1999. Macroeconomic V:ews of the East Asian Crisis: A Comparison 41 TABLE 3.3 Inflation and interest rates I Nominal interest rate (percent per year) 1996 1997 1998 1Q 20 3Q 4Q AVG 1Q 2Q 3Q 4Q AVG 10 2Q 3Q 412 AVG Indonesia 16.24 15.41 14.76 13.31 14.93 13,25 13.69 23.48 28.50 19.74 47.00 59.80 69.65 37.50 53.48 Korea 11.8 11.6 12.2 12.6 12.1 12.7 11.7 12.4 24.3 15.3 19.0 16.6 12.5 8.3 14.1 Malaysia 7.11 7.33 7.36 7.33 7.28 7.28 7.53 8.03 9.08 7.98 10.85 11.10 7.15 6.25 8.83 PhiLippines 12.88 13.07 11.59 11.68 12.31 9.72 10.97 14.96 18.10 13.43 15.78 15.00 13.80 13.50 14.52 ThaiLand 6.58 8.78 12.93 12.12 10.10 8.34 15.10 23.87 21.70 17.26 20.57 18.60 7.17 2.63 12.24 Note: 1. Indonesia-1-month interbank deposit rate 2. Korea-yield rate on corporate bond with 3-year maturity 3. MaLaysia-3-month interbank rate 4. PhiLippines-91-day treasury bill rate 5. Thailand-weighted average interbank lending rate II Inflation (CPI, percent change over the same perod of the previous year) 1996 1997 1998 1Q 2Q 3Q 4Q AVG 1Q 20 3Q 4Q AVG 1Q 2Q 30 42 AV6 Indonesia 12.5 9.9 8.9 8.2 9.9 4.5 4.9 6.4 9.2 6.2 27.7 49.7 76.3 78.4 58.0 Korea 4.7 4.9 5.1 5.1 4.9 4.7 4.0 4.0 5.0 4.4 8.9 8.2 7.0 6.0 7.5 Malaysia 3.4 3.7 3.6 3.3 3.5 3.2 2.5 2.3 2.7 2.7 4.3 5.7 5.7 5.4 5.3 PhiLippines 11.0 10.4 8.1 6.7 9.1 5.3 5.3 5.9 7.2 5.9 7.9 9.9 10.4 10.6 9.7 Thailand 7.4 6.2 5.2 4.6 5.9 4.4 4.3 6.2 7.5 5.6 9.0 10.3 8.2 5.0 8.1 Source: JP Morgan 1999. TABLE 3.4 Current account balances (percent of GDP) 1996 1997 1998 1Q 20 3Q 40 AVG 1Q 2Q 3Q 40 AVG 1Q 2Q 3Q 4(l AVG Indonesia -3.6 -4.6 -3.7 -1.9 -3.4 -4.3 -2.1 -2.6 -0.4 -2.3 4.8 3.2 - -- 4.0 Korea -3.6 -4.2 -6.0 -5.2 -4.7 -6.6 -2.5 -1.9 3.6 -1.8 14.2 14.3 12.4 - 13.6 Malaysia - - - - -4.6 - - - - -4.9 - - - - 7.5 Philippines -3.7 -9.3 -0.2 -5.7 -4.7 -2.5 -8.0 -7.0 -3.3 -5.2 -0.4 - - - -0.4 ThaiLand -7.3 -10.6 -7.8 -5.9 -7.9 -5.5 -8.1 -1.9 7.5 -2.0 14.2 9.4 11.5 - 11.7 Sources: JP Morgan 1999. Bank Indonesia, Indonesian Central Bureau of Statistics. Bank Negara Malaysia (Central Bank of Malaysia). Bank of Korea, Korea National Statistical Office. Bank of ThaiLand. Banko Sentral ng Pilipinas (Central Bank of Philippines). Indonesia is suffering from the worst crisis among the and industrial production figures improved, rotably in five East Asian countries and its economy has not been Korea. By the end of 1998, over half of the sharp initial stabilized yet. exchange rate depreciation had been reversed in Korea and Thailand. Compared with the level in December Stabilization and the prospects for recovery 1997, the stock price index in Korea increased by 49 percent. And most important, foreign investors' confi- Korea and Thailand. After the free fall in the first half, dence improved and foreign private capital inflows rnacroeconomic indicators started to stabilize in the resumed. The yield spread between a dollar-denomi- second half of 1998 in Korea and Thailand. Real GDP nated Korean government bond and the U.S. Treasury 42 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries bond was reduced significantly in the second half of considering the nature of previous fire sales and the 1998, reflecting the decline of sovereign risk. The infla- export of raw materials. If so, the inventory stocking tion rates were also well contained and became lower would have a larger negative impact on current than the precrisis level. High nominal interest rates, account balances instead of having a positive effect on which strangled these highly leveraged countries, have production. since dropped drastically owing to the relaxed mone- Indo;nesia. Unlike Thailand and Korea, Indonesia tary policy. In Thailand and Korea, the interest rates in showecl no sign of recovery even as of the second half of the last quarter of 1998 were significantly lower than 1998.9 Political uncertainties seem to play an important their precrisis values. Only the performance of unem- role in undermining reform progress and delaying ployment rates had yet to show signs of improvement, recovery in Indonesia. For example, the implementa- but it is understandable that employment would require tion of the IMF program was derailed by severe civil a more sluggish adjustment process on the road to unrest, which led to the resignation of President recovery.7 Suharto in May 1998. However, it was the mismanage- Despite the recent signs of stabilization in Korea and ment of monetary policy that prevented recovery and Thailand, it is still premature to conclude that recovery brought the danger of hyperinflation in Indonesia. has developed into a trend. There is reason for concern. Facing ;he financial sector strain and the danger of bank The improvement in the growth rates of real GDP and runs, the Bank of Indonesia injected massive liquidity industrial production in the last quarter of 1998 might supporn- to troubled financial institutions and made a be only a statistical phenomenon that is attributable to limited effort to sterilize it. Between November 1997 a sharp recession at the beginning of the crisis. Also, the and March 1998, the increase in net domestic assets of recent GDP growth was mainly due to the changes in the certral bank amounted to more than twice the inventory investment. Figure 3.1 shows the movement entire stock of base money in the beginning of that of the ratio of inventory investment to GDP during the period. 10 The growth rate of M2 rose to 80 percent in crisis in Korea. After the crisis erupted, inventory the second quarter of 1998, well above its growth rate investment fell sharply to -15 percent of GDP. The in 1997, which was 25 percent. Uncontrolled monetary sharp decline in inventory investment was historically expansLon with no progress in structural reform pushed unprecedented in Korea and quite different from the the eco aomy to the verge of a vicious circle of hyperin- stylized cyclical pattern observed in the literature.8 It flation and currency depreciation. Indonesia's experi- clearly indicates how panicky the businessmen felt ence highlights the fact that relaxed macroeconomic because of the crisis; the decline was largely associated with fire sales and exports of existing stocks, especially raw materials. High interest rate expenses, exchange rate depreciation, and the lack of cash flows must have FIGURE: 3.1 forced the disposal of existing stocks. After the free fall, the inventory investment reached Inventory investment to GDP almost zero in the last quarter of 1998. The concurrent percent increase in inventory investment from -15 percent of 10 GDP to zero (not the increase in inventory stock) was 5 the main factor behind the sharp increase in the recent 0 GDP growth rate. It is not certain at this stage whether .D S ..> 4 4 inventory restocking and thereby production increase -5 t @o @t@o40Q will follow in the near future. If the prospect for eco- -10 nomic recovery is not bright, sellers might not want to V . rebuild inventory stocks, and production would stag- nate. Even if recovery is a reality, there is a possibility -20 that inventory restocking can be done through the Source: WorLd Bank, Firm-LeveL Survey. increase of imports. This negative scenario is likely- Macroeconomic Views of the East Asian Crisis: A Comparison 43 policies can aggravate the crisis if structural problems Changing the policy focus from stabilization to expan- remain unresolved. sion could provide short-term relief to Malaysia. Malaysia. Until mid-1998, Malaysia's response to the However, it should not be forgotten that resumption of crisis can be described as the "virtual IMF" policy pack- foreign capital inflows is critical for bolstering the econ- age of austeritv measures-except that the country tried omy in the long run. Whether foreign capital will return to cut imports by increasing import duties and impos- despite the experience of capital controls is a key risk fac- ing other regulations.1" In December 1997, Malaysia ing the country. Also, completing corporate and financial announced a program to slow down the economy and sector reforms while providing liquidity supoorts is a to raise foreign investors' confidence to cope with the major challenge. The outcome of the capital ccntrol pol- regional crisis. The growth outlook was adjusted down- icy in Malaysia will be an interesting touchstone for eval- ward and the current account deficit was targeted to uating the standard IMF policy in the future. decrease to 3 percent of GDP. Public expenditures The Philippines. The Philippines were also severely including mass development projects were reduced and damaged by the spillover effects of the Thai crisis, but it reprioritized with significant budget cuts of 18-20 per- was able to at least sidestep the free fall of economic cent. Monetary policy was tightened, credit expansion activity. Even though the real GDP growth rate dropped was placed under control and the benchmark interest from 5 percent in 1997 to -0.4 percent in 1.998, this rate was raised. In sum, the same prescription of the reflected more the impact of the disastrous weather standard IMF package was implemented in Malaysia than of the regional crisis. Excluding the agricultural until mid-1998 without being officially bound by IMF sector, the Philippine real GDP would have grown 1.1 conditionalities. percent, instead of -0.4 percent. The structural reform, However, the tight monetary and fiscal policies failed particularly the financial sector reform, which had been to stabilize the Malaysian economy in the first half of steadily pursued from the early 1990s protected the 1998. The resulting credit crunch slowed economic Philippines from the full brunt of the regional crisis, growth and aggravated the recession. Despite the even though its external debt-to-GDP ratio was the higher adjustment of interest rates, the exchange rates highest among these five countries. I lowever, despite were steadily depreciated and remained volatile. relatively less severe economic contractions, the Frustrated with the worsening economic performance, prospect of recovery for the Philippines is not necessar- Malaysia decided to reverse the policy direction toward ily brighter. While the external situation has showed expansion. In July 1998, it announced the National some improvement in the second half of 1998, it is still Economic Recovery Plan (NERP), which focused on beset with ongoing problems such as a high budget easing monetary and fiscal policy to provide a stimulus deficit, rising inflation, and increasing poverty. The cur- to economic activities. In order to alleviate the credit rency depreciation also increased debt-servicing costs crunch, prudential standards were relaxed even though significantly and could delay its recovery. they remained tighter than precrisis levels. In September, the government introduced capital controls Monetary and fiscal policies in the on outflows of capital and fixed the exchange rates at adjustment process 3.805 rupiah to the dollar. It intended to gain flexibility for easing monetary policy. Following the adoption of The severe contraction of the East Asian countries these measures, the interest rates were reduced to the raised serious questions as to whether the initial precrisis level. response of the IMF packages was unnecessarily tight There are some recent signs that after the introduc- for these countries. The critics argue that instead of hav- tion of this expansionary policy, the economy started to ing favorable impacts on foreign investors' confidence, stabilize in Malaysia. However, reaching judgment on the stringent macroeconomic policies and tie conse- this would still be premature, given the short span of quent high interest rates have had a negative effect on time in which the new policies were introduced. The these highly leveraged countries. This section reviews consensus on capital control seems to be that it could the magnitude and the impact of the tightened mone- bring benefits in the short run, but not in the long run. tary and fiscal policies in the evolution of the crisis. 44 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries Monetary policy money. M2 and domestic credit deflated by the con- sumer price index (CPl).12 Several features are appar- Figure 3.2 shows the movement of monetary aggre- ent. In Indonesia, they increased significantly in the gates in Indonesia, Korea, Malaysia, Thailand, and the first half of 1998, showing that the Indonesian govern- Philippines. They are the monthly stock of reserve ment was losing control of the money supply in bailing FIGURE 3.2 Real money aggregates indexes Thailand Korea 1.6 1.4 1.6 1.2 ~~~~~~~~~~~~~~~~1.4 1.2 1.2 0.8 0.8 0.6 ~~~~~~~~~~~~~~~~0.6 0.4 0.4 0.2 0.2 Indonesia Philippines 2 ~~~~~~~~~~~~~~~~~1.6 1.8 1.4 1.6 1.2 1.4 1.04 1.2 8 0.8 0.8 '~0.6 0.6 0.4 0.4 0.2 0.2 0 0- 90S 9rO\ 9r S098\ q\9- 9p \'tS~b q9°0 lbO- 0 0o<9 Malaysia 1.6 1.4 1.2 1 Reserve money mmM2 0.8 0.6 Domestic credit 0.4 0.2 0 Source: Wor[d Bank, Firm-Leve[ Survey. Macroeconomic V.ews of the East Asian Crisis: A Comparison 45 out troubled financial institutions and preventing bank of inflation made real interest rates low immediately runs. In contrast, real M2 and credit in Malaysia after the crisis erupted. But soon after the onset of the steadily decreased in 1998. Even after abandoning the crisis, real interest rates soared to a historical high. The "virtual IMF" policy in July 1998, there was no sign of increase was highest in Korea where real interest rate significant monetary expansion in Malaysia until the rose from 7.2 percent prior to the crisis to 20 percent at very end of the year. It is harder to judge how tight the its peak. In Malaysia, Thailand, and the Philippines, the monetary policies in Korea, Thailand, and the increase was relatively mild, from 5 to 10 percent in Philippines are by looking at the figures. Reserve money Malaysia, from 5 to 14 percent in Thailand, and from 5 and M2 decreased little or grew at slightly slower rates to 10 percent in the Philippines. than previously in the first half of 1998. But from the Lane and others (1999) argue that these initial second half of 1998, there was no sign of monetary con- increases in real interest rates were not atypical com- traction, particularly in Korea. In sum, real monetary pared with those seen in other crisis-hit countries. aggregates and credit in Korea, Thailand, and the However, even though it is true that the magnitude of Philippines did not seem to be severely contracted the increase was not exceptional, high interest rates except for the brief period at the beginning of 1998. imposed a crushing burden on real economic activity. Initial monetary policies were tight and caused a Highly leveraged corporate structures made these credit crunch. Based on the fact that the slower growth economies extremely vulnerable to the increase of inter- rates of real money and credit were not dramatic, some est rates. Especially, business investment demand col- raised doubts about the view that the tight monetary lapsed. Moreover, the interest rates in figure 3.3 policy was the main cause of the sharp economic down- underestimate the severity of the credit crunch. To truly turn in the East Asian countries.13 However, quantity evaluate the severity of the credit crunch, we have to changes in monetary aggregates may not be fully ade- measure the increase of interest rates that marginal quate in reflecting the severity of credit tightening. firms are facing. Given the lack of adequate data that Despite the decrease in supply, the equilibrium quantity measure the interest rates prevailing at the secondary of monetary aggregates may not change much if the market, it is hard to evaluate rigorously the degree of demand for credit does not change and becomes inter- the credit crunch in these East Asian countries. But est-inelastic. Needless to say, the firms' investment there is ample anecdotal evidence that it was wide- demand fell drastically after the crisis erupted, but it spread. For example, as shown in figure 3.4, only the was only a part of the demand. Facing increasing uncer- very large conglomerates with low bankruptcy proba- tainties, precautionary demand for credit increased to bilities were able to issue corporate bonds after the cri- prepare for the anticipated loan recall, loss of trade sis erupted in Korea. The share of corporate bonds credit, expected increase in interest rates and operating issued by the five largest conglomerates increased from costs, and so on. Servicing existing debt to avoid bank- 47 percent prior to the crisis to 87 percent i-n the first ruptcies also made the demand for credit highly inelas- quarter of 1998.16 There were many anecdotes showing tic to the changes in interest rates. As a consequence, that small and medium-size firms did not even dare to when the monetary policy tightened, interest rates sell their bonds in the market in the first half of 1998. soared even though the equilibrium growth rate of The interest rate differentials between the corporate credit was not drastically slowed down. Therefore, the bonds issued by the five largest conglomerates and by changes in interest rate, not the quantity of monetary the others widened from 0.12 percent prior to the crisis aggregates or credit, may be a better measure of a credit to 3.5 percent in March 1998. This gap still anderesti- crunch for the duration of the crisis. 14 mates the risk premium because of the sample selection Figure 3.3 shows the behavior of nominal and real bias, which dictated that only a few qualified medium- interest rates in these five countries.15 In Tndonesia, even size corporations could sell their bonds in the market. though nominal interest rates were increased signifi- Ding, Domac, and Ferri (1999) also document that the cantly, real interest rates were consistently negative "flight to quality" phenomenon was widespread and from late 1997 to mid-1998 owing to high inflation. In had negative impacts, particularly on small banks and Korea, Malaysia, and Thailand, a high but brief surge enterprises in the other East Asian countries. 46 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries FnGURE 3.3 Real interest rates Korea Indonesia 30 80 25 60 20 40 / x 20 15 0 10 N xx 1~~~~~~~~~~~~~~~~~~\N$A> I A i'> s -20 \ 0omina interest 1 ~~~~~~~-40 0 -60 e -5L 1 , _ -80 Thailand Malaysia 30 12 25 10 20 8 15 0~~~~~~~~ 0ih oeayplc ln a o 01 l 01 01hev 0iniflto spirals In1 hnsg t, the IMF clarl $4~%~Xq,$ K'cŽ-2 0- 0j01 Philippines 25 20 -xchange r s i T i t m aNominal interest 15 large ReaL interest 10 0 -5 0 Source: WorLd Bank, Firm-Level Survey. Tight monetary policy alone was not able to achieve tion-inflation spirals. In hindsight, the IMF clearly exchange rate stability. The initial tight monetary pol- underestimated the negative effects of interest rate hikes icy ordered by the IMF was aimed at prcventing the in these highly leveraged economies. However, it is hard large currency depreciation from initiating deprecia- to denyv that some period of high interest rates must Macroeconomic VWews of the East Asian Crisis: A Comparison 47 Credit concentration and risk premium Newly issued corporate bonds Interest rate differential percent percent 100 ~~~~~~~~~~~~~30 4.5 100 25 4 70 20 3 60 2.5 50 15 2 40 10 1.5 301 20 5 0.5 10 0,5 0 A.0 0 ~~~~ A ~~~~~~~~~~~ Share of the 5 Largest corporations 5 Largest congLomerates Others Difference Source: WorLd Bank, Firm-Level Survey. have been unavoidable in order to stabilize the ning of 1998, the riggit started to depreciate again and exchange rates. Two channels had been important in remained volatile until Malaysia introduced its own ini- achieving this goal. First, the increase in interest rates tiated policy in July 1998. As figure 3.3 shows, the real was called for mainly to stem the outflow of capital. interest rate started to fall only after the government The high interest rate failed to restore foreign investors' started to regulate interest rates and introduced capital confidence and bring back capital inflows in the midst controls. of the crisis, but it was effective in preventing a sharp The Malaysian case shows that tight policy alone is increase in demand for foreign currency by domestic not sufficient to restore exchange rate market stability. firms and individuals. Second, the severe recession Stemming capital outflows and building foreign induced by the tight monetary policy was a main factor reserves by belt-tightening is not enough to reduce the in reducing imports and rapidly improving current panic. Resumption of capital inflows, especially private account balances in Korea, Malaysia, and Thailand. capital inflows, seems to be the key factor. Korea and Without a significant current account surplus, restock- Thailand benefited from official program loans by the ing foreign reserves and restoring foreign investors' IMF and other international financial irnstitutions confidence would not have been possible. immediately after the crisis erupted. The Korean gov- The tight monetary policy, however, did not succeed ernment also succeeded in rolling over the short-term in stabilizing the exchange rate market in all of the external debt of the banking sector in March 1998. countries. In Korea and Thailand, the exchange rate Thanks to the private debt rescheduling, the proportion market started to stabilize steadily in the second quar- of short-term debt in Korea decreased from 60 percent ter of 1998, allowing room for the government to relax to 21 percent and significantly alleviated liquidity prob- the monetary policy. Consequently, these countries' lems. In contrast, a "virtual IMF" package imple- interest rates in the last quarter of 1998 became even mented by Malaysia did not benefit frorn official lower than their precrisis levels, leading the recovery of program loans. The country's political instability and real activities. However, the "virtual IMF" policy in the restrictive government policy in capital flow prob- Malaysia failed to stabilize the exchange rate market. ably deterred the resumption of private capital After showing a brief sign of stabilization at the begin- inflows. The lack of capital inflows im,plies that 48 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries Malaysia had to achieve a more drastic current account Korea, Malaysia and Thailand amounted to about -7, adjustment and face a deeper contraction even though -5, -1, and -4.5 percent of GDP. its precrisis economic environment was better than that However, so far the fiscal expansion has not been as of Korea and Thailand. effective as the increased budget deficit figures suggest. Relaxed monetary policy proved effective only when Instead of being a discretionary change, they were accompanied by structural reforms. The relaxed mon- mostly induced by the fall of tax revenues owing to the etary and fiscal stance since the second half of 1998 severe economic downturn and sharp exchange rate contributed to the rapid decline of interest rates and the depreciation. In fact, even though budget deficits were recovery in Korea and Thailand, where corporate and widened, instead of increasing, the government con- financial reforms have been progressing significantly. sumption expenditures decreased by 9 percent in Korea However, it should be emphasized that expansionary in 199 S. Also, among government expenditures, the macroeconomic policy alone cannot have a large impact proportion of transfer payments increased owing to the if structural problems remain unsolved. In Indonesia, increas,- in demand for social expenditures. As long as uncontrolled monetary expansion not only delayed transfer payments have a smaller multiplier effect than recovery but also brought the country to the verge of government purchases of goods and services, the hyperinflation. By contrast, the rapid decline of interest expans ionary effect of the increased budget deficits rates and fast recovery in Korea was the result of the must be limited. progress in the country's structural reform as well as the Irrespective of their effectiveness in boosting the expansionary monetary policy. The reform progress econonmy, budget deficits in these Asian countries are reduced sovereign risk premium and inflation expecta- likely ta grow in the near future. The unemployment tion by offsetting the initial worries that the government problern will not be resolved any time soon and the would monetize bailing-out costs for troubled financial demand for social expenditures will rise. More impor- institutions. As little as the origin of the East Asian cri- tant, the governments' support is essential in financial sis has to do with macroeconomic imbalances, it is restrucl:uring. Considering the upcoming need for more understandable that macroeconomic policy alone can- government expenditures, it is fortunate that the East not solve its problems. Eventually the recovery must Asian countries had maintained nearly balanced bud- depend on the structural reform that addresses the roots gets priDr to the crisis. It made it possible for these coun- of the problems that caused the crisis in the first place. tries to allow temporal budget deficits in the future without incurring negative side effects. FiscaL policy Assessment of the adjustment process In the same fashion as monetary policy, tight fiscal pol- icy was initially tried in the East Asian countries after Many factors contributed to the sharp fall of economic the crisis erupted. The initial tight fiscal policy was activities in these countries. Among them, our previous introduced to improve current account balance by discuss:.on highlighted the three most important factors: increasing government savings, and to alleviate the need (a) drastic reversal of capital flows, (b) tight monetary to squeeze private savings excessively. It also aimed at policy, and (c) uncertainty caused by financial restruc- securing noninflationary funds for financial restructur- turing. It is hard to deny that some period of tight ing. But starting in early 1998, the severity of the eco- macroeconomic policy was unavoidable to prevent nomic downturn made it necessary to expand the fiscal depreciation-inflation spirals and eventually the recov- stance. As the effectiveness of the monetary policy was ery should depend on the progress of financial reform. constrained by the credit crunch, the fiscal policy had to However, in the short run, these three factors exacer- play a greater role. As a result, budget deficits increased bated the degree of the credit crunch and their contrac- in these East Asian countries in 1998. Prior to the crisis, tional impacts were greater than anyone, including the government budgets were in balance or in surplus in IMF, had imagined. Only at the end of 1998 did signs these countries. But in 1998, budget deficits in Indonesia, of recovery became visible in the region, particularly in Macroeconomic V ews of the East Asian Crisis: A Comparison 49 Korea and Thailand. In this section, we review some from -11 percent to -0.6 percent of GDP. This fast forces behind the recent recovery. response happened because the economy became more open and private-sector oriented. Unless the economy High market sensitivity of the open and is led by the private sector and export-oriented, we private sector economies believe that such a dramatic improvement in the current account positions as experienced in Korea and The quick response to stabilization as well as expan- Thailand in 1998 would be virtually impossible. sionary policies was possible since the East Asian coun- tries were more open and private sector-oriented. The Favorable development of the external crisis in East Asia was caused by private sector overin- environment vestment, not by public sector overexpenditure, and the adjustment of the private sector under the changed The favorable turn in the external environrnent also macroeconomic circumstances tends to be much helped bring about a quick recovery of these economies. quicker than that of the public sector. Also, the reces- The appreciation of the Japanese yen with three con- sion in the domestic market could generate a larger secutive cuts in U.S. interest rates starting in mid-1998 improvement in current account balances since these allowed Korea and Thailand to cut domestic interest economies were more open and export-oriented. rates substantially without destabilizing their exchange Table 3.5 shows the degree of difference in the open- rates. The Japanese yen appreciation also re(duced the ness and private sector orientation between East Asian possibility of the Chinese yuan's devaluation and indi- and Latin American economies. Mexico is a good rectly contributed to the stabilization of the exchange example. In the 1982 crisis, Mexico was less open and market in Korea and Thailand. more public-sector dominated. After the crisis, its cur- rent account balance improved owing to severe reces- PoLicy implications and concLudinig sion but the change was not as fast as those of the East remarks Asian cases. The current account balance was -7.9 per- cent of GDP in 1981,-3.8 percent in 1982, and 4.3 per- In our review of the adjustment processes of the five cent in 1983.17 By contrast, in 1994 Mexico had a East Asian countries since the currency crisis erupted in smaller budget deficit and became more open after the Thailand in 1997 we observe that after covering enor- North American Free Trade Agreement (NAFTA) was mous economic and social costs, the real wages have passed. In the 1994 crisis, the real GDP growth fell from been substantially reduced, interest rates have dropped 4.5 percent in 1994 to -6.2 percent in 1995 and the cur- below the precrisis level, currency overvaluation has rent account deficit improved sharply within a year been corrected-perhaps somewhat excessively-and TABLE 3.5 Openness and private sector orientation in selected countries (percent) Indonesia Korea Malaysia Philippines Thailand Mexico Brazil Argentina chile 1996 1996 1996 1996 1996 1982 1995 1982 1995 1982 1995 1982 1995 40.8 57.8 158.0 65.8 69.1 21.3 32.7 13.8 14.2 16.9 14.7 30.0 49.0 Note: (Export + Import)/GDP Indonesia Korea Malaysia Philippines Thailand Mexico Brazil Argentina Chile 1996 1996 1996 1996 1996 1982 1995 1982 1995 1982 1995 1982 1995 14.6 18.3 22.6 18.5 16.1 30.0 16.1 9.1 14.0 20.3 14.5 36.0 19.9 Note: Government Expenditure/GDP Source: IMF, InternationaL FinanciaL Statistics. 50 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries rental costs have plummeted in these countries. This these economies will be realized only after these prob- development now provides a much more favorable lems have been properly resolved. business environment in these economies that had been Second, resumption of capital inflow will be a key suffering for a while from the weakening competitive- factor for the fast recovery of these economies. ness of their exports and structural inefficiencies owing Malaysia adopted a less tight monetary policy than to the rigidity in the labor and financial markets. Korea (lid in the first half of 1998, but its economic con- Nevertheless, there still remain formidable con- traction was at least as severe as Korea's and its straints to recovery. Among other things, the list exchange market remained more unstable. If Malaysia includes continuing low aggregate demand in both had been able to receive external financial assistance domestic and foreign markets; a persistent credit crunch organi2ed by the IMF or another institution, it could that is attributable to the unresolved financial instabil- have avoided such a severe economic contraction. ity; weakness in the corporate financial structure and Judging from this experience, the right mix for the overcapacity; and lack of foreign capital inflow. In con- economies in this region may have been a less strict sta- nection with these constraints, the following policy bilization policy package and a larger amount of finan- implications may follow from the review and the com- cial assistance that was heavily front-loaded. Since it parison of the adjustment experiences of these would be hard to expect a quick resumption of the pri- economies so far. vate capital inflow to a crisis-hit country, there is an First, accommodative macroeconomic policies will be urgent aeed to expand the available financial resources needed for a while to prevent further contraction in through multilateral and regional financial institutions. domestic demand and weakening of the corporate In thi s regard, it is encouraging to see recent discus- financial structure. This is also important in preventing sions on the expansion and establishment of emergency asset deflation, which would have a significant adverse financing facilities such as the contingent financing impact on the corporate and financial restructuring facility under the IMF and the enhancement of its role process. Since the corporate sector of these economies, as an effective lender of last resort in the international particularly in Korea and Thailand, is highly leveraged, capital market (see Fischer (1999), and McKinnon a tight monetary policy would accelerate corporate (1998)). Discussions on the establishment of regional bankruptcies and asset deflation. This would then financing facilities are also an encouraging step toward impose a heavier burden in resolving financial instability. this end. However, it is equally important in these dis- However, striking the right balance between the cussions to include schemes for involving greater par- accommodative macroeconomic policies and driving ticipation of the private sector so as to facilitate the timely financial and corporate sector reforms will be an orderly workout of debt rescheduling, a fairer sharing important challenge to these economies. In practice, the of losses, and quicker resumption of private capital accommodative macroeconomic policies can give sig- inflows. nals to corporate firms to be complacent and hang on Third, more serious and comprehensive efforts are to their overcapacity. The experience of Indonesia has necessary to encourage the development of the capital made it clear that the expansionary monetary policy markets in these economies. One of the key factors in without necessary financial and corporate sector achievinig successful corporate restructuring-which reforms is ineffective in bringing recovery-and it will facilitate full economic recovery, particularly in causes hyperinflation. Through the experience of the Korea and Thailand-is to reduce the corporate lever- Philippines, we can glimpse the importance of the qual- age rati o. Substantial inflow of foreign capital, particu- ity and sustainability of recovery. What shielded the larly foreign direct investment, will be necessary to this Philippines from the full brunt of the regional crisis was end, especially when the prospect of the new domestic its structural reform, particularly the financial sector funding is poor as it is now. reform, which had been steadily pursued starting in the However, given the huge size of the overall debt of the early 1990s. Because the root cause for the financial corporate firms in these economies, this ultimately will instability in this region was the structural weaknesses have tc be achieved by a substantial conversion of debt of the corporate and financial sector, full recovery of to equity, and the change of domestic financial market Macroeconomic Views of the East Asian Crisis: A Comparison 51 structure to support this conversion. Corporate finan- N otes cial structure mirrors the structure of the financial mar- ket and patterns of financial savings of households in an Yoon Je Cho is with the Graduate SchooL of Internation aL Studies at Sogang University in Seoul, Korea, and Changyong Rhee with the fac- economy. Improvement in corporate financial structure uLty of Economics at SeouL NationaL University, Korea. The authors are could hardly be expected unless there is concomitant grateful to Dominique Dwor-Fr&aut, Mary HaLlward-Driemeier, the change in the domestic financial market structure. participants of the conference for their vaLuabLe comments, and Chung-ChuL Chung, Han Kyu Lee, Sam Ho Lee, and Sun Hyeong Lee for Therefore, serious efforts have to be made to expand exceLLent research assistance. Any errors in the text, however, remain the equity market in these economies by encouraging the responsibiLity of the authors. collective investment vehicles, including mutual funds 1. Mexico is a good exampLe. In the 1980s, when Mexico had a Large government budget deficit, the stabiLization poLicy was not very effec- and investment and trust businesses. Further stabiliza- tive in curtaiLing current account deficits. In 1994, when Mexico had tion of domestic interest rates will play a crucial role for a smaller budget deficit and became more open after the North this purpose. American Free Trade Agreement (NAFTA) was passed, the stabilization poLicy brought sharp swings in the current account balance. Finally, we may draw some lessons for reference in 2. The structural weaknesses were of a different nature as weLL. In future currency crises. The experience of the East Asian Korea, the poor governance of corporate and financiaL sectors was the economic adjustment suggests that policy packages to main cause of the country's structuraL weakness. In Thailand, the lib- .ustment suggests that pol' y packages to eraLization of the financiaL system and the external capil:aL accounts be imposed on the crisis-hit countries will need to be without an adequate reguLatory and supervisory system pLayed a more better tuned to individual market circumstances. In significant role. economies such as Korea and Thailand, which are quite 3. The Bank for InternationaL SettLements (BIS) (1997) official esti- e o s ha quite mates for actuaL nonperforming Loans in MaLaysia in 1996 Nas 3.9 per- open, private-sector oriented, and have a very high cent of totaL Loans, which was significantly Lower than those of leverage ratio in the corporate sector, the sensitivity to a ThaiLand (7.7 percent) and Indonesia (8.8 percent). But ii: was higher stabilization package could be higher than in other than those of Korea (0.8 percent). The other estimates show that the ratios were not significantLy Lower in MaLaysia than in the other cri- economies. sis-hit countries in 1997 and 1998. See table 5 in GoLdstein (1998). The main purpose of the stabilization policy in the 4. The financial capitaL flows in table 2 are not totally private. They economies facing currency crisis is belt-tightening and incLude portfoLio investment and direct investment by the govern- strengthening the foreign in ~~~ments. strengthening the foreign debt service capacity. But m 5. The ThaiLand figure is the most recent estimate of the IMF, and these economies, the stabilization policies may far over- is different from the number in tabLe 4, which does not cover the Last shoot their original goals. Sharply increased interest quarter of 1998. 6. It is true that the export voLume increased significantLy after the rates and depreciated exchange rates in the initial stage initiaL depredation of the Korean won. But its growth slowed down have enormous balance sheet effects on highly lever- quickly thereafter. Moreover, there was no improvement of exports in aged economies and lead to drastic declines in domestic doLlar-denominated terms. 7. See Lee and Rhee (1998) for the stylized pattern of employment investment and employment. Furthermore, the stabi- growth in previous IMF program countries and its policy irnpLications. lization policy package that is implemented in conjunc- 8. When an unanticipated demand shock occurs, production usuaLLy tion with the tight schedule of bank restructuring can foLLows final demand with a Lag, implying that inventory stocks rise in the short run. See Bernanke and GertLer (1995), Christiano, accelerate the credit crunch and systemic corporate Eichenbaum, and Evans (1994), and Sims (1992). bankruptcies. This tight monetary policy is inevitable in 9. OnLy very recentLy did the Indonesian crisis start to show signs order to be able to prevent further deterioration of for- of abating. 10. In December 1997, the Bank of Korea aLso injected massive Liq- eign exchange market stability in the earlier stage of the uidity support (more than one-third of reserve money) in preventing currency crisis. But here again, the maintenance of a the coLLapse of the banking system. However, in contrast to Indonesia, c1areful balance between the conflicting goals of stabi- the Bank of Korea sterilized the injection. 11. See Yusof (1998) for a detaiLed expLanation of l:he shift in lizing the exchange rates and preventing massive bank- MaLaysian economic poLicy from mid-1997 to the end of 1998. ruptcies and rapid aggravation of financial instability is 12. For comparison, the graph shows the indexes whose average essential to avoid severe economic contraction and value in 1996 is equal to 100. 13. Lane and others (1999) pointed out that the degree of mone- resulting social problems. tary tightening in the East Asian countries was not as draconian as in the cases of other countries facing an exchange rate crisis;. For exam- ple, the growth rate of real money in Mexico declined b y almost 26 percent in 1995. Dollar and Hallward-Driemeier (1998) also provide microeconomic evidence that shows onLy weak support of a credit 52 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries crunch story. Using the survey resuLts of 1200 manufacturing firms in 15. ReaLinterest rates are constructed by subtracting a three-month ThaiLand, they concLuded that the faLL in demand, not the restricted moving average of monthLy CPI infLation rates (previous month, cur- access to credit, was the main constraining factor in sLowing down the rent morth, and one month ahead) from nominaL interest rates. ThaiLand economy. 16. Tco prevent the concentration of the funds in the five Largest 14. The fact that the issuing of corporate bonds increased whiLe congLomerates, the government started to reguLate the maximum domestic credit by the banking sector decreased in Korea can be indi- amount 3f corporate bonds issued by the five Largest congLomerates rect evidence that the suppLy of credit, not the demand for credit, is that financiaL institutions coutd hoLd, starting with October 1998. a constraining factor. ALso, monetary and credit aggregates do not Therefore, the figures after October shouLd be interpreted with care. indicate how credit is aLLocated within the economy, which is a main 17. The country's reaL GDP growth rate was 8.5 percent in 1981 but theme of this conference. it dropped to -0.6 percent in 1982 and -3.5 percent in 1983. Macroeconomic Niews of the East Asian Crisis: A Comparison 53 The New Miyazawa Initiative and Response to the Corporate Debt Problem Kiyoto Ido T - he currency and financial crisis that started in Thailand in July 1997 had a major impact not only there and in neighboring Asian coun- tries, but on the global economy as a whole. Various causes for this crisis have been identified, such as a rigid exchange rate system, short-term cap- ital flows as typified by hedge funds, and fragility in the private financial sec- tor-and included with them is also the lack of corporate governance. Soon it will be two years since the currency crisis erupted, and we are now seeing some hopeful signs in the economies involved in the crisis. However, it would be dif- ficult to claim that adequate progress has necessarily taken place with regard to the corporate debt problenm. Given this situation, it is very good timing, indeed, that the present confer- ence sponsored by the World Bank offers us an opportunity to discuss issues of corporate governance. In what follows, I would like to address how the problem of corporate debt should be dealt with and what the New Miyazawa Initiative currently being implemented by the Japanese government can do to assist with this problem. Basic perspectives As indicated in table 4.1 and figure 4.1, even among countries that experienced the same currency crisis, corporate debt problems differ by country in, among other things, their scale (relative to GDP and total external debt) and in the composition of indebted corporations (domestic financial institutions, foreign financial institutions, nonfinoncial institutions, and so on). Therefore, specific 55 FIGURE4 .1i that end, it is not enough to just reduce their burden of d e bt. The underlying premise of the so ution is corpo- Debt to Bank fo nertona ete ns rate restructuring and the question we must bear in mind is how to ensure an appropriate capital flow to Percent these corporations. ln this sense, we must not cnly work 100 X X X g Wto restore sound management in the financial institu- 80 XOM W S g tions I mentioned, but we must grapple with the devel- 70 opment of capital markets in the medium and long run. 50 40 Issues for the promotion of debt 30 20 restructuring 10 Indonesia Korea MaLaysia PhiLippines ThaiLand To achieve a resolution of corporate indebtedness along these lines, we will be required to tackle the problem from a number of different angles. With respect to the Percent 14.2 restructuring of corporate debt currently underway in each country, a variety of bottlenecks have been identi- fied. Here, I would like to point out some items that must be considered in connection with the promotion of debt restructuring. 15.1 Establishing relationships of mutual trust between debtors and creditors In order to move negotiations toward a successful con- 70.6 clusion, it is vital for the parties involved to establish relationships of mutual trust. To that end, it is necessary that they share information, and it is essential that there Banks * Public sector m Nonbank private sector be a greater degree of transparency and disclosure on the part of the indebted corporations as a group, includ- Source: World Bank, Firm-Levet Survey. ing the activities, assets, and liabilities of overseas cor- porations. I would also like to add that when people responsible for decision-making at indebted corpora- measures applicable to actual situations must be taken tions take part in discussions, it is important for them to in each country. respond to their creditors with responsibility and good Most cases have one thing in common, however: the faith. handling of corporate indebtedness is closely tied to the problem of bad debt among domestic financial institu- Improvement of the legaL environment tions. Early resolution of corporate indebtedness is essential for the recovery of function in the financial sys- Inadequacies in the basic legal framework relating to tem, and it is necessary to tackle the corporate debt the execution of obligations, such as bankruptcy laws problem at the same time as the problem of nonper- and accounting systems, have delayed resolution of the forming loans in the financial sector. problem of corporate indebtedness. The provision of a At the same time, ensuring that the debtor corpora- legal environment and the creation of an atnmosphere tions themselves engage in proper activity is also of the that will facilitate the progress of negotiations on greatest importance for macroeconomic recovery. To restructuring are important tasks. 56 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries On this point, we welcome Thailand's efforts to Moreover, the substance of restructuring should not amend its bankruptcy laws (which have passed its upper rely oni such methods as uniform debt reduction to house) and other progress in developing a legal system. enlist the support of debtors. Rather it should present a It is important for the future not only to enact and flexible menu of voluntary options that reflect the spe- amend laws and ordinances, but also to reinforce cific needs of different situations. It is important in these capacity building as necessary among those who are in cases thlat the schemes make it easier for debtor corpo- charge of conducting business, and in such ways that rations to continue obtaining domestic and interna- would establish effective operation of the system. tional capital for their continuing survival. Clear setting of the framework for Provision of working capital negotiation When zorporations are making proper efforts to revive For solving the debt problem, initiation of bankruptcy themselves and are carrying on a restructuring of debt proceedings should be the last recourse. Prior to that, as described above, it is important to serve an environ- negotiation should be sought between creditors and ment in which appropriate working capital can be debtors on the basic premise that indebted corporations extended to corporations. In this respect, multilateral should be preserved. From this perspective, the kind of agency assistance and bilateral support can be effective comprehensive framework for promoting negotiations as well. As I will explain next, Japan is also implement- on indebtedness that we find in the Bangkok Initiative ing assistance through the New Miyazawa Initiative to and Jakarta Initiative are of great importance. It is provide capital to manufacturing industries. essential on these occasions to make clear to the parties involved the procedures for implementation and Approaches to the corporate debt authority of reform, and to make it possible for both problLem under the Miyazawa Initiative creditors and debtors to participate in the scheme with- out apprehension. Negotiation is a matter that princi- As corporate indebtedness is a problem that occurs in pally involves the creditors and debtors, but the private enterprise relationships, it should basically be government of the countries concerned must also pro- settled within the private sector. However, it should also vide the leadership needed to bring both sides together be noted that when the governments of Asian countries on a level playing field. affected by the currency crisis are making comprehen- sive eficorts to deal with the problems of corporate debt TABLE 4.1 External debt of four Asian countries (biLlions of U.S. dolLars) Thailand Indonesia Malaysia b Korea, Rep. of Dec. 1997 Dec. 1998 Dec. 1997 Mar. 1998 Dec. 1997 Sept. 1998 Dec. 1997 Dec. 1998 External debt 93.4 86.2 137.4 138.0 43.6 39.6 158.1 149.4 Short-term debt 34.8 23.5 n.a. n.a. 11.2 7.0 63.2 30.8 Private sector debt 69.1 54.7 74.0 72.5 26.8 22.9 135.8 112.9 Corporate debt 29.5 25.7 58.8 64.5 18.4 18.3 46.2 41.0 Extemal debt per GDP (percent)0 External debt 60.7 56.0 63.9 64.2 44.5 40.4 35.7 33.8 Short-term debt 37.3 27.2 n.a. n.a. 25.7 17.7 40.0 20.6 Private sector debt 74.0 63.4 53.8 52.5 61.4 57.8 85.9 75.6 Corporate debt 31.6 29.8 42.8 46.7 42.2 46.2 29.2 27.4 a. Per nominal GDP in 1997. b. Corporate debt for MaLaysia is figured by subtracting short-term banking sector debt from privatE sector debt. Sources: Official data by each individual country. The New Miyazawa Initiative and Response to the Corporate Debt Problem 57 and the financial sector, considerable amounts of lion for a banking system reform project intended to resources will be required. take a further step in structural reinforcement of the As you are aware, in October 1998, Japan announced banking sector and avert worsening of the domestic a New Initiative to Overcome the Asian Currency Crisis credit shortage. In addition, JEXIM is providing the ("the New Miyazawa Initiative"), to solve the eco- equivalent of US$500 million in untied two-step nomic difficulties of Asian countries affected by the loans to the Development Bank of the Philippines to recent crisis and to stabilize international financial mar- make capital available for investment in plant and kets. Specific support measures have been decided for working capital in the private sector. the five countries, and we are working steadily to imple- * Republic of Korea. JEXIM is providing the yen ment those measures. equivalent of US$1.3 billion in untied two-step loans The object of this scheme is to help fulfil the financial to the Industrial Bank of Korea to make capital needs of the following measures for recovery of the cri- available to small and medium-sized enterprises for sis-hit countries' real economies: investment in plant and working capital. * Providing support for corporate debt restructuring Japan has been supporting these countries' efforts to in the private sector and measures to make financial overcome the problem of nonperforming assets by con- systems sound and stable; tinuing to give careful scrutiny of their capital needs. * Strengthening the social safety net; Moreover, as we work for close cooperation among the * Stimulating the economy (promoting public works countries and multilateral agencies involved, we are to increase employment); and studying such policies as the following. * Taking measures to address the credit crunch (facil- First, in order to facilitate fundraising by the Asian itating trade finance and assisting small and medium- countries in international financial markets, JEXIM sized enterprises). will guarantee sovereign bonds issued by these coun- To deal with the problem of corporate debt and credit tries. Guarantees from JEXIM will make it possible for crunch that are linked with each other, the following them to issue bonds at higher ratings and lower cost, support measures have been declared under the New and so promote the smoother acquisition of capital. It Miyazawa Initiative. will be necessary to amend the law before JEXIM can * Thailand. To sustain the reform of the financial and guarantee bond issues, and such a revised law is now industrial sectors and strengthen the competitive being presented to the legislature. It is hoped that in the fundamentals of the economy, Japan is providing the long run this scheme will lead to the establishment of a yen equivalent to US$600 million for economic and new international guarantee institution focused on the financial adjustment in cofinancing with the World Asian countries. Bank's Economic and Financial Adjustment II Second, in order to provide guarantees and interest (EFAL II) program. In addition, the Export-Import subsidies, Japan will establish and fund an Asian Bank of Japan (JEXIM) is providing the yen equiv- Currency Crisis Support Facility. This facility will guar- alent of US$50 million in untied two-step loans to antee loans to Indonesia, Malaysia, the Philippines, the Industrial Finance Corporation of Thailand and Thailand, and other countries affected by the currency the Krung Thai Bank to make capital available in the crisis provided through cofinancing by the Asian manufacturing sector for investment in plant and Development Bank (ADB) and private financial institu- working capital. tions, as well as bonds issued by countries receiving * Malaysia. A yen loan in the amount of approxi- ADB support. The facility will also provide capital for mately Y16.3 billion is being provided to the Fund bond guarantees and interest subsidies to reduce the for Small and Medium Scale Industries to make cap- burden of repayment for countries that receive loans ital available to small and medium-sized enterprises cofinanced by ADB and JEXIM or private financial for investment in plant and working capital. institutions. It is our intention in Japan to make this * The Philippines. A loan cofinanced with the World Support Facility into an open framework that is also Bank will provide the yen equivalent of US$300 mil- accessible to other Asian countries not affected by the 58 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries recent currency crisis, and we hope to see more coun- ever, we also seek efforts on the part of recipient coun- tries participate. tries tD establish transparency in their markets and shareholder-oriented corporate governance. The Asian Growth and Recovery Initiative (AGRI) Transparency in markets The Asian Currency Crisis Support Facility is to be uti- In several crisis-hit Asian countries, collusive relation- lized in part for the Asian Growth and Recovery ships between corporations and financial institutions Initiative (AGRI). Japan, the United States, the World have produced a fundamental lack of transparency. Bank, and the ADB are the core members of the initia- Consequently, the financial institutions failed to con- tive, and the AGRI aims to help facilitate Asian coun- duct adequate reviews, and this resulted in loans and tries' efforts to finance restructuring of financial unplanned capital investment by corporations, which in institutions and the corporate sector. This was turn brought about the accumulation of nonperforming announced jointly by Prime Minister Obuchi and loans and excessive debt. When accurate information President Clinton on the occasion of the Asia-Pacific on a corporation's activities and financial situation are Economic Cooperation (APEC) Summit on November made available in a timely fashion within an environ- 16, 1998. ment that provides sufficient transparency, internal and This initiative has four major components: the Asian external checking mechanisms can function properly Growth and Recovery Program (AGRP) that assists the and this enables firms to avoid problems such as expe- financing of Asian countries to promote restructuring rienced currently. of financial institutions and private sector corporations; expansion of trade finance; mobilization of private sec- Establishing stockholder-oriented corporate tor capital; and enhancement of technical assistance. gover-nance The AGRP component aims to mobilize $5 billion through guarantees, loans, and bond purchases. A part As ariother matter related to the question of trans- of the Asian Currency Crisis Support Facility will be uti- parency, the clarification of stockholders' rights and the lized for this program. protection of those rights will enable stockholders to To promote implementation of this initiative, Japan, function as a restraining influence on top management. the United States, the World Bank, and ADB, as well as This is also important in terms of fostering sound cor- potential donor and beneficiary countries, and porate management. Germany, which is chairing the Asia-Europe Meeting, have been invited to participate in a meeting in Conclusion Singapore on April 12, 1999. At this meeting, the cur- rent status of restructuring efforts will be presented by The corporate debt problem, which was brought to Thailand, Korea, and Indonesia; and the overview of light by the Asian crisis, is in some respects rooted in AGRP and multilateral development banks' (MDBs') business practices that could be characterized as policies concerning guarantees and related matters will "Asian," and reform and improvement of this deep- be explained by the World Bank and ADB. rooted issue will require considerable time and cost. However, the goal is to have the Asian countries achieve Transparency in markets and sustainable growth for the coming twenty-first century, stockholder-oriented corporate and not to fall behind other emerging economies. In governance order to accomplish this goal, we must take this oppor- tunity to work out methods for dealing with corporate Up to this point, I have spoken about issues of corpo- debt and establishing proper corporate governance. rate debt restructuring in Asian countries, and Japan's CorpDrate governance, in particular, is an issue that support in that regard. In providing this support, how- Japan also must address. In this regard, too, the Japanese The New Miyazawa Initiative and Response to the Corporate Debt Problem 59 government recognizes that the Asian countries must reinforce their cooperative framework further. Note Kyoto Ido is a Deputy Director GeneraL with the International Bureau, Ministry of Finance, Japan. 60 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries o-~j-eer I~rpn _______ Asian Corporate Credit Needs and Governance Dominique Dwor-Fr6caut Mary Hallward-Driemeier Francis X. Colaqo T he nature of corporate finance and its governance has been consid- ered to be at the core of the major economic downturns in all five East Asian "crisis' countries-Indonesia, the Republic of Korea, Malaysia, the Philippines, and Thailand. It has been argued by some that the structure of corporate finance, in particular high exposure to short-term debt (principally loans from banks) and high debt-equity ratios (or leveraging), has made it extremely difficult for East Asian corporates to manage the turbulence in financial and currency markets of recent years.' Also, the slow pace of cor- porate recovery in these countries has been attributed primarily to a continu- ing lack of credit for financially and economically viable projects and firms, at prevailing interest rates. These hypotheses can now be examined directly with firm-level data that have recently become available. The five "crisis" countries surveyed a total of 3,700 manufacturing firms between November 1998 and February 1999. The quantitative indicators in the surveys include information for 1996, the first and second halves of 1997, and the first half of 1998, while the qualitative information refers to the firms' views in the period from November 1998 to February 1999. The quantitative information deals with production, employment, and balance sheet indicators. The qualitative questions that were answered by the owner or senior manager of the firm in a personal interview dealt with views regarding the prospects for recovery and the impediments to it. This information provides for the first time a basis for examining the structure of domestic finance prior to the crisis at the firm level-not just for firms listed on the stock exchange, but also for unlisted companies and small and medium enterprises. It also provides a valuable source for the qualitative views of the sample firms on what problems they con- front and on what needs to be done to accelerate corporate recovery. 61 The sample was designed in conjunction with the sta- put. Less than 20 percent export the majority of their tistical agency in each country. The firms were selected production. A quarter of the firms have a foreign part- from the principal manufacturing sectors in each coun- ner holding at least a 10 percent ownership stake. The try. The sectors selected were auto parts, chemicals, ownership structure varies across countries: on average electronics, food processing, garments, machinery, and 20 percent of the firms are publicly listed, 55 percent are textiles. The sectoral composition differs across coun- private corporations, and the remainder are partner- tries, but each sector was chosen by at least three coun- ships, single proprietorships, cooperatives, and other tries, thus providing a basis for regional comparisons. A forms of business. random sampling technique was used to select firms, in This paper, drawing on the surveys, presents in the order for the survey to be representative of the popula- next section the structure of corporate finance prior to tion of firms in each sector of each country. the crisis and in mid-1998 in the five crisis countries, Approximately two-thirds of the resulting sample, including leveraging (or debt-equity ratios) of the firms drawn from firms with more than 20 employees, com- included in the surveys. It considers issues relating to prises small and medium enterprises (firms with fewer the allocation of credit, and the financing of the firms' than 150 employees), and one-third is made up of large requirements for working capital, investment, and firms (see table 5.1). Just over one-half of the firms in exports. In particular, it examines the role of short-term these tradable goods sectors export some of their out- debt and of financing by domestic and foreign banks. TABLE 5.1 Characteristics of the sample (percent) Size Export orientation FDIfirm Sector Totat Small Large Nonexporters Exporters No Yes Food Text. and garments Electr. Mach. Chem. Auto. Country Indonesia 56 44 64 36 82 18 32 26 12 30 - 816 Korea, Rep. of 65 35 25 75 83 17 - 23 35 28 14 857 MaLaysia 74 26 53 47 74 26 26 31 20 20 4 693 PhiLippines 48 52 48 52 64 36 26 37 21 16 - 564 Thailand 63 37 43 57 70 30 10 54 16 20 659 Sector Food 66 34 64 36 84 16 - - - - - 649 Textiles and garments 63 37 48 52 82 18 - - - - - 1194 Electronics and electricaL machinery 58 42 29 71 61 39 - - - - - 752 Chemicals 61 39 44 56 73 27 - - - - - 717 Auto parts 63 37 44 56 75 25 - - - - - 277 Size SmaLL - - 60 40 85 15 19 34 20 20 8 2077 Large - - 24 76 62 38 16 33 23 21 8 1257 Export orientation Nonexporters 80 20 - - 90 10 25 35 14 19 8 1629 Exporters 46 54 - - 64 36 12 33 28 20 8 1923 FDIfirms No 69 31 54 46 - - 20 36 17 20 8 2792 Yes 38 62 19 81 - - 12 25 33 22 8 889 Indebtedness Low 63 37 49 51 73 27 17 33 22 20 8 1204 High 55 45 36 64 76 24 12 35 24 19 9 772 Foreign borrowing No 67 33 49 51 80 20 16 36 21 20 8 1911 Yes 37 63 13 87 58 42 6 29 30 21 13 700 Total 2000 1221 1570 1861 2688 872 649 1194 752 717 277 3589 Note: Percentages represent the share of the row variabLe that has the corresponding coLumn characteristic. Source: World Bank, Firm-LeveL Survey. 62 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries With this factual basis, the paper next explores a central Corporate finance: liquidity, credit, domestic issue that is important for policy: is corporate recovery and foreign debt constrained by the availability of credit? The following section takes up a selected number of issues regarding Before examining issues of credit availability, it is corporate financial distress, including the profitability important to be familiar with the financial characteris- of the firms, and more important, the firms' views as tics of the firms. As the database represents a set of firms reflected in the surveys on their ability to service loan for which little prior information was available, the repayments in the twelve months beyond the timc of the description of the financial position of firms, especially surveys. Then the paper examines some issues that are of the small and medium enterprises (SMEs) and important to evaluating corporate financial governance unlisted firms, is of particular intcrest in itself. and the institutional framework in which it occurs. The final section presents the conclusions of the analysis and Financing of working capital and investment their implications for policy. In analyzing corporate finances, it is important to dis- Structure of corporate finance prior to tinguish between "liquidity" (or cash flow) and credit the crisis and in mid-1998 (in other words, the firms' debt). The former is a broader concept that includes internal earnings, own- Approximately two-thirds of the firms, as noted above, ers' equity, and credit from domestic and foreign banks, are categorized as small and medium, and one-third are financial institutions, and suppliers. Credit refers to large (more than 150 workers). The survey sample only the latter items. The distinction will be important includes a preponderance of unlisted firms (in other in the discussion below of liquidity problems and the words, firms that are not listed on stock exchanges), role of credit constraints. from which financial information has been collected for Almost 40 percent of the total financial resources the first time. These firms do not generally have care- available to the firms in the survey, both for short-term fully audited financial statements, and they are not financing and investment, came from internal earnings accustomed to answering detailed questions on finan- in bot h early 1997 and in 1998 (see figure 5.1). In fact, cial matters. The survey results on corporate finance, these ratios showed a slight increase after July 1997 as therefore, have to be interpreted with caution. the tendency to resort to borrowing decreased. It should also be noted that this survey, as is also true Borrowing from domestic banks and other financial of other similar surveys, suffers from a survival bias, in institutions, which covered about 38 percent of short- that only the firms that had survived until the end of term liquidity needs and 43 percent of long-term needs 1998 could be included in the sample. Statistical agen- in the first half of 1997, had declined to 34 percent and cies, in order to get some measure of this bias, noted the 38 percent respectively in the first half of 1998. The nonresponse rate of firms that no longer existed share of financing coming from internal sources is par- because of bankruptcies or closures. On average, 10 ticularly high in Malaysia and lowest in Thailand. The percent of the firms in the sample were no longer in extent of the reliance on internal earnings as a source of operation at the time of the interviews.2 Thus, the funding helps explain why many firms do not regard results are likely to represent a more optimistic view of credit constraints as the chief obstacle to recovery in the reaction to the crisis relative to the entire population 1999. of the firms in mid-1997. The focus of this paper is on Lookcing specifically at the sources of working capital, the prospects for recovery of the firms that existed at the the bulk (between 50 and 65 percent) of working capi- time of the survey. The analysis should not be affected tal requirements of the firms in Korea, Malaysia, and by this form of bias. Nevertheless, the results are pre- the Philippines were met out of retained earnings. By sented as reflecting a broad tendency rather than point- contrast, this ratio was 39 percent for Indonesian and specific quantitative estimates. The qualitative answers only 27 percent for Thai firms (see figure 5.2). Around represent a brand new source of information for how 30-40 percent of working capital requirements came the firms see their problems and prospects. from loans in all five countries, with the remainder Asian Corporates' Credit Needs and Governance 63 FIGUREs5.1; 07M tf; nS 7777 Sources of liquidity by country Sources of short-term Liquidity by country Sources of Long-term liquidity by country Share of short-term liquidity (percent) Share of long-term liquidity (percent) 60 60 50 50 40 ~~~~~~~~~~~~~~40 30 30 20 20 10 10 0 m0 Indonesia Korea Malaysia Philippines Thailand Indonesia Korea Malaysia PhiLippines Thaitand 1 Sakes/internal revenues U Domestic financial institutions El Foreign financial institutions U Securties markets U Other Source: WorLd Bank, Firm-LeveL Survey. coming from informal sources of financing-family, Financing in foreign currency partners, and informal moneylenders. In the case of Indonesian and Thai firms, these latter sources pro- While foreign banks appear to play a small role as a vided about one-third of total working capital require- source of credit, a distinction must be made between ments; in the case of Korean, Malaysian, and Filipino using foreign banks and borrowing in foreign currency. firms, only about 15 percent came from these sources. While few firms borrowed from foreign banks, the There does not seem to be much variation across sectors share of foreign currency debt was higher-1'7 percent in the tendency to seek informal sources of finance for on average. For large firms and exporters, the share of working capital. Curiously, large firms seem to rely foreign debt is approximately one-quarter of their total more on informal sources to meet their working capital borrowing. The predominance of large firms and of needs than do small firms. exporters helps explain why foreign credit was higher in Turning to credit, figure 5.3 illustrates the differences Korea (29 percent) than in Indonesia, Malaysia, the between SMEs and large firms in the source of credit Philippines, and Thailand (between 6 and 14 percent). they rely on. The chart indicates both the reliance on (See table 5.2). credit and the shares of credit represented by domestic While foreign debt as a proportion of total debt financial institutions, foreign banks, securities markets, declined in Indonesia and Korea from 1996 to the first and other, more informal, channels of lending. Korea is half of 1998 and remained relatively steady in the the only country where large firms rely less on credit Philippines, it increased in Malaysia and I'hailand. than SMEs. Although SMEs generally have a smaller Reflecting the export-oriented nature of activities, as share of credit in their overall financing, domestic finan- well as the existence of foreign joint-venture partners, cial institutions represent roughly equal shares of the firms in the auto parts and electronics sectors had the credit borrowed by SMEs and large firms. Much more largest exposure to foreign debt, which nev ertheless striking is the large firms' share of credit from foreign represented only 21-26 percent of total debt. banks, at four times the rate of SMEs. SMEs relied to a The relatively low exposure of the firms in r:his sam- greater extent on more informal sources of borrowing ple-tvo-thirds of which are SMEs-to foreign financ- for their credit needs in every country but Korea. The ing implies that the fluctuations in international average was 21 percent of credit versus 14 percent for finance (supply, exchange rates, and interest rates) larger firms. were primarily transmitted to the largest number of 64 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries FIGURE 5.2 Sources of working capitaL, first haLf of 1998 Indonesia: smalL Indonesia: large 350 35% 340 24% 31% Korea: small Korea: Large 110/1 450/a -a X 530/a 36% J w . / 36% 0a Malaysia: small MaLaysia: large 100/a 19% 210/ 690/0 31% - Philippines: small Philippines: Large 13%0/ 14%0/ 280/ 590a% 350/a Thailand: small ThaiLand: large %270 25% 28% 370/ 36% 47% * Retained earnings * Loans L Other Source: World Bank, Firm-Level Survey. Asian Corporates' Credit Needs and Governance 65 FIGURE 5.3 Sources of short-term credit, first half of 1998 Indonesia: small Indonesia: large 49/ 5 (58%) (57%) Korea: small Korea: large 00/ 70/ 70a / 30/ 3/ 2 90_ (48%) 8 (42%) Malaysia: small Malaysia: Large 230/ 00/a 4%/ 15%0/ 730/a 3% (51%) w - %~~~(33%) 7 Philippines: small Philippines: Large 1563 40/ 650 (60%) (65%) Thailand: small Thailand: large 29~~~~~~~~~~~~~~~~~~~~0/ 20/a ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ 0 (69%) (740/a) * Domestic financial institutions * Foreign banks El Securities [ Informal/other Note: Share of credit in totaL short-term financing is reported in Lower righthand corner. Source: World Bank, Firm-LeveL Survey. 66 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 5.2 Financial structure by firm characteristics (percent) Totai equityl Short-term debV Foreign debt Share of working capital totalfinancing totat debt total debt financed with internalfunds 1998first 1998first 1998 first 1998 first 1996 1997 half 1996 1997 half 1996 1997 half 1996 1997 half Country Indonesia 52.7 53.7 56.3 55.4 55.1 56.2 6.9 6.0 6.1 38.1 38.3 38.5 Korea 35.3 34.7 41.9 50.9 51.9 50.0 36.9 29.7 29.2 49.7 50.1 51.9 Mataysia 44.6 46.2 45.5 52.5 53.1 52.8 8.5 9.8 10.0 64.9 64.4 64.8 Phitippines 37.6 43.9 44.3 51.3 55.8 55.5 8.7 8.9 8.8 55.9 55.5 55.6 ThaiLand 47.1 46.8 51.1 55.3 57.6 56.8 10.7 12.4 13.2 27.7 27.5 27.4 Sector Food 48.7 50.5 51.3 53.6 54.2 53.9 5.7 5.6 5.0 51.5 51.7 52.4 TextiLes and garments 43.1 44.9 48.9 53.3 55.6 55.9 14.2 12.7 13.2 43.2 43.4 44.5 ELectronics and eLectrical machinery 40.4 41.7 44.5 53.8 55.5 54.9 23.1 21.9 21.3 50.4 50.9 52.2 Chemicals 44.4 45.9 49.6 51.4 52.3 49.9 19.5 17.7 17.6 47.3 46.8 48.4 Auto parts 42.0 43.2 46.6 52.4 53.3 52.5 26.4 22.1 23.5 42.0 40.4 37.0 Size SmaLl 46.6 48.2 51.6 50.2 51.4 50.9 11.6 10.6 10.7 50.8 50.5 50.2 Large 39.1 40.4 43.0 56.3 58.3 57.9 25.0 22.5 22.7 40.1 40.8 43.3 Export onentation Nonexporters 49.4 51.1 53.7 50.2 51.9 51.8 5.1 5.6 5.3 51.5 51.0 49.9 Exporters 39.1 40.3 44.0 54.7 56.1 55.1 25.4 22.4 22.6 43.2 43.6 46.0 FDI firms No 43.8 45.3 48.5 50.9 52.4 51.6 14.1 11.9 12.0 47.3 47.4 47.9 Yes 42.8 44.4 47.3 59.0 60.7 60.4 27.4 27.8 27.8 45.7 45.4 47.1 Totol 43.6 45.1 48.3 53.0 54.5 53.8 17.4 15.8 15.9 46.9 46.9 47.6 Source: World Bank, Firm-LeveL Survey. firms indirectly through the domestic banks and finan- corporate financial governance is the ability to manage cial institutions that were the major borrowers from risk through financial instruments. foreign sources.3 The domestic financial system has thus played a critical role in the downturn in corporate Short-term debt and leveraging activity and must be a central factor in its recovery. For the large firms, and those that are exporters, there was The high recourse to short-term debt and the high level also a direct impact, since their foreign debt exposure of leveraging (debt-equity ratios) have been advanced as was higher. characteristics of East Asian firms that reflect inade- The major role of banks, in particular domestic quacies in corporate governance and make them vul- banks, in financing the firms' both working capital and nerable to financial crises. The results of the surveys investment, reflects the state of development of domes- illustrate the extent of the accuracy of this portrayal, tic financial markets.4 It is not a reflection necessarily allowing for some important distinctions based on firm on the quality of corporate governance by the firms characteristics. included in this survey. The paucity of financial instru- As can be seen in table 5.2, the proportion of short- ments and limited variety of financial institutions, as term debt in total debt was reasonably high in these five well as the lack in many cases of bankruptcy and fore- countries-just over 50 percent for all five countries. closure laws and institutional limitations (the predomi- Domestic banks and suppliers provided the bulk of this. nant use of real property) on collateral, constrains the Foreign currency debt accounts for 6 to 13 percent of ability of the firms to manage risks and returns through the total, with the exception of Korea where foreign the use of financial instruments. The essence of good debt was almost one-third of the total debt.5 There is Asian Corporates' Credit Needs and Governance 67 TABLE 5.3 Median debt-equity ratios by sector and size, 1997 Food Textiles and Electronics and processing garments electrical machinery Chemicals Auto parts Country average Small firms Indonesia 0.6 0.3 1.2 0.7 - 0.57 Korea - 3.2 2.1 2.1 2.3 2.15 MaLaysia 0.7 0.6 0.6 0.7 0.6 0.67 Philippines 1.0 1.5 2.9 1.3 - 1.47 Thailand 1.2 1.1 1.4 - 0.8 1.10 Large firms Indonesia 1.0 1.5 2.1 1.4 - 1.53 Korea - 4.1 1.9 1.5 2.7 2.40 Malaysia 0.7 1.0 0.9 0.9 3.3 0.96 Philippines 1.4 2.4 1.0 1.3 - 1.77 Thailand 1.7 1.9 0.8 - 1.7 1.56 Mean debt-equity ratios by sector and size, 1997 Food Textiles and Electronics and processing garments electrical machinery Chemicals Auto parts Country average Small firms Indonesia 1.4 0.9 1.3 1.5 - 1.29 Korea - 4.1 2.7 2.7 2.8 2.98 MaLaysia 1.4 1.4 1.3 1.9 2.5 1.53 PhiLippines 1.7 2.4 3.3 3.7 - 2.75 ThaiLand 2.4 2.1 2.7 - 2.3 2.28 Large firms Indonesia 1.9 2.5 2.8 2.3 - 2.37 Korea - 4.6 3.3 2.3 4.2 3.47 MaLaysia 2.5 3.1 2.3 3.0 3.6 2.80 PhiLippines 2.6 4.0 1.6 3.2 - 2.95 ThaiLand 2.5 2.6 2.2 - 2.9 2.53 Source: World Bank, Firm-Level Survey. not much variation in the reliance on short-term debt On average for all firms included in the surveys, debt across sectors. However, exporters and large firms do represented 55 percent, and equity 45 percent, of total have somewhat higher ratios. The average short-term financing. However, there is considerable variation debt in this sample is just over 50 percent of the total, across countries, sectors and firm size (see table 5.3). compared with about 25 percent for firms in the United Overall, the median ratios are lower than the means, States and 45 percent for firms in Germany. Country indicating a skewed distribution with some firms hav- variation was greater in the use of suppliers' credits, a ing quite high debt-equity ratios.6 Korean firms stand form of self-liquidating short-term debt. It represented out as having higher debt-equity ratios, with signifi- 30 to 40 percent in Thailand and Indonesia, and over cantly higher median ratios than the other countries. 50 percent in the other three countries, reaching 65 per- The median ratio is 2.19 and the mean is 3.13 in Korea cent in the Philippines. One consequence of the crisis is compared with a median of 0.88 and mean of 1.78 in that the share of both inputs and outputs financed with Indonesia, or of 0.67 and 1.99, respectively, in suppliers' credits declined (11 percent and 4 percent, Malaysia. In almost every category, large firms have respectively) between the first half of 1997 and the end much higher debt-equity ratios than small firms. The of 1998, as firms that found themselves in tight liquid- overall mean for small firms is 2.19 versus 2.77 for large ity positions restricted their provision of credit. This firms. This reflects the greater access large firms have to was true across all sectors. external financing, particularly to foreign banks and to 68 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries equity and bond markets. Across sectors, electronics, reflecting the fact that the sector experienced the auto parts, and textiles have higher debt-equity ratios, sharpest fall in domestic demand. The firms in food, reflecting the greater capital intensity of these indus- and textiles and garments experienced smaller declines, tries. While not reported in table 5.3, there is a shift in while the firms in electronics and electrical machinery, the ratios over time. The pattern appears to be an initial and chemicals actually saw their average profitability increase in 1997 relative to 1996, followed by a decline rise. The most important predictor for whether a firm's in 1998. This can be explained by the initial rise in debt profit margin fell was its level of indebtedness. Highly owing to both exchange rate effects on foreign currency leveraged firms were significantly more likely to have liabilities and the firms' borrowing more to finance the lower profits, consistent with the need to cover larger higher cost of imported inputs. However, with the rise interest payments as interest rates rose sharply follow- in interest rates and the decline in domestic demand, the ing the implementation of stabilization programs. demand for loans declined. This was coupled with a decreased willingness to lend on the part of the financial Determining whether credit availability sector. From 1997 to 1998, the amount of debt did is a constraint to corporate recovery in decline on average across all countries. Asia The above debt-equity ratios compare with 1.03 for listed firms in the United States and 1.51 for those in Firms ia the crisis countries have been hit by a combi- Germany. The leverage ratios of firms included in this nation of collapse in domestic demand, currency depre- East Asian sample are higher than those of firms in ciations, and increases in interest rates following the more industrialized countries and even of those of large implementation of stabilization programs. The declines firms in Latin American countries.7 These high leverag- in domestic demand, except for the firms that have been ing ratios indicate the riskiness of the financial struc- able to shift sales to foreign markets, have resulted in tures of the East Asian firms included in the surveys, reductions in sales revenues, the principal source of liq- and their vulnerability to financial fluctuations and uidity. Currency depreciations have substantially movements in interest rates and exchange rates. For increased input costs and reduced profit margins and example, the rapid increase in interest rates following available retained earnings. Higher interest rates have the adoption of stabilization programs by these coun- increased debt-service payments, especially for firms tries, as discussed below, put severe strains on the that borrowed heavily from domestic banks for work- capacity of the firms to maintain required debt-service ing capital and investment needs. These factors have payments and simultaneously to generate the funds to strained the liquidity positions of the firms, particularly cover working capital needs. as banks and other financial institutions have become more selective in credit provision. Corporate profitability A much-debated issue of significant policy importance is whether at the time of the survey (from November In a recent paper using data only for listed companies in 1998 to February 1999) the sample firms' recovery was 1996 (that is, prior to the onset of the crisis), Claessens, being constrained by the availability of credit. The five Djankov, and Lang (1999) conclude that in terms of country papers on Indonesia, Korea, Malaysia, the return on assets, Indonesia, the Philippines, and Philippines, and Thailand, prepared for the Conference Thailand had the most profitable firms in their on Corporate Recovery, all come to the same conclu- Worldscope sample of 46 countries, with Malaysia fol- sion. Firms included in the surveys see the collapse in lowing close behind. With the onset of the crisis this demand and the high cost of inputs, resulting from the performance changed dramatically. The survey data increases in interest rates and the major currency deval- indicate that profit margins declined between 1996 and uations, as significantly more important factors the first half of 1998 in all five countries. The declines accounting for their present predicament than aggregate were smaller in Indonesia and Korea, and up to 5 per- credit availability. Broader studies by the Economic cent in Thailand. The sample firms in the auto parts sec- Research Department of the Bank of Thailand8 and tor suffered the largest declines in profitability, Swati R. Ghosh9 come to a similar conclusion. Asiaa Corporates' Credit Needs and Governance 69 However, policymakers have in some cases been per- firms and projects that are not viable at prevailing inter- suaded that increases in aggregate credit availability are est rates-it leads to financial crises. There is evidence necessary, and may even be critical, for corporate recov- that it was this kind of behavior by financial in stitutions ery. In this section we examine the evidence from the that contributed to the recent financial crises in East survey data on this important issue. Asia and elsewhere. In this case, increases in r.he aggre- In the earlier discussion, a distinction was made gate supply of credit are not the recommenced policy between "liquidity" or cash flow and credit-it was noted because they might lead to further expansions in loan that the former is a broader concept that subsumes the portfolios, worsen problems of capital inadequacy, and latter. Here the concern is with credit, or the availability delay financial and corporate restructuring. Rather, of financing from sources external to the firm, be they increases in the pool of viable projects are to be fostered domestic or foreign. The issue, at one level, is whether by stimulation of aggregate demand accompanied by in the aggregate the demand for credit for viable pro- financial and corporate restructuring. jects exceeds its aggregate supply at prevailing interest It could be, however, that when interest rates are high, rates.10 At another level, and one to which the survey there is adverse selection and an exaggerated perception data are specifically relevant, the issue has to do with of risk by lending institutions. This could arise because the allocation of credit and the availability of credit to of imperfections in information about the true quality specific firms and projects at prevailing interest rates. of firms and projects, or owing to lending institutions' In formulating policies it is important to understand exaggerated aversion to risk. In such a case, improve- the nature of an aggregate credit availability constraint, ments in transparency and information availability, if it exists. The very fact that the aggregate supply of through improved accounting and auditing, could credit has decreased does not, in and of itself, imply that reduce perceived risks. Also, institutional improve- there are viable firms and projects that are not securing ments, such as required legal changes for ba.nkruptcy credit at prevailing interest rates. It is important to and foreclosures, and mergers and acquisitions would examine both the supply and demand for credit for facilitate required corporate and bank restructuring. viable projects at prevailing interest rates. The firms' Nevertheless, to the extent that there is a group of demand for credit depends on their production and firms and projects, within the total set of firms and pro- sales prospects. There could simultaneously have been jects that are economically and financially viable at pre- an even larger decrease in demand in response to the vailing interest rates, that are not receiving required decrease in demand for the firms' output-such that credits, special measures may be required. Such mea- there would be, at prevailing interest rates, an excess sures, however, should be carefully designed to meet the supply, rather than a shortage of credit. If, however, specified needs of the adversely affected groups of firms there is an excess demand for credit, then measures to and projects, while maintaining lending standards, and increase liquidity are required. Increases in liquidity not retarding bank and corporate restructuring. would also have the impact of lowering interest rates. Information of the kind collected in the present surveys The trajectory of nominal interest rates could thus be could be useful in coming to judgments about required an indicator of the tightness of credit conditions. Rising measures. nominal interest rates would be an indicator of excess The next two sections of this paper will examine the aggregate demand for credit, while falling interest rates evidence on the role of credit availability as a constraint would indicate excess aggregate supply of credit. to corporate recovery in 1999 for firms in the sectors Credit aggregates, however, do not indicate whether and countries included in the surveys. We will start by there is rationing of credit, or inefficiencies in the allo- examining the evolution of aggregate supply of credit to cation of credit. Credit rationing is a normal function of the private sector, as well as the evolution of nominal financial institutions. Credit rationing involves the and real interest rates, both of which have important selection of viable firms and projects for financing at implications for the viability of firms and projects. We prevailing interest rates. It is thus a desirable role for will then present the firms' views on the impact of liq- financial institutions. If this principle is systematically uidity availability on their ability to expand output and violated-that is, if credit is systematically provided to exports. 70 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries Aggregate supply of credit to the private domestic credit to the private sector is shown in figure sector and interest rates 5.4; credit to the private sector declined between mid- 1997 and mid-1998 in Indonesia, the Philippines, and Despite a reversal in capital flows, which represented Thailand.12 This decline is mirrored by the decline in on average 10 percent of the gross domestic product industrial production. (GDP) in the five countries, there was no commensurate The crisis and the stabilization programs that were decline in credit to the private sector.1 The evolution of adopted in the immediate aftermath greatly curtailed FIGURE 5.4 Real domestic private credit and industrial production, 3-month moving average 1996-98 (Index July 1997=100) Indonesia Korea 110 110 100 105 100 I 0 90/ 80 90 70 85 60 80 JuLy 1997 Dec. 1997 May 1998 Oct. 1998 July 1997 Dec. 1997 May 1998 Oct. 1998 MaLaysia Philippines 110 115 105 100 95 85 90 75 July 1997 Dec. 1997 May 1998 Oct. 1998 July 1997 Dec. 1997 May 1998 Oct. 1998 Thailand 110 100 IndustriaL production index 90 \= Private domestic credit index 90 80 July 1997 Dec. 1997 May 1998 Oct. 1998 Source: International Monetary Fund, InternationaL Financial Statistics. Asian Corporates' Credit Needs and Governance 71 the availability of credit. Bank liquidity and capital countries, real interest rates by the end of 1998 were were severely affected by mounting stocks of nonper- below their precrisis levels. forming loans. Estimates of peak nonperforming loans ranged from 30 percent of the total loan portfolio of Liquidity constraints and output and exports banks in Korea to 75 percent in Indonesia, while the banking sector in the Philippines did not experience The surveys included qualitative questions. These asked systemic difficulties.13 The credit constraint was exacer- firms to rank on a scale from 1 (least important) to 5 bated in the immediate postcrisis period by the tighten- (most important), the factors that accounted for the ing of capital adequacy and loan classification rules that decline in output and exports. These qualitative ques- were implemented. Obviously, and consistent with his- tions were asked in the period between December 1998 torical experience in financial crises, risk aversion by and January 1999, 18 months after the onset of the cri- banks increased. This issue of credit allocation, how- sis. The results are summarized in figure 5.6. Surveyed ever, cannot be examined with aggregate data. The sur- firms in all countries expressed the view that the col- vey data indicate (as discussed below) that some firms lapse of domestic demand was the most important fac- felt severely credit-constrained in undertaking viable tor leading to declines in output; this was followed by projects. the increased costs of inputs and by the high cost of The evolution of nominal interest rates is an indicator credit. The lack of working capital, of credit 1for expan- of the balance between the supply and demand for sion, and the debt burden seem to have played a lesser credit over time. The main impact of the reversal of cap- role.14 ital flows has been on domestic interest rates. The evo- In the case of exports, their decline was attributed to lution of nominal and real interest rates over the period a combination of loss of competitive advantage, credit 1997-98 is shown in figure 5.5. Nominal interest rates constraints, and to higher import costs associated with rose sharply soon after the crisis hit, in mid-1997 in currency devaluations.15 The survey asked whether the Indonesia, the Philippines, and Thailand, and at the end firms encountered problems in having adequate liquid- of 1997 in Korea, indicating an excess demand for ity to finance production. On average 40 percent of the credit at prevailing interest rates. In Malaysia, which firms in the five countries reported experiencing liquid- had lower short-term foreign indebtedness, nominal ity constraints. interest rates rose progressively starting in mid-1997, Figure 5.7 and table 5.4 show the breakdown of the but by much less than in the other countries. In the five sample firms by various categories. About one-half of countries, nominal interest rates declined in the second Korean and Thai firms claimed to be experiencing liqui- half of 1998; in Korea, Malaysia, and Thailand they are dity problems. Such problems were most acute in the now below their precrisis levels. This supports the view auto parts sector and least acute in the food products that in the period after the second half of 1998, a period sector. Small firms, nonexporters, and firras selling when the current survey was undertaken, excess credit mainly to the domestic market were more a:5fected by demand had been met. liquidity difficulties, than were large firms, exporters, The behavior of real interest rates-that is, nominal or those that had foreign direct investment. Firms that interest rates adjusted with the producer price index- were highly indebted were more liquidity-con-strained, however, was somewhat different. Real interest rates while there was little difference in the firms' exposure to rose sharply immediately after the crisis hit and then foreign debt. This latter finding, while puzzling given began a rapid decline, particularly in Indonesia, owing the extent of the depreciation, is consistent with the fact to the surge of inflation, which occurred following the that larger, exporting firms with foreign partners were currency devaluations. Inflation then slowed markedly predominantly those that borrowed in significant in the second half of 1998, and real interest rates rose in amounts in foreign currency. However, even if they the five countries, except for the Philippines. While were not severely liquidity-constrained, there are still a nominal interest rates were at historical high levels but number of large firms, exporters, and more dynamic declining in 1998, real interest rates remained negative firms complaining that credit constrained their ability through most of 1998 in these countries. In all five to export. 72 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries FIGURE 5.5 Nominal and real interest rates, March 1997-December 1998 Indonesia Korea 90 40 60 30 30 2 0~~~~~~~~~~~~~~~~~~~~~~~ -30 -60 -90 -10 - _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Mar. 1997 Aug. 1997 Jan. 1998 June 1998 Nov. 1998 Mar. L997 Aug. 1997 Jan. 1998 June 1998 Nov. 1998 Malaysia Philippines 15 20 10 ~~~~~~~~~~~~~~~15 10~~~~~~~~~~~~~~~~1 5 0 -5 -5-- Mar. 1997 Aug. 1997 Jan. 1998 June 1998 Nov. 1998 Mar. 1997 Aug. 1997 Jan. 1998 June 1998 Nov. 1998 Thailand 25 20 15 10 5 -5 Mar. 1997 Aug. 1997 Jan. 1998 Juie 1998 Nov. 1998 _~ ReaL interest rate, - NominaL interest rate a. Producer price index is used as deflator. Source: InternationaL Monetary Fund, InternationaL FinanciaL Statistics. Asian Corporates' Credit Needs and Governance 73 Sources of output decline Sources of export decline Importance to output decline (1=not important, 5=important) Importance to export decline (1=not important, 5=important) 5 5 4 4 3 3 2 21 2 1 Source: WorLd Bank, Firm-LeveL Survey. Source: World Bank, Firm-Level Survey. FIGURE 57 ~~~~~~~~~noted earlier, relied on retained earnings to finance almost one-half of the total. Thus, factors that affected Sources of inadequate liquidity cash flow rather than credit received the most attention Contribution to inadequate liquidity (1=no contribution, by these firms. Firms in Thailand, the country that has 5=major contribution) seen the largest decline in capacity utilization. gave the 5 highest score to lower revenue. Thailand is also the country where loans finance the largest share of work- 4 _ ing capital-and Thai firms complained the most about the lack of loans for working capital. Similarly, firms in 3 the auto parts sector, which also saw the largest sectoral decline in capacity utilization, also gave the highest 2 _ _ _ _ _ _ scoretorevenue factors. A policy implication of these survey results is that, I even though there is no evidence that at the time of the ,o$9 9s9. . surveys (from November 1998 to February 1999) there 't4 N9%Z0" @ tsG 99s >'stz was in the aggregate a shortfall of credit availability, Source: World Bank, Firm-Level Survey. credit allocation from domestic and foreign sources is inefficient. Small and medium firms, which constitute two-thirds of the sample, have traditionally hlad diffi- culties in getting credit from the banking sys:-em. The When asked about the causes of their liquidity prob- surveys indicate that this problem has been exacerbated lems, the firms listed in declining order of importance by the crisis. Also, many viable firms complain that they the following: the decline in revenues, higher input costs are squeezed out of credit while their working capital that had raised the need for working capital and the needs have increased and other sources of liquidity have burden of servicing outstanding debt, and the lack of decreased. Policy and institutional changes to address loans for working capital. These answers reflect the these problems, some of which are long-standing, are sample firms' structure of working capital, which as required along with selective credit measures. 74 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 5.4 Source of liquidity problem Share claiming inadequate liquidity (percent) By source of problem Yes Lower revenue High input costs DE bt burden Insuff. wk. cap. Insuff. sup. crd. Others Country Indonesia 35 3.5 3.7 - 2.9 2.5 1.8 Korea 48 4.1 3.4 3.1 3.2 2.5 2.5 Malaysia 25 4.1 4.0 3.3 3.3 2.9 1.8 Philippines 23 3.8 - - 3.3 2.8 2.3 Thailand 56 4.4 4.3 3.9 3.7 3.2 4.2 Sector Food 28 3.7 3.7 3.3 3.0 2.5 2.0 TextiLes and garments 42 4.0 4.0 3.5 3.4 2.9 2.4 ELectronic and electricaL mach. 37 4.3 3.7 3.2 3.3 2.7 2.0 Chemicals 33 3.8 3.7 3.3 3.1 2.6 2.0 Auto parts 61 4.6 3.9 3.6 3.5 2.8 3.0 Size Small 42 4.2 3.8 3.3 3.2 2.7 2.1 Large 32 3.8 3.8 3.7 3.4 2.8 2.3 Export orientation Nonexporters 41 4.1 3.9 3.4 3.2 2.6 1.9 Exporters 36 4.0 3.8 3.5 3.4 2.9 2.5 FDI firms No 41 4.1 3.8 3.4 3.3 2.7 2.1 Yes 30 4.0 4.0 3.6 3.2 2.7 2.4 indebtedness Low 34 4.1 4.0 3.4 3.3 2.7 1.9 High 44 4.2 3.9 3.5 3.5 3.0 2.5 Foreign borrowing No 40 4.2 3.9 3.4 3.4 2.9 3.1 Yes 40 4.0 3.7 3.6 3.4 2.6 2.7 Total 38 4.1 3.8 3.4 3.3 2.7 2.2 Source: WorLd Bank, Firm-Level Survey. The firms' views on Loan repayment this category are 10-15 percent of the firms in Thailand prospects and Malaysia, 20 percent in Indonesia and Korea, and one-thi]-d in the Philippines. A third category is of firms The questionnaires, as noted earlier, in addition to seek- ing quantitative information from the firms, sought their FIGURE 5.8 qualitative views on their ability to meet required loan payments, if interest rates remained at current-that is, Abilitll to meet loan payments, by country end-of-1998 to early 1999-levels. The questions asked 100 the firms to indicate their perceived ability to meet 90 80 required loan payments, by three-month intervals, over 70 the next twelve months and beyond. About 2,000 firms 60 50 in the five countries responded to this question. 40 The firms' responses are shown in figure 5.8. In the 30 five countries, a first category of firms that indicate that L they do not expect to have problems in servicing their 0 K loan repayments range from over two-thirds in Korea, Malaysia, and Thailand, to one-half in Indonesia and T Can pay for up to 3 months a Can pay for 3 months to 1 year the Philippines. A second category indicates that the El Can pay for more than 1 year firms expect to be able to meet loan payments for the Source: WorLd Bank, Firm-LeveL Survey. following twelve months but not beyond that period. In Asian Corporates' Credit Needs and Governance 75 that have indicated that they are currently having diffi- of 1997. About three-quarters of Malaysian firms and culties in meeting loan repayments, or expect to be able two-thirds of Thai and Indonesian firms in this category to meet loan repayments only for the next three months reported low levels of overall indebtedness. By contrast, and not beyond. About 25 percent of the firms in two-thirds of Korean firms and one-half cf Filipino Indonesia and Thailand, 20 percent in Malaysia, and 10 firms report high overall indebtedness. The majority of percent in Korea fit this category. firms in this category, except for those in Korea and Firms in the first category-in other words, those Thailand, indicate that securing adequate 1:iquidity is that do not expect to have loan repayment difficul- not an issue. Despite high levels of indebtedness, ties-are mainly small (see table 5.5) especially in Korean firms in this category indicate fewer difficulties Korea, Malaysia, and Thailand, and less so in Indonesia in securing external financing. Thai firms. however, and the Philippines. The majority of these firms in despite having lower indebtedness levels than those in Korea, Malaysia, and the Philippines are exporters; Korea, indicate difficulties in securing bank financing Thai firms are evenly distributed between exporters and and required liquidity for production. This could be an nonexporters, and Indonesian are mainly oriented to indication of the different pace of corporate and bank the domestic market. On average, capacity utilization restructuring. for this group had declined by 15 percentage points Firms in the second category-those that do not since 1996 and 11 percentage points since the first half expect to be able to meet loan payments beyond 12 TABLE 5.5 Profile of firms with different expectations on remaining current on debt payments (Percentage of firms in each category) Firms that expected to remain currentfor more than 1 year Indonesia Koreo Malaysia Philippines Thailand Average Experienced output decline 80 70 71 77 73 74 Capacity utilization a 59 71 69 70 64 66 SmaLL size 51 67 63 54 64 57 Exporter 45 63 51 55 42 49 Low indebtedness 67 37 75 47 63 60 Foreign debt 17 44 20 14 28 27 Liquidity is a probLem 36 60 23 28 55 42 Firms that expected to remain currentfor more than 3 months and less than 1 year Indonesia Korea Malaysia Philippines Thailand liverage Experienced output decline 76 72 86 81 73 77 Capacity utilization a 63 67 64 61 60 63 SmaLl size 55 77 76 53 68 64 Exporter 38 65 48 41 69 51 Low indebtedness 71 54 91 40 66 62 Foreign debt 10 40 20 11 28 22 Liquidity is a problem 30 58 46 36 69 44 Firms that were not current or did not expect to remain currentfor more than 3 months Indonesia Korea Malaysia Philippines Thailand Average Experienced output decLine 80 73 73 81 88 81 Capacity utilization' 56 69 58 62 52 57 SmaLL size 62 42 71 49 62 57 Exporter 38 85 52 50 52 51 Low indebtedness 62 42 72 57 45 55 Foreign debt 21 54 12 23 28 26 Liquidity is a problem 45 70 62 43 85 61 a. Average capacity utilization. Source: World Bank, Firm-LeveL Survey. 76 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries months following the surveys-are relatively few, par- * Are financing a greater portion of their working cap- ticularly in Korea, Malaysia, and Thailand, and even ital with retained earnings (Filipino firms are an less so in the Philippines and Indonesia. On average, exception); and they are evenly distributed between exporters and non- * Have experienced far fewer difficulties in securing exporters, with country differences: about two-thirds adequate amounts of liquidity for production. are exporters in Korea and Thailand, but only about 40 The above information indicates that the sample percent in Indonesia and the Philippines. On average, firms in the five countries see themselves at various capacity utilization has declined by 18 percentage stages in the recovery process, as well as in their access points since 1996 and 13 percent since the outset of the to liquidity required for production. The bulk of the crisis. About two-thirds of Thai and Indonesian firms, firms ir Korea, Malaysia, and Thailand consider them- over half of Korean firms, and 90 percent of Malaysian selves to be in good financial condition. This is less the firms in this category reported low levels of indebted- case in Indonesia and the Philippines. There remain, ness. However, 60 percent of Filipino firms in this cate- however, a significant number of firms in all five coun- gory reported high indebtedness. The majority of the tries that were either experiencing loan repayment dif- firms in this category reported that securing adequate ficulties at the time of the survey, or thought that they liquidity was not an issue, except for those in Korea and would find themselves in that situation in the not too Thailand. distant future. This financial fragility of a significant Firms in the third category-those currently having proportion of firms in the five countries is linked both or expecting in the near future to have loan repayment to macroeconomic conditions and the pace of bank and difficulties-are mainly nonexporters in Indonesia, pre- corporate restructuring. dominantly (85 percent) exporters in Korea, and divided equally between exporters and nonexporters in Issues in corporate financial the other three countries. In Malaysia, Thailand, and governance Indonesia the great majority are small firms, while in Korea they are mainly large firms. On average, capacity The surveys included a number of questions on corpo- utilization for the firms in this group has decreased by rate financial governance, use of audited financial state- 20 percentage points since 1996, and 15 percentage ments, and the nature and use of collateral. This points since the first half of 1997. About 60 percent of information has to be interpreted with caution, taking the firms in this group also reported difficulties in secur- into account the nature of the firms included in the sam- ing adequate liquidity for production-70 percent in ple and the institutional context in which they operate. Korea, 85 percent in Malaysia and Thailand. In The samples contain a predominant number of small Indonesia and the Philippines, the majority of the firms and mcdium-size firms that find it costly and difficult to in this category did not report liquidity access problems, produce good-quality financial information. Instead perhaps because the demand for their production had they anrd their credit sources tend to rely on well-estab- declined substantially and they were not seeking access lished and long-standing relationships that have to liquidity. Finally the majority also report low levels proved reliable for credit decisions. As firms grow, of indebtedness. A high debt stock, with the exception however, the more formal instruments and organiza- of the firms in Korea, does not seem to have been a tional arrangements become mechanisms for ensuring major factor in loan repayment difficulties. greater transparency. A comparison of the firms in the first and third cate- gories indicates that, on average, the firms that are not Audited statements reporting loan repayment difficulties: * Have experienced smaller declines in capacity uti- The surveys asked whether the firms were required to lization (Korean firms are a significant exception); produce audited statements when they applied for * Are exporting more (Korean and Thai firms are loans. There is considerable variation across countries exceptions); in the responses. The audit rate is highest in the Asian Corporates' Credit Needs and Governance 77 Philippines (65 percent), Korea (63 percent), and FIGURE 5.10 0 Malaysia (61 percent)-and below 40 percent in . Thailand and Indonesia (see figure 5.9). These audit auditing requirements rates, however, give no indication of the quality of Percent auditing standards across countries. 90 It is not the case, however, that firms without audited 80 statements do not have access to bank credit. For firms 70 that receive at least 20 percent of their credit from 60 banks or finance companies, over one-third do not use 50 audited statements. The numbers are the same for both short-term working capital and longer-term investment 40 financing. Within this group, Malaysian firms are most 30 likely to have audits, with over 80 percent reporting 10 that they provide audited statements, while the propor- 0 tion is two-thirds for Korean and Filipino firms, and Indonesia Korea Malaysia Philippines ThaiLand less than one-half for the Indonesian and Thai firms. Ž Audits required U Audits not required Audited firms are, in principle, better informed of Source: World Bank, Firm-LeveL Survey. their financial positions, and disclosing this informa- tion to potential creditors should reduce the risk assessed with the loan, making access to credit some- emerges from the related issue of auditing practices in what easier. However, the surveys do not reveal this pat- firms with inadequate liquidity. In Indonesia and tern across all countries (see figure 5.10). While this Korea, those with liquidity problems are less likely to pattern does hold in Indonesia and Korea, in Malaysia, audit their statements, while in the other three coun- the Philippines, and Thailand, firms that are not tries, those with liquidity problems are more likely to be required to provide audited statements are less likely to required to submit audited statements. report having adequate liquidity. A similar pattern In all countries, highly leveraged firms with substan- tial access to bank credit are more likely to have audits than is the average firm (see figure 5.1 1). However, only FIGURE 5.9 in Indonesia is the difference between highly leveraged Share providing audited statements firms and low-leveraged firms very striking. Within this IShare providing audited statementsI and collateral, by country and size of firm group of highly leveraged firms, however, there are still significant proportions-40 percent in Indonesia and 100 Korea, and 60 percent in Thailand-that do not pro- 90 vide audits. 70 While highly leveraged firms are more likely to pro- 60 vide audited statements, there is surprisingly no clear 50 relationship between the maturity of the credic obtained 40 and whether audited statements are required. Thus, the 30 firms that have a substantial share of long-term credit 20 10 3are not more likely to have been requirecL to have 0 .~audited statements than the firms without long-tcrmn / &<9s¢\@a >S8^2 OxWagS9 > | debt. Likewise, the firms that are requirecL to have l e 49 e $ audited statements do not have significant differences in SmaLl Large the share of long-term debt to total debt than the firms U ColLatera[ provided C1 Audits required that are not so required. This may also reflect the fact Source: World Bank, Firr-Leve. Survey. that long-term investments are often financed by rolling 1 ______________________________________________________ _ 1 over short-term credits. 78 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries The more striking difference is for firms that borrow CoLlatfral in foreign currency. Here the pattern is more similar across countries. Such firms are significantly more Land and physical assets are the principal form of col- likely (85 percent) to have audited statements. The lateral :.n these countries, representing at least part of same is true for large firms and exporters. the collateral in 90 percent of the cases in which collat- The legal organization of the surveyed firms is also eral is provided. Machinery and equipment is the sec- correlated with whether or not they audit their financial ond most common form, and in Korea the use of statements. Partnerships and single proprietorships (20 financial instruments is starting to increase. The use of percent of the sample) are much less likely to do so; collateral in securing loans is by far the most common two-thirds of incorporated companies, however, have in Korea where 90 percent of firms have collateralized external audits. In Korea, almost all private corpora- loans. In Malaysia, 40 percent of firms provide collat- tions do provide the required external audits, while in eral, arid between 50 and 60 percent of firms in the Malaysia and Indonesia only 50 percent of the corpo- other countries do so. rations have external audits, and less than 10 percent of Firms that provide collateral are slightly less likely to unincorporated firms have them. have liquidity problems, although this is not uniformly The correlation between legal organization and size is the case. In fact, two-thirds of the firms with collateral also reflected in the survey data. Three-quarters of the in Thailand are facing liquidity problems. In Indonesia, large firms provided audited statements versus 40 per- Malaysia, and the Philippines, two-thirds of the firms cent of the small firms. For the smaller firms, develop- with collateral are not liquidity-constrained. In Korea ing a relationship with the creditor is often seen as more the ratios are even. reliable than the system of accounts used in such firms. Other than in Malaysia, highly indebted firms are sig- Small firms have dealt with their primary creditor for nifican:ly more likely to have to provide collateral for 70 percent of the life of the firm. (The high is 88 percent loans. B3ut as with the auditing results, there are still in Thailand and the low is 60 percent in Indonesia). over 301 percent of highly indebted firms in each coun- Thus small firms that do not provide audited statements try, except Korea, that qualify for loans without collat- are often characterized as having a long-standing rela- eral. In Indonesia and Malaysia, firms that rely to a tionship with their primary creditor. major extent on short-term debt are less likely to pro- vide collateral, although little difference is discernible in Korea and Thailand. FIGURE 5.11 The information on collateral usage needs to be sup- FIGURE 5.11 plemented with other information available to lenders. Share required to have audited statements for Other questions in the survey indicate that financial bank loans, by degree of leverage institutions do have information about their clients that Percent they m:.ght be using instead of relying on collateral. On 80 average, sample firms have worked for over nine years 70 with their primary financial institution. These tradi- 60 tional relationships may be efficient substitutes for 50 some of the more common financial reporting require- 40 - * * ments, in view of the high cost of reducing information 30 asymmetries for small and medium-size firms. 20 Governiance 10 Inoe. r y p Only one-third of the firms in Korea have independent Indonesia Korea MaLaysia PhiLippinesThailand directors on their boards. In Indonesia the correspond- Source: World BnHighly Leveraged y Low leverage ing figure is 10 percent, in Thailand 14 percent, in the Source: World Bank, Firm-LeveL Survey. Philippines 20 percent, and in Malaysia 25 percent. Asian- Corporates' Credit Needs and Governance 79 Employee representation on boards is highest in the small subset of large firms is short-term foreign cur- Philippines at 18 percent, almost triple the rate in the rency debt a significant share of total debt. The sur- other four countries. Only in Malaysia and the veyed firms, with the exception of those in Korea, Philippines, however, is the board likely to have a dom- had relatively low exposures to foreign financing, inant say in decisions. In Korea, management has the and relied primarily on domestic banks and finan- dominant role. In Indonesia and Thailand, the original cial institutions for their credit needs. The higher owners control the firms. exposure to foreign finance by banks, combined In a sample of listed companies analyzed by Claessens, with their less than careful approach to loan evalu- Djankov, Fan, and Lang,16 there are significant cross- ation, has resulted in overexposed positions, and ownership links between firms and financial institu- consequent reluctance to lend. tions, which could lead to preferential access to credit. * The firms do not think that there is an aggregate In this sample, on first evidence and without detailed shortage of credit relative to their needs for financ- examination, it seems that only 3 percent of the firms ing viable projects. In other words, at prevailing have reported financial institutions with an ownership interest rates, credit availability in the aggregate is stake in them. not seen by the surveyed firms as being a major However, there is a heavy concentration of owner- impediment to corporate recovery. Their principal ship, as also evidenced in the sample provided by concern is with the low level of domestic demand. Claessens and others (1999). Approximately 20 percent The surveys, however, offer evidence that there are of the firms have 1O or more shareholders. Among these inefficiencies in the allocation of credit, and that firms, the top 10 shareholders own three-quarters of the some firms, including small and medium-size firms, firm. This concentration raises issues about minority feel credit constrained. shareholder rights. * The great majority of the sample firms in Korea, Malaysia, and Thailand believe they will be able to Concluding comments meet loan repayments as required. This is less the case in Indonesia and the Philippines. However, This paper has analyzed the evidence regarding corpo- there remain significant numbers of firms in all five rate credit needs and governance from the surveys of countries that were either experiencing loan repay- some 3,700 firms in five countries-Indonesia, Korea, ment difficulties at the time of the survey, or thought Malaysia, the Philippines, and Thailand, covering that they would find themselves in that situation in major manufacturing and export sectors. The surveys the near future if prevailing macroeconomic condi- were completed in February 1999. The quantitative tions persisted. This weak financial cond&tion of a information relates to the period between 1996 and the significant proportion of the firms is linked to both first half of 1998; the qualitative information covers the macroeconomic conditions and the pace of bank survey period from November 1998 to February 1999. and corporate restructuring. Traditional relation- The survey sample includes firms that are listed on ships are important between small and medium-size stock exchanges, as well as those that are not; the latter firms and their lenders, and have compersated for represent 80 percent of the sample. For this latter group weaknesses in commonly accepted aspects of corpo- of firms in particular, financial information has been rate governance, including availability and utiliza- collected for the first time, and therefore may not be of tion of audited financial statements, collateral the same quality as for the listed firms. Accordingly, the requirements, and corporate management struc- survey results are presented as gcneral indications of tures. Improvemcnts in financial transparency are tendencies rather than as point estimates. required for more efficient allocation of credit and The principal findings of this paper are as follows: reduction in its cost. * The international financial fluctuations of recent * The corporate recovery is taking place at an uneven years were transmitted to the firms primarily pace between countries, sectors, and firms, with sig- through their impact on domestic banks. Only for a nificant weaknesses remaining. 80 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries Notes eign bor-owing, so certainly some of the exchange rate shocks were transmitt:ed directLy to the corporate sector. Dominique Dwor-Frecaut and Mary HalLwood-Driemeier are with the 4. Dernirguc-Kunt and Maksimovic (1995). World Bank. Francis Colaco is with Asia-Pacific Management 5. For a more in-depth discussion of the patterns of foreign cur- Consultants, Inc. The authors gratefully acknowledge comments rency borrowing, please see Kawai, Hahm, and Iarossi (1999), pre- received from participants at the Conference on Corporate Recovery pared for the Asian Corporate Recovery Conference. held in Bangkok from March 31 to April 2, 1999, and seminars at the 6. Care was taken to remove obvious outliers or firms with incon- WorLd Bank in Washington and in Kuala Lumpur, Manila, Jakarta, sistencies in their reported financial data, so the higher means are not Singapore, Hong Kong, Tokyo and Seoul, and the meeting of the due to a few very high observations. Association of South East Asian Nations (ASEAN) Chambers of 7. Claessens, Djankov, and Lang (1999). Commerce and Industry. The views expressed in the paper are strictLy 8. Waiquamdee, Krairiksh, and Phongsanarakul (1999). those of the authors and should not be attributed to the World Bank 9. Ghosh (1998). or its affiliated institutions. The authors would also like to thank Stacy 10. See Stiglitz and Weiss (1981). Nemeroff, Giuseppe Iarossi, Dennis Tao, and Hairong Yu for research 11. Cho and Rhee (1999). assistance. 12. In the case of Thailand, the decline in the suppLy of credit is 1. Claessens, Djankov, and Lang (1999). This paper is based on well doCLmented in the paper by Takatoshi Ito and Luis Pereira da Silva information for 5,500 firms listed on stock exchanges in nine coun- (1999). 'he paper analyzes aggregate data on the financial sector of tries incLuding Japan, Hong Kong, Singapore, Taiwan (China), ThaiLand, and the responses from 10 foreign and 7 Thai banks that Indonesia, the Republic of Korea, Malaysia, the Phidlipines, and returned questionnaires in April and May 1998. Thailand. The results of that paper and the current one are, therefore, 13. See Shirazi (1999). not strictLy comparabLe, and should rather be seen as complementary. 14. Urfortunately the option of the impact of the debt burden was 2. Thailand represents a special case as another survey, in late 1997, not included in the PhiLippines and Indonesia. was carried out in addition to the present one. Both use the same sam- 15. Again, this option was not included in the Philippines and pLe of firms. In Thailand, 10 percent of the firms had gone out of busi- Indonesil. ness between the two surveys. In order to get clearer indications of 16. Claessens and others (1999). the characteristics of the firms that cLosed during 1998, a follow-up study of the Thai data is underway using these two sets of data. A fur- ther folLow-up survey in the five countries, planned for earLy 2000, will also give an indication of normaL attrition rates. 3. The listed companies in the sample show higher reLiance on for- Asian Corporates' Credit Needs and Governance 81 C'Ptetw s- JE,' Financial Sector Restructuring: Progress and Issues Javad K. Sbirazi his paper provides a review of the progress and the key issues in T restructuring the financial systems of the countries at the center of the 1997-98 East Asian crisis-Indonesia, the Republic of Korea, Malaysia, and Thailand.1 The first section contains an overview of the genesis of the crisis. The paper then examines the restructuring and recapitalization of these countries' financial institutions. This is followed by a section summariz- ing the steps taken to strengthen the prudential standards and the legal frame- works to facilitate debt recovery and restructuring. Then a brief discussion on interest rates, spreads, and loan growth is included. The final part of the paper attempts to draw some conclusions and lessons from the Asian crisis and the steps taken to restore health to the financial sector The paper is not intended to be an exhaustive survey. The genesis of the crisis In early 1997, despite signs of mounting currency pressures in Thailand, few- if any-observers could have predicted that East Asia would face a financial and economic crisis of the intensity and duration that it has. With a stellar growth performance spanning two decades, and a sustained record of broadly prudent economic management, the region was the envy of the developing world and attracted substantial and growing inflows of international capital from the industrial countries as a sign of confidence. What led to the unprece- dented crisis that engulfed the region? While much has been written on the origins of the crisis,2 its root causes can be summarized simply as follows: 83 * Private investment booms in the 1990s and the asso- The unprecedented capital inflows into the region ciated asset bubbles that were fueled by (perceived) played a critical role in fueling the rapid growth of cheap foreign credit, mostly in the form of short- banks' and other financial intermediaries' balance term bank lending to both financial institutions and sheets. The quality of assets being acquired was often corporates; poor and there was inadequate appreciation of, and * Large (Malaysia and Thailand) and growing pricing for, liquidity and credit risks. The massive cred- (Indonesia and Korea) current account deficits, its extended to the real estate sector are indicative of this incurred under fixed or nearly fixed exchange rate phenomenon. As the exchange rate crises unfolded and regimes with the exchange rate pegged to a rising the interest rates were raised, the impact on the balance dollar; sheets of financial institutions and corporations was * Declining productivity of investment, as manifested severe. The subsequent contraction of economic activ- in rapidly rising incremental capital-output ratios, ity exacerbated the damage. Ironically, the large-scale and erosion of export competitiveness, particularly capital inflows, which were in part attracted by sound in Thailand, caused by real wage increases signifi- macroeconomic policies, led to the buildup of external cantly outstripping productivity growth; and domestic financial imbalances that made the sys- * Weak and inadequately regulated financial systems, tems highly vulnerable to loss of confidence, speculative which could not handle the rapid growth of domes- tic credit and price risks appropriately; and * Questionable and nontransparent corporate prac- F 6.1 tices and governance. Net private capital fLows of Asia 5 Once the financial turbulence began in one country, $US billions the contagion effects were strong, generating a wide- 100 spread crisis of confidence and ensuing panic, which on the whole was clearly unwarranted on the basis of the 80 "fundamentals," but perhaps not irrational from the 60 vantage of individual market players, given the rapidly 40 growing realization of actual and perceived systemic 20 vulnerabilities. It is beyond the scope of this paper to examine in any 9 s0 91 92 93 94 95 96 \7 98P 99f detail all of the above factors;3 however, two aspects -20 \ that are particularly relevant to the subject matter under -40 discussion-the financial sector-need to be high- 4t lighted. The first is the scale of external capital inflows, f. forecast Source: 1990-94 data: IMF 1998. and the second, the pace of expansion of domestic 1995-99 data: Deutsche Bank Research 1998. credit (to the private sector). Net private capital inflows into Asia 5 (Indonesia, Korea, Malaysia, Philippines, and Thailand) totaled some $US178 billion in 1995 and 1996, exceeding the combined flows of the preceding TABLE 6-1 five years (see figure 6.1). Productive absorption of Domestic credit and growth rates these flows proved to be infeasible. The countries also Credit CAGR experienced rapid expansion of domestic credit relative (percent of GDP) (percent) to output growth. By 1997, credit-GDP ratios were in Country 1991 1997 1P91-97 the range of 1.4-1.6 in all of these countries except for Indonesia 50.3 65.4 21.5 Indonesia, which had levels substantially higher than at Korea 94.5 137.9 19.0 Malaysia 116.7 165.4 1.9.9 the beginning of the 1990s (see table 6.1). By contrast, ThaiLand 96.3 147.7 19.1 in Mexico, at the time of its banking crisis, the credit- CAGR: Compound AnnuaL Growth Rate. GDP ratio was less than 0.5. Source: Deutsche Bank Research 1998. 84 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries attacks, and strong contagion effects. Credit as a per- and to strengthening the developing countries' eco- centage of GDP rose particularly rapidly between 1991 nomic policymaking and monitoring institutions. This and 1997, despite the strong growth of nominal GDP strategy will enable us to reduce the risks of future crises (see table 6.1). in an increasingly globalized setting in which markets In an earlier paper,4 the author argued that the rever- can inflict disproportionate punishment for policy mis- sal of capital flows after the onset of the crisis was par- takes and reassessed structural weaknesses. ticularly punishing and laid the grounds for the subsequent economic dislocations experienced. In Restructuring and recapitalization 1997, the reversal amounted to more than 10 percent of the combined preshock GDP of Asia 5. The large real The sc:ale of the problem and the fiscal exchange rate depreciations, the financial sector and impact asset price distress, the collapse of investment activity, and the erosion of incomes and consumer confidence By any standard, the scale of the financial sector distress must be seen and understood in light of this extraordi- in East Asian countries is large. Given the dynamic of nary reversal of external flows. In a comparative per- the crisis in East Asia, the moral hazard problems that spective, what happened in East Asia in 1997 is arise from weak bankruptcy and foreclosure laws and tantamount to a reversal of $800 billion or about 70 their enforcement, and uncertainty over the timing and percent of an entire year's private capital formation in strength of recovery, estimation of the health of bank the case of the U.S. economy. Paul Krugman, in a recent portfolios in a dynamic sense is fraught with uncer- paper, attempted to shed light on the East Asian crisis tainty and could embody significant margins of error. by formally modeling the large required adjustments in Nevertheless, many estimates are available from private the current account through real exchange rate depreci- and official sources and all indicate that the scale of the ation, recession, or both, and the consequent erosion of problem and the fiscal impact are extremely large. As the firms' balance sheets.5 It is this dynamic that lies at indicat,d in table 6.2, peak nonperforming loans the heart of the financial sector and corporate distress (NPLs) as a percentage of loan portfolios are estimated faced in these countries. The fragility that may have to range from 30 percent in Korea to 75 percent in existed in the financial sector and corporate balance Indonesia. In relation to GDP, the projected net losses sheets received a large shock caused by the very policies range from 16 percent in Korea to 34 percent in put in place to cope with the precipitous fall in the Thailand. The sharp currency depreciation and decline exchange rate and to restore external balance stability. in asset values combined with a strong downturn in eco- Krugman's tentative conclusion, which merits serious nomic activity led to a mounting deterioration in bank reflection, is that "even a very clean and prudent bank- asset quality throughout 1998. For example, estimated ing system may not be enough to protect open NPLs fDr Thai banks rose from 43 percent at the end of economies from the risk of self-reinforcing financial Septem ber to 49 percent at the end of the year (see table collapse."16 6.3). Many observers, however, feel that NPLs will peak Accordingly, the conventional wisdom about the during the first half of 1999 in most of the crisis- Asian crisis that generally apportions much of the affected countries. blame to weaknesses in the financial sector and corpo- Converting NPLs into estimates of ultimate losses rate governance is at best simplistic. Belatedly, there is a involves a number of assumptions, including those on welcome recognition in western policy circles that the peak NPLs and recovery rates from the disposal of col- root cause was not so much the weaknesses of the finan- lateral. One set of projections, prepared by Deutsche cial sectors (a common feature in developing Bank Research, indicates that the total loan net losses economies), but rather the excessiveness of capital could range from 16 percent of GDP in Korea to 34 per- inflows relative to the system into which they must be cent in Thailand, based on the June 1997 portfolio data. absorbed.7 This recognition is particularly important in In aggregate terms, potential losses on NPLs would terms of shifting the emphasis of the current discussions exceed by varying margins the total capital of the to reforming the international financial architecture financial institutions in these countries, with Indonesia Financial Sector Restructuring: Progress and Issues 85 TABLE 6.2 debt-GDP ratios were relatively modest in these coun- Peak nonperforming loans and tosses tries will help mitigate the future debt-servicing burden. NPFs Net loss (percentage of (percentage of Losses/capital Restructuring approaches and country Country loan portfolio) GDP) (percent) experiences Indonesia 75 30 474 Korea 30 16 126 The financial sector crisis in Indonesia, Korea, MaLaysia 35 20 120 Malaysia, and Thailand has clearly proved to be a sys- ThaiLand 50 34 248 temic one that requires major restructuring. Broadly Note: Assumptions on recovery rates are 25 percent for Indonesia, 30 percent for Thailand; and 50 percent for Malaysia and Korea. "Net Loss" is defined as the dete- speakig, the approaches adopted in the four countries rioration in bank capital resulting from the impLied writedown of Loans. June 1997 have been similar and have involved elemenms of both baLance sheet data on Loans and capital are used as a base. Source: Deutsche Bank Research 1998. the "flow" and "stock" solutions, with the emrphasis on the latter. The former has entailed injection of central TABLE 6.3 bank liquidity (for example, through the Financial Institutions Development Fund in Thailand) and regu- latory forbearance (Indonesia and Malaysia in particu- NPLs/loans (percent) lar). The "stock" solutions have focused on thle closure Financial organization Sept. 1998 Dec 1998 of deeply insolvent financial institutions, takeovers, Thai banks 43 49 carving out and transferring bad assets to a central Private banks (8) 37 42 agency, and capital injection from private and public State-owned banks (8) 55 63 sources. Foreign banks 8 10 TotaL banking system 38 44 Given the scale of the fiancal managemert distress, Finance companies (35) 61 70 governments have had to inject substantial sums to pre- TotaL financiaL system 40 46 vent a complete collapse of the payment systems and to Source: Bank of Thailand. speed up the rehabilitation process. In this respect, Korea has acted expeditiously. By the end of 1998, pub- and Thailand affected particularly heavily. (This does lic funds injected into the banking system since the not, of course, imply that all the financial institutions inception of the crisis amounted to nearly US$31 bil- are insolvent.) Estimates of the fiscal and quasi-fiscal lion, with an additional US$18 billion programmed for costs of restructuring will depend not only on the ulti- 1999. The Korean Asset Management Company mate levels of NPLs and recovery rates, but also on the (KAMCO) and the Korean Deposit Insurance Company loss-sharing arrangements between the government and (KDIC) are the two institutions engineering the removal the private sector. Projections by multilateral institu- tions and private analysts indicate a range of 10-20 per- TABLE 6.4 cent of GDP for Malaysia and Korea, and 30-40 Government debt as percentage of GDP percent for Indonesia and Thailand. Assuming that Country 1996 1999o 20000 government bonds at market interest rates are used to . . . . ~~~~~~~~ ~ ~~Indonesia 51.1 93 98.3 finance the recapitalization, the annual government Domestic 25.1 57 64.3 interest expense would range from about 1.5 percent to Foreign 26 36 34 3 percent of GDP in these countries. The government Korea 28.2 41.3 40.7 Domestic 19.2 25.3 24.7 outlays and obligations for financial sector restructur- Foreign 9 16 16 ing, deficit spending for other purposes, and the other MaLaysia 47.7 59.5 63.3 Domestic 31.7 36.5 39.3 crisis-related fiscal costs will sharply raise government Foreign 16 23 24 indebtedness in the four countries (see table 6.4). While Thailand 11 55.4 52.7 the debt projections are subject to the usual uncertain- Domestic 2 26.4 24.7 ties, the pace of buildup is alarming, particularly in Foreign 9 29 28 a. Projected. Indonesia and Thailand. The fact that the precrisis SOurce: World Bank. 86 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries of NPLs from the banks and their disposition. Bonds in 25 percent of book value of the assets sold. Another exchange for bad assets have been the main instrument auction covering about US$6 billion of the loans of the for the asset swaps. KAMCO has disposed of the defunct finance companies was held on March 19, acquired assets in a variety of ways, including auctions 1998. Reportedly, the bids averaged 18 percent of the and direct sales. KDIC has covered the deposits of the face value of the loans and AMC purchased over three- 16 merchant banks that were shut down and has quarters of the value of the assets auctioned. injected new capital to facilitate the acquisition of the To deal with the restructuring and recapitalization of nonviable banks by viable institutions and to prepare the barLking sector, the Thai government unveiled a plan the sale of Korea First Bank and Seoul Bank, both of in Augast 1998. This plan offered public funds as capi- which were acquired by the government at the onset of tal injeztion for banks that were prepared to restructure the crisis. Fifty-one percent of the shares of the former up front, accelerate corporate debt restructuring, and has been acquired by a U.S. investment company and undertake new lending. The support facilities provide 70 percent of the latter is reported to have been both Tier I and Tier II capital, involving funding on a acquired by a foreign bank. These sales were effected matching basis to that of new private capital. Losses are through international auctions. The Korean strategy, to be borne fully by existing shareholders up to their which has involved nationalization, closures, disposi- equity limits, with additional losses, if any, to be shared tion of NPLs, and injection of capital by specialized by the government and new investors. The plan also agencies, mergers and subsequent privatization, has includes the purchase of preferred shares by the gov- been adequately funded and rapidly implemented as ernment to bring Tier I capital up to 2.5 percent. Above market conditions permitted. In moving forward to that level, the government will match the amount establish "clean banks," the authorities have applied injected by private investors. About 200 billion baht stringent safeguards to minimize moral hazard and have been earmarked for Tier I. However; financial public losses. instituiions must fully meet the central bank's loan loss Thailand's approach to financial sector restructuring provisioning requirements and submit an acceptable has entailed two distinct components: the finance com- plan for organizational restructuring. For Tier II capi- panies and the banks. In the case of the former, by tal, the plan calls for placing some 100 billion baht of December 1997, all but two of the 58 finance compa- nontradable government bonds in exchange for bank nies suspended earlier in the year had been closed down. debentures for a maximum of two percent of risk- An independent entity, the Financial Restructuring weighted assets. The amount of funds available would Agency (FRA), was set up in October 1997 to deal with hinge on write-downs of earnings resulting from corpo- the 58 suspended finance companies, and an Asset rate re,tructuring and the expansion in new loans to the Management Corporation (AMC) was formed to man- private sector. age and dispose of the bad assets of the banks. The Despite the massive losses suffered by Thai banks in assets of the 56 closed finance companies amounted to 1998 (see table 6.5) and the rising levels of NPLs, banks 371 billion baht at face value. Financial Institutions have not availed themselves of the facilities set up by the Development Fund (FIDF) outlays to these entities govermment (particularly the Tier I facility), because exceeded 1 trillion baht or the equivalent of about 18 they are reluctant to write down their capital in return percent of the 1998 GDP. for public money and accept the dilution of the owner- On December 15, 1997 the FRA auctioned over ship that comes with the deal. Thus far, only one bank US$11 billion of the commercial and real estate loans (Siam Commercial Bank) has formally requested Tier I from the 56 finance companies that had been closed support. Thai Farmers Bank has raised capital through down. The auction, which included both foreign and the issuance of linked preferred stocks and subordi- Thai bidders, generated only 11.66 billion baht (about nated debentures. Two other banks are following a sim- US$3 billion) for 9 tranches (out of the 45 tranches ten- ilar approach. These new instruments are perceived as dered). Negotiations following the auction raised the temporary solutions and there is concern about the total disposed to 41 percent of the portfolio initially extent of fresh money actually raised since over one-half offered. The FRAs realization is reported to have been of the buyers are depositors of the issuing bank or other Finan:ial Sector Restructuring: Progress and Issues 87 TABLE 6.5 It was only on March 12, 1998 that the government Net profit (loss) and assets of Thai banks announced a much-awaited comprehensive bank restructuring and recapitalization plan. Thirty-eight Net profit (toss) Assets Losses/assets banks were closed down, their assets to be managed by (Baht mittions) (Baht millions) (percent) IBRA. Seven banks were taken over by the go vernment Bank 1997 1998 Sept. 1998 Sept. 1998 in order to facilitate the payment system. Seventy-three banks with capital asset ratios equal to or greater than Krung Thai Bank 210 (60,079) 1,143,637 5.3 Bangkok Bank 4,057 (49,500) 1,302,192 3.8 4 percent will remain open. The government will issue Thai Farmers Bank 801 (39,883) 733,272 5.4 bonds in order to provide up to 80 percent of the financ- Siam CommerciaL Bank 3,194 (12,861) 699,658 1.8 ing for the recapitalization of nine banks. The remain- Bank of Ayudhya 1,962 (9,203) 482,527 1.9 Thai Military Bank 1,368 (7,700) 361,596 2.1 ing 20 percent will be provided by the owners of these Source: Far Eastern Economic Review 1999. banks. The terms of the government's interest in these nine banks will be restricted to decisions on strategic issues, leaving the day-to-day affairs to the private own- Thai banks.8 The five state-owned commercial banks ers. The original shareholders will have the opportunity are raising capital from the government. to buy back their shares within three years. C)therwise It would be fair to conclude that the Thai experience the government will sell its shares in the open market thus far points to a restructuring process for commer- over the next two years. The gross cost of the restruc- cial banks that is moving rather slowly and hence can turing package is estimated at 300 trillion rupiah (30 impede the restoration of normalcy in the financial and percent of the fiscal 1998 GDP). The recapitalization of corporate sectors. Recent statements by the authorities the nine private banks amounts to less than 10 percent have indicated that Bank of Thailand may take further of the total cost with the liquidation of the 38 banks and steps to accelerate recapitalization if the voluntary the recapitalization of the central bank responsible for actions fall short of the central bank's expectations. the lion's share of the expenses. Some 73 private banks This would be justified given broader concerns about that were not closed down or marked as candidates for economic recovery and the role of the banking system recapitalization assistance will be closely supervised. in that process. Compared with Indonesia and Thailand, Mvalaysia's Indonesia's banking system, though smaller in terms banking sector difficulties were less pronounced before of assets relative to GDP, is clearly the most distressed the crisis began to unfold. The risk-weighted capital in the region because of weaker precrisis conditions, the adequacy ratio of commercial banks was 10.8 percent sharper depreciation of the currency in a setting in at the end of 1996. As the regional crisis unfolded, non- which the private sector has very large external liabili- performing loans rose from 8 percent of total loans at ties, and the worst contraction in economic activity the end of 1997 to 13.6 percent at the end of 1998 experienced in 1998 by any country in the region. (measured on a three-month classification standard), as Several early steps to restructure the banking system reported by Bank Negara Malaysia (Central Batnk). The were taken in the early phases of the crisis. These overall capital-adequacy ratio at the end of 1998 was included the formation of a bank restructuring agency reported to have fallen to 8.7 percent. Between October (the Indonesian Bank Restructuring Agency or IBRA), 1997 and March 1998, the authorities announced a the closure of 23 private banks, the placement of 61 pri- series of measures that involved tightened regulations vate banks under the supervision of IBRA, and the for- regarding loan classification and higher capital ade- mation of a new bank (Bank Mandiri) to absorb four quacy ratios, but the new norms were subsequently state banks. After the initial progress, however, the pace relaxed in September 1998 (see the section on strength- of restructuring proved to be sluggish, owing largely to ening prudential standards and the legal frameworks the sheer size of the problem coupled with political below). The government then took the initiative to uncertainty and interference in the decision-making establish entities similar to those set up in Korea. authority of IBRA. Danaharta, an asset management company, was set up 88 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries in May 1998 with a total funding of 15 billion ringgit, introduced the tighter norms in a phased manner. In and is mandated to acquire NPLs from financial insti- Korea, the Financial Supervisory Commission (FSC) tutions and to maximize their recovery value. By the has spearheaded the introduction of international stan- end of 1998, it had acquired 8.11 billion ringgit of NPLs dards for accounting and reporting.9 In June 1998, all at an average discount of 61 percent. Additionally, financial institutions were required to follow a step-by- Danaharta managed 11.62 billion ringgit of bad loans step schedule to switch over to a mark-to-market basis in 1998 and expects to complete the acquisition of the for accaunting for securities. By July 1998, loan classi- remaining bad loans in the system by June 1999. fication procedures had been revised to fully reflect A second agency, Danamodal, was established in capacity to pay. In addition, it became mandatory for August 1998 with an expected funding of 16 billion banks to disclose connected lending information and ringgit (10.7 billion has been raised so far). Danamodal manag,- their foreign exchange exposure in order to is expected to recapitalize and consolidate the banking avoid maturity mismatches. The calculation of capital sectoL Institutions availing themselves of the assistance asset ratios was modified in order to incorporate a more of Danamodal are required to sell to Danaharta their conservative standard-loan provisions classified as NPLs in excess of 10 percent of their loan portfolios. substandard or lower were deducted from Tier II capi- Thus far, Danamodal has injected 4.5 billion ringgit tal. Thailand has set a legal minimum for capital ade- into nine financial institutions in the form of quacy :;atios of 8.5 percent for banks and 8 percent for Exchangeable Subordinated Capital Loans. Danaharta's finance companies, with January 15, 1999 as the dead- estimated funding was derived based on the basis of the line. Thai authorities have also shortened the basis more lenient six-month classification of NPLs. Based period for mandated disclosure of NPLs from 12 to 6 on the three-month definition, the funding require- months, though eventually they plan to establish a ments would have been larger. Malaysia's approach to three-month basis by the year 2000. restructuring centers on balance sheet cleanup-but not In Indonesia, the authorities announced a sharp liquidity injection, since the payment for NPLs is in the increase in minimum capital requirements for banks form of long-dated zero coupon bonds. and tightened loan classification and provisioning A major difference in the financial sector restructur- guidelines in January 1998. However, the increase in ing strategy of Malaysia compared with the three other capital requirements was later reversed. Current stan- countries has been its reluctance to close or nationalize dards are a minimum capital-asset ratio of 4 percent, to banks and finance companies. With the exception of be increased to 12 percent by 2001. The three-month MBf Finance Bhd and Kewangan Bersatu Bhd, 2 inde- definition for overdue loans will be in effect by then as pendent finance companies that were taken over by well. In January 1998, Malaysia tightened loan loss Bank Negara in January 1999, Malaysia has been provisioning standards by establishing a three-month unable to complete its plans for the consolidation of 40 classification and higher capital adequacy ratios for finance companies into 8. In all likelihood Danamodal finance companies in order to strengthen the banking could end up bearing more of the burden of recapital- system. However, in September 1998 the government ization than shareholders, unless the government takes rescinded some of these banking regulations to reduce a firmer stand in its position regarding closures. the severity of the credit crunch, which they believed had been caused by the new regulations. The classifica- Strengthening prudentiaL standards tion of NPLs is once again based on a six-month rather and the legal frameworks than a three-month standard (see table 6.6). In comparison to the other countries facing financial As a central feature of financial restructuring in the cri- sector distress, Malaysia ranks fairly high in having a sis-affected countries, all the countries have moved viable legal framework for bankruptcy and foreclosure. toward adopting international standards for loan classi- The Indonesian and Thai legal systems, by contrast, fication, income recognition, and minimum capital-ade- have required major changes to facilitate bank and quacy ratios. The general approach has understandably corporate restructuring. In the former much remains to Financial Sector Restructuring: Progress and Issues 89 TABLE 6.6 FIGURE6.2 Prudential standards Interest rates Definition of NPLs Copital-asset rotio Percent Country (months overdue) (percent) 18 17 % Indonesia 3 (by 2001) 4 (12 by 2001) 16 Korea 3 8 15 Malaysia 6 8 (10 by 1999) 14 ThaiLand 3 (by 2000) 8.5 13 Source: Country authorities. 12 11 be done. In Thailand, the signing of a bill in February to 10 establish a Bankruptcy Court paved the way for the J une Sept. Dec. Mar. June Sept. Dec. reform of the legal system. In mid-March, the Thai 1997 1997 1997 1998 1998 1998 1998 Senate approved the pending revisions in the remaining Korea -Thailand Malaysia key bankruptcy and foreclosure laws (the Bankruptcy Note: Korean rates are lending rates on general Loans for up to one /ear. Thai Bill, the Petty Cases Bill, and the Foreclosure Bill), rates are minimum lending rates for commerciaL banks. MaLaysiar rates are average Lending rates for commercial banks. which were subsequently ratified by the Lower House. Source: Bank of Korea, Bank of ThaiLand, and Bank Negara MaLaysia. These new legislations, which are major achievements, provide the impetus for speedier resolution of NPLs. However, their ultimate effectiveness will depend heav- FIGURE 6.3 ily on the efficacy of the judicial system to move the Spreads process forward. prent In Korea, corporate restructuring has been tradition- 7 ally handled through workouts rather than the legal 6 process. In February 1998, exit barriers were dimin- 5 ished through a simplification of the legal procedures 4 . applicable to corporate restructuring and bankruptcy. 3 / / Interest rates and loan growth 1 Broadly, the crisis countries have experienced a similar OJune Sept. Dec. Mar June Sept. Dec. pattern with respect to lending volumes and interest 1997 1997 1997 1998 1998 1998 1998 rate movements-that is, there has been a sharp slow- -Korea ThaiLand Malaysia down in credit growth and rising spreads even as nom- Note: Korean spreads are the difference between Lending rates on generat Loans inal interest rates were being lowered in response to the for up to one year and fixed deposit rates for between one and two tears. Thai spreads are minimum tending rates for commerciat banks minus depcsit rates. stabilization of the currencies, falling inflation rates and Malaysian spreads are the difference between average tending rates for commercial banks and one-year fixed deposit rates. the need to stimulate economic activity (see figure 6.2). Source: Bank of Korea, Bank of ThaiLand, and Bank Negara Malaysia. Because of mounting NPLs, however, banks have tended to opt for higher spreads to cushion, at least in a modest way, the impact of rising losses. Thai spreads, high, are not sufficient given the level of NPLs and the defined as the difference between the minimum lending recapitalization requirements. To stay financially rate and a weighted deposit rate, rose from approxi- viable, banks would need to maintain spreads as high as mately 4.25 percent in July 1997 to 4.75 percent a year 12 percent, which would be infeasible. later, reaching 7 percent in September 1998, before Loan growth in Thailand in January 1999 relative to declining to 5.5 percent (see figure 6.3). An unofficial a year earlier had slowed to 2.5 percent (see figure 6.4). survey done by the Bank of Thailand in October 1998 A similar pattern has emerged in Malaysia, where the estimated that the current spreads, though historically loan volume, which grew 26 percent in 1997, barely 90 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries increased in 1998 (see figure 6.5). The Malaysian credit a grovith of 15 percent in 1997. In Indonesia, where the crunch was very likely exacerbated by tighter banking inflatian rate and nominal interest rates were very high standards introduced in October 1997, which the gov- during much of 1998, the spreads between lending and ernment then rescinded in September 1998. deposIt rates rose sharply between July and December Recognizing the fact that high interest rates were con- 1998 'from about 9 percent to over 14 percent). tributing to the credit crunch, the government lowered interest rates and directed banks to reduce their maxi- Conclusions and lessons mum spreads over the base lending rate to 2.5 percent. In Korea, though deposit rates have come down, lend- The pace of financial sector restructuring, recapitaliza- ing rates remain relatively high, reflecting built-in risk. tion, and return to some semblance of "normalcy" has Loan growth (adjusted for NPLs bought by the govern- been slower than envisaged in all of the crisis countries, ment) was essentially stagnant in 1998, compared with with rhe possible exception of Korea. This is under- standable given the extent of distress in the sector and FIGURE 6.4 the deepening economic dislocation during most of ThaiLand. toan growth 1998. Just as the magnitude of the economic contrac- ThaiLand-loan growth tion unleashed by the events of 1997 was repeatedly Percent underestimated by international institutions and 12 domestic policymakers, as well as many private ana- 10 lysts, the scale of asset destruction in the financial sec- 8 tor was also inaccurately predicted. These two 6 misjudgments were of course not unrelated. 4 The initial optimism about market-based solutions, 2 particularly a recapitalization strategy predicated on 0 prival:e sector funding, has proved unjustified. Despite Jan. May Sept. Jan. May Sept. Jan. some early successes in Thailand, it has increasingly 1997 1997 1997 1998 1998 1998 1999 becore evident that the investor appetite for Asian Source: Deutsche Bank Research; Asia Economics Weekly 1999. become evit tat te inveso aetiter Asia ________________________________________ banks' equity was very limited. Hence, greater public sector involvement in recapitalization has become FIGURE 6.5 essenrial. An earlier appreciation of this reality would have perhaps led to the design and implementation of Bank lending and NPLs, Malaysia resolution packages with greater emphasis on closures Biilions of ringitts Percent of deeply insolvent institutions and on government par- 422 16 ticipation in recapitalizing potentially viable ones (as 420 14 was done in Korea, for example), as well as a more 12 forceFul way of inducing bad debt recognition and 418 10 write-offs on the part of private shareholders. 416 8 The extent of domestic debt overhang (essentially the 414 6 losses in the banking and corporate sectors) has been 412 4 simp]y too large to allow for governments to avoid 2 socializing the vast bulk of the costs of asset quality 410 D b A 0 deterioration. An earlier realization of the dynamics set 1997 1998 1998 1998 1998 1998 1998 in motion by the pernicious combination of large cur- - Total loans (billions of ringitts) rency depreciation, high interest rates engineered to NPLs/total loans (percent) deferd the currencies, declining terms of international Source: Bank Negara Malaysia. Ratios of NPLs to totaL Loans are computed on trade, and the sharp decline in domestic demand (par- a net basis-specificaLly, Net TotaL Loans equaL Outstanding Gross Loans minus tiCUILrly investment spending), would have led to more Interest-in-Suspense and Specific Provisions. realistic external financing, fiscal stance, and financial Financial Sector Restructuring: Progress and Issues 91 sector restructuring strategies (including judicious use prove to be destabilizing in the medium term. of forbearance). These in turn could have mitigated the Therefore, privatization of public enterprises and steps extent of the loss of wealth and output. designed to broaden the tax base and strengthen tax International experience indicates that countries are administration have particular importance for manag- far more successful in restoring the solvency of their ing the medium-term fiscal consequences of the crisis. banking systems than in engineering increases in prof- The crisis underscores the need for redoubling efforts itability. Thus far, there is no evidence suggesting that to develop domestic debt markets. The underdeveloped the East Asian experience will prove to be different. debt markets led to excessive reliance on banks and The rapid decline in domestic inflation rates and the finance companies as the principal vehicles for term deflationary pressures affecting export prices do not financing during the crisis. More developed domestic bode well for the remaining agenda of cleaning up the debt markets would have lowered the risks of maturity banking systems and corporate debt restructuring. mismatch faced by banks and also would have reduced Stagnant or falling wholesale prices have offset the the probability of sharp and sudden reversals of capital decline in nominal interest rates, implying a rise in the flows, as the debt markets would have more effectively firms' debt burden in real terms. Given that the opera- intermediated the surge in inflows. tional restructuring (in other words, measures aimed at In the early 1990s, it had become an article of faith increasing efficiency) of the banking system has barely among most economists that developing countries begun, and considering the need to generate margins needed to generate fiscal surpluses in order to accom- that facilitate recapitalization, the prospects for easing modate the absorption of private capital inflows. As the debt burden of the borrowers are not bright. long as external capital inflows (equity or debt) were In this context, accelerating the overhaul of bank- being utilized to finance private investment, it was ruptcy and foreclosure laws and, more important, argued, the authorities did not need to be concerned putting in place effective implementation mechanisms, with the volumes and maturities of these inflows. The are critical for separating expedient defaulters from naivete of this view-particularly in terms o f under- others and for facilitating debt-equity swaps. This is an standing institutional weaknesses in credit allocation aspect of the financial sector-corporate restructuring and risk management in developing economies-has nexus that has moved forward at an extremely slow been starkly exposed by the experience of the past two pace. years. Policymakers are once again reminded of the Dealing with the inevitable large increases in the gov- close linkages between the management of clomestic ernment debt burden arising from financial sector financial markets, international private capital flows, restructuring and with the other aspects of the crisis can and overall country debt management. 92 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries Annex 6.A . The Korean asset management corporation, (KAMCO) had disposed of NPLs with a face value of 12.6 trillion won by the end of 1998, with an Financial restructuring in East additional 1S.4 trillion won scheduled for 1999. Asia at a glance . A second agency, KDIC, injected 21 trillion won of func.s into the financial system, of which one-third covered the deposits of 16 distressed merchant Indonesia banks closed by the government, another third cov- ered losses for viable financial institutions (mainly 5 * Until recently, the Indonesian Bank Restructuring banks), and the rest was channeled toward mergers Authority (IBRA) had not been funded or given of banks that were not considered viable. proper authority. However, 23 private banks have * The government has privatized two of its banks. The now been closed, 61 have been placed under the sale of 51 percent of Korea First Bank to Newbridge supervision of IBRA and 5 state banks have been Capital has been finalized and a memorandum of merged under a new entity called Bank Mandiri. understanding has been signed for the sale of 70 per- * On March 12, 1998 the government announced a cent of Seoul Bank. restructuring and recapitalization package, the cost * The FSC has also set a strict timetable for the adher- of which is estimated to be 300 trillion rupiah (30 ence of commercial banks and non-banks to 8 per- percent of the fiscal 1998 GDP). cent capital ratios by the year 2000, as well as to • The largest part of the cost will be the liquidation other international standards. and closure of 38 banks and the recapitalization of the central bank to compensate it for large liquidity Malaysia injections incurred in 1998. • Nine banks will be recapitalized up to 80 percent of * The Malaysian government has set up two agencies the amount needed to resume a Tier-I capital ratio to aid in the financial sector restructuring: of 4 percent, with the original shareholders con- Danaharta (an asset management company) and tributing at least 20 percent in cash at a cost of about Danamodal (to provide liquidity and recapitaliza- 10 percent of the recap package. tion). e 73 banks with capital ratios equal to or greater than * Danaharta has purchased 8.11 billion ringgit of 4 percent will remain open. nonperforming loans at a discount of 61 percent, for * Seven large private banks (with 80,000 or more which it paid 4.26 billion ringgit out of its total deposit accounts) will be taken over by the govern- funding of 15 billion. Danaharta also managed ment to minimize disruption to the payments sys- 11.62 billion ringgits of bad loans in 1998. tern. * Daramodal has injected 4.5 billion ringgit into nine * The government has set new capital adequacy tar- financial institutions in the form of Exchangeable gets-banks must achieve a capital-adequacy ratio Subordinated Capital Loans. The government has of 4 percent, 8 percent, and 10 percent by the end of estimated that Danamodal would require approxi- 1998, 1999, and 2000, respectively. mately 16 billion ringgit, of which it has raised 10.7 so far. Korea - Two finance companies, MFf Finance Bhd and Kewangan Bersatu Bhd have been taken over by * The Korean government has mobilized 64 trillion Bank Negara. won in capital for the recapitalization and disposal * Prudential standards were tightened in April 1998. of nonperforming loans. By the end of December Nonperforming loans were defined as those loans 1998, 41 trillion won had already been spent. that: were three months overdue. Financial Sector Restructuring: Progress and Issues 93 * In September 1998, standards were relaxed again TABLE 6.A.I and the definition of nonperforming loans changed The consolidation of banks and finance companies to six months overdue. Intervened or under To be ThaiLand Country supervision cdosed Merged Nationalized Sold Indonesia 57a 61' 4' i1 o * The government unveiled a financial restructuring Korea 17 i 6e glf 2 09 plan on August 14, 1998, which pledged a total of Malaysia 0 0 0 2 0 300 billion baht in Tier I and Tier II capital to under- Thailand 0 56 3 4 2 capitalized banks. For both schemes, a capital ade- Notes to table quacy standard of 4.25 percent is required. * In the Tier I scheme, banks are required to first write a. PLaced under IBRA. SharehoLder rights were suspended and a down their capital by recognizing losses upfront and state-owned bank appointed to manage and control the bank. then change management in return for official b. Depositors' accounts were transferred to the Largest state bank. money. Siam Commercial Bank (SCB) has applied c. Four state banks are being merged into one entity along with the for Tier I capital, and another application is being corporate section of Bank Rakyat Indonesia. considered. d. Three commerciaL banks are stilL under the supervision of FSC; 14 • In Tier II, incremental government capital is pro- merchant banks have to comply with a timetable to achieve capitaL vided to individual banks depending on the bank's adequacy ratios. corporate restructuring performance. Two applica- e. Sixteen merchant banks were cLosed. tions for Tier II capital assistance have also been f. This number refers to 5 commercial banks whose proposals were approved-for TFB (Thai Farmer's Bank) and SCB. rejected, 2 that were able to merge and 4 others that did not meet • Thai Farmer's Bank and Bangkok Bank have inde- capitaL adequacy standards. pendently raised Tier I capital through issues of pre- g. None have been soLd yet but a Memorandum of Unclerstanding ferred shares, debentures, refinancing and has been signed between Korea First Bank and Newbridge Capital, and recognizing capital gains. between Seoul Bank and a British bank. * Krung Thai Bank has merged with First Bangkok h. Of these 56 finance companies, 12 have been merged under City Bank and taken over Bangkok Bank of Krungthai Thanakit. Commerce and received 77 billion in assistance from the FIDF, with an additional 108 billion forthcom- ing after its restructuring plan is approved. * The FRA auction held in December 1998 resulted in sales of 41 percent of the commercial and real estate loans worth a total of 371 billion baht. FRA's receipts amounted to nearly 25 percent of the book value of the assets. Another auction ($6 billion in loans) was held on March 19, 1999. * Legislature pertaining to Bankruptcy Court has already been ratified. Three bills-Bankruptcy, Foreclosure, and Petty Cases Bills-were passed in mid-March by the Senate and the Lower House, giv- ing a major boost to progress in the reforms that are critical to Thailand's financial and corporate restructuring. 94 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries Notes small private externaL debt and Low debt-equity ratios aLso made the system less susceptibLe to shocks. The author is a regional head of Deutsche Bank in Asia. The views 2. SeE, for exampLe, World Bank 1998 and IMF 1998. expressed in this paper are solely those of the author. They should not 3. For an elaboration, see Shirazi 1998. be attributed to the WorLd Bank, to the financiaL or other cosponsors 4. Shirazi (1998). of the Conference or to Deutsche Bank, with which the author is cur- 5. Krugman (1999). A concise summary of Krugman's paper is pro- rentLy affiLiated. The author wishes to thank Shonar LaLa for research vided by the Deutsche Bank's Angus Armstrong (see Armstrong 1999). assistance in the preparation of this paper. 6. SeE Krugman (1999), p. 20. 1. The PhiLippines are not covered in this paper, as its banking sys- 7. See, for example, Larry Summer's remarks in Tokyo on February tem, which had gone through a restructuring exercise a few years ear- 26, 1999 as reported in Sunday (Singapore) Times 1999. Lier, was not significantLy affected by the crisis. The authorities 8. WorLd Bank (1999). implemented a number of precautionary steps in 1998. The country's 9. See for detaiLs, RepubLic of Korea 1998. Financial Sector Restructuring: Progress and Issues 95 c-h a~~ts- ,r ; wt & Publicly Listed East Asian Corporates: Growth, .Financing, and Risks; Stijn Claessens Simeon Djankov sing a database of 5,550 publicly-listed corporations in nine East m |r Asian economies over the period 1988-1996, we find large differ- %'j ences in performance and financial structures across economies. Profitability, as measured by r eal return on assets in local currency, was rela- tively low in Hong Kong, Japan, the Republic of Korea, and Singapore throughout the period, whilc corporates in Indonesia, the Philippines, and Thailand had high real return:;-on average twice as high as those recorded in Germany and the United States. Nominal returns in dollars were high as well in the region, but reflected in part the real appreciation of currencies. During 1994-1996, measured perforrmance declined in several economies, especially in Japan and Korea. This did not show up as much in terms of a decline in sales growth because investment rates were high and they continued to drive output growth rates in many economies. The combination of high investment and rel- atively low profitability in some economies meant that much external financ- ing was needed. As outside equity was used sparingly, leverage was high in most East Asian economies relative to other economies, and on the rise in Korea, Malaysia, and Thailand. Shcrt-term borrowing became increasingly impor- tant, especially in Malaysia, Taiwan (China), and Thailand. Some of the vul- nerabilities in corporate financial structures that have now become a highly visible factor in triggering and aggravating the East Asian financial crisis were thus already in existence in the early 1990s. As a result of these vulnerabilities the impact of interest and exchange shocks has been large-43 percent of the corporations in our sample are estimated to face liquidity problems and 17 per- cent face solvency problems. 97 The East Asian financial crisis has in part been attrib- Asian miracle was indeed based on a vibrant corporate uted to the weak performance and risky financial struc- sector. tures of corporates. In retrospect, it has become clear However, the combination of high investment and that the operational performance of East Asian corpo- relatively low profitability in some economies meant rates was indeed not as stellar as many had thought and that much external financing was needed. Since outside in fact involved investments with high risks. Also with equity was used sparingly, partly because stock markets hindsight, it has become apparent that the financial were depressed (as was the case in Japan) or insiders structures of many East Asian corporates were not preferred to retain control, leverage was high in most strong enough to withstand the combined shocks of East Asian economies and on the rise in Korea, increased interest rates, depreciated currencies, and Malaysia, and Thailand. This created large risks as large drops in domestic demand. This poor perfor- short-term foreign exchange borrowing became mance and these risky financing structures were not, increasingly important in the last few years, especially however, notably featured by observers writing on East in Malaysia, Taiwan (China), and Thailand. Some of Asia prior to the financial crisis. Quite to the contrary, the vulnerabilities in corporate financial structures that East Asian corporates were considered an important have now become a highly visible factor in triggering contributing part of the region's miracle and were gen- and aggravating East Asia's financial crisis, were thus erally viewed as highly competitive and adept at already in existence in the early 1990s. exploiting new market opportunities; they consequently As a result of these vulnerabilities, the impact of inter- attracted considerable amounts of foreign capital. est and exchange shocks over the last year has been very Reconciling the differences between these ex post and large. Using the balance sheet and profit and loss state- ex ante views will likely be a topic of much future ments for a subset of corporations in our sample, we research.' In this short paper, we are less ambitious and quantify the impact of the currency and interest rate start with documenting the basic record in corporate shocks on individual firms' liquidity and solvency. We performance and financing structures for a number of find that 43 percent of the firms in the five most affected large, publicly listed East Asian corporates over the last economies (Indonesia, Korea, Malaysia, the decade. Specifically, we use a database of balance sheet Philippines, and Thailand) are currently illiquid and 17 and income statement data for 5,550 East Asian firms percent could be technically insolvent. Worst affected is listed on stock exchanges in nine economies over the Indonesia with 64 percent of its firms illiquid and 53 period 1988-1996 for establishing the stylized facts on percent insolvent, followed by Korea and Thailand. corporate performance and financing structures. The Malaysia has the smallest proportion of insolvent firms, main data sources are the annual reports of the compa- 1.5 percent, but 41 percent of its firms are illiquid, nies filed with the major stock exchanges in the region. which is about the same percentage as in the Philippines We find large differences in performance and finan- and Thailand. While these amounts are substantially cial structures across economies. Profitability, as mea- lower than those in the spring of 1998, when interest sured by real return on assets (ROA) in local currency, and exchange shocks were much worse, financial dis- was relatively low in Hong Kong, Japan, Korea, and tress in East Asia's corporate sector is still of systemic Singapore throughout the period, while corporates in proportions. Furthermore, about one-third of solvent Indonesia, the Philippines, and Thailand had high firms are illiquid, and risk insolvency unless their liq- returns, on average twice as high as those recorded in uidity constraints are relieved. Germany and the United States over the same period. In the years 1994-1996, measured performance declined The data somewhat in several East Asian economies, especially in Japan and Korea. These differences in performance did The data come from annual reports of the companies not show up as much in sales growth, as investment listed on the major stock exchanges in the region and rates were high and continued to drive output growth also from Worldscope and Extel databases. The data rates in all economies. These facts suggest that the East sets are unbalanced-that is, the number of observa- 98 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries tions varies from year to year. We excluded companies TABLE 7.1 that reported data less than three times over the period Summary statistics of size, 1996 1988-96. We excluded also financial and banking insti- (Medians, sales, and assets are in US$1,000) tutions (Standard Industrial Classification [SIC] Number 6000-6999). Finally, in any given year, we excluded Economy of firms Sales Assets Employment companies that did not include all of the following vari- Hong Kang 463 202,124 121,387 2,194 ables-net sales, net income after taxes, cost of goods Indonesia 264 91,254 54,284 2,675 sold, total assets, and the value of common equity. The Japan 2,234 488,076 457,648 1,436 data set consists of 588 companies in Hong Kong, 317 Korleysia 258 502,486 411,116 1,631 companies in Indonesia, 2,526 companies in Japan, 392 Phitippines 146 108,776 52,344 2,232 companies in Korea, 772 companies in Malaysia, 170 Singapore 283 142,789 86,248 1,416 Taiwan, China 222 284,717 180,624 966 companies in the Philippines, 348 companies in Thailancl 427 69,712 45,582 1,587 Singapore, 265 companies in Taiwan (China), and 564 Source: W)rLd Bank, Firm-LeveL Study. companies in Thailand. Several caveats apply to the data. First, the statistics we report do not attempt to correct for cross-economy Frecaut, M Hallward-Driemeier, and F Colaco; and differences in industrial structure. If an economy data other papers submitted to this conference. Table 7.1 set has many utility firms, for example, average leverage shows that our sample of companies in East Asian might be higher and profitability lower. The data also economies complements these authors' sampling of cover mainly large firms-the median size of the 5,550 smaller and medium-size firms, as the average size is firms is 1,612 employees, with the largest company much larger and the number of employees per firm employing more than 150,000 employees. This selec- about 10 times as high. tion pattern arises since the firms have to be listed on a stock exchange in order to enter the database, and listed Performance measures companies tend to be large. Table 7.1 provides descriptive statistics on the size of As our first measure of performance we use the real rate the firms in our sample, broken down by country or of return on assets in local currency. This is calculated economy. We use three measures of size: sales revenue, at the firm level as the earnings before interest and taxes the value of fixed assets, and employment. Japanese and (EBIT) in local currency over total assets, minus the Korean firms have the largest sales revenue and assets. annual inflation rate in the economy. The advantage of The median firm in these two countries produces half a this measure is that it is not influenced by the liability billion U.S. dollars worth of goods or services, and uses structure of the corporate, as it excludes interest pay- slightly less than half a billion dollars of assets. In con- ments, financial income, and other income or expenses. trast, the median Indonesian, Malaysian, and Thai firm Table 7.2 shows that across economies, East Asian cor- has less than 100 million dollars in sales revenue and porates have had quite different ROAs. Relatively low only about 50 million dollars in assets. The ranking in profitability rates have been recorded by corporates sales and asset size is not matched by a ranking by from Hong Kong, Japan, Korea, and Singapore, with employment. Indonesian and Philippine firms have real ROAs averaging about 5 percent. High-profitabil- now the largest number of workers, more than 2,000, ity economies, at least for most of the period we study, while the median firm in Taiwan (China) has less than have been Indonesia, the Philippines, and Thailand. 1,000 employees. This of course reflects the differences Corporates in these economies averaged real ROAs of in capital- versus labor-intensity across our sample of about 9-10 percent for the whole period. ROAs for cor- economies with very different levels of economic devel- porates in Malaysia and Taiwan (China) fall in between opment. We can compare our sample with those used these two groups, but their returns of about 7 percent by M. Kawai, H. Hahm, and G. larossi; D. Dwor- are still closer to the high performers. These ROAs can Publically Listed East Asian Corporates: Growth, Financing, and Risks 99 be compared to ROAs of about 5 percent in Germany Next we calculate the return on assets in U.S. dollars, and the United States,2 providing support to the notion adjusted for the effects of currency movements (see that the corporate sector contributed significantly to the table 7.3). This measure of performance presents the so-called "East Asian Miracle" during most of this point of view of an international investor whc can allo- period. cate resources across several economies. With the As a further comparison of the performance of East exception of Japan (6.6 percent) and Taiwan, China Asian corporates, we plot the average 1988-96 ROA (8.4 percent), all East Asian economies have ROAs in for corporates in all other economies that report to U.S. dollars that are higher than the U.S. median (8.7 Worldscope (see figure 7.1). Thailand, the Philippines, percent). The Philippines (18.7 percent), Thailand (14.7 and Indonesia have the highest ROAs in this sample of percent), and Indonesia (13.0 percent) have the highest 46 economies, while Taiwan (China) and Malaysia are average returns over the 1988-96 period. close behind. At the other end, Korea and Japan have The high returns in table 7.3 are driven to some the lowest ROAs in the sample, together with Norway, extent by the real exchange rate appreciation in the Sweden, and Austria. Singapore and Hong Kong have respective economies. Correcting for the real exchange also relatively low ROAs in real local currency. rate appreciation in relation to the U.S. dollar, we find TABLE 7.2 Return on assets for nine Asian economies, Germany, and the United States (percent, medians, in real LocaL currency) Economy 1988 1989 1990 1991 1992 1993 1994 1995 1996 1988-96 Hong Kong 5.1 5.3 4.9 4.8 4.5 3.8 3.9 3.9 4.1 4.6 Indonesia - - 9.4 9.1 8.6 7.9 7.4 6.2 6.5 7.1 Japan 5.7 5.4 4.6 4.7 4.8 4.5 4.1 3.8 3.6 4.1 Korea 4.4 3.9 4.1 4.0 3.9 3.6 3.4 3.6 3.1 3.7 Malaysia 5.4 5.6 5.4 6.2 6.0 6.5 6.3 6.1 5.6 6.3 PhiLippines - - - 7.1 6.4 8.1 8.5 6.8 8.4 7.9 Singapore 4.9 4.5 4.2 3.9 5.2 4.6 4.5 3.9 4.0 4.4 Taiwan, China - - - 5.1 6.2 6.5 6.8 6.5 6.6 6.7 ThaiLand 10.8 11.0 11.7 11.2 10.2 9.8 9.3 7.8 7.4 9.8 United States 4.7 4.8 5.1 4.9 5.2 5.4 5.3 5.2 5.2 5.3 Germany 5.3 5.5 5.5 5.7 5.6 5.2 5.1 4.9 5.0 4.7 - : not avaitable Source: World Bank, Firm-Level Survey. TABLE 7.3 Return on assets for nine Asian economies and the United States (percent, medians, in nominal U.S. doLLars) Economy 1988 1989 1990 1991 1992 1993 1994 1995 1996 1988-96 Hong Kong 8.0 8.4 7.2 12.9 14.3 12.5 11.5 8.0 10.3 10.3 Indonesia - - 16.0 13.7 12.6 15.3 11.7 10.7 11.2 13.0 Japan 6.5 -6.0 13.3 14.8 7.0 16.2 15.6 1.0 -9.2 6.6 Korea 25.1 10.3 7.3 7.2 6.4 5.9 12.1 9.9 -1.0 9.2 MaLaysia -0.8 8.8 7.2 9.9 14.8 6.1 15.5 12.2 9.5 9.2 Philippines - - - 23.2 21.2 5.4 29.4 7.5 16.5 17.2 Singapore 8.9 9.4 15.6 13.6 6.9 9.3 16.4 9.0 6.8 10.7 Taiwan, China - - - 6.2 12.0 4.6 12.4 6.3 8.9 8.4 ThaiLand 13.9 14.6 19.3 16.9 13.4 13.1 16.6 13.2 11.5 14.7 United States 8.7 9.6 10.5 9.1 8.3 8.4 7.9 8.0 8.1 8.7 -: not availabLe Source: World Bank, Firm-LeveL Survey. 100 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries FIGURE 7.1 International comparison on return on assets Country Austria Sweden Korea Japan Norway Pakistan Italy Brazil Colombia Singapore Switzerland PortugaL Hong Kong, China Canada E Ireland Hungary Germany Denmark Belgium United Kingdom _n Sni LankaI Mexico Argentina United States Spai Luxembourg France Peru Netherlands Israels China Turkey Finland _ South Africa Venezuela New ZeaLand E AustraLia Greece Malaysia India Taiwan, China Poand ChiLe Indonesia The PhiLippines Thailand 3 4 5 6 7 8 9 10 Return on assets Source: World Bank. significantly lower ROAs. For example, the return in of good sold, as a share of sales (see table 7.4). The lia- U.S. dollars once a correction is made for real currency bility structure or other income and expenses of the cor- appreciation is 8.4 percent in Korea in 1988. porate do not influence this measure either, but the Mathematically, this is the sum of the real ROA in capita] intensity of the individual corporate does. The Korean won (4.4 percent) and the inflation rate in the operational margin measure shows less cross-economy United States (4.0 percent)-all other terms cancel out differences and has been stable for most economies in the calculation. This implies that the relative com- throughout the period. The cross-economy differences parisons of the ROAs corrected for real exchange rate may indicate that firms across East Asia were exposed appreciations are the same as those in table 7.2. to differing degrees of (international) competition. Our third measure of profitability is operational mar- Relativrely lower-margin producers seem to be gin, calculated as the difference between sales and costs Singap ore, followed by Hong Kong, Malaysia, and Publically Listed East Asian Corporates: Growth, Financing, and Risks 101 Korea. Surprisingly, Japanese firms have higher margins table 7.5). Most East Asian corporates recorded on on goods sold ratios than these developing economies, average high, real sales growth over the period. which may reflect the high capital intensity of Japanese Malaysia, Indonesia, and Thailand stand out, with firms and the lower level of competition within Japan, averages of 11.9, 10.6, and 9.7 percent, respectively, as is often argued. Relatively high-margin producers are followed by Taiwan (China) with 9.3 percent. Other the Philippines, Indonesia, and Thailand, which may economies also had high sales growth rates, which are reflect the degree of domestic competition, lower about double those of Germany (2.6 percent) and the wages, and the high share of natural resources in their United States (3.7 percent). The economy with the low- exports (the last factor is especially prominent in the est corporate sales growth in East Asia is Japan, aver- case of Indonesia). No strong trend appears over time; aging 7.7 percent. These high sales growth rates mirror however, there is some decrease in operational margins the high growth in export and domestic demand that for Hong Kong, Indonesia, and Singapore. This may be has characterized this region over the last decade. We reflective of these economies' higher wage growth coin- do observe some slowdown in 1996, however, in sales ciding with their facing increased competition. growth for Indonesia, Japan, Singapore, Taiwan The cross-economy differences in returns on assets do (China), and Thailand, possibly reflecting low er export not reflect themselves directly in differences in sales growth rates. growth, which are also more variable over time (see TABLE 7.4 Operational margin for nine Asian economies, Germany, and the United States (percent, medians) Economy 1988 1989 1990 1991 1992 1993 1994 1995 1996 1988-96 Hong Kong 23.5 19.5 22.2 19.6 17.4 16.6 17.3 14.6 14.2 18.7 Indonesia - - - 35.7 33.3 34.4 32.8 31.2 30.6 32.9 Japan 22.2 22.7 22.9 22.4 21.9 21.8 21.8 23.1 23.3 22.1 Korea 13.7 16.8 17.3 16.9 19.2 18.7 19.6 21.4 22.1 19.6 Malaysia 16.4 16.3 17.1 17.3 17.6 17.4 18.4 19.5 25.5 18.1 PhiLippines - - - 36.1 26.4 26.4 27.5 30.8 33.3 27.7 Singapore 17.3 16.7 16.8 15.5 15.5 15.2 14.1 13.6 13.1 14.9 Taiwan, China - - - 25.4 21.4 22.7 22.6 22.3 21.9 22.6 Thailand 21.9 24.3 25.7 27.3 25.9 25.1 24.9 24.7 22.7 25.2 United States 14.1 13.9 14.1 14.3 15.5 14.0 14.7 14.8 14.6 14.4 Germany 13.2 13.4 13.7 13.5 13.8 14.1 15.6 16.7 17.1 14.6 -: not avaiLabLe Source: World Bank, Firm-Level Survey. TABLE 7.5 Real sales growth (year-on-year) for nine Asian economies, Germany, and the United States (percent, medians) Economy 1989 1990 1991 1992 1993 1994 1995 1996 1988-96 Hong Kong 10.1 11.6 10.2 12.4 9.8 9.4 9.7 11.8 9.2 Indonesia - - - 10.7 12.1 12.4 9.4 8.3 10.6 Japan 7.4 8.2 8.4 8.3 8.8 8.5 7.2 4.3 7.7 Korea 8.4 8.7 8.2 8.3 7.6 7.3 7.2 8.6 8.2 Malaysia 9.7 12.3 11.8 12.7 13.1 12.6 11.7 11.9 11.9 Philippines - - - 8.4 6.7 7.6 10.6 12.2 8.2 Singapore 8.4 8.6 8.1 9.4 11.6 11.8 10.2 7.7 8.7 Taiwan, China - - - 7.1 11.3 10.3 9.7 8.4 9.3 Thailand 11.6 10.3 10.8 9.6 8.3 10.1 10.7 5.7 9.7 United States 4.3 3.4 -1.8 4.3 2.8 6.9 4.1 4.3 3.7 Germany 5.0 4.4 5.1 1.1 -4.2 2.3 1.3 4.7 2.6 -: not availabLe Source: WorLd Bank, Firm-LeveL Survey. 102 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 7.6 Capital investment for nine East Asian economies, Germany, and the United States, 1988-1996 (percent, medians) Economy 1988 1989 1990 1991 1992 j 993 1994 1995 1996 1988-96 Hong Kong 14.3 16.6 8.3 7.6 7.2 19.8 7.6 5.8 9.3 8.3 Indonesia - - - 12.4 13.4 8.6 15.8 13.8 11.8 12.7 Japan 11.6 14.2 8.3 4.6 7.6 6.8 7.3 7.5 7.1 8.0 Korea 15.6 13.8 13.2 19.6 11.6 11.2 12.2 12.4 13.7 13.6 MaLaysia 8.6 7.6 8.9 9.6 11.3 13.4 15.2 14.6 16.1 10.7 Phitippines - - - 9.1 8.9 7.8 13.5 14.1 14.5 10.8 Singapore 7.8 7.6 7.4 8.8 9.6 11.3 13.4 12.5 13.5 10.4 Taiwan, China - - - 14.3 8.2 8.4 8.7 11.2 8.6 8.7 Thailand 10.4 12.9 12.3 15.0 14.9 15.0 14.7 14.5 5.8 13.8 United States 3.8 4.1 3.0 -1.4 4.0 2.6 6.4 3.7 3.8 3.4 Germany 4.9 4.8 4.2 5.0 0.9 -3.8 2.1 1.3 4.6 2.5 -: not available Source: WorLd Bank, Firm-Level Survey. TABLE 7.7 Leverage for nine Asian Economies, Germany, and the Unitedl States (percent, means) Economy 1988 1989 1990 1991 1992 1993 1994 1995 1996 1988-96 Hong Kong 1.832 2.311 1.783 2.047 1.835 1.758 2.273 1.980 1.559 1.902 Indonesia - - - 1.943 2.097 2.054 1.661 2.115 1.878 1.951 Japan 2.994 2.843 2.871 2.029 2.042 2.057 2.193 2.367 2.374 2.302 Korea 2.820 2.644 3.105 3.221 3.373 3.636 3.530 3.776 3.545 3.467 MaLaysia 0.727 0.810 1.010 0.610 0.627 0.704 0.991 1.103 1.176 0.908 Philippines - - - 0.830 1.186 1.175 1.148 1.150 1.285 1.129 Singapore 0.765 0.922 0.939 0.887 0.856 1.102 0.862 1.037 1.049 0.936 Taiwan, China - - - 0.679 0.883 0.866 0.894 0.796 0.802 0.820 ThaiLand 1.602 1.905 2.159 2.010 1.837 1.914 2.126 2.224 2.361 2.008 United States 0.798 0.848 0.904 0.972 1.059 1.051 1.066 1.099 1.125 1.034 Germany 1.535 1.552 1.582 1.594 1.507 1.534 1.512 1.485 1.472 1.514 - : not avaiLabLe Source: WorLd Bank, Firm-LeveL Survey. That these sales growth rates were maintained at such Finaticial structures a high level-and at rates that are extremely similar across economies-reflects in part the high investment The degree of riskiness inherent in the liability struc- rates in this region (see table 7.6). We measure invest- tures cf East Asian corporates is evident from the data. ment growth in new dollar investments as a share of The high investment rates, and relatively low ROAs for existing fixed assets. Over this period, Indonesia, some economies, meant that external financing had to Korea, and Thailand stand out, with investment rates of be large, as internal sources of capital-in other words, up to 13 percent (and in some years even more), fol- retained earnings-were limited. This high external lowed by Malaysia, the Philippines, and Singapore, financng, mostly from the banking systems, has been with rates averaging about 10 percent. Hong Kong, always a characteristic of the "East Asian Miracle." Japan, and Taiwan (China) had growth in investment in Leverage, defined as total debt over equity, also has fixed assets of about 8 percent. Japan has had low remained high for many East Asian economies, much investment rates, particularly since 1990. This probably above that observed in other developing economies and reflects in part its sustained financial and corporate cri- many industrial economies (see table 7.7). The highest sis since the early 1990s. leverage over this period was in the case of Korea- Publically Listed East Asiar. Corporates: Growth, Financing, and Risks 103 about five times that of the lowest, Taiwan (China). It and loans were rolled over in the later part of the was also low in Malaysia; but rising in the Philippines, period. Leverage consequently rose. The rise in leverage where it was still much below that of Indonesia and in the Philippines is probably the result of its r eforms in Thailand. the mid-1980s, which led to revived corporate and Most East Asian economies saw some increase in financial sectors and better financing possibilities. leverage in the last few years: this was most notable for To study the riskiness of the financial structures of Japan, Korea, Malaysia, and Thailand. Japan had seen East Asian corporates, we next compare their average some de-leveraging earlier in the decade-possibly 1988-96 leverage ratios with the leverage ratios in the owing to some financial retrenchment in the early other Worldscope economies (see figure 7.2). Korean 1990s-but lack of equity and corporate sector diffi- and Japanese firms have the highest leverage among all culties may have meant that no new equity was raised corporates in this group of economies, while companies FIGURE 7.2 X 5 ;FP M; m ; International comparison of leverage Country Peru Chile Argentina VenezueLa Sri Lanka Australia Taiwan, China Israel Portugal New Zealand CoLombia Malaysia Singapore Spain South Africa Mexico India United Kingdom- The Philippines BraziL United States _ Ireland PoLand Netherlands Canada Turkey China Denmark Norway Hungary Germany U Austra _ Sweden Pawkistan I- Greece Italy France Hong Kong, China urn Finland Indonesia I i =mum U ThaiLand U I BeLgium l Switzerland . Japan rh Korea * 1 1________________1____1____i_ di!ll 0.5 1 1.5 2 2.5 3 3.5 Leverage Source: WorLd Bank. 104 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries in Thailand, Indonesia, and Hong Kong also have The international comparison of the maturity of debt among the ten highest leverage ratios. At the opposite structu re (see figure 7.3) reveals that most East Asian extreme, firms in Taiwan (China) show relatively low econoniies rank below European and Latin American leverage ratios. Firms in the Philippines, Singapore, and econonmies in their share of long-term debt.3 Among Malaysia also have below-average ratios. The pattern East Asian economies, only corporations from the across other regions is also interesting. Western Philippines have an average share of long-term debt European economies typically display high leverage that is greater than 50 percent. There is a general ten- ratios, with Swiss firms having leverage almost as high dency for corporates in richer economies to have larger as Japanese firms. In contrast, corporates in South long-term debt. Some other, low-income Asian American economies (Peru, Chile, Argentina, economies (Sri Lanka, Pakistan, China, for example) Venezuela, and Colombia) have low leverage, reflecting have indeed low shares of long-term debt. But many of the less deep banking systems of these economies. the hig]-er-income East Asian economies are outliers to Long-term debt (as a share of total debt) has been low this pattern, as they rely less on long-term debt than throughout the 1988-96 period in all East Asian whatwould be expected on the basis of their per capita economies (see table 7.8). Malaysia, Taiwan (China), income level. Japan, for example, ranks below many and Thailand stand out with less than a one-third share. other developed economies. Among developing Japan and the Philippines have the highest share at one- econonmies, Chile stands out as one with an extremely half, while the others have their proportion at about high share of long-term debt. 0.43. In contrast, about three-fourths of U.S. corporate The Structure of debt (domestic vs. foreign; and short- debt is long-term, while in Germany the ratio is 0.55. In vs. long-term) was different across economies, however. spite of the considerable attention given to the role of Figure 7.4 reports the distribution of debt across these short-term debt in the East Asian financial crisis, these four categories in 1996 for the six economies most data do not suggest a massive buildup in short-term affected by the crisis. Korea has the highest share of for- debt for the East Asian economies, at least up to the end eign short-term debt share, followed by Malaysia and of 1996, but rather a consistently low share of long- Thailand. In contrast, the Philippines and Taiwan term debt. In fact, only Japan saw some decrease in the (China) have the largest share of domestic long-term share of long-term debt. As these data do not distin- debt.4 guish foreign exchange from domestic debt, it can of The data also suggest large differences across course be that the composition may have shifted away econoraies in interest payment coverage. This is calcu- from short-term domestic debt toward short-term for- lated as the ratio of earnings before interest and taxes eign exchange debt. (but adding back depreciation)-that is, EBITDA or TABLE 7.8 Long-term debt share for nine Asian economies, Germany, and the United States (percent, medians) Economy 1988 1989 1990 1991 1992 1993 1994 1995 1996 1988-96 Hong Kong 59.7 59.5 53.8 56.5 44.7 44.7 40.7 37.3 36.4 44.9 Indonesia - - - 52.4 40.8 39.6 41.6 41.8 43.3 43.1 Japan 49.9 54.1 53.8 49.9 49.4 51.7 47.7 44.4 40.8 48.4 Korea 55.7 47.2 49.8 49.8 44.2 43.7 41.4 40.4 41.5 43.7 MaLaysia 35.8 35.5 32.5 27.1 26.9 26.6 27.2 27.8 29.9 29.2 Philippines - - - 57.2 53.1 50.3 50.2 49.8 51.4 52.2 Singapore 57.2 55.4 54.1 33.8 33.8 33.9 40.2 38.6 41.1 43.3 Taiwan, China - - - 53.9 44.4 32.8 34.6 34.3 38.9 35.9 ThaiLand 58.1 49.8 38.8 34.3 25.2 26.4 27.6 32.9 32.8 30.9 United States 77.7 77.2 76.3 76.7 75.8 76.2 75.2 74.6 74.1 75.9 Germany 56.8 55.4 54.5 53.9 55.2 55.4 55.4 55.3 54.7 55.3 - not avaiLabLe Source: WorLd Bank. Publically Listed East Asian Corporates: Growth, Financing, and Risks 105 operational cash flow-to interest expenses (see figure Effect of exchange rate and interest rate 7.5). With the low interest rates in Japan, Japanese cor- shocks porates needed to devote only a small fraction of EBITDA on interest payments, so the interest coverage We next assess the impact of the currency and interest ratio is about 8 in 1996, followed by Taiwan (China) rate shocks these economies have experienced since the with 6.1. Thai and Korean corporates had the lowest second half of 1997 on firm liquidity and solvency.S We interest coverage ratios-about 2.7 and 2.1, respec- start by describing the exchange rate and interest rate tively. Corporates in Hong Kong, Malaysia, Indonesia, shocks we use. For each economy, we calculate the aver- and the Philippines averaged between 3 and 4 while age exchange rate over the period February 15-March Singaporean firms averaged 4.5. 1, 1999, and compare that with the average exchange FIGURE 7.3 International comparison of long-term debt share Country Malaysia Thailand Sri Lanka Pakistan Taiwan, China China Greece Turkey Spain Hungary Italy Indonesia Singapore Korea Honig Kong Chia BraziL Peru Japan Belgium Luxembourg The Fhilippines Argentina Germany VenezueLa Mexico Ireland Colombia Portugal PoLand ==_ France Denmark India United Kingdom = Israel __ South Africa Netherlands Chile Austria Finland = Australia - _ Sweden - New Zealand - United States - - Switzerland Norway = _ Canada i 20 30 40 50 60 70 80 90 Percent of long-term debt Source: World Bank. 106 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries FIGURE 7.4 first hal: of 1997, again taking it as the precrisis value. We also revise upward the interest rate paid on foreign Foreign versus domestic and currency debt by a factor proportional to the increase in shrcnt- versus tong-termthe spread between the economy's rate on U.S. dol- lar-denominated sovereign bonds and the rate on U.S. oa0 | | gTreasurr bonds of analogous maturity.6 90 | | Next, we compute the impact of these shocks in terms 80 g of corporate financial obligations using the end-of- 70 1996 balance sheet figures and 1996 profit and loss statements. We define firms as technically insolvent 60 when the increase in financial obligations calculated at 50 new exchange and interest rates exceeds the corpora- 40 tion's end-of-1996 equity. We define firms as illiquid 30 when 1996 EBIT falls short of debt-service obligations projected at new exchange and interest rates. We use 20 | | | | | | both exchange rate and intercst rate shocks at the same 10 time. o The in-crease in financial obligations attributable to Indonesia Korea Malaysia PhiLippines Taiwan, Thailand the two shocks is computed as follows. The exchange CDetlohIoeica shortrate shock is calculated as the increase in the value of . Foreig Long F Forein short end-of-1996 foreign currency debt-assumed to be * Foreign long N1 Foreign short entirely denominated in U.S. dollars-that is attribut- able to the domestic currency devaluation.7 The interest rate shock is computed by (a) applying the estimated FIGURE 7.5 increase in domestic corporate borrowing rates to the Interest coverage in nine Asian economies, 1996 end-of- 1996 debt denominated in domestic currency;8 and (b) applying the estimated (as described above) Percent of EBmTDA increase in corporate foreign currency borrowing rates to 8 the end-of-1996 debt denominated in foreign currency.9 7 1 m | Table 7.9 reports the share of firms that are techni- 6 cally insolvent, illiquid, or both after the two shocks. 5 On average for the five affected East Asian economies, 4 the share of insolvent firms is 17.3 percent. Indonesia is 3 by far the hardest-hit economy-more than half of its 2 firms are estimated to be insolvent, with the damage to I 1 1i 1 00 t the corporate sector mainly stemming from the large I 111|1 | 1111 1111 1111 1111 11|11 1111 1111 I depreciation of the currency. In Korea, about 14 percent I 4 ep ,9 < ;. bs of the corporates are technically insolvent at current ' o ' v interest and exchange rates. In the Philippines and '| sF N ' xO' 4' |ferent practices. Some enforce layoffs, while others 4$jqo& <>^StN OOJ payoG cut rorkshtat PaL part-time Length of the measures ~~ ,~~~~? ,~~~~~ ~~ S' ~~c"' work shifts work work week '5,~~~~~~~~~~~~~~~1 Source: WorLd Bank, Firm-LeveL Survey. Source: World Bank, Firm-Level Survey. FIGURE 12.11a Sources of short- and long-term financing (before the crisis) Percentage of total financing 60 50 40 30 20 10 0- Long-term financing Short-term financing E Sales * Local banks E Foreign banks U Otherfinancial inst. N Money lenders U FamiLy & fnends * Suppliers H Partner firm HI Bonds * Equity market E Inter-holding cos. U Others Source: WorLd Bank, Firm-LeveL Survey. The Asian Financial Crisis: Impact at the Firm Level-The Malaysian Case 185 FIGURE 12.ll b Sources of short- and Long-term financing (after the crisis) Percentage of total financing 60 50 40 30 20 20 0 Long-term financing Short-term financing E Sales E LocaL banks [ Foreign banks H Other financial inst. 3 Money Lenders U Family & friends * SuppLiers D3 Partner firm Z Bonds * Equity market E Inter-holdingcos. * Others Source: WorLd Bank, Firm-Level Survey. FIGURE 12.1 iUE 12.13 Average debt-equity ratio Reliance on short-term finance Ratio Share of short-term debt (ratio) 1.40 0.55 0.50 2.38 0.45 0.40 1.36 0.35 0.30 1.34 0.25 2.32 0.15 2.30 ~'5 1996 1991 LH198" 5 Source: World Bank, Firm-Level Survey. Source: World Bank, Firm-Leve[ Survey. 186 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 12.4 Firm profiLes, first half of 1998 Borrow in By foreign employment Bj export Byforeign currency size' onentation control' FDIfirm Total No Yes Large Small Nonexporters Exporters None Some Total No Yes Finoncial indicators Short-term debt/ TotaL financing ratio 0.31 0.61 0.51 0.30 0.27 0.46 0.32 0.46 0.45 0.32 0.46 0.36 Long-term debt/ TotaL financing ratio 0.69 0.39 0.49 0.70 0.73 0.54 0.68 0.54 0.55 0.68 0.54 0.64 Debt/Equity ratio 1.16 2.43 1.87 1.14 0.96 1.63 1.22 1.52 1.80 1.24 1.62 1.37 Firm characteristics No. of employees 111 672 584 41 50 338 97 278 501 90 432 184 Share that export (percent to total firms in each category) 40.1 96.7 84.5 32.7 - - 33.7 73.1 90.5 32.8 84.5 47.3 Share that are FDI (percent to total firms in each category) 20.8 71.4 56.0 17.0 8.3 50.2 2.2 100.0 100.0 - - 28.2 Response to the crisis Current capacity utilization (percent) 64.8 71.7 72.7 64.0 63.6 68.9 64.9 64.1 71.8 65.0 69.1 66.2 Share with fewer workers (percent to totaL firms in each category) 28.8 44.0 39.6 29.4 28.0 36.8 30.3 26.9 41.8 29.8 38.1 32.2 Optimistic for future growth (% to totaL firms in each category) 22.4 26.4 31.4 20.8 18.6 28.6 21.3 34.3 26.6 21.5 28.0 23.3 -: not availabLe. Note: a. "Large"" if total employment is 150 workers or more; "SmalL' if Less than 150 workers. h. "None" if foreign ownership is less than 10 percent of equity; "Some" if 10 perccent or more but less than 50 percent; and "Totar if 50 percent or more. Source: WorLd Bank, Firm-Level Study. The proportion of short-term to total debt in general cent) j-ound access to credit from foreign banks less was 36 percent, as shown in table 12.4. In terms of the forthcoming. It is noted, however, that even in the case distribution of short-term debt, it is observed that of local banks, the percentage of firms that found it exporting, foreign-controlled, and large firms as more restrictive was less than 25 percent. This implies opposed to nonexporting, local, and small firms rely to that w hile there was some credit squeeze, the problem a greater extent on short-term financing, with the for- may not be as widespread or as severe as has generally mer's share of short-term debt to total debt close to 50 been perceived,13 at least in the manufacturing sector. percent (see figure 12.13). The adequacy of working capital Availability of credit The s:ructure of working capital did not change after It is observed in general that after the crisis, the firms the crisis. The firms, on average, continued to rely pre- found the availability of credit from local banks-and domirLantly on their retained earnings (64 percent) to to a lesser extent from suppliers-to be more restrictive finance their working capital as shown in figure 12.15, relative to other sources as shown in figure 12.14.12 while bank loans only constituted 25 percent. On aver- Only a small percentage of the firms (less than 10 per- age by June 1998, across sectors, almost 75 percent of The Asian Financial Crisis: Impact at the Firm Level-The Malaysian Case 187 FIGURE 1.a1t FU 12.15 Availability of credit after the crisis, by source Structure of working capital Percentage of firms Percentage of total working capital 70 70 60 60 50 50 40 40 30 30 20 20 10 L10 0L E t. c,b5^oS \0. Z fb9 F December June December June < .' °9e 4tQw *% FA 1996 1997 1997 1998 #69 95,", '5, k3 0 Retained earnings C Bank Loans U Others E UtiLization rate U Percentage with Less avaiLable credit Source: World Bank, Rrm-Level Survey. Source: World Bank, Firm-Level Survey. course of the crisis. Initially, the government ,ightened FIGURE 12.10 both its fiscal and monetary policy in order to address Firms with adequate liquidity to finance the concerns about inflationary pressure and the persis- production, by sector tent current account deficit in the balance of payment. Subsequently, in mid-1998 the government relaxed Percentage of finns both its fiscal and monetary policy when economic 80 activities began to slow down, with the objective of reactivating economic growth. At that time, the threat 75 * * g _ of inflationary pressure had abated and the current 70 * * * _ * * account of the balance of payments was beginning to 70- - * * * improve. The major policy initiatives, particularly those 65 targeted at reviving the performance of the corporate sector, are summarized below. The measures address 60 the issues of accessibility to credit, stimulating output 9o°% ,, 5<<4 *, However, most, if not all, of these studies have examined the impact of the crisis from a macroecortomic perspective. Certainly the crisis' impact will vary based on the size of a firm and the economic sector it is in; accordingly, different firms will have diffirent responses to the crisis. Fairly detailed and accurate knowledge of these issues can greatly help in fine-tuning the govern- ment policies and programs cLesigned for staging a rapid economic recovery in the short term. This, however, requires good firm-level survey data. Such data had been unavailable prior tc this study, which attempts to analyze the impact of the Southeast Asian financial crisis on the Philippine industry and the indus- try's initial responses to the crisis to stay alive. The data for this study come from a sample of manufacturing firms. Although the study uses purely descriptive analyses, the results it yields can provide insights that are useful for policy formulation.2 The survey results clearly show that the capacity utilization rate of Philippine enterprises started to decline even before the crisis struck in July 1997, and it continued to drop as the crisis deepened. This, however, varied across sectors, with the electrical machinery sector being the hardest hit in the most recent period. Nonexporters 195 and small firms were more adversely affected by the cri- textiles, apparel and footwear, chemical and rubber sis compared with exporters and large firms. The firms' products, and electrical machinery. net profitability declined along with the capacity uti- More detailed descriptions of each sector in terms of lization rate. Although labor layoffs could not be the 1994 Philippine Standard Industrial Classification avoided under this unfavorable circumstance, a large are given in annex A. These particular manufacturing proportion of the firms resorted to other measures, such sectors are among the top 10 contributors to manufac- as cutting down on work hours and days, to preserve turing output. In addition, electrical machinery (the sec- some jobs. tor that includes semiconductors and electronics) and The structure of the firms' sources of short- and long- food products sectors rank high among both import- term funds did not significantly change before and after dependent and export-oriented industries. the crisis-reliance to a great extent on income from Standard sampling methodology for Philippine estab- sales and bank loans to finance operations being the lishment surveys utilize a List of Establishments (LE) general trend. The overall average debt-equity ratio compiled and updated by the National Statistics Office inched up a little in 1997, but declined in the first half (NSO). The sampling frame of the survey of Philippine of 1998 as the firms reduced their outstanding debt. At industry was the 1997 updated version of the LE, which the time of the survey, the share of short-term debt in included about 3,800 establishments belonging to the total financing had not changed substantially in the last five sectors covered by the survey. Food products (32 two and a half years. On the whole, there seems to be percent) and apparel and footwear (29 percent) com- no clear evidence of a supply-side credit crunch, as most prised 61 percent of the total number of relevant estab- firms-regardless of how they are classified, whether by lishments. In terms of employment size, 68 percent of sector, export orientation, or size-claimed to have con- firms in the sampling frame are listed as having less than tinued access to credit during the crisis period. Also, 100 workers. Over half of the establishments in the most claimed that they had not encountered a liquidity sampling frame are located in the Nationa:' Capital problem during the crisis period. What is worrisome, Region (NCR). though, is that an overwhelming majority was pes- Based on the list, establishments were independently simistic about business prospects for the next six selected from each sector with a goal of spreading the months. sample across the five sectors roughly equally. The The following section gives a brief description of the number of engaged workers was used as a stra.ification survey of the Philippine industry and a few of the char- variable-a greater number of samples were selected acteristics of the sample firms. The paper then examines from establishments with more than 100 workers. A issues pertaining to the impact of the crisis on surveyed simple random sample was drawn within each stratum. firms and their views on the causes of the crisis. Another Annex B shows the percentage distribution of establish- section discusses issues related to the firms' main ments by sector and classes in the frame and in the sources of funding, debt structure, transparency, and resulting sample selected. policy environment. This is followed by a brief discus- The questionnaire consisted of two separate forms. sion on the firms' assessment of the prospects of their Form 1 was designed to elicit responses from irterviews business in the short term. The last section offers con- with the sample establishments' chief executive officers cluding remarks and suggests some policies. Form 2 was designed as a self-accomplishing schedule for personnel officers, production managers, or finan- Description of the survey cial managers. The questionnaires were fielded from September 1998 to January 1999 by the NSO. The Survey of Philippine Industry and the Asian This report is based on the responses of 541 estab- Financial Crisis covered establishments engaged in the lishments out of a targeted number of 750. Food prod- following manufacturing industries: food products, ucts, apparel and footwear, and electrical machinery sectors are about equally represented in th~e set of 196 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries respondents, with textiles and chemical products hav- were evenly represented among "older" firms. Among ing half that number (see table 13.1). This is attribut- manufacturing sectors, food products and chemicals able to the fact that most of the establishments for these had more nonexporters; the reverse is true for apparel two sectors were contacted much later and the retrieval and footwear and the electrical machinery sectors. rate was thus lower. About 53 percent of exporters may be considered as The responding firms had an average number of 388 "high" volume exporters-that is, exports comprise employees in 1996. Small establishments (defined as more than 50 percent of their sales. Except for the food those with employment in 1996 of less than 150) dom- products and chemicals sectors, in which more firms inated the food products and textiles sectors with 57 were small- or medium-volume exporters (meaning, and 64 percent shares, respectively. Apparel and exports comprised less than 50 percent of sales), high- footwear and electrical machinery sectors are both volume exporters dominated all sectors. This is most equally represented in terms of size. evideni: in the electrical machinery sector, which Fifty-six (56) percent of the responding firms were includes the "electronics" sector in which 71 percent located outside the NCR. More likely than not (65.3 were high-volume exporters. percent of the time) the respondent firms were "old"- A firn is defined as having "no foreign control" if for- in other words, established prior to 1990. eign equity comprises less than 10 percent of the firm's Establishments in the electrical machinery and elec- equity. If foreign equity accounts for at least 50 percent tronics sector employed more workers than any other of the equity, the firm is said to be under "total foreign sector, averaging about 643 workers. Establishments of control." About 21 percent of the responding firms "older" firms had more employees than new ones, and were under total foreign control. For all sectors, the establishments located outside the NCR had more majoriy of the firms had "no foreign control." Only 8 employees than those in the NCR. percenr of the food products sector were under total Exporters comprised 51.9 percent of the sample foreign. control, but this figure rose to 39.3 percent in respondents. For "new" firms and those located outside the electrical machinery sector. The proportion of firms the NCR, there were more exporters (56 and 58 per- with large foreign equity was grcater among new firms. cent, respectively) than nonexporters but both groups Because most industrial estates and technological parks TABLE 13.1 ProfiLe of responding firms By export By volume of Byforeign Average By size orientation exports control number of Large Small Exporters Nonexporters Small Medium High None Some Total employees Total Sector Food 59 78 51 82 24 8 19 113 13 11 384 137 TextiLes 28 49 39 37 14 4 21 58 8 11 242 77 Apparet 61 62 78 42 30 4 44 78 16 29 331 123 ChemicaLs 47 40 38 49 19 7 12 62 8 17 250 87 ELectricaL machinery 59 58 70 46 17 3 50 62 9 46 643 117 Age New 71 105 98 77 39 2 57 96 19 61 330 176 Old 183 182 178 179 65 24 89 277 35 53 413 365 Location NCR 113 125 105 131 34 19 52 188 22 28 429 238 Others 141 162 171 125 70 7 94 185 32 86 342 303 Total 254 287 276 256 104 26 146 373 54 114 388 - -: not availabLe. Source: WorLd Bank, Firm-LeveL Survey. The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 197 are located outside the NCR, it is understandable that capacity utilization rate dropped from 75 percent in more firms outside the NCR had large foreign equity. 1996 to 66 percent (the food sector) in the sanme period. Table 13.2 gives a quick look at the profile of the sam- The percentage changes in the capacity utilization of ple firms using 1996 data, except for information refer- different sectors that are season-independent: can also ring to the firms' responses to the crisis. The be computed from figure 13.1. The first half of 1997 information contained in this table will be the main had already seen a significant decline in the capacity uti- focus of discussion presented in the subsequent sections lization rate (-3.4 percent relative to the 1996 average of this study. for all sectors), with apparel and leather as the worst performer experiencing a -5.5 percent change. Food Analysis of the impact of the crisis on products also did poorly, reducing the rate by 5.1 per- the firms cent during the first half of 1997. Although the decline continued in the seconid half of Capacity utilization 1997, it was not as deep as in the first half. On average, it dropped by only 2.3 percent relative to the first half The period from 1996 to the first half of 1998 saw a of the same year. continuous decline in the capacity utilization rate in the The results seem to suggest that the recessionary manufacturing sectors covered by the survey. From an effect took its toll on the Philippine industrial sector average high of 78 percent for all sectors in 1996, the during the first half of 1998. The capacity utilization rate declined to an average of 69 percent in the first half rate declined on average by 6.5 percent relative to the of 1998 (see figure 13.1). previous period. The worst performer was the electrical The performance varied across sectors. Of the five machinery sector whose rate shrank by 10.8 percent. manufacturing sectors, the apparel sector attained the The survey results also show the difference between highest capacity utilization rate in 1996 of 82 percent, the capacity utilization rates of exporters and nonex- while the food and textile sectors registered the lowest porters-results indicate that the latter were hit harder rate of 75 percent. In the first half of 1998, all sectors by the crisis compared to the former. For example, in experienced a drop. From a high of 82 percent in 1996, 1996, exporters and nonexporters had a rate of 78.2 the highest rate declined to only 71 percent (the chemi- percent and 77.2, respectively. In the first half of 1998, cal sector) in the first half of 1998. Similarly, the lowest the rate of the latter was down to 65.2 percent, while that of the former decreased to 71.9 percent. TABLE 13.2 Profile of firms Borrow in foreign currency Size Export orientation Foreign control FDI firm Yes No Large SmoaL Exporters Nonexporters None Some Total Yes No Total Financial indicators Short-term debt/TotaL financing 0.33 0.26 0.31 0.31 0.31 0.30 0.32 0.38 0.26 0.19 0.2r 0.31 Long-term debt/Total financing 0.27 0.15 0.23 0.24 0.22 0.25 0.25 0.24 0.17 0.30 0.31 0.23 Debt-equity ratio 2.95 1.57 2.19 2.32 2.14 2.66 3.00 2.79 1.41 1.65 3.OC 2.27 Firm characteristics Number of employees 485 285 711 58 608 190 283 625 692 668 267 406 Share that export (percent) 64 36 65 35 - - 50 12 38 55 45 Share that are FDI (percent) 34 22 40 15 84 16 5 12 38 - - Response to the crisis Current capacity utiLization (percent) 78 77 79 76 78 77 77 84 79 81 76 78 Share with few workers (percent) 69 31 50 50 47 53 72 10 18 29 71 41 Optimistic of future growth (percent) 59 41 28 26 31 23 25 35 30 32 25 27 Total 61 39 47 53 52 48 69 10 21 34 66 - -: not available. Source: Wortd Bank, Firm-Level Survey. 198 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries FIGURE 13.1 Capacity utilization Capacity utilization by sector 1 00 80 60 40 20 Sector 1 Sector 2 Sector 3 Sector 4 Sector 5 ALI sectors E1996 75 75 82 77 79 78 *1997 lst half 71 73 77 75 79 75 11997 2nd haLf 71 72 75 73 76 73 *1998 1st half 66 69 70 71 68 69 Capacity utiLization by export orientation 80 6 0 Exporters Nonexporters [1 996 78.16 77.16 *1997 a 76.13 74.03 C11997 b 75.57 70.79 El 998a 71.93 65.18 Capacity utitization byl size 100 80 60 40 20 0 Large firms Small firms [3 1996 79.41 76.29 *1997a 78.73 72.16 E1997b 76.99 70.45 *1998a 73.29 65.13 Source: World Bank, Firm-Levet Survey. The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 199 Figure 13.1 also divides the sample firms into two cat- FIUR 13.2 egories: large and small. Based on the trend, it would appear that small firms were hit harder than the large Net profitability over time ones. In 1996, small firms had a capacity utilization rate Percent of 76.3 percent. In the first half of 1998, their rate 12.07 dropped to 65.7 percent (or a decline of 13.9 percent). 12 l 1996 The drop for large firms was only 9.4 percent over the 10 0 1997 same period: from 79.4 percent in 1996 to 72 percent in 8 l First half of 1998 the first half of 1998. 6 4 3.53 Profitability 2 2.06 The continuous drop in the firms' capacity utilization 0 rate translated into poor performance in terms of net Source: WorLd Bank, Firm-Level Study. profitability. From a high of 12.1 percent in 1996, net profitability of the sample firms dropped dramatically I 133 to 3.5 percent in 1997and to 2.1 percent in the first half of 1998 (see figure 13.2). Growth rate The average profitability of the firms classified Percent according to export orientation and size shows a con- 20 -Real GNP - ReaL manufacturing GVA Inflation rate sistently declining trend for the last two and a half 15 Real exports years. Among the five sectors, the food and electrical machinery sectors exhibited a consistently declining net 10 profitability during this period, while the textile, 5 apparel, and chemical sectors showed a fluctuating profitability. 0 -5 <~~< 9< 9< 9< 9< Sectoral performance versus broader sector 9 9'? 9 ? 9 'e performance Year Source: World Bank, Firm-Level Study. Table 13.3 presents indicators of the general macroeco- nomic environment in the Philippines during the period sector reached a peak of 43.6 percent in the fourth quar- of analysis. Real GNP growth reached a peak of 7.8 ter of 1997. Following that period its growth deceler- percent in the third quarter of 1996, subsequently ated considerably, although it did not contract. decelerated, and started to contract in the second quar- Based on these indicators, the survey result, seem to ter of 1998. In the fourth quarter of 1998, real GNP have confirmed the general slowdown in the manufac- contracted by 1.2 percent (see figure 13.3). turing sector. The overall output of the manufacturing sector started to contract in the second quarter of 1998. By the Perceived causes of slowdown fourth quarter, it had declined by 3.4 percent. In terms of the sectors covered in the study, only The survey identified ten major causes of output apparel registered an improvement in real growth in the decline. These are (a) decline in domestic demand; (b) gross value added. In particular, this sector registered a decline in foreign demand; (c) insufficient credit being peak of 18.2 percent in the second quarter of 1998. The extended by suppliers; (d) insufficient bank c:redit for rest of the sectors, however, slowed down consider- working capital; (e) insufficient bank credit for expan- ably-including the electronics sector. The electronics sion; (f) high interest rates; (g) high cost of raw materials 200 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 13.3 Macroeconomic variables (Growth rate) 1996ql 1996q2 1996q3 1996q4 1997ql 1997q2 1997q3 1997q4 1998ql 1998q2 1998q3 1998q4 Gross nationaL product 7.3 8.7 7.8 5.1 5.4 5.3 5.2 5.3 2.0 (0.3) (0.0) (1.2) Gross domestic product 5.3 6.1 6.9 4.9 5.5 5.6 4.9 4.8 1.6 (0.8) (0.7) (1.9) Agriculture, fishery, and forestry 2.9 6.8 7.9 (0.5) 4.9 1.8 0.4 4.1 (3.8) (11.5) (3.1) (7.8) Industry sector 5.8 5.5 7.0 6.5 5.1 7.6 6.4 5.6 1.6 (0.2) (3.5) (4.4) Mining and quarrying 4.6 (19.2) (3.3) 3.1 (13.1) (1.0) 1.8 23.9 17.5 5.7 0.3 (16.0) Manufacturing 4.9 6.2 6.3 4.9 2.3 5.3 4.3 4.7 2.0 (0.9) (1.5) (3.4) Food 3.3 10.1 5.2 7.8 3.4 2.7 (0.6) (1.9) 5.7 0.9 1.5 - Textiles (3.1) (6.1) 7.4 (8.0) (14.1) (6.8) (0.1) 4.6 (4.1) (8.5) (8.8) - AppareL, Leather 4.3 (4.7) (4.5) (23.3) (14.0) 4.3 6.2 7.9 5.3 18.2 9.1 - ChemicaLs, rubber, pLastic' (2.1) 6.5 11.0 6.6 10.2 2.7 10.0 6.1 (5.6) (2.1) (0.3) - ELectronics 14.9 17.9 14.3 12.3 21.8 20.6 33.7 46.3 21.9 7.3 7.9 - Construction 7.6 9.3 12.8 13.8 21.3 18.5 18.1 7.6 (5.0) (1.8) (15.6) (10.0) Service sector 6.1 6.3 6.5 6.7 6.1 5.7 5.6 4.6 4.5 3.6 2.7 3.3 Exportb 12.9 11.3 5.3 8.7 8.6 15.2 17.6 14.5 13.4 3.7 3.7 - Garments 11.6 (7.2) (12.9) (6.4) (13.9) (5.8) 9.9 (9.6) (0.1) 8.5 (8.2) - Semiconductors 25.4 14.3 (2.5) 3.5 3.6 21.1 43.6 41.9 25.4 15.1 1.6 - Inflation rate 11.6 10.5 7.0 4.8 4.8 4.5 4.8 6.0 7.0 8.0 10.4 10.6 1991-Treasury biLL rate' 13.0 12.8 11.5 11.5 10.1 10.5 15.3 17.7 16.6 14.0 13.8 13.4 -: not avaiLabLe. a. Chemicals onLy. b. In reaL peso vaLue. c LeveL of T-bills Note: DetaiLs for Mfg: 1985 constant prces. 1991-T-BilLs: End of period was used. Inflation rate was computed using the average consumer price index. ql = first quarter; q2 = second quarter; q3 = third quarter; q4 = fourth quarter. Source: NSO. owing to the depreciation of the peso; (h) increasing FIGURIE 13.4 labor costs; (i) shortages in raw materials; and (j) non- Perceived causes of current output decline delivery of goods by suppliers hurt by the crisis. If one .. . . ,. r i\l~~~~~~~~~* onexporters assumes that reduced capacity utilization implies * Exporters reduced output level, then the above reasons could also be used as causes for the drop in the capacity utilization probLem rate discussed earlier. Figure 13.4 presents separate sets of results for the problem exporters and nonexporters with regard to their per- ception on the possible causes of the decline in output LocaL Foreign Access Depreciation. Labor High Raw and capacity utilization. In the survey, 1 means that the demand demand to inPut cost interest materials respondent believes there is no contribution, while 5 capitat costs raftes shortage Perceived causes of current stowdown identifies the factor as a major contributor. For both Exporters Ronk Peso dlepreciation-input coscs 3.66 exporters and nonexporters, the biggest contributor to Higher interest rates 3.26 2 Foreicn demand 3.21 3 the slowdown in output was the increase in input costs Labor cost 3.08 4 the 1~~~~ of the peso. effect the ~~~~~~~~Access to capitaL 2.68 owing to the depreciation of the peso. The effect of the Locat demand 2.49 6 currency depreciation was slightly bigger for nonex- Accesstocreditforexpansion 2o40 7 Nonexporters Rank porters (3.88) than for exporters (3.66). Note that Peso lepreciation-input costs 3.88 l LocaL demand 3.72 2 while a peso depreciation would be favorable to all Higher interest rates 3.232 Lahor cosc 3.11 4 exporters, it would adversely affect some of them Access to capital 2.53 because of the relatively high import content of their Accews to credit from suppliers 2.533 6 products. Source: W6orld Bank, Firm-LeveL Study. The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 201 For the exporters, the second major cause of the slow- 13.5 down was high interest rates. By contrast, for the non- Competitor's profile exporters, the second major factor was the decline in (percent) domestic demand. Changes in foreign demand emerged as the third most DomesticaLly important factor causing the slowdown as far as the 50 exporters were concerned, while high interest rates 40 turned out to be the third-ranking factor causing the 20 decline in output for the nonexporters. 10 For both exporters and nonexporters, the fourth- and 0 1996 1997 1998 first haUf fifth-ranking factors were the same-labor cost and m Domestic producers 50.35 4414 4| 010 access to capital, respectively. For the exporters, the sixth factor and the last factor on the list were local 20 InternationaLLy demand and access to credit for expansion. However, 15 for nonexporters, the sixth factor was raw material 10 shortage, while the last on the list was access to credit 5 from suppliers.3 0 1996 1997 1998 first half From the point of view of a firm facing a competitive nLow-cost producers 9.89 11.88 13.00 *Neighboring countries 12.37 14.43 13.95 market, the results discussed above seem to suggest that ElNICs 8.83 8.66 9.51 . . . * . . . * * * I-~~~~~~~~~~~~~OECD countries | 6.54 6.96 8.40 l the simultaneous drop in demand and increase in the average cost during the crisis period squeezed a firm's Note: Low-cost producers are firms in Vietnam, China, Cambodia, Laos, and Myanmar. profit. The results also seem to suggest that the surveyed Neighborng countres' data are from firms in Malaysia, Indonesia, a,id Thailand. NICs' data are from firms in Korea, Taiwan, Hong Kong, and Singapo-e. firms did not face much difficulty in accessing credit, OECD countries' data are from firms in the United States, Japan, anc Europe. although they had to pay a higher interest on it.4 Source: WorLd Bank, Firm-Level Survey. The proportion of firms reducing the number Competitor profiles of workers The results shown in figure 13.5 indicate that for those About two-fifths of the firms surveyed reported that firms selling to the domestic market, the biggest com- they had been operating with fewer workers since the petitors were other domestic producers owned by local crisis struck in July 1997 (see figure 13.6). Firms in the investors or owners. Joint venture companies and apparel and leather sector had the highest pioportion multinationals were considered far less of a threat than (49 percent) that reduced the number of workers in the other domestic producers in terms of competition in the wake of the crisis, followed by the electrical machinery domestic market. sector (44 percent). In terms of other criteria, the figure In the international market, the biggest threat to the was 46 percent for nonexporters versus 38 percent for local exporters in terms of competition were those firms exporters; 44 percent for large firms versus 394 percent within the neighboring countries (in other words, firms for small firms; 43 percent for firms with no foreign in Malaysia, Indonesia, and Thailand). Not too far control versus 41 percent with some foreign co-ntrol and behind the first group were firms in low-cost producing 35 percent with total foreign control. countries such as Vietnam, China, Cambodia, Laos, and Myanmar. The third group of firms that posed mar- The profile of workers who lost jobs ket competition in the international market were firms in newly industrialized countries (South Korea, Taiwan, The survey results show that those leaving the firms Hong Kong, and Singapore). The last group of firms were younger workers and newer arrivals t see table was from developed countries. 13.4). This is not surprising; the firms had little capital invested in these employees. Also, many of those newly 202 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 13.4 Profile of workers leaving the plan (percent) Average age (years) Average tenure (yeors) 30 or tess 31-50 Above 50 3 orless 4-10 Above 10 By sector Food products 43 42 15 40 31 30 TextiLes 51 38 10 41 35 24 Apparel, Leather 59 36 5 50 29 21 Chemicals, rubber, pLastic 49 42 9 44 31 25 ElectricaL machinery 71 26 3 53 36 11 Total 55 37 9 46 32 22 By export orientation Exporters 58 34 8 49 30 21 Nonexporters 51 40 8 43 35 22 Total 55 37 8 46 3221 By size SmaLL 58 35 7 51 31 18 Large 52 38 10 41 33 26 Total 55 37 9 46 32 22 Source: Wortd Bank, Firm-LeveL Survey. FIGURE 13.6 hired workers may not have earned their permanent appointmlient yet. Percent of firms with fewer workers More than half (55 percent) of the workers leaving Percent offirms the firrms were thirty years old or less. Another 37 per- 60 cent were between 31 and 50. There was a higher pro- S0 48.78 43.59 46.1 4445 portion of younger and newer wvorkers leaving the firms 40 36.535.6 3737 35.1 38.7 ' in the electrical machinery sector than in the other four 30 sectors; in exporting firms than in nonexporting firms; 20 and in small firms than in large firms. 10 As regards tenure, almost half of the employees had 0 l, , . , been with the company for 3 years or less while about se&eF9°KoW '' 9ee >2 ',ei9° '°ffii&iS <.ot°&c,o4 o4 s :one-third had been there for 4 to 10 years. Percent offirms The piroportion of firms retrenching workers 60 or using other methods of reducing labor 46.09 47443.43 44.49 40 | g 37.68 35 09 4m g s 36.68 Some 39 percent of the surveyed firms were filling up their vacancies as workers left (see table 13.5). 20 Howevrer, 29 percent had laid off workers as a result of the crisis. Some 61 percent gave severance pay or bene- Nonexporters some foreign control SmaLL fits to workers who were separated from work. WhiLe the apparel sector (42 percent) and the chemi- Source: Wor[d Bank, Firm-LeveL Study. cal secLor (43 percent) had a higher proportion of firms The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 203 filling up their vacancies than the other sectors, they vacation was greater for the exporters than for the non- also had a higher proportion (34 percent and 37 per- exporters. However, more nonexporters than exporters cent, respectively) laying off workers as a result of the cut down on work hours or days and froze salary increases crisis than the other sectors. And the electrical machin- of both rank-and-file and management personnel. ery, textiles, and apparel sectors gave severance pay or In terms of size, a higher proportion of large firms benefits at a higher rate than other sectors, at 48, 54, than small firms cut down on work hours or clays, com- and 55 percent, respectively. pressed the work week, and resorted to forced vacation. A higher proportion of exporting firms than nonex- In terms of freezing salary increases for rank-and-file porters filled up their vacancies, but in terms of laying workers, however, the ranking was reversed. off workers the order was reversed. Nearly equal pro- Membership of workers in unions was mentioned by portions of firms in each category gave severance bene- 41 percent of the sample firms (see table 13.6). fits to their laid-off workers. Compared with firms in other sectors, the electrical A higher proportion of large firms than small firms machinery sector had the lowest proportion (23 per- filled up their vacancies and laid off their workers. The cent) of workers who were members of unions. The fig- proportions were about equal in terms of giving sever- ures were 43 percent for exporting firms and '3 percent ance benefits to laid-off workers. for large firms-surpassing nonexporting and small Aside from laying off workers, firms in general may firms, respectively. resort to other measures to respond to an economic cri- As regards formal training activities, 52 percent of the sis that will possibly affect them. These may include (a) surveyed firms claimed that they had formal training cutting down on the work hours or days of workers activities for their workers (see table 13.6). More than paid hourly or daily; (b) compressing the work week for half of the firms in the food, chemical, and electrical workers paid monthly; (c) introducing forced vacation machinery sectors also made this claim. Exporting firms leaves; and (d) freezing salary increases or cutting (61 percent) and large firms (67 percent) had higher salaries of rank-and-file workers, management, or proportions in this category than nonexporting and both. Almost two-fifths of the sample firms cut down small firms, respectively. on work hours and days, about one-fifth implemented Among those firms that had training activities for a compressed work week, about one-fourth used forced their workers, one-fourth reported that they were plan- vacation, and close to one-third froze the salary ning to reduce the amount of training for their workers increases of rank-and-file employees and management. owing to the crisis. The apparel and leather sector had Only a small proportion of the sample firms imple- the highest proportion of firms planning a reduction. mented salary cuts for rank-and-file (3 percent) and Nonexporters had a higher proportion than exporters management personnel (5 percent) (see table 13.5). in this regard. And finally, one-fourth of the large and In terms of sectors, the apparel and leather sector had small firms planned to decrease their training activities. the highest proportion of firms that cut down on work- ing hours in response to the crisis. The electrical Labor policy machinery sector had the highest proportion of firms that resorted to compressing the work week for their Minimum wage fixing. The prevailing law governing employees. Forced vacation, by contrast, was used by a minimum wage in the country is the Republic Act (RA) higher proportion of firms in the food and electrical 6727 or the Wage Rationalization Act enactecL in 1989. machinery sectors than in other sectors. The textile and It created the National Wage and Productivity electrical machinery sectors had a higher proportion of Commission,5 but wage fixing was devolved to the firms that froze salary increases of rank-and-file employ- Regional Wages and Productivity Tripartite Boards. In ees than other sectors. Freezing the salary increases of terms of promulgating wage orders, the Tripartite management personnel was employed by more firms in Boards have been proven to be faster than wage legisla- the food and textile sectors than in other sectors. tion despite the required hearing and consultation In terms of export orientation, the number of firms process to be followed. resorting to compressing the work week and forced 204 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 13.5 Responses to crisis: Labor (percent) Filling Laying off Paying Reducing Compressing Mandating Freezing Freezing Cutting Cutting vocancies workers severance hours work week vacation salary: salany: salary: salary: rank &file mgL rank &_file mgt. By sector Food products 39 21 68 38 16 26 27 32 2 4 Textiles 31 29 65 36 17 20 29 37 1 9 Apparel, leather 42 34 56 41 20 23 27 29 6 7 Chemicals, rubber, plastic 43 37 70 33 18 23 31 29 4 2 Electrical machinery 38 29 47 40 22 25 28 27 3 4 TotaL 39 29 61 38 19 24 28 31 3 5 By export orientation Exporters 47 29 59 34 20 26 25 29 3 5 Nonexporters 30 31 62 43 18 22 32 33 4 5 Total 39 30 60 38 19 24 28 31 3 5 By size Small 33 27 59 37 17 16 29 31 4 5 Large 45 32 62 39 20 32 27 31 2 4 TotaL 39 29 61 38 19 24 28 31 3 5 Source: World Bank, Firm-Level Survey. The minimum wage has been adjusted almost regu- TABLE 13.6 larly and the past year is not an exception. The inflation Human resource and training rate has been the primary factor contributing to wage (percent) hikes. The wage adjustment in 1998 was a response to Workers With Decreased the increase in the inflation rate brought about by the member formal amount of of union training training substantial depreciation of the domestic currency. Restrictions on layoffs. Tenure security is one of the By sector F:ood prociucts 45 51 26 employee rights that is safeguarded by the Constitution. TextFiles 45 51 26 Textiles ~~43 44 21 This right prohibits management from terminating the Apparel, leather 48 44 38 services of a regular employee without just cause and ChemicaLC , rubber, plastic 49 59 24 Electrical machinery 23 62 18 without due process of law. TotaL 41 52 25 Mandated severance pay. There are authorized causes By export orientation for termination of employment by employers. These Exporters 45 61 22 include (a) installation of labor-saving devices; (b) redun- Nonexporters 37 42 31 Total 41 52 25 dancy; (c) retrenchment to prevent losses; or (d) long- B size term illness or disease. In the case of (a) and (b), the Small 27 38 25 separation pay is one month pay or at least one month Large 55 67 25 pay for every year of service, whichever is higher In the TotaL 41 52 25 .. Source: WolI akFr-ee uvy case of (c) and (d), it is one month pay or one-half S odd Bank, Firm-LeveL Survey. month for every year of service, whichever is higher. Under the Accord, employers promised that they would Social programs "exercise the utmost restraint in the lay-off, termination or rotation of their employees, which should be availed In response to the crisis, the Department of Labor and of only as a last resort." On the part of workers, they Employment (DOLE) was able to work out on pledged that they would "exercise utmost restraint in February 6, 1998 a tripartite agreement dubbed the declaring or going on strikes, slowdown of work and "Social Accord for Industrial Harmony and Stability." other forms of concerted work stoppages, which should The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 205 be availed of only as a last resort." Similar accords have that this program violates the government's standing been brokered by DOLE in various regions of the coun- policy of doing away with subsidized credit programs. try. The statistics on labor strikes seem to suggest that Still another program proposed was the setting up of the accord is holding. In particular, the number of a guarantee facility for loans to small anc. medium recorded strikes has not significantly gone up during the enterprises that are still viable but are under distress crisis period compared with the period before the crisis. owing to the crisis. The program, called the Elnterprise Moreover, on February 11, 1998, a National Stabilization Guarantee Fund, is being implernented by Economic Summit was convened by President Ramos the Small Business Guarantee and Finance Corporation to draft a comprehensive response to the crisis. Among (SBGFC). The proposed facility will guarantee up to 50 the proposals taken up was for DOLE to monitor percent of the principal loan balance. While awaiting worker layoffs, provide job placement for displaced the proposed financing requirement of P1 billion, the workers, disseminate information on job vacancies, and SBGFC has already set aside P200 million froni its own implement programs for retraining, entrepreneurship, funds for the project. As of March 1999, there was still and credit and livelihood assistance. It should be noted, no available record of performance other than the however, that these are ongoing activities of the depart- preparation of the guidelines and presentation of the ment. The monitoring of worker layoffs is being done project to government and private institutions that are by the Bureau of Labor and Employment Statistics, involved with small and medium enterprises. With the which publishes on its Web site (www.manila- Department of Trade and Industry's endorsement, the online.net/bless/welcome.htm) the latest update on project was presented to donor agencies for possible actual and planned layoffs including the number and funding support. firms involved. While DOLE has prepared the program document Financial position of the firms biefore for the "Comprehensive Program Package for and after the crisis Displaced Workers," there appears to be no readily available data on actual assistance given to displaced The sources of funds workers. The program includes monitoring, job loss prevention, training, livelihood programs, placement Firms raise short- and long-term funds from internal assistance, and educational assistance for the children and external sources. As can be observed from figure of displaced workers. 13.7, income from sales and loans from local banks Another recommendation that came out of the were the two main sources-internal and external, Summit was for the Social Security System (SSS) to respectively-of short-term and long-term funds for the implement a 200 million peso Emergency Loan sample firms before (that is, January to June 1997) and Program for displaced workers. According to a pub- during the crisis period. It should be noted that this lished report,6 P3 007 million had already been dis- source structure has hardly changed at all since the bursed as of December 1998, and the SSS has recently onset of the Southeast Asian financial crisis. approved the allocation of another P200 million for the program. As reported by the SSS, the program had The firms' reliance on debt already approved some 25,815 applications as of February 22, 1999. The program offers a maximum of The average debt-equity ratio of the surveyed firms in P12,500 to members at 6 per year payable in 24 equal 1996 stood at 2.27 (see figure 13.8 and table 13.7).8It monthly installments starting after a 12-month grace inched up to 2.46 in 1997, but dropped to 2.04 in the period. Borrowers are required to be members in good first half of 1998, a level that is below that of 1996. This standing and present either termination papers or proof pattcrn holds true for large and small firms, for export- of employment from DOLE and certification from the ing and nonexporting firms, and for all sectors but employer that they have suffered loss in income because one-namely, electrical machinery, whose debt-equity of job rotation or reduced work hours. It must be noted ratio had already started to decline in 1997. The above results seem to suggest that the surveyed firms 206 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries FIGURE 13.7 Source of short-term and Long-term financing (percent of total financing) Before the crisis 40 40 25 15 20 5 Short-term financing Long-term financing El SaLes 37.81 40.04 * LocaL bank 36.97 31.98 E Foreign bank 1.45 2.44 E Financial institution 0.90 1.93 * LocaL money lenders 1.01 0.16 1 Suppliers 2.70 2.80 * Partner 1.21 2.36 During the crisis 40 30 25 20 10 5 0 Short-term financing Long-term finandng l SaLes 36.02 38.03 * SuppLiers 36.20 30.67 11 Foreign bank 1.13 2.25 * Financial institution 0.93 1.13 * LocaL money Lenders 0.98 0.26 [ Suppliers 2.70 3.01 * Partner 1.39 2.61 Source: WorLd Bank, Firm-Level Study. The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 207 TABLE 13.7 Financial indicators Indicators Sector Size Export orientation 1 2 3 4 5 Large Small Exporter Nonexporter Aiverage Short-term debt/total financing° 1996 0.29 0.30 0.34 0.27 0.33 0.31 0.31 0.31 0.30 0.31 1997 0.30 0.33 0.39 0.31 0.34 0.35 0.32 0.34 0.33 0.33 First half of 1998 0.27 0.34 0.44 0.26 0.32 0.33 0.31 0.34 0.29 0.32 Long-term debt/total financingb 1996 0.21 0.30 0.25 0.24 0.20 0.23 0.24 0.22 0.25 0.23 1997 0.20 0.26 0.19 0.25 0.19 0.21 0.22 0.20 0.23 0.21 First haLf of 1998 0.19 0.26 0.17 0.25 0.20 0.21 0.21 0.19 0.23 0.21 Debt-equity ratio 1996 2.27 1.94 2.65 1.67 2.94 2.19 2.32 2.14 2.66 2.27 1997 2.40 2.23 2.85 2.18 2.71 2.40 2.54 2.29 2.75 2.46 First haLf of 1998 1.80 2.18 2.40 1.56 2.19 2.12 1.92 1.98 2.16 2.04 a. Both sectors 2 and 3 incLude 3 outliers. b. Sector 2 incLudes 3 outLiers; sector 3 includes 1 outlier. Note: Sector Codes: 5ector I-Food products. Sector 2-TextiLes. Sector 3-Apparel. leather. Sector 4-ChemicaLs, rubber, pLastic. Sector 5-ElectricaL machinery. Source: Wored Bank, Erm-Level Survey. attempted to reduce their debt as they began to feel the trast, the textile sector made the smallest adjustment in effects of the financial crisis in 1998.9 However, the the first half of 1998. In 1996, the electrical rmachinery degree of adjustment in the debt-equity ratio seems to sector obtained the highest debt-equity ratio, followed vary by firm type. More specifically, the decline in the by the apparel and leather sector. This ranking was debt-equity ratio in the first half of 1998 was much reversed in the first half of 1998. larger for nonexporting firms than for exporting firms. The shares of short-term and long-term debt in the Small firms made greater adjustments than large firms total amount of financing could serve as a good indica- during the same period. Among the five sectors, the tor of the firms' vulnerability to sudden tightness in the food and chemical sectors experienced much larger credit market. Short-term debt comprised almost one- declines compared with the other three sectors. By con- third of the firms' total financing (see figure 13.9 and table 13.7). The firms' share of or degree of reliance on FIGURE 13.8 short-term debt changed little during the period from 1996 to the first half of 1998; this was especially true Debt-equity ratios for large firms regarding the degree of reliance. 3.0 2.46 Regarding changes in share, large firms showed much 2.5 2.27 2.04 larger changes than small firms during the indicated 2.0 period. In the first half of 1998, the large firms' share of 1.5 short-term debt stood at 33 percent comparedi with 31 1.0 percent for small firms. Some differences in the behavior pattern of the short- 0.5 term debt's share among various sectors can also be dis- Average cerned during this period. The food, chemical and MM 1996 * 1997 E111998 1st haLf electrical machinery sectors exhibited an inverted U- *1996e: World Bank, 3irm-Level Survey. shape. By contrast, the textile and apparel sectors showed a rising share. It should be noted that the 208 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries FIGURE 13.9 same level and pattern of behavior during the indicated Ratio of short-term debt to totaL financing period. Exporters and nonexporters showed a similar pattern, but the former's share of long-term debt was 0.34 0.333 lower than that of the latter. Among the five sectors, the 0.34 textile and apparel sectors experienced a significant 0.33 et 0.33 decline. while the other three sectors went through little 0.32 0.320 change. In the first half of 1998, the textile and chemi- 0.32 0.309 cal sectors showed a much higher share of long-term 0.31 debt than the other three sectors. 0.31 The results discussed above suggest that the decline in 0.30 the deft-equity ratio experienced by the firms in the Average first half of 1998 can be attributed to the drop in both G 1996 0 1997 G 1998 1st haLf their short- and long-term debt during the same period. Source: World Bank, Firm-Level Survey. The avaiLabiLity of credit apparel sector stood out prominently among the five The respondents were asked whether banks or finance sectors with its short-term debt accounting for 44 per- companies had declined to grant them a loan before and cent of total financing. When the firms are classified during the crisis. Only 6 percent answered positively to according to export orientation, results show that the this qu,stion before the Southeast Asian financial cri- share of short-term debt of nonexporting firms declined sis-that is, from January to June 1997 (see table 13.8). to 29 percent in the first half of 1998 from 33 percent During the crisis, the proportion of firms being denied in 1997, whereas that of exporting firms remained the bank loans had doubled. It should be noted that this same at 34 percent during the same period. proportion in the first half of 1998 was slightly higher The surveyed firms' share of long-term debt in total for exporters (14 percent) than for nonexporters (12 financing declined a little from 23 percent in 1996 to 21 percent). Large firms also slightly surpassed small firms, percent in 1997, and stayed at that level during the first at 15 versus12 percent. The electrical machinery sector half of 1998 (see figure 13.10 and table 13.7). The appears to be the least affected by the crisis in terms of shares reported by large and small firms had almost the TABLE 13.8 Firms that were denied bank Loans (percent) FIGURE 13.10 January 1- July 1- January 1- Ratio of Long-term debt to totaL financing Category June 30, 1997 December 31, 1997 March 30. 1998 0.235 0.232 By sector Food prodlucts 6.31 16.22 11.71 0.230 TextiLes 6.15 9.23 15.15 0.225 AppareL 7.48 15.89 17.59 0.220 ChemicaL; 6.49 10.26 15.38 0.215 0.213 ElectricaL machinery 5.61 7255 6.54 0.210 ~~~~~Total 6.42 12.21 12.98 0.210 0.205 By export orientation 0.200 Exporters 6.61 11.98 14.34 Nonexporters 6.28 12.56 11.61 0.195 Total 6.45 12.26 13.03 Average By size oaffirms SmaLL 5.24 8.66 11.16 U1996 01997 E19981st haLf Large 7.56 15.68 14.77 TotaL 6.42 12.21 12.98 Source: WorLd Bank, Firm-Level Survey. Source: WoiLd Bank, Firm-Level Survey. The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 209 access to bank credit-only 6 percent of the firms in this credit to their customers. The proportion of firms sector were turned down for credit in the first half of extending credit to their customers appears to be higher 1998. By contrast, 18 percent of the apparel sector for nonexporters than for exporters, and higher for firms were denied bank loans in the first half of 1998, large firms than small firms. Among the five sectors, the up from only 7 percent in 1996. chemical sector had the highest proportion, while the Note that though the percentage of those that admit- apparel and leather sector had the lowest. ted having been denied a loan by a bank or finance com- The firms were asked about which usual source of pany had doubled during the crisis period, this is still loans or credit had become more restrictive in making much smaller than what was generally expected con- credit available to them since the onset of the regional sidering the economic uncertainty brought about by the financial crisis in July 1997 (see figure 13.1 1). I)omestic Southeast Asian currency meltdown. In other words, a great majority of the sample firms continued to have ;FIGURE 13.11 access to credit during the crisis period. Restrictiveness of credit after the crisis Firms typically buy inputs on credit. Seventy-four (74) percent of the surveyed firms confirmed this prac- 40 tice (see table 13.9). This proportion does not signifi- 35 cantly differ among different categories. The results 30 seem to suggest that the firms' access to supplier credit 25 during the crisis was not hampered. As table 13.9 20 shows, 81 percent of the sample respondents said that 15 their input suppliers were still extending credit to them 10 after July 1997. The proportion does not significantly 5 differ among the various categories either. 0 mm Firms also typically sell their products to their cus- . 03 tomers on credit. About three-fourths of the sample Xa firms were doing this before the crisis. During the crisis period, a little over three-fourths of the sample firms S Source: Wor[d Bank, Firm-Leve[ Survey. claimed to have continued selling their products on TABLE 13.9 Access to suppliers' credit (percent) Suppliers still Still extending Buying inputs extending credit Selling products credit to buyers Category on credit (after July 1997) on credit (after Jby 1997) By sector Food products 71.43 82.30 80.45 84.96 TextiLes 72.73 84.06 83.12 81.16 AppareL 69.42 75.45 55.37 59.63 Chemicals 75.58 82.72 86.05 9C.00 ElectricaL machinery 80.00 83.33 80.00 79.25 TotaL 73.68 81.29 75.94 78.20 By export orientation Exporters 72.89 84.34 71.79 74.39 Nonexporters 75.10 77.92 80.63 82.17 Total 73.95 81.25 76.05 78.15 By size of firms SmaLl 69.96 75.31 75.27 76.37 Large 77.91 87.19 76.71 8C.00 TotaL 73.68 81.29 75.94 78.20 Source: WorLd Bank, Firm-Level Survey. 210 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 13.10 tation. However, when the sample firms are classified Adequate liquidity to finance production by sector, the electrical machinery sector appears to (percent) have a different pattern of responses from the rest. In Category Yes particular, half of the firms in this sector claimed that their access to credit had not changed at all during the By sector crisis period. Only a little over one-fifth indicated that Food products 75.00 Textiles 67.57 it had become more restrictive. Apparel 73.28 Chemicals 80.95 ElectricaL machinery 82.88 The tic,uidity problem Total 76.22 By export orientation The satnple firms were also asked whether they, at the Exporters 79-77 time of the survey, had adequate liquidity to finance Nonexporters 72.18 Total 76.08 their production. About three-fourths of the total sam- By sizeoaffirms ple of i.irms declared having no liquiditv problem at Small 74.36 that moment (see table 13.10). The claim was made by Large 78.33 a rouglily equal proportion of small and large firms. The same can be said of exporters and nonexporters. Source: World Bank, Firm-LeveL Survey. Looking at the responses of the firms broken down by sector, the textiles sector appears to have the lowest percentage. banks were the most frequently mentioned source in Among those claiming that they had inadequate liq- response, followed by input suppliers. Interestingly, 36 uidity to run their operations, a little over half singled percent of the firms mentioned that the availability of out low revenue as the major reason (see table 13.11). A credit from their usual source had remained the same. little over one-third mentioned low collection rates and The same pattern of responses can be observed when insufficient loans as the major reason for encountering a respondents are broken down by size and export orien- liquidity problem during the time of the interview. TABLE 13.11 Causes of inadequate liquidity (percent) Insufficient Insufficient credit Low collection Category Low revenue loans from suppliers rate Others By sector Food products 44.83 32.26 24.14 37.93 13.33 Textiles 50.00 28.57 20.00 33.33 6.67 Apparel 60.71 60.71 25.00 30.77 28.57 ChemicaLs 40.00 14.29 15.38 50.00 40.00 Electrical machinery 66.67 14.29 6.67 28.57 22.22 TotaL 52.63 34.26 20.00 35.58 21.43 By export orientation Exporters 52.08 32.61 16.28 19.05 29.63 Nonexporters 53.03 35.48 22.58 46.77 16.28 Total 52.63 34.26 20.00 35.58 21.43 By size of firms Small 59.09 35.48 25.00 38.33 22.73 Large 43.75 32.61 13.33 31.82 19.23 TotaL 52.63 34.26 20.00 35.58 21.43 Source: World Bank, Firm-LeveL Survey. The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 211 Transparency (83 percent). The rest have proportions ranging from 89 to 92 percent. Financial statements, collateral and Results show that even though 88 percent of the total guarantees sample respondents for this study claimed that their financial statements were audited by independent audi- Accounting information-in other words, balance tors, only 65 percent said that they typically needed sheets and income statements-is one of the instru- audited financial statements to apply for and receive a ments that can make firms transparent to lenders. The bank loan (see table 13.13). As expected, largc firms value of this information can be enhanced if it is certi- reported a higher proportion (71 percent) than small fied by an independent auditing firm. firms (60 percent) with regard to being required to sub- Philippine firms and banks are required to maintain mit audited financial statements when appl-ying for a appropriate financial records that observe standard and loan. The difference is less significant between customary accounting and auditing principles and pro- exporters (68 percent) and nonexporters (6_3 percent). cedures. Out of the total sample of firms in this study, Among the five sectors, the electrical machinery sector 88 percent claimed to have financial statements audited reported the lowest proportion (56 percent) concerning by an independent auditing firm (see table 13.12). As this requirement. expected, the proportion of firms having audited finan- Usually, the longer the maturity of the loan, the cial statements is lower for small firms (82 percent) than greater the chance that a bank will require collateral for large firms (93 percent). Ninety-three (93) percent from a borrower The results of the survey support this of exporting firms maintain audited financial state- trend. Almost half of the total number of respondents ments, whereas 82 percent of nonexporting firms do so. said that they had typically had to provide collateral The rigor involved in competing in the international when they borrowed for 12 months or longer; the per- market is perhaps one of the compelling reasons for centages were only 27 percent when borrowing for 6 exporters to have audited financial statements. Looking months or longer, and 24 percent for less than 6 months at the five sectors, the textile firms appear to have the (see table 13.14). There is not much difference in this lowest proportion of firms with financial statements respect when respondents are grouped by export orien- audited (80 percent), followed by food-producing firms tation or size. When classified by sector, the tzxtile sec- tor appears to have the highest proportion of TABLE 13.12 TABLE 13.13 FinanciaL statements audited by independent Submission of audited financial statemenit to auditing firm apply for a loan (percent) (percent) Category Yes Category Reqaired By sector By sector Food products 83.49 Food products 66.67 Textiles 80.30 TextiLes 63.D8 AppareL 88.89 AppareL 64.31 ChemicaLs 91.25 Chemicals 78.48 ELectricaL machinery 91.74 Electrical machinery 55.36 TotaL 87.50 Total 65.25 By export orientation By export orientation Exporters 92.71 Exporters 67.48 Nonexporters 81.61 Nonexporters 62.e5 Total 87.45 TotaL 65.32 By size of firms By size of firms Small 81.55 Small 59.48 Large 93.31 Large 70.33 TotaL 87.50 Total 65.25 Source: WorLd Bank, Firm-Level Survey. Source: WorLd Bank, Firm-Levet Survey. 212 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries TABLE 13.14 and effective system of accounts, safeguard the integrity Requirement of a collateral for a loan of their assets, and devise a system of internal controls (percent) that will help establish the viability of the business.10 Loan Following the Statements of Financial Accounting Less than 6 months 12 months Standards, an enterprise must include a description of Category 6 months or longer or longer the accounting policies it has adopted as an integral part of the financial statements. Financial statements are By sector Food products 22.77 25.77 50.00 generated by an accounting process that follows the Textiles 37.29 41.38 55.00 generally accepted accounting principles (GAAP) on AppareL 25.25 29.90 50.49 three levels: pervasive principles, broad operating prin- ChemicaLs 18.67 19.18 56.41 Electrical machinery 17.65 21.00 35.64 ciples, and detailed principles. TotaL 23.39 26.59 48.65 The enterprise's "accounting principles" are the spe- By export orientation cific accounting principles and methods that are con- Exporters 21.97 25.00 45.61 Nonexporters 24.64 28.02 51.87 sidered by the enterprise as the most appropriate i TotaL 23.27 26.48 48.64 presenting its financial position, the changes in said By size offirms financial position, and the results of operations in SmaLL 23.56 25.49 46.98 accordance with the GAAP. Some examples of disclo- Large 23.25 27.60 50.22 Total 23.39 26.59 48.65 sure of accounting principles and methods are, among Source: World Bank, Firm-LeveL Survey. others, depreciation methods, amortization of intangi- bles, inventory pricing and overall valuation policy, respondents claiming that they were required to present methods of revenue recognition, and gains and losses a collateral for their loans with a maturity period of less on disposal of property. The GAAP also require the dis- than six months. By contrast, the electrical machinery closure of related party transactions including those sector had the lowest proportion of firms reporting that between a parent company and its subsidiaries, they were required to present a collateral for their long- between or among subsidiaries of a common parent, an term loans. enterprise and trust for the benefit of employees, and so Of those who said that they were required by their on. Transactions involving related parties cannot be banks to present collateral, 87 percent mentioned land presumed to be carried out at arm's length because the and buildings they had been using as collateral and 65 requisir.e conditions of competitive, free market trans- percent named machinery and equipment. Only 24 per- actions may not exist. Finally, the nature of the control cent mentioned stocks used as collateral. relationship among enterprises under common owner- In some cases, banks have required their borrowers to ship or management control must also be disclosed. have guarantors for their loans, especially if the bor- The Philippines has an Auditing and Standards rowers were unable to present an acceptable collateral Counc.l, established in 1987, which issues statements or if the collateral was inadequate. Twenty-nine (29) on the "Generally Accepted Auditing Standards." percent of the total number of respondents mentioned These standards are approved by the Board of having obtained guarantees on their financing. Large Accountancy and the Professional Regulation firms and exporters had a higher proportion of respon- Commission. The standards require the independent dents obtaining guarantees for their loans than small auditor to indicate whether the financial statements and nonexporting firms. A large proportion of them (60 present:ed conform to generally accepted accounting percent) mentioned their stockholders as their usual principles. guarantors, and one-fourth mentioned other banks. The generally accepted auditing standards are applic- able in the audit of the financial statements of banks, The levet and depth of accounting practices related financial institutions, and business enterprises. The primary objective of an audit is the statement of an Philippine enterprises are duty bound to adopt sound opinion by the independent auditor on the financial accounting policies and practices, maintain an adequate statements of a business enterprise. For this purpose, The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 213 the auditor studies and evaluates the accounting sys- wanting to cover their foreign exchange exposure-and tems and internal controls, tests the operation of those in the domestic interest rate. controls, and assesses the accounting transactions and The government issued Executive Order (EO) 465 on account balances. January 13, 1998, to modify the nomenclature and tar- There are more than 200 accounting and auditing iff structure of 22 industries identified as "Philippine firms registered with the Securities and Exchange winners." These are the industries that have proven to Commission (SEC). Almost all of them are located in the be competitive or shown some potential. EC, 465 was NCR; however, they also provide auditing services to the result of the review of the pace of tariff reduction firms located outside the NCR by sending audit teams. under EO 264 in consideration of the recent Asian In conclusion, it can be said that the existing account- financial crisis. ing and auditing systems are comparable to those of The rates of duty for certain tariff lines were either more developed countries. However, the actual raised or reduced under EO 465. Other tariff lines had accounting and auditing practices are different from the same rate as set under EO 264. It should, however, their respective standards. In particular, small- and be noted that EO 465 was not designed to delay the medium-sized firms seldom keep good accounting sys- attainment of a uniform tariff rate of 5 percent by 2004. tems and this is one of the reasons why banks seldom While it resulted in a small increase in the overall aver- lend to this group of borrowers. Also, it has been a gen- age nominal tariff rate from the pre-EO 465 level, the eral practice among firms to keep two books of overall effective protection rate actually went down. accounts, one for their creditors (this is called the "in- The government secured in December 1998 from the house financial statement") and one for the Bureau of World Bank US$150 million for the Private Enterprise Internal Revenues (BIR) for tax purposes, and the dif- Credit Support Project, which aims to help enterprises ference between the two is glaring. This is complicated restructure and meet their permanent working capital because auditors certify only the accuracy of the needs, improve productivity, and create jobs. It also accounting information and methods used, not neces- secured another US$150 million from the World Bank sarily the veracity of the information. This is because for its Third Rural Finance Project, which will assist under the Philippine practice, much depends on the farmers and agribusiness undertake new pro jects, and willingness of the firm to disclose pertinent information finance working capital requirements. A US$7 million about itself and the project. Therefore, audited financial microfinance component is included in the project to statements are as good as the amount and quality of supplement ongoing microfinance programs and help information provided by the firm. Under this environ- satisfy demand for credit by small-scale enterprises. ment, the problem of asymmetric information persists. Short-run prospects Measures to assist Philippine enterprises A great majority of the sample firms were not optimistic Concerned about the rapidly deteriorating condition of about the economy in general, and their situation in the corporate sector as the crisis continued to deepen, particular, regarding the six months followingy the sur- the government introduced some measures to alleviate vey. Almost half thought that their capacity utilization the firms' plight. rate, which had already significantly dropped since the The Bangko Sentral ng Pilipinas created in December onset of the crisis, would remain the same, while one- 1997 the Currency Rate Protection Program, which fourth were expecting a further decline (see figure essentially is a nondeliverable forward facility, to pro- 13.12). Only 27 percent were optimistic--namely, tect corporations with foreign exchange liabilities expecting a rebound in their capacity utilization rate in against currency fluctuation risk. Since this program the next six months. In terms of export orientation, can spread the demand for dollars between the spot and results suggest that nonexporters were more pes- forward market, it can also ease the demand pressure in simistic-they expected the rate to decline fiarther or both the spot market-caused by corporate borrowers remain the same in the next six months-than exporters. In terms of size, small firms were more pessimistic than 214 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries FIGURE 13.12 While banks are now much more discriminating in Expected output, June-December 1999 lending to the business sector, the decline in total loan growth in 1998 could also be attributed to the lower 50 OM Decrease demand for credit, which was brought about by the 40 * Increase sharp reduction in demand for goods produced by the El Same firms during the crisis period. 30 The significant drop in the firms' capacity utilization rate andl output during the crisis period would normally 20 have required a drastic cut in the workforce. However, 0_ to minimize layoffs, the sample firms resorted to other means, such as reducing the work week or work days, 0 applying forced vacation leave, and freezing salary Source: World Bank, Firm-Level Survey. increases, to save some jobs. This study has generally confirmed the adverse impacts of the financial crisis on the manufacturing sec- large firms. When classified according to sector, it tor; however, it also yields some positive signs that the appears that the apparel sector was the least pessimistic government can use as a platform for formulating poli- and the textile sector the most pessimistic about busi- cies and programs to stage a rapid economic recovery. ness prospects in the short-term. First, most of the firms surveyed were still earning prof- its, alb it declining in the last two and a half months. If Conclusions and recommendations the worst of the crisis has already passed, then these firms can quickly rebound, using partly their profits to The survey results clearly show that the capacity uti- finance their growth. Second, most of the firms still lization rate of the Philippine manufacturing firms have access to credit, although at a relatively higher started to decline even before the crisis struck in July price. A reduction in the interest rate will surely help 1997, and that it continued to drop as the crisis deep- them a lot during the recovery period. Third, although ened. While the recent drop can be attributed to the the firns resorted to some cost-cutting measures, most slowdown in both the domestic and foreign demand for of thern preferred to preserve jobs, a strategy they think goods and the sudden rise of the interest rate and of the will pay off once the crisis fades away. With most of cost of inputs (especially imported inputs), thereby their core staff intact and excess capacity readily avail- squeezing the firms' profits, the earlier drop could per- able, a resurgence in demand will certainly be most wel- haps be attributable to overinvestment made by the come by them. firms in building additional capacity given a much more All this leads us to conclude that the most appropri- liberal and cheaper access to external sources of funds. ate policy that the government could adopt now would Thus, the current capacity underutilization may be be an expansionary one to stimulate aggregate demand. attributed to both cyclical and structural factors, which Both rnonetary and fiscal policies are required to sup- call for demand management as well as industrial port such an expansionary policy. restructuring policy measures. There is still some room for relaxing monetary policy. As the crisis deepened, it seems that a consensus First of all, the inflation rate had already started to emerged: the firms were facing a credit crunch. In other come down last February. The agricultural sector-par- words, institutional lenders had stopped lending to ticularly the crop subsector, which suffered a large them because of the highly volatile economic situation. decline in 1998 as a result of the El Nino weather phe- The results of this study do not provide clear evidence nomenon-is expected to rebound in 1999. Second, the on the existence of a supply-side credit crunch during reserve money level during the February 1999 test the crisis period. It should be noted that a great major- perioc6 was found to be P30 billion below the level ity of surveyed firms still had uninterrupted access to agreecl upon between the government and IMF under institutional loans, albeit at a much higher interest rate. the existing standby arrangement program. The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 215 The relaxation of the monetary policy, which will mass housing projects in their respective localities. Of push the interest rate down, can accomplish four things. course, the government housing finance system has to One is that it will lighten the debt-service burden of be reformed quickly so that it can efficiently provide the enterprises, freeing some resources that can be used to services the public requires of it, without necessarily dis- meet increased demand for goods. It can also reduce the sipating its funds. cost of debt restructuring, whenever resorted to by both To support its pump-priming measures in 1998, the enterprises and banks. Still another benefit is that it can government tapped foreign sources of funds to avoid stimulate consumer spending and revive the sagging crowding out the private sector and also secure foreign consumer durable goods sector. Finally, it can help exchange to beef up the country's international arrest the appreciation of the peso in relation to the U.S. reserves. Since private sector demand for funds is still dollar and improve the competitiveness of the export down and the interest rate has already come down to sector, which has been stimulating the economy during the precrisis level, it would be worthwhile for the gov- this crisis period. ernment to secure funding for its pump-priming mea- There is a limit to how much of the task outlined sures for 1999 from the local market, where the cost of above can be accomplished by monetary policy. financing is now lower than in foreign markets. Pushing the interest rate further down and exhorting Finally, the recent crisis has underscored the impor- banks to lend to private enterprises would not be suffi- tance of keeping a flexible exchange rate policy. cient to stimulate growth unless demand for goods is However, even if a flexible exchange rate policy is pur- increased with the help of fiscal policy. Thus, on the fis- sued and corporate governance is improved, the level of cal side, the pump-priming measures should continue in foreign capital inflows experienced by the country 1999, focusing on the critical sectors of the economy, before the Asian financial crisis is unlikely to be specifically the agriculture sector, which has the most attained in the near term unless additional measures are extensive linkages with the rest of the economy, and the put in place. One way is to liberalize further the entry of social sectors, such as health, education, and housing. foreign banks into the country, preferably allowing for- However, there are two important programs that the eign banks to wholly own domestic banks-either by government could launch to help the labor and manu- establishing new subsidiaries or buying existing ones, facturing sectors directly. One is to provide skill train- especially those that are not well capitalized. The pres- ing programs for those who have been laid off as a ence of more foreign banks in the country can certainly result of the retrenchment undertaken by firms in the breathe new life into the banking system and make wake of the crisis. These programs should be offered in additional capital available to the Philippine economy. various regions of the country so that the benefits can be widely spread. It should be noted that those who were laid off are younger, and therefore most probably less experienced and less skilled-but highly trainable. The government may give incentives to those firms that have resorted to reducing work hours and days to encourage them to offer their unutilized facilities and perhaps the slack time of their senior staff for training. The other is for the government to stimulate the hous- ing sector, which is a strategy with direct short-term economic and social impact. There is still a huge back- log of housing units, especially for lower middle class and poor households, in the country today. One of the ways of doing this is to strengthen the Home Insurance Guarantee Corporation so that it will have additional resources to provide guarantees to bonds to be issued by local government units for the purpose of financing 216 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries Annex 13.A Sector Industry codes Description 1. Food products 1512 Production, processing, and preserving of maat and meat products 1513 Production and preserving of fish and fish products and other seafoods 1514 Processing and preserving of fruits and vegetabLes 1515 Manufacture of vegetable and animaL oils ard fats 152 Manufacture of dairy products 154 Manufacture of starches and starch products 156 Manufacture of bakery products 157 Manufacture of sugar 158, 1593, 1594 Manufacture of coconut-based products 1591 Manufacture of cocoa, chocoLate and sugar confectionery 1592 Manufacture of macaroni, noodles, couscous, and simiLar farinaceous products 1595 Coffee roasting and processing 1599 Manufacture of other food products, nec (eg, soup, vinegar, nuts) 2. Textiles 171 Spinning, weaving and finishing of textiLes 172 Manufacture of other textiLes 173, 174 Manufacture of knitted and crocheted fabrics and articLes; manufacture of embroidered fabrics 3. Wearing apparel and footware 181 Ready-made garments manufacturing 189 Manufacture of wearing apparel, nec 192 Manufacture of footwear 4. Chemical products, rubber 2411 Manufacture of basic chemicaLs except fertiLizers and nitrogen compounds 2412 Manufacture of plastics in primary forms and of synthetic rubber 2423 Manufacture of paints, varnishes and similal- coatings, printing ink and mastics 2424 Manufacture of pharmaceuticaLs, medicinaL chemicals and botanicaL products 2425 Manufacture of soap and detergents, cleaninig and poLishing preparations, perfumes and toilet preparations 2429 Manufacture of other chemicaL products, nec (e.g. matches, ink, gLues and adhesives) 243 Manufacture of man-made fibers 251 Manufacture of rubber products 252 Manufacture of pLastic products 5. Electrical machinery 311 Manufacture of eLectric motors, generators and transformers 312, 313 Manufacture of eLectricity distribution and control apparatus; manufacture of insuLated wire and cables 321, 322 Manufacture of eLectronic vaLves and tubes; manufacture of semiconductor devices and other eLectronic components 323, 324 Manufacture of teLevision and radio transmitters and apparatus for line telephony and Line teLegraphy; manufacture of teLevision and radio receivers, sound or video recording or reproducing apparatus, and associated goods The Impact of the Southeast Asian Financial Crisis on the Philippine Manufacturing Sector 217 Annex 13.B Industry stratum/sector ATE class 20-49 50-99 100-199 >=200 % of total Total Frame 46.9 21.1 15.7 16.4 100.0 SampLe 19.3 17.2 18.0 45.5 100.0 Food products % frame 54.1 21.0 11.5 13.3 32.0 % sampLe 18.1 17.4 19.6 44.9 22.0 Textiles % frame 40.1 24.1 11.5 13.3 32.0 %o sample 21.3 23.2 18.5 37.0 18.0 Wearing apparel and footware % frame 46.8 19.7 15.8 17.7 20.0 % sample 15.6 12.5 13.7 58.2 22.0 Chemical products, rubber % frame 46.3 22.1 19.4 12.2 23.0 % sampLe 20.3 15.2 16.9 47.6 20.0 Electrical machinery % frame 21.8 19.0 21.8 37.5 6.0 % sampLe 21.8 19.0 21.8 37.5 18.0 Notes or regression anaLysis to test some hypotheses. The authors p[an to do this in subsequent studies using the same database. The authors are with the PhiLippine Institute for Development 3. The issue regarding the impact of the crisis on the firms' access Studies (PIDS). The survey of sample firms, which was conducted by to capitaL is discussed in greater detail beLow. the NationaL Statistics Office (NSO), and this report were funded by 4. This issue wiLL be discussed in greater detail beLow. the WorLd Bank. The authors are gratefuL to Ms. OfeLia M. Templo, 5. The NWPC serves as the consuLtative and advisory body to the Assistant Director General of the NationaL Economic and DeveLopment President on matters reLating to wages, income, and productivity-and Authority, for providing direction to the research team. The authors aLso exercises technical and administrative supervision over the RWPTBs. are aLso gratefuL to Ms. Ma. CheLo V. ManLagnit and Ms. Hope A. Gerochi 6. Business World. for research assistance and to Ms. Juanita E. ToLentino for secretariaL 7. Another P100 miLLion has been added to the initial fund of P200 assistance. This report is avaiLabLe at the Institute's web site: million. http://www.pids.gov.ph. 8. This is based on the median. 1. For example, see Lamberte (1999) and Virtucio (1998). 9. See below for a discussion on the credit crunch. 2. There is no attempt in this study to do cross-tabulation analysis 10. This section draws on Lamberte and Llanto (1995). 218 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries Thailand: The Road to Recovery Fiscal Policy Office and the Office of Industrial Economics, Bangkok, Thailand his report presents the results of a comprehensive survey-conducted T from October 1998 to February 1999-of 700 firms in key manufac- turing sectors in Thailand. The survey provides microeconomic-level information on the impact ol0 the financial crisis on output, employment, cor- porate finance, and profitability. It also provides insights into the efficacy of government programs, and -he prospects for corporate recovery as seen by these firms. Similar studies undertaken in Indonesia, the Republic of Korea, Malaysia, and the Philippines allow for regional comparisons and the possibil- ity to benchmark firm performance. The macroeconomic story of the crisis has become a familiar one. Until now, however, much less has been known about the microeconomic-level impact of the crisis and how firms have responded over the last 18 months. Based on new information collected from 642 establishments in five principal manufacturing sectors, this paper provides insights into the key difficulties facing the firms and relates them to the policy environment and policy reforms enacted by the gov- ernment in response to the crisis. After having enjoyed a reab annual growth rate of 9.6 percent between 1986 and 1996, Thailand sufferecl a sharp economic downturn with the combina- tion of currency and financial crises in 1997 as a result of the unsuccessful defense of the currency and the weak banking system. At the onset of the cri- sis, Thailand faced four major macroeconomic problems: * Net international reserves were depleted because of the unsuccessful defense of the Thai baht; * There were systemic problems in the financial sector; * The real sector faced a serious liquidity shortage; and * Regional economic turmDil was a significant constraint in terms of the country's ability to resolve its economic difficulties. 219 The substantial depreciation of the baht instantly the already rich findings from Dollar and others (1998), brought soaring costs of foreign debt servicing and for- this paper further investigates (a) whether all these eign exchange losses to those firms that had borrowed issues have become apparent to Thai industries (and in heavily abroad or imported their inputs. This com- what ways, if they have), and (b) to what extent the pounded the difficulties facing firms whose profits had recent monetary and fiscal policies have become effi- already been squeezed by rising labor costs throughout ciently implemented from the perspective of key indus- the 1990s. Things got even worse after the economic trial sectors. In line with the previous finclings the turmoil spread to other Asian tiger countries' and empirical results indicate that: became the so-called Asian Financial Crisis. The depre- * From 1997 to the first half of 1998, macroeco- ciation of currencies across the region and the growth ill nomic stability came at the price of shrinking excess capacity in many manufacturing sectors meant domestic demand, output decline, and high unem- that firms faced declining export prices in U.S. dollar ployment. terms at the same time that many saw their costs * There was little evidence of a severe credit crunch increasing. after the crisis. However, the survey does slhow that To restore economic stability swiftly, the government the availability of credit has been declining. initially pursued tight monetary and fiscal policies by * Toward the end of 1998, there were some signals of imposing temporary capital controls, raising interest improvement in the firms' financial conditions and rates and running budget surpluses-which eventually growing confidence in the current policy environ- prevented the baht from entering a free fall and brought ment. However, substantial corporate restructuring stability toward the end of the first half of 1998. has yet to begin and strengthening long-term com- Unfortunately, economic stability did not come without petitiveness has become an important issue. a price. Domestic demand plunged at both the house- This paper is organized as follows. The next section hold and corporate levels. Furthermore, the soaring describes the industrial survey regarding the sectors domestic interest rates raised the firms' costs of debt ser- covered and the sample composition. This is followed vicing considerably. The economic slowdown in by a section discussing the impact of the crisis on the regional trading partner countries also brought signifi- surveyed firms such as changes in demand, level of pro- cant falls in foreign demand. Consequently, corporate duction, employment, profit margins, and capital struc- profits declined sharply, and hence impaired firms' abil- ture. The subsequent section presents an in-depth ity to pay back their debts. With accumulating nonper- analysis of the constraints to corporate recovery and forming loans, the financial sector became risk-averse their implications on government policies. The issues and was less willing to give credit to the corporate sec- addressed include global demand, credit availability, tor. Therefore, many firms were left with insufficient and industrial competitiveness. Prospects for the first working capital and unable to sell their goods, faced the half of 1999 and policy recommendations are discussed real prospect of becoming insolvent. in the last main section. Finally, key macroeconomic Nevertheless, in recent months financial conditions data and methodology are presented in annexes 14.A have continued to improve. The strengthening of mar- and 14.B. ket confidence has extended beyond the exchange rate to declining inflation and a leveling-off in indicators of Description of the survey production and demand. Fiscal policy has been assigned the task of supporting domestic demand by The data used in this paper come from the Office of expanding fiscal deficits while interest rates have been Industrial Economics and the World Bank's 1998-99 allowed to decline substantially in line with improved survey of Thailand's manufacturing sectors, which is a market confidence and falling inflationary pressure. follow-up to the similar survey conducted between (See figure 14.A.1.) October 1997 and March 1998. (See Dollar an, others Using data from the Office of Industrial Economics (1998) for a description of the first survey and its find- and the World Bank's 1998-99 Industrial Survey and ings.) There were five manufacturing sectors selected 220 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries for the surveys, based on their contributions to the FIGURE 14.1 country's export and GDP. The five sectors are (1) gar- ments, (2) textiles, (3) electronics, (4) food processing, Sampte distribution and (5) auto parts. (See tables 14.A.1 and 14.A.2 for (percent) sector shares.) In the 1998-99 survey, each establish- Sectors Firm sizes ment was asked over 300 questions on the plant's pro- _ 32 3 duction, financial structure, and labor force in 1996, ' 1997, and the current period. Close to 90 percent of the 10 1,227 establishments surveyed in 1997 (1,107 estab- lishments) survived the year and were still engaged in 7 manufacturing operations in 1998. Out of 1,107 inter- 17 21 viewees, 642 establishments were re-interviewed. Thus, a 58 percent response rate was achieved for the second U Ga ments Li Electronics Cl SmaLl * Large survey during November 1998 and February 1999. E Te tiLes A Food The sectoral coverage of these establishments is dis- * Auto parts tributed unequally, in part as a reflection of the differ- Export onentation Foreign controL ent numbers of establishments in each sector in the 9 broader manufacturing population. Thus, fewer foodfo7 processing plants are included in the sample, in line 44 with the smaller number of such plants overall. In the sample, about one-third of the firms are relatively new, 55 having been established since 1990; one-third are large, 2 with over 150 employees; 55 percent export at least some of their output, and 29 percent have a partnership 1 Nonexporters 1E None * Some or joint venture with a foreign firm. (See figure 14.1 and * Exporters E:1 TotaL tables 14.1 and 14.2 for more details regarding the l characteristics of the sample.) While the sample of firms was chosen randomly to minimize possible biases and to allow for statistically Changes in domestic and foreign demand significant analysis, it should be noted that as a re- suvey, there is a bias in favor of more successful firms. The downward pressure on the Thai and neighboring Firms that had to close because of current economic dif- economies caused by the currency depreciation brought ficulties would have been less likely to participate in the substantial declines in both domestic and foreign survey, so the results tend to represent upper bounds, or demaad. However, from the perspective of the Thai more optimistic projections, of firm performance relative firms that were surveyed, the impact of the contraction to the entire population of firms in the Thai economy. of domestic demand was larger than that of foreign demand. Approximately 82 percent of the nonex- Corporate adjustments to the crisis porte^s addressed the shrinkage in domestic demand as their major current difficulty, whereas 51 percent of the This section will use the microeconomic evidence from exporters reported a decline in foreign demand as a sig- the survey to analyze the impact of this crisis in five con- nificant concern. In part this reflects the fact that not all texts: (1) changes in domestic and foreign demand, (2) of these firms export, but also that losses in exports to changes in the level of production, (3) changes in the the crisis countries were partly offset by gains in exports level of employment, (4) changes in profit margins, and to no ncrisis countries such as the ones in the Euro Zone (5) changes in the capital structure. and North America. Firms whose primary export market is within the region (including Japan) were significantly Thailand: The Road to Recovery 221 TABLE 14.1 Characteristics of the sample By size By export orientation By volume of exports Byforeign control FDI firm Average no. of Large Small Exporters Nonexporters Small Medium High None Some Total Yes No employees Total Sector Garment 64 130 133 73 5 23 93 167 31 3 42 159 236 207 TextiLes 41 85 53 84 6 19 24 113 15 6 24 110 201 138 Electronics 43 48 68 38 8 18 31 50 20 34 61 43 443 106 Food 33 22 45 19 7 5 29 42 16 4 22 40 718 64 Auto parts 40 83 56 68 8 23 16 91 25 9 38 87 268 127 Age New 86 131 133 94 9 32 74 160 40 22 70 152 342 230 OLd 130 225 214 178 23 23 54 116 288 65 33 113 273 300 Location Non-BKK 47 41 70 30 7 16 36 57 20 23 49 51 502 101 Grtr. BKK 174 327 285 252 27 72 157 406 87 33 138 388 279 541 Total 221 368 355 282 34 88 193 463 107 56 187 439 312 642 Source: Office of IndustriaL Economics. TABLE 14.2 Profile of the firm Borrow in foreign currency Size Export orientation Foreign control FDI firm Yes No Large Small Exporters Nonexporters None Some Total Yes No Total Financial indicators Short-term debt/total financing 0.43 0.29 0.42 0.27 0.39 0.25 0.32 0.29 0.52 0.36 0.3-. 0.32 Long-term debt/totaL financing 0.18 0.26 0.21 0.26 0.23 0.25 0.25 0.27 0.07 0.22 0.24 0.24 Debt-equity ratio 4.21 3.40 4.4 3.2 3.89 3.32 3.53 3.20 5.20 4.01 3.4:. 3.62 Firm characteristics Number of empLoyees 593 215 736 58 471 130 229 559 653 611 201 312 Share that export () 85 44 79 38 100 0 46 77 96 81 45 55 Share that are FDI (%) 59 18 45 17 43 12 5 100 100 100 0 29 Response to the crisis Current capacity utiLization (%) 64 60 67 57 67 55 60 64 66 64 60 61 Share with few workers 46 53 45 56 41 63 53 52 36 48 53 51 Optimistic for future growth 32 19 28 19 30 13 21 20 41 27 21 22 Total 27 73 34 57 55 44 72 17 9 29 68 100 Source: Office of Industrial Economics. more likely to see their exports decline and to cite a fall lishments reported an increase in their export volume. in foreign demand. Yet, over 60 percent of these establishments identified Among the 34 percent of establishments whose price competitiveness and exchange rate effects as their export volume declined, 49 percent, 56 percent, and 58 major sources of export increases. This opposite effect percent identified, respectively, loss of price competi- caused by price competitiveness reflects the currency tiveness, unstable political and economic conditions in depreciation of crisis countries and the fact that export markets, and a fall in foreign demand as their regional excess capacity helped to drive down dollar- major concerns. By contrast, 41 percent of the estab- export prices. Increasing export volumes is thus not suf- 222 Asian Corporate Recovery: Findings from Firm-Level Surveys in Five Countries ficient to ensure improved firm performance if the val- pliers were more willing to give credits and services to ues of exports are falling at a higher rate. larger firms, owing to their higher buying volume. Respectively, 27 percent and 21 percent of the small Changes in the leve( of production firms reported supplier credits and goods deliveries as their major difficulties-compared with 16 percent and In keeping with changes in demand, 70 percent of the 5 percmt for the large firms. surveyed establishments reported a decline in their level Likewise, 74 percent of the non-foreign direct invest- of outputs after the crisis. The average capacity utiliza- ment (FDI) firms reported a decline in output compared tion fell down from 71 percent in the first half of 1997 with 63 percent of the FDI firms. Firms with no foreign to 61 percent in the first half of 1998, or a 12 percent ties were more likely to experience a decline in output reduction in utilization rate for each surveyed firm. than those with foreign ties (that is, those that are under These establishments cited a contraction in domestic foreign control or are joint venture firms), which is demand and a sharp increase in input costs caused by attributable to the smaller share of exporters among the currency depreciation as their major sources of output non-F DI firms (45 percent compared with 81 percent in decline. Interestingly, these firms perceived access to the F]DI firms). capital as a less severe problem. Over 70 percent of The sector that experienced the greatest fall in output them identified a fall in domestic demand and higher is auto parts, with a 25 percent decline in the utilization input costs from currency depreciation as their major rate. Of all the sectors, it is the one most influenced by problems, while less than 35 percent and 52 percent, the state of the domestic economy. New cars or motor- respectively, reported access to working capital and cycles represent large durable good purchases that costly loans as their main obstacle. many consumers have decided to postpone in this time The degrees to which the firms experienced a decline of crisis. Electronics is the other sector that has been hit in production varied by firm characteristics. About 84 particularly hard, with a 22 percent decline in utiliza- percent of the nonexporters reported a decline in their tion. While geared toward export markets, the firms output after the crisis, compared with 60 percent of have suffered from excess capacity within the region exporters. There was also a significant difference in the and the largest fall in export prices.2 (See figures 14.2 reduction in utilization rate between the nonexporters through 14.4.) and the exporters; on average, capacity utilization fell by 10 percent more for the former. This reflects the fact Changes in the Level of employment that the contraction in domestic demand was larger than that of foreign demand as mentioned in the previ- The downward trend in the level of production led to a ous section ("Changes in domestic and foreign decline in employment during the crisis. However, these demand"). changes in employment were smaller than those in out- By the same token, 79 percent of the small establish- put l,vels. Even though 70 percent of the surveyed ments (compared with 60 percent of the large establish- establishments reported a decline in their outputs after ments) reported a decline in output after the crisis. the crisis, approximately 50 percent reported a decline These small establishments experienced a 13 percent in employment. This is because these firms, to some decline in utilization rate, compared with 11 percent extent, were committed to their workers. In addition, among the large establishments. This partly reflects the labor and welfare regulations (which are costly sever- fact that over 60 percent of the small firms were nonex- ance compensation payments) might turn them away porters, while nearly 80 percent of the large firms were from laying off their workers. Therefore, firms pre- exporters. In addition, being labor-intensive, high labor ferred other measures (such as reducing the length of costs had more impact on the small firms' production the workweek and cutting administrative costs) over costs than on that of the larger firms. Nearly 56 percent laying off workers. of the small establishments identified high labor costs as Or ly 17 percent of the firms that experienced a reduc- their major sources of output decline, compared with tion in employment identified layoffs as the measure 38 percent in the large establishments. In addition, sup- they had adopted during the crisis. However, over 70 Thailand: The Road to Recovery 223 percent of them reported not filling vacancies and ask- lishments whose number of workers either decreased or ing for volunteer leave, and about 46 percent reported remained the same. About 41 percent of them used paying severance compensation as the actions they rotational work shifts and 38 percent reduced the took. Also, other alternatives were used among estab- length of their work week. Similar to changes in the level of production, the FIGURE 14.2 \ extent to which surveyed firms experienced a decline in FIGURE 14.2 employment-and the employment policies they Capacity utilization by sector adopted to cope with the crisis-varied by firrm charac- Percent teristics. Larger shares of the small firms (56 percent) 90 and the nonexporters (63 percent) reported a (lecline in their level of employment, compared with .he large 80 firms (45 percent) and the exporters (41 percent). Close to 80 percent of the small establishments and 60 percent 70 = = L _ L of the large establishments experienced declines in out- put, whereas, respectively, 56 percent and 45 percent 60 * *; 0 | l 0 | l0000 reported decreases in employment. This reflects their difference in work force reduction policies. Ihe man- 50 * 0 l: 0 000 l0:;0 E 000 agement and owners of the small firms tendecd to have closer ties with their workers. Consequently, aggressive 40 * ll [ l l 11 [ ~~~~policies such as layoffs and severance compensation Garments TextiLes ELectronics Food Autoparts Atl Sectors payment were more preferable among the large firms, *Capacity utilization 1996 *Capacity utiLization 1H 1997 whereas defensive policies such as not filling vacancies and volunteer leave were chosen byv the small firms. Of H Capacity utilization 2H 1997 E Capacity utilization 1H 1998 the smll eab e 71 perent and 6prcent, the small establishments, 71 percent and 63 percent, Source: Office of Industrial Economics. FIGURE 14.3 Perceived causes of current output decline Domestic demand Foreign demand Depreciation Labor costs Costly loans Heavy debt burden Wk. capital Expans. credit Suppl. credit U Nonexporters Raw materiaLs 5 Exporters Nondelivery of goods |- p @ 99Go9s<,OR