EAST ASIA BRIEF Regional Overview Special Focus: Asian Trade Special Focus: Poverty during Crisis and Recovery Country Briefs: China Indonesia Korea Malaysia The Philippines Thailand Vietnam September 2000 East Asia and Pacific Region The World Bank REGIONAL OVERVIEW EASTASIA'S RECOVERY: · The buoyant external market continues to be a positive GATHERING FORCE engine of growth. This has made trade integration with the global economy even more attractive-- East Asia's recovery continues at an impressive pace. international trade is likely to grow by 11 percent Growth for the region as a whole was 6.4 percent in 1999 annually this year, double last year's rate. Growth in and is on a pace to exceed that rate in 2000. Growth among export revenues has mitigated the twin negatives of the five crisis-affected countries remained robust, if with the rising global costs of capital associated with wider dispersion around the growth mean. The transition monetary tightening in the US and the rising East Asia countries of China and Vietnam have moved to sounder risk premium associated with emerging markets ground on a high growth plateau. The newly industrialized generally. No wonder that the major regional policy economies--Taiwan (China) Singapore and Hong Kong developments in the last two quarters entailed two key (China)--are now expanding rapidly. Finally, the small countries leveraging this resurgent global demand to countries, save for the strife-riven islands, are benefiting promote their faster domestic growth: China's WTO from the rising regional tide (Figure 1). prospective entry and Vietnam's bilateral trade arrangement with the US. (See "Special Focus: Asian Figure 1: Growth rate in East Asia resumes... Trade".) (Real GDP growth, yoy) · Policy efforts throughout the region to provide 15 stronger structural underpinnings to the recovery have 10 EA5 paid dividends in the form of more rapid growth and reductions in poverty. Here too dispersion of policy 5 China NIEs effort is wide and roughly correlated to the present 0 outlook. Korea and Malaysia (from quite different -5 starting points) have undertaken the strongest efforts -10 in restructuring their distressed corporations and -15 banks, and reducing policy barriers to entry 97 97 97 97 98 98 98 98 99 99 99 99 00 (particularly to foreign direct investment in the case of Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Korea). These countries have experienced the sharpest Four patterns, vaguely discernible earlier in the year, have rises in domestic equity markets, rapid declines in now become clearer: costs of external capital, and most rapid overall economic growth. China's accession to WTO, and-- · The recovery is becoming increasingly broad-based more important--its continued progress on reforms across the region, even as the dispersion in country necessary to secure the benefits from greater growth rates widens. Korea, China, Malaysia and the globalization have had similar positive consequences. NIEs are setting a blistering 6.5-8.5 percent pace. The risks to the recovery have receded since the beginning Thailand and Vietnam, for quite different reasons, are of the year. This is because the pre-crisis forms of in a second tier range of strong recovery (4.5-6 vulnerability continue to fall ­ for example, the short-term percent this year), with the clear potential to move into debt to reserves is far lower in all countries, the explicit the high-growth camp but with fitful progress on foreign exchange rate guarantee has been withdrawn, and reforms hampering full acceleration. Some of the the high leverage ratios in the corporate sectors have smaller countries--Mongolia and Cambodia--also gradually come down. Equally important, the international fall in this tier. Even the slower growing economies of environment is moving onto more certain footing and Indonesia, the Philippines, and PNG have picked up progress on domestic policy continues to accumulate. steam at about 4 percent, though all face a wider range of uncertainty in domestic policy implementation. Nonetheless, because the crisis has left three enduring Only the Pacific Islands, torn by racial strife and legacies--heavy debt, skittish investors and greater political instability, are still suffering deep recession. household insecurity--the region remains vulnerable to · demand shocks. Recovery remains dependent on the Throughout the region, expanding economies are virtuous cycle that growth has unleashed. If demand beginning to reduce poverty. In all of the crisis- should suddenly collapse, companies that can now pay affected countries, poverty rates have come down their debt and are beginning to invest could quickly go from their heights during the 1998 recession. Falling under. Governments that depend on rebounding revenues unemployment has begun to restore lost incomes and to service debt might suddenly have to cut back on social growth has raised rural incomes. (see "Special Focus: or other important spending. Investors ­ domestic and Poverty During Crisis and Recovery") September 18, 2000 2 East Asia Brief foreign -- have emerged from the crisis much more fleet- As the recovery exhausts the rebound phase from the footed, ready to exit at the slightest provocation. Finally, 1997-98 recession, sustaining rapid growth rates will turn the poor and near-poor, having seen their incomes fall increasingly on unlocking new sources of productivity already, may be less patient with governments that ask growth, and this in turn requires ever greater policy them to sacrifice yet more. For these reasons, maintaining attention to improving institutions--particularly businesses the pace of growth well into the future is not only and governments. While much of the legal framework desirable, it is essential to provide time to reduce these necessary to sustain high growth is coming into place, it weaknesses. will take many more years to weave the necessary Threats to growth, while lower than 6 months ago, are still institutions to produce sustained increases in productivity. present. They continue to emanate from slow or imperfect These are the issues at the heart of the medium-term policy initiatives and from an always possible global or development agenda. regional downturn. (Intra-regional political strife, though less probable, would be particularly devastating and merits Good News: Strong Recovery in 2000 continued attention.) Governments have to maintain focus on removing the main remaining drags on growth: dealing The outlook for 2000 has improved across the board. The with the domestic debt overhang in banks and EA5 are expected to grow in the 4.0-8.5 range, the corporations, and improving public institutions that transition countries between 5.0-8.0 percent, and the small provide the services necessary to better compete in the countries in the 3-6 percent range, except for the Pacific global environment and mitigate households' insecurity. Islands (Table 1) Table 1: East Asia's prospects remain bright.. Real GDP % change Actual Projection 1996 1997 1998 1999 2000 2001 East Asia 5 Indonesia 8.0 4.5 -13.7 0.2 4.0 4.0 Korea 6.8 5.0 -5.8 10.7 8.5 6.5 Malaysia 8.6 7.5 -7.5 5.6 8.0 6.0 Philippines 5.8 5.2 -0.4 3.3 4.0 4.5 Thailand 5.5 -1.3 -10.0 4.2 4.5 4.5 Transition Economies China 9.6 8.8 7.8 7.1 8.0 7.5 Vietnam 9.3 8.2 5.8 4.4 5.0 4.5 Small Economies Mongolia 2.4 4.0 3.5 3.5 4.0 4.5 Cambodia 7.0 1.0 1.0 5.0 5.5 5.5 Lao PDR 6.8 6.9 4.0 7.3 6.0 6.0 PNG 3.5 -4.6 2.5 4.2 3.4 2.7 Fiji 3.4 -1.8 -3.7 7.8 -15.0 4.0 Solomon Islands 0.6 -0.5 -7.0 -0.5 -20.0 2.0 East Asia NIEs Hong Kong SAR 4.5 5.3 -5.1 3.1 8.7 4.4 Singapore 7.5 9.0 0.3 5.4 8.1 6.4 Taiwan (China) 5.7 6.8 4.8 5.4 6.6 5.9 Japan 5.0 1.4 -2.8 0.3 1.9 2.0 Source: World Bank for EA5, Transition and Small Countries; World Bank DECPG for Japan; Consensus Forecast September 2000 for Hong Kong(SAR), Singapore, Taiwan (China). with an accommodating monetary policy that provided East Asia 5 low interest rates, a fiscal stance that has begun to consolidate, and sufficient progress on structural reforms Within the crisis affected five countries of East Asia-- to provide confidence to investors (Figure 2). Inflation Korea, Malaysia, Thailand, Indonesia and The has stabilized at low rates. And even the strong oil price Philippines--macroeconomic policy remained stable, rise has only shown up as a small up-tick in the headline September 18, 2000 ` Regional Overview 3 inflation rate. As a result, interest rates have remained rates have also broadly stabilized (except for Indonesia), below pre-crisis levels, despite up-ticks of 50-100 bp in both in nominal and real terms, at currency values 15-20 Korea, Indonesia, Malaysia and Thailand in response to percent lower than their their pre-crisis level in real terms, rising global rate increases. The low inflation, low interest providing a healthy boost to exports. rate environment has been particularly beneficial in the unwinding of the domestic debt problem faced by firms and consumers in the crisis-affected countries. Exchange Figure 2: East Asia 5 Surge in 2000 Monetary policy provides low, stable interest rates... ...while fiscal policy remains expansionary EA5: Nominal Interest Rates % EA5: Consolidated Budget Balances, 100 % of GDP, 1996-2000 90 80 70 60 Indonesia 4 50 2 40 0 1996 30 Thailand -2 -4 20 2000 Philippines -6 Korea 10 -8 Malaysia 0 Indonesia* Korea Malaysia Philippines Thailand * Central Government defict only (FY basis) ...allowing imports to recover... ...and reserves to continue increasing ... EA5: Reserves US$ Billion 115 EA-5: Trade US$ Billions 105 Exports 210 200 95 190 180 170 85 160 150 140 75 130 120 Imports 110 65 100 90 80 55 97 97 97 97 98 98 98 98 99 99 99 99 00 00 1997 1997 1997 1997 1998 1998 1998 1998 1999 1999 1999 1999 2000 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 ... and recoveryto gain momentum ...on a foundation of lower risk. Quarterly GDP growth rate yoy % change Short-term Debt to Reserves Ratios 250 15 Korea 10 200 June 1997 5 Philippines 0 150 -5 Thailand 100 March -10 Malaysia 2000 -15 Indonesia 50 -20 -25 0 1997 1997 1997 1997 1998 1998 1998 1998 1999 1999 1999 1999 2000 2000 China Indonesia Korea Malaysia Philippines Thailand Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 source:BIS September 18, 2000 4 East Asia Brief This environment allowed Korea to grow at 10.7 percent last year and seems likely to surpass 8 percent this year, a Figure 3: Stock markets still ahead of 1998 lows... tribute to its swift and steady progress in restructuring its (Stock market capitalization US$ value) financial system and strategy of increased trade 350 integration. Malaysia, riding the global electronics surge, 300 may attain 8 percent growth this year. Thailand, which Korea experienced a deeper shock with lingering overcapacity 250 and high NPLs, has generated an expansion of 4.5 200 percent. The Philippines and Indonesia, now both heavily 150 Indonesia indebted, seem destined to grow at about 4 percent this Philippines 100 year. Philippines has suffered from a poor agricultural performance, unfavorable press associated with the tourist 50 Thailand Malaysia kidnappings, and sporadic strife in Mindinao. Indonesia's 0 Ma Ma Ju Se No Ma Ma Ju Se No Ma Ma Ju Se No Ma Ma Ju Se problems are more severe as it copes with fractious Jan- 97 r-97 y-97 l-97 p-97 v-97 Jan- 98 r-98 y-98 l-98 p-98 v-98 Jan- 99 r-99 y-99 l-99 p-99 v-99 Jan- 00 r-00 y-00 l-00 p-00 internal politics, militant separatists forces, and religious violence in Ambon. Figure 4: Equity Market Performance, 2000 125 The post-crisis change in external position has persisted: 120 Nasdaq C omposite large, though attenuating, current account surpluses have 115 netted out against the capital account to produce a continuing rise in reserves. Foreign direct investment has 110 dominated capital inflows, supplemented with positive 100 = 105 portfolio investments. As elsewhere, Indonesia is the 0002 100 exception as FDI flows registered net outflows in 1999 3, 95 IFC I-Asia with no evident turn around this year. Private debt flows an.J 90 remained sharply negative as banks continued to unwind 85 their huge pre-crisis positions, in some cases converting 80 debt to equity (registered as both an outflow of borrowing 75 and inflow of foreign direct investment). When coupled 3-J an 3-Feb 3-Mar 3-A pr 3-May 3-J un 3-J ul 3-A ug with unrecorded movements in errors and omissions, the total net flows of private capital--FDI, portfolio, and Sovereign bond market spreads, after falling steadily in loans--remained negative and large. Since countries are 1999, are now rising (Figure 5), and have risen for Korea, also beginning to repay the IMF in large amounts, the net Malaysia, and--especially--for The Philippines and debtor position of these countries is gradually unwinding, Indonesia. Those foreign investors that are coming to East and thus far in sustainable manner. Asia are looking for long term positions where they can On balance, investors, domestic and foreign, are participate in the real economy or improvements in its exhibiting greater confidence in all of the crisis-affected fortunes, rather than taking short-term positions; countries (with the possible exception of Indonesia), if domestic investors are back but are now more integrated with greater skittishness than in the halcyon days of the with the global economy, and probably more risk and early 1990s. Investment is picking up and now therefore interest rate sensitive. This underscores the contributing positively to growth everywhere but importance of progress on the reform agenda. Indonesia. Savings rates remain high and exchange rates Figure 5: Spreads over US Treasury bonds have been remarkably stable despite interest rates hovering at lower post-crisis levels. All equity markets monthly averages 1800 were up in 2000--measured in US dollar market capitalizations--from their lows in the third quarter 1998, 1600 and Korea is up several multiples (see Figure 3). 1400 1200 Indonesia s But signs of skittishness abound. Short-term capital nt 1000 outflows and repayment of post-crisis debt continued to poi sis 800 offset capital inflows last year. Also, with the rising risk ba 600 Philippines premium to equities evident in the adjustment in the US 400 equity markets, equities in Asia have also taken a hit Malaysia 200 Korea Thailand (Figure 4). Nonetheless, there is considerable variation in 0 China M Ma Ju Nov M Ma Ju Nov M Ma Ju Nov M Ma Ju market performance within the region that corresponds to Jan-97 ar-97 Sep-98 Jan-99 Sep-99 Jan-00 y- l-97 Sep-97 Jan-98 -97 ar-98 y- l-98 -98 ar-99 y- l-99 -99 ar-00 y- l-00 perceptions of policy progress. 97 98 99 00 September 18, 2000 ` Regional Overview 5 The sectoral pattern of recovery has varied enormously by country. Figure 6: Quarterly GDP Growth 20 Indonesia · In Indonesia, virtually the only bright spot was 10 agricultural growth dating back to 1998 fourth 0 -10 quarter (see Figure 6). Even this sector has lagged -20 beginning in mid-1999, replaced finally with some up -30 ticks in manufacturing. The financial and -40 -50 construction sectors weighed down the economy until Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 late early year. 1998* 1999* 2000 Agriculture Manufacturing Construction Financial, ownership & business · In Korea, the recovery has been across the board in Trade GDP all sectors except construction. Manufacturing, * preliminary feeding a ravenous export appetite at the post-crisis 30 Korea exchange rates and now an increasingly strong 25 20 private domestic consumption, has led the way. Since 15 10 mid-1999, wholesale and retail trade have picked up 5 sharply. Agriculture was among the first sectors to 0 -5 respond dating back to the first quarter of 1999, and -10 -15 has remained steady. Even the financial sector has -20 picked up. Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 1998 1999 2000 · Malaysia's recovery shows virtually the same pattern, Agriculture Manufacturing Construction Finance Insurance and business with early recovery of agriculture (Q2 1999) but Wholesale and Retail Trade GDP increasingly greater dominance of manufacturing 30 growth. In the last four quarters virtually all sectors, Malaysia 20 including construction, registered positive growth. 10 · The Philippines recovery in early 1999 was led by 0 sharp increases in agriculture. Manufacturing picked -10 -20 up in the last four quarters, helping to drive growth -30 through the first half of the year, but a turnaround in Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 investor confidence is needed to sustain a strong 1998 1999 2000 recovery. Agriculture Manufacturing Construction Finance, Insurance, RE and Business · The Thai recovery was weighed down by the slow Wholesale and Retail Trade GDP recovery of construction (which did not record any Philippines positive growth until 1999 third quarter) and the 10 5 persistent and heavy losses in the financial sector. 0 Manufacturing began to show signs of life in early -5 1999 and has led growth since then. In the financial -10 sector, the contrast with Korea--where the -15 government moved swiftly to recapitalize the banks -20 and takeover the bad debt--is stark. Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 1998 1999 2000 Agriculture Fishery and Forestry Manufacturing Construction Finance Trade GDP 20 Thailand 10 0 -10 -20 -30 -40 -50 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1998 1999 2000 Agriculture Manufacturing Construction Financial Intermediation Wholesale retail trade GDP September 18, 2000 6 East Asia Brief Despite these positive trends, there is no question that the Poverty and Social Developments poor come out of the crisis more vulnerable than before. Labor markets are less stable, and, having drawn down The 18 month recovery has now reversed some of the savings or borrowed to survive the recession years, devastating consequences of the crisis of 1997-98. The millions still have their livelihoods at stake and are at risk deep recession had pushed millions of East Asians below of falling back into poverty if economics conditions the poverty line, measured by consumption expenditures should worsen. (often partially financed through drawdowns in past savings or transfers from government programs), and EA5 Reform Agenda: Restructuring and Public ended a decade-long trend of steady reductions in the Institutions number of people living below the poverty line. Economic recovery is now transmitting benefits to the poor. Restructuring. Revitalizing the domestic business sectors has moved to the forefront of the policy agenda for the Projections for 2001 for the East Asia 5 countries show EA5 countries. The recovery of demand has pushed up that the percentage of the populations spending below capacity utilization rates in manufacturing throughout the $1.50 per day (except for Korea where the benchmark is region, creating new demand for investment. Companies $7.94 per day) has fallen from their crisis peaks, though to with outstanding loans that are not being serviced and do varying extents. In Malaysia, the number of poor was not have restructuring programs will not be creditworthy already low to begin with (1.9 percent of the population in for the borrowing necessary to invest. The refusal of 1995), and they are projected to decline to negligible Hyundai's creditors to accept its latest restructuring levels. In Philippines, the percentage of the poor was proposal until ownership and management changes were 27.5 in 1997, and is expected to be 25.4 in 2001 and in implemented is one prominent example. Unless Thailand, from 15.7 percent in 1999 to 12.2 percent in agreements are forged, banks, saddled with a segment of 2001. Korea too has seen sharp reductions in poverty. their portfolio that is not generating interest income, will Poverty is projected to fall to 12.5 percent in 2001 down not have the capital base that will permit them to meet from 23.2 percent at the peak of the crisis in 1998, but new demand for loans. Therefore, moving swiftly to still higher than 1997 rates of 11.4 percent. Indonesia restructure loans, take losses, and seeking out new capital for banks and corporations (which may require diluting among the East Asia 5 lags furthest behind. Although the data prevent definitive conclusions, the poverty rate is ownership) requires persistent effort. expected to drop from the highs of 37 percent in 1999 to 31.8 percent; these levels are still well above the 25.7 percent rates prevailing on the eve of the crisis. Table 2. NPLs of Crisis-Affected Countries (a) (percentage of total loans) 1997 1998 1999 2000 Dec. Dec. Mar. Jun. Sept. Dec. Mar. Jun. Indonesia (a)0 -- -- -- -- -- -- 58.4 58.7 excl. IBRA 9.3 19.8 58.6 -- -- -- 41.5 39.7 Korea (b) 6.0 7.4 8.7 8.7 6.2 8.3(c) 14.0(d) 12.2 Malaysia (e) 6.0 22.6 22.7 23.4 23.6 23.6 23.3 23.2 excl. Danaharta -- 18.9 18.2 18.1 17.8 16.7 16.7 -- Philippines (f) 4.7 10.4 13.2 13.1 13.4 12.5 14.4 14.6 Thailand (g) -- 45.0 47.0 47.4 44.7 41.5 39.8 34.8 excl. AMCs -- 45.0 47.0 47.4 44.7 38.9 37.2 32.0 Note: (a) The first line uses the "stringent" definition of an NPL; the second line excludes transfers to IBRA. (b) Figures include commercial and regional banks only, excludes specialized banks, and excludes KAMCO holdings of impaired assets. (c)Figures starting in December 1999 reflect the application of the new Forward Looking Criteria (FLC) to the valuation of assets. (d) Figures starting in March 2000 reflect the application of the FLC to restructured loans, including loans to all workout companies and companies under court receivership. (e) Figures include commercial banks, finance companies, merchant banks, and Danaharta. (f) Figures are for commercial banks. (g) First line includes commercial banks, finance companies, and the estimated amount of NPLs transferred to wholly-owned private AMCs. September 18, 2000 ` Regional Overview 7 Three components are particularly important: corporation to write down loans is particularly noteworthy. Foreign creditors agreed to write off 60 · raising the capital of the banks and reducing the percent of their loans in late July 2000. More than nonperforming loans; 200 foreign creditors agree to allow Korean creditors · pushing through the restructuring of domestic to buy $4.8 billion in unsecured loans at 40 percent of corporate debt and disposing of assets now in the value. This marks the defining step in the year-long hands of the AMCs, a process that has barely begun; work out since Daewoo defaulted on KW$ 89 billion · making the new governance framework and (US$80 billion) in July 1999. This paves the way for bankruptcy laws work in practice for both the banks completing the restructuring of 12 core companies, and corporations. including the sale of Daewoo Motors to Ford Motor Company for about $6.9 billion. Most of the debt will Virtually all countries in the region have improved their be transferred to the Korean Asset Management capital position since 1998. However, NPLs remain a Corporation for resolution, while many creditors have burden on bank profitability, especially in Indonesia and swapped debt for equity in one of the resulting new Thailand (Table 3). Despite the capital injections, banks' companies (Financial Times, July 25, 2000). balance sheets are still weak: NPLs currently are five-fold loan loss provisions in the crisis four countries, and much · In Thailand, the pace and quality of the financial and more than that in China. Banks need more capital. The corporate restructuring continue to be the major capital shortfall ranges from 1.7 percent of banking assets constraint on the cementing of recovery. While about in Malaysia to 18 percent in Indonesia with Korea (at 4 $22 billion of private capital has been injected into percent) and Thailand (8.1 percent) in between. banks since the crisis (o/w $7.8 bn. in tier 1 capital from private investors), this is still insufficient. NPLs · In Indonesia, much remains to be done in are 32 percent (35 percent including loans transferred implementing an in-depth restructuring program that to bank's own AMCs) and the number of addresses the deep weaknesses within the banking restructuring cases has slowed down. Debt system. Banks barely meet the 4 percent capital restructurings have been dominated by reschedulings adequacy limits and many have negative capital. which may not be a final solution. However, the first Some state banks have been approved for straight sale by a Thai bank of a large proportion of recapitalization contingent upon new arrangements its NPLs to third parties has occurred. Accounting for improved governance structures (e.g. new principles are being strengthened. Operational oversight committee). Lending shows signs of restructuring of the large public KTB is planned. incipient recovery. IBRA sales are progressing but There is little restructuring of non-viable firms, but more slowly than target promises; gains are being legal filings appear to be picking up. made in bankruptcy decisions. JITF survey shows corporate indebtedness at $117 billion, of which 64 Public Instititions. One drag on growth coming out of the percent is said to be non-performing. Most of the on- crisis is public sector debt. Debt service has risen and shore debt is held by IBRA, which has relied mainly squeezed non-interest public spending at exactly the time on financial restructurings to resolve matters--only when governments everywhere have wanted to spend about one-third of the large debtor NPLs have been more to protect low income groups as wages and restructured as of July. However, overall progress is employment have fallen, and at a time when the urgency slow and may slow further if recalcitrant debtors of global competitiveness has required more efficient decide to brake the process and off-shore debt customs administration, infrastructure development, and restructuring is further delayed. more efficient cities. In the process, the crisis has revealed that institutions in the public sector have lagged behind · In Korea, NPLs have begun to decline. Merchant other modernizing trends. In many cases, the structure of banks and investment trust companies are being public administration is not up to the challenges of a restructured and the government also announced modern, globalized economy in the new millennium, plans to merge three state-owned commercial banks evident in areas as diverse as tax and customs into one entity. A second round financial administration to bank supervision to line ministries. restructuring was announced totalling 30 trillion won. Budgeting institutions ­most notably in Thailand and Public funds are also being used to ensure the Indonesia (which is benefiting from higher oil prices) -- corporate bond market does not suffer an undue have had difficulty adjusting to new priorities and liquidity crunch. On the corporate side, the adapting to new realities that require flexibility and consolidated financial statements of the top 4 innovation in spending (see World Bank, East Asia: chaebols show higher-than-expected debt/equity Recovery and Beyond 2000). ratios at around 230 percent. Generally, progress has been commendable in enhancing corporate The good news is that increase in public debt has governance and improving corporate accounting stabilized, if at high levels. A fortuitous combination of standards. Among recent developments, the low low real interest rates remain low, high growth rates, agreement among creditors of Korea's giant Daewoo and an appreciating currency has substantially mitigated September 18, 2000 8 East Asia Brief debt levels in Korea and Malaysia. Other countries may the long deflationary cycle. First half growth topped 8.1 soon benefit from these debt dynamics. Nonetheless, for percent (yoy). Exports led the way with a surge of 38 the medium term, the burden of interest and amortization percent relative to the first semester of 1999. The payments require substantial improvement in expenditure economic stimulus package has increased the fiscal deficit management to avoid crowding out of social and to 3.6 percent of GDP. The CPI registered increases-- important public expenditures. albeit barely at 0.1 percent--for two consecutive quarters. These numbers failed to relieve concerns about the anemia in private consumption. Retail sales, one Figure 7 : Public Debt (national government debt as a percent of GDP) indicator, continued to grow modestly in the 10 percent range, but with no clear upward trend. 100 90 Nonetheless, the three policy questions that dominated the 80 headlines last year appear to have been answered: 70 60 Foreign · Would China devalue the RMB? China has not 50 devalued­ in nominal terms. However, in real terms, 40 Domestic it has. The floating upward of its trading partners' 30 currency values had by the third quarter of 2000 20 depreciated the currency by about 5 percent relative 10 to December 1998. Authorities have also widened the 0 band slightly, perhaps as a precursor to introducing '96 '99 '00e '96 '99 '00e '96 '99 '96 '99 '00e '96 '99 '00e '96 '99 '00e Indonesia Korea Malaysia Philippines Thailand China some flexibility. Because of strong inflows of FDI in e - estimate the first half, galloping exports, and fast rising reserves, the RMB has tended to close at the top of the band. The external sector is a bright spot that has While political administrations have changed in most of boosted the economy in 2000. the countries, the institutional reforms of public sectors have barely begun. Fiscal pressures, emanating from debt · Would China gain accession to the WTO? The service burdens and larger changes in society, together favorable votes in the US Congress in June, coupled with globalization, is driving countries to rethink the role with the subsequent agreements with the Europeans of the state. Under pressure to do more with less, in July, have provided a resounding answer. Already governments will have to focus on regulations that the effects are being felt: foreign investors, seeing a support market development, contain its negative spin- new anchor to policy, have responded with greater offs, and help incorporate those left behind; they may investments. Contracted investment (as distinct from have to enlist private investment in activities now the sole investment flows) are up 25 percent in the first domain of the state. Governments are also compelled to semester (yoy). rethink the organization of the state, and accord more · Would the short-term fiscal stimulus undermine responsibility and power to subnational levels of medium term reform efforts of the banks and state government. Finally, the post-crisis world is compelling enterprises? The main driver of SOE reform into the governments to focus on improving institutions of public post-crisis period was the increasingly hard budget management--revenue and expenditure agencies and constraints that denied access to credit to under- ministries--as well as the civil service. performing SOEs, especially medium and small Most countries have at least begun this process--and all SOEs. The credit loosening since 1998, designed to have much to do. Among the EA5, Korea and Thailand counter deflationary forces, could have eased the have enacted major reforms designed to change the focus pressure on SOEs to reform. It apparently has not. of government activities through a purposeful retreat from Premier Zhu Rongji's three year program to increase state ownership in some areas, to improve revenue and SOE efficiency appears to be on track: One indicator: expenditure management in ministries and in sub-national aggregate state enterprise reported profits tripled in levels of government, and to improve the competence and 1999 relative to their low base the previous year. This remuneration of the civil service as well as deliver year profits continue to improve, in part because of services more efficiently. The Philippines and Indonesia oil price rises in the state monopoly, price rises in the have articulated ambitious reform programs in all of these loss-making steel and metal working industries, and areas, but program in these are still in the early stages. reductions in interest costs associated with debt equity swaps. Some administrative mechanisms-- Transition Countries: China vaguely reminiscent of the US National Recovery Administration in the 1930s--may also be contributing upward pressure on prices. In textiles, The economic stimulus of 1998-99, coupled with strong the government has proscribed investment in new export performance, at last paid dividends with definitive capacity; in steel, the government has tried to shut signs of rebound in the first half of 2000, and of an end to many small enterprises that are producing inferior September 18, 2000 ` Regional Overview 9 steel and otherwise rationalize capacity; in for the East Timorese people and the international electronics, it has allowed television makers to community. cartelize prices; in airlines, it has similarly allowed the 35 airline companies to set prices collectively; in Fiji had seemed poised to take full advantage of its photography, the government encouraged Kodak to flourishing tourist industry, bumper sugar crops, and invest $1.2 billion in three ailing SOEs by promising economic diversification efforts. In fact, in 1999, growth to maintain high external tariffs until 2002, and so had rebounded to nearly 8 percent due to a recovery in form capture a 48 percent market share and establish sugar production. But the May coup attempt had severe a near duopoly with Fuji (which has 40 percent). economic repercussions. The Government estimated that Concerns remain that the improved profit output could decline by 15 percent in 2000, as sugar performance ­imperfect indicators anyway -- may output, garment production, and tourist arrivals all prove illusory once these administrative measures contracted. Sugar is harvested primarily by Indo-Fijian wane. More important, short-term success could farmers who have leased native land, and sugar output is undermine efforts to sell off and/or restructure large projected to decline due to the delay in milling caused by state enterprise. the recent unrest, as well as the delay in the renewal of a large number of land leases that are currently expiring. Several other policy initiatives are noteworthy. In finance, Tourist arrivals are projected to fall by more than 50 the government signaled its intent to push ahead with percent from the record 1999 level, while garment interest rate liberalization, proceed gradually in coming production is projected to decline as Australia and New years toward capital account liberalization and reduce Zealand suspended preferential trading arrangements to state control over the four large state commercial banks, protest the overthrow of a democratically elected probably over a three year period. The latter might be government. Longer-term repercussions of the coup could implemented through a 25 percent ownership dilution include an exodus of skilled Indo-Fijians and their capital. over an extended period. At the same time, the Commission on Securities Regulation indicated that the Ethnic tensions in the Solomon Islands exploded last year government would soon be considering allowing and have plunged the economy into a severe recession--a foreigners to invest in the A share market, perhaps contraction of 20 percent or more is expected in 2000. beginning with a "qualified institutional investor" scheme Tensions intensified in 1999 between the indigenous that allows the government to regulate overall portfolio majority in Guadalcanal and migrants from the amounts. Prices in the stock market have risen steadily neighboring island of Malaita, reflecting the perception by since the beginning of the year. the Guadalcanal population that Malaitans have enjoyed greater success in the competition for jobs and resources The Small Economies: Will They Be Left Behind? in Guadalcanal. These tensions escalated into ethnic violence in May 2000, and resulted in a change of The strong global rebound in the aftermath of the crisis government. Meanwhile, economic production in has been accompanied by rising tourism and construction critically important areas has virtually collapsed, with demand, and higher prices for a number of the primary closure of the Gold Ridge mine, the main palm oil commodities that comprise important exports for East plantation, and the large-scale departure of foreign Asia's small economies-- East Timor, Fiji, the Pacific residents. The latter has brought logging operations to a Islands, Cambodia, Laos, and Mongolia. Such conditions virtual standstill. The collapse of major revenue sources in principle should be conducive to promoting recoveries and the need for additional spending for security has in these countries--which had suffered from the opposite resulted in fiscal crisis. commodity price and demand trends during the crisis. Yet In contrast to these cases of political or ethnic conflict, these positive external trends have had to compete with Papua New Guinea has recovered from two years of man made disasters that have proved far more harmful. economic decline in 1997-98--reflecting natural Perhaps the most poignant example is that of East Timor. disasters, the Asian crisis, and severe deterioration in the The independence referendum in August 1999 triggered policy environment. Growth during 1999-2000 is widespread violence, damage to private property and expected to average 4 percent. But this is less the result of public infrastructure. Real GDP is estimated to have the more favorable external environment than an declined by nearly 40 percent in 1999 reflecting the improved policy environment: higher commodity prices disruption of the agricultural cycle, destruction of local have actually been offset in 2000 by near exhaustion of a inventories of basic manufacturing goods, and major oil field which has reduced export volume, and displacement of the labor force. While the economy may excessive rainfall which has damaged the coffee crop. recover by about 15 percent in 2000, unemployment and Since the current government assumed office in July underemployment remain widespread. Transforming East 1999, it has embarked on a wide ranging structural reform Timor from U.N. administration to a self-governed and program intended to enhance governance in the public viable nation represents a major development challenge and financial sectors, and lay the foundations for raising the country's poor social indicators. The initial reaction of September 18, 2000 10 East Asia Brief investors has been favorable, as evidenced by a stronger Bank forecasts, will surpass 4.1 percent in 2000, more currency and recovering foreign reserves. than twice the growth rate of 1998.2 Moreover, international trade volumes will in all likelihood top 11 The Indo-china countries have also been able to take percent this year, more than twice the rate of 1999. On advantage of the strong international market. Cambodia balance, any dampening effects from higher oil prices this may attain growth of 5.5 percent or more on the strength year (on oil importers) and higher interest rates have been of robust external demand for textiles, logs, and tourism. offset with stronger global demand generally. The Policy reforms, supported by the World Bank and IMF, outlook for 2001 is for global growth of 3.2 percent and are improving the domestic investment climate. The fiscal world trade growth of 7.5 percent. deficit has come down to levels that can be financed from external savings, and the government has not had to take One emerging source of risk is the surging price of recourse to monetary financing. Benefiting from a more petroleum. This month prices topped $35/bbl, causing disciplined monetary policy, inflation has come down to disruptions in some European countries. While the World under 8 percent annually and the exchange rate has Bank's baseline forecast at present is that oil price will stabilized. The Lao PDR has tamed the fires of high average about $28/bbl in 2000 and come down to $25/bbl inflation that threatened the economy in 1998-99, and in 2001 and then $21/bbl in 2002, there is some--albeit growth this year should top 6 percent. Policy in many probably low--risk that prices will stay high for some areas ­ fiscal and monetary management ­ has improved time. If these numbers are to materialize, the resulting oil somewhat, and this has provided enough stability for the shock is roughly one-third the level of the 1972-74 and economy to take advantage of the much improved 1978-80. The oil market is likely to remain tight for the external environment to expand. remainder of this year because existing stock are low heading into the northern winter, because high prices Mongolia's economy suffered over the last 3 years from discourage inventory accumulation, and because only a an external terms of trade shock and policy slippages, a few OPEC producers have enough capacity to meet the consequence of the political paralysis in the run up to the expanded quotas agreed on September 10. If oil prices July elections. Even so, recent stabilization efforts, were to be $5/bbl higher than projected this year and together with a reversal in external demand that have $10/bbl next year, they would dampen world growth by as improved copper, gold and cashmere prices, are paying much as 0.25 percent this year and 1 percent next year. early dividends. The world economy in this scenario would on balance be Looking to the future, while improving external much less supportive of East Asia's expansion. Within environments can power development, the size and the region, the effects of the oil shocks are quite isolation of most small economies in the region pose a differentiated. At one end of the spectrum, oil and unique set of challenges. Political stability and ethnic petroleum derivatives constitute 18 percent of Korea's peace are clearly pre-requisites for successful merchandise imports ($14.8 billion) and 8 percent of development in the island economies, particularly since Thailand's and Philippines' ($3.4 billion and 2.2 billion, tourism tends to be such an important economic factor. respectively). China too is an oil importer, albeit in small But to make any recovery enduring, policy reforms are amounts ($4.3 billion in 1999). At the other end, essential. Most countries have taken only the first initial Indonesia and Malaysia benefit because they are net steps. At the same time, the policy regimes of crisis exporters ($5.7 billion and 2.5 billion respectively in afflicted neighbors have improved markedly in the wake 1999). The consequences of oil at the baseline projection of the crisis--in policies to manage globalization, to of $28/bbl and $25/bbl are likely to help Indonesia more revamp banks and corporations, and to improve public than they hurt the oil importers in the region. Should oil institutions.1 This poses the risk that the small countries, prices surge to a new high plateau, such as $35/bbl; if they do not match the reform pace of their neighbors, however, the twin effects of slower global growth and could be left behind. deteriorating trade balances will reduce growth of oil importers. Korea and potentially Japan, so far weathering External Risks the higher prices well, could loose competitiveness and would certainly see their growth rates slow. Philippines Risks to East Asia's recovery emanating from abroad and Thailand could also be adversely affected, an effect have attenuated in two dimensions: economic and that could be magnified because of weak banks and political. corporations. Because oil could induce a much larger shock with unanticipated global ramifications, it could be Economic Environment the source of exactly the type of destabilizing demand shock that vulnerable East Asian countries would have difficulty navigating. As of this writing however, this still The international economy has provided an unusually remains a low probability scenario. supportive environment for East Asia's recovery ­ and 2000 is shaping up to be the best in the last three years and 2001 nearly as good. World GDP, according to World September 18, 2000 ` Regional Overview 11 The US economy has shown signs of slowing under the growth in the 5-6 percent range. Eastern Europe will tightening rein of the US Federal Reserve. Since June produce grow in the 2-3 percent range. 1999, the Fed has raised interest rates by 175 basis points. Autos, home sales, and other interest sensitive goods have The importance of this environment should not be come down from their boom in the previous two quarters, underestimated. A recent paper3 found that over long a reflection of higher interest rates, rising oil prices, and periods OECD growth rates explain a large portion of perhaps wealth effects associated with the 5-10 percent growth in developing countries, and that the secular deterioration in financial asset values in equity markets. It slowdown observed in the 1980s in the OECD reduced is still too soon to say that the much awaited US soft growth in developing countries, despite their generally landing has been achieved--consumer spending could improved domestic policies. The recent steady and high surge anew and further interest rate tightening may yet be growth in the late 1990s, if sustained, may similarly auger needed--but the highest-probability scenarios point to a well for a robust global expansion whose beneficiaries somewhat slower and more comfortable growth pace. The will include the world's 2 billion poor living in the risks of recession, arising from precipitous declines in developing world. asset prices or external events, seem to have abated. Lost US momentum has been taken up in Europe and in Regional Political Risks Japan. European growth has been revised upward to 3.8 percent on the strength of consumer and investment One external risk has been the threat that festering demand. Growth in Italy appears particularly strong, regional political conflicts could explode into violence, though Germany and France add ballast to this outlook. and could cut short the region's recovery. Three issues command constant attention: tensions across the Taiwan The outlook for Japan, despite the Sogo bankruptcy and straits, tensions on the Korean Penninsula and political subsequent policy vacillation, looks ever brighter. events in the Indonesia. Corporate profits are predicted to rise by 20 percent, investment is at last turning positive and the Tankan The June summit between South Korean President and survey of business has registered its best report in years. Kim Dae Jung and North Korean leader Kim Jong Il in Even consumer sentiment has improved as unemployment Pyongyang is taking on the appearance of a watershed at last began to fall steadily in the second quarter. Japan event in one of these arenas. The remarkable meeting was could register GDP growth approaching 2 percent in 2000 followed in quick succession with the decision to and somewhat higher in 2001. establish a rail link between North and South, the invitation for Foreign Minister Paek Nam Sun to the The developing countries taken as a group also offer ASEAN Regional Forum in Bangkok in July, and the added buoyancy to the global economy. Latin America is opening of liason offices at Panmunjom in August. If this in an expansionary phase after the dip following Brazil's positive momentum can be continued, it will constitute an devaluation in 1999, though the growth impetus is less important building block in a lasting economic recovery. than East Asia's. South Asia too remains robust with - The Regional Overview was prepared by Masahiro Kawai (EAPVP) and Richard Newfarmer with contributions from Sanjay Dhar and David Bisbee (EASPR). 1 See World Bank, East Asia: Recovery and Beyond 2000. 2 This section is based on the World Bank's Development Prospects Group analysis. 3 Easterly et al 2000 September 18, 2000 SPECIAL FOCUS: ASIAN TRADE fundamentally reductions in price distortions, and changes Coming in From the Cold--Integrating in the governance of firms that would allow them to China and Vietnam into the World Trading respond to the signals given by prices. Major changes in System the foreign exchange and foreign trade regimes were required, including abolition of the trading monopolies, China and Vietnam have both spent long periods of and liberalization of the market for foreign exchange. isolation from the world economy in pursuit of egalitarian With modernization a priority goal, a favorable foreign ideals. Neither government has changed its goals, but both investment regime was introduced in conjunction with have found it necessary to be much more pragmatic in the special economic zones. Later, both the investment policies they use to achieve these goals. In doing so, both incentives and the free trade treatment for inputs used in have chosen to become much more engaged with the the production of exports were extended much more world economy. This policy shift is not something that broadly in China--a policy reform that needs to be taken has been undertaken lightly. In China's case, it builds on a into account when assessing the implications of further process of reform that became official policy in 1978. For reform (Ianchovichina, Martin and Fukase 2000a). Vietnam, the turning point was the adoption of Doi Moi in 1986. Leaders in these countries realized that their By the mid-1980s, China's policy-makers had recognized inward-looking policies were not yielding the expected the importance of engagement in the world trading benefits, and that their levels of technology were falling system, and applied to join the GATT in 1986. At the behind the rest of the world. time, China's trade regime was still highly distorted, and GATT's market-based rules would have fitted China's Isolation from the world economy has many costs. Costs situation only with considerable difficulty. However, of production differ sharply between countries for many during the 14 years since China first applied to join the reasons, and countries that are isolated are unable to gain world trading system, it has radically reformed its trade by exporting goods where their costs are relatively low regime. In the early 1980s, the introduction of quotas, and importing goods where their costs are high. Isolation licenses and relatively high tariffs was, paradoxically, an has also dynamic costs. It becomes difficult for producers important element of reform and liberalization because it to keep up with the latest developments in product and was associated with the break up of the state trading process technology. When producers do master new monopolies. During the 1990s, the emphasis was on the techniques, they are unable to take advantage of their abolition of quotas and licenses, on increasing access to competitive advantage beyond the limits of the local trading rights, and on progressive reductions in tariffs. market. Further, the policies used to restrict trade Table 1 shows the sharp reductions in tariffs during the typically create large differences between prices inside 1990s, together with the estimated reductions associated and outside the economy, creating large incentives for with the phase-in of the tariff reductions associated with corruption and wasteful rent-seeking behavior. WTO accession. Once reforming economies begin to engage in world The tariff reductions in Table 1, and the elimination of trade, they encounter a new set of problems. If they are large numbers of nontariff barriers, were largely the result outside the WTO, they are vulnerable to pressures from of China's own assessment that it needed a more open major trading powers, such as the imposition of punitive economy. However, China's desire to rejoin the tariffs, or the threat of sanctions if they do not meet international trading system also played a role. China's unilaterally-determined standards. They lack the participation in APEC was also helpful, and President protection provided by agreed rules of the trading system, Jiang Zemin announced a number of important reductions and access to an objective forum for dispute resolution. in protection at APEC. By 1999, China's trade regime To overcome these problems, China and Vietnam have was a fundamentally market-oriented system, and within clearly chosen to engage more fully in the world striking distance of the likely requirements for WTO economy, rather than to turn back, and begin to accept the accession. The reductions in tariffs associated with WTO discipline and protections available under the multilateral accession are substantial, but smaller overall than those system. achieved during the 1990s. China While the details of China's accession to the WTO are not yet finalized, the bilateral agreements with the US and the China's reformers recognized the need to open up to the EU provide a good indication of the likely nature of the world economy very early in the reform process. This final package. In it, China has committed to open up trade process required reforms in a range of areas, but most and distribution rights to domestic and foreign firms, to reduce tariffs, to abolish all nontariff barriers except state September 18, 2000 2 East Asia Brief trading for a short list of mainly agricultural commodities, worrying feature of the agreement, reflecting fears by and to liberalize trade in a wide range of services, China's trading partners about China's strength as an including banking, insurance and telecommunications. It exporter, is that it makes it easier for China's trading will also commit to provide intellectual property partners to use safeguards and anti-dumping measures. protection consistent with the TRIPS agreement. One Table 1. Changes in average tariff rates in China All products Primary products Manufactures Simple Weighted Simple Weighted Simple Weighted % % % % % % 1992 42.9 40.6 36.2 22.3 44.9 46.5 1993 39.9 38.4 33.3 20.9 41.8 44.0 1994 36.3 35.5 32.1 19.6 37.6 40.6 1996 23.6 22.6 25.4 20.0 23.1 23.2 1997 17.6 18.2 17.9 20.0 17.5 17.8 1998 17.5 18.7 17.9 20.0 17.4 18.5 2005* 15 7.8 17.5 16.88 9.4 6.9 *Estimates for 2005 reflect introduction of tariff bindings agreed in China-US bilateral negotiations. The WTO accession agreement is expected to strongly with China in a range of products. A clear contribute strongly to China's integration into the world political advantage of accession is that it will remove the economy. Table 2 shows China's shares of world markets need for annual renewal of China's MFN treatment in the in 1995 and projected shares in 2005 with and without United States1. Another is that it will ensure abolition of accession from Ianchovichina, Martin and Fukase (2000a). the bilateral quotas imposed against China's exports of Without accession, China's share of world output and of textiles and clothing. Current quotas are to be phased out world trade are projected to grow because of China's high by 2005 and any additional safeguards by 2008. For rates of investment in physical and human capital, and reformers within China, the agreement has another high rates of productivity growth. With the opening up important advantage-- it shifts the political balance on associated with accession, China becomes much more trade policy sufficiently to allow reductions in protection integrated with the world economy, and its share of world to politically influential sectors such as automobiles. export markets rises to almost seven percent, making Finally, of course, accession to the WTO will give China a China one of the largest trading countries in the world. voice in setting the rules of international trade Table 2. Changes in China's Share of World Table 3. Implications of China's WTO accession Markets for welfare $bil at 1995 prices 1995 2005 2005 With Without WTO North America 9.5 Accession Accession Western Europe 7.1 % % % Japan 2.9 Global Output Share 3.4 5.2 5.2 China 28.6 Global Export Shares 3.7 4.8 6.8 Indonesia -0.2 Global Import Shares 3.4 5.3 6.6 India -3.2 While China's WTO accession agreement requires many Other 11.3 politically difficult changes in China's trade regime, Total 56.1 China's leadership has, after considerable reflection, The welfare estimates in Table 3 are likely to substantially decided to go ahead. Why might this be? One obvious underestimate the long run gains from China's WTO advantage is that it will generate substantial income gains accession. The WTO agreement will enhance the for China, as shown in Table 3, which reports annual gains credibility of China's commitment to an open trade regime of almost $29 billion to China. Reflecting the positive-sum nature of trade, these gains are linked with substantial gains to China's major trading partners such as the US and 1 This is not a necessary consequence of accession to WTO. The the EU. There are, however, some relatively small losses United States, or any other member, could choose not to apply to countries such as India and Indonesia that compete MFN, or other aspects of the agreement, at the time China joined. September 18, 2000 Special Focus: Asian Trade 3 and is likely to both stimulate investment and encourage remaining problem areas, such as the use of nontariff productivity growth in ways that will generate much barriers to regulate trade flows, were more likely greater income gains. There will, of course, be a need for consequences of import-substitution goals, or of weak considerable restructuring, particularly in currently highly administrative capacity, rather than legacies of central protected sectors such as automobiles. Some of this planning. restructuring will involve layoffs, and so is likely to be painful, and to require supporting policies if these workers Economically, the reform policies were extremely are to be quickly and efficiently re-employed. The phased successful, and resulted in very high growth rates of output nature of the commitments is likely to be helpful, since it and exports. Perhaps because of this unexpected success, allows a period of transition for declining industries, while however, the process of reform slowed down (Leung and providing a clear indication of the longer-term direction of Riedel 2000). Policy backsliding occurred in both trade policy. and investment policies, particularly through the introduction of nontariff barriers into the trade regime, Vietnam through arbitrary administrative actions that reduced the transparency of the investment regime, and through On July 13, 2000, Vietnam and the United States signed a policies that directed joint venture activity predominantly bilateral trade agreement that is likely to mark a major into partnerships with SOEs. While the average tariff rate turning point for Vietnam. After the introduction of the does not appear particularly high, with a weighted average Doi Moi policy in 1986, reform of the trade regime and of 19 percent, the tariff schedule is varied enough to create supporting policies proceeded very rapidly as is evident enormous variation in the effective rates of assistance to from Table 4. By the early 1990s, very few of the elements individual sectors, as is evident from Table 5. of the centrally-planned trade regime remained. The Table 4. Some major changes in Vietnam's trade policy since the beginning of the reform era Year Changes in trade and exchange system Other reforms 1986 Party Congress declares beginning of Doi Moi 1987 Law on foreign investment--introduction of `open door' policy Land Law establishes private use of allocated land in agriculture 1988 Retention of foreign exchange liberalized. Cooperative method of agriculture production Exchange rate devalued abandoned in favor of households. Introduction of a customs tariff Encouragement of private enterprises becomes official policy 1989 Producers of exportables allowed to sell to any foreign trade Nearly all forms of direct subsidization of production company and price control removed Foreign exchange rate unified All budgetary export subsidies and most quotas abolished 1991 Inputs used to produce exports exempted from duty Private companies allowed to engage directly in international trade 1992 Foreign investment law amended to reduce discrimination in Pilot equitization program for SOEs introduced favor of joint ventures against foreign owned enterprises 1994 Vietnam gains GATT observer status Introduction of interbank foreign exchange market 1995 Coverage of export quotas reduced to rice New regulations on land limits nature of land use rights. Vietnam joins ASEAN 1996 Maximum tariff rate reduced to 80 per cent Law on State Budget formalises budgetary practice and defines revenue and expenditure responsibilities of different levels of government Table 4 continued.. September 18, 2000 4 East Asia Brief ...continue Table 4 1997 Imports of sugar prohibited Announcement of a VAT from 1999 Temporary prohibitions imposed on imports of wide range of Law on Cooperatives confirms continued government consumer goods then lifted support for cooperative business 1998 Highest tariff rate reduced to 60 per cent and imports of most Taxpayer identification numbering system introduced consumer goods managed by tariffs rather than QRs Domestic enterprises authorized to directly export production without an export/import license Amendment to import/export tax law introduces 3- schedule tariff, and provision for antidumping and countervailing duty Source: Based on Table 1.3 of CIE (1998). Table 5. The structure of Vietnam's tariff protection Nominal Protection Effective Rate of Protection (ERP) Description Weighted Average ERP for Import ERP for Substitution Export Production (%) (%) (%) Paddy rice 5.0 4.2 -3.8 Forestry 1.2 -20.5 -22.9 Fishing 18.9 66.6 -45.7 Oil 1.0 -13.9 -15.9 Vegetable oils and fats 12.3 1.4 -98.5 Textiles 30.0 115.0 -138.0 Wearing apparel 49.4 229.8 -231.9 Leather products 13.5 -15.1 -67.1 Ferrous metals 6.0 3.7 -25.3 Metals n.e.c. 10.4 21.9 -103.8 Metal products 16.6 34.5 -33.9 Motor vehicles and parts 18.6 186.4 -200.7 Overall Average 19.0 Source: Fukase and Martin (2000b) The results in Table 5 highlight the very high rates of fact that it currently faces US General Rate tariffs rather effective assistance provided to import competing than the MFN tariffs that apply to most of its competitors. activities in sectors such as textiles, clothing, fishing and The difference between these two sets of rates is frequently automobiles. Since the tariff rates applying to inputs are very large, as is clear for commodities such as clothing, also very high in these sectors, production for export is light manufactures and basic manufactures in Table 6. The discouraged by extraordinarily high negative effective figures in this table understate the overall impact of the US rates of protection. Without duty exemptions or use of general rates, because Vietnam is simply unable to drawbacks, production for export would be essentially compete in many of the products subject to the highest impossible. Such large distortions between sectors create tariffs, and hence these have zero weights in the strong incentives to divert resources away from the sectors calculation of the averages. in which they would be most productive. As Fukase and Martin (2000a) have shown, moving from The continuing presence of high rates of protection in the General to the MFN rates will greatly reduce the tariffs politically sensitive sectors such as automobiles has applied against Vietnam's exports, and will allow very created serious costs. With additional negative shocks substantial expansion in labor-intensive exports such as from the Asian financial crisis, the growth rate of output clothing and textiles if they are not choked off by MFA- fell to under 5 percent in 1999, a rate that does not type quotas. In return, Vietnam has committed to a range generate sufficient employment to keep up with of reforms including abolition of nontariff barriers on Vietnam's rapidly growing labor force goods, tariff reductions, protection of intellectual property rights, liberalization of trading rights for enterprises, services trade liberalization, investment liberalization, The recent bilateral agreement with the United States is business facilitation, and transparency in the trade regime. part of an invigorated reform process. This agreement the addition of Vietnam's reforms to the US grant of MFN overcomes one of the biggest problems that Vietnam faces in increasing its exports to the world's largest market--the September 18, 2000 Special Focus: Asian Trade 5 access will greatly expand Vietnam's exports to the USA, in trade volumes will be very small for the United States, and roughly triple the welfare gains to Vietnam.2 largely because of the relative sizes of the two economists. Table 7 - Key results of the US-Vietnam Table 6 ­Weighted average tariff rates trade agreement facing Vietnam's exports to the United States Vietnam United MFN General States % % % % Agriculture and 0.0 0.3 Export Value 21.28 0.11 forestry Export Price 5.3 -0.014 Processed 1.6 6.6 Export Volume 15.2 0.12 agriculture Price Index 8.4 -0.021 Beverage and 2.2 17.4 Real Income per Capita 5.6 0.009 tobacco Coal, oil, gas 0.4 1.3 Decomposition of $million $million Textiles 4.4 38.5 Equivalent Variation Clothing 14.3 58.0 Total EV of which 1089 451 Light manufactures 8.5 25.9 Allocative Component 660 653 Basic manufactures 3.7 39.0 Terms of Trade 429 -202 Chemical, rubber, 30.8 49.6 Component plastics Tariff Revenues 218 224 Electronics and 3.1 32.2 Vietnam's ability to implement the US-Vietnam agreement machinery has been substantially enhanced by its accession to the Average 4.7 11.8 ASEAN Free Trade Area (AFTA), which has provided technical assistance in areas such as customs tariff harmonization, and begun to expose its industries to In many respects, the structure of Vietnam's bilateral competition from more efficient producers. The non- agreement parallels China's WTO accession agreement. discriminatory nature of most of the liberalization under The MFN tariff cuts3 are more narrowly focussed, and not the agreement with the United States, and under any WTO as deep4 as China's, but other aspects of the agreement accession package, is an important advantage over the appear to involve quite deep liberalization. Vietnam has, AFTA reforms. The economic benefits of AFTA accession for instance, committed to liberalize around 50 service for Vietnam are likely to be small small because Vietnam sectors, as against around 40 included in China's WTO will gain little in terms of improved market access, and accession package. Many of these commitments are in will suffer from a tendency under AFTA to replace imports important sectors such as banking, where US firms will be from outside AFTA with more costly imports from AFTA allowed to establish 100 percent owned subsidiaries after countries (Fukase and Martin 2000). The key is to use nine years. Vietnam has also committed to essentially the AFTA accession as a stepping stone to the wider, and non- full package of intellectual property protections required of discriminatory, liberalization that is likely to be required WTO members. for WTO accession. Preliminary estimates (Ianchovichina, Martin and Fukase The liberalization associated with AFTA accession, with 2000b) of the impact of this agreement for Vietnam and the Vietnam-US agreement, and ultimately with WTO the United States are given in Table 7. These results accession, will require substantial changes in Vietnam's suggest that the agreement will be a powerful force for industrial policies. It will no longer be possible to focus on expansion in Vietnam's exports, and will generate income the development of sophisticated industries by providing gains to Vietnam in the order of $1 billion per year, as well protection to favored enterprises through trade and as a substantial increase in government revenues. The investment policy incentives. A much better approach for United States also stands to reap substantial gains in long term development in the future would focus on absolute terms, although the relative change in income and improving the physical infrastructure and supporting institutions, and on assisting people to acquire the skills 2 needed for modern industries. The inevitable, and painful, Ianchovichina, Martin and Fukase (2000b) adjustments associated with restructuring of the inefficient 3 Although this is a bilateral agreement, the liberalization industries, such as automobiles, created by past policies commitments are nondiscriminatory except for a few sections on can best be eased by focussing on helping the affected investment and services that refer specifically to US firms. workers to adjust. In many cases, this assistance may best 4 It appears that the US emphasized elimination of nontariff be provided through training programs. In other cases, it barriers over tariff reduction, on the grounds that Vietnam's may be more cost-effective to use lump-sum transfers, of average tariff of around 17 percent was reasonably low for a country at its level of development (Manyin 2000) September 18, 2000 6 East Asia Brief the type widely used in restructuring of Chinese state Implementation of the agreements in China and Vietnam owned enterprises, to help workers adjust. will involve restructuring of sensitive industries that have become distorted and vulnerable as a result of past policies Conclusions of trade protection. The best policy response to this problem is to focus on the adjustment needs of workers, China and Vietnam both have suffered mightily during rather than of firms. If governments try to determine the earlier periods of isolation from the world economy, and structure of the post-reform industries, they risk becoming have concluded that the benefits of returning to the world trapped in a web of vested interests, and of creating a new economy substantially outweigh the costs. Moreover, they set of distortions. When China, and ultimately Vietnam, recognize that it is important for them to enter the world enter the WTO, they need to maintain their focus on trading system under the best available rules. To this end, selecting policies that are good for development, rather China has pursued liberalization through a combination of than adopting a mercantilist approach that defends costly its own liberalization and through liberalization agreed as protectionist policies. part of the process of accession to the WTO. Vietnam has followed the same broad approach, but is using AFTA membership as a stepping stone towards more comprehensive liberalization. This year it has taken an decisive step. - The Special Focus: Asian Trade was prepared by William Martin (DECRG) References * * CIE (1998), Vietnam's Trade Policies, 1998, Centre for International Economics, Canberra and Sydney. Fukase, E. and Martin, W. (2000a), `The effects of the United States granting MFN status to Vietnam', Weltwirtschaftliches Archiv, forthcoming. Fukase, E. and Martin, W. (2000b), Free Trade Area Membership as a Stepping Stone on the Development Path: Examining the Expansion of the ASEAN Free Trade Area, World Bank Discussion Paper, forthcoming. Hach, S. (2000), `Transition of the Cambodian economy' Paper for presentation to the Conference on "Achieving High Growth: Experience of Transitional Economies in East Asia", Australian National University, Canberra, 6-7 September. Ianchovichina, E., Martin, W. and Fukase, E. (2000a), `Assessing the Implications of Merchandise Trade Liberalization in China's Accession to WTO', Paper presentated to the Roundtable on China's Accession to the WTO sponsored by the Chinese Economic Society and the World Bank, July 8, 2000, Pudong, Shanghai Ianchovichina, E., Martin, W. and Fukase, E. (2000b), The effects of the US Vietnam trade agreement, Mimeo, World Bank. Leung, S. and Riedel, J. (2000), `The role of the state in Vietnam's economic transition', Paper for presentation to the Conference on "Achieving High Growth: Experience of Transitional Economies in East Asia", Australian National University, Canberra, 6-7 September. Manyin, M. (2000), `The Vietnam-U.S. bilateral agreement' CRS Report RL30416, Congressional Research Service, Library of Congress. September 18, 2000 SPECIAL FOCUS: POVERTY DURING CRISIS AND RECOVERY Consumption poverty Figure 1: Actual and projected poverty headcount The decade or so prior to the onset of the crisis in late indices for Indonesia, Malaysia, Philippines, South 1997 was a period of significant growth and poverty Korea and Thailand, 1984-2001 reduction in the "crisis" countries, with the exception of 7 0 the Philippines which experienced a halting pattern of In d o n e s ia 6 0 growth and stagnation. The proportion of population in 5 0 absolute poverty declined at impressive rates since the 4 0 mid-1980s up to the crisis. This is evident from the 3 0 consumption poverty rates in Annex 1, estimated using a 2 0 poverty line of $1.50 per person per day (1993 PPP dollars) for four of the five crisis countries, and the 10 national poverty line of $7.94 for South Korea.1 For 0 19 8 4 19 8 7 19 9 0 19 9 3 19 9 6 19 9 9 2 0 0 0 2 0 0 1 comparative purposes, these poverty estimates are based 2 5 on nominal consumption distributions and use poverty M a la y s ia lines that are different to the national poverty lines that 2 0 are commonly used in country assessments. 15 The gains from poverty reduction were not limited to 10 those in the neighborhood of the poverty line. On the contrary, they appear to have been widely shared amongst 5 those below the poverty line. This is evident from the 0 higher rates of decline in the depth and severity of 19 8 4 19 8 7 19 8 9 19 9 2 19 9 5 19 9 7 19 9 8 2 0 0 0 2 0 0 1 poverty. Most of the gains in poverty reduction were 4 5 P h ilip p in e s driven by an impressive growth in average living 4 0 standards, while there was no trend growth in inequalities 3 5 over this period of rapid growth.2 3 0 2 5 2 0 This trajectory of growth with poverty reduction was 15 interrupted by the onset of the crisis. Estimates of the 10 impact on poverty vary, depending upon different 5 0 assumptions regarding the use of household survey data, 19 8 5 19 8 8 19 9 1 19 9 4 19 9 7 19 9 8 2 0 0 0 2 0 0 1 poverty lines, and changes in cost of living for the poor. 50 S.Korea The estimates in Figure 1 (see also Annex 1) indicate that 45 the incidence of consumption poverty increased 40 substantially in Indonesia and South Korea. The effect on 35 30 consumption poverty in Thailand, Malaysia and the 25 Philippines appears to have been more limited. It is, 20 however, worth noting that these "before-after" 15 comparisons of poverty nevertheless tend to 10 5 underestimate the true impact on the crisis because in the 0 absence of the crisis poverty rates would have declined 1990 1991 1992 1993 1994 1995 1996 1997 1998 2000 2001 further below the levels observed before the crisis. 4 0 T h a ila n d 3 5 3 0 1 This poverty line, while higher than the dollar-a-day poverty 2 5 line often used in international poverty comparisons, is similar 2 0 to the national poverty lines used in four of the five crisis 15 countries. Except Korea, the national poverty lines for the other 10 countries range between $1.46 (Malaysia) to $1.67 (Thailand). For Korea, the national poverty line is $7.94 per person per day; 5 poverty rates are negligible at poverty lines below $2. 0 2 The growth rate of the Gini index is not significantly different 19 8 8 19 9 2 19 9 6 19 9 8 19 9 9 2 0 0 0 2 0 0 1 to zero. The exception for the Philippines is also more apparent than real; the significant trend in Gini disappears once the last estimate for 1997 is excluded. September 18, 2000 2 East Asia Brief In most cases, the increases in poverty were mediated market outcomes, people's own perception of poverty and through the labor market (decline in employment and real vulnerability. wages, see discussion below). In the case of Indonesia in particular, the sharp increase in the relative price of food, Education outcomes especially rice, was a key instrument in eroding household living standards. The increase in consumption Despite the large declines in economic output during the poverty appears to have occurred primarily through a crisis, the impact of the crisis on school enrollments has decline in average living standards. For the countries for been modest in all the crisis countries. In Thailand, which household surveys since the crisis are available, enrollment rates continued to increase over the crisis there is not much evidence of an increase in consumption period, albeit at a slower pace. In Indonesia, where GDP inequality during the crisis. For Korea, on the other hand, declines were the largest, enrollment rates for primary and income inequality worsened during the crisis. junior secondary levels saw a leveling off (or a slight decline) in 1998. But enrollment rates for 1999 at all Since 1999, crisis-stricken countries in East Asia have levels (primary, lower secondary and senior secondary) embarked on the process of economic recovery. Key have bounced back and are higher than their 1997 levels. indicators of economic performance have improved, and While the overall picture for education is more optimistic macroeconomic stability is being restored. As this than for consumption poverty, there are areas of concern. process gathers momentum, though at varying pace in There is indication that the transition rates in both different countries, there is concern about the extent to Indonesia and Thailand have been adversely affected, which this economic recovery is translating into reduction with students delaying their entry into secondary school. of absolute poverty. Health outcomes Evidence from projections based on available household survey data suggests that with the possible exception of Indonesia, the countries are well on their way to The evidence on health outcomes is more limited - but recovering lost ground in poverty reduction due to the here too, the overall effect has been less dramatic than crisis. With the economic recovery, poverty levels have predicted. In Indonesia, self-reported morbidity, based on started climbing down from their crisis peaks. Based on the SUSENAS household surveys, documents a reversal the Consensus growth rate projections,3 Annex 1 and in 1998, with the percentage of the population which self- Figure 1 also present projections for poverty for the years reported an illness, increasing slightly from 24.4 percent 2000 and 2001. The projections assume there is no change in 1997 to 25.5 percent in 1998 before falling back to 24.6 in the relative inequalities since the latest available survey percent in 1999. Nutritional indicators of children under for a country. 5 do not show a worsening over the course of the crisis. The clearest impact of the crisis in Indonesia has been in utilization patterns. Utilization rates (percentage of the If 1996-97 estimates are taken to be indicative of the "pre- population visiting a provider during the last month) for crisis" situation, the projections suggest that the incidence modern medical facilities declined from 12.8 percent in of poverty is expected to decline to, or below, pre-crisis 1997 to 10.5 percent in 1998, with most of the decline in levels by 2001 in Malaysia, Thailand and the Philippines. the use of public services. The shift away from the public For South Korea too, the projected poverty incidence for sector may, in part, be due to a deterioration of the quality 2001 is almost on par with the levels prior to the crisis. of health services resulting from a drop in real For Indonesia, while the recovery is expected to result in government expenditures. There has been a partial a substantial decline in poverty since the peak in 1999, recovery of the utilization rates in the public sector in poverty levels for 2000 and 2001 are still expected to be 1999. In Thailand, in contrast, the budget cuts in health above those for 1996. The incidence of poverty (at $1.50 were limited, the utilization of public services increased per day) in 2001 is thus projected to be about 6 percentage points higher than that in 1996.4 and the demand for programs, such as the low-income health card for the poor, and the Voluntary Health Card Insurance Scheme, increased between 1997 and 1998. In Poverty is, however, a multi-dimensional concept. It is Malaysia, health indicators continue to show an important to look at the trends in other dimensions of improvement between 1997 and 1998. welfare, such as outcomes in education and health, labor Labor market outcomes 3 From the Asia Pacific Consensus Forecasts, August 7, 2000. 4 The estimates for Indonesia subject to some uncertainty on One of the main effects of the crisis, was the reduction in account of a drift between the growth in mean consumption labor demand. Flexible labor markets helped cushion the implied by the surveys relative to the national accounts. landing, but the extent to which the adjustment occurred Significantly lower levels of poverty are obtained from through changes in open unemployment or projections using the 1996 survey and the national accounts growth in mean consumption during 1996-99. Under this underemployment, or through reduced real wages varied projection, the headcount indices for the years 2000 and 2001 across countries. Unemployment rates that doubled in are estimated at 27.6 and 26.0 respectively. Thailand and Korea after the onset of the crisis are on a September 18, 2000 Poverty during Crisis and Recovery 3 decline, albeit more rapidly in Korea, (Figure 2 and earnings was more than twice the decrease of real GDP Annex 2). Korea's unemployment rate peaked in 1998, between 1997 and 1998. However, real earnings have and continued to fall throughout 1999 into the second recovered more quickly vis-à-vis the rise in real GDP. In quarter of 2000. In Thailand, unemployment rates have Thailand, the magnitude of percentage decline in real been edging upward through 1999, before beginning to earnings and real GDP was about the same between 1997 fall in late 1999. Real wages declined by just under 10 and 1998. Unlike Korea, real earnings in Thailand have percent in Korea, and by under half that in Thailand not improved since the crisis albeit a modest growth of between 1997 and 1998. With the recovery, the real wage real GDP between 1999 and 2000. In Indonesia, the level in Korea has surpassed its pre-crisis level but that in percentage decline in the real earning was almost three Thailand has not recovered beyond its 1997 level. times larger than that in GDP, while in contrast in Malaysia the percentage decline in real earnings were Indonesia saw the smallest increase in open only half that of GDP. unemployment from 4.7 percent in 1997 to 5.5 percent in 1998, while real wages declined by a whopping 34 Male and Female Workers Figure 3 shows the trends of percent in the formal sector and by 40 percent in the unemployment and labor force participation rates, by agricultural sector. The latest estimates from August gender, in Korea and Thailand between 1996 and 1999. 1999 show that the unemployment rate has risen to 6.4 Korean male workers experienced a larger increase in percent, but real wages show a recovery and increased by unemployment rates than female workers in 1998 and over 10 percent. Agricultural wages have however, 1999. This, however, is only part of the story: there was continued to decline, with wages in 1999 four percent a relatively large (5 percent) reduction in labor force lower than their 1998 levels. In Malaysia, most of the participation among female workers during the crisis, and adjustment occurred on the quantity side, with a 2.7 female workers, instead of staying in the labor force as percent increase in unemployment between 1997 and unemployed, may have just dropped out of the labor 1998, and a real wage decline of only 1 percent. force. Male participation rates barely changed. In Unemployment rates in Malaysia have declined from their Thailand, male unemployment rates have also risen more peak of 4.9 percent in the first quarter of 1999, to 3.0 substantially than female unemployment rates, probably percent in March 2000. Job vacancies have risen sharply reflecting the fact that sectors with a higher male/female since the beginning of this year. In the Philippines, composition (e.g. construction) might have been more unemployment increased over the crisis period, while real adversely affected by the crisis. In terms of real wages, wages remained largely constant, there has been a decline the crisis has also more adversely affected male workers. in the unemployment rate since April 1999. The most The male/female wage gap has diminished by about 2.5 recent estimates for April 2000 show an increase, and this percent in Thailand and 3.5 percent in Korea during the is a cause for some concern. crisis. The male/female wage ratio in Thailand was 1.18 in 1997, but fell to 1.14 in 1998 before edging up to 1.19 The extent to which labor bore the brunt of the shock is in 1999. Similarly in Korea, the ratio stood at 1.61 in examined by comparing the relative magnitudes of the 1997 but slid to 1.57 in 1998 and 1.58 in 1999. percentage decline in labor earnings (calculated by multiplying total employment by the average real wage) and GDP. In Korea, the percentage drop in real total Figure 2: Indices for Unemployment Rates, Real Wage and Labor Force Participation Rates in Korea and Thailand (year 1997 = 100) Indexof Total Unemployment Rates for Korea Real Average MonthlyWage Index in Korea Index for Labor Force Participation Rates: and Thailand,1996-2000 and Thailand,1997-2000 Korea and Thailand,1996-2000 300 120 140 250 120 100 200 100 80 150 80 60 100 60 Korea Korea 40 Korea 50 40 Thailand 0 20 Thailand 20 Thailand 1996 1997 1998 1999 2000 0 0 years 1997 1998 years 1999 2000 1996 1997 years 1998 1999 2000 September 18, 2000 4 East Asia Brief Figure 3: Indices for Unemployment Rates and Labor Force Participation Rates in Korea and Thailand, by Gender (year 1997 =100) By Gender: Index of Unemployment Rates in Korea and By Gender: Index of Labor Force Participation Rates in Korea Thailand, 1996-1999 and Thailand, 1996-1999 300 250 100 200 95 90 150 Korea male 85 Korea male 100 Korea female 80 Korea female 50 Thailand male 75 Thailand male 0 Thailand female Thailand female 70 1996 1997 1998 1999 years 1996 1997 years 1998 1999 Self-rated poverty and vulnerability Who the poor are at any point is a fluid group that changes from year to year as households enter and exit episodes of An alternate measure of poverty, based on the households' poverty. A significant proportion of those who are own assessment of their living standards, is available for currently not poor nevertheless face a risk of falling into the Philippines. Self-rated poverty levels, based on the poverty. Recent analysis for Indonesia shows that while threshold level which households regard as "minimum under a third of the population are currently poor, between acceptable income" in surveys of perceptions of poverty, 30-60 percent of the population are vulnerable to poverty, are much higher than the levels of consumption poverty. that is, they face a probability of being poor that is above And unlike consumption poverty, they do not show a trend 50 percent over a three year time horizon. decline over the past two decades. This may reflect rising household expectations in response to either rising There are also concerns about other groups that may be incomes or greater exposure to how the rest of the country vulnerable. In Korea, while unemployment rates have and indeed the world lives. Self-rated poverty incidence declined sharply, there has been concern that many of the averaged 59 percent for the period 1996-97. It increased to new jobs which have contributed to falling unemployment 61 percent in 1998. Despite signs of economic recovery rates are temporary in nature and, therefore, less secure during 1999, self rated poverty rates fluctuated between with lower pay. The government has, however, 59-63 percent. strengthened its safety nets remarkably during the crisis, by expanding social protection measures for temporary workers, part-time workers, female heads of households, and workers in small firms. September 18, 2000 Poverty during Crisis and Recovery 5 Annex 1: Mean consumption, inequality and poverty at survey dates, and projections for 2000 and 2001 (Poverty line: $1.50 per person per day at 1993 PPP $) Year Mean consumption (1993 Gini Headcount index Number of poor PPP $ /person/day) (%) (%) (million) Indonesia 1984 1.64 30.3 60.6 97.0 1987 1.83 30.8 49.5 83.6 1990 2.02 28.9 45.4 80.9 1993 2.25 31.7 35.7 67.0 1996 2.85 36.5 25.7 50.6 1999 2.20 31.7 37.0 76.3 2000* 2.30 -- 33.6 70.3 2001* 2.36 -- 31.8 67.4 Malaysia 1984 3.96 45.5 22.2 3.38 1987 4.17 42.3 14.9 2.48 1989 4.65 41.6 9.0 1.59 1992 6.03 42.9 3.0 0.57 1995 6.58 43.7 1.9 0.39 1997 8.28 44.2 0.04 0.01 1998 7.22 -- 0.74 0.16 2000 7.91 -- 0.11 0.03 2001 8.41 -- 0.02 0.00 Philippines 1985 2.46 41.0 40.5 22.1 1988 2.72 40.7 35.1 20.8 1991 2.88 43.8 35.9 23.0 1994 2.93 42.9 34.0 23.3 1997 3.62 46.2 27.5 20.2 1998 -- -- -- -- 2000 3.73 -- 26.1 20.5 2001 3.79 -- 25.4 20.4 S Korea ($8-a-day) 1990 9.90 29.9 46.4 14.7 1991 10.86 29.9 38.4 12.5 1992 11.90 29.9 31.0 10.4 1993 12.59 29.4 26.1 9.0 1994 13.52 29.4 21.2 7.5 1995 14.47 29.1 16.8 6.1 1996 15.80 29.7 12.7 4.7 1997 15.91 29.0 11.4 4.4 1998 13.18 29.4 23.2 9.1 2000 15.23 -- 14.8 6.0 2001 15.96 -- 12.5 5.2 Thailand 1988 2.97 43.8 34.2 18.4 1992 4.26 46.2 19.8 11.4 1996 4.74 43.4 12.5 7.5 1998 4.44 41.4 12.5 7.6 1999 4.37 43.5 15.7 9.7 2000 4.56 -- 14.0 8.7 2001 4.75 -- 12.2 7.7 Note: The poverty lines are set at $1.50 per person per day (at 1993 PPP$) for all countries. For Korea, we also use the national poverty line equivalent to about $7.94 per person per day. The 1993 PPPs (local currency units per USD) are as follows: Indonesia 635.655; Malaysia 1.579; Philippines 10.975; S Korea 694.599; Thailand 13.452. The PPPs are the 1993 World Bank PPPs, except for the Philippines the PPP for which is from Penn World Tables. Projections are based on Consensus growth rate forecasts for the years 2000 and 2001, and assume that there is no change in the Lorenz curve since the latest available survey for a country. Estimates for all countries except Malaysia are based on surveys of household consumption. The estimates for Malaysia are based on income surveys; the income distribution is adjusted to derive a corresponding distribution of consumption. * There is some uncertainty regarding the estimates for Indonesia. Considerably lower estimates of the headcount index are obtained with an alternative set of projections, based on the 1996 household survey and growth in per capita consumption estimated from the national accounts. Under this projection, the headcount indices for the years 2000 and 2001 are estimated at 27.6 and 26.0 respectively. September 18, 2000 6 East Asia Brief Annex 2: Labor Market Indicators for Korea and Thailand, 1996-2000 KOREA THAILAND Unemployment Average Labor Unemployment Average Labor Rate (%) monthly participati rate (%) monthly participation real wage on rate (%) real wage rate (%) (1997=100) (1997=100) 1996 2.0 97.64 62 2.1 --- 53.4 1997 2.6 100 62.2 2.3 100 53 1998 6.8 90.72 60.7 4.8 96.5 52.7 1999 6.4 100.8 60.5 5.4 100.03 53.3 2000 4.5 114.95 61.4 4.8 99.13 53.2 Indices (index 1997=100) for Employment, real earnings and real GDP in Korea and Thailand, 1997-2000 KOREA THAILAND Employment Real Real Employment Real Real GDP Earnings = GDP Earnings = Real Wage * Real Wage * Employment Employment 1997 Q1 100 100 100 100 100 100 1998 Q1 94.40 85.64 99.11 97.18 93.68 92.52 1999 Q1 98.05 98.86 98.37 99.20 92.20 92.67 2000 Q1 96.24 110.63 109.31 100.51 92.59 97.48 Note: Employment for Korea refers to total (wage employees and self-employed) employed in the economy whereas employment for Thailand refers to only wage employees in the economy. If third quarter data are used instead of those of the first quarter, findings are similar except that the drop in Real GDP is bigger from 1997 to 1998 by a few percentage points. Note: Employment for Korea refers to total (wage employees and self-employed) employed in the economy whereas employment for Thailand refers to only wage employees in the economy. If third quarter data are used instead of those of the first quarter, findings are similar except that the drop in Real GDP is bigger from 1997 to 1998 by a few percentage points. - Special Focus: Poverty During Crisis and Recovery was prepared by Tamar Manuelyan Atinc, Gaurav Datt, Benu Bidani, Chorching Goh and Limin Wang (EASPR) September 18, 2000 CHINA (a third of GDP) grew at 8.1 percent, off from its late-1999 MACROECONOMIC UPDATE high (see Figure 1). OVERVIEW Industrial output reflected the effects of the macro- stimulus program and rising exports, at the same time as the Government continued to implement programs to Compared to 1998 and 1999, there is greater certainty reduce capacity in traditional industries. For enterprises today about the likely direction of the Chinese economy. large enough for full reporting, output growth was 11.2 Several economic trends have become better established. percent, implying significantly slower growth for smaller Policy implementation--more easily interpreted by firms. Basically, and unusual in China's recent external observers than policy debate--has accelerated in experience, many state-owned and state-controlled firms many critical areas. matched the growth rate of non-state firms (although as a On the domestic front, fiscal stimulus continues to serve its whole they did not), and heavy industrial output outgrew intended purpose of propping up overall demand and light industry by more than two percentage points. employment, while major structural changes and reforms Electronics and sectors linked to exports grew especially in the economy work themselves out. In the external fast, with clothing and textile output growing in the 12-to- sector, favorable regional and world trade conditions and 25-percent range and electronics products by 23-to-90- WTO-accession related foreign investment inflows have percent. provided a recent boost. Progress in the core reform areas (for example, the civil service, enterprises and banks) is Expenditures unmistakable. In others--such as law, governance, Again reflecting the Government's stimulus program, housing, farming, and social insurance--the results from fixed asset investment rose about 11 percent in real terms numerous pilot experiments are beginning to feed into the (Figure 3). Assuming reasonable changes in inventory, development of clearer strategies and, in some cases, to and noting that net exports amounted to 2 percent of GDP, guide implementation. domestic consumption grew in the 6-to-7-percent range, In the near term, poverty reduction, growth and economic with the rise in government spending somewhat faster than stability will require closer coordination of that of households.1 This domestic consumption pattern macroeconomic management tools, especially fiscal and corresponds roughly with results based on surveys of monetary policy, improvements in incomes in the rural urban and rural households in the first half, which show economy, and decisive measures to tackle the issue of household income up just under 5 percent in real terms. urban jobs. China's development path for the next decade is expected to be set in the context of three policy drivers. Figure 1. Quarterly GDP growth and CPI These are: the Tenth Five Year Plan (2001-2005), accession to the WTO, and the focus on development of CPI y-o-y % CPI (Left Scale) GDP y-o-y % the lagging western region of the country. 6 GDP (Right Scale) 10 These themes are discussed further in the following 5 9 updates of macroeconomic developments, and the 4 8 corporate, financial and social sectors. 3 7 6 2 Trends 5 1 4 0 Sectoral Growth. 3 -1 2 The National Bureau of Statistics (NBS) reported an 8.2 -2 1 percent growth in GDP in the first half of 2000, as exports -3 1997 1998 1999 0 surged and the CPI edged above zero for the first time in two years (see Figure 1). This follows 7.1 percent growth Qtr-1 Qtr-3 Qtr-1 Qtr-3 Qtr-1 Qtr-3 Qtr-1 for all of 1999, and 6.7 percent in its second half. Industry and construction (half of GDP) clearly led the recovery, with 9.9 percent growth, while agriculture's performance was especially weak in the first half--and declined year- on-year (y-o-y) in the second quarter. The service sector 1 NBS does not report quarterly GDP by expenditure groups. September 18, 2000 2 East Asia Brief Figure 2. GDP by sector effects of the soft landing engineered through macroeconomic and other policies in the second half of the % y-o-y 1990s, and a soft rural economy. The first of these can be Growth Primary Secondary T ertiary expected to intensify with accession to the WTO, and the 12 second is being offset by a fourth round (in three years) of fiscal stimulus. However, decisive economy-wide 10 measures to counter the weaknesses in rural prices, 8 incomes and demand are yet to be implemented. 6 Demand Constraint 4 Slow rural income growth and stagnant rural consumption reflect farm policies introduced as early as 1995. 2 According to the original State Council notice, these 1997 1998 1999 policies were explicitly designed to expand grain planting 0 for the purpose of reversing increases in food prices, especially grain prices. The policy was successful, and by Q-1 Q-3 Q-1 Q-3 Q-1 Q-3 Q-1 the outset of the Asian crisis, China's CPI growth had Figure 3. Fixed asset investment growth dropped below 3 percent. However, the policies continued in force through 1999. As a result, grain prices are now in 35 %y-o-y their fourth year of absolute decline. The growth of rural Total household incomes has slowed dramatically, and Growth consumption growth has been zero for three years. In 25 1999, the number of rural persons with income under the Chinese and World Bank poverty lines increased slightly, 15 rather than continuing the previous declining trend. Mid- year data show that rural cash income growth was only 5 2 percent, compared to 8 percent in the cities. Given the large numbers of rural residents, the weakness in rural -5 demand constitutes a major drag on the economy; 1997 1998 1999 2000 consumption by rural households is half the national 1 3 1 3 1 3 1 household consumption. Qtr. Qtr. Qtr. Qtr. Qtr. Qtr. Qtr. Employment Industrial employment growth has been soft since 1996, Prices turning negative in both 1998 and 1999. About 1.96 Price trends during the first-half of 2000 helped clarify the million workers were laid-off from state-owned enterprises picture with respect to the underlying trend in the in the first half of this year, with the total reaching 6.77 economy. Prices appeared to be strengthening. The CPI million at end-June. The proximate reasons seem to be the recovered from an average decline of one percent in the program to downsize the state enterprise sector, but weak second half of 1999 to a slight increase of 0.1 percent in rural consumer demand for manufactured products plays a the first half of the year. However, almost all of the key role. The Government continues to close inefficient increase was due to administrative adjustments in prices in coal mines, steel mills, and cement, textile and auto plants, the service sector (education fees, healthcare, housing to mention a few affected sectors. Layoffs are expected to rentals). Food and clothing prices declined further. continue in the second half of the year. At the same time, Producer prices also showed an uptick in the first half, but large numbers of rural enterprises have also closed. As these too were due almost entirely to price rises for steel urban state-owned enterprises have laid off workers, most and coal (whose exports rose sharply) and petroleum and large cities have tightened regulations limiting the related chemicals. Prices for water were also employment of rural persons in urban jobs. As a administratively raised, but with one or two exceptions all consequence, revised data for 1999 show that employment other producer prices either declined or stayed the same. in farming increased in both 1998 and 1999, a trend not In particular, producer prices for building materials, foods, seen since China's growth slump in the early 1990s (see beverages and clothing all declined year-on-year. Figure 3). Such price trends partly reveal the basic weakness of the current economic situation. Demand-side weakness, at least as far as the needs of poverty reduction and job growth are concerned, stems from three main factors. They are increased competitive pressures, the lingering September 18, 2000 China 3 Figure 3. Annual employment growth conditions have been eased progressively, although since end-1999 money (M2) growth has slowed slightly to13.4 percent at end-July, 2000. As intended, there has been a % T otal 9 Growth Primary decline in the growth rate of time and savings deposits (8.3 7 Secondary percent compared to 23.7 percent for M1), and within this T ertiary category a sharper decline in household deposits. This drop 5 was linked to increased spending for the national week- long holiday. Interest in the stock market as an alternative 3 form of savings also seems to be on the rise. At end- 1 August, local share prices on the Shanghai market were up 40 percent on the year, and 17 percent since early June. -1 Moreover, the increase in foreign currency deposits in the -3 banking system (now about 10 percent of the total) has been faster than the increase in M2. This, too, represents 1991 1992 1993 1994 1995 1996 1997 1998 1999 increased portfolio diversification on the part of the households. Going forward, however, the potential for Fiscal more active switching between Renminbi and foreign In this context, the prospects for further macroeconomic or currency deposits in the domestic banking system may external stimulus become key issues. On the fiscal front, constrain the scope for monetary policy actions to manage the government deficit has doubled since 1997 to a aggregate demand. Credit growth is relatively slow, rising budgeted 3.6 percent of GDP, despite a stronger revenue a mere 6.3 percent y-o-y at end-July. However, there are effort over the period. Tax revenues were up 18 percent y- signs that credit to private enterprises and individuals is o-y in the first half, more than double the nominal growth rising faster, which is in line with the attention being given rate of GDP. They were a little more than half of the total currently to stimulating consumption and the non-state anticipated for the year which, given the heavy seasonal segments of the economy. increase in collections in the second-half, means revenues are significantly ahead of original projections. Higher Trade and Payments tariff revenues and better tax administration were largely External sector developments have been favorable, responsible. Expenditures, which are also generally obviating the need for even more domestic stimulus. The heavily concentrated in the second half, increased 26 robustness of international trade and the stronger foothold percent through June, in part because of a 195 percent for recovery in the Asian region have helped support increase in social security outlays. Despite the rapid export growth. In addition, export tax rebates have been growth of expenditures, the government budget had an continually raised. Export growth was weak in the first RMB40 billion surplus, again because seasonality in half of 1999, but surged after July, thanks in part to new expenditures has traditionally led to a first-half surplus. VAT rebates. As a result, late-1999 improvements in Despite buoyant tax revenues, an additional RMB50 extended into the first-half of 2000, with exports rising 37 billion of public debt (0.5 percent of GDP) will be issued percent in the second quarter. China's exports are in the second half to support infrastructure investments and diversified sufficiently with respect to destination as well other public programs. China continues to maintain as product groups to withstand softness in specific conservative macroeconomic policies, which accounts for markets. Thus, small declines in demand in the US its low stock of government debt. However, the widely- market--which most analysts think is softening--are not recognized off-budget liabilities of the Government, expected to have much of a negative impact as long as combined with a high degree of uncertainty about their Japan recovers steadily and Europe continues to grow at its size, has implied that medium-term sustainability issues current pace. However, imports have also been rising fast, are given close attention by the authorities. This is nearly 24 percent in the second-quarter. The macro- especially the case today, as the costs of the reform and stimulus program combined with promotional programs to development programs in core areas of the economy (for fund technical upgrading has led to sharp increases in example, development of the western region, education, equipment purchases from abroad. As domestic firms and energy) are being factored into estimates of future foreign-invested enterprises prepare for a post-WTO expenditures. Therefore, while fiscal policy is pro-active, accession world, such imports will keep rising. In the and may need to be so until employment growth is first-half, the trade surplus was US$14.4 billion, but WTO stronger, it needs support from other macroeconomic related factors will likely narrow it below the 2.9 percent policies and longer-lasting structural measures. of GDP for 1999. This reduced contribution of net external demand to aggregate growth needs to be Monetary monitored closely. It does not seem to have figured in the consensus forecasts of Chinese economic performance in Unfortunately, the scope for monetary policy stimulation 2000 and 2001, but has important implications for the of aggregate demand continues to be limited. Monetary September 18, 2000 4 East Asia Brief macroeconomic stance the Government will adopt in the Western Region Development near term More details regarding the policy and project packages to After declining for nearly four years, new FDI develop the lagging western region of the country are commitments increased almost 25 percent, to US$27.6 beginning to be reported. So far, many of the proposals billion, in the first seven months of 2000, although actuals seem to be market-friendly, and in accordance with the were down by 7.4 percent, to US$19.9 billion. Grade-A new policy directions that have evolved over the past few office space in Beijing has experienced a drop in vacancy years. However, strong constituencies exist in favor of the rates in the first half, reportedly because of demand from traditional instruments that were used to develop the foreign enterprises preparing for China's WTO accession. coastal regions. Many of these instruments--possible Hence, if WTO accession is achieved in the second half, when government revenues were over 30 percent of GDP imports and anticipatory FDI may continue to rise, but the but infeasible when they are less than 15 percent--may effect on exports will likely be delayed. Although prove to be ineffective, given the different conditions in developments in the capital account are difficult to project, the western areas. The role accorded to the private sector the pattern of inflows reported to end-July suggest that the will be a key element to watch, especially with regard to balance of payments is in surplus, and will remain in participation in core infrastructure projects; similarly, the surplus for 2000. External reserves reached US$158.6 degree to which the development plans build on the billion at end-June, representing an increase of US$3.9 comparative advantage of the regions will largely billion from end-1999. This represents a merchandise determine long term prospects. import coverage ratio of 9.3 months, compared to 11.2 months at end-1999. Developments to Watch Several areas deserve attention over the next year: Tenth Five-year Plan The State Development Planning Commission, starting in September, will be fully engaged in writing the basic Plan document for implementation during 2001-2005. A start was made in the two previous Plan periods to move away from detailed investment planning. However, the forthcoming Plan will mark a decisive shift towards strategic/indicative planning of the kind practised in other parts of the world. Key features of the Plan to watch are the relative emphases given to the quality of growth, economic control and coordination problems, and measures to meet the demands of globalization. WTO Accession The final package negotiated between China and its trade partners is expected to reflect the need for gradual adjustment in the domestic economy, given the current employment situation. The balance between safeguarding domestic interests and meeting new international commitments is a delicate one, and one which will be subjected to close external scrutiny. How policymakers decide on such issues will signal the extent to which some of the constraints on efficiency and growth will be removed in the future. Much of the administrative infrastructure to manage post-accession developments is yet to be put into place, so it is unclear how the new openness will play out in practice. Therefore, developments need to be watched closely, especially their effects on employment and wage inequality, as both will be affected greatly by the new trading regime. September 18, 2000 China 5 15 percent of total bank lending goes to these lagging areas. FINANCIAL SECTOR UPDATE Support to distressed financial institutions. PBC recently Overview approved RMB20 billion in lending to rural credit cooperatives (RCC) to support agriculture. This compares Although the financial sector reform agenda in China is to an annual amount of RMB15 billion in 1998 and 1999. vast, several of the policy debates from 1998 and 1999 By the end of April, deposits in RCCs had reached have now found concrete expression in implementation. RMB1.4 trillion (12 percent of fianancial institution These include the operation of the AMCs (see Corporate deposits) and lending had reached RMB986 billion (10 Sector Update), the degree and nature of support for the percent of the total outstanding loans). In early April, PBC smaller distressed financial institutions, and the confirmed its liquidity support to city commercial banks to progressive liberalization of interest rates. A shortage of meet their payment obligations. Most of the 90 City information on many core components of the financial Commercial Banks, which emerged from the merger of system makes it difficult to assess its underlying urban credit cooperatives at the municipal level, are performance and dynamics. WTO accession has stirred an considered by experts to be insolvent. internal debate on meeting the challenges of global competition. Banking Sector Developments Trends Supervisory Panels. As in the case of the supervisory panels established by the State Council to audit state RMB convertibility. Governor Dai Xianglong of the enterprises (see previous section), panels were constituted People's Bank of China (PBC), stated in July that that there for 16 major state financial institutions--eight banks, four was no timetable for full Renminbi convertibility. asset management AMCs, three insurance companies and a However, according to the negotiated WTO agreement securities firm. with the US, foreign banks will be permitted to offer Senior management changes. Following the major services in Renminbi to Chinese individuals within five reshuffle of top management in the PBC, China Securities years after China's accession. Many experts believe that it and Regulatory Commission (CSRC) and the state banks, will be a great challenge to keep the capital account closed announced on February 22, 2000, further changes were under such circumstances. announced. Mr. Wang Mingquan has replaced Mr. Liu Interest rate liberalization. Mr. Dai also stated that the Minkang as Chairman of the China Everbright Group. Mr. liberalization of domestic interest rates would be Fang Chengguo replaces Mr. Wang as President of the coordinated with RMB convertibility. "If the local Bank of Communications (BOCOM). currency is a freely convertible currency...the exchange China Association of Banks (CAB) was established on rate should be a floating exchange rate regime and in turn May 10, 2000 under PBC guidance. Twenty-two banks, the interest rate should also be liberalized". He noted that including four SOCBs, three policy banks and 11 share- foreign currency interest rates would be liberalized first, holding commercial banks, became the initial members. followed by RMB lending rates in rural areas. In other CAB will have the function to limit harmful competition, areas and sectors the fluctuating band of lending rates supervise members' compliance with banking laws and around the base rate would be expanded before liberalizing regulations, and provide services to its members. The PBC deposit rates. "All of this work can be completed within will gradually transfer some of its non supervisory work to about three years but with the deposit rates we will pay CAB. special attention". PBC followed through on these statements this week, when it announced the liberalization Integration of payment systems. Under the umbrella of of interest rates in the on-shore foreign currency market. PBC, the four SOCBs and BOCOM, expect to connect their bank card networks to the National Bank Card Bank Accounting Rules. Tighter interest accrual Switching Center managed by PBC by October 1, 2000. accounting rules, have been in effect since the beginning All other commercial banks are scheduled to connect their of this year. Banks are required to discontinue interest internal card networks by the end of 2000. accrual for loans overdue for more than six months (formerly 12 months). Nevertheless provisioning and Licensing of foreign bank RMB lending. The number of accrual accounting rules continue falling short of banks licensed to undertake RMB lending business international norms. At present, Chinese banks are increased from 25 to 32 of which 24 are operating in regulated by adverse accounting regulations limiting Shanghai and 8 in Shenzhen and neighboring areas. provisions to one percent of outstanding loans at the end of The Industrial and Commercial Bank of China (ICBC), each year. This overstates the taxable income of banks. signed an agreement recently with 11 foreign banks to Support for developing the western region. PBC has urged handle banking bills and capital transfer businesses on state banks, and in particular policy banks, to increase financing for western region development. Currently, just September 18, 2000 6 East Asia Brief their behalf. Customers of these foreign banks can do listing the SOCBs. Earlier this year, PBC Governor Dai RMB business at ICBC's branches and thereby have more said there would be no policy obstacles for turning the big freedom to expand into central and western areas of the state banks into "shareholding entities". country. The 11 banks are the Hong Kong and Shanghai Banking Corp, the Citibank Corp, the Credit Agricole Hong Kong to become Hub for SOCB's overseas IndoSuez, the Bank of East Asia, Credit Lyonnais operations. BOC Group announced its plan to merge its Shanghai, the International Bank of Shanghai and Paris, 12 "sister banks", which includes BOC Hong Kong the Bank of Tokyo-Mitsubishi, Dai-Ichi Kangyo Bank, Branch, 4 Hong Kong and 7 Beijing incorporated banks Sanwa Bank, Sakura Bank and the Korea Development into one bank, which would constitute the second largest Bank. ICBC also signed a far reaching cooperation bank in Hong Kong following HSBC. The merger is agreement with Shenzhen Development Bank, which may intended to bring about significant cost savings for BOC's also be viewed in connection with ICBC's strategy to operations in Hong Kong and to strengthen BOC's strengthen its presence in the Hong Kong. overseas operations. BOC has transferred the management of its overseas business to Hong Kong. Other SOCBs also Capital increase for smaller banks envisaged. Recently plan to do so. both PBC and CSRC indicated that nationwide shareholding banks would be provided wider instruments Meanwhile ICBC fully acquired Union Bank of Hong for resource mobilization. These would include issuance of Kong Ltd. ICBC aims to draw on Union Bank's retail shares and bonds at the national equity and bond markets. infrastructure to fit into ICBC's strategy for wholesale, The banks include the BOCOM, China Everbright Bank retail and investment banking in Hong Kong. Union Bank (CEB), CITIC Industrial Bank (CITIC bank), Pudong is a listed company on the Hong Kong Stock Exchange. It Development Bank (PDB), Hua Xia Bank (HXB), maintains 23 branches in Hong Kong with assets of Minsheng Banking Corporation (MBC), China Merchants HK$21 billion (US$2.8 billion) and net assets of HK$2.4 Bank (CMB), Shenzhen Development Bank (SDB), Fujian billion (US$320 million). Following the full acquisition Industrial Bank (FIB), and Guangdong Development Bank ICBC changed Union Bank's name to Industrial and (GDB). BOCOM's and Minsheng's listing seems to be at a Commercial Bank of China, Asia Ltd (ICBC Asia). more advanced stage. CCB - business focus, new products. CCB President, Wang Moody's upgrades seven smaller banks' rating outlook Xuebing outlined, in a recent interview with foreign from negative to stable. Recognizing their recent media, CCB's future business along four main lines, restructuring efforts, somewhat more stable economic corporate banking, consumer lending, mortgages and conditions and reduced regulatory uncertainty. The banks midmarket services such as fund management. He also include BOCOM, CEB, CITIC Bank, PDB, CMB, SDB, emphasized the urgent need for improving personnel and GDB. policies and staff pay systems to be able to recruit and retain well qualified staff, which might otherwise be SOCB reform ­ capital increase. There was significant absorbed by foreign banks. Their urgency notwithstanding discussion among senior bankers and regulators to allow improvement of staff performance and loan portfolio SOCBs raising capital through equity markets earlier this quality would however only improve over the long run. year. Liu Minkang, Bank of China (BOC) President said: "We should be permitted to raise funds via various While CCB introduced several new products recently financial instruments, such as by issuing shares or including securities-backed loans, mortgage-backed bonds, convertible bonds." and on-line and telephone banking, Mr. Wang pointed to important obstacles in developing these: "All financial CSRC Chairman Zhou Xiaochuan said that going public products require the approval of the central bank. That is on the stock market, either at home or abroad, would be something, I think, that has got to be liberalized." options the SOCBs. Despite the government's recent efforts to improve capital adequacy of the four SOCBs, he Mr. Wang has requested the authorities to set up a said the government's ability to recapitalize SOCBs is specialized financial institution to buy and sell mortgage- limited considering the lingering deficit and heavy public backed securities. The institution, which could be set up spending needs. The participation of non-State capital this year, would pool the bank's fast-growing pile of would give commercial banks' operations a clearer goal individual home loans and resell them to bond investors. and help them fend off administrative interference. The government could still retain dominant stakes in the banks, Bad debt restructuring such as 75 per cent, to ensure its capability to weather According to press reports four AMCs have "settled" outside impacts on the stock, Zhou said. about three third of the NPL transfer originating from pre- Mr. Wang Xuebing President of China Construction Bank 1996 loans of a total estimated RMB1.3 trillion. Press (CCB) and former President of BOC indicated in a recent reports also recently stated the following status of interview to foreign media that the country's four big state transfers: banks won't merge or be listed on any stock market for several years. Also PBC released no immediate plans for September 18, 2000 China 7 Trans- Receiving NPL NPL Com- companies with Chinese partners. Market regulators say fering AMC RMB bn RMB bn pletion one or two foreign companies will likely be approved to Bank Transfer Total Rate begin operations later this year. American International Group, which already sells insurance in China, is expected CCB Cinda 250 250 100% to be among them. CDB2 Cinda 100 100 100% Corporate Bonds ­ CDB and CCB. CDB issued a RMB17 ICBC Huarong 379 408 93% billion 10-year floating rate bond to domestic financial ABC3 Great Wall 345 345 100% institutions on April 26 and to be tradable on the interbank BOC Dongfang 260 267 97% debt market. CCB issued 5-year floating rate bonds in mid Total 1334 1370 97% 2000 in Hong Kong, marking its return to the international The definition of "transfer" and "settlement" is not clear in market after the Asian financial crisis. this context. Policy Implementation and Assessment AMC started to varying degrees working on asset appraisal, classification and disposal. Banking Additional NPL restructuring at second tier banks is Banking reform has been recognized as enormously currently under consideration. This may include the complicated given the size and the institutional complexity separation of accounts and the creation of AMCs, however of the Chinese financial sector, the fiscal costs of repair, without central government support. AMCs are expected and the complexity of political decision-making process. to take over, restructure, and manage the non-performing China's entry into WTO and the associated commitments loans of their parents, sell assets, design debt for equity to liberalize and open up the financial sector to foreign swaps, and list assets competition and the recent re-endorsement of a private According to press reports, 601 state companies have sector-dominated economy will steadily impart urgency to negotiated debt for equity swaps and 62 were approved by the interest and exchange rate reforms and bank the State Council in May for the first batch. restructuring process. With each additional reform measure, Chinese authorities are running out of easy Debt-clearing scheme will face hurdles. Many senior reforms and forced to confront the larger, more complex, officials and analysts warn that the ambitious scheme to and sometimes neglected problems. clear about RMB1.3 trillion worth of debt of the state- owned enterprises is fraught with difficulties. The AMCs Capital Markets are short of experience and qualified personnel, an inadequate operating and legal framework, highly China faces even greater hurdles implementing a unrecoverable loans, likely limited domestic and consistent package of reforms in the capital markets. international investor interest in the non-performing loans, While authorities have broken new ideological ground in and the need to obtain senior government approvals for recognizing the role of private sector in the economy and transactions. of stock and bond markets in financing the private sector as well as in the divestment/financing of SOEs, daunting Capital Markets Development problems remain. First, China has managed to get only about 950 companies listed in the stock market over a Government Bond Markets. The government has taken a decade, more than 900 of which are state-owned. The step forward to standardize treasury bond issuance by recent announcement by the government to dilute its selecting 66 financial institutions to undertake the sale of average holding in listed SOEs from 62 percent to 51 all T-bonds to be issued this year. These include percent alone implies an issuance equal to an additional 25 commercial banks, Rural Credit Cooperative Unions percent of the currently traded stocks. Even if only a (RCCU), insurance companies and securities companies. modest portion of the over 9,000 large SOEs and 8,000 The government so far issued RMB110 billion in treasury medium size SOEs are listed, it may overwhelm the bonds Also MOF started issuing RMB28 billion 10-year listing/trading/placement/-regulatory capacity of the floating rate bonds to domestic financial institutions. The exchanges, brokerages and CSRC. The debt-equity swap government plans issuing bonds worth RMB438 billion activities of the AMCs, divestment, and new listing (US$53 billion) this year. portend a glut of Chinese security issuance. The government's capacity to maximize divestment revenue, Foreign financial institutions would soon be allowed to avoid a downturn in the market, and execute well- underwrite local-currency bonds issued by the central prepared, transparent divestment transactions is likely to government. In a first step foreign asset managers would be tested. be allowed to establish joint-venture fund-management The bond market is affected by interest rate controls, directed lending, restrictions on foreign financial 2China Development Bank (CDB) institutions' RMB activities and lacking institutional 3Agricultural Bank of China (ABC) September 18, 2000 8 East Asia Brief investors. Despite a substantial increase in issuance China Technical Assistance / Trust Funds lacks an integrated professional government securities market. Among the myriad problems are lack of PHRD/ASEM Grants. Two technical assistance grants systematic benchmark issuance and maintenance of the addressing bad debt resolution with PBC and Cinda yield curve, multiple issuance methods aimed at exploiting funded by PHRD (US$1.5 million) and ASEM (US$1.37 segmented and differentiated prices, inadequate million) are being implemented. Consultants for the PHRD development and standardization of issuance process and grant are currently being selected. Short-listed consultants market makers, and coordination between MOF, PBC and under the ASEM grant are currently preparing proposals. other quasi-sovereign issuers. The Second phase of a 12 month TA to upgrade the credit Development of institutional investors, sorely needed to risk management process at the Bank of Communications intermediate China's vast retail pool of savings and help its is being completed. The TA is funded by ASEM grant large population obtain adequate financial services, are "Strengthening Smaller Banks" (US$1.52 million). missing for a variety of reasons. Pension funds are An ASEM grant for the Establishment of Deposit essentially non-existent and will remain so without a major Insurance Program (US$370,000, May 28, 1999) is now reform that tackles at the same time SOE restructuring, being implemented by PBC. funding of accrued pension rights, and swapping of state- owned assets and housing to fund/discharge accrued pension liabilities. While the average Chinese household is estimated to hold a substantial amount of financial assets at 52,895 yuan(USD6,373), and these savings have risen 71 percent since 1996, 80 percent continue to be invested in savings accounts, 4.3 percent in cash, and only 11.6 percent in securities. Current Programs The Bank's Financial Sector Board approved special resources for FY 01 to initiate a multi-year program in cooperation with the PBC. A Mission to support the Government's preparation on interest rate liberalization was fielded in July 2000. Further work in this area as well as the areas of banking supervision, resolution of second tier banks and preparation of banks for WTO is envisaged under this arrangement during the ongoing fiscal year. The next mission is envisaged for October 2000. Lending and TA Assessment of CDB. The assessment report was submitted to the Government in February, 2000. An Technical assistance project to support CDB's institutional reforms and risk management capacity over the coming 18 months was jointly designed by the ADB and the Bank in April 2000. The Financial Sector Technical Assistance project (FSTA) is largely completed. Around $39 mn is disbursed, the rest fully committed. The Board approved in July 2000 a supplemental loan amounting to US $ 8 mn to finance the additional cost of the payment systems component. An assessment of the primary and secondary government bond market will be completed by end 2000. Accounting Reform and Development project. A Bank loan of $27.3 million and an IDA Credit of SDR 4.1 million (US$33 million equivalent) The Project is now being implemented. A supervision mission was undertaken in December 1999. September 18, 2000 China 9 some relief, the government continued its efforts to reduce capacity. PBOC and SETC issued a notice to require CORPORATE SECTOR UPDATE banks stop lending to firms that are found in SETC catalogs for closure and prevention of duplicated Overview investment. Government actions so far in 2000 have deepened In the steel market, increased export and slowed supply structural reforms. The objective of the measures taken so growth resulted in a reduction of supply in the domestic far is to complete the transformation to an open market market, which has helped to pull up prices and profitability economy led increasingly by the private sector. of steel makers. This was also the case in the coal mining industry, where exports increased by 44 percent in the first · Local governments have taken radical steps to quarter and capacity was cut by 40 million tons. In the accelerate ownership diversification among state textile industry, sharp rise of sales contributed to large owned enterprises (SOE). profit increase and loss reduction. A new plan for reorganization of the state owned airline · The participation of AMCs as large, and in many industry was unveiled in late July. The plan proposes that cases the largest, shareholders in many traditional ten existing companies be put into three groups led by Air SOEs, and in the firms they in turn control, has paved China, China Eastern Airline and China Southern Airline. the way for further changes in corporate control and After the reorganization, the companies will be allowed ownership. more managerial autonomy from the Civil Aviation Bureau. The proposal needs State Council approval before · The government has decided to take comprehensive it can be implemented. actions, including the sales of state owned assets, to speed up social security system reform. Foreign Investment. Tax receipts from foreign-invested enterprises (FIE) soared last year. Reasons probably · include the expiration of tax holidays resulting from the Premier Zhu Rongji recently declared that the three- aging of the FDI stock, efforts to improve tariff year turnaround target to cut the share of loss-making collections, and better profitability. In the first quarter of SOEs to a level comparable to large firms in this year, tax receipts from FIEs rose by a further 40 developed countries will be met. The State Economic percent. and Trade Commission (SETC) reports that of 6,599 large and medium industrial SOEs that incurred losses In view of China's opening under the WTO, there is in 1997, 3463 firms, or 52.5 percent, had turned a increasing debate whether to reconsider tax preferences for profit or broke-even by end-July. FDI. Last year, tax preferences went as far as exempting domestic sales of equipment from VAT if the buyers were Trends foreign-invested firms. The effective income tax burden is about 22 percent for mainland firms but 12 to 15 percent Industry Performance for foreign-invested firms. Profitability. During the first seven months of this year, SME Development. As a result of the strong growth of industrial enterprises reported a sharp increase in net exports (16 percent y-o-y), township and village profits to RMB202.2 billion, an increase of 110 percent enterprises (TVEs) posted a 14.7 percent increase in net over the previous year. This included profits of profits. RMB113.2 billion by SOEs (wholly and majority state- Nevertheless, obstacles to the further growth of TVEs and owned), an increase of 190 percent. A large part of the SMEs are still serious. According to the Township profit increase came from price increases and reductions in Management Bureau of the Ministry of Agriculture interest payments (for example, through debt-equity arbitrary and redundant charges on township firms swaps). Price increases particularly aided the state- amounted to RMB110 billion last year. Enterprise start-ups monopolized oil industry and the loss-making metallurgy require up to 20 approvals, cost entrepreneurs on average industries. 20 percent of the start-up costs of the business. Additional Rationalization. In the National People's Congress session costs stemmed from abuses such as forced contributions to earlier this year, Premier Zhu highlighted the need to hospital construction and excessive social security rationalize industries. He proposed restricting production premiums. of those products that have no market, and closing down small factories and mining pits that operate with backward Corporate Financial Restructuring technology, produce low quality products, waste resources Asset Management Corporations. The transfer of a large and pollute the environment. While prices of traditional part of the non-performing loans (NPLs) of the four major industrial products such as steel, coal and sugar have state-owned banks to AMCs is close to completion. Cinda increased sharply since this year and these enterprises felt has transferred RMB350 billion of NPLs from China September 18, 2000 10 East Asia Brief Construction Bank and the State Development Bank some clarify the release of information related to meetings with months ago. In early-August, Huarong had received creditors and debt reorganization plans. They also say NPLs from the Industrial and Commercial Bank of China when trading should be halted or reinstated, and require of RMB379.2 billion (involving more than 70,000 immediate delisting once a court has reached a decision on borrowers), accounting for 93 percent of the total planned bankruptcy and the move has been reported to the transfer. Orient has reportedly completed a transfer of securities commission. RMB260 billion of a total of RMB267.4 billion in the Bank of China (BOC). Its President declared earlier that Corporate Governance and Financing the focus would now shift to asset disposal. Great Wall completed its transfer of RMB345.8 billion in late-July. Capital Markets. The market value of "A" shares (for The work load at Great Wall was particularly heavy due to Chinese residents only) rose 61 percent in the first-half, to the large number of small loans transferred from RNB 1.28 trillion. The value of "B" shares (for foreigners Agriculture Bank of China (ABC). Each employee only) grew roughly 40 percent. Investors have been reviewed on average nearly 1,800 borrowers and over discussing the possibility of a merger of "A" and "B" 4,000 loans in a period of 120 days. The scope of such shares. A key consideration in effecting the merger, transfers is unclear. Possibly, claims on debtors have been however, continues to be the non-convertibility of the transferred from banks to AMCs. It is equally unclear how Renminbi. the AMCs made payments to the banks. A number of regulatory changes have occurred, or are The implementation of debt/equity conversions, as expected shortly: designed by the government has been a top priority. Among the 601 SOEs slated by SETC for debt/equity · NASDAQ-type boards are expected to be opened in swaps, framework agreements have been reached in 569 Shanghai and Shenzhen, starting in early 2001. cases, of which 62 have been formally approved by the Listing requirements are to include one year of State Council. The first debt/equity swap for Beijing profitability (rather than three at the current boards) Cement Factory has been followed by its corporatization. and RMB 30 million minimum registered capital. Cinda now holds 71.4 percent of the company and has four Daily price movements would have no limits, seats in a board of seven directors. Similar ownership compared to 10 percent on the main boards. Foreign- changes have taken place in some listed companies. In invested firms would be allowed to list on the Hubei province, for example, Cinda had a debt equity exchanges, but trading will be open to domestic swap deal with Meierya Group, in which the latter agreed investors only. This will provide small firms with to buy back the debt-converted equity with its shares in a much needed access to capital market funds. listed company, Meierya Ltd. As a result of the transaction, the Meierya Group lost its position as the · Since October, 1999 insurers can invest 5 percent of largest shareholder in Meierya Ltd. total assets in mutual funds (rather than be restricted to government bonds and bank deposits). In March AMCs have also managed to initiate other forms of asset this year, the limit was raised to 10 percent for four disposal. The first bankruptcy filing against a mainland- local insurance companies. Now, one company listed firm, and the first by an AMC, has been carried out (China Pacific Investment) has been allowed to invest by Cinda AMC against Zhengzhou Baiwen, a firm in 15 percent, with others expected to follow suit. CSRC Henan Province. Assets sales by AMCs to date include a confirmed that insurance firms will be allowed successful auction held by Huarong AMC in late May in gradually to invest a larger share of assets in the stock Guangzhou. One floor of a shopping center with an area of 6028m2 was sold for RMB55m. Leases of plant and real market. estate by Great Wall AMC primarily to individual Corporate governance. A series of steps have been taken investors took place successfully in Dalian in mid-June. to strengthen the audit industry and, through stronger Great Wall has also led a debt reorganization operation in auditing and compliance reviews, to influence corporate a PT listed company Yu Tai Bai in Chongqing, in close governance: cooperation with the municipal government. These examples show the range of situations covered. · The State Council renamed the "special inspector" and assistants as a "supervisory panel". This replaces Bankruptcy. As part of the continuing efforts of the a State Council regulation of 1994 on the "external Capital Structure Optimization Program launched in 1994, supervisory board" (a name that distinguishes it from in late-July SETC approved 1093 proposals for SOE the "internal board" elected by shareholders in a bankruptcy and merger, to be implemented this year. The corporation, as per the Company Law). The State National People's Congress (NPC) has resumed its review Council, in cooperation with the Party Enterprise of the draft Bankruptcy Law, which had been shelved for Working Committee, dispatched 27 Supervisory some years. The Shanghai and Shenzhen stock exchanges Panels in mid-August to oversee the performance of have set new rules on public disclosure in bankruptcy 67 large SOEs and SOE groups. cases as well as procedures for delisting. The new rules September 18, 2000 China 11 · The national associations of certified asset appraisers advice to the Government on the legal framework and and certified tax advisors merged with the association other environment to support private sector development. of certified accountants. The latter had earlier For instance, IFC is helping SETC to undertake a absorbed the association of auditors. The combined diagnostic of China's private sector and SDPC to review entity now represents 300,000 professionals. private participation in infrastructure. Officials have stated that mergers will make it easier The Bank's PSD Unit for East Asia and Pacific has for such firms to diversify and, thus, to compete recently been put under joint management with the IFC's against foreign firms. They have also required Country Department for the same region. The IFC resident official agencies that sponsored such professional country managers have taken the lead in representing both service firms to sever link, which should reduce these units in the client countries and coordinating private monopolistic and predatory market practices sector development strategies. These institutional changes exercised by the former. will help to harmonize country strategies for the enterprise sector, offer a broader range of instruments, cross-fertilize · The government is also attempting to strengthen expertise, and provide clients and private sector partners auditing enforcement and sanctions for wrongdoing. with a one-shop window. Following a random examination by the Ministry of Finance of audited reports of 100 SOEs, 16 certified accountants in 8 audit companies were punished for breaking laws and regulations. One firm got suspended for one year from auditing SOEs. Bank Instruments The Enterprise Reform Credit (LIL) in four pilot cities continues to be the core of the Bank's Enterprise Reform Assistance Program. Together with the Technical Cooperation Credit III and the Shenyang Enterprise Reform Loan activities are coordinated with the work of other Bank units. These cover the reform of accounting and audit, economic legislation, and the pension system, and grant-funded assistance for bank debt resolution, institution-building of AMCs, health services rationalization, etc. Older loans support reforms in telecommunications and technological research institutions. PHRD grants are utilized for the following activities: enterprise reform in Wuhan, preparing SOE reform, corporate restructuring policy and pilots, and the foundations of urban micro credit. ASEM grants are utilized for the following activities: corporate financial workouts and labor issues of enterprise reform. Studies on bankruptcy, private equity financing of non- state firms, and a background note on credit securities are being finalized, while a study on corporate governance has just started. A policy note on the linkage between pension and SOE reform and SOE reform has been submitted to the authorities. IFC operations in China have expanded. In the last six months, IFC has committed: US$16 million equity for Shanghai Midway Infrastructure, US$68 million loan for Shanghai Krupp Stainless Steel, US$22 million equity for Bank of Shanghai, US$20 million loan for Shanxi International Casting, equity for China Infrastructure Group, and a loan for Lafarge Dujiangyan Cement. IFC is currently preparing an initiative to assist SMEs in Sichuan province through a special advisory center in Chengdu. (iii) Investment Environment TA: IFC has been providing September 18, 2000 12 East Asia Brief Ministry of Finance statements that without it, reforms in state-owned enterprises will be threatened. Further, two SOCIAL SECTOR UPDATE major international conferences on social security reforms were held, the first organized by the Ministry of Finance in Key Social Indicators June and the second organized by the Development Research Center of the State Council in August. Latest Previous Data Period Social security reform is critical for enhancing labor mobility, for providing adequate social safety nets, and for Human Development1 (%) 1999 1985 shifting the management of social insurance increasingly Primary enrollment (gross) away from enterprises and towards government. Female 123 114 Consolidating social insurance (unemployment, medical, pension, death, disability and maternity) and integrating Male 123 132 information systems at a national, provincial, and Secondary enrollment (gross) municipal or prefecture levels will help ensure contributions and benefits are paid and received, initially Female 66 33 for the urban population. Male 73 46 Tertiary enrollment (gross) Social insurance Female 3.9 1.7 Nationwide campaigns exist to extend the pension Male 7.3 3.9 coverage (from 84 to 110 million workers) and unemployment insurance (from 80 to 137 million). Targets Poverty 1998 1996 were also announced for expanding health insurance (the Rural Headcount Index (%) original scheme was announced in November 1998) to cover 70 percent of the country's cities, with 50 million Government poverty line, $0.7/day 4.6 6.3 people expected to become involved in a basic medical Higher poverty line, $1/day 2 11.5 15.0 insurance system to be established for urban and town- Government Expenditures3 1997 1996 level workers. Combined worker/employer contributions will be paid into an individual account (5 percent) and a Education (at 1990 prices, RMB 98.0 88.5 national health-insurance program (3 percent). The new billion) as % GDP 2.50 2.46 system will cover state firms, private enterprises and foreign-funded companies. The funds are to be managed Labor Market 1998 1997 by local labor and social security departments. Concerns Registered Unemployment Rate4 (%) 3.1 3.1 are being raised about the capacity of cash-strapped enterprises to pay and the ability of local labor and social Unemployed + Laid-off Workers4 7.9 6.5 (%) security bureaus to manage funds effectively. 1 Data on secondary and tertiary enrollment are for 1996. Primary Financing social security education covers grades 1 through 9. Source: Education Indicators for East Asia and the Pacific, World Bank, 1999. The Central Government has had to increasingly effect 2.Income based, using 1985 PPP. 3.Statistical Yearbook resource transfers to provinces and some cities in order to 4 Labor Statistics Yearbook compensate for social security cash-flow deficits. In 1999, an estimated RMB17 billion was transferred to 25 Trends provinces to compensate for pension deficits between Over the course of the last quarter, there have been major revenues and disbursements. and the transfers are likely to policy announcements (or heightened emphasis on be greater in 2000. previously announced policies). Key among them are: (i) The Government is currently exploring options for reforming the social security system; (ii) bolstering urban containing and financing this cash-flow need, as well as safety nets; and (iii) generating employment for both the financing options for partially or fully funding what have laid-off state owned enterprise workers and for the rural to-date been largely notional individual accounts. surplus labor force. Government has indicated its intention to transfer management responsibility for pensions and other social Social security reform. insurance from enterprises to municipalities/prefectures. The government has long recognized the need to Making sure, therefore, that contributions are paid and strengthen its social security system as an essential benefits received is an important function of an integrated condition for further structural economic and social security information system. administrative reforms. In recent months, there are signs of In the interim, however, it has been difficult to get increased urgency for major reform, as evidenced by enterprises to make contributions, especially cash-starved September 18, 2000 China 13 firms. To address this issue, the State Council nearly RMB26 billion. The additional money will target promulgated two regulations in 1999 on enterprise poor farmers and augment other poverty-relief efforts in contributions to pension and other social funds. These remote areas and ethnic minority regions. The central regulations include substantial new penalties (including government has also asked local governments to back up seizure of assets) for firms that fail to make required the government's spending. Statistics indicate that, in 1999, contributions. The financial burden of providing income local governments spent RMB1.78 billion on poverty support to laid-off SOE workers has, not surprisingly, also relief, a 20 percent increase over 1998. fallen onto central government. During the first half of 1999, RMB8.8 billion (US$1.06 billion) was raised to Developments to Watch finance allowances for laid-off workers, of which the lion's share (47 percent) came from fiscal expenditures, a Linkage between SOE and Social Security third from SOEs and the rest from other agencies. Reforms. Urban safety nets. The increasing willingness of the Government to take measures for ownership diversification of SOEs has come An "income distribution adjustment program" was up against difficulties. Many such SOEs are providers of announced in September 1999 to provide low income pension and other social insurance benefits, which the residents a minimum living subsidy. To implement this Government cannot take over in the short-term. In those policy, the Ministry of Civil Affairs approved the cases where pension contributions are not pooled at a Regulations on Minimum Living Standard of Urban municipal or prefecture level and where disbursements are Residents, which was expected to take effect by December not carried out by the state (but, rather, remain the 1999. The urban residents' fund would be set up across the responsibility of the enterprise), commitments to retirees country. More details are not available at this time. can deter enterprise restructuring including share sales, However, it was announced that the income from the 20 merger and bankruptcy. When alternative arrangements are percent tax on interest on personal bank savings begun in not available, the result is a slowing down of enterprise November is to be spent on "social welfare projects and reform; neither liquidation nor joint ventures nor mergers programs" (although the tax explicitly exempts medical can proceed smoothly unless the issue of social obligations insurance, basic life insurance and unemployment is settled. As such, the establishment of municipal insurance, as well as housing subsidies, education unification, pooling, and unified management systems savings). become integral to enterprise financial restructuring to the degree that pension liabilities continue to reside with the Employment. enterprise. SOE and social security reforms are, therefore, Priority continues to be placed on training and re- linked. employing laid-off enterprise workers. During 1999, 6.1 million state enterprise workers lost their jobs (roughly the Floating Population. same level as in 1998). However, the Minister of Labor The relaxation of China's system of residency permits has and Social Security told a national labor conference in resulted in a growing number of temporary and illegal early-January that as many as 12 million state-owned- rural migrant workers, known as the "floating population". enterprise workers could lose their jobs this year, as the Estimated at over 100 million nationwide, these workers SETC intensifies reform efforts, calling 2000 "the year of tend to be engaged in construction, vending, garbage decisive battle". collecting and other low level jobs. The absence of More positively, the recent announcement on establishing permanent resident certificates means that they lack access a level playing field for the private sector and increased to housing, medical care, unemployment insurance and incentives to foreign firms should help increase schooling for their children. A leading article in the New employment, particularly in urban areas. One estimate has York Times (12/12/99) highlighted the plight of the credited foreign-funded firms with creating 5.2 million estimated 100,000 children of migrant workers in Beijing jobs in urban areas (or nearly a quarter of total urban job who were unable to access public schools. As noted above, growth) between 1990 and 1998. In rural areas, the WTO accession is likely to exacerbate rural to urban Ministry of Agriculture announced plans to absorb surplus migration, placing further strain on urban management and farm labor by supporting the development of township increasing social tensions. enterprises, which they expect to grow by 14 percent in the coming year. HIV/AIDS. The first HIV case was identified in Yunnan Province in Poverty relief budget. 1985; by late 1999, all 31 Chinese provinces had reported Government announced it will increase its poverty-relief HIV infections, with most serious epidemics in Yunnan, fund by RMB1 billion this year. This extra money will Xinjiang, Guangxi, Sichuan and Guangdong. The total raise the central government's anti-poverty allocation to infections in the country has been estimated to range between 400,000 and 500,000. Most of the infections have September 18, 2000 14 East Asia Brief started from sharing contaminated needles among intravenus drug users (IDUs) and this source of transmission still predominates, but sexual transmission is now gaining momentum fast. Minorities living in border areas seem to be most at risk but the trend among the mainstream population seems to be changing quite rapidly too. The main factors leading to this rise include China's phenomenally high internal migration, rise in IDUs, fast growing prostitution and the rise in sexually-transmitted diseases (STDs). China signed the Paris Declaration at the World AIDS Summit in December 1994 indicating its commitment to the global AIDS prevention effort. It also pledged to undertake in its national policy to protect and promote the rights of individuals through improvement of the legal and social environment, full involvement of non-government organizations (NGOs) and community-based organizations. The World Bank's Health Nine Project ($10 million) represents the first large-scale program to prevent and control HIV/AIDS in China. Bank Engagement The Bank currently has ongoing projects in Social Protection as follows: Pension Reform Project, Enterprise Housing and Social Security Project, and the Labor Market Development Project. Late in 1999, the Chongqing Industrial Pollution Control Project was restructured to potentially provide financing for the development of an integrated labor and social security management information system. Project implementation continues in the health and education sectors with five and seven projects respectively. A PHRD grant has been utilized for one activity: preparation of a pension reform project. Policy notes were prepared in 2000 on pension reform and on the linkage between pension and SOE reform. Further analysis is planned in 2000 on projecting the unfunded pension liability and proposing financing options. An ASEM-funded technical assistance activity continues to examine the social aspects of corporate restructuring, including the transfer of social assets from SOEs to local government, labor retraining and leveraging excess enterprise assets to fund enterprises' social security liabilities. - Macroeconomic Update was prepared by Albert Keidel (EACCF) - Corporate Sector Update was prepared by Chunlin Zhang (EACCF),Gary Fine (EASPS) . - Financial Sector Update was prepared by Rainer Hartel and Jun Wang (EACCF), Xiaofeng Hua (EASFS) - Social Sector Update was prepared by Teresa Ho), Mark Dorfman , Halsey Beemer, Janet Hohnen, Jagadish Upadhyay (EASHD September 18, 2000 China 15 China Economic Indicators 1997 1998 1999 2000/p 1999 2000 China Key Indicators Year Year Year Year Q3 Q4 Q1 Q2 May Jun Output, Employment and Prices GDP ( % change previous year) 8.8 7.8 7.1 7.3 7.0 6.8 8.1 8.3 Industrial production index (Value-added) 11.2 8.9 8.5 10.0 9 7.2 10.7 9.7 Unemployment Rate (%) /1 3.0 3.1 3.1 3.3 Real Wage Growth 1.1 7.2 13.1 Consumer price index (% change, previous yr) 2.8 -0.8 -1.4 0.1 -1.2 -1 0.1 0.1 Public Sector Government balance (% GDP) -1.8 -3.1 -4.1 -3.6 Domestic public sector debt (% GDP)/7 12.3 16.4 20.7 22.6 Foreign Trade, BOP and External Debt Trade balance ($US Million) 40,420 43,475 29,213 11583 9823 5200 7092 3100 1892 Exports of goods, ($US Million) 182,790 183,529 194,931 54210 57950 51700 62793 20100 22193 (% change, previous year)/2 21.0 0.5 6.1 30.0 14.9 16.2 39.1 37.7 29.5 44.9 Key Export (% change, previous year) /3 23.0 3.0 7.0 20.0 17.3 18.6 40.6 37 Imports of goods ($US Million) 142,370 140,166 165,718 42630 48120 46500 55701 16966 20301 (% change, previous year)/2 2.5 -1.5 18.2 32.0 24 15.5 41 32.6 24.5 39.8 Current account balance ($US Million ) 29718.1 29321.1 15882.4 17,000 (percent GDP) 3.3 3.1 1.6 1.6 Foreign Direct Investment (US$ Billion)/4 44.2 43.8 38.8 10.6 10.8 7.1 10.1 -1.8 4.4 Total external debt ($US Billion) 131.0 146.0 151.8 (% GDP) 14.6 15.4 15.3 15.4 Short-term debt ($US Billion ) 18.1 17.3 15.2 Debt service ratio (% exports of g&s) 8.6 8.5 5.8 Reserves, including gold ($US million) 143,363 149,812 158,337 (months of imports of goods and services) 10.3 10.8 10.0 Total reserve without Gold ($US Million) 105809.0 105955.0 114919.0 Financial Markets Domestic credit (% change, previous year) 18.5 20.0 12.1 13.5 12.1 12.287 Short-term interest rate (less than 20 days)/5 8.9 6.3 3.9 3.2 3.24 3.24 3.24 3.24 3.24 3.24 Exchange rate (end-period) 8.2798 8.2787 8.2795 8.28 8.2775 8.2795 8.2787 8.278 8.2773 8.278 Real effective exchange rate ( + = appn) 1995=100 112.17 112.35 106.94 107.26 105.01 (% change, previous year) 4.5 0.2 -4.8 -5.389 -2.498 Stock market index (Dec. 19, 1990=100),close/6 1,264.8 1,331.9 1,554.4 1801.43 1554.38 1927.28 Memo: GDP in Billion US$ 898.2 946.3 991.2 1065.5 249.0 305.0 219.507 257.526 1. Official Unemployment only, not including laid-off workers 2. Norminal growth rate 3. Manufactured Exports 4. Gross FDI 5. Central Bank loans to financial institutions. 6. Shanghai Stock Exchange High Comprehensive Index (A share, 1990, Dec.19=100). 7.It includes treasury bond, policy financial bond and other financial bond (end-period outstanding). September 18, 2000 INDONESIA those that have not yet completed restructuring their MACROECONOMIC UPDATE outstanding debts) continue to find it difficult to obtain new financing from the banks. In addition, the Current Developments unwillingness of banks to lend can also be attributed to the prevailing uncertainties in Indonesia. Firms are meeting Despite the recent political uncertainties and episodes of their working capital needs largely through internal cash sporadic violence, Indonesia's macroeconomic indicators generation, including through non-payment of scheduled remain stable. debt service. With a view to boost exports from Indonesia's Small and Medium scale Enterprise (SME) On August 23, 2000, the President issued a decree that sector, the Government (Department of Industry and delegates key functions of the Office of the President to Trade) has teamed up with the Indonesian private bank the Vice President, Megawati Sukarnoputri. This decree Danamon to provide loans to SMEs through a new small will be effective until the end of President Wahid's five- enterprise and trade institution (LPT Indak). year term in 2004. The Vice President will now: The manufacturing and services sectors are beginning to · Chair cabinet meetings and explain of the results of show some increased activity, but it is too early to arrive at the meetings to the public, as well as monitor and any conclusions about attaining an upward trend. In the evaluate the performance of cabinet ministers in second quarter of 2000, all sectors other than agriculture implementing government programs. contributed to the GDP increase. The current calendar · Coordinate with other state institutions regarding the year's real GDP growth is expected to be at about 4% in implementation of government programs. line with consensus forecasts from market participants. · Sign decrees on government policies--"but only after Figure 1. Domestic demand shows an upturn they have already been approved by the President"-- including decisions on the structure of department- (year on year, percent growth by quarter) level or non-department level government institutions, including the appointment of "echelon one" officials 30 in those agencies; promotion, removal, or retirement 20 of civil servants and military and police personnel. 10 On the preceding day, The President dissolved his two 0 advisory councils--the National Economy Council (DEN) and the National Business Development Council (DPUN). -10 -20 The newly appointed Coordinating Minister for Economy--Dr. Rizal Ramli--launched a 10-point -30 "Economic Recovery Acceleration Plan" on September 4, GDP -40 2000. This plan will endeavor to implement measures to: Private consumption Investment achieve stability in the financial sector; boost exports; -50 97Q1 97Q3 98Q1 98Q3 99Q1 99Q3 00Q1 increase the productivity and welfare of farmers; promote "Equity-based Recovery instead of Loan-based Recovery"; privatization that is "value-creating"; implement The fragility of the macroeconomic stability is being decentralization; better utilize Indonesia's natural resource demonstrated by the recent increase in domestic interest endowment; promote the micro, small and medium scale rates (with the 30-day SBI rate inching up to the 13-14% enterprise sector (SMEs); promote rural development and range in July, 2000, up from 12.33% the preceding month) accelerate banking and private sector restructuring. and an inflation estimate for July 2000 of 1.3 percent (up from 0.5% in June 2000) which is somewhat higher than Gross Domestic Product (GDP) rose by 4.13 percent in the anticipated (Figure 2). The annual inflation rate estimate at second quarter of 2000 compared to 3.7 percent the same end-2Q 2000 is 4.6 percent. The stock market also remains quarter a year ago (up by 0.53 percent over the previous susceptible to political events. quarter). Although this increase continues to be driven by increased household consumption (which rose by 0.4 The period of political uncertainty leading to the percent), this quarter's GDP growth was influenced by President's accountability speech slowed the pace of both increases in fixed capital formation. Inventories continue the state-bank restructuring and the asset disposition to be drawn down sharply so that total investment posted a programs The cabinet reshuffle and particularly the recent decline this quarter (Figure 1). However, as discussed later changes in the roles and responsibilities of various bodies in the Corporate Sector Update, most firms (especially on the economic arena threaten to cause further delays in September 18, 2000 2 East Asia Brief the implementation of the structural reform program, at likely shortfall in asset recovery and privatization, the need least in the short run. for foreign budget financing remains. Figure 2. Recent inflationary pressure but since Figure 3. Non-oil exports and imports on the rise the crisis a sharp decline (US$ million) 4,250 115 4,000 3,750 Export of 90 3,500 non-oil Food Price 3,250 3,000 65 2,750 General CPI 2,500 40 2,250 2,000 Import of 15 non-oil 1,750 1,500 -10 1,250 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jun-00 The second quarter of 2000 saw the rupiah weaken beyond Issues and Areas to Watch the Rp9,500/USD mark and subsequently strengthen to a two-month high of Rp8,045 to the US dollar (on August The effectiveness of the recent delegation of 21, 2000) as decisions on the new Cabinet and economic responsibilities from the President to Vice President team came to closure. The depreciating rupiah and weak Megawati Sukarnoputri and the cohesiveness of the new domestic demand have improved the trade account Cabinet (and Economic Team). This will have key significantly. (Figure 3) Total exports are sharply higher implications in demonstrating the Government's resolve than last year and higher than any pre crisis year -- $2.9 towards pushing ahead with the ongoing economic reform billion in the first half of the year 2000, 34.7 percent agenda. higher than the same period 1999, and 14 percent higher than 1997. Though this increase has been helped by high Fiscal situation will continue to be monitored, especially oil prices, non-oil exports are also sharply higher -- up 27 the extent of revenue generation through asset sales under percent in the first half year, and 16 percent higher than in the ongoing financial sector restructuring program--a key the first four months of 1997. Non-oil exports reached US$ aspect of the most recent Letter of Intent (LOI)--and 22.7 billion for the first half year 2000, while oil-gas expenditure implications from the implementation of the export reached US$ 6.5 billion. Manufacturing exports fiscal decentralization laws. rose rapidly to the level 32.5 percent higher in the first five months of 2000 than in the same period in 1999. Textiles, The budget preparation process for the coming fiscal year furniture and electrical equipment did particularly well. will be greatly influenced by the quality of the relationship Agricultural and non-oil mineral exports actually fell by between the Parliament and the new Economic Team of 21.8 and 9.0 percent respectively. The US and Japan the Government. remain the dominant export destinations for Indonesian goods, with each accounting for more than 24 percent of exports in January-June 2000. Program Implementation and Assessment Total imports are recovering from their 1999 lows, to the The next meeting of the Consultative Group on Indonesia level 18.4 percent higher in the first semester of 2000, but will be held in October 2000, in Tokyo. Follow-up they are still 36 percent below pre-crisis levels. Capital meetings on specific issues and consultations with civil good imports increased by 16.5 percent in the first five society will continue to be held in advance in Jakarta. months of 2000. The net effect has been an increase in the current account balance and comfortable reserve levels. This quarter also witnessed the completion of the second review under the Extended Fund Facility (EFF) agreement On the fiscal side, actual spending is more on track than between the International Monetary Fund (IMF) and the last year. Nevertheless, the projected FY2000 fiscal deficit Government (a three-year SDR 3.638 billion program) and is, like last year, unlikely to meet its targeted 4.8 percent of the signing of a Letter of Intent on September 6, 2000. GDP. Higher than expected revenues due to increased oil This LOI was a slightly amended version of the earlier one prices more than offset the increased expenditures due to that Minister Kwik Kian Gie had signed on July 31, 2000. the depreciated Rupiah, the additional spending on fuel The current LOI, that has been endorsed by the new subsidies due to the postponement of fuel price increases, economic team, was approved by the Fund's Board on and the postponed revenue measures. But because of the September 15. This would trigger the release of about a US$400 million second tranche of the EFF to Indonesia. September 18, 2000 Indonesia 3 Bank Instruments international and Indonesian experts for IBRA, and to enhance TA coordination for IBRA and Bank Indonesia. The World Bank is preparing a new Country Assistance ASEM support has also concentrated on improving Strategy and is currently holding civil society stakeholder institutional performance at the local level. ASEM is also consultations in Indonesia. The new CAS is scheduled to playing a key role in helping Indonesia's decentralization be completed for a World Bank Board discussion in early efforts with programs to improve local government public FY00/01. expenditure and financial management systems - Improving Local Government Public Expenditure The Bank's policy-based lending with Indonesia is closely Systems, Reporting and Transparency (US$298,500); and coordinated with the overall reform agenda that is a Water Utility Rescue Program (US$396,000). ASEM underway with support from the IMF, ADB, Japan and our also finances a program to Improving Fiscal Policy other development partners. The form and focus of further Analysis by the Ministry of Finance (US$440,000). In the adjustment support is currently being discussed. In social sectors, an ASEM grant is being used towards addition, there are two adjustment loans that are currently SMERU (US$790,000), which funds social impact being disbursed: (a) Social Safety Net Adjustment Loan - monitoring activities and social data analysis; and another US$600 million in two tranches (approved May 27, 1999 (US$693,000) to support (a) Community Based and became effective in February 2000). Second tranche Monitoring (US$200,000) (SSN programs and other yet to be disbursed; and (b) the Water Sector Adjustment community development activities), (b) the TKPP Loan - US$300 million in three tranches (approved May ($241,000) (innovative social safety net performance 27, 1999, effective and first tranche released in June 1999). targeting and safeguarding activities), and (c) Tim Second tranche not yet disbursed. In addition, the World Pengendali (principally LD) ($252,000) (for independent Bank has supported IBRA and JITF and is providing TA verification of SSN program performance). Also, an for implementation of banking reforms through the Bank ASEM grant of US$171,000 supported data analyses for Restructuring Assistance Project (BRAP) - US$20 million. the recent poverty assessment. The Bank is implementing (approved 12/4/1997 and made effective on 4/8/1998) and two PHRD technical assistance grants of $1.3 million and the Corporate Restructuring Technical Assistance Project $1.7 million, mainly to help assist corporate restructuring. (CRTAP). One CRTAP component provides for PHRD TA Grants (US$847,920) are being used to support assistance for strengthening the Commercial Court. The the ongoing financial sector reform effort. IFC has been Bank, in coordination with other donors, has continued to working on individual corporate restructuring transactions provide direct support to the social safety net and key in which it is an investor and drawing legal, regulatory, social services through its investment project portfolio. In tax, and procedural issues to the attention of Bank staff. the social sectors, a new project to support employment IFC is also implementing a $1.7 million PHRD grant to and income-generating activities in urban areas ­ the identify good potential corporate restructuring candidates Urban Poverty Project ­ became effective in late 1999. and begin their restructuring on a pilot basis. The corner stone of the project is facilitating the formation of legitimate and democratic kelurahan-level institutions Analytical and Advisory Services are being provided in the through the support of local facilitators and a team of areas of good governance, civil service reform, fiscal and technical experts. These institutions, called the BKM, administrative decentralization, debt management, poverty receive a grant that is used as a revolving fund for micro- assessments, fiscal transparency and budgetary processes, credits to community groups. The project includes 1300 SME development and trade financing. To facilitate kelurahan in the first stage and another 1800 in the second corporate restructuring, the Bank is providing advisory stage. In the first six months of operation, approximately services to help in developing and implementing a 1300 BKM have formed. They have lent to 28,000 corporate legal reform and corporate governance strategy; community groups with roughly 200,000 individual a strategy for developing small and medium enterprises; recipients. In addition, the Bank continues to support and direct advice for reform and privatization of state- structural poverty reduction and governance reform owned enterprises. The Bank is also advising the Financial through the Kecamatan Development Project and the Sector Policy Committee (FSPC) Secretariat and the other Village Infrastructure Program. 727 kecamatans in 19 relevant institutions on policies pertaining to corporate provinces are included in this second year of activities restructuring. A series of working papers on the social under KDP, and 750 kecamatans are targeted for the third impact of the economic crisis from both quantitative and year. The portfolio also includes the "stay in school" qualitative research have been produced by the Social project for scholarships and block grants for primary Monitoring and Early Response Unit (SMERU), a unit set schools, in coordination with ADB, and several projects in up with support from the World Bank, AusAid, USAID, the health sector. and ASEM trust funds. These are available on SMERU's web page: www.smeru.or.id. Much of this work has been Grant Funds. The Bank-administered ASEM Trust Fund is incorporated in the World Bank's Poverty Assessment that supporting a program of Financial Sector Advisory is underway. A draft of this report will be presented to Services (US$385,000 and US$305,000), primarily to help civil society and donors prior to the CGI scheduled for establish an Independent Review Committee of October. September 18, 2000 4 East Asia Brief rest of the proceeds coming from IBRA's treasury activities. However, with the negative market reaction FINANCIAL SECTOR UPDATE to the new economic team and the continued uncertainty over the respective roles of FSPC, MoF Current Developments and the OSC in steering IBRA going forward, IBRA will have a difficult time meeting the highly ambitious Despite the continued uncertainty in the political arena and disposition targets set forth in the Fund LOI for both the persistent difficulties in enforcing contracts through the end of September and for FY2000. judicial system, IBRA maintains slow but steady progress · IBRA raised IDR 420 billion from the sale of 6.1% in asset disposal and outsourcing activities and in meeting stake in First Pacific, a regional conglomerate listed various institutional objectives set forth in the structural on the Hong Kong Stock Exchange. The stake reform program. originated from the Salim Group, and was sold through a private placement to a Hong Kong based In the cabinet reshuffle IBRA's Chairman Cacuk investment company, Capital International. Sudarijanto was named to the post of Junior Minister in Meanwhile, IBRA is proceeding with preparations for charge of Restructuring and the National Economy. It is the sale of also other Holdiko Perkasa assets, namely still unclear what this appointment will mean to IBRA as Wisma BCA (with an international sale tender already Cacuk will continue to serve as the Chairman with no launched), Karimun Granite, Mosquito Coil and the changes having been indicated in IBRA's management. Palm Plantations. · IBRA concluded successfully the first corporate loans · Oversight Committee (OSC) established to improve sale. Salomon Smith Barney-Citigroup, BCA and IBRA's corporate governance. Minister of Finance Hammers Rui were declared as winning bidders in signed the Decree on IBRA's oversight committee on IBRA's first corporate loans sale. The offered July 17 appointing two ex-officio and seven corporate loans included loans originating from five independent members to the committee with the IRC debtors, PT Astra Graphia with debt amounting to Chairman Mar'ie Muhammad receiving the post as the US$10.6 million, PT Federal International Finance Chairman of the OSC. The members are decreed to (US$1.1 million and IDR 45 billion), PT Karang Mas be "independent professionals with a high level of Sejahtera (US$23.9 million), PT Satelindo (US$62.4 integrity and commitment in carrying out the tasks million) and PT Tiger Mandiri Pratama (US$0.7 entrusted to them." The IBRA Chairman and the million). The loans recovery rate is expected to reach Secretary of the Financial Sector Policy Committee 71% (restructured ) of their total book value of USD (FSPC) will concurrently be members of the 98.7 million. Committee ex-officio. The OSC will serve as the · IBRA completed the outsourcing of its commercial Executive and Monitoring Committee of the loans. Bank Bukopin and Bank Artha Graha-Grant Implementation of the Tasks of IBRA to strengthen Thornton consortium won IBRA's auction to service IBRA's operational transparency, to monitor IBRA the last portion (tranches III and IV) of its commercial performance and to provide guidance to IBRA's loans portfolio. These tranches are valued at IDR 6.8 management on strategic issues. Its tasks specifically trillion and include 600 commercial debtors. include: · IBRA completed the sale of the second tranche of upholding corporate governance and transparency mortgage loans. Bank Artha Graha won this auction at IBRA, including monitoring policy with bid price of IDR 389.1 billion. In this deal IBRA compliance; achieved 50% recovery rate, exceeding the return of monitoring the performance of IBRA, especially 41% attained in the Tranche I sale. regarding strategic issues; and · IBRA offered a 100% interest discount to retail and offering recommendations, solicited or otherwise, SME debtors participating in the Special Crash to IBRA and the FSPC to further the success of Program (SCP). The SCP program provides a 100 IBRA. percent discount on interest payments and fines to those retail and SME debtors who are willing to repay · IBRA's governance structure has further been fully their loans. The SCP excludes housing, car and enhanced through the establishment of an independent credit card loans. To date, IBRA's retail and SME Audit Committee. portfolio includes 75,000 debtors with an outstanding · IBRA grossed IDR 4.66 trillion in revenues during the IDR 6.4 trillion. first quarter of FY 2000. IBRA is making some · Divestment plans of BCA and Bank Niaga to be progress in its efforts to deliver the IDR 18.9 trillion presented to Parliament by end August. The collection target set for FY2000. By end of first government has been preparing the divestment plans quarter 2000 the Asset Management Credit (AMC) for both BCA and Bank Niaga for review before unit collected IDR 3.44 trillion, Bank Restructuring Parliament by end this August. Market sources have Unit (BRU) generated IDR 0.987 trillion with and the questioned the viability of the government's plan to September 18, 2000 Indonesia 5 divest both banks according to the schedule presented. governance, audits, and preparation for privatization -- Hence, due to weak investor confidence the sale of all crucial elements for the recovery of the state these two banks may fall short the targeted revenue of banking sector and thus for the economy. The cabinet IDR 3.2 trillion. reshuffle moving the responsibility of all SOE's to · IBRA, Bank Indonesia and Rudy Ramli reached the MOF adds to the uncertainty. In spite of management agreement to end all litigation related with the changes and the on-going recapitalization to be transfer of Bank Bali to IBRA. Following the completed in October, interim performance contracts agreement, the Parliament approved the Bank Bali have thus far proven insufficient to bring about recapitalization plan for IDR 5.356 trillion. In substantive improvement in the restructuring of the preparation for Bank Bali's recapitalization, the EGM state banks. There remains the need to strengthen has approved the bank's plan to go forward with its their governance and management as well. rights issue. IBRA will underwrite any unsubscribed shares. As further legal procedures will have to be · Banks gradually resuming their lending to the real undertaken prior to recapitalization, it is currently sector. Albeit limited, banks are starting to extend new expected that the bank will be fully recapitalized by loans. BI's survey on fifteen banks that represent 75 October 2000. percent of total banks' deposits found that a total of · IDR 15.8 trillion new loans have been extended since IBRA won its first bankruptcy case in the Commercial the beginning of year 2000, which represent a 5.7 Court. IBRA has won a bankruptcy petition against percent year to date growth. It must be noted, one of its non-cooperative debtors, PT Mahadjaja however, that this figure includes both renewed and Gemilang, with total debt outstanding of IDR 19.3 restructured loans, which means that truly new lending billion. The court decision, involving use of ad-hoc is significantly lower. Privately recapitalized banks judges, was the first one with favorable outcome to and nationalized banks under IBRA's control report IBRA. The company has been declared bankrupt, and that a majority of these new loans are being directed to placed in receivership. corporates and SMEs. Table 1. State-owned banks Financial highlights Despite these positive signs, with the slow pace of (in IDR trillion ) new lending, banks will be unlikely meet their financial targets. Banks' lending activities are Loans/dep. Recap bonds Net Income restrained by the limited room in their capital levels, (%) (issued) which barely meet BI's 4 percent limit due to the Bank Mandiri 34 175.0 (100%) 6.6 dominance of zero risk government bonds in banks' BNI 43 62.0 (100%) (2.4) portfolio. Hence, banks will need to intensify their BRI 69 20.4 (70%)* 1.2 operational restructuring, particularly in the area of BTN 45 9.8 (70%)* (1.0) asset rehabilitation. * as of 25 July 00 ­ remaining 30% expected end-October · Management changes in state banks completed. This year the management of all the state-owned banks The Government has been taking steps to introduce more have been changed, with BRI (in July) and BTN (in active governance in the state-owned banks, the mandate May) being the most recent. This preceded the of the newly established over-sight unit in the Ministry of approval of the banks' business plan by MOF and Finance remains narrow and somewhat unclear. Along infusions of recapitalization bonds covering 70% of with the implementation of recapitalization (see Table 1 their recapitalization needs. The new management for status of state bank recap), the Indonesian banking teams signed an interim performance contract with sector is beginning to show signs of stabilization. Positive MOF, defining performance targets and milestones for trends are emerging such as, inter alia, the rise in interest the second recapitalization tranche expected in margin and capital, as well as the decline in non- October 2000. performing loans, and new lending to real sector gradually resuming both in the state banks and the IBRA controlled In general, the new directors and commissioners selected banks. Nevertheless, the banking sector has not yet fully by the government had their career in the state banking recovered and much remains to be done in implementing sector (particularly with banks merged into Mandiri), thus an in-depth restructuring program that addresses the deep raising concern among market participants over their structural weaknesses within the banking system. ability to follow through on the much needed changes in the state banking sector. In order to quell such worries, the · The Ministry of Finance took steps to make its banks have either engaged consultants (BNI, BTN) or Monitoring Unit operational to monitor the international staff just below board level (BRI - for IT and performance of the state banks and their compliance MIS) with appropriate private banking sector experience. with the interim performance contracts, signed by · The implementation of the restructuring of BNI their new management. By decree, the Monitoring continues with the help of Credit Lyonnais Securities Unit's mandate was set in a very narrow scope, and it Asia (CLSA) and the Boston Consulting Group. remains unclear what its role will be with regard to While BNI will benefit from the consultants help, September 18, 2000 6 East Asia Brief particularly in the debt restructuring. The consultants Committee, and the various economic advisory are currently reviewing the business plan to be committees will be determined. annexed to the final performance plan and a contract · MOF's ability to create sufficient and credible is expected to be signed in the last quarter of this year. momentum to the reform program of the state bank · Irregularities detected in the property transfers to sector will be closely watch by the market, as will be Bank Mandiri. The State Audit Agency (BPK) found continued impetus in IBRA's asset disposition irregularities in the sale of property of banks that were program. merged into Bank Mandiri altogether amounting to IDR 674 billion. During the merger, directors of Bank Exim, BBD, BDN and Bapindo transferred part of the property to PT Pengelola Harta Tetap Mandiri (PHTM). Thereafter, the property appears to have been sold without appropriate approval by the regulatory authorities. · Housing finance strategy in the works. The Ministry of Housing, in coordination with MOF, has started implementing a new strategy for the housing and housing finance sector. The World Bank held a workshop in July this year with the participants from several ministries to discuss the new strategy that is, among other things, expected to modify the subsidy system for low income mortgage loans. · Twenty-four foreign banks participate in the Trade Maintenance Facility program. The foreign banks have committed to lend a total of US$ 1.6 billion to 38 Indonesian banks for international trade transactions, of which US$ 86 million have already been realized. The program requires government guarantees for the transactions. · The Commonwealth Bank of Australia plans to invest Aus$ 13 million in a joint venture bank. The Commonwealth Bank of Australia is planning to increase its stake in BII-Commonwealth to 99 percent. · The Attorney General's Office (AGO) filing litigation against 10 banks that received BLBI. Following the submission of BPK audit on BLBI, the AGO is to start litigation against 10 closed banks (BDNI, BUN, Pelita, Modern, Istismarat, Servitia, Utama, Centris, Deka and Aspac) for misuse of IDR 34.7 trillion of BLBI funds. Meanwhile, BI officials involved in the extension of BLBI are facing further questioning by the AGO. · The AGO for the second time extended detention of Syahril Sabirin, Central Bank Governor. The AGO prolonged the detention of the suspended central bank governor for another 20 days. According to the AGO, the central bank governor could be sentenced to five years in prison if the court found him guilty for corruption in the Bank Bali case. Issues and Areas to Watch · The concrete steps the new economic team takes to reassure the markets of the Government's commitment to the state bank and corporate restructuring programs. A key issue being is how, and how quickly, the relative roles and responsibilities of the FSPC, the economic ministers, IBRA's Oversight September 18, 2000 Indonesia 7 largest creditor countries therefore account for more than CORPORATE SECTOR UPDATE 50 percent of Indonesia's offshore corporate loans. Current Developments The Indonesian Bank Restructuring Agency (IBRA) holds 77 percent (28.9 billion) of the onshore distressed loans. The enhanced corporate restructuring framework that was Of this amount, large private corporates (debts of more adopted in early 2000, and agreed as part of the new IMF than IDR 50 billion) account for 87 percent. On the $21 program has begun to achieve results. Earlier delays had billion onshore performing loans SME's (loans of less than contributed to delays in the disbursement of funds to IDR 50 billion) account for 60 percent, state owned Indonesia from the IMF. During the first three months of enterprises (SOEs) for 22 percent and the remaining 18 2000 the Jakarta Initiative Task Force (JITF) had percent is owed by large private corporates. experienced discontinuities in its management following the resignation of the Chairman and the Chief Operating The published figures and anecdotal evidence suggest that Officer. There were delays in appointing their successors over recent months the pace at which IBRA and private and immediately thereafter, the newly appointed Chairman creditors have been finalizing restructuring deals with resigned. Another new JITF Chairman was put in place in corporate debtors has been gaining momentum. As of July March. Government decided in June this year to close 22, IBRA's AMC had provisionally resolved 35 percent of INDRA. Only one corporate restructuring deal had taken Rp 88 trillion in credits to its Top 21 obligors--Rp 25 advantage of the facility since it was created. trillion through restructuring agreements and Rp 6 trillion through commencement of litigation. Groups that have More recently, the newly appointed Coordinating Minister agreed on restructuring 50 percent or more of their IBRA of Economic, Finance and Industry--Dr. Rizal Ramli-- AMC credits without extensive litigation include Bakrie, has stated that Mr. Cacuk Sudarijanto (the IBRA Napan, Raja Garuda Mas, Rajawali, and Argo Pantes. Chairman) will also assume responsibility over the JITF. Groups that have reached little or no agreement with IBRA Meanwhile, the Financial Sector Policy Committee (FSPC) AMC and/or are heavily involved in litigation, however, has proven to be an effective coordinating mechanism, include Texmaco, Hasan, PSP, Tirtobumi, Bahana, IBRA and JITF are cooperating better than before and Dharmala, and Kodel. While quantitative estimates are not Indonesia has met the corporate restructuring targets yet available, foreign creditors are also indicating that a agreed with the IMF in the current Letter of Intent (LOI). number of large debt restructuring agreements have been concluded or are imminent. The Jakarta Initiative Task Force (JITF) has just completed it's first quarterly survey of corporate indebtedness. Both IBRA AMC and private creditor restructuring deals According to the preliminary results of this survey, total have relied mainly on term extensions, debt/asset swaps, corporate debt in Indonesia amounted to $117 billion as of and debt/equity conversions. Sales of non-core businesses June 2000. Of this around 50 percent ($58.6 billion) is or assets to foreign or domestic investors, mergers or owed to offshore creditors and the other 50 percent ($58.4 spinoffs, additional equity financing, management billion) to onshore creditors. Of the total onshore debt changes, or court-supervised reorganizations or around 45 percent ($ 26 billion) is denominated in foreign liquidations have so far not played as great a role in exchange. This heavy exposure to foreign exchange Indonesia as in other East Asian countries. If this denominated loans leaves Indonesian corporates still continues then Indonesian corporations could emerge from extraordinarily vulnerable to further devaluations of the the crisis mostly intact. rupiah. IBRA's AMC recently announced the sale of $103 million Of the onshore portion of the corporate debt, around 64 (book value) in restructured corporate debt to a consortium percent ($37.4 billion) is classified as non-performing. including Salomon Smith Barney-Citibank and Bank The percentage of offshore loans that are non-performing Central Asia for $72.3 million--a 71 percent realization. is not known yet but if the same ratio is applied to that of Included were the debts of five companies--PT Astra the onshore loans then around $37.5 billion of the offshore Graphia (electronics), PT Federal International Finance, loans would also be non-performing. At the end of 1997 PT Karangmas Sejahtera (hotel), PT Satelindo, and PT around 95 percent of total loans in the domestic banking Tigermandiri Pratama (plastic ware). system were categorized as performing. By the end of 1999 this had fallen to around 36 percent and in June 2000 As indicated in Figure 4, the IBRA AMC portfolio remained at around 36 percent indicating little includes Rp 41 trillion in corporate credits below the Top improvement in the domestic banks' portfolios during the 21-level on which little or no progress has been made. A first half of this year. Among the offshore creditors, number of foreign and domestic financial institutions have Japanese banks are the largest group, accounting for 29.3 expressed an interest in bidding for these unrestructured percent of offshore loans. The second largest group is the loans and a willingness to share any upside recoveries with US banks (14.4 percent) followed by the Netherlands IBRA. Foreign financial institutions, however, typically (10.56 percent and Germany (6.28 percent). The three feel that loan pools for auction must be large enough (e.g., September 18, 2000 8 East Asia Brief Rp 10 trillion) to make it worth their while to bid and set Table 2. JITF is currently facilitating the restructuring up a local operation to restructure/administer purchased of US$13.3 billion in corporate debt loans. (67 active corporate cases). Figure 4. Status of IBRA AMC's efforts to resolve INDUSTRY NO. OF EST. US$ EST. EST. credits to top 200 obligors SECTOR CASES DEBT RUPIAH TOTAL (of which (US$ Mn.) DEBT DEBT completed) (Rp. Bn) (US$ Mn Rp trillion equiv.) 100 Top 21 Obligors Remaining 179 firms 90 Agri-Business 4 (1) 677 4,665 1,260 80 70 Basic Industry 15 (5) 4,064 1,576 4,261 And Chemicals 60 50 Consumer 3 (2) 423 76 432 40 Goods 30 20 Finance 8 (3) 1,224 1,382 1,397 10 0 Infrastructure, 3 (2) 313 281 349 Early Stage Middle Stage Late Stage Utilities and Status of Corporate Debt Resolution Source: IBRA (July 22, 2000) Transportation On July 25, Minister Kwik announced that the Mining 2(1) 71 130 88 Government may scrap agreements entered into by IBRA with such groups as Salim and Gajah Tunggal in Property And 10 (2) 548 1,838 778 settlement of violations of limits on lending by their banks Real Estate to related parties. Separately, it has been reported that the Trading, 10 (7) 2,125 130 2,142 Government is exploring a "package" sale of Salim Group Services And assets to several potential investors--including to Investment companies linked to the Malaysian Government or to an investor group linked to the Salim family. Other 12 (1) 2,165 3,859 2,648 Table 2 shows that as of August 25, JITF had 67 active TOTAL 67 (24) 11,612 13,939 13,355 corporate cases involving $13.3 billion in debts. (Previously registered but inactive cases have been Source: Jakarta Initiative Task Force (JITF). removed from JITF's reported figures) These active cases have included six referrals from the Financial Sector The lack of reliable means to impose losses on debtors or Policy Committee (FSPC). 24 JITF cases have been force their cooperation has continued to bedevil corporate completed, involving $5.2 billion in debt. This represents restructuring in Indonesia. Over the last two months IBRA important progress when compared with the less than $1 has won two small bankruptcy cases in the Commercial billion in debt restructured through JITF up to February of Court, one against PT Landasan Terus Sentosa, and more this year. JITF has so far been meeting its targets as recently a second against Mahadjaja Gemilang, and further spelled out in the LOI to the IMF. Particularly useful have referrals by IBRA are planned. Other creditors in recent been the new time bound mediation procedures and the months have successfully brought bankruptcy cases improvements regulatory incentives for corporate against debtors in the Commercial Court. Another restructuring. encouraging development over the last few days is the announcement that three judges will be prosecuted for corruption. But all the recent bankruptcy cases that IBRA Issues and Areas to Watch has won are still subject to possible reversal by the Progress in corporate restructuring is still slow and it Supreme Court. Until there is an assurance of more remains to be seen whether major non-cooperative debtors reliable court decisions, referrals may serve only to re- can be successfully pressured into reaching agreements. A emphasize the relative weakness of creditors. key issue is whether the new Cabinet will continue support for the enhanced corporate restructuring framework that is While recent progress by IBRA's AMC in reaching debt at last beginning to produce concrete results and will push restructuring agreements with its Top 21 obligors is for more rapid corporate restructuring encouraging, some bankers have questioned whether debtors have the cash flows and the will to implement these deals. IBRA will need to monitor implementation of these agreements and respond to lags or shortfalls in implementation. September 18, 2000 Indonesia 9 There remain a number of tax, legal, and regulatory to allowing financial institutions to hold converted equity impediments to corporate restructuring. In the most recent indefinitely, but to insist on the most conservative LOI, the Government has committed to addressing many accounting (e.g., 1 Rp per share) for converted equity. of these impediments. JITF has been taking the lead, with some success, to provide regulatory relief in cooperation Improved access to financing for working capital and with the various agencies concerned, in particular Bank capital investment is likely to be the greatest incentive for Indonesia, BAPEPAM, Jakarta Stock Exchange, and the corporations to undergo necessary corporate restructuring. Ministry of Finance. Financial institutions will be more willing to provide additional loans or equity investments in companies whose Progress by IBRA AMC in resolving the corporate debts managements have demonstrated their readiness to focus of its top 22-200 obligors bears watching along with the on core competencies, sell non-core assets, exit from non- manner in which it disposes off the restructured corporate competitive businesses, eliminate cross guarantees and loans that fall under its purview. In all cases, these credits otherwise adopt more straightforward capital structures, should be priced through a competitive auction process. seek strategic investors, provide or raise additional equity Appropriate pricing and provisioning of loans is essential financing, pay down debt, improve financial disclosure, for acquiring banks to push for additional corporate and strengthen corporate governance. Both the restructuring measures ­ e.g., sales of non-core assets, Government and international financial institutions (IFIs) exits from unprofitable businesses ­ that may require should work with private investors to encourage greater banks to recognize losses along with their corporate linkage between access to financing and additional clients. necessary restructuring. Companies need to obtain sufficient financing. While trade finance is available and some groups have access to overseas sources of funds, several factors may limit the access of many corporations to financing for working capital or capital investment ­ e.g., the weak capital position of local banks, country-exposure limits for foreign banks, mistrust, and non-transparent corporate structures. Corporations may need to demonstrate a credible commitment to deeper corporate restructuring in return for access to additional financing. Policy Implementation and Assessment Initial results from the enhanced corporate restructuring framework are encouraging. There is, however, a continuing need for Indonesia's legal system to provide more reliable protections for creditors. Various proposals to provide stronger "sticks"--e.g., ad hoc judges for insolvency cases, Attorney General/Joint Investigative Team investigations of dubious court rulings, more frequent IBRA use of PP-17 powers, Jakarta Stock Exchange de-listing of recalcitrant debtors, and withdrawal of licenses or privileges extended by the Government-- should be pursued. Recent experience suggests, however, that reform of Indonesia's legal system will take time and that ongoing efforts to promote corporate restructuring cannot assume the availability of a robust bankruptcy option. The relevant parties--including Bank Indonesia, BAPEPAM, Jakarta Stock Exchange, and the tax authorities--should continue efforts to remove unwarranted impediments to corporate restructuring transactions. The current requirement for financial institutions to sell converted equity within 2-5 years is of particular concern, since debt/equity conversions are likely to feature prominently in Indonesian corporate restructuring transactions. Consideration should be given September 18, 2000 10 East Asia Brief Kupang, West Timor, and significant new waves of refugees headed to North Sulawesi and Irian Jaya are being SOCIAL SECTOR UPDATE accepted with increasing reluctance by local governments and residents. Man-made disaster was capped on August Key Social Indicators 29th by an earthquake registering 6.4 on the Richter scale. Intensive violence also spread to North Maluku during the Latest Previous Period past few months, resulting in large movements of IDPs to data (date) North Sulawesi and other areas. A 3-month "humanitarian (date) pause" took effect in Aceh on June 2nd, during which 63 Human Development 1999/2000 1997/98 people have been killed in the province. Parties are now Primary enrollment rate (net) 95.1 94.1 considering an extension of the "pause." Female Male The MPR concluded its annual session in mid-August. In Secondary enrollment (net) 55.2 54.4 addition to the cabinet re-shuffle noted earlier, the Female Parliament unanimously passed a controversial TNI- Male sponsored Constitutional amendment prohibiting Tertiary enrollment 2,285,170 2,451,000 retroactive prosecution for crimes committed when no Female (% total enrollment) 46.3 41.3 laws against such acts existed. This has put into question Male (% total enrollment) 53.7 58.7 the ability of the Attorney General to effectively prosecute the cases of human rights abuses in East Timor. Suspects Infant mortality rate in the cases are/were expected to be announced shortly. From DHS 45.7(92-97) 58.9(87-92) From SUPAS 51.4 (1991) 71 (1986) Social impact of the crisis. Substantial work has recently Poverty & Income Distribution. 1999 (Feb.) 1996 (Feb.) been completed on the impact of the crisis using various National Headcount Index 1/ 27.1 15.7 data sources. This section discusses very briefly each of Urban Headcount Index 1/ 16.3 7.2 six topics: (a) the change in measured poverty rates over Rural Headcount Index 1/ 34.1 20.5 the course of the crisis; (b) who the poor are; (c) where the Gini Index 0.32 0.36 poor are; (d) impact on education, health and nutrition; (e) Government Expenditures 98/99 96/97 the impact on employment; (f) how households cope with Health budget (`93 rp billion) 2,105 2,592 the crisis. The crisis impacts and coping strategies reveal As % of total 2.6 2.7 information about the Indonesian economy, society and Education budget (`93 rp billion) 4,229 5,846 government that are critical elements in building a poverty As % of total 5.2 3.9 reduction strategy. The major points that emerge are: Labor Market 1999 (Aug.) 1998 (Aug.) Unemployment rate (%) 6.4 5.5 · That the shock and the rise in poverty was far from Female 6.9 6.1 uniform, and there is large fluidity in who, at any Male 6.0 5.0 point in time, is "poor." Participation rate (%) 67.2 66.9 Female 51.2 51.1 · That individuals and communities are not passive, Male 83.6 83.2 but actively respond to changed circumstances with # of strikes/# of workers/ NA 350/221,537/ strategies to cope as families and communities. days lost 2.5 m (1996) Real wages ( %change) +12.0 (98-99) · That the crisis did not cause, but has laid bare and worsened, long-standing weaknesses in the education and health sectors. Formal as % of total employment 35.6 34.2 Female/male wage ratio 0.79 0.82 The change in measured poverty rates over the course of the crisis. The National Socioeconomic Survey 1/ Using a poverty threshold of $1.30 at 1993 PPP dollars (SUSENAS) is the main data source of information on Current Developments poverty in Indonesia. Measures gathered from SUSENAS 1996 and 1999 indicated that the crisis has resulted in a Social/Political highlights. A state of civil emergency was substantial increase in poverty. Our estimates indicated declared in Central Maluku as the sectarian violence that national level poverty increased from 15.7 % to 27.1 worsened over the past few months with the arrival of %. The number of urban poor has doubled, while we have jihad forces. Pattimura University in Ambon was seen a 75 % increase in the number of rural poor1. Recent destroyed in a July arson attack, with resulting losses surmounting Rp 1 trillion. About 300,000 residents are currently living in temporary shelters in and around 1These estimates were computed using iterative methods. In Ambon. 15,000 Ambon IDPs have now arrived in order to produce a methodologically superior estimate we had to September 18, 2000 Indonesia 11 estimates of gini coefficients show that inequality has problems. There is some evidence that women's health has decreased slightly over the three-year period. suffered more than men's and children's. Women report a larger increase in health problems and women's body mass Who are the poor? They tend to have low education, work indexes have declined.4 in agriculture and live in rural areas. Eighty seven percent of the poor live in households in which the head of This lack of a large crisis impact is cause for relief, but not household has a primary school education or less--only 5 cause for complacency, as even before the crisis Indonesia percent of the poor have a secondary school education or had quite poor indicators of nutritional status. Some of the better. Almost 60 percent of the poor are in households apparent "increase" in malnutrition is simply a greater where the agriculture sector is the main source of income openness and willingness to admit and confront the issue. (whether from labor or land) -- even though the "modern" The situation in health is similar to that in education: the sector has a quarter of all workers, they only have 15 problem is not so much the new impact of the crisis as the percent of the poor. In keeping with that, fully three continuing, and chronic, problems that have developed in quarters of the poor live in rural areas. the basic health care and education delivery systems in Indonesia. Where are the poor? The poorest regions--all with poverty rates 10 percent or more above the national The impact on employment. The main direct labor market average--are scattered rural areas: the Eastern Islands impact was a large reduction in the industrial and (Papua, NTT, Maluku, NTB) but also others (SE Sulawesi, construction sectors in the urban areas, most of whom E. Java, Lampung, W. Kalimantan, C.Java). However the found employment in the informal sector at much lower bulk of the poor are in Java--where 61 percent of the poor incomes. At the same time, the total labor force continued live, mainly because Java was slightly poorer than average to grow, with an additional 2.1 million workers entering (as measured in 1999) and 54 percent of Indonesians live the labor force in 1999. Open unemployment continued to on Java. rise slightly, from 4.7 percent in 1997, 5.5 percent in 1998, to 6.4% in 1999. However, the decline in real wages Vulnerable to poverty. Who is poor at any point in time is has had a larger impact than the contraction in the labor very fluid, and people and households enter and exit market, although recent estimates of real wages by sector periods of poverty frequently. This means that a large provides some hope. For most sectors we observe swath of the Indonesian population that is today "not poor" substantial, i.e. more than 10 %, increase in real wages is nevertheless at risk of becoming poor. Any adverse between 1998 and 1999, except for agriculture and mining shock to their incomes (or necessary expenditures) could sectors where real wages have dropped by 4 % and 16 %. easily force them over the (arbitrary) line into poverty. Even if only 27 percent are poor now, between 30 and 60 The labor market has also seen a shift in women's percent of households are vulnerable to poverty over a employment patters. First, many of the modern sector three year horizon2. factories employed young, mostly unmarried, women, and these sectors were hit particularly hard. Second, in many Impact on education, health, and nutrition. Whether in households with children, women had to take on additional response to government scholarships and block grants to work for pay so that the fraction of women in the labor school programs or otherwise, school enrolments have not force in certain areas actually went up as women took on declined markedly, although there have been higher drop additional earning activities. Third, there are reports of out rates amongst poorer families. Primary school difficult changes in the rural areas as migration patterns enrolment rates continued to increase during the crisis and changed the labor market in some agricultural tasks which junior secondary school enrolments decreased very slightly had become predominantly female. We find no substantial in 1998 but increased to beyond their pre-crisis level in changes in the sectoral shares of employment between 1999. 1998 and 1999. Studies revealed very little crisis impact on health. For Coping Strategies. People are not merely passive victims instance, the number of malnourished children has slightly of the crisis, but have coped with the crisis relying on increased and the infant mortality rate has continued its themselves and their families, friends and communities, steady decline through the crisis.3 There have been slight (and to varying degrees) government programs. A survey increases in the number of people reporting health in December 1998 asked people what means they had used to cope with the crisis, which were three-fold: reducing sacrifice comparability with the BPS estimates (11.3 percent in expenditures, borrowing, and attempting to raise incomes, February 1996) the results are presented. In reducing expenditures non- 2Pritchett, Lant, Asep Suryahadi and Sudarno Sumarto (2000), necessities were cut most frequently: clothing (68%) and Quantifying Vulnerability to Poverty: A Proposed Measure, with recreation (53%) were most frequently cut. Then followed Application to Indonesia, SMERU Working Paper, May, Social necessary expenses, but which could be reduced, such as Monitoring and Early Response Unit, Jakarta. 3World bank Annual Development Report 1979-1999, as cited in Atmarita et al. (1999). 4As shown in the Susenas and IFLS data. September 18, 2000 12 East Asia Brief reducing the quality of foods (52%) and reducing have also been established, and 222 districts have initiated transportation expenses (48%). Another 38% of the poor public consultation forums with civil society (but only 22 percent of non-poor) were even forced to representatives on social safety net activities. reduce the quantity of food consumed. A second option of the poor was to maintain necessary expenditures by Implementation of the SSN programs is mixed. borrowing or selling assets. By far and away the most Implementation of the he OPK (the targeted subsidized frequent means was to borrow from others, which almost a rice) and education and health programs are continuing third of the poor (and a quarter of the non-poor) did during this fiscal year. Budgets for the PDM-DKE and the labor the crisis. The third option was trying to raise incomes. In creation programs were only released in August 2000, and a flexible labor market this comes from doing additional these programs are not expected to be fully operational jobs, working more hours and expanding the number of until November at the earliest. members in the family who work. Efforts to maintain government spending on health and PROGRAM IMPLEMENTATION education at constant real levels have not been successful. Total public sector health spending fell by 8 percent in Background. The 1997/98 economic contraction resulted 1997/98 and a further 12 percent in 1998/99. This in rapid increases in poverty in Indonesia, in particular in represents a 9 percent and 13 percent decrease respectively urban areas and on Java. In response to the 97/98 in real per capita terms. The gap between the budgetary economic contraction, the Government of Indonesia allocation and actual expenditure has also increased since (GOI), supported by the Bank and other donors, developed the crisis, from 10 percent in 1994-97 to 32 percent in a three-pronged response to the social impacts of the crisis: 1998/99 (for the 73 percent of the health sector budget for (i) maintaining food security; (ii) expanding employment which data are available). Expenditure data for 1999/2000 and income generation opportunities; and (iii) preserving are currently being updated and are expected to be access to critical social services. This was accompanied available in October. by a public commitment by the government to address governance issues, in particular efforts to minimize In the education sector, total public expenditure on corruption in safety net programs. education fell by 41 percent between 1996/97 and 1997/98, but rebounded somewhat in 1998/99 to 72 percent of pre- Recent developments in the social sectors. The crisis levels. Total realized public spending on education Government's operational guidelines for the "key" safety has declined both as a share of total government net programs include five-point monitoring plans to expenditures (7.7 percent in 1996/97 to 3.9 percent in strengthen transparency and financial controls in the 1997/98) and as a share of GDP (1.4 percent in 1996/97 to programs. Information folders on key safety net programs 0.7 percent in 1997/98). have been compiled and made available to the public in 230 districts in Indonesia. Complaint resolutions units - Macroeconomic Update was prepared by Sudarshan Gooptu (EASPR) - Financial Sector Update was prepared by Paula Perttunen and Ruth Neyens (FRO) - Corporate Sector Update was prepared by Bernard Drum and Bill Mako (EACIF) Social Update was prepared by Jacqueline Pomeroy with inputs from Ani Dasgupta, Sandy Lieberman, Scott, Vivi Alatas and the SMERU (EACIF). September 18, 2000 Indonesia 13 INDONESIA ECONOMIC INDICATORS 1997 1998 1999 1999 2000 Year Year Year Q3 Q4 Q1 Q2 May Jun Jul Output, Employment and Prices GDP ( % change previous year) 4.7 -13.0 0.3 1.2 5.0 3.6 4.1 Industrial production index (1993=100) 157.4 136.4 169.8 185.1 190.6 (% change, previous year) 13.2 -13.3 24.5 34.7 32.6 Unemployment Rate (%) 4.8 18.4 19.1 Real Wage Growth (%) 4.1 -29.9 2.0 Consumer price index (% change, previous year) 6.1 58.5 20.5 1.2 1.9 -1.2 2.0 1.2 2.0 4.4 Public Sector Government balance (% GDP) -0.6 -2.1 -1.5 Domestic public sector debt (% GDP) Foreign Trade, BOP and External Debt Trade balance (million$US) 4/ 10,067 18,429 20,643 6,344 5,804 6,264 6,353 Exports of goods, ($millionUS) 56,297 50,371 51,242 14,270 13,760 15,113 15,212 (% change, previous year) 12.2 -10.5 1.7 6.0 26.4 39.8 22.7 Imports of goods, ($millionUS) -46,230 -31,942 -30,599 -7,946 -7,926 -7,956 -8,849 (% change, previous year) 4.5 -30.9 -4.2 -5.2 8.3 30.7 -211.5 Current account balance ($millionUS ) -604 4,097 5,781 1,885 1,536 1,898 2,095 (percent GDP) -0.3 4.1 4.0 5.7 3.9 4.8 Foreign Direct Investment (million US$) 4,677 -356 -3,270 -698 -1,450 -1,232 -942 Total external debt (million $US) 136,088 150,886 148,097 145,942 148,097 144,282 (% GDP) 64.0 150.6 103.3 110.0 93.0 92.2 Short-term debt (million $US ) 35,104 23,702 19,035 19,035 Reserves, including gold ($US billion) 16,587 22,713 26,445 26,032 26,445 28,461 (months of imports of goods and services) -3.0 -5.3 -6.4 -7.7 -8.0 -8.0 Financial Markets Domestic credit (% change, previous year) 42.0 36.0 17.3 9.7 17.3 43.4 60.6 46.0 60.6 Short-term interest rate /5 25.4 41.4 12.2 12.5 12.2 10.8 10.37 10.43 10.37 Exchange rate (end-period) 2,953 9,875 7,809 8,368 7,059 7,608 8,741 8,460 8,741 Real effective exchange rate (1990=100 and + = appn) 96.6 47.3 68.1 61.8 74.5 73.1 74.5 (% change, previous year) -5.5 -51.0 43.9 61.4 12.0 Stock market index (end-period, Aug 88=100) 402 398 677 548 677 583 515 454 515 Memo: GDP in US$ million 212,562 100,218 143,353 33,173 39,821 39,133 35,407 35,407 September 18, 2000 KOREA second quarter after increasing 75.5 percent year-on-year MACROECONOMIC UPDATE in the first. Domestic construction orders remained modest, increasing 19.6 percent year-on-year in the second Current Developments quarter, about the rate achieved in the fourth quarter of 1999. Growth and Domestic Economic Activity It appears that the current business cycle may have peaked although the composite index of coincident economic The pace of economic activity remained strong through indicators has not reached 100, the point at which past August, although there are definite signs of a slower business cycles have reached their peak. The index has growth for the year compared to the sharp and rapid been on a downtrend throughout much of the year. recovery in 1999 and the 11.1 percent GDP growth rate in the first half of 2000. External Sector Industrial production grew 19.3 percent year-on-year in The current account surplus dipped to $4.4 billion in the July but the rate of increase has been slowing down since it first semester of this year from $12.2 billion in the same reached its peak of 28.9 percent year-on-year in the fourth period last year largely due to a lower trade surplus and to quarter of 1999. The index grew 23.4 percent year on year larger deficits in the service and income accounts. As in the first quarter of this year and 18.3 percent in the economic activity has strengthened, the trade surplus has second. considerably narrowed. Export volume remained strong in the first semester, averaging a 25 percent year-on-year The slowdown in production has been largely driven by a increase from January to May. However, import volume moderation in domestic demand. In contrast to export growth also remained vigorous, rising to an average 26.1 shipments which have remained generally robust percent year-on-year increase from January to May throughout the first semester, shipment for domestic compared to 23.6 percent in the same period last year. demand fell to under 15 percent year-on-year growth in the Capital goods imports related with the economic recovery second quarter from 23.7 percent in the first quarter and have largely accounted for increasing import values. 21.1 percent in the fourth quarter of 1999. The slowdown Rising international crude oil prices have also added to the in consumption has been most visible. Wholesale and import bill. The trade surplus for the first seven months retails sales increased at only 8.3 percent year-on-year in now amounts to $5.1 billion, down from $13.1 billion in July in contrast to 11.1 percent in June and 14.7 percent in the same period last year. The government now expects a May. In particular, the shipment of durable goods which current account surplus of $9 billion for the year, sharply has led the expansion of consumption thus far declined 6.2 lower than the earlier forecast of $12 billion. percent year-on-year in June, its first downturn since January 1999. Korea: Exports andImports (customs clearance basis) Korea: Real GDP Growth 25 18000 ear)y-n 20 16000 15 14000 10 n 12000 ear-o 5 10000 (yt 0 8000 -5 illiom$ 6000 -10 4000 Percen -15 I I I I 2000 III III III 0 97: 98: 99: 00: 97: 98: 99: -2000 1 4 7 10 1 4 7 10 1 4 7 Consumption: Contribution to Growth 98: 98: 98: 98: 99: 99: 99: 99: 00: 00: 00: Fixed Investment: Contribution to Growth Change in Stocks: Contribution to Growth Trade Balance Exports Imports Net Exports: Contribution to Growth GDP Real Growth Rate The capital account recorded a surplus of $12.7 billion in the first half of this year, a significant increase from the $290 million deficit in the same period last year, mainly on Investment has also begun to show signs of a slowdown. the basis of increased inflows of foreign direct and Facilities investment, which rose steeply 50 percent year- portfolio investments. Foreign direct investment continues on-year in the first quarter, increased by only 26.1 percent to be significant; net flows amounted to $2.1 billion in the year-on-year in June and 30 percent in July. Domestic first semester compared to $1.3 billion in the same period machinery orders were up 48.6 percent year-on-year in the September 18, 2000 2 East Asia Brief last year. Net inflows of portfolio investment (equity economy, the monetary policy-making body felt securities) remain sizable amounting to $8.8 billion from sufficiently concerned with unstable conditions in the January to June, up from $7.2 billion in the same period financial markets to maintain the overnight rate at its last year. current level. Credit conditions have recently tightened as The strong capital account performance, aided in part by liquidity problems in the Hyundai Group re-emerged in the domestic banks' increased repayments of their Bank of July and large enterprises faced difficulty in issuing Korea deposits at their overseas branches, has raised corporate bonds and commercial paper. Bond and usable reserves to $91.4 billion at the end of August, up commercial paper financing to the corporate sector $17.4 billion from reserves of $74.1 billion at the end of declined by Won 6.0 trillion in June from May (after last year. The reserves amount now amount to 5.5 months decreasing by another Won 786 billion in May from April) of imports of goods and services (compared to 4.9 months while bank lending fell by Won 5.8 trillion in June from of imports at the end of last year) and to 189 percent of May (after decreasing by another Won 7.8 trillion in May short-term external debt (compared to 194 percent at the from April). end of last year). Employment and Wages Korea: Interest Rates The unemployment rate continued to fall in July, extending 30 its downward trend for the eighteenth month in a row. On a seasonally adjusted basis, the unemployment rate was 3.7 25 percent in July compared to 3.8 percent in June. The t 20 number of unemployed workers was down to 804,000 in 15 July from 1,040,000 at the end of last year. Percen 10 5 Korea: Unemployment Rate 0 1 4 7 10 1 4 7 10 1 4 7 98: 98: 98: 10 98: 99: 99: 99: 99: 00: 00: 00: 9 Overnight Call Rate Corp Bond Yield 8 Overnight Call Rate (Real) Corp Bond Yield (Real) 7 t 6 Fiscal policy this year has been largely geared toward 5 Percen 4 withdrawing stimulus and initiating the medium-term 3 consolidation of the budget. 2 There have been two announcements of a tighter fiscal 1 stance this year. In March, the government revised 0 1 4 7 10 1 4 7 10 1 4 7 downward the fiscal target (excluding privatization 98: 98: 98: 98: 99: 99: 99: 99: 00: 00: 00: receipts and including the civil service pension fund) for the year from 3.75 percent of GDP to 3.25 percent. The government also announced that it would target a balanced Monetary and Fiscal Policy Developments budget by 2003, a year ahead of the target announced in late 1999. In July, the government announced an even Monetary policy has remained largely accommodative of tighter fiscal stance--a deficit target of 2.5-3.0 percent of the recovery so far, although the monetary authorities have GDP--in view of the economy's strong cyclical position now stated that signs of higher inflation have become more and pressure from capital inflows. evident recently. Consumer prices rose again in August-- With the strong revenue performance in 1999 continuing by 0.8 percent month-on-month, after increasing 0.3 into the first semester, the outturn for the first five months percent in July. For the first eight months of the year, of this year shows a surplus of 1.9 percent of full year consumer prices have now risen 1.8 percent from the same GDP. It appears therefore that the deficit for the year will period last year. be below 2.5 percent of GDP. In its meeting in September, the Monetary Policy Committee of the Bank of Korea, however, decided to Macroeconomic Outlook maintain the overnight call rate at around its current level The macroeconomic outlook remains strong. The of 5.1 percent. The overnight rate has been at this level economic recovery is expected to continue this year, since February when the monetary authorities first raised although the pace of output growth is likely to decelerate the rate in a year in a bid to narrow the then widening gap to a more sustainable pace as the economic activity figures between short-term and long-term interest rates. While currently indicate. The government now projects an 8.5 cognizant of potential inflationary pressures in the percent GDP growth in 2000 following last year's sharp September 18, 2000 Korea 3 and higher-than-expected 10.7 percent turnaround and the restructuring and reform. Although systemic distress has equally strong 11.1 percent performance in the first half of eased, there remain cases of corporate distress that need to 2000. Continuing last year's trend, growth is expected to be resolved. It is also now crucial to move toward a be driven this year by private consumption, equipment longer-term reform agenda in the corporate sector with an investment and exports. The fast pace of import growth emphasis on multi-year restructuring and de-leveraging. however indicates that contribution of net exports to GDP The consolidated financial statements of the top four growth will significantly moderate. chaebols released in July now show debt-equity ratios Despite the pick-up in consumer prices in the past two sizably higher than those reported under non-consolidated months, it is unlikely that CPI inflation will exceed the accounting methodologies. The market's adverse reaction projected 2.0 percent average for the year. The GDP to the difficulties at Hyundai signal its evaluation that the deflator, the broader measure of inflation, actually fell 0.5 chaebols have made insufficient progress in restructuring percent in the first quarter when GDP growth reached 12.8 and therefore remain vulnerable to financial shocks. percent. Still, the continued decline in unemployment and Restoring the stability of the financial sector will also rising inflationary expectations could be expected to lead depend critically on the firm pursuit of the second stage of to some buildup in inflationary pressures by early next the financial sector restructuring program. The application year. of forward-looking criteria to the accounting of impaired Although the current account surplus is expected to dip to assets of the banks indicate that as much as 13.2 percent of around $9 billion this year (2 percent of GDP), sharply total loans (12 percent of GDP) can be classified as lower than the government's earlier forecast of $12 billion substandard and below. The banks have been asked to and last year's actual performance of $25 billion (6.1 specify plans to dispose of bad loans through provisioning percent of GDP), the outcome appears less a matter of and other means and to book the additional provisions no imbalance than a faster return to medium-term later than the end of this year. The full accounting of equilibrium. The current account is now projected to reach impaired assets should now alleviate some of the market's broad balance in 2002. Meanwhile, the trade numbers uncertainties, although the challenge remains as to whether show that export volume growth remains vigorous as the banks can aggressively deal with the potential losses. external demand remains strong. While remaining strong, As the stability of the financial system is restored, import growth can be expected to decelerate as overall anchored in a more competitive and financially sound growth moderates and as machinery orders and equipment corporate sector and based on adequately-capitalized and investment augment productive capacity. These more durable financial institutions, the conduct of developments should allow the attainment of the revised monetary policy will become less constrained. The Bank current account target for the year. of Korea estimates that monetary policy works with a 5-6 The overall balance of payments position is expected to quarter lag. The need to be able to conduct monetary remain strong, as inflows of foreign direct and portfolio policy flexibly is therefore of growing importance as the investment should remain sizable during the year. The recovery progresses and the output gap narrows to zero, if already rapid build-up in reserves (to $91.4 billion at the inflationary pressures are to be kept in check next year. end of July, from $74.1 billion at the end of 1999 and Bank Instruments against a target of $95 billion for 2000), coupled with the reduction in short-term liabilities, have now sharply The Bank has been supporting Korea's reform program reduced the economy's external vulnerability. through adjustment lending operations, technical assistance, trust funds--ASEM and PHRD--and analytical Policy Implementation and Assessment and advisory work in key areas of macro, financial corporate and social sectors. As the recovery strengthened sharply last year, the authorities decided to shift the orientation of Policy-based lending. Economic Reconstruction Loan macroeconomic policies from an expansionary stance to a (US$3 billion, approved 12/97); SAL I (US$2 billion, more neutral one. However, the major burden of approved 3/98); SAL II (US$2 billion, approved 10/98). adjustment in the policy stance has been carried by fiscal TA Loan. Financial and Corporate Restructuring assistance policy. The scope for flexibility in monetary policy has (US$48 million, approved 8/98). been relatively limited, owing to the fragility of the financial sector. Trust Fund support. PHRD grant (US$1.45 million, approved 2/98) for financial sector. ASEM grant (US$0.8 The instability of the financial sector, in turn, has reflected million, approved 9/98) for financial sector. ASEM grants market sentiment regarding progress in corporate sector approved for implementation of social sector reforms in restructuring. There has been a sharp tightening of credit the areas of: social protection for workers, protecting the conditions for the corporate sector, following the Hyundai poor and protecting the elderly. IDF support for crisis for instance. The financial market instability Accountability and Good Governance. ASEM and PHRD highlights the need to strengthen the momentum of grants for corporate governance through institutional September 18, 2000 4 East Asia Brief strengthening in accounting and auditing and more transparent regulatory environment. FINANCIAL SECTOR UPDATE Analytical and Advisory Services. An economic report entitled Korea: Establishing a New Foundation for Sustained Growth was issued by the Bank in November Current Developments 1999, and a report on Korea's Transition to a Knowledge- Based Economy was issued in June 2000. The Bank's Additional Public Funds for Financial Sector program for analytical and advisory services in Korea Restructuring. After the formation of a new cabinet, the includes several other papers and policy notes in the areas Ministry of Finance jointly announced with the ruling of economic policy, financial and corporate sector party that the government would seek parliamentary restructuring, and social security reform. approval of additional public resources to complete the second round of financial and corporate restructuring. Before this announcement, the official government position was that a total 30 trillion Won would be needed, 20 trillion of which would be required this year and 10 trillion Won next year and that the fund needed would be financed by recycling government assets which were owned by two government agencies, KAMCO and KDIC. The public was skeptical because the market believed the amount announced was understated and there was a question whether KAMCO and KDIC could generate the amount required. As a result, the market skepticism generated some financial market instability. The government announcement has provided a new impetus to the financial and corporate restructuring program as it is now felt by market participants the task will be completed properly. In making the announcement, the government did not disclose the amount that was required but indicated the issue was under review and the results would be announced shortly. Along with the plan to seek additional public resources, the government also announced a revised timetable for financial sector restructuring: Bank restructuring and mergers, which were expected to be completed this year, have been postponed to February 2001. · Banks that have not met the BIS capital ratio are still expected to submit self-rescue plans by September. A decision on the viability of those banks has been pushed back to November 2000. · A "White Book" will be published shortly detailing the use of public funds thus far in the restructuring process. The government will release a plan which will ensure more transparency in future uses of public funds. · There will not be any change in the implementation date of the partial depositor guarantee program scheduled to go into effect as of 2001. · The government will also disclose its policy on the current 4 percent ceiling on bank ownership. September 18, 2000 Korea 5 Korea Asset Management Corporation (KAMCO) has not Commercial Banking Sector finalized the terms of purchases of Daewoo commercial paper (CP) from domestic institutions and foreign During the past few months, the government has creditors. announced several different plans to deal with the · nationalized banks. One of these plans called for the three When the Daewoo group faced a severe liquidity commercial banks that are majority owned by the problem last summer, the government put strong government (Hanvit, Cho-Hung, and KEB) to merge in pressure on domestic financial institutions to purchase order to strengthen their financial health and become 4 trillion Won of Daewoo CP, backed by collateral globally competitive. The merged bank would operate worth 10 trillion Won. With falling securities prices, under the financial holding company scheme with total the value of collateral has dropped to one trillion Won. assets of 206 trillion Won and 23,000 employees. The new KAMCO has offered to pay domestic financial bank will be ranked 55th in the world in terms of assets. institutions 80 percent of the face value of the CP, but The merged bank will have 20 trillion Won of non- the financial institutions strongly oppose the 20 performing loans (NPLs). The new bank is expected to percent discount. Because of their weak financial dominate the corporate lending sector covering perhaps 70 conditions, many of the financial institutions are not in to 80 percent of the entire corporate loan market in Korea. a position to absorb these additional losses and would require government help. NPLs in the Banking Sector. The Financial Supervisory · Not all foreign creditors have agreed to the final Commission (FSC) announced that total NPLs in the purchase price of 39 percent of the face value of banking sector amounted to 27.4 trillion Won at the end of Daewoo loans. However, since formal approval is June, about 8.3 percent of total loans. Six banks had more required from only 95 per cent of the creditors, it is than 10 NPLs. expected that the transaction will be completed. According to the report, KFB had the highest NPL ratio at 18.5 percent, resulting primarily from the Daewoo debt. Hyundai--Korea's largest industrial group may be facing Two commercial banks which are majority owned by the a liquidity problem. Fifteen domestic creditor banks of government, namely, Cho-Hung and Hanvit, reported high Hyundai Group decided to roll over Hyundai Engineering NPL ratios of 11 percent and 10.8 percent respectively. & Construction Co's. (HEC) debts until the end of Hana Bank had the lowest NPL ratio at 4.4 percent, September. The decision came at a meeting of presidents followed by Shinhan at 4.5 percent, Housing and of the 15 banks after a briefing by Mr. Kim Kyung-lim, the Commercial at 5.2 percent, and Kookmin at 6.4 percent. president of Korea Exchange Bank, Hyundai's main creditor bank. However, concerns were expressed in the market that the NPLs reported were not accurate and that corporate Following Hyundai Investment Trust Company's financial restructured loans were being reported as difficulties, the Hyundai group was asked by the normal/precautionary loans despite the fact that these loans government to provide full financial support to its affiliate. were non-performing. To address market concerns, FSC However, given the large amounts involved, the financial asked all commercial banks to disclose all their non capacity of the Hyundai group to support such an performing loans using the stricter forward looking criteria undertaking was questioned by the market, which reduced (FLC) by June 30, 2000. Based on the stricter criteria, its appetite for Hyundai commercial paper. The banks announced on June 30th that potential losses (i.e. government therefore arranged new funding to Hyundai losses that would be additionally incurred following the group companies through Korea Exchange Bank (KEB), application of FLC to all borrowers) amounted to Won 3.9 with certain conditions. Some of these conditions were trillion . that: the Chung family should resign from Hyundai Group management, the group should sell 6 trillion of assets, and Korea First Bank (KFB). Korea First Bank continues to certain key officials must also resign. absorb public funds even after the government sold a controlling interest to Newbridge Capital. Under the At the end of June, Hyundai signed a memorandum of existing non-performing loans buy-back agreement understanding with a group of US investors AIG Global between the Government of Korea and Newbridge Capital, Investment, W.L. Ross (merchant bank), GE Capital, and the government has been asked to provide 2.4 trillion Won few institutional investorsfor a $815 million capital to Korea First Bank to cover losses that have been recently injection into Hyundai Investment Trust Securities, the identified in the loan portfolio or provide 3.5 trillion Won marketing and distribution company of Hyundai to buy these non performing loans at book value. Investment Trust. This money will be injected in three stages after a due diligence. According to KFB's report, the adverse loans are from the Daewoo group and non-Daewoo companies under workouts, court receiverships and court mediations. Only September 18, 2000 6 East Asia Brief 297 billion Won was identified as bad loans under the new responsible for investment losses and gains. loan classification system using the forward-looking criteria (FLC). Restructuring of Investment Trust Companies. At the end of May, the government ordered Korea's two largest ITCs, The government so far has injected 12.3 trillion in public Korea and Daehan, to separate their marketing and money into KFB. Assuming the government injects distribution functions from the fund management function another 2.4 trillion Won into the bank, the total public and transfer the new functions to newly established funds injected will increase to 15.8 trillion Won. The total securities company affiliates. As part of the restructuring, fund may further increase to 17.3 trillion Won if additional the government injected 8 trillion Won to cover the losses losses of 1.5 trillion Won materialize in 2002. the two ITCs had accumulated over the years, including those incurred from Daewoo debt. Subordinated Bond Issues by Commercial Banks. The Bank of Korea announced that commercial banks should Merchant Banks. be more cautious in issuing subordinated bonds to increase their capital base. The Basle capital accord allows for Merchant banks in Korea posted large losses during FY subordinated bonds to be included in the calculation of 1999 (ending in March 2000). Investors are concerned capital as tier 2 capital but places some overall limitations. about the health and financial viability of merchant banks As these bonds are being issued at a very high rate and the in light of their large losses, impact of reform of the proceeds are being invested at a much lower rate, there is a deposit insurance coverage, and the implementation of negative impact on the banks' profitability. Furthermore, more strict loan classification system (FLC) for merchant by raising such capital, the banks are not effectively banks effective July 1, 2000. addressing the real issue that has given rise to the capital shortage, i.e., the huge level of non performing loans. The Eight local merchant banks posted a net combined loss of Bank of Korea report recommends that banks be more 131 billion Won compared to a loss of 87 billion Won a prudent in issuing subordinated bonds because once the year ago. Like last year, four merchant banks reported market for a bank's bonds is saturated it will reduce the profits while the remaining four reported losses. The major bank's options for raising new capital. Furthermore, cause of the losses was the provisions which the merchant because of the increasing risk profile, the rating agencies banks had to set aside for Daewoo. may assign a lower grade to the bank's rating. These losses have caused a loss of confidence by investors Investment Trust Companies. in merchant bank paper. To alleviate the merchant banks' liquidity crunch, the government will purchase Financial Supervisory Commission Chairman Lee Keun- subordinated bonds and inject public funds when large young recently urged managers of ITMCs to follow shareholders are unable to provide sufficient funds. through on their restructuring plans to enhance Merchant banks play an important part in providing short- competitiveness and to develop the capital market. term financing to corporations. Therefore any liquidity Meeting with heads of the 35 ITMCs, Chairman Lee crunch faced by the merchant banks can lead to liquidity stressed the need to improve management transparency by problems in the corporate sector. subjecting their finances to external audits and disclosing yields of each trust fund. Life Insurance Companies Chairman Lee advised ITMCs to focus on profitability FSC Chairman Lee has said the listing of the life insurers rather than expanding sales. Heads of the ITMCs in turn should be revisited because one of the issues needed to be asked the Chairman to come up with solutions for addressed before they can be listed, i.e., the distribution of corporations that have difficulty in repaying or refinancing shares to policy holders may conflict with relevant laws. maturing bonds. They noted that a total of 26 trillion Won worth of corporate bonds would mature by the end of the Since 1980s, life insurance companies have tried to list year. Chairman Lee said FSC has taken some corrective their shares but the plan has been postponed due to weak measures such as introducing primary CBOs market sentiment. Recently, the plan was revived in order (collateralized bond obligations) to help firms unable to to allow life insurance companies to raise capital and to refinance maturing bonds based on their own credit. impose market discipline and transparencies in their operations. But before it can be done, the government ITC Marking to Market (MTM). The government has wanted the participating policy holders to receive part of introduced MTM, effective July 1, 2000 to all new money the profit that had been accumulated. The insurance being invested in ITC/ITMC trust funds. Losses that are industry strongly opposed the government's plan. In order yet to be realized in old funds will be borne by managers to settle the issue, former FSC chairman Lee Yong-keun and distributors. It is expected the implementation of employed a foreign consulting firm to explore alternative MTM will have an important implication for the approaches. The recent announcement postpones the development of the capital market as investors will now be decision to next year. September 18, 2000 Korea 7 Korea Deposit Insurance Corporation (KDIC) · Structural adjustment lending: Economic Reconstruction Loan (US$3 billion, approved 12/97); The government announced the introduction of the new SAL I (US$2 billion, approved 3/98); SALII (US$2 deposit insurance scheme starting July 2000. Under the billion, approved 10/98). new plan, premiums paid by insured banks will double. · Trust Funds support: Japanese PHRD grant (US$1.45 KDIC expects to collect close to 1 trillion Won annually in million, approved 2/98); ASEM grant (US$0.8 premium income. In addition, there have been active million approved 09/98). discussions among the government, the academic · Essential Technical Assistance Programs: technical community and the private sector on whether the assistance (US$1.6million) funded under SFO's previously announced deposit insurance reform to reduce FY99 internal budget. the insurance coverage to 20 million Won should be implemented in January 1, 2001 as scheduled. In anticipation of the reduction in insurance coverage, depositors have shifted their deposits to higher-quality banks and this has caused liquidity problems in some of the smaller financial institutions. Issues and Areas to Watch Corporate bond market. A key concern in the Korean financial market is the liquidity crunch faced by the corporate sector. Following the crises at Hyundai and Daewoo, and with serious concerns raised on the health of the merchant banks and the trust industry, investors have been withdrawing their money from these institutions. The money withdrawn has been flowing as deposits to commercial banks but because of their lower risk appetite, it has not found its way to the corporate sector. It remains to be seen whether the measures introduced by the government such as the bond stabilization fund, CBOs, are enough to address the problem. Daewoo Restructuring. No significant transactions involving sale of major Daewoo businesses or assets have been finalized since the Daewoo crisis broke out last summer. Negotiations concerning the restructuring are still continuing. Second round of financial restructuring. The market will be watching very closely the government's announcement on the amount required for the second round of financial and corporate restructuring. In order for the plan to be acceptable, it must be credible and realistic, especially the part which provides information on how much funds KAMCO and KDIC can generate from recycling their assets. Consolidation in the financial sector. A large banking sector merger and other type of mergers are likely to take place in 2000. The process would require financial institutions to use the financial holding company structure that the government has been supporting. Instruments for the Financial Sector · Technical assistance loan: Financial and Corporate Restructuring Assistance Project (US$48 million approved 8/98). September 18, 2000 8 East Asia Brief 3.3 trillion in corporate self-help was achieved)1. The greatest lags in self-help have been in the sales of real CORPORATE SECTOR UPDATE estate, business affiliates and other assets. In addition to debt restructuring, Won 1.65 of new financing trillion had Recent Developments been provided to workout companies. Despite these measures, many companies remain deeply distressed and The instability in financial markets over the past few face uncertain prospects and a heavy debt load, raising months has been a reflection of the continued weaknesses serious doubts as to their viability once debt repayment of corporate financial structures. The liquidity problems of grace periods expire. a few affiliates of Hyundai, including of its Investment Trust Company in April, followed by the admission by In an effort to assess companies' progress towards meeting some chaebols ranked among the 6-64 group (e.g. Saehan), restructuring benchmarks and to improve the monitoring in May 2000 that they could not meet their debt service, ability of banks, the FSS and the CRCC performed on-site have served to emphasize the continued vulnerability of examinations at the end of April. The exercise involved an the corporate sector. Estimates suggest that about 25 assessment of the current status of management percent of Korean manufacturing corporates may not be normalization, operations by management control teams generating sufficient cash flow to cover their interest and progress made towards enhancing corporate payments. In turn, this has raised serious concerns in the governance. Based on this review, the FSS announced the market about quality of financial institutions' portfolios, exit of 32 firms from their workout programs. Of these, 11 especially those of merchant banks and the trust industry, firms were graduating for progress made toward given their exposure to the corporate sector. Consequently, turnaround, 18 were pursuing self-rehabilitation under a investors have been withdrawing their money from these private accord with their creditors, and 3 firms were placed institutions, and the corporate sector has been facing a for likely liquidation or court receivership. serious credit crunch stemming from the inability of investment trust companies and merchant banks to roll The top 4 chaebols. According to the FSS, the top 4 over maturing corporate paper. These developments (Hyundai, Samsung, LG and SK) had all reduced their highlight the fact that more needs to be done to improve liabilities/equity ratios to below 200 percent at the end of corporate finances and governance. 1999. However, although these figures excluded the effects of revaluation, they were not based on combined financial Resolution of Daewoo. Following objections by foreign statements. Figures based on consolidated financial creditors to proposed workouts for the four largest statements were released in late July 2000. As expected, affiliates, local creditors agreed to a mediated plan to buy the debt/equity ratios for the largest chaebols, excluding $4.84 billion in unsecured debt from foreign creditors at Samsung (whose debt equity ratio based on consolidated about 40 percent of face value. Top management has been accounts was 194 percent), have turned out to be sizably replaced and creditors control the workout affiliates. higher. Among the big four, Hyundai reported 229.7 However, successful resolution will also require progress percent in debt/equity ratio, LG 260 percent and SK 220 on operational restructuring. So far, there have been no percent, up by 30-80 percent points from the figures under significant sales although at the end of June, Ford Motor the old statements. If financial units are included, the Won the sole right to negotiate the purchase of Daewoo debt/equity figures are be much higher, with Hyundai at motor--beating the combined bids of Daimler Chrysler and 296 percent, and Samsung at 445 percent. In addition, Hyundai Motor, and General Motors and Fiat. sales and net profits of the four largest chaebols are 30-50 percent lower once double entries are deducted. Workouts under the CRA framework. At end- March 2000 there were a total of 76 firms under workout programs, Court supervised insolvencies At end 1999, 187 companies covering Won 43 trillion (9 percent of GDP) of troubled with combined assets of Won 50 trillion (10.5 percent of debt. The workout MOUs at the end of 99 had envisaged a GDP) were under court receivership. Notable progress rough balance of 4:1 of troubled debt restructuring and among the larger cases have included: (i) Kia's successful "self-help" efforts (e.g. asset or affiliate sales, new equity, emergence from receivership; (ii) the sale of Hanbo Steel cost reductions etc), implying Won 33.7 trillion of and Anam to a foreign consortium and (iii) creditors' restructuring (about three quarters of which would be agreement on the sale of 70 percent of Samsung Motors to interest rate reductions or rescheduling, and much of the Renault from out of receivership. However, in late 1999, remainder conversions into equity or convertible bonds) the FSS concluded that about half of the chaebol affiliates and Won 9.5 trillion of "self help". Based on this end-99 under court supervision had made insufficient progress on plan, the implementation rate for restructured debt at the reorganization. end of March was 86 percent (as Won 29 trillion had been restructured) and around 35 percent for self help (as Won 1As there has been little change in the extent of self-help since end-99, it appears that planned amounts of self-help have been reduced since then. September 18, 2000 Korea 9 Policy Implementation and Assessment financial capacity to turn around these companies in a second workout. The creation of corporate restructuring Although progress has been made in corporate debt vehicles should help in the selling of financial of their restructuring and reform, many chaebols remain over- shareholdings to outside investors or to professional asset leveraged and their profitability and cash flow remain low. managers. The still high leverage and low profitability of these corporates makes them vulnerable to adverse financial Court supervised insolvency framework. The legal market developments--as underlined by the liquidity framework for court supervised insolvency has been problems recently faced by some Hyundai affiliates and by strengthened, including through legal amendments adopted Ssangyong, and the collapse of Saehan (ranked 27th among in 1999. An important step that is now being taken is the the largest chaebols). While, with the easing of systemic introduction of pre-packaged bankruptcies. Under this corporate distress, the focus can shift to longer-term system, companies under a workout program will go into reform (financial disclosure, corporate governance, court receivership if at least half of the creditors agree. The prudential regulation, and court supervised insolvency) and new measures will encourage the voluntary agreement pushing ahead with multiyear restructuring and de- among the creditor financial institutions; however, in order leveraging, there remains an urgent need to encourage the to expedite and facilitate the process, the company will be resolution of the remaining cases of corporate distress. automatically subject to court receivership should the creditors fail to reach consensus within a certain period of Resolution of Daewoo affiliates. Creditors need to time. complete strategic sales, spin-offs and other operational restructuring of the remaining Daewoo affiliates in a Multiyear deleveraging and reform Recent measures such transparent and timely fashion. The restructuring of as requiring conglomerates to submit their combined Daewoo electronics and Daewoo Heavy Industries have financial statements will enable financial institutions to been delayed by opposition of minority shareholders to take these statements into account in applying the FLC to planned debt for equity swaps which would dilute their loans extended to these corporates, and encourage ownership interests. An appropriate balance will need to be healthier corporate financial structures and more robust achieved between protecting minority shareholders and financial institutions over time. More broadly, good pushing forward with needed restructuring. progress has been made in enhancing corporate governance, and in improving corporate accounting Strengthening the results of the workouts under the CRA standards. Continued improvements would enable market framework. An important reason why chaebols and discipline to play a stronger role in driving the companies that have been subject of debt workouts have restructuring process. remained highly vulnerable, is that restructuring of debt through workouts has not gone far enough. In turn, an Bank Instruments important underlying factor for this is the fact that loans restructured through workouts were subject only to Loans. (i) The Financial and Corporate Restructuring minimum provisioning of 2-20 percent, (although Korea Assistance Loan (US$48m, FY99), a TA loan, has largely has adopted forward looking classification (FLC) for been implemented. Still on-going are the components on classification and provisioning of banks loans in general). competition policy, corporate governance, insolvency This special provisioning has been a disincentive for banks system reform, and financial supervision reform. (ii) to engage in deeper restructuring, such as debt equity Building on reforms implemented under the Structural conversions or write-offs, and has resulted in a tendency Adjustment Loans I and II in 1988-99, a package of towards more superficial restructuring, predominately reforms in the corporate and financial sectors was prepared through loan rescheduling. However classification and in the latter half of 1999 in the context of a follow-up provisioning standards for restructured loans, including to policy-based loan (Corporate and Financial Sector workout companies, are being tightened and henceforth Restructuring Loan). The Government has largely financial institutions are to apply fully forward looking implemented this package of reforms, although the loan criteria (FLC) to such loans. More realistic provisioning itself will now not be disbursed since Korea is no longer in requirements should encourage creditors to sell their need of quick-disbursing financing from the World Bank interests in distressed workout companies to specialists given the improvement in its financial position and with the capacity to realize whatever potential there exists reserves. for recovery. To facilitate the transfer to these investors, it Grants. (i) A Special PHRD grant for corporate will be important to value conservatively any convertible restructuring (CR) of US$1.3m is financing assistance for bonds and equity issued in exchange for debt, particularly CRVs, environmental liabilities in the context of CR, in the case of equity for which no market exists. It is regulatory streamlining, and competition policy. (ii) Grant important to ensure that workout companies deemed to be funding is also supporting reforms in private participation non-viable be forced to exit promptly, as in such cases in infrastructure, and in accounting and auditing. financial institutions are unlikely to have the managerial or September 18, 2000 10 East Asia Brief Missions and Other Field Presence. Five CR-related missions have taken place since end-June. A trust-funded SOCIAL SECTOR UPDATE consultant has been providing client liaison in the field. Current Developments Indicators in the labor market are reflecting strong recovery: real wages maintained an upward trend, increasing by 5 percent in June 2000 over a year ago while the unemployment rate fell to seasonally adjusted 3.7 percent (and unadjusted 3.6 percent) in July 2000, marking a 18th consecutive month of decline from a peak of 8.6 percent in February 1999. Both seasonally adjusted and unadjusted unemployment rates marked the lowest levels since the crisis began in December 1997 when they stood at 3.0 percent and 3.1 percent, respectively. For the year of 1999, unit labor costs (hourly wage divided by productivity) declined 3.1 percent from the previous year, compared with a 5.7 percent drop in 1997, and a 9 percent contraction in 1998. Poverty rates (seasonally adjusted) have come down sharply from 22.9 percent in the 3rd quarter of 1998 to 15 percent in the fourth quarter of 1998, and have continued to decline at a more moderate pace to 13.8 percent in the 3rd quarter of 1999. There is evidence of increasing inequality in incomes (the Gini coefficient for urban incomes increased from 0.27 in 1997 to 0.30 in 1998) and the government has proposed several measures in April 2000 to improve the situation. According to recent reports from the National Statistical Office, the ratio of incomes between the top and bottom deciles of urban households widened to 8.5 in 1999 from 6.9 in 1997. There is also concern that many of the new jobs that have contributed to falling unemployment rates are temporary in nature and therefore, less secure and at lower pay. Prior to the crisis, Korea had made sustained progress in reducing poverty with little change in inequality. In 1997, the incidence of poverty in urban areas was 8.5 percent. The trend was seriously disrupted by the onset of the crisis. Urban poverty rose dramatically through the third quarter of 1998 to nearly 23 percent. While the distribution of income became more unequal during the crisis, the Gini coefficient of consumption expenditure remained unchanged, reflecting reduced savings among the poor to cushion the impact of the income shock on their consumption. Labor Issues With an 8 to 9 percent growth predicted for 2000, the major nationwide labor unions have demanded wage increases of about 13-15 percent for year 2000 to compensate for wage losses suffered during the crisis. The Korea Employers Federation (KEF) has responded by proposing a 5.4 percent increase while recommending that wages at ailing firms under court receivership or debt rescheduling accords should be frozen at 1999 levels. KEF leaders have also expressed their willingness to consider shortening legal working hours from 44 to 40 hours per week under certain pre-conditions (e.g., September 18, 2000 Korea 11 flexibility in the introduction of the five-day workweek by participants to take advantage of retraining opportunities. industry and company size and cuts in overtime pay). The Employment Security Centers (affiliates of the Ministry of Tripartite Commission, consisting of representatives of Labor) are strengthening services such as job counseling, labor, employers and government, will provide a legal employment referrals and vocational training to help framework to address this issue. Comprehensive public works participants. improvement plans will also be developed concerning pay, holidays, and vacation. A second round of labor sector Livelihood Protection. Before the crisis, the government reform will establish a new labor-management culture, maintained a regular livelihood protection program intended to enhance labor market flexibility. targeted at the poor who passed a means test determined by current income and value of assets. Since poverty had While labor disputes over issues such as employment been declining, the livelihood budget was to be reduced security and compensation are expected, government from 1.4 million beneficiaries in 1997 to 1.2 million in officials still anticipate an overall atmosphere of 1998. To compensate for the reduction in the regular cooperative relations during year 2000 wage negotiation. livelihood program, in May 1998, the government The Ministry of Labor will support and strengthen rational implemented a temporary livelihood protection program bargaining practices through tripartite discussions, that maintained the income test but relaxed the asset test so seminars, and advertisements. As of May 31 2000, some that the newly unemployed could qualify. The government 33 percent of 5116 firms with 100 or more workers have also introduced a means-tested pension for 660,000 needy concluded wage negotiations. One factor that would help elderly people. In August 1999, the National Assembly the government to keep labor wage demands within a passed the National Basic Life Protection Act which will realistic range is the credibility it has built up since the go into effect in October 2000. The Act guarantees a crisis by strengthening social safety nets, such as minimum standard of living for all Koreans; those who are unemployment insurance. under the poverty line will be entitled to receive income support from the government, covering living, education, Program Implementation in the Social Sector and housing expenses. It is expected that nearly 2 million poor people will benefit from it. Expansionary fiscal policies in 1998 and 1999 were critical in softening the impacts of the crisis on the poor and the Assistance to Women. In February 2000, the government unemployed. Looking forward, the government is keen to announced that the coverage of the minimum wage will be move away from a crisis-induced patchwork of expanded to include companies with fewer than five interventions towards a consolidated social safety net for employees. This change and the expansion of the medium term. President Kim Dae Jung has coined the unemployment insurance are expected to help women phrase "productive welfare" to convey the emphasis on workers since these firms employ 80 percent of the total achieving shared growth primarily through expanding female workforce. The President has announced that a opportunities for self-improvement instead of passive ministry for women's affairs will be set up while the social assistance to the poor. The government responded to Ministry of Labor has created a special "Window for the crisis by more than tripling its expenditure on social Reporting Dismissal of Women," and is assisting protection, from 0.6 percent of GDP in 1997, to 2.0 unemployed women who are heads of household through percent in 1999. Most of the incremental outlays funded training programs, public work projects, and wage expansion of diverse income maintenance programs. subsidies to firms who hire female heads of household. Unemployment Insurance (UI). The UI scheme, Pension Reform. The Government announced in April introduced in 1995, was expanded to cover smaller firms 2000 that its national pension program will be expanded to (five or fewer workers), temporary and daily workers cover informal workers. Presently, informal workers can during the crisis. In year 2000, a total of 6.46 million join the program only as regional subscribers. Regional workers or 75 percent of the labor force will be covered by subscribers have to pay the contributions in full themselves the scheme. Also, UI is paid for up to 12 months, an instead of having their employers pay half. This change in increase from10 months. status of informal workers will take effect starting October 2000. In addition, the government is reviewing options for Public Works. The government introduced a temporary a major reform of the pension system to improve public works program in May 1998. Total expected outlay efficiency, equity, and sustainability of the system. The for public works programs in 2000 (Won 1.2 trillion) is contemplated reform also aims to reduce labor market about half of that in 1999, reflecting improved economic distortions, and develop the capital market by promoting a conditions and lower rates of unemployment. In addition, private pension industry. A Government Task Force has the government is expected to expand effective programs prepared a White Paper on pension reform, with World to include participation from private organizations. The Bank's analytical and advisory help. An international government will focus on the poor and their eligibility for conference is planned in February 2001 to discuss and public works, and introduce flexible hours to allow exchange views on policy implications and September 18, 2000 12 East Asia Brief implementation strategies. partnership for a one year pilot. The first component of the partnership involves the Bank's provision of analytical Other government initiatives to expand the social safety and advisory services to support Korea's continuing net included a proposal by the Ministry of Labor during structural reforms and its transition to a knowledge-based the Economic Policies Coordination Meeting (April 2000) economy. The second component represents a major to support worker living standards through downward innovation where the Government, through its research interest rate adjustment for loans for the unemployed, and institutions, will provide at its costs, capacity-building and increasing workers' asset by expanding the stock option analytical services to interested third countries. system to non-listed companies. The tax system is also utilized ­ through a higher ceiling on tax deductions for Governance insurance, medical, and educational expenses and strict enforcement of inheritance and donation taxes. Coverage In the aftermath of the financial crisis, Korea has of industrial accident compensation insurance to all undertaken a series of bold and fast-paced reforms to companies regardless of size has begun in July 2000. Also address structural weaknesses in the economy. The effective on July 1 2000, the National Health Insurance reforms represent a fundamental paradigm shift towards Act has consolidated medical insurance funds for self- modernizing its institutions, and making Korea globally employed and salaried workers to reduce costs, improve competitive. The government has shown a firm management, and ensure a more equitable distribution of commitment to establishing the rule of law and a market insurance premiums. Separation of medical and economy with transparent rules. pharmaceutical services was implemented as scheduled on July 1, 2000. Following the election in February 1998, the new government embarked on an ambitious program to reduce Human Capital and a Knowledge-based Economy corruption in the public sector. To eliminate potential causes for corruption, the program intends to rationalize Although the government's response on social protection the institutional framework, and streamline the during the crisis was exemplary, public spending on government's regulations and procedures to create an traditional human capital e.g., health and education, was environment less conducive to corrupt behavior, where not increased in line with the overall budget, and real deregulation is a major component. The government plans spending either fell or remained constant. Within the to strengthen international cooperation, and will organize smaller envelope for health, however, spending on primary an international conference on combating corruption in care was protected. President Kim recently announced 2000. Korea's goal is to become a "transparent state" by institutional changes which signal the increasing 2003, and rise from 43rd to 20th place in the ranking of importance of education. In this context, the Education Transparency International. Minister is to be elevated to one of two Deputy Prime Ministers, responsible for human resources, in the cabinet · A comprehensive package of anti-corruption measures (the other being the Minister of Finance and Economy). is to be debated in the National Assembly. The main The president has also announced tuition exemption for components are: 400,000 middle and high school students from low income families; low interest loans to some 300,000 university · Implement administrative reforms in corruption prone students; and further expansion of life-long education and sectors, e.g., the construction industry, tax vocational training programs. administration, police force, environmental policy and administration, food and sanitation businesses, Post-crisis government efforts are also focused on creating education, military conscription, government conditions for a competitive and knowledge-based procurement, and customs; economy. In his New Year policy speech, President Kim announced the government's intention to provide, free of · Establish an anti-corruption infrastructure, e.g., an charge, personal computers to all teachers and classrooms anti-corruption law, and an independent anti- in primary, middle, and high schools to create a corruption committee with representatives from knowledge-based economy that will bolster Korea academia, business, and civic organizations; competitiveness in the global market, and help make Korea · Expand citizen participation in anti-corruption an "information and knowledge superpower." The activities, e.g., providing support to NGOs to conduct president has also pledged to increase research and awareness campaigns and voluntary monitoring.; development expenditure to 5 percent of the budget. · Build up the social environment for anti-corruption, A three-year Action Plan for the Development of a including an educational and public awareness Knowledge-based economy will be implemented, and program, review administrative procedures to improve infrastructure innovations will be promoted to cultivate an transparency, and disclose more information to the information society. On June 28, 2000, the government public. and the World Bank signed a Memorandum of Understanding laying out parameters of a knowledge September 18, 2000 Korea 13 · The package also includes specific targets and reform program supported by the Bank in its measures such as increasing salaries for public adjustment lending and TA loan (Financial and servants to match those in the private sector within 5 Corporate Restructuring Assistance, US$ 48 million, years, compensating those who report corruption with approved 8/98, closing 6/02). cash rewards proportional to recovered resources, launching inspections of large local governments upon · Trust Funds. ASEM grants have supported the request of 1000 or more citizens, and making it government implementation of social sector reform obligatory to disclose the contents and use of political agreed under the structural adjustment programs. funds. Specific projects of the grants included (i) social protection for workers, (ii) protecting the poor, and (iii) protecting the elderly. Several technical studies Bank Instruments related to labor market reforms and safety nets were The Bank has actively supported the strengthening of discussed at an international conference in May 2000, social safety nets and improvements of governance jointly organized by the Bank and Korea Labor through the following instruments: Institute. An ASEM grant approved in June 2000 will support higher education reform while a PHRD grant · Policy-based lending. Economic Reconstruction Loan will support an assessment of the type and scope of (approved 12/97, US$3 billion, closed in 5/99), problems affecting women and families after the crisis Structural Adjustment Loan I (approved 3/98, US$2 and development of policy recommendations for billion) and Structural Adjustment Loan II (approved incorporating counseling services in the routine health 10/98, US$2 billion) addressed comprehensive social care delivery system. An IDF grant has supported sector reforms in labor markets, anti-poverty preparation of the Government's anti-corruption programs, health insurance and pension system. In the program, with a PHRD grant supporting corporate sector, corporate governance reform has implementation. been one of the main areas of the government's - Macroeconomic Update was prepared by Swati Ghosh and Tony Ollero (EASPR). - Financial Sector Update was prepared by Alain Soulard (FRO). - Corporate Sector Update was prepared by Swati Ghosh (EASPR). - Social Update was prepared by Chorching Goh (EASPR) September 18, 2000 14 East Asia Brief Korea Economic Indicators 1997 1998 1999 2000/p 1999 2000 Year Year Year Year Q3 Q4 Q1 Q2 May Jun Jul Aug Output, Employment and Prices GDP ( % change previous year) 5.0 -6.7 10.7 8.5 12.8 13.0 12.8 9.6 .. .. .. Industrial production index (1995=100, seas. 114.5 106.1 131.7 .. 135.5 144.9 148.2 149.7 151.3 155.1 160.1 adj.) (% change, previous year) 5.3 -6.5 24.1 .. 31.1 26.6 23.6 18.3 20.0 17.9 19.3 Unemployment Rate (%) 2.4 6.8 6.3 .. 5.6 4.6 5.1 3.8 3.7 3.6 3.6 Real Wage Growth (% change previous year) 3.0 -9.1 11.0 .. 14.7 13.7 7.6 7.2 6.8 5.0 Consumer price index (% change, previous 4.4 7.5 0.8 2.0 0.7 1.3 1.5 1.4 1.1 2.2 2.9 2.7 yr) Public Sector Government balance (% GDP) 1/ -1.7 -4.3 -3.3 -2.5 Consolidated central government debt (% 24.7 33.2 36.2 GDP) 2/ Foreign Trade, BOP and External Debt Trade balance ($US b) 3/ -8.5 39.0 23.9 13.5 5.3 6.9 0.5 3.7 1.4 2.2 0.8 Exports of goods, ($US) 3/ 136.2 132.3 143.7 169.9 35.1 42.6 39.3 43.5 14.7 15.3 14.5 (% change, previous year) 3/ 5.0 -2.8 8.6 18.2 17.8 22.7 30.0 21.8 28.5 19.4 23.6 Key Export: Electronic Parts, (% change, 8.0 -6.7 33.6 .. 38.4 52.5 44.3 45.1 47.0 48.9 previous year) Imports of goods, ($US b) 3/ 144.6 93.3 119.8 156.4 29.8 35.7 38.8 39.8 13.3 13.2 13.7 (% change, previous year) 3/ -3.8 -35.5 28.4 30.6 38.7 44.8 51.8 38.3 40.4 29.0 40.1 Current account balance ($US b ) -8.6 40.6 25.0 9.5 6.7 5.7 1.7 2.7 1.6 1.5 0.8 (percent GDP) -1.7 12.6 6.1 2.1 6.6 4.9 1.6 Foreign Direct Investment (US$ b) 4/ -1.6 0.7 5.1 3.7 1.8 1.3 0.7 1.8 1.2 0.1 -0.1 FDI Commitments (US$b) 5/ 7.0 8.9 15.5 .. 4.0 7.1 2.7 0.8 Total external debt ($US b) 158.1 149.3 136.4 130.3 140.9 136.4 143.2 141.0 141.5 141.0 142.1 (% GDP) 33.4 46.4 33.4 26.8 36.5 33.4 Short-term debt ($US ) 63.2 30.8 38.1 36.0 35.0 38.1 43.4 47.0 46.8 47.0 47.8 Debt service ratio (% exports of g&s) 8.9 12.9 23.7 12.6 Usable reserves ($US billion) 8.9 48.5 74.1 95.0 65.5 74.1 83.7 90.2 86.8 90.2 90.4 91.4 (months of imports of goods and services) 0.7 4.4 4.9 6.1 5.4 4.9 4.9 5.5 5.5 5.5 5.4 5.5 Financial Markets Domestic credit (% change, previous year) 21.9 9.8 Short-term interest rate 6/ 13.2 15.0 5.0 .. 4.7 4.7 4.9 5.1 5.1 5.1 5.1 5.1 Exchange rate (end-period) 1695.0 1204.0 1138.0 .. 1216.4 1138.0 1106.0 1115.0 1129.4 1115.0 1116.7 1108.8 Real effective exchange rate ( + = appn) 92.9 69.0 78.3 .. 78.1 78.5 82.4 84.5 85.0 84.6 (% change, previous year) -6.0 -25.6 13.5 .. 5.0 8.0 6.8 6.2 7.3 3.9 Stock market index (Dec 1996=100) 68.1 81.4 149.0 .. 121.1 149.0 128.9 118.9 106.0 118.9 102.2 Memo: GDP in US$ b 476.5 317.1 406.9 .. 102.0 117.4 .. .. .. .. 1/ Consolidated central government. Excludes privatization proceeds. For 2000, includes the civil service pension fund. 2/ Includes domestic and external debt. Includes bonds issued outside the budget for bank restructuring in 1998 and 1999, and the global bond issue in April 1998. 3. Trade figures are on a customs-clearance basis. 4/ Foreign direct investment is on a net basis as reported in the BOP. 5/ FDI commitments are reported by the Ministry of Commerce, Industry and Energy. 6/ Overnight repo rate (end-of-period). September 18, 2000 MALAYSIA higher prices charged by domestic producers. MACROECONOMIC UPDATE Export growth continued in the first half of 2000. Exports CURRENT DEVELOPMENTS up 19.5 percent in the first half compared with the same period in 1999, while imports increased by 29.4 percent resulting in a 13.7 percent contraction of the trade surplus. Q uarte rly G D P G ro wth Electronic goods continue to dominate exports accounting % chang e yo y for over half of export receipts. Imports of capital goods surged by 50.7 percent accounting for 14.6 percent of total 12 10 imports. 8 6 4 2 Imports Exports and Trade Balance 0 -2 10000 -4 -6 9000 -8 8000 -10 7000 -12 97- 79l- 79-v 98- 89l- 89-v 99- 99l- 99-v 00- 00l- 6000 5000 Mar Ju No Mar Ju No Mar Ju No Mar Ju 4000 3000 First half growth up. GDP rose 8.8 percent in Q2 over the 2000 same quarter last year. This follows 11.9 percent growth in 1000 0 Q1. The continuing expansion has now raised quarterly GDP above the previous high achieved in 1997 Q4. Exports Imports Trade Balance Consumer and Producer Prices (% change yoy) Foreign exchange reserves rose to US$ 34.0 billion or about 6.4 months of retained imports as of end June 2000. 20 PPI This compares with US$30.9 billion at 1999 year end and 15 reflects continued current account surpluses. 10 CPI 5 Commercial Bank Rates (%) 0 Base lending rate -5 16.0 3m inter bank rate Average lending rate -10 14.0 12.0 98 8 99 9 00 0 an-J r-9pA 89-l 89-t 10.0 Ju Oc an-J r-9pA 99-l 99-t Ju Oc an-J r-0pA 00-l Ju 8.0 6.0 4.0 Growth broadens. The expansion was broadly based and growth rates were positive in all sectors except agriculture. 2.0 1998 1999 Manufacturing sector growth of 22 percent was particularly 0.0 strong. The 25.8 percent increase in investment in Q2 (13.9 Interest Rates. The central bank's intervention rate to was percent Q1) and was reflected in higher imports of capital reduced to 5.5 percent in August 1999 and has remained goods (up 63.1 percent in Q2). However investment remains there since. The base lending rates declined from 8.89 in below pre-crisis levels. September 1999 to 6.79 at end 1999 and 6.75 at end June 2000. Average lending rates have declined more rapidly in Inflation remains low. Consumer price inflation remains the face of increased competition and ample liquidity. The tame and stood at 1.4 percent in July. Producer price average lending rate for Commercial banks stood at 7.66 at changes, which remained in negative territory for most of end June 2000. The 3-month interbank rate was 3.18 1999, began to rise this year. The yoy increase in the PPI to percent. June was 7.3 percent (5 percent in May) largely reflecting September 18, 2000 2 East Asia Brief Fiscal policy remains expansionary The government is continuing to apply fiscal stimulus with a projected budget deficit of 4.25 percent of GDP in 2000--only slightly less FINANCIAL SECTOR UPDATE than the 4.5 percent deficit in 1999. CURRENT DEVELOPMENTS POLICY IMPLEMENTATION AND ASSESSMENT Progress on Non-Performing Loans is steady but slow. As The recent macroeconomic data clearly an entrenchment of at end June 2000 NPLs remaining in the banking system the recovery. Going forward the challenge will be to ensure amounted to RM 65.2 billion based on three month that destabilizing forces are not allowed to emerge. The classification standards and RM48.1 billion based on six authorities have indicated that they do not intend to alter the month classifications. The peak of the NPLs was registered exchange rate regime at this time. The exchange rate in the last quarter of 1998, but the reductions since then turbulence earlier in the crisis made company valuations have been slow. NPLs as a share of total bank lending difficult, frustrating corporate restructuring efforts declined from 18.9 percent at their peak to 16.2 percent at especially given the highly open nature of the Malaysian the end of Q2 2000. economy. Fixing the ringgit to the dollar gave a higher degree of certainty. However, recently the dollar-yen and Lending growth picks up slightly. Loan repayments had dollar-deutsche mark rates have become more volatile. A outstripped disbursements until February this year. Since depreciation of the dollar in response to the sharply then however the situation has reversed and total loans widening US trade deficit could introduce more instability increased by 2.5 percent. (including those sold to Cagamas particularly as the ringgit is presently undervalued. Should and Danaharta or 1.8 percent (excluding Cagamas and this happen speculative short term capital inflows could Danaharta). The largest share of the additional lending has mount quickly in anticipation of an exchange rate been for residential property. Total deposits increased adjustment. An early move towards a more flexible marginally over the first half to RM446.3 billion at end June exchange rate regime would help insulate the economy from 2000. The Loan to Deposit Ratio increased slightly from such external disturbances. 84.1 percent to 84.8 percent over the same period. New lending was concentrated in residential real estate. BANK INSTRUMENTS Bank capital increases. The purchase of NPLs by Danaharta The objectives of the Bank's Country Assistance Strategy, forced banks to record losses on their balance sheets thereby approved by the Board on March 30, 1999 and prepared in reducing capital. Initially it was estimated that RM 31 response to the 1997-98 crisis are: (a) mitigating the social billion would be needed for recapitalization through consequences of the crisis and preventing the erosion of Danamodal. In the end the actual amount required fell far social sector achievements in the short-medium term; and short of this figure ­ RM6.2 billion was injected during (b) supporting measures to restore growth and confidence 1998 and 1999 and as at end January 2000 the net capital and enhance Malaysia's competitiveness over the medium injection by Danamodal stood at RM 5.3 billion and was term. falling as earlier injections began to be repaid. The RWCR stood at 12.8 percent by the end of June 2000 up from 12.3 As part of non-lending services, a Structural Policy Review percent at end 1999 and 11.8 percent at end 1998. and Public Expenditure Review were completed in FY99 and discussed with Government in May and August. Both Lending and NPLs have been released in gray cover. An update of the RM b. Structural Policy Review has been completed and will be 500 discussed with the Government in the fall. 400 Bank NPLs Loans sold to 300 Danaharta 200 Performing Loans at banks 100 0 1Q Q3 1Q Q3 1Q Q3 1Q 97 98 99 00 Bank profits improve. The banking system showed pre-tax profits of RM5.3 billion in 1999 as compared with losses of RM 5.7 billion in 1998. This rise in profitability was due partly to the large spread between lending rates and deposit September 18, 2000 Malaysia 3 rates. However this is now changing. While base lending about a consolidation of the financial industry covering 58 rates have remained basically unchanged for the 12 months financial institutions (21 banks, 25 finance companies and to August 2000, increasing competition among banks has 12 merchant banks). It was hoped that the consolidation pushed the average lending rates down by some 34 basis would 1) improve the competitiveness (and thereby ensure points. In addition, BNM announced an agreement with the the survival) of the domestic banking industry in the face of banks on August 4 this year that deposit rates would be increasing foreign competition in the future and 2) avoid the increased by 25 basis points. potentially destabilizing consequences of a number of domestic banking institutions going bankrupt under the weight of market forces in an increasingly competitive KLSE Composite Inde x environment. On February 14, 2000, the Government granted approval for the formation of 10 banking groups to 1200 be led by anchor banks. The banks have until the end of 1000 2000 to devise and implement the consolidation plans around these groupings. The deadline for qualifying for 800 merger incentives comprising exemption from stamp duty, real property gains tax, as well as the tax credit on 50 600 percent of the accumulated losses of banking institutions 400 which are to be acquired, has been extended to August 31, 2000. BNM has not issued formal instructions to the 200 individual groups regarding execution of the mergers. 0 However, it has issued directives regarding the process that 1999 2000 the groups will be expected to follow. Accordingly, qualified external experts have been hired to advise on Stock market settles back after substantial rise The KLSE human resource needs and operational restructuring, and index increased almost four-fold from its low of 263 in financial institutions are formulating restructuring plans September 1998 reaching 1010 in February 2000 sparking without resort to forced retrenchments. This may entail fears that a new speculative bubble might be in the making. careful severance package design. According to a BNM With stock market capitalization approaching 250 percent of directive the new groups will be organized in such a way GDP, the stock market played an important role in that a member of the anchor bank sits on the loan committee Malaysia's economic recovery by boosting consumption. of each acquired institution. It is expected that the formal Rising share prices also reduced the level of NPLs held by mergers will be accomplished as planned by the end of banks and finance companies which had directly or 2000. But integration of operating and IT systems as well as indirectly financed share purchases prior to the economic rationalizing the human resource needs will take much crisis. The index has since fallen and stood at 799 at end longer. July, 21 percent off its February peak. The markets remain vulnerable to adverse stock price movements in the US and Europe. Progress in Financial Sector Restructuring The Property Market. While the market for residential real Danamodal was established in August 1998 to recapitalize estate has begun to recover, vacancy rates remain high for undercapitalized banking institutions to increase their commercial space. In part this reflects excessive pre-crisis resilience and enhance their ability to generate new lending expansion and the long gestation times in commercial real activities. Originally, it was anticipated that up to 23 estate planning and construction. In 1997 there was a 24 financial institutions would become undercapitalized and percent increase in the stock of purpose-built space. Despite would require up to RM16 billion in capital injections the general economic downturn another 24 percent increase through Danamodal. In fact only RM7.6 billion was injected was recorded in 1998. At the same time occupancy rates fell into 10 financial institutions. Some of the institutions have from 95 percent in 1997 to 80 percent in 1998. They have already begun to repay and the amounts due to Danamodal continued to fall steadily since, and stood at 76 percent as of have been reduced to RM5.3. Danamodal's funding is the end of Q1 2000. Retail occupancy rates have begun to comprised of paid-up capital of RM3 billion provided by recover from the low of 62 percent in 1998 but were still BNM and RM7.7 billion obtained by issuing zero coupon only 77 percent in Q1 2000 as compared with rates well in bonds to 57 banking institutions. excess of 90 percent prior to the crisis. Excess capacity in the property market should be expected to act as a drag on The Financial Stability Forum. The FSF was established in the construction sector and on the building material. February 1999 by the G-7 Finance Ministers and Central Bank Governors to promote international financial stability Banking Sector Consolidation through information exchange and international co- operation in financial supervision and surveillance, to promote international financial stability, and improve the In July 1998, the Government announced a plan to bring functioning of markets and reduce systemic risk. Malaysia September 18, 2000 4 East Asia Brief was particularly active in the Working Group on Capital Flows. The Deputy Governor of BNM a member of the this CORPORATE SECTOR UPDATE group which produced its report in April 2000. Malaysia emphasized the potential role of capital controls as a Corporate restructuring in Malaysia is carried out in three prudential measure in preserving international financial ways: a) restructuring via the national asset management stability as well as the importance of considering both debt corporation, Danaharta; b) voluntary restructuring either and non-debt flows. Malaysian views were also reflected in directly between parties or with assistance of the CDRC; the Working Group acknowledgement of the responsibility and c) court supervised restructuring under Section 176 of of both foreign and domestic banks in managing cross- the Malaysian civil code. border credit risk. Danaharta BANK PROGRAM Danaharta was launched as an asset management company An ASEM Grant for Financial Sector Strengthening was in the third quarter of 1998 with the objective of removing signed by the Government in August 1999. The grant is NPLs from the banking system and maximizing the being used to (a) assist Bank Negara Malaysia design and recovery value of the acquired assets. It has legal powers implement an Early Warning System for the banking sector, that have had an important bearing on its success. First, on an individual institution basis, and (b) conduct a special vesting powers insulate it, and subsequent technical study on international practices regarding purchasers, from undisclosed claims made after acquisition depositor protection and deposit insurance schemes and of the asset from the creditor. Second, it has the power to examine possible implications for Malaysia. Grant appoint special administrators without having to go to court. implementation is underway. In November 1999 a group of Finally, it can assume ownership of the assets and foreclose four central bank officials visited France, Italy, the on collateral just as if it were the original creditor. Netherlands and the U.S. to discuss the early warning Danaharta completed two asset carve-outs in the second half systems used by those countries and to assess the of 1999. Its acquisition phase is now over and as of June 30 appropriateness of those systems for Malaysia. A seminar 2000 it had RM46.8 billion in its portfolio including on deposit insurance systems was held in Malaysia in RM36.9 billion which represents NPLs removed from the January 2000 with presentations on traditional deposit banking system. The remainder consists of loans under insurance and alternatives made by three international management for various government entities. specialists from Canada, France and the U.S. Asset Tenders Heldby Danaharta(June 1999to present) Indicative/principal amounts Amount Recovery total withdrawn* net offered received rate * 1 2 3 (=1-2) 4 4/3 RMm. RM m. RMm. RM m. % First property tender 123 107 16 18 108 Secondproperty tender 276 172 104 106 102 First foreign loantender 541 181 361 199 55 Secondforeign loantender 957 27 930 658 71 TOTAL 1897 486 1411 982 70 * Assets that didnot get Danaharta's reservation price were withdrawn. Recovery rates apply only to assets sold. Source: Danaharta Danaharta has begun the more difficult task of asset sales and operational restructuring. Here the progress has been slow but steady. Four asset tenders were held including two property tenders held in November 1999 and April 2000, as well as two foreign loan tenders. A third tender for RM616.39 million worth of foreign loans is planned for September. Procedures for selecting and valuing assets for are clearly defined and executed. Independent expert advisors are contracted for valuing assets. Those that do not attract offers close to the independent valuations are withdrawn from the auction and transferred to Danaharta Hartanah a property management subsidiary of Danaharta. All 17 of the properties left over from the first property tender were re-entered in the second tender and eight of September 18, 2000 Malaysia 5 them were sold, accounting for roughly a third of the mechanisms for exit and entry are kept functional. Eighteen proceeds of the second auction. companies filed for court protection under Section 176 of the Companies Act in the first quarter of 2000 bringing the Special Administrators are appointed to oversee the total to more than 192. Winding up petitions exceed 1,000. management of companies under Danaharta control so as to Merger and acquisition activity has also increased. restructure and stabilize the firms. As of July 24 2000, 73 Traditionally, court ordered workouts under Section 176 of the were under special administration. Companies Act, have advanced more slowly than CDRC or Danaharta-led restructuring. Through amendments to Section In sum, workouts have been arranged and are in progress for 176 and the option of creditors to sell their loans to Danaharta, RM25.7 billion of the total RM46.8 billion of NPLs that the willingness to move restructuring forward increased. But Danaharta controls. About RM 6.6 billion are plain the ability of firms to ask for extensions of stay orders against restructuring deals. In addition RM2.5 billion have become their creditors hinders restructuring. performing and RM3.0 billion have been fully settled. Corporate governance In the first quarter of 2000 Danharta issued five year zero coupon bonds with a face value of RM795 million bringing A comprehensive report on corporate governance was the total amount of bonds issued to RM11.1 billion. approved in February, 1999. It was based on the recommendations of the High Level Finance Committee on Corporate Debt Restrucutring Committee Corporate Governance which comprised members of the (CDRC) Securities Commission (SC) the KLSE and the Registrar of Companies. Some of the recommendations implemented or The CDRC seeks to restructure the debt of viable where implementation is imminent include amendment of corporations in order to minimize losses to creditors and the Securities Commission Act 2000; introduction of a shareholders and to avoid placing viable companies into (voluntary) Malaysian Code on Corporate Governance liquidation, thereby preserving jobs and productive capacity. which sets out broad principles of good governance and best The CDRC process is voluntary, along the lines of the practices for listed companies; and mandatory accreditation "London Rules" approach. As of 30 June 2000, CDRC had of directors which will require directors to attend resolved the debts of 25 companies amounting to RM18.4 compulsory training programs. billion out of the 71 applications received with total debts of 39.6 billion. The majority of 25 structured companies are POLICY IMPLEMENTATION AND ASSESSMENT main board listed companies and investment holding companies. Excluding the 16 withdrawn/rejected due to the Malaysia has made significant progress in the area of lack of viability and those 9 cases transferred to Danaharta, corporate restructuring and corporate governance. the outstanding cases is 21, accounting for 29.6 percent of Disclosure throughout the restructuring process has been the total number. The outstanding value of debts to be good. Details of significant developments concerning the resolved amounts to RM15.7 billion representing 39.5 CDRC, Danamodal or Danaharta have been made available percent of the value of application. These cases are currently in a timely manner on web sites, and in press releases and at the detailed discussion stage. operational reports. In March 1999, Danaharta released detailed operational results providing information on the CDRC Actions (as of June 30, 2000) amount of NPLs acquired and the discount to face value Number Value (RM bn) paid, in aggregate and on a bank by bank basis; in April, it Total applications 71 39.6 announced the loan restructuring guidelines it will follow in Withdrawn or rejected 16 3.8 restructuring NPLs. Danamodal released its first set of Referred to Danaharta 9 1.8 financial statements in the fourth quarter of 1998. The Resolved 23 17.4 details of the cases resolved by the CDRC have been made Resolved with Danaharta 2 1.0 public and widely discussed in the Malaysian and Evaluated but pending 21 15.7 international press. The policy actions following on the completion work of the High level Commission on Corporate Court Led Bankruptcy and Restructuring Governance represent a step forward and the revisions to the (Section 176) powers of the KLSE and the SC will enhance transparency. Further steps coould be taken to bring accounting standards more closely into line with the IAS. Ownership patterns Restructuring is also occurring outside the remain concentrated and there is still a high level of cross CDRC/Danamodal/Danaharta framework. Market based ownership in the corporate sector. restructuring under the Companies Act is also taking place. This type of restructuring is playing an important role in complementing the Government's efforts, reducing the Government's fiscal burden and ensuring that market September 18, 2000 6 East Asia Brief vacancies have risen sharply since the beginning of the year Unemployment peaked at 4.9 percent in the first quarter of SOCIAL SECTOR UPDATE 1999 has fallen steadily and stood at 3.0 percent at the end of the first quarter of 2000. KEY SOCIAL INDICATORS Previous no. Retrenchments and Vacancies Latest data period 14000 (date) (date) vacancies 12000 Human Development: 1998 1997 10000 Primary enrolment rate (gross) 95.4 95.3 8000 Female (share) 49.0 6000 retrenchments Male 51.0 4000 Secondary enrolment rate 58.0 57.7 2000 0 Female (share) 51.0 89-l 98-t 99-l 99-t 00-l Male 49.0 an-98J r-98pA Ju Oc an-99J r-99pA Ju Oc an-00J r-00pA Ju Tertiary enrolment rate (public only) 8.2 7.5 Infant mortality rate (%) 7.9 (1999) 7.9 (1998) While unemployment and the incidence of absolute poverty Poverty and Income Distribution 1998 1997 remain low, Malaysia has relatively unequal distribution of income. This stems in part from the rapid development of National poverty incidence 7.6 6.8 the manufactured export sector which provides urban jobs Urban 2.4 with wages that are high relative to those in rural Rural 11.8 agriculture. Ensuring more broad-based participation in the Hardcore poverty incidence 1.5 1.4 Gini coefficient 0.468 0.47 modern sector is the key to achieving a more even distribution of income. This in turn is dependent on Government Expenditure 2000a 1999 development of human capital through education and training that will provide a wider cross section of the Education (current RM million) 15,632 15,323 As % of total expenditure 20.6 22.1 population with the skills necessary to function effectively Health (current RM million) 4,948 4,461 in the modern sector. As % of total expenditure 6.5 6.4 CPIand Food Prices Labor Market 2000 1999 % change yoy Unemployment Rate (%) 3.0 (March) 3.4 14% Retrenched Workers (June) 2,446 1,107 Vacancies (Jan) 11,885 7,299 12% CPI food 1998 1997 10% Labor force participation rates 64.3 66.6 Male 86.7 86.9 8% Female 46.8 47.3 6% 4% CPI Sources: Government of Malaysia, Malaysian Quality of Life, 1999; 2% Key Economic Indicators; and 1999-2000 Economic Report (budget data). 0% a. Budget. CURRENT DEVELOPMENTS The strong economic recovery has contributed to improved Budget. Government spending on education and health were social conditions. GDP growth of 10.8 percent (quarterly well protected during the crisis. The share devoted to social yoy) helped to lift average household incomes increased by services in 1998 rose to its highest level since 1986 as 3.7 percent in 1999. The recovery continued into 2000 with resources were shifted away from less critical areas. Now GDP growth of 11.7 in the first quarter. that the recovery well underway spending is being rebalanced and the share of expenditures on the social sector Labor market conditions improve. Retrenchments have has settled back to more traditional levels. Nevertheless the continued to fall and at 826 and 1107 in May and June, are fiscal and demand stimulus package announced in the 2000 their lowest levels since the beginning of the crisis. Job budget included a series of measures which will directly September 18, 2000 Malaysia 7 impact individuals, including the poorest. Among these are provides funding to continue core programs in basic substantial new resources for rural development, water education, and support polytechnic education to provide supply, housing, rural health clinics and smallholder skilled technicians for the medium-term economic recovery. replanting, cash crop, and poverty reduction programs. Efficiency improvements through further staff development and institutional strengthening are also being provided. BANK INSTRUMENTS Implementation is proceeding on schedule. The Social Sector Support Project has been cancelled at the The World Bank assistance for the social sector is being governments request. offered through the Education Sector Support Project which The Malaysia Brief was prepared by Ron Hood (EASPR). September 18, 2000 8 East Asia Brief MALAYSIA ECONOMIC INDICATORS Economic Indicators 1997 1998 1999 1998 1999 2000 Year Year Year Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 May Jun Jul Output, Employment and Prices GDP ( % change previous year) 7.5 -7.6 5.6 -10.9 -10.3 -1.3 4.1 8.5 10.8 11.9 8.8 .. .. .. Industrial production index (1993=100) 156.1 144.9 158.0 143.7 144.9 142.1 155.0 164. 170.9 175.5 185.6 188.2 185.0 .. 1 (% change, previous year) 10.6 -7.2 9.0 -10.4 -10.9 -2.3 6.2 14.2 17.9 23.5 19.7 21.2 20.1 .. Unemployment Rate (%) 2.4 3.2 3.0 3.3 3.4 4.5 3.3 3.3 3.0 3.0 .. .. .. .. Real Wage Growth (%) 6.2 0.9 Consumer price index (% change, previous yr.) 2.7 5.3 2.8 5.7 5.4 4.0 2.7 2.3 2.1 1.6 1.4 1.3 1.3 1.4 Public Sector Government balance (% GDP) /1 2.6 -1.8 -3.2 .. .. 4.6 -0.5 -6.6 -9.0 1.3 -1.9 .. .. .. Domestic public sector debt (% GDP) 27.3 31.2 29.5 36.1 31.0 29.9 29.5 30.5 .. .. .. .. Foreign Trade, BOP and External Debt Trade balance ($US billions) -0.3 14.9 19.1 4.2 5.2 4.1 4.8 4.9 5.2 4.3 3.4 1.21 1.29 .. Exports of goods, ($US billions) 78.7 73.3 84.6 18.2 20.0 18.3 20.5 22.0 23.8 22.2 24.1 8.1 8.4 .. (% change, previous year) 0.6 -6.9 15.3 -10.8 5.0 4.0 14.6 20.8 18.9 21.51 17.4 19.7 21.0 .. Electronics export, (% change, previous year) .. 1.9 -0.8 24.9 22.4 41.1 40.7 .. .. .. Imports of goods, ($US billions) 79.0 58.4 65.5 14.0 14.8 14.1 15.7 17.1 18.6 18.0 20.7 6.9 7.1 .. (% change, previous year) 0.8 -26.1 12.1 -29.3 -20.7 -7.9 8.9 21.2 25.6 27.1 31.6 36.0 28.7 .. Current account balance ($US billions) -5.0 9.4 12.6 3.1 3.5 2.8 3.2 3.7 2.8 .. .. .. .. .. (percent GDP) -5.5 12.9 15.9 17.3 18.6 15.9 16.6 18.1 13.3 .. .. .. .. .. Foreign Direct Investment (US$ billions) 3.8 2.2 Total external debt ($US billions) 45.6 42.6 42.3 42.6 42.0 42.7 43.7 42.3 40.8 41.0 .. .. .. (% GDP) 46.6 59.2 53.5 Short-term debt ($US billions) /2 13.9 8.4 6.0 5.7 5.2 Debt service ratio (% exports of g&s) 6.5 6.6 Reserves, including gold ($US billions) 20.9 25.7 31.0 20.8 25.7 27.3 30.7 31.2 31.0 33.7 33.8 33.5 33.8 .. (months of imports of goods only) 3.2 5.3 5.7 4.2 5.2 5.6 6.3 1.8 4.7 5.1 4.8 4.9 4.8 .. Financial Markets Domestic credit (% change, previous year) 29.3 -2.7 0.3 1.2 -2.7 -3.1 -2.2 1.3 0.3 .. .. .. .. .. Short-term interest rate /3 9.1 6.5 3.2 7.5 6.5 6.3 3.4 3.2 3.2 3.2 3.2 3.2 3.2 3.4 Exchange rate (end-period) 3.9 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 Real effective exchange rate (1995=100, + = appn) 101.8 81.0 83.1 80.4 81.1 82.8 84.3 83.5 81.6 82.9 84.2 85.1 83.9 85.0 (% change, previous year) -2.4 -20.5 2.6 -21.2 -4.5 4.7 1.7 3.7 0.5 0.0 -0.2 0.8 -0.8 0.5 Stock market index (Dec 1996=100) 48.0 47.3 65.6 30.3 47.3 40.6 65.5 54.6 65.6 78.7 67.3 73.7 67.3 64.5 Memo: GDP (US$ billions) 100.2 72.5 79.0 17.8 18.6 17.9 19.5 20.4 21.2 21.1 22.4 .. .. .. 1. Federal government. 2. BIS consolidated international banking statistics for end-December 1998 and previous issues. 3. 3-month interbank rates. September 18, 2000 THE PHILIPPINES MACROECONOMIC UPDATE during the same period in 1999. Finally, the services sector expanded by 5 percent in the second quarter. Second quarter growth higher than predicted. GDP growth in the second quarter of 2000 reached 4.5 percent (year-on- Unemployment rose sharply in April. The unemployment year), well above the average private forecast of 3.5 rate in April rose to 13.9 percent--its highest in 9 years-- percent and a revised first quarter growth rate of 3.2 compared to 11.8 percent in April 1999 and 9.3 percent in percent; GNP growth in the second quarter was 4.6 January 2000, primarily reflecting a sharp drop in percent. GDP and GNP growth in the first half of 2000 agricultural employment. Given the agricultural recovery reached 3.9 percent and 4 percent respectively. The in the second quarter, the unemployment rate in July is sources of growth on the demand side were double digit expected to have declined. export growth (led by electronics) and private consumption, which expanded by 3.2 percent. Investment Inflation remains below its programmed level and is on and imports however both declined in the second quarter track to fall below its targeted (year average) level of 6 and first half as sharp falls in public construction more percent. Nonetheless, on a year-on-year basis, inflation than offset positive growth of investment in durable has risen--from a low of 2.6 percent in January to 4.6 equipment. The second quarter outcome increases the percent in August--as a result of higher fuel and food likelihood that growth for the year could reach at least the costs. Reflecting weak private credit demand, market lower end of the government's 4-5 percent target range for interest rates remain close to their recent lows--with the GDP growth. 91-day Treasury Bill below 9 percent--but further declines have been constrained by increases in U.S. rates as well as concerns about prospective government financing 20 15 requirements and the weakening peso. 10 h 5 owt gr 0 entc -5 -1 0 C P I In fla tio n & S h o rt-te rm In te re st R a te per -1 5 -2 0 1 4 1 4 -2 5 9 8Q 1 Q 2 Q 3 Q 4 99Q 1 Q 2 Q 3 Q 4 00Q 1 Q 2 1 2 1 2 1 0 1 0 P ers ona l c on. G ovt C o n. K F orm atio n N et ex po rts G D P tnecr 8 8 tnecr pe 6 6 pe 4 4 2 M May Ju Sep- No M May Ju 2 ar-9 9 -99 l-99 Jan- ar-0 99 v-99 00 0 -00 l-00 15 C P I In fla tio n In te rb a n k ra te (rh s ) 10 th 5 The current account surplus remains large, but reserves grow 0 have fallen from their peak. The Philippines' trade surplus ent perc -5 more than tripled in the first half of 2000 to $2.28 billion, -10 reflecting weak imports and export growth of 11.5 percent to $17.6 billion. The current account surplus in 1999 -15 98Q1 Q2 Q3 Q4 99Q1 Q2 Q3 Q4 00Q1 Q2 reached $7.2 billion (nearly 9 percent of GNP) and a sizeable surplus is again expected in 2000. The recorded Agr., Fis hery and Forestry Ind. S erv. GDP current account surplus is, however, thought to be overstated due to data deficiencies, including inadequate recording of profit remittances of (mainly multinational) On the supply side, agriculture (including fishery and electronics exporters. Hence the very large negative errors forestry) rose by 4.8 percent, following practically no and omissions--nearly 10 percent of GNP in 1999 at a growth in the first quarter, reflecting double digit growth time when recorded net capital inflows were nearly 6 rates for rice, corn and a number of other important crops. percent of GNP--may also be overstated. Nonetheless, While industrial growth slowed--from 4.4 percent to 3.7 capital outflows have risen in recent months, and gross percent between the first and second quarter reflecting a reserves, which peaked in March 2000 at $16 billion, had steeper decline in construction, growth of manufacturing fallen to $14.8 billion as of July (but still amounted to production rose slightly; its 6.1 percent growth during the about four months equivalent of goods and services first semester compares very favorably to zero growth imports). September 18, 2000 2 East Asia Brief E x p o rt G ro w th a n d In te rn a tio n a l R e se rv e s counted as a revenue item in the official accounts) more than accounted for the deficit overrun. The budget had 4 0 1 7 3 5 1 6 assumed P15.5 in privatization receipts through July, 3 0 1 5 t largely from the sale of the government's stakes in 2 5 1 4 cenrep 1 3 2 0 bill. Meralco and the Philippines National Bank (PNB), neither 1 2 $ 1 5 1 1 US 1 0 of which materialized in the first half as envisaged--the 1 0 5 9 former slowed by delayed enactment of the Omnibus 0 Apr-99 Jun-99 Aug-99 Oc De Feb-00 Apr-00 Jun-00 8 Power Bill. While the government's 30 percent stake in t-99 c- 99 PNB was sold in July, the revenue implications for 2000 are subject to some uncertainty, as it is unclear yet whether E x p o rt s R e s e rve s (rh s ) the government will be paid in full in September 2000 or in installments over 18 months. Exchange Rate & Stock M arket Index (Phisix, 1994=100) Although government expenditures through July were 100 46 within target, spending in recent months has exceeded 80 44 monthly allocations, and there are concerns that the 42 conflict in Mindanao and weaker-than-programmed peso 60 40 could make it more difficult to remain within budget for 40 38 the full year. On the revenue side, the budget figures were 20 36 based on a GDP growth assumption of 4.5 percent; to the 0 Mar-99 May-99 Jul-99 Sep-99 Nov-99 Jan-00 Mar-00 May-00 Jul-00 34 extent that growth is lower, tax revenue can be expected to remain below its target for the year. Stock Market Index Peso/dollar (rhs) Government borrowing exceeds target. Net borrowing by the National Government through July reached P104.7 billion, sharply exceeding a programmed level of P63.2 Financial markets remain adversely impacted by investor billion. While domestic financing accounted for more than concerns with a widening budget deficit, alleged cronyism half this total, net foreign borrowing was also higher than within government, upsurge in violence in Mindanao, as programmed, primarily reflecting: a $1.6 billion U.S. well as external factors such as rising U.S. interest rates. dollar denominated bond in March 2000 (at spreads over · On September 6, the peso reached a 32 month intra- U.S. Treasury Bond yields of 350 basis points for the 2010 day low against the U.S. dollar of P45.84/$. maturity bond and 440 basis points for the 2025 maturity · Equity prices had fallen by 28 percent in 2000 bond); and JPY35 billion in the form of Samurai bonds in through end-August, although they were up by about July 2000 (3.2 percent coupon maturing in 2005). The 7.5 percent in August. government is unlikely to tap the international bond · Net outflows of foreign portfolio flows during market in the short run, in view of the diminished appetite January to mid-August 2000 reached $389 million among foreign investors. Instead, the government is (inflows of $1.935 billion, outflows of $2.324 considering utilizing a medium-term dollar denominated billion) versus a $468 million net inflow for the same loan from commercial banks based in the Philippines and period in 1999. Foreign direct investment relying more heavily on official flows. registrations, as reported by the Board of Investments also fell by 63 percent during January-July 2000. On July 24, the government proposed to Congress a budget The value of approved foreign investment in the first of P725 billion in 2001 (representing an increase of 12 quarter fell by 42 percent. percent over 2000) and a deficit of P85 billion (2.2 percent · The risk premium on secondary market trading of of projected GNP), or slightly higher than the targeted Philippine external debt has increased sharply in deficit ratio for 2000. The proposed budget incorporates 2000; for example, the spread over the 10 year US an effort to raise public spending in Mindanao, but is Treasury Bond on government eurobonds peaked at subject to Congressional debate and authorization. over 500 basis points, though it has fallen since then to 432 basis points as of end-August. Spreads on Legislative progress on structural reforms. Following the longer-term Philippine paper have ranged higher--in establishment of an Economic Coordinating Committee in the mid-600 basis point range. January 2000, the government has been more successful in delivering new economic legislation, including: Retail Budget deficit above target. The National Government Trade Liberalization; General Banking Act; Road Users deficit through July 2000 reached P59.7 billion versus a Tax; E-Commerce Law; and the Securities Act. In targeted P37.3 billion for the period, rendering the P62.5 addition, the House and Senate both passed versions of the billion annual target unattainable. Through July, shortfalls Omnibus Power Bill but have yet to reconcile their in tax collection by the Bureau of Internal Revenue (P13.4 versions of the Bill. Passage of an appropriate Bill is billion) and in privatization receipts (P13.6 billion-- September 18, 2000 The Philippines 3 needed to facilitate restructuring within the power sector and privatization of the National Power Corporation. FINANCIAL SECTOR UPDATE Policy Implementation and Assessment Philippine financial markets have weakened through much With an open capital account, a significant public debt of 2000 for reasons already described. Sector-specific burden--non-financial public debt is estimated at 85 issues that may have contributed to such weakness include percent of GNP, and relatively short maturity profile on the failure of a small bank in April, handling of domestic debt, there are limits to the use of fiscal policy to government divestment in a major commercial bank boost economic growth: unless creditors can be assuaged, (PNB), the persistence of significant problem assets in the the cost of borrowing can become a binding constraint. At banking system amid recovering but modest loan growth, the same time, it should be recognized that the level of and citation of the Philippines as a money laundering prevailing deficits is not excessive, even though deficit center. targets have proved difficult to meet. If steps are taken to credibly improve tax collection, particularly at the BIR, NPLs remain high. financing the projected downward path for outer year deficits need not become problematic. The non-performing loan ratio has fluctuated around 13-15 percent since mid-1999; as of June 2000, it stood at 14.65 Restoring the confidence of investors remains percent for commercial banks, surpassing the previous critical. high of 14.61 percent in November 1999. While NPLs remain well below those in countries more severely In the short term, how the widening budget deficit is affected by the Asian crisis, this could change if economic handled and evolution of the conflict in Mindanao may and credit recovery in the Philippines is relatively slow. dominate investor perceptions. While the fifth review of Thanks largely to a high capital adequacy ratio for the the IMF Stand-by Program was successfully completed on system as a whole (17.8 percent in June), the problems in July 31, implementing credible financial policies will Philippine banking do not affect the financial bulk of the remain vital as the IMF program concludes. At least as system. Nonetheless, a relatively large number of small important over time will be to tackle the problems of rural and cooperative banks remain severely stressed. corruption in government and address perceptions of increased cronyism. Recent progress on the legislative Bank lending recovering gradually. agenda is encouraging; early passage of a Power Bill that leads to restructuring of the sector and NPC privatization After remaining flat in 1999, commercial bank loans as of would be a further boost. Ensuring adequate mechanisms June had risen by 4.7 percent year-on-year. Bank lending to resolve bad debt problems lingering from the regional however slowed during the month of June--May-on-May crisis will also be needed. loan growth was 5.7 percent--as banks continued to channel their idle funds into the short-term money market. Bank Instruments General Banking Act passed. In June 2000, a Consultative Group meeting of aid donors was held in the Philippines, co-chaired by the Philippine The General Banking Act, passed in April, permits greater Government and World Bank. Bank documents circulated foreign participation (up to 100 percent of a bank in certain prior to this meeting included: a Social and Structural circumstances), higher penalties for violations of banking Review; Poverty Assessment; and a report on Combating regulations, independent members on the bank boards, Corruption. At the CG meeting, donors committed some tighter controls over related lending, and further $2.6 billion for the Philippines, with a commitment to encouragement to consolidation of the banking sector by redirect assistance programs more heavily towards prohibiting new commercial bank licenses until mid-2003. Mindanao as security conditions warrant. PDIC was, however, deprived of its independent supervision authority in the course of passage of the Discussions with the Bank on a public sector reform General Banking Act. And two other financial sector bills, program--encompassing civil service reform, medium- the revised central bank and PDIC charters are still term budgeting, tax administration and policy, and awaiting Congressional approval. improving public sector governance--as well as judicial reforms have been ongoing. Government fully divests its holdings in PNB. The government finally divested its holdings of 30.4 percent in Philippine National Bank in June to a group of investors led by local businessman, Mr. Lucio Tan. The group now controls a stake reported at around 76 percent. With the September 18, 2000 4 East Asia Brief bank fully privatized, the central bank is focusing on its a transparently budgeted and targeted housing assistance rapid financial rehabilitation through a memorandum of program. There is also an urgent need to address the understanding with the bank. While not yet profitable, and problem of weak institutions such as Pag-IBIG and suffering from high NPLs, the bank is expected to receive NHMFC. private capital of P10 to P20 billion, with a P10 billion capital infusion expected in September. Its management In the contractual savings sector, a Retirement Income expects to restore the bank to profitability next year. Commission was appointed in November 1999, but a technical and political consensus on comprehensive reform Central Bank (BSP) Actions. In April, a small of the social security system is still needed. This calls for commercial bank (Urban Bank) was closed and placed rationalizing long-term contribution and benefit rates, under receivership. The episode--and accompanying removing disparities in public and private sector retirement negative political climate--created some nervousness and programs, striking a balance between defined contribution a modest flight of deposits to quality, requiring central and defined benefit plans, rationalization of investment bank liquidity support of about 0.5 percent of GDP. The policy, improvements in coverage and portability, and authorities have dealt with this failure decisively and are improved prudential regulation and supervision of private pursuing criminal actions against certain officials. PDIC plans. It also requires major institutional reforms such as officials expect to reopen the bank following its merger restructuring Pag-IBIG--which is funded with social with another bank. The central bank is also considering security liabilities but invests in socialized housing loans other measures such as increased accountability of chief and has accumulated large losses, and rationalizing the executive officers, presidents and directors for risk-taking roles of SSS and GSIS. On the positive side, the activities of the bank that affect public interest or the government has provided the DOF the policy oversight bank's viability, and requiring the banks to set up risk mandate for these two important social security management committees headed by a chief risk officer. institutions, thus partially consolidating the fragmented responsibility for policy formulation. To address international concerns regarding money laundering, BSP is proposing to waive the Philippines' Bank Instruments tight secrecy law--which prevents supervisor access to depositor information on a routine basis--for large Lending. A Banking System Reform Loan (BSRL) of deposits. $300 million was approved on December 3, 1998 and the first tranche was released on December 30, 1998. The The investment house sector, falling within a gray area of second tranche has been delayed due to delays and supervision between the central bank and securities problems relating to rehabilitation of and divestment in exchange, has pronounced weaknesses. Recognizing this, PNB but is expected to be released in the fourth quarter of the BSP has suspended granting of new trust licenses for 2000, after the expected infusion of private capital of P10 quasi-banking operations. billion in PNB. A program of policy reforms in the pension, pre-need and life insurance sectors is under Policy Implementation and Assessment discussion. The passage of the General Banking Act and Revised Technical Assistance Grants. Securities Act (discussed below) represent significant achievements--though the long delays in their passage Two ASEM and one PHRD Grant involving a wide range underscore difficulties of legislating reforms--which of advisory and training services for the DOF, the central would be bolstered by expeditious passage of the revised bank, PDIC and SEC remain under implementation. Two central bank and PDIC charters. One key measure in the ASEM grants providing support for social security and two proposed bills is stronger protection from lawsuits for housing finance reforms are also under implementation. banking regulators, which has been a particularly weak DOF has now formed a secretariat to support the point of Philippine banking regulation. At the regulatory Retirement Income Commission, and thus the social level, the BSP has taken several measures to strengthen security component of these grants is expected to be more banking supervision over the past two years, including actively implemented. issuing further guidelines for prompt corrective action, stepping up on-site inspections, improving coordination between BSP and PDIC in resolving distressed banks, and strengthening oversight of market risk in addition to credit risk. In the housing finance sector, the government has yet to rationalize its role by: moving away from direct lending and public sector subsidies; facilitating private sector-led primary and secondary mortgage markets; and developing September 18, 2000 The Philippines 5 operations and reduce the perception of the exchange as a closed brokers' club. These are (i) the appointment of a CORPORATE SECTOR UPDATE majority of non-brokers (up from 3) to the exchange's 15- Equity market developments mirror person board; and (ii) the conversion of the exchange from a member-organization to an open joint stock company, in corporate earnings. a process known as "demutualization." Market analysts have estimated that corporate earnings of publicly traded companies may have fallen by as much as But short-term impact on corporate 30 percent on average from the same six-month period last restructuring is of concern. year. Equity prices have largely mirrored earnings performance, but have not been out of line with several The Revised Securities Act repealed the provisions of other regional markets, with markets in Seoul, Bangkok PD902A that gave the SEC jurisdiction to deal with and Jakarta posting similar declines in 2000. suspension of payments cases. New bankruptcy cases are now to be handled by the Regional Trial Courts. The Insider trading/price manipulation scandal. existing insolvency law (which dates back to 1909) does not, however, provide for rehabilitation of distressed The BW Resources Corp price manipulation scandal companies. Hence revisions to the law are needed and continues to take a toll on investor sentiment, reflecting a regulations for the new bankruptcy law will also need to be continued lack of confidence in the self-regulating capacity promulgated. The judiciary will also need to receive of the PSE. The price of BW skyrocketed from P1.90 per training to apply the new legislation and regulations, once share in February 1999 to P107 in October. Following a these are put into place. significant investment by a major Macau gambling tycoon in October, prices dropped to a low of P7.70 by January Bank Instruments 2000. According to the PSE, there were no disclosures to the general public from company investors, brokers or the Private Participation in Infrastructure. In June, the Bank company regarding the initial price rise nor subsequent hosted a conference and investor roundtable to discuss the fall, and it took no action to halt trading. The SEC, Country Framework Report (CFR) on Private Participation however, began to suspect insider trading and price in Infrastructure. The CFR lays out a short-term strategy manipulation activity. To complicate matters, a key for bringing the PPI agenda forward and can also serve as principle of BW is an associate of President Estrada, who a vehicle for addressing reforms within infrastructure. publicly admonished the now former SEC chairman over Most substantive Bank lending on PPI is being undertaken his zealous handling of the case. By mid-July, the SEC in the water sector, where the LGU Urban Water Project had filed its report on the stock fraud scandal to the and the Water District Development Project aim to Department of Justice with recommendations to indict 39 enhance private participation beyond the large cities. The individuals, including eight brokerages and two Bank is also assessing prospects for private participation in corporations for violations to the securities act, and the the rural electric cooperatives. BIR began its own tax evasion investigation of the BW principle. The BW affair highlighted weaknesses in the Corporate governance. The Bank continues to support the PSE's ability to self-regulate, resulting in the SEC's Institute of Corporate Directors with ASEM grant funding, suspension of PSE's self-regulating role until certain including assistance in the staging of two conferences in actions mandated by the new securities law are adopted. the first half of 2000. A core course in corporate governance for the East Asia region is planned for January Revised Securities Act designed to enhance 2001 in Manila. The course will be developed with the governance and transparency. Institute of Corporate Directors as the local counter and several countries in the region linked through distance The scandal is said to have accelerated Congressional learning facilities. The Bank and IFC are also passage in July of the Revised Securities Act, which participating in the development of a national corporate embodies most of the reforms needed to safeguard investor governance action program covering reforms in corporate, interests. The law strengthens the SEC's powers, tender banking and securities market governance. rules and other minority protection measures, and restricts brokers' dealings on their own account. Following passage The Bank anticipates enhanced support for corporate of the Act, the SEC has urged brokers to register either as governance reforms in the banking system, in state-owned market makers--with higher capital requirements--or firms (GOCCs), in implementing new accounting and desist from trading on their own account. auditing standards and in public advocacy for corporate governance strengthening. The Bank will also be Two key mandated changes in the governance of the stock supporting the transition of insolvency proceedings from exchange should increase transparency of exchange the SEC to the courts, as mandated in the new securities law. September 18, 2000 6 East Asia Brief International Finance Corporation activities During FY01, IFC's investment approvals are expected to SOCIAL SECTOR UPDATE be about US$100 million or about two times the total approvals in FY99. Philippines is now IFC's ninth largest Key Social Indicators country exposure worldwide. FY00 was a record year for IFC in the Philippines with 7 approvals for a total Latest data Previous investment of US$105m (US$85m for IFC's account). (date) period These investments were: (date) HUMAN DEVELOPMENT 1999-00 1998-99 (i) US$20m in Stradcom, IFC's first investment PRIMARY ENROLLMENT 97.0 95.7 worldwide in a unique project to computerize and RATE (NET) outsource the back-office of the Land Transport SECONDARY 65.4 65.2 Office (LTO); ENROLLMENT RATE (NET) Immunization rate (percent) 73 (1998) 72 (1993) (ii) US$0.25m is IFC's first investment worldwide in e- POVERTY AND INCOME DISTRIBUTION1 Commerce--PlantersbankeCommerce.com, a 1999* 1997 venture that will provide SMEs low cost access to National Headcount Index 26.3 25.1 the internet and e-Commerce services; Urban Headcount Index 12.7 11.9 Rural Headcount Index 38.7 36.9 (iii) US$14m in Asian Hospital, IFC's first healthcare Gini Index 0.43 0.43 project in the country; Government Expenditure 1999 1998 (iv) US$25 m in PlantersBank, a thrift bank focused on Education ('98 bn Pesos)2 106.3 106.2 the SME sector; Education (percent of total) 19.4 20.1 (v) US$0.35 m in a microfinance institution to be based Health ('98 bn Pesos)2 13.3 13.7 in Davao, Mindanao; Health ( percent of total) 2.4 2.6 Labor Market Apr `00 Apr `99 (vi) US$10 m credit line for a forfaiting facility to help importers source key raw materials and, Unemployment rate (percent) 13.9 11.8 Male 12.7 11.2 (vii) US$15 m in Mariwasa, post-crisis restructuring of Female 15.9 12.8 a construction materials manufacturing firm. Underemployment rate 25.1 22.7 (percent) In addition, IFC is trying to work with or help create Participation rate (percent) 66.7 69.6 intermediaries to reach out to SMEs and micro Male 83.8 86.3 entrepreneurs especially in the underdeveloped regions. In Female 49.7 53.0 this context, IFC's Board has approved: (i) a US$25 Days lost due to 229 (1999) 557 (1998) million investment in Planters Development Bank, which strikes/lockouts (`000) focuses on SMEs; and is soon expected to consider: (ii) an Real wages (percent change) equity investment of about US$0.3 million to help set up a Non-agricultural +0.9 (`99 micro-finance institution in Mindanao. Agricultural over `98) +8.3 '98 over IFC is also looking to invest in a bank that would set the '97) standard in e-banking and governance in the Philippines. 1 Based on a poverty threshold of about $2 per person per day at 1993 In addition, IFC is looking to provide technical assistance PPP dollars (10577 to assist in setting up an intermediary to help finance rural Peso/person/year at 1997 Manila prices). electric cooperatives. IFC is also keen to promote * Projections based on 1997 FIES data and sectoral growth rates from consistent and better financial reporting by Philippine the national accounts. 2 Using an year on year inflation rate of 5.7 percent for July 1999. corporations and is looking to support efforts for adoption and implementation of International Accounting Standards. Higher growth in the second quarter of 2000, if sustained, bodes well for poverty reduction, particularly as it is driven by better performance in agriculture and services, where most of the poor are employed. The continued decline in the construction sector--an important source of employment for the urban poor--is however a source of concern. September 18, 2000 The Philippines 7 Of special concern, are the economic and social costs of · There were significant regional disparities in growth the Mindanao conflict, which has displaced over 200,000 and poverty reduction. Five regions appear to have by some estimates, and has disrupted the lives of an even lagged in terms of poverty reduction. In the case of larger number. Indirect costs of the conflict include four of these (ARMM, CARAGA, Central Mindanao weakening social cohesion, declining confidence, and and Central Luzon), this is driven by the lack of increased military expenditure. Mindanao has historically significant growth in mean consumption; for Eastern been a poor and lagging region by a number of economic Visayas, there was some growth but the poor failed to and social indicators. While the provision of relief to the share adequately in its benefits due to an increase in displaced population is an immediate priority, the conflict inequalities. underscores the need for redressing the regional imbalance · Poverty is highest in the agriculture sector (which also in development as an integral part of the solution to the accounts for two-thirds of the poor) and the sector also conflict. experienced the slowest poverty reduction. But the sectoral composition of poverty remained stable, Preliminary results from Census 2000 became available reflecting the shift of population out of agriculture. recently. A total population of 75.3 million is estimated · Educational attainment is a key determinant of for the year 2000, up by 6.7 million since the last census in household welfare. In 1997, 75 percent of the poor 1995. Population growth slowed somewhat to 2.02 lived in households where the head had no more than percent per year during 1995-2000 compared with 2.32 an elementary education. percent during 1990-95. Between the last two censuses, · Self-rated poverty levels are much higher, and unlike the average household size also decreased marginally from absolute poverty, do not display a trend decline. The 5.07 to 4.92. threshold level which households regard as "minimum acceptable income" has risen dramatically since the World Bank Poverty Assessment. mid-1980s, which appears to reflect rising household expectations in response to either rising incomes or According to the Bank's recent Poverty Assessment, a greater exposure to how the rest of the country and quarter of the Filipino population in 1997 had consumption indeed the world lives. levels below the poverty line. Estimates based on sectoral GDP growth rates indicate that poverty may have NAPC Anti-Poverty Agenda. increased to 27.8 percent in 1998. The subsequent recovery in 1999 is estimated to have reduced the Following its consultations at the central and regional incidence of poverty to 26.3 percent. Other notable levels, the National Anti-Poverty Commission (NAPC) findings of the report include: recently finalized a National Anti-Poverty Action Agenda · The incidence of poverty declined from 41 percent in (NAAA). The NAPC plans to organize a Poverty 1985 to 25 percent in 1997. But much of the progress Symposium that would feature the operational plan of the during 1985-97 was confined to the first and last three NAAA, which translates the objectives and strategies in years when growth was robust. Between 1988 and the NAAA into concrete anti-poverty plans at different 1994, the headcount index barely moved--from 34 levels of government, and integrates NAAA priorities into percent in 1988 to 32 percent by 1994--reflecting the programs of line agencies. Operationalizing the content of country's anemic growth during those years. the NAAA will remain a priority task for the NAPC. · Social indicators improved steadily over the 1980s and 1990s, including life expectancy, literacy for both The National Statistics Office (NSO) completed the second males and females, immunization and access to safe round of the Annual Poverty Indicators Survey (APIS) for drinking water in both rural and urban areas, and child 1999. The first round of APIS was conducted in 1998 with malnutrition and infant mortality rates. These the express objective of collecting information on the improvements are also reflected in the UNDP's socio-economic impact of the crisis. The 1999 round of the Human Development Index for the Philippines, which APIS, which maintains a panel with the 1998 survey and rose from 0.683 in 1985 to 0.740 in 1997. allows tracking of individuals, includes a module with · Growth, while limited, appears to have been broadly qualitative questions about changes in welfare (instead of shared across income groups. Inequality fluctuated the crisis module in 1998); the 1999 APIS data are during the period without a significant trend. expected to become available in October 2000. The NSO Nonetheless, inequality in the Philippines is relatively is now in the process of implementing its Family Income high, especially for income (Gini coefficient of 0.51 in and Expenditure Survey for the year 2000. the mid-1990s)--at par with levels in Thailand and Malaysia, and significantly above levels in Indonesia, Korea and China. Inequality is also much higher in urban than rural areas but again there is no evidence of a trend over the period. September 18, 2000 8 East Asia Brief Fund. The survey canvasses users' perceptions of Growth problems in accessing and utilizing public services in percent change year on year sectors such as basic education, health, drinking water, 4 low-income housing and subsidized food. An innovative Per capita private consumption 3 Per capita GDP 2 feature of this survey is that it combines qualitative 1 questions on public services with a quantitative 0 -1 consumption module taken from the Annual Poverty -2 Indicators Survey conducted by the NSO. -3 -4 -5 A Workshop on Fighting Poverty: From Global to Local 97 97 97 97 98 98 98 98 99 99 99 99 00 00 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Perspective is to be held in Manila on September 15. At this workshop, the Bank's World Development Report (WDR) 2000 on Attacking Poverty will be launched. This Inflation WDR focused on the themes of empowerment, opportunity percentage change over previous year General CPI and security for the poor. The key findings and messages 14 from the Philippines Poverty Assessment will also be 12 Food 10 presented at the Workshop with a view to promoting 8 public debate. The Workshop will also report on the 6 4 Bank's activities for poverty reduction in the Philippines to 2 gather feedback on performance and priorities for the 0 -2 future. A Social Expenditure Management Loan (SEML), approved by the Bank's Board on February 15, aims to Unemployment rate help the government maintain non-personnel social percentage point change, year-on-year expenditures for the poor within the budget and improve 4 financial management and procurement systems. 3 The seven sub-projects under an Out of School Children 2 and Youth (OSCY) program are all underway, benefiting 1 334 OSCYs who are now enrolled in various trade skills 0 development courses such as IT/networking, agro- -1 mechanic training, and industrial skills training. 150 -2 OSCYs are now back in school, and the implementing Apr- Jul- Oct- Jan- Apr- Jul- Oct- Jan- Apr- Jul- Oct- Jan- Apr- Jul- Oct- Jan- Apr- NGO, Pearl Buck Int'l., is now in the process of recruiting 96 96 96 97 97 97 97 98 98 98 98 99 99 99 99 00 00 150 more OSCYs. One of the last sub-projects to be Bank Instruments approved--the Industrial Skills Training and Placement for Female OSCY High School Undergraduates, being The Bank is preparing a report based on findings from the implemented by the Rogationist Academy College of Filipino Report Card on Pro-poor Services. The Report Technology (Silang, Cavite)--is in the process of Card was based on a national survey of 1200 households screening applicants for their electronics training program conducted by the Social Weather Stations, Manila, and was partially funded by a grant from the ASEM Trust - Macroeconomic Update was prepared by Sanjay Dhar (EASPR) - Financial Sector Update was prepared by Hemant Shah (EASFS) - Corporate Sector Update was prepared by Aldo Baietti (EASPS) - Social Sector Update was prepared by Gaurav Datt (EASPR) September 18, 2000 The Philippines 9 Philippines Economic Indicators 1997 1998 1999 2000/p 1999 2000 Year Year Year Year Q3 Q4 Q1 Q2 May Jun Jul Output, Employment and Prices GDP ( % change previous year) 5.2 -0.5 3.2 3.6 3.8 4.9 3.4 Industrial production index 156.2 138.2 142.4 148.8 140.4 142.4 143.0 (% change, previous year) 5.0 -11.5 3.0 4.5 -0.3 8.5 0.7 Unemployment Rate (%) 8.7 10.1 9.7 8.9 8.4 9.4 9.3 13.9 13.9 Real Wage Growth /1 5.2 -2.0 1.4 -0.2 6.4 9.5 9.5 Consumer price index (% change, previous yr) 6.6 5.6 4.5 3.0 3.9 4.1 3.9 Public Sector Government balance (% GDP) /2 -0.8 -2.7 -3.7 -3.3 -0.1 -0.03 -0.03 -0.04 Domestic public sector debt (% GDP) 65.4 64.2 54.1 49.5 Foreign Trade, BOP and External Debt Trade balance ($US billion) -11.3 -0.03 4.3 5.2 1.8 1.9 0.7 0.5 Exports of goods, ($US billion) 25.2 29.5 35.0 39.9 9.8 9.5 8.6 2.9 (% change, previous year) 22.7 17.0 18.7 13.9 22.9 23.8 9.7 6.7 Key Export, (% change, previous year) 41.0 38.0 27.0 15.0 33.4 25.0 2.4 Imports of goods, ($US billion) 35.9 29.5 30.7 34.7 8.0 7.6 7.9 2.4 (% change, previous year) 11.2 -18.0 4.2 12.9 7.7 11.2 7.8 -3.8 Current account balance ($US billion) -4.3 1.3 7.2 1.3 2.4 2.4 (percent GDP) -0.1 0.0 0.1 0.02 Foreign Direct Investment (US$ billion) 1.2 1.7 1.1 1.0 0.1 0.4 Total external debt ($US billion) 46.7 46.3 52.2 51.2 52.2 (% GDP) 0.6 0.7 0.7 Short-term debt ($US billion) 8.6 9.1 5.7 6.6 5.7 Debt service ratio (% exports of g&s) 11.7 11.4 12.7 Reserves, including gold ($US billion) 8.9 10.7 15.0 14.5 15.0 15.9 15.3 (months of imports of goods and 1.9 3.0 3.8 3.4 3.6 services) Financial Markets Net Domestic credit (% change, previous year) 2.7 Short-term interest rate /3 15.8 13.8 10.8 8.8 8.7 8.8 Exchange rate (end-period) 40.0 39.2 40.3 40.2 40.6 41.1 42.8 Real effective exchange rate ( + = appn) 88.5 69.5 74.6 74.8 70.8 71.8 71.28 (% change, previous year) -3.3 -21.5 7.3 9.2 2.0 -4.5 -8.3 Stock market index (Dec 1994=100) 67.1 70.7 76.9 75.3 77.0 60.4 55.1 53.1 55.1 50.9 Memo: GDP in US$ billion 82.5 65.5 76.5 18.9 21.1 18.4 1. Non-agriculture, National Capital Region 2. National Government 3. Interbank Call Rate 1. Non-agriculture, National Capital Region 2. National Government 3. Interbank Call Rate Note: Year 2000 projections are based on the RMSM-X generated forecasts, consistent with the unified survey submission and the SSR. September 18, 2000 THAILAND MACROECONOMIC UPDATE mains stable and will likely remain above the pre- crisis level of 2 percent of GDP. Thus, international KEY DEVELOPMENTS reserves are likely to remain above USD 30 billion, comfortably covering short term external debt · Recovery is on track but it remains fragile. The economy has continued to expand in 2000 (in Q1 · Fiscal policy continues to support the recovery. The 2000, real GDP grew by 5.1 percent). Exports remain overall public deficit for year 2000 could approxi- the main driver of growth. Private investment has mate 7 percent. Given the slow pace of recovery in shown some signs of improvement, in selected export domestic demand, the government has delayed the oriented industries. The increased market volatility, normalization of the value added tax (from April the increase in oil prices, and the uncertainty arising 2001 to October 2001). The targeted overall fiscal from forthcoming elections, may have adversely af- deficit for year 2001 is thus close to 6 percent. fected consumer confidence. On balance, Thailand is expected to grow by 4-5 percent in 2000. The down- · While public debt has increased, and will pose chal- side risks to the potential growth scenario include a lenges in the future, it is manageable. Public debt further fall in the market confidence arising from a has reached 55 percent of GDP not including addi- slow down in the implementation of the structural re- tional US$ 800-1,200 billion of expected losses from form program as the Government gets distracted by FIDF. However, provided that growth does not slow the elections, and export growth loosing some of its down below 4 percent and real interest rates do not vigor in the third and fourth quarter with the possible shoot up, public debt can be reduced below 40 per- soft landing of the US economy. cent of GDP by year 2010 with fiscal consolidation in the medium term. · While market volatility has increased, it is unlikely to lead to a turmoil. Since January 2000, the Stock Ex- · Monetary policy continues to be accommodating. change of Thailand index has lost 36 percent of its Given a still frail real economy, and inflation ex- value, and it remains volatile, in part reflecting mar- pected to remain low (2-3 percent) despite the in- ket discontent with the pace of reforms and political crease in oil prices, BOT has maintained an accom- uncertainty. The Baht has depreciated by 7.7 percent. modative monetary policy. The inflationary impact of These adjustments, however, do not point towards a oil price increases is likely to be neutralized by in- new crisis as the balance of payments situation re- creases in productivity growth, low industrial capac- mains comfortable. ity utilization, and wage increases which remain mod- est given the still relatively high unemployment rate. · The pace and quality of the financial and corporate reform continue to be the major constraint to the full · Total factor productivity (TFP) and the quality of the cementing of the recovery. NPLs still represent 32 labor force are trending-up. TFP, which began to de- percent of total credit (see the Financial Sector Up- cline well before the crisis, is now trended upwards. date) and the total credit value of cases that have The manufacturing sector has witnessed a significant failed the CDRAC process and require legal action is turnaround in productivity. It is difficult to estimate a growing concern (see the Corporate Sector the extent to which the productivity growth is struc- Upadate). Moreover, successful debt restructuring is tural or cyclical, although there is some evidence that often limited to rescheduling. Thus, despite high lev- the structural reform program has begun to pay divi- els of liquidity in the financial sector credit flows dends. have not recovered. Going forward, this could jeop- ardize the financing of new investments in sectors · The social impacts of the crisis are still being felt. that are currently running close to full capacity (e.g., The latest Socioeconomic Survey shows that poverty integrated circuits, tires, an paper products). incidence in 1999 reached 16 percent. Given a pov- erty/growth elasticity of 1.3 and a GDP growth rate of · Thailand external position remains comfortable. 5 percent, poverty incidence could go back to pre- While exports slowed down in Q2 2000, performance crisis levels by year 2003/2004 (see the Social Sector continues to be solid (15 percent growth). Despite Update). the fast growth of imports (26 percent in Q2 2000), the current account remains positive and is able to compensate for weakness in the capital account re- sulting from accelerated debt repayments. FDI re- September 18, 2000 2 East Asia Brief Growth and its key drivers Figure 2: Per capita Income will reach pre-crisis levels by the end of year 2002/2003 After a sharp contraction in 1998, real GDP is estimated to have grown by 4.2 percent in 1999 and is expected to grow 130 by 4-5 percent in 2000. A major downside risk to the 120 growth scenario is the observed slowdown in manufactur- 110 ing production (particularly for domestic oriented indus- 100) 100 GDP 6= tries) which reflects weak domestic demand. Despite gov- 90 GDP per capita ernment interventions (subsidies and prices controls) to 80 minimize the impact of higher energy prices, these may 199(xednI 70 also be contributing to a downward adjustment of aggre- 60 50 gate supply. Signs of this slowdown are given by the 1996 1998 2000 2002 2004 downward trend in the manufacture production index dur- ing the last 6 months and the fall in industrial capacity utilization which in July stood at 55 percent. Thus, it is The dependency of the recovery on foreign demand creates likely that GDP growth rates in Q3 and Q4 2000 would be an important down-side risk. Thirty six percent of Thai below those observed in the first two quarters. exports go to NAFTA and Japan. Therefore, a slowdown of the United States economy or the lack of full recovery in Figure 1: The economy may be slowing down Japan could slowdown economic growth. The effect of Capacity utilization index Manufacture production index high energy prices and a global slow down in the third and fourth quarters and next year may also have adverse effects 70 130 125 on Thai exports. Some estimates suggest, for instance, that 65 120 if growth in the world economy falls below 3 percent, eco- 3 months MA 115 60 110 nomic growth in Thailand could be reduced by 1 to 2 per- 3 months MA 55 105 100 centage points. 50 95 90 45 85 Figure 3: Exports and imports growth 40 80 98 89-r Jan- Apr-98 98 Jan- Apr-99 99 an-J 89-y 89-l 98 98- 99 99-r 99-l 99 99- 00 00-r 00-l t-98 t-99 Ma Ju Jul-99 Jul-00 Ma ep-S Nov an-J 99-y Ma Ju Ma ep-S Nov an-J 00-y Ma Ju Ma Jul-98 Oc Oc Jan-00 Apr-00 50.00% imports 40.00% Table 1: Contributions to Growth (Baseline case) 30.00% Growth Contributions 20.00% to growth 10.00% Real GDP growth (%) 4.5 4.5 exports Private consumption 6.4 3.4 0.00% Public consumption 4.9 0.46 -10.00% GDFI 8.04 1.37 -20.00% Public total investment 4.5 0.43 Private total investment 11.0 1.22 Jan-99 r-99 y-99 p-99 v-99 n-00 r-00 y-00 Ma Ma Jul-99Se No Ja Ma Ma Jul-00 Exports 11.0 6.33 Imports 17.0 -7.54 The rapid growth of imports suggests that recovery may be Source: Staff calculations broadening. After growing by 21.3 percent in 1999, im- ports are expected to grow by 17 percent in year 2000. Exports continue to be the key driver of the recovery. In While initially growth was mainly due to consumers goods, 1999, exports grew by close to 9 percent, and are expected imports of raw materials and capital goods are now the to grow by 11 percent in 2000 contributing 6 percentage major drivers. points to economic growth. During Q1 2000 monthly ex- ports (in dollars) were growing at an average of 30 percent External balance remains comfortable. Despite the fast (y-o-y). While in the second quarter exports growth growth of imports, the resource balance remains positive slowed down, performance continues to be remarkable. and has compensated for some weakness in the capital ac- The expansion of exports, however, has concentrated in the count resulting from accelerated debt repayments following manufacturing, mining and re-export sectors. Agricultural the increase in interest rates in the United States. While exports have been left behind due to weather problems and there is evidence that FDI is slowing down in sectors such depressed prices for agricultural products. as real estate, financial intermediation, and construction, as foreign investors are exhausting extraordinary opportuni- ties, in sectors such as services and trade trends are stable and could peak up. Overall, it is likely that in the medium term FDI flows will be above the pre-crisis level of 2 per- September 18, 2000 Thailand 3 cent of GDP. Given a flexible exchange rate regime, the Figure 5: Investment seems to be recovering surplus on the trade balance, and improved prospects for the tourism industry, it is expected that gross official re- 4.4 serves will remain above US$ 30 billion, enough to cover 4.2 comfortably current cash in circulation. Import of capital goods (3 months MA) 4 3.8 Private consumption may be slowing down. In 1999 pri- vate consumption grew by 3.5 percent, recovering from the 3.6 Domestic Cement Sales (3 months MA) sharp contraction in 1998 (-12.3 percent). During Q1 2000 3.4 consumption grew by 5 percent. This recovery is broadly 3.2 consistent with the return of consumers confidence, re- 3 flected in an increase in the propensity to consume, as well 98 9 99 Jan-0 Apr-00 0 as the recovery in aggregate disposable income resulting Jan-98Apr- Jul-98Oct-98 Jan-9 Apr- Jul-99Oct-99 Jul-00 from rising wages and higher levels of employment. More recently, however, consumer confidence may have weak- ened, as indicated by the private consumption index. The major obstacle to investment growth is the high level Given observed growth rates of indicators such as car sales of NPLs, and the slow pace of financial and corporate and the VAT tax, which are highly correlated with quar- sector restructuring, which make banks reluctant to lend. terly consumption, it is, however, unlikely that the growth During the first 7 months of year 2000 total credit has con- rate of consumption in year 2000 will be below 5 percent. tinued to contract at an average of 5 percent (y-o-y). The cutbacks, however, do not affect all sectors in the same Figure 4: The consumption index is flattening way. For instance, in the manufacturing and export sec- tors, since December 1999, total credit has been increasing 102 at an average of Baht 2.5 and 1 billion per month respec- 100 tively. In contrast, in the agricultural sector, total credit 98 3 months MA has been decreasing at an average of Baht 1.2 billion per 96 month. A pro-active management of financial and corpo- 94 rate sector restructuring continues to be essential for re- 92 viving business investments particularly in the case of 90 SMEs. 88 Jan-98 Apr-98Jul-98 t-98 Jan-00 Ap r-00 Figure 6: Average monthly change in credit Oc Jan-99 Apr-99Jul-99 t-99 Oc Jul-00 between December 1999 and May 2000 Private investment remains fragile but observed levels are 3000 sufficient to sustain growth rates of 4-5.5 percent during 2500 the next two or three years. In 1999, total investment 2000 reached 20.4 percent of GDP, an increase of 12 percent 1500 from 1998 (in 1996, 1997 and 1998 total investment as a thaB 1000 n share of GDP was respectively 43 percent, 34 percent and 500 illio 19 percent). Since January 1999, indicators such as cement M 0 sales and BOI approvals have remained mostly flat. How- -500 e ever, historically, BOI only represents a small share of total -1000 Mining Exports investment (less than 3 percent of GDP). Other indicators -1500 Agriculture nufacturing Residenc Ma al such as imports of capital goods, which constitute a better Person proxy for aggregate investment, are trending up, suggesting Source: BOT that investment is recovering. Total investment in the economy is expected to grow by close to 8 percent this Sectoral performance year (this trend is also supported by an increase in SOE investment). While the recovery is still unbalanced. Not all sectors have recovered in the same way. Initially the recovery was driven by the manufacturing sector, in particular outward oriented industries (the sector grew by 9.5 percent in Q1 2000 with sub-sectors such as electronics and computers growing by over 15 percent). Gradually other sectors have started to expand. For instance, the construction sector, badly hit by the crisis (this sector contracted by 8.7 percent in 1999), grew by 1.1 percent in Q1 2000, mainly as a re- September 18, 2000 4 East Asia Brief sult of an increase in private construction. Nonetheless, the financial and agricultural sectors continued to display a Figure 8: Labor productivity is increasing poor performance in Q1 2000, contracting by 4.3 percent (1980=1) National and 1.5 percent respectively. The poor performance of the 1.8 agricultural sector, however, is not crisis related but re- 1.6 1.4 sponds to weather problems that affected the production of 1.2 1 shrimp and high oil prices which raised production costs in 0.8 0.6 fisheries. 0.4 0.2 0 1980 1985 1990 1995 2000 2005 Prospects are encouraging given the turnaround in pro- By Sector ductivity growth. TFP growth slowed down since 1990, 1.8 1.6 becoming negative around 1996, and collapsing with the 1.6 1.4 xed 1.4 1.2 onset of the financial crisis. However, since 1999, TFP 1.2 xed 1 iny 1 in appears to have started to grow again in all sectors, par- lita 0.8 yitlauQ 0.8 0.6 0.6 Agriculture ticularly manufacturing. New calculations show that in the Qu 0.4 Industry 0.4 Services 0.2 Manufacture 0.2 medium term TFP growth in industry, agriculture, and the 0 0 1980 1985 1990 1995 2000 1980 1985 1990 1995 2000 service sector could reach 6 percent, 3 percent and 1.4 per- cent respectively. At the national level TFP could be ex- Source: Authors calculations. pected to grow at close to 3 percent, provided that the gov- ernment continues to make progress in the implementation of its agenda to renew competitiveness. Figure 9: Returns to capital have stabilized Figure 7: Total factor productivity is growing 45.00% 45.00% 40.00% Agriculture All sectors Services 40.00% 35.00% 35.00% 30.00% 30.00% 125 25.00% 25.00% 120 20.00% 20.00% xedni 115 15.00% 15.00% 110 10.00% 10.00% tyivticudorP National 105 5.00% 5.00% 100 0.00% 0.00% 95 1980 1982 84 19 1986 1988 19901992 1994 1996 19982000 1980 1985 1990 1995 2000 90 85 Source: Authors calculations. 80 0 198 19 The stock market remains volatile but it is not perceived as 82 84 86 88 90 92 94 96 98 00 19 19 19 19 19 19 19 19 20 a major threat to the recovery. Since January, the SET has 120 Industry 130 120 Agriculture lost 36 percent of its value. Initially, prices dropped as 100 dexni 110 80 foreign investors cut their positions on Thai stocks (in yt ndexi 100 vii January and February, foreign investors were net sellers of 60 yt 90 vii 80 Services uct 40 Manufacturing odrP 70 20 ductorP close to US$ 280 million). In part adjustments in portfolios 60 0 50 were introduced to reflect the lower weighting of the SET 1980 1982 1984 1986 1988 1990 19 92 94 96 98 00 40 19 19 19 20 1980 1985 1990 1995 2000 in the MSCI, after the inclusion of the Malaysian and Tai- Source: Authors calculations. wanese stock markets in the benchmark, and given expec- The productivity of the labor force has been improving as tations of rising US interest rates, which make US bonds the share of educated workers increases. In the medium more attractive. Nonetheless, the adjustments may also be term, labor productivity is expected to grow by 1.7 percent reflecting uncertainties in the Thai economy arising from per year. Growth will be driven predominantly by the (a) the forthcoming elections and the possible change in the manufacturing sector (2 percent). In the services and agri- Government, (b) the slow pace of financial and corporate cultural sectors labor productivity growth is estimated at 1 restructuring. percent and 0.3 percent respectively, although there is sig- nificant upside potential in the services sector. As a response, the SEC and SET are devising reforms to enhance the competitive edge of the Thai stock market in Returns to capital have stabilized in all sectors. The rate response to globalization. Their proposal has four major of return to capital, which had been falling in all sectors components: (1) merging the foreign board with the main since 1990, appears to be stabilizing. In the agricultural board to increase flexibility for foreign investors; (2) al- sector the rate of return to capital has been growing aggres- lowing for dual or multiple listings; (3) allowing securities sively since 1994, in part reflecting Thailand's comparative companies to invest overseas; and (4) introducing new advantage in the sector. hedging instruments. The new Derivatives Act, which would introduce these reforms, is expected to go to the Parliament in July. September 18, 2000 Thailand 5 Figure 10: Stock market remains volatile Macroeconomic policy 600 Monetary policy remains accommodative. The BOT has opted for low interest rates. This policy seems appropriate 500 given the still frail situation of the financial sector and a 400 much improved external position. In particular, short term 300 external debt has decreased dramatically, falling from 65 200 percent of exports prior to the crisis to 27 percent to date. 100 0 Figure 12: Real interest rates have decreased 003/1/ 003/2/ 003/3/ 003/4/ 003/5/ 003/6/ 003/7/ 003/8/ 18.0 16.0 M inim um le nding 14.0 r ate Labor markets 12.0 Bank of Thailand 10.0 rate 8.0 Employment is growing in all sectors except agriculture. 6.0 The Labor Force Surveys (LFS) for August and November 4.0 De pos it rate 1999 showed that while the unemployment rate had begun 2.0 0.0 to fall, employment was contracting and the share of the y r. labor force working less than 20 and 30 hours per week -97 g. r. c. Ma Sep. Dec. Ap Au Dec. Ap Aug. De Jan was increasing. The falling unemployment rate was simply due to the fact that since 1989 the participation rate (the share of the labor force in the population over 13 years of The effect of the nominal depreciation on exports and im- age) had been falling at an average rate of 1.4 percent per ports, depends on the dynamics of the domestic inflation year. The latest round (February 2000) of the LFS con- rate relative to the inflation rate of major commercial part- firms its long-run downward trend. However, the survey ners. For instance, the 4.2 percent nominal depreciation of also shows that for the first time since the crisis, employ- the exchange rate observed between January and May, was ment has expanded in all sectors except agriculture. In- accompanied by an appreciation of the real exchange rate deed, between 1999 and 2000 approximately 500 thousand of 1 percent. Basically, the observed nominal depreciation new workers were employed thus reducing the February was not sufficient to maintain the competitiveness of Thai unemployment rate from 5.4 percent in 1999 to 4.8 percent exports given relatively higher domestic prices. The mac- in 2000 (data on the average number of hours worked is roeconomic model developed by BOT suggests that, for not yet available). each percentage point difference between the growth rate of the goods and services exports price index and the con- Figure 11: Participation rate has continued to fall sumer price index in the United States, the growth rate of 74 73.0 exports could be reduced by 0.4 percentage points. 73 72 Nominal exchange rate depreciation is healthy 71 tnecr 69.8 70 60 95 69.2 90 Pe 69 55 68 85 68.2 50 Real ER 67 Feb round ht 80 66 A ugust round 45 xed Ba 75 In 65 40 70 1995 1996 1997 1998 1999 2000 35 Nominal ER 65 30 60 The fact that employment in the construction sector is ex- t-99Jan-00 Apr-00 panding (as well as output, see Section on Sectoral Per- Jan-98 Apr-98Jul-98Oct-98 Jan-99 Apr-99Jul-99Oc Jul-00 formance) is encouraging. Indeed, in the past, the con- struction sector constituted a safety net for agricultural Given steady reductions in uncertainties over the past one workers during the non-harvesting season. Despite the and a half year, the authorities contend that the case for observed recovery, however, claiming that the construction stabilizing expectations by maintaining the Baht in a rela- sector is ready to resume this role would be premature. tively tight range has become less compelling. They have Government safety net programs remain important. also clarified that they do not intend to tighten existing capital controls. Looking forward, fluctuations in the ex- September 18, 2000 6 East Asia Brief change rate will be tolerated as long as they are consistent with the announced inflation target. Table 3: Public debt dynamics is sustainable Inflation is not a risk. High oil prices, and a shrinking out- Target for the total public Primary Balance (as % of GDP) required sector debt to GDP ratio by to stabilize debt. put gap, over time, could add inflationary pressures. year 2010 (%) Nonetheless, given low commodity prices and low capacity g-r=-1% g-r=0% g-r=1% g-r=2% utilization, forecasts suggest that inflation in year 2000 will 60 0.18 -0.82 -1.78 -2.7 be below 3 percent. Important progress has been observed 50 1.8 0.84 -0.07 -0.96 in the implementation of the framework for inflation tar- 40 3.43 2.51 1.63 0.78 i is real interest rate, and g is real GDP growth geting. The Monetary Policy Board has initiated bi- Calculations assume a seignorage revenue of 1 percent of GDP equal to monthly meetings and has tentatively set a medium-term the average for the period 1980-1995. Seignorage revenue is defined as target for the inflation rate of 3.5 percent. (Base money/GDP)*Nominal GDP growth Source: Staff calculations Fiscal policy continues to support the recovery. The over- all public sector deficit (including interest cost of financial Table 3 shows the size of the primary fiscal balance that sector restructuring) for year FY00 is projected to be the Government will need to generate to stabilize the pub- around 7 percent of GDP and is expected to contribute lic-debt-to-GDP ratio, under different assumptions on the around 1 percentage point to economic growth. The deficit gap between the real GDP growth rate (g) and the real in- for January-March 2000 has been in line with the target (in terest (r) paid on debt. Even under a worst case scenario, March the budgetary deficit amounted to Bt 4.9 billion). assuming that the fiscal cost of financial sector restructur- However, there is a downside risk of a shortfall in the ing turns out to be higher than currently projected, with overall deficit during the second half of this fiscal year. In public debt peaking at 65 percent of GDP, debt dynamics July, government revenues increased by 5.9 percent (y-o-y) is sustainable. For instance, to reduce the debt/GDP ratio while expenditures increased only by 0.8 percent. The to 50 percent by year 2010, under the assumption that the MOF has appropriately decided to postpone raising the real interest rate exceed growth by 1 percentage point, VAT tax (from 7 percent to 10 percent) until October 2001 Thailand would need to generate a primary surplus of 1.8 (the original target was April 2001). percent. The fiscalization path for additional FIDF losses could be set to keep the debt service/budget ratio close to While the public debt has increased and will need to be 10 percent while ensuring that capital expenditures targets carefully managed, it is sustainable, provided the growth are met. momentum is maintained and the reform program is on track. As of March 2000, Thailand's public debt had in- creased to close to 55 percent of 1999 GDP according to POLICY IMPLEMENTATION AND ASSESSMENT the Royal Thai Government estimates (including Bt 500 billion issued to cover FIDF debt and additional 776 bil- Going forward, the quality of recovery in 2000 will depend lion of currently outstanding FIDF liabilities). While ex- on several factors including: isting FIDF liabilities are included in March 2000 public · A pro-active management of financial and corporate debt figure, only current and future net losses will impact sector restructuring the central government budget. MOF and BOT estimates · Macroeconomic policies continuing to be supportive place these losses in the range of Bt 800-1,200 billion. of the recovery process Table 2: Public debt as of March 2000 · Safety net and fiscal stimulus measures to ensure that domestic demand effects contribute to recovery and Baht poverty alleviation Billion Central Government debt 983.2 · Sustaining the structural reform process to ensure im- Guaranteed SOE debt 698.4 provements in efficiency and TFP growth. Non-Guaranteed SOE debt 139.2 FIDF outstanding liabilities (a) 776.8 BANK INSTRUMENTS Total public sector debt 2,597 Source: Ministry of Finance Public Sector Reform Loan (PSRL). The PSRL of US$400 (a) as of December 1999 million is a programmatic structural adjustment loan (PSAL). This loan will support Thailand's program to im- prove public sector management through: 1) improved performance-based resource management, 2) better service delivery, and 3) greater accountability and transparency. Thailand intends to achieve these objectives by imple- menting specific action plans in the five areas of (i) expen- diture management, (ii) human resources management, (iii) September 18, 2000 Thailand 7 revenue management, (iv) decentralization, and (v) cross- government accountability and transparency. FINANCIAL SECTOR UPDATE Comprehensive Development Partnership. The World Bank Group has initiated discussion with the Government CURRENT DEVELOPMENTS of Thailand to prepare a Country Development Partnership on Competitiveness (CDPC). The CDPC is a non-lending Headline non-performing loans (NPLs) are falling slowly instrument that would support the modernization of institu- (see Figure 1). NPLs in the commercial banks, finance tions and policies to promote a competitive business envi- companies and credit fonciers peaked at Baht 2.73 trillion, ronment that rewards innovation, investments in human or 47.7 percent of total loans in May 1999, and have since capital, the adoption of new technologies and the rational declined to Baht 1.62 trillion, or 32 percent of total loans use of natural resources . in June 2000. If NPLs transferred to bank-owned AMCs are included, headline NPLs as of June would have been Economic Management Assistance Project (EMAP). The Baht 1.75 trillion, or 35 percent of total loans. EMAP is a US$15 million technical assistance loan which started in 1997 and ends in February 2001. The main ob- The following observations can be made about the jectives of the EMAP are as follows: 1) streamlining eco- dynamics of NPLs over time: (1) While new NPLs are nomic management which includes macroeconomic analy- entering into the sytem, the amount of new NPLs has sis, public resource management, and administrative re- trended down. (2) The reported magnitude of NPL re- newal, 2) reforming public enterprises, and 3) strengthen- entry has been small at only 0.3 percent of total loans per ing industrial competitiveness. month, but the general quality of restructuring is questionable. To avoid more provisions for loan losses, Social and Structural Review (SSR). The SSR is an ana- banks are rescheduling NPLs (term extension with grace lytical work underpinning adjustment lending of the World periods) instead of restructuring them at market rates such Bank to Thailand. It collects the central messages of the that repayments can be supported by the borrower's on-going policy dialogue with the Thai authorities regard- underlying cash flow. (3) 46 percent of total NPL ing short and medium term reform. The SSR covers rele- reduction results from debt restructuring. Debt vant issues on economic growth, poverty alleviation, finan- restructuring activity usually accelerates at the end of each cial sector reform, private sector development, environ- accounting period (June and December). (4) Economic mental challenges, debt management and public sector recovery accounted for 10 percent of the decline in NPLs. reform. (5) Write-offs have become the second largest contributor to the drop of headline NPLs (21 percent). (6) 10 percent Advisory services: The Bank is supporting Thailand's re- of the NPL reduction came from transfers to asset form program with advisory services. Short policy notes management corporations (AMCs). Transfers of NPLs to and informal workshops are increasingly becoming instru- banks' AMC subsidiaries do not resolve the NPLs, but ments of policy dialogue. The Bank also publishes the only transfer the management of the accounts to a different Economic Monitor which reports on the issues and chal- organizational unit. lenges facing the real economy, financial and corporate restructuring, corporate governance, public sector reform, The first straight sale by a Thai bank of a large proportion legal reform, privatization and SOE reform, social safety of its NPLs to third parties has occurred. DBS Thai Danu nets and labor markets, and medium term competitiveness Bank (DTDB) recently agreed to sell 77 percent of its issues. remaining NPLs (Baht 39.7 billion as of June 2000) to third parties at a deep discount. Proceeds will amount to Baht 9.25 billion, which represents a 70 percent discount from the Baht 30.6 billion outstanding principal balance (OPB). The loans sold include Baht 9 billion of retail loans and Baht 21.6 billion of corporate loans. The retail loans and the corporate loans will be sold at a discount of approximately 50 percent and 78 percent respectively. The average discount of both the retail and corporate loans will approximately be 70 percent. Private Asset Management Companies (AMCs) have not progressed as expected. Since the removal of tax disincen- tives in October 1999, the BOT has approved the estab- lishment of eight AMC subsidiaries by seven banks and one finance company, and is reviewing the application for September 18, 2000 8 East Asia Brief the set up of four more. However, only one private bank management expects KTB's NPLs to drop to Baht 140 has established a wholly owned AMC and transferred billion (16 percent of total loans) and its capital is pro- NPLs at fair value. Those loans are managed by third jected to be 9.56 percent. Third party managers will be party professionals. Because other private banks are un- selected by the FIDF's board to manage the AMC. der-provisioned and are capital constrained, their proposed transfers of NPLs to AMC subsidiaries have not been at Bangkok Metropolitan Bank (BMB) will be privatized fair market value. This has resulted in a deadlock with while the resolution for Siam City Bank (SCIB) has not auditors, who will not recognize the transfer. This has been finalized. The most likely case is that bad assets of stalled the implementation of private AMCs. Total trans- SCIB (Baht 230 billion) will be transferred to the govern- fers to private AMCs have been only Baht 304.5 billion. ment-onwed AMC, which was set up as a bidder of last resort for the FRA's auctions. The remaining good assets The SEC has identified a roadmap to enhance valuation of SCIB may be merged into Bankthai (BT), which was standards, certification requirements and methods. Ap- established by mergers of several failed institutions. The praisal of loan collateral is crucial to determine losses in government may separate BT into a good bank and a bad the financial system since current prudential rules calculate bank as well. provisions for loan losses net of collateral value. Sampling of appraisals in bank credit files shows that most are done The SEC has issued its medium-term strategy to boost by the cost method, without regard to future income poten- competitiveness of Thai capital market. Its strategy fo- tial. Key weaknesses in the valuation industry include: (1) cuses on six areas: equity market, bond market, futures few number of appraisers experienced with best practice, market, securities industry, fund management industry, and (2) valuation techniques and certification requirements are investors. Its strategies for the equity market include: (1) below international standards and (3) little supervision and improve the quality and quantity of supply; (2) stimulate regulation. Currently there are two sets of appraisal stan- demand by encouraging contractual savings in the country; dards and code of conduct set by two local associations. and (3) restructure the stock exchange (SET). Its strategies Quality control of the profession is weak and there is no for the bond market include: enhancement of the primary penalty in case of non-compliance. The SEC is contem- market activities by improving flexibility in bond issuance, plating a project to develop Thai standards based on inter- encouraging new instruments and enforcing credit ratings national standards. for new issues. The investor base should be expanded, and infrastructure for the secondary market will be developed The Bank of Thailand (BOT) will allow hybrid debt capital further. Standards and practices of both the securities and instruments as upper Tier-2 capital. This modification mutual fund industries should be improved, clients should should enable Thai banks to have greater flexibility in be well protected, and supervision will be improved to managing their capital. As provisioning erodes Thai ensure the stability. In order to set up the domestic futures banks' tier-1 capital, the amount of subordinated debt market, the SEC plans to develop the necessary legal which qualifies as tier-2 capital proportionately declines framework and infrastructure. since lower tier-2 capital cannot exceed the limit of 50 percent of tier-1 capital. In case of hybrid debt capital Domestic bond issuance slowed in 1H 2000. From Janu- recently approved by the BOT, the total amount issued can ary-June 2000, issuance amounted to Baht 229 billion, be counted as tier-2 capital. Key features of upper tier-2 which was about 29 percent of the 1999 total (Baht 795 capital are that issuers have the option to defer payment of billion). Bond issuance by the central government in the interest and principal on certain circumstances, and such first half was Baht 31 billion, as compared to Baht 333 debts must be able to absorb losses (junior to lower tier-2 billion in 1999. However government bond issues should capital). Such instruments must not be redeemable without continue to lead activity in the primary bond market due to the prior consent of the regulators. Upper tier-2, however, fiscalization of FIDF's losses over the next five years. The is suitable for banks with sufficient core capital and earn- authorities have estimated FIDF's losses between Baht ings, which may not be the case for some Thai banks. The 800-1,200 billion. The amount of corporate bonds issued total capital requirement will remain unchanged at 8.5 per- in the first half of 2000 has also declined substantially fol- cent of risk assets, 50 percent of which must be tier-1 lowing the SEC's new requirement that all debentures must capital. be rated after April 2000. The Government will split the largest state bank (KTB) The BOT is reviewing a pricing scheme to promote the into a good bank and an AMC, which will be wholly wider use of a more efficient and lower-risk electronic owned by the FIDF. This will allow the management to payment system. The payment system in Thailand has un- focus on the good bank. KTB expects to complete the dergone substantial technological development in the past transfers of its Baht 537 billion NPLs to an AMC by Sep- decade. However, it is still paper-based (cash and checks) tember. Transfer pricing of NPLs are set such that KTB's and relatively high cost. For example, actual costs of us- capital position becomes adequate, but uncovered losses ing and clearing checks significantly exceed fees and are have been transferred to the AMC. After the transfers, its subsidized by other payment channels. There are many September 18, 2000 Thailand 9 challenges facing the BOT in the development a new pric- ing of large syndicated loans may end if Corporate Debt ing scheme to encourage migration into electronic pay- Restructuring Advisory Committee (CDRAC) winds down ments. While increasing fees for using checks may encour- its operations next year. Moreover as of June 2000, Bt1.1 age corporat to switch to electronic payments, retail cus- trillion in CDRAC's portfolio were not resolved on a vol- tomers do not have similar access. An unintended result untary basis by the deadline, and will have to be resolved may be more cash payments. Accessibility by all non-bank in court, where there are capacity constraints and time con- financial institutions (as well as foreign banks) is also an suming processes. Given current completion and filing issue going forward. Thai banks have legacy systems rates, it may take the courts approximately six to seven which slow the transition to electronic payments. years to reach judgements on that backlog. After judge- ments are received, the auction of the collateral and reso- Achievement to Date lution of the claim may take another two years. Crisis management was effective; the macro economy has DTDB's loan sale has set a benchmark price for NPLs of stabilized. Failed finance companies were liquidated, other Thai banks. DTDB's recent sale of its NPLs is more failed banks were sold, and now FIDF-owned asset man- recent than the FRA auctions of assets from the failed fi- agement companies, managed by professional third parties nance companies, and its portfolio should be more similar under incentive arrangements, hold promise for resolution to NPLs of other banks. But prices were similar to prices of debts in state banks. achieved by the FRA. DTDB sought bids for its NPLs a year ago, but did not sell the loans at that time. According A market-led approach to financial sector and corporate to management, prices offered in last year's bid were not debt restructuring has attracted about Baht 314 billion of substantially different from prices offered in the recent loan private tier--1 capital into the private banks since the cri- sale. The positive market reaction to the sale suggests that sis broke. This has reduced the cost to the taxpayer for the DTDB's strategy is sound, and that on a net present value guarantee of depositor's funds in financial institutions. basis, the legal process for debt collection of NPLs is pro- Total capital raising by financial institutions from January hibitively expensive. 1998 to June 2000 amount Baht 900 billion. This enables them to meet the provisioning rules under the forbearance While banks will meet the year-end 2000 provisioning re- program (stepped up until the end of year 2000). Still quirements set by the regulator, the banking system re- more is needed to absorb the full losses of NPLs. mains capital constrained. Thai banks have raised Baht 844 billion tier-1 capital of which Baht 314 billion came The infrastructure for the bond market has been improved from private investors. Although significant unrealized and the authorities are increasing capacity to manage losses remain on the balance sheets of some banks, regu- public debt. The MOF established the Domestic Bond latory forbearance allows banks to delay loss recognition Market Committee to build a domestic bond market, with a such that banks are not forced to recapitalize quickly and primary focus on the government securities market. The sufficiently. Explicit forbearance, which includes the Public Debt Management Office (PDMO) has been estab- phase-in of provisions over time, will cease at end 2000. lished to manage government debt. The office has already However implicit forbearance, which is less transparent, pulled existing resources from the Fiscal Policy Office and will continue after 2000. Implicit forbearance allows banks the Comptroller General Office. A road map for strength- to provision for loan losses net of collateral value, which is ening the office is being developed, including asset liability mostly property. Collateral value appears overstated due management, a resource plan and an information technol- to the weakness in the profession, practices and standards ogy development plan. of property valuation in Thailand. In addition, quality control on the reclassification of restructured NPLs appears Supervision regime is being strengthened. The Draft "Fi- weak. Capital constraints in the banking system, together nancial Institution Law" was approved by Cabinet and the with a weak legal regime for collection, are slowing the Council of State in Q1 2000. The BOT is reengineering its pace and quality of loan restructuring. supervision function, with the assistance of a management consultant and professional supervisors from the US. Risk- The Government's program, which provides public capital focused supervision is replacing transaction testing. as a last resort to private banks, will expire early next year. The government established a public recapitalization Issues and Areas to Watch program in August 1998 to provide public funds to recapi- talize private financial institutions on a matching basis with Reduction in NPLs is expected to slowdown as Bt1.1 tril- private capital. Banks view the scheme as a last resort be- lion are headed for the courts. Easier cases have been cause they fear that it will bring government interference in restructured by banks. The remaining cases are believed to management, even after 1999 amendments to the scheme. be more complex, difficult to resolve and reflect deeper To date only 23 percent or Baht 70.5 billion has been util- losses. The informal platform for out-of-court restructur- ized by private banks. The scheme is set to expire in March 2001 and the Ministry of Finance is considering September 18, 2000 10 East Asia Brief whether to let it expire or amend the law so that funds can Appendix: be used for other purposes. Figure 1: Declining NPL The SET has been under-performing some other stock markets in the region. Foreign investors have been net Billion Baht sellers in the SET (see Figure 2). Thai stock market turn- 100 50% over hit a record low in July. The allocation of Thai stock 0 45% market in several benchmark indices, which are used to (100) 40% measure the performance of international institutional in- (200) vestors, was revised down according to comparative levels (300) 35% of market capitalization. The result is that portfolio inves- (400) 30% 9 99 99 99 00 0 00 tors allocate less of their funds to Thai stocks. r-9pA un-J g-uA 99-t Oc ec-D b-eF r-0pA un-J IncrementalNPLs (LHS) The challenge ahead is to attract private capital to invest IncrementalLoans (LHS) in Thai banks to cover losses and provide a platform for NPLRatio (RHS) NPLRatio w/ AMCs (RHS) new lending, once capacity utilization picks up. Other- wise, the taxpayers will pay for remaining losses. A change in the incentives would give investors confidence Source: Bank of Thailand that banks (and borrowers) can more expeditiously resolve Table 1: Changes in NPLs outstanding NPLs, would stimulate the secondary markets 4Q 99 1Q 00 2Q 00 Total Break for loans and collateral, and would more equitably distrib- down ute the losses among taxpayers, borrowers and lenders. Increase in NPLs 170 138 114 422 100% New NPLs 137 100 66 304 72% Instruments for the Financial Sector Reentry NPLs 33 38 47 118 28% · Technical assistance lending: Financial Sector Im- NPL Reduction 606 236 491 1,333 100% Debt Restructuring 259 150 208 616 46% plementation Assistance Project ($15m, FY98). Reclassified as per- 70 34 35 140 10% forming loans · Structural adjustment lending: Finance Companies Others (principal re- 68 45 40 154 12% payment, sell-offs, Restructuring Loan ($350m, 12/97); Economic & Fi- etc.) nancial Adjustment Loan I ($400m, 7/98); EFAL II Transfer to AMCs 140 0 0 140 10% ($600m, 3/99). Write off 70 6 207 283 21% Source: Bank of Thailand · Trust Funds support: Japanese PHRD grant ($1.2m, 2/98); World Bank Institutional Development Fund ($0.3m, 2/98); European ASEM grant ($0.74m, 10/98); Japanese PHRD II ($2.4m, 7/99). · Essential Technical Assistance Programs: technical assis- tance ($1.6 m annually) funded under SFO's internal budget. · Country Development Partnership for Competitive- ness (CDPC): CDPC will carry forward financial sector reform September 18, 2000 Thailand 11 level observed in May 1999. However, NPLs have only declined by Baht 1.14 trillion ($28.5 billion) or CORPORATE SECTOR UPDATE 41.8 percent from the peak level including NPLs that were transferred to AMCs. There are three factors Figure 13. Progress corporate debt restructuring which explain the discrepancy between the reduction in NPLs and the completed restructuring amount: (1) new NPLs continue to enter into the system; (2) some 3.0 60% restructured NPLs have turned non-performing again 2.5 50% (re-entry); and (3) restructured loans include proac- 2.0 40% tive restructuring of near NPLs (those which were not previously classified as NPLs.) 1.5 30% 1.0 20% · The non-FDI corporate sector continues to show 0.5 10% anemic recovery, and some sectors are still in decline. 0.0 0% Commercial bank lending has yet to rebound. 98 9 99 99 99 0 00 r-9 y-a pt-99 r-0 Dec- In process restructuring Ma M un-J Se Dec- Ma un-J · Because recovery and restructuring has been slow, Completed restructuring approximately 88 percent of remaining NPLs are at Total NPLs % NPLs least twelve months past due. Between January 1999 and March 2000, loans over 12-months past due grew Source: The Bank of Thailand by over 60 percent in Thai commercial banks (in- CURRENT ASSESSMENT cluding the impact of absorption of failed institu- tions). Since recovery rates from distressed debt are often inversely correlated with time, the growing pro- While the pace of restructuring has been steady and entry portion of long-term NPLs implies declining recovery of new non-performing loans has slowed, the level of non- rates. performing loans remains high. Restructuring has brought down non-performing loans from the peak of 47.7 percent Voluntary informal workouts of small cases continue at a in May 1999 to 38.6 percent in January 2000 and to 32.1 steady, slow pace. The Bank of Thailand's Corporate Debt percent at the end of June 2000. Overall, restructuring is Restructuring Advisory Committee (CDRAC) Program is still concentrated in large viable firms; there is relatively beginning to add to restructuring volumes since cases are little progress with less viable borrowers. beginning to reach deadlines. However, the process is re- sulting in both agreements and failures, which will have to · Between January and June 2000, corporate debt re- be resolved in the courts. The legal filings in the Civil structured averaged Baht 77 billion ($1.93 billion) Court and the Central Bankruptcy Court appear to have per month, with a cumulative total of Baht 1.59 tril- picked up since January. lion ($39.7 billion). Debt restructuring proceeded at an average pace of Baht 74 billion ($1.85 billion) per The Corporate Debt Restructuring Advisory Committee month in 1999 and reached a cumulative total of Baht (CDRAC) monitors the restructuring of both corporate and 1.07 trillion ($26 billion) by end 1999. The increase small-medium-sized loans. A total of 9,582 target cases was significant as compared to 1998, when restruc- with the credit exposure of Baht 2.59 trillion is under the turing averaged Baht 11 billion ($275 million) per auspices of CDRAC. To date, Baht 1.01 trillion or 39 per- month and the cumulative total restructuring of cent of total credit exposure has been restructured. slightly over Baht 100 billion ($2.5 billion). · Initially, CDRAC monitored 702 large corporate · The entry of new non-performing loans slowed in the "target debtors". Since October 1999 an additional first and second quarter of 2000. As a result, NPLs 2,039 target cases were added, increasing the number which peaked at 47.7 percent of total credit in May of cases to 2,734 (Baht 2.29 trillion). Of the total 1999 began to decline. By June 2000, NPLs had de- corporate target cases, 2,124 firms signed the Debtor clined to Baht 1.62 trillion ($40.5 billion), 16 percent Creditor Agreement (DCA). Unlike most of the re- below the of Baht 2.73 trillion ($71.8 billion). The gional variants of the London Rules, CDRAC re- decline was also aided by the transfer of NPLs to quires that a plan be confirmed on its second vote, AMCs. within 6-8 months. At the end of July, 40.8 percent (credit exposure of Baht 935 billion) of the corporate · Baht 1.59 trillion ($39.7 billion) of loans restructured target cases were restructured, while 45.3 percent (approximately 58 percent of peak NPLs) as of June (credit exposure over Baht 1.03 trillion) have failed 2000 suggests that NPLs of the financial system to settle and are reverting to the courts. The total should have been more than halved since the peak September 18, 2000 12 East Asia Brief credit value which has failed the CDRAC process and dent in the legal protection under the court system. proceeded to legal action is a growing concern; it ex- While still slow, debtors are increasingly filing peti- ceeds the amount of completed restructuring. The in- tions to protect their businesses as out-of-court nego- creasing court filings may further delay debt restruc- tiations with creditors proved futile. turing if there are delays in the court processes and decisions. Table 2 Progress of central bankruptcy court business reorganization and liquidation · In addition to the large corporate cases, CDRAC is also responsible for 6,841 small-medium-sized loans, (as of Ju 30, 2000) which represents credit exposure of Baht 295 billion. Jun-Dec Jan- Apr-Jun Jan-Jun To date, restructuring of this target group has pro- Type of Volume 1999 Mar 2000 `00 Filing 2000 Total duced a 25.9 percent completion rate, which remains slow. Business Cases 37 14 51 65 Re-- Mill Bt 362,841 169,93 248,226 418,164 Table 1 Status of CDRAC Target Cases (Corporate organiza- 8 tion and SMEs) As of July 31, 2000 Cases 441 167 224 391 Stage No. Out- Share of Liquidation Mill Bt 10,500 10,707 17,845 28,552 Cases standing Out- Source: Central Bankruptcy Court of Thailand Credit standing (million baht) POLICY IMPLEMENTATION AND ASSESSMENT Completed, signed and documented 4,538 818,451 restructuring deals In addition to measures to stimulate the economy and re- Deals in Process of Signing and 147 192,534 capitalize banks, the Government's strategy toward the Legal Documentation Total Completed Cases 4,685 1,010,985 39 % corporate debt problem has been three fold: Cases in Debt Restructuring Proc- 1,519 244,108 9 % ess 1. to strengthen the legal framework for recovery of non- Cases failed to reach agreement: 1,692 405,064 performing debt through an improved Bankruptcy Act CDRAC advises legal action Cases in which the courts have 1,626 768,854 and amendments to the Code of Civil Procedure de- accepted filing petitions signed to accelerate enforcement of security interests; Unsuccessful cases in Process of 3,318 1,173,918 46% Legal Action 2. to provide a mechanism for voluntary, out-of-court Cases recovered to normal status 60 159,662 6% without restructuring settlements with institutional support through the Bank Total 9,582 2,588,673 100 % of Thailand; and Source: Bank of Thailand Office of Corporate Debt Restructur- ing 3. to provide incentives for firms and banks to restruc- ture debt through tax policy and regulations. Court-supervised resolution of NPLs has been slow in 1999, but the volume of court filings for business reorgani- Legal Framework for Insolvency. Prior to 1998, a court- zation and liquidation appears to have picked up since supervised rehabilitation was not possible under Thai law. January 2000. Bankruptcy was used strictly for winding down companies, and was used rarely for large corporate cases. Bankruptcy · Through December 1999 the Central Bankruptcy cases were heard in the civil courts, which had a very slow Court has received 37 business reorganization peti- non-continuous hearings schedule. Thailand created a re- tions (value over Baht 362 billion) and 441 liquida- habilitation law in 1998, provided technical improvements tion petitions (value under Baht 11 billion), of which to it in 1999, and created a specialized Central Bankruptcy 416 were smaller liquidation cases. Since January, Court and Business Reorganization Office. These amend- the volume of court filings in both categories has in- ments were intended to lead to greater use of formal reor- creased significantly. Between January through ganization as a restructuring vehicle, a mechanism for con- March, 14 reorganization petitions (value over Baht firming voluntary settlements, and as a restructuring incen- 169 billion) were filed with the court, and the number tive. of filings increased to 65 petitions (value over Baht 418 billion) at the end of June. Liquidation petitions Through December 1999, banks did not appear to be filing have also increased during the first six months of year petitions for bankruptcy liquidation or rehabilitation in 2000, 224 petitions were filed (value over Baht 17 numbers commensurate with the magnitude of distress ­ billion) at the end of June. Court officials felt that the this has undermined the potential leverage created by the debtors and creditors have a better understanding of amendments. In November and December 1999, the Court the bankruptcy law and process, and are more confi- received one reorganization petition per week, which is an September 18, 2000 Thailand 13 increase from the previous pace of 1.5 -2 petitions per and in the execution of the auction of the collateral in month. The 37 petitions received are still a minor fraction the market. of the nearly 400,000 non-performing debtors. The rea- sons for the low utilization are several: Voluntary Framework for Corporate Debt Restructuring. . · Uncertainty over proving insolvency. The law in- cludes a wide range of causes for presuming insol- The Corporate Debt Restructuring Advisory Com- vency, including a "liquidity" test, which are rebutta- · mittee (CDRAC) was established by the Governor of ble by the debtor. Judges have discretion, and have the Bank of Thailand to monitor progress in target been trying to judge whether assets exceed liabilities, cases and accelerate their restructuring. With the instead of whether the debtor has the ability to meet support of the Thai Bankers' Association, Foreign its obligations as they fall due. Banks' Association, Association of Finance Compa- nies and Federation of Thai Industries, Board of · Uncertainty over naming the planner and therefore Trade of Thailand, CDRAC created three civil con- controlling the bankruptcy. Intended to provide bal- tracts: Debtor Creditor Agreement (DCA), Inter- ance, the law includes an option for creditors to form creditor Agreements (ICA), and the Simplified a 2/3 majority to override the planner if nominated by Agreement (SA) for small-medium-sized loans. Sig- the debtor. This makes creditor filings less likely, natories agree to adhere to a process with defined unless they have conferred with other creditors to as- procedures for case entry, information sharing, nego- sure a 2/3 vote to control the planner appointment. tiations, and 75 percent majority voting approval. It includes options for CDRAC-arranged mediation, as · Allocation of power and limitations of planner. The well as intercreditor arbitration, which has since been Thai law transfers to the planner, whether debtor or cancelled by CDRAC due to lack of capacity and creditor appointed, an extraordinary degree of control human resources. The agreements empower the Bank over both operational management and developing of Thailand to enforce compliance by creditors the turnaround plan. It is possible that the resulting through warnings and substantial monetary damages, turnaround plan transfers all equity to creditors. This and creditor enforcement of debtor compliance makes debtor filings unlikely, unless the debtor has through court filings. Court filings are required if a obtained the consent of a critical mass of creditors to workout process ends in failure. control the planner appointment process. Further- more, there are several problems with the planner po- · The voluntary agreements under CDRAC will expire sition - no clear indemnification or separation from at the end of December 2000. The crucial issue is director liability, and unclear remuneration rules if what will happen to the incomplete cases at the end of the plan is not approved. the year when the voluntary agreements under the CDRAC process expires. The Bank of Thailand ex- · Non-legal reasons. First, as a large portion of dis- pects that most of the work-in-process cases at that tressed debt owed to Thai banks is secured, bank- time will be the small-medium-sized loans. The BoT ruptcy reorganization may not provide a value- is also considering two options, either to wind down maximizing solution. Second, Thai firms are under- the CDRAC process such that the unfinished cases capitalized to such a large extent (i.e., if assets were will have to be resolved through the courts, or to ex- discounted to market values and the discount was also tend the voluntary agreements and allow the Office of applied to equity) that large creditors are de facto CDRAC to continue to facilitate debt restructuring owners. These creditors may not see a bankruptcy until the voluntary process is completed. If the BoT which has the potential to crystallize an immediate winds down the CDRAC process, it is expected that and large loss as value-maximizing. Thirdly, long- the court filings, especially in the Civil Court, will standing ties and formal equity relationships between dramatically increase during the first quarter of 2001, creditors and debtors may further inhibit filings. and further backlog will certainly occur. The court will need to increase capacity and streamline the pro- · The amendment to the Code of Civil Procedures on cesses for both judgements and post-judgement auc- default was passed into law in March 2000. The tions in order to bring timely resolutions to the pend- amendment eliminates a frequent delay tactic by ena- ing cases. The more likely scenario is the extension bling judges to issue a judgement in favor of the of the voluntary agreements under the auspices of plaintiff if the defendant fails to appear for a hearing. CDRAC and BoT, the process of which is likely to However, since the enactment of the new default pro- continue until mid-2001. Under this scenario, the cedures, creditors have reported increasing delays in potential failure of the CDRAC process still remains, the civil court process for enforcing security interests, and the failed cases will have to be resolved in court. The most effective means to accelerate resolution of September 18, 2000 14 East Asia Brief cases under CDRAC is then the most crucial consid- concentrated in the real estate, services, and import eration of the BoT in the immediate future. sectors (Table 3). · Capital adequacy continues to constrain restructur- · Few, if any, mergers between distressed firms have ing. Thai banks are not required by their regulators to occurred. The merger process in Thailand is time fully provision against recognized loan losses until consuming and onerous, requiring six months notice end-2000, and are only required to provision net of period during which creditors may object to the collateral values on secured loans. As provisioning merger or demand immediate payment. The Civil needs increased through new entry of NPLs and the and Commercial Codes and the Public Limited Com- aging of NPLs into higher-provision categories, banks panies Act require that the two merged entities lose have restructured extremely conservatively and legal status before creating a new legal entity out of slowly. As a result, (1) debt reduction is rarely a part the two independent units. In addition, although the of settlements, and extension of maturities, interest Government has extended numerous tax incentives to rate reductions, and new capital injected by the debtor induce mergers such as the waiver of tax on non-cash or new investor are typical outcomes; (2) banks have mergers, the actual transactions are few in number. been reluctant to use available legal options to force The primary obstacle to the mergers is the inability to corporations to address their operational and financial carry net losses forward into the new entity. condition, as doing so would crystallize a more im- mediate and potentially larger loss and (3) only viable · Creditor-driven removal of capacity is by and large sectors have been addressed. not occurring. Even where firms have negative eq- uity and whose petitions are likely to be accepted by · State-owned banks face unique obstacles. While Thai the bankruptcy court, creditors have in general not private commercial banks have 1.8 times the out- filed petitions. As a result, assets are not clearing. standing credit of state-owned banks, private banks have restructured 3.3 times the number of cases. To Table 3. NPLs in Key Sectors, March 2000 facilitate more rapid progress, the Bank of Thailand (Billion baht) will soon issue the "Principles and Guidelines for Debt Restructuring by State Banks", which aim to re- Critical Out- 12 3-12 NPL % of duce the potential for legal liability. The State Enter- Sectors standing Months Months Loans Loans Past Due Past Due prise Employees Act provides for criminal liability on Manufac- 1,563 430 80 33% the part of employees who accept a loss on behalf of turing the state, even if it was a reasonable write-off ac- Wholesale & cepted in a debt restructuring. Retail Trade 806 276 43 40% Imports 202 84 11 47% Exports 157 50 13 40% · CDRAC needs to take a more active role in conten- Services 417 167 29 47% tious cases, supported by appropriately skilled per- Real Estate 550 315 35 64% sonnel. Administrative sanctions should support and Construction 230 93 12 46% be coordinated with CDRAC. Over time, the firms Source: Bank of Thailand approaching CDRAC for assistance are likely to be in Real Estate Sector. The recovery of the real estate market less viable sectors or smaller. CDRAC's successful value in Thailand is largely driven by property type: resi- restructuring will require more resources devoted to dential or commercial. Currently, the market condition is analysis and business restructuring. The resources considered poor; there is both excess supply and shortage made available through existing loans and grants of demand for both types of properties. Property values should be deployed immediately. have been either stabilizing or falling depending on loca- tion. Based on the electricity meter statistics from the · Excess capacity in several sectors not being ad- Metropolitan Electricity Authority (MEA), which measures dressed. In a restructuring environment characterized vacancies in the Bangkok Metropolitan Area (BMA), there by low capitalization and weak legal implementation, is 47 percent vacancy rate of all properties. sectors which do not promise a high recovery rate on restructuring will pose an overwhelming challenge. Completion rates for debt restructuring are low in the real Long-term NPLs (those over 12 months past due) in estate sector. Property sector restructuring includes sub- Thai banks increased rapidly in critical sectors. From stantial asset redeployment, for which the court process is October 1999 through March 2000, loans over 12 very slow. In addition, most loans involve multi-creditors months past due increased over 75 percent in manu- and/or syndicated lenders which increases the complexity facturing, over 120 percent in real estate, and over and time in restructuring. Finally, the lack of legal action 150 percent in construction. At the end of March has kept assets from distressed owners out of the market. 2000, NPLs as a percentage to outstanding loans are September 18, 2000 Thailand 15 During the last quarter of 1999, Land and House, Plc., the cal assistance projects have been provided by the Bank in largest real estate developer in Thailand successfully re- support of the corporate reforms, funded primarily by structured its Baht 20 billion debt and raised Baht 2.5 bil- ASEM Trust Fund and PHRD grants. This includes train- lion capital through public offering. In March 2000 Sansiri ing programs provided to bank and finance company Plc., another large real estate developer also successfully workout departments, seminars provided to corporate sec- restructured its Bht 14 billion debt and brought in a foreign tor managers in operational restructuring, automated strategic partner. The market viewed these developments monitoring and project management database system pro- positively. As mortgage interest rates have fallen in recent vided to the Bank of Thailand, assistance to the develop- months, the outlook for the sector improvement is favor- ment of guidelines for restructuring among state-owned able. banks, tax and legal standardized documentation support for restructuring, pilot mediation programs provided Steel Industry. Over-supply of steel products continues to through CDRAC, the development of Thailand Institute of persist due to declining construction activity. The demand Directors to enhance the corporate governance of listed for steel is sluggish and may not recover for some time. firms, and the development of regulations for the Thai There are several large-scale steel producers, most with Trade Competition Commission. sizeable, multi-creditors, foreign currency debts. Restruc- turing of steel firms is happening mostly through CDRAC, Adjustment Operations. The emphasis of CDPC is com- and the progress is slow. In some cases, negotiations with petitiveness, including the trade and competition policy, creditors have been ongoing for over two years without technology, logistics, financial and legal requirements for resolution. Recently merger discussions were restarted Thailand to enhance the ability of its corporate sector to which may ultimately reduce the number of producers. enhance value-added exports. Currently, the top four producers (SCC, NTS, BSI, and Nam Heng Steel) are negotiating a merger, and an MOU is Trust Funds. (i) PHRD: Corporate restructuring compo- expected to be signed by late 2000. To this end, the gov- nent of Miyazawa Special Contribution. $0.7 million. (ii) ernment is considering incentives to the merger that would PHRD: Corporate Revival ($.2 million) (iii) ASEM: Re- prevent foreign take-over of the companies. vival of the Corporate Sector. $0.75 million. The medium-term agenda: Rebuilding Competitiveness. It Coordination with IMF, ADB and Bilateral Donors. Co- is unlikely that growth will be reestablished on the basis of ordination with the IMF is well established, with Bank staff debt-financed investment in fixed assets in the near future. joining or review Fund assessment missions and holding A medium-term growth strategy will depend on enhancing regular consultations. A joint review of insolvency legis- total factor productivity growth. This will require sharp- lation is planned with ADB, IMF and IFC. ening the impact of public sector investments in skills and technology, addressing tariff structures and investment incentives and implementing the ongoing programs in the financial and corporate sectors. Strengthening Corporate Governance. The most critical factor input for the recovery of distressed firms is decisive management focused on creating value for all stakeholders. This includes strategies which limit non-core or low- contribution investments, find highest value use for assets, maximizing cashflow to enhance share value, and reduce the cost of capital by seeking outside equity investors where necessary. This often requires change in manage- ment. BANK INSTRUMENTS Policy support for corporate restructuring was provided under EFAL I and II adjustment loans and the IMF struc- tural adjustment program. The Thai authorities, with Bank support, are now developing a third tranche work program, The Country Development Partnership for Competitiveness (CDPC) will include a policy program completing the fi- nancial and corporate sector reforms, and a new reform program to support competitiveness. A number of techni- September 18, 2000 16 East Asia Brief CURRENT DEVELOPMENTS SOCIAL SECTOR UPDATE Poverty The effects of the crisis on poverty continue to be felt. Lat- KEY SOCIAL INDICATORS est and preliminary data indicate that the poverty Previous headcount index increased from 11.4 percent in 1996 to Latest data Period 15.9 percent in 1999. (date) (date) Human Development 1997-98 1994-95 The increase in poverty has been distributed unevenly Primary enrollment rate (gross)1 91.4 91.0 throughout the country. While poverty incidence rose be- Male 93.1 92.3 Female 90.0 89.0 tween 1996 and 1999 in the country as a whole, it actually Secondary enrollment rate (gross)1 60.3 60.0 declined in the municipal areas (inner urban) from 1.6 per- Male 58.0 58.4 cent to 1.3 percent. In the sanitary areas (outer urban), Female 63.0 61.0 poverty incidence increased from 5.8 percent to 8.8 per- Tertiary enrollment rate1 21.0 19.3 Male 19.0 18.0 cent, while it jumped from 14.9 percent to 21.5 percent in Female 23.1 21.0 the villages (rural areas). Likewise, between 1996 and Infant mortality rate2 26.1 (1995- 34.5 (1991) 1999, the incidence of poverty declined in the North and 96) Bangkok vicinity, while it increased in the Northeast, Poverty and Income Distribu- 1999 1996 South, and Central Regions. The Northeast experienced tion3 the largest increase in poverty incidence during this period National Headcount Index 15.9 11.4 -- from 19.4 percent in 1996 to 30.8 percent in 1999. Urban Headcount Index 1.3 1.6 Urban/rural Headcount Index 8.8 5.8 Poverty is concentrated among certain population groups. (sanitary districts) Rural Headcount Index 21.5 14.9 Households headed by farmers, the elderly (aged 70 and Gini Index 0.533 0.515 over), and people with less-than-primary schooling are particularly vulnerable to poverty. Children under the age Allocation4 (Billion Baht) (Billion Baht) of 17 years, accounting for 38 percent of the total poor, are FY00 FY99 at a much greater risk of poverty than adults. Public Health 65.7 62.5 As percentage of Total Budget 7.6 % 7.6% Education 222.4 209.9 Labor Markets As percentage of Total Budget 25.9% 25.3% Social and Public Welfare 93.7 98.7 As percentage of Total Budget 10.9% 12.0% Flexible labor markets minimized the impact of the crisis. During the economic crisis, the flexibility of Thailand's Labor Market February February labor markets helped lessen the impacts of the economic 2000 1999 downturn. Wages and the number of hours worked ad- Unemployment rate (%)5 4.3 5.2 justed downwards, thus containing the unemployment rate Female 4.6 5.5 which increased from close to 1 percent in 1996/1997 to Participation rate (%) 6 68.1 68.9 3.4 percent in 1998 (August round). Female 59.4 60.0 Male 76.9 77.5 The impact of the crisis was more severe among low-wage Strike incidents/workers involved 2/290 (1999)7 2/685 (1998) during year workers. Low-wage workers (usually young, less educated 1. Office of the National Education Commission. workers) were more likely to lose their jobs and suffer pay 2. NESDB/ADB, "Health and Nutrition in Thailand", Volume 3, Num- cuts than their high-wage counterparts, and were also less ber 3: July 1999. Estimates obtained from the Survey of Population likely to be reached by government interventions. About Change. 1.8 million workers with primary and less-than-primary 3. National Statistics Office Socio-Economic Survey. NESDB/ADB, "Poverty and Inequality During the Economic Crisis in Thailand", education lost their jobs, and the aggregate wage earnings Volume 3, Number 1: January 1999. of this group fell by 13-20 percent during the crisis. 4. Bureau of Budget, Sectoral budget classification. 5. National Statistics Office Labor Force Survey. Government interventions were crucial to minimize wel- 6. National Statistics Office Labor Force Survey. 7. Bank of Thailand, Key economic indicators, November 30, 1999. fare losses. The single most important government initia- tive was employment generation through public spending, financed largely by external sources. The Miyazawa Pro- gram provided employment to the equivalent of 319,182 person years (3.5 million people employed for an average of 18 days each). The World Bank's Social Investment Program also supported the Government's job-creation September 18, 2000 Thailand 17 programs. These programs likely contributed to the 14 per- Population and Housing Census 2000 cent drop in unemployment from August 1998 to August 1999 ­ Thailand's first year-on-year decline in unemploy- Preliminary results from the 2000 Census show that on ment since the onset of the crisis. April 1, 2000, Thailand had a population of 60,606,947. Out of this population 29,844,870 were males and Comparative data from other crisis-affected countries in- 30,762,077 were females. Thailand is the fourth largest dicate that Thailand weathered the crisis much better than country in Southeast Asia in terms of population size. In- did Korea or Indonesia. Thailand's decline in wage labor donesia is the largest (209 million), followed by Vietnam earnings was less than that of GDP, while the decline in (79 million) and the Philippines (74 million). The annual wage labor earnings in Korea and Indonesia were nearly population growth rate at the time of the 1990 Census was three times as large as the GDP decline. This suggests that 1.96, the annual growth rate is now 1.05. Regional com- Thai labor markets have generally worked well to cushion parisons reveals that 34.2 percent of the population live in the effects of the crisis. Wage flexibility of labor markets the Northeast, 23.3 percent in the Central and 18.8 percent and quantity flexibility of farm employment have both in the North. played a critical role in spreading the impact more evenly among workers and preventing massive open unemploy- AREAS TO WATCH ment. The prolonged lag in social recovery behind economic However, many of the labor-protection programs in place growth shows no signs of sudden improvement. Such lags in Thailand have very small population coverage. In addi- are expected, but the combined effects of weak agricultural tion, because of implementation and enforcement prob- commodity prices, slow recovery in consumption, and very lems, these programs are biased in favor of formal-sector low levels of construction activity have held back the de- employees, who tend to be better-off than informal-sector mand for labor and may prolong wage and employment employees. As such, low-wage and disadvantaged workers stagnation. who most need protection during economic downturns fall beyond the purview of these programs. As part of the Government's decentralization plan, the Bu- reau of the Budget (BOB) intends to devolve funds to the The challenge for the future will be to maintain the labor Tambon Administrative (TAO) level. During its planning flexibility that served Thailand well during the economic process the BOB has been consulting with the Social Fund crisis, but at the same time ensure that poor and under- Office in order to determine how to introduce participatory privileged workers who typically bear the brunt of eco- planning processes in conjunction with the allocation of nomic downturns, are better protected from consumption funds. The BOB hopes to borrow from the successful pio- shocks. neering work of the Social Fund. AIDS Vaccine Trials There is an intensifying debate on the issue of rural pov- erty, as evidenced by the increasing protests by the Assem- Thailand's first large-scale anti-AIDS vaccine trial has mo- bly of the Poor. While the protests began with dams and bilized 2,500 volunteers to test the effectiveness of the other development projects like Pak Mun, the broadening vaccine over a three-year period. All the volunteers have of the protests to include a much larger group of people, received their first shots of the vaccine. The volunteers are discussing a much wider range of issues, points to a deeper either recovered intravenous heroin users or rehabilitating problem -- poverty, particularly in the Northeast. addicts on methadone treatment and will receive a total of seven doses of the injection. None are HIV-positive. Half BANK INSTRUMENTS the volunteers will receive the candidate vaccine while the other half will receive a placebo. Blood from the volun- Social Investment Project. By end August 2000, disburse- teers will be taken for tests two weeks after every shot they ments from the World Bank total US$168.5 million or receive. The vaccine, Aidsvax, is the second candidate 55.97 percent of the loan amount. Significant progress has vaccine of VaxGen Incorporation which is currently under been achieved in the creation of employment opportunities a large-scale trial. The trial in Thailand is the first of its through the implementation of small-scale civil works kind because it was especially designed for the country. (weirs, foreground dredging, rural roads and school reno- vation). The study is being monitored with the collaboration of the Bangkok Metropolitan Administration, Mahidol Univer- Since the Social Investment Fund, a SIP component, was sity's Faculty of Tropical Medicine, the Thai Government, launched on September 9,1998, a total of 2,687 sub- The Center for Disease Control (CDC) of the US, and projects have been approved with a total budget of Bt2,805 VaxGen Incorporation. million (approximately $71.9 million). The subprojects cover 76 provinces of the country with over 7 million September 18, 2000 18 East Asia Brief beneficiaries. The SIF is widely recognized in Thailand as provision of informal safety net services; and (iv) labor a major element of the Government's crisis alleviation market data and policy analysis. strategy. The Social Fund Office has managed to mobilize a large number of volunteers all over the country, including The fourth issue of the Thailand Social Monitor entitled individuals from the NGO community, government civil "Thai Workers and the Crisis" was disseminated in July servants, academics, physicians, teachers, and religious 2000. Future issues will focus on AIDS and Poverty. leaders help prepare, review, screen, and implement proj- ects. The SIF has become a social movement, promoting Ongoing initiatives on AIDS. Country dialogue on AIDS lasting goals of community self-reliance and cooperation, vaccines included a consultative meeting in May 1999 mutual learning and continuous development, and the between the Bank's AIDS Vaccine Task Force and donors, strengthening and stabilizing of society through community health ministry policymakers, pharmaceutical companies, networks. NGOs, and the national Technical Subcommittee on AIDS Vaccines. A forthcoming Brief on Thailand's Response to Social Protection Program Partnership. The World Bank AIDS will focus on the lessons learned from the Thai expe- is forging a partnership with the Ministry of Labor and rience that are applicable to the rest of the region and on Social Welfare to promote a Social Protection Program. strategic priorities in the response to AIDS in Thailand The key elements of this program include: (i) occupational now. The paper will serve as a basis for discussion with health and safety; (ii) job information, placement and government, NGOs, donors, and UN agencies and will counseling services; (iii) strengthening the role of CSOs in suggest actions for the UN Theme Group to assist Thailand over the next 12 months. - Macroeconomic Update was prepared by David Robalino (EACTF) - Financial Sector Update was prepared by Thomas Rose (FRO) - Corporate Sector Update was prepared by Tanatat Puttasuwan, EACTF and Arvind Gupta, EASPS - Social Sector Update was prepared by Maryam Salim and Christopher Chaberlin (EACTF) September 18, 2000 Thailand 19 THAILAND ECONOMIC INDICATORS Sep-99 1997 1998 1999e 2000e 1998 1999 2000Ja n Year Year Year Year Q3 Q4 Q1 Q2 Q3 J Output, Employment and Prices GDP ( % change previous year) -1.3 -9.4 4.0 4.5 -12.5 -5.0 0.9 3.3 7.7 97.3 107.2 96.5 92.8 106.0 104.6 109.0 (% change, previous year) -0.5 -10.0 12.6 -9.5 -3.6 4.8 10.5 17.5 7.7 Unemployment Rate (%) 1/ 1.9 4.0 3.5 .. .. .. .. .. Real Wage Growth (%) 1/ .. .. .. .. .. Consumer price index (% change, previous year) 5.6 8.1 0.3 2.5-3.0 7.0 4.3 1.6 -1.2 -0.8 0.2 Public Sector Government balance (% GDP) 2/ -0.32 -2.80 -6.6 -7.0 -8.56 -3.34 -0.01 -4.14 -4.12 Public sector debt (% GDP) 3/ 27.0 40.0 50.0 66.0 .. Domestic 6.0 14.0 29.0 45.0 Foreign 21.0 21.0 21.0 21.0 Foreign Trade, BOP and External Debt Trade balance (million$US) 4/ -4,626 12,232 8,900 3,146 3,359 2,671 2,119 2,400 Exports of goods, ($millionUS) 56,721 52,873 56,785 13,258 13,415 12,692 13,684 14,702 (% change, previous year) 3.8 -6.8 7.4 9,6 -8.7 -9.9 -4.2 5.7 10.9 Imports of goods, ($millionUS) 61,347 40,641 =47,834 10,112 10,056 10,021 11,565 12,330 (% change, previous year) -13.4 -33.8 17.1 19.0 -34.2 -18.9 -1.0 11.7 21.9 Current account balance ($millionUS ) -3,112 14,290 11,300 3,409 3,861 3,439 2,554 2,796 (percent GDP) -2.0 12.7 9.0 12.6 11.7 11.0 8.6 9.2 Foreign Direct Investment (million US$) 3,733.0 7,131.0 1,432.0 1,025.0 1,025.0 2,210.0 1,153 Total external debt (million $US) 93,416 86,160 86,792 86,160 83,865 80,655 78,734 (% GDP) 60.8 76.8 61.3 53.0 .. .. .. .. Short-term debt (million $US ) 34,258.0 23523.0 26,193.6 23,522.7 20,521.0 17,566.7 15,688 Debt service ratio (% exports of g&s) 15.6 20.3 20.4 18 24.2 19.3 21.5 19.0 Reserves, including gold ($US billion) 27.0 29.5 34 27.3 29.5 29.9 31.4 32.4 (months of imports of goods and services) 4.7 7.3 8.7 6.9 7.6 7.5 7.2 Financial Markets Domestic credit (% change, previous year) 30.1 -3.3 -3.5 3.6 -3.3 0.8 -4.8 -4.9 Short-term interest rate /5 10.8 6.0 8.0 6.0 5.0 4.8 4.4 Exchange rate (end-period) 31.4 41.4 37.5 39.2 36.9 37.7 36.9 41.4 Real effective exchange rate (1990=100 and + = 75.5 88.8 88.06 87.8 88.8 87.8 89.9 82.3 appn) (% change, previous year) -29.9 17.6 0.2 2.8 17.6 0.3 3.2 -2.5 Stock market index (Dec 1996=100) 44.8 42.8 74.2 30.7 42.8 42.3 62.7 54.9 Memo: GDP in million US$ 153,711.8 112,257.7 27,241.04 33,018.9 31,831.4 29,702.8 .. 2/ Central Government (CY Year) 4/ In Million US $ September 18, 2000 VIETNAM MACROECONOMIC UPDATE Non-agricultural growth--which has been falling since 1997--has turned around too. In the first half of this year, Current DEVELOPMENTS industrial GDP growth rose more than a percentage point relative to last year to 8.8 percent and service sector growth was nearly double the rate of 1999. Stronger Fragile Recovery. After two years of low growth, the industrial performance is also confirmed by the fact that economy is in recovery. However, the recovery is a industrial output grew by more than 15 percent (see fragile one because the investment-response remains Corporate Update section). Agricultural GDP grew weak and because rapid credit expansion has increased robustly, but given large declines in world prices of the risks for inflation and for the health of the banking agricultural commodities, agricultural growth could slow sector. GDP growth picked up in the first half of 2000 on down in the second half if agricultural output falls in the back of Government's demand stimulation, rising response to depressed prices. consumption and strong export performance. Total investment, as a share of GDP, though rising slightly, is Table 1: GDP growth (%) still lower than it was in 1997. Domestic private investment rose--in response to the liberal Enterprise Law 1999 2000 that came into effect in January of this year--but the 6M 6M magnitude of this rise is unclear. Foreign investment Total GDP 4.3 6.2 remains depressed and foreign investor confidence Agriculture 2.7 4.0 remains low. Inflation has not picked up, but that could change if rapid monetary expansion continues. In the Industry & construction 7.5 8.8 absence of more information on the uses of this credit, a Of which: Industry 9.4 10.8 better assessment of the risks for inflation and for the health of banks is not possible. Service 2.8 5.3 Of which: Trade 2.1 6.5 Continued reforms. Recent reform measures give cause for hope. If those measures are complemented by the Source: GSO approval of a significant SOE reform program, they could Aggregate Demand turn investor confidence around. The signing of the bilateral US trade agreement ­ opening up trade and foreign investment in Vietnam and giving Vietnamese The rise in domestic demand is driving the pickup in GDP exporters access to the US market ­ has somewhat growth, as the contribution of external sector demand has improved the mood, even if the real effects will not flow been negative. Most of this demand growth has come until late next year. The opening of the long-awaited from private and Government consumption, as investment stock market -- even if it is more form than function ­ has remains low. reinforced that mood by signaling continued reform. Similarly, the elimination of additional business licenses Private consumption. Government's demand-stimulus and better implementation of the Enterprise Law has measures, in terms of credit expansion and the 25 percent sustained growth of new entry of private firms. The recent rise in public sector wages, contributed to higher private shift to a more flexible interest-rate policy, have given consumption growth. Though detailed demand-side more freedom to banks to price loans in line with estimates are not made by GSO, figures on retail sales differences in borrower risk, even if continuation of a growth of 8 percent in the first six months of 2000, ceiling rate limits the amount of risk that banks can take. compared to 4 percent and 1 percent in 1999 and 1998 respectively confirms this view. Industrial output of GDP and Output consumer durables has also risen considerably as Table 3 shows. Also import growth has picked up sharply; this was due in part to the need to replenish inventories Pick up in GDP Growth.. After growing at 4 percent in depleted over the last three years of stagnant import-value both 1998 and 1999 (official estimates were higher), real as also increased consumer imports. GDP growth is expected to climb to around 5.0 percent this year. Official estimates of GDP growth for 2000 are higher, based on the half-yearly estimate of 6.2 percent. There is no doubt that a pick up in economic activity is occurring, irrespective of whether World Bank or official numbers are used. ` September18, 2000 2 East Asia Brief Table 3: Consumer durables : half-yearly volume In the first 8 months of 2000, export earnings increased growth (%) by 27 percent over the same period last year, with most of it due mainly to oil. Non-oil export earnings growth has 1999 2000 slowed but its still at a respectable 14 percent. This is 6M 6M because rice export price and volume is down, and Motorbikes 42.8 50.3 garment and footwear exports are not growing at the rates of last-year. Televisions -4.0 37.0 Cars and trucks 60.9 76.4 Table 4: Export Earnings Growth (%) Source: GSO Export Earnings 1999 1999 2000 8M 12M. 8M Investment: Investment demand rose only modestly; thus it remains below 1997 levels. Most of this was from Oil exports 25.8 69.7 94.4 domestic sources. Government investment increased due Non-oil exports 15.4 16.3 14.3 to special efforts of Government to make rural investments. Domestic private investment is likely to have Rice 16.6 0.1 -41.0 risen, as more than 7000 new firms registered under the Garment 8.4 29.3 1.9 Enterprise Law, and rural credit was expanded. Foreign Footwear 32.3 39.1 9.1 investment inflow, which averaged US$2 billion a year Seafood 11.4 16.3 39.6 during the period 1995-1997 (representing 8-10 percent of Electronics 21.1 23.5 35.5 GDP or more), averaged $600 million a year during 1998- Total Exports 15.0 23.4 27.4 2000 (see figure below). Source: GSO Investment: 1995-2000 Rapid Import Growth. After increasing by just 1 percent 12% Domestic in 1999, the dollar value of imports in the first 8 months 10% P of 2000 grew by 34.2 percent over the same period last 8% Foreign GD year. In 1999, lower foreign direct investment inflows and 6% of worries about a slowdown in export growth led the % 4% 2% authorities to impose import restrictions. These import 0% controls were lifted in the second half of 1999, leading to 1995 1996 1997 1998 1999 2000 a strong increase in imports of intermediates and 6m. investment goods in the first half of 2000. Imports of consumer goods also increased, pointing towards the recovery in domestic consumption. Source: World bank estimates External Sector Inflation Net exports. Net exports moved from positive to negative In 1999, average consumer prices were 4.3 percent higher between 1999 and 2000. In 1999, exports had rebounded than in 1998, but the year-on-year increase in consumer unexpectedly in the second half and thus import-growth price index (CPI) in December was only 0.1 percent. In lagged and was less than export growth. In the first 8 August 2000, year-on-year inflation is negative. This months of 2000 however, imports have been growing at a reflects a continuing monthly fall in the food price index faster rate than exports. Vietnam registered a trade deficit (see figure below), which accounts for about two-thirds of of about $500 million in this period. If import growth the CPI. Non-food prices have increased by 0.7 percent continues--and export growth slows down over the next since the beginning of the year and by 1.3 percent since four months--trade deficit is likely to widen further. August 1999, preventing serious deflation pressures. However, changes in the relative price of food has Strong Export Earnings Performance: Export earnings adversely affected farmers' terms of trade and real jumped in the second half of 1999--and continued in incomes. 2000--in part due to oil volume and price increases, but also due to large rises in garment and footwear exports. A large fraction of this growth was a one-shot jump and is unlikely to be sustainable. For example, crude oil volume and price rises are unlikely to continue (according to forecasts) and higher quotas for garments provided by Europe in 1999, are unlikely to be repeated anytime soon. September18, 2000 Vietnam 3 were eased, encouraging deferred payment. It is possible, Index Monthly CPI (Dec 1998 = 100) however, that inefficiencies in the exchange rate 110 mechanism also prevented the imbalance between 105 demand and supply to translate into a larger change in the exchange rate. The daily exchange rate is set as a 100 weighted average of the previous day's rates on the inter- 95 bank market - which is itself only allowed to fluctuate 90 within a daily band of 0.1 percent. Dec 98 Apr-99 Aug-99 Dec-99 Apr-00 Aug-00 Food Non-food Foreign reserves. In 1999, foreign exchange reserves increased to twelve weeks of imports, contributing to the Source: GSO and WB estimates stability of both the nominal and real effective exchange rate. For 2000, the SBV targets a similar coverage of POLICY IMPLEMENTATION AND ASSESSMENT reserves. However, this objective may be difficult to achieve as imports pick up and as foreign exchange regulations are increasingly being relaxed. In 1999, the Monetary and Fiscal Policy Government has taken steps to reduce the foreign exchange surrender requirement from 80 percent to 50 percent. This year, following the new foreign investment Monetary Policy. Since 1999, the State bank of Vietnam law, the foreign exchange balancing requirement for (SBV) has been loosening monetary policy and expanding foreign invested enterprises has been eliminated. domestic credit. In 1999 credit expanded by 20 percent and in the first half of 2000 it is expanding at a projected Table 5: Fiscal Situation annual rate of 30 percent. In the 12 months between June 1999 and June 2000, 60 percent of total credit expansion Share of GDP (%) 1997 1998 1999 2000 has gone to the non-state sector, implying a shift in credit Rev. Rev. Est. 6M. Est. composition towards non-state sector. However such Total Revenues and 21.1 19.0 18.6 18.4 rapid credit expansion exposes the economy to two risks. Grants First, it will generate inflationary pressures, though its not Tax Revenues 17.2 15.4 15.2 15.1 clear why that has not manifested itself yet. There is Non-tax Revenues 3.1 3.1 2.9 2.8 some indication that a lot of the credit expansion has Grants 0.8 0.5 0.5 0.5 leaked into imports and to finance stocks of rice and Current 15.7 13.7 12.5 12.3 coffee. Second, it is likely to weaken the already fragile Expenditures health of the state-owned commercial banks (SOCBs), (exc. Interests) given the inadequacies in their credit-risk assessment Social 7.6 6.9 6.3 6.5 expenditures process. Capital 6.2 5.5 7.0 6.5 expenditures Interest Policy. In July, the SBV dropped its fixed interest (exc. On-lending) rate policy and adopted a more flexible interest-rate Interests (paid) 0.6 0.6 0.6 0.8 policy, allowed commercial banks to price their loans in Contingency 0.0 0.3 0.0 1.2 line with borrowers' risk-profile. It set a base rate On lending 2.2 2.1 1.4 2.6 (currently at 0.75 percent a month) and allowed credit Total expenditures 22.6 20.1 20.1 20.8 institutions to offer any rates that do not exceed the base Overall Balance -1.4 -1.1 -1.5 -2.4 rate plus 0.3 percent for short-term loans and plus 0.5 Source: MOF and WB staff estimates percent for medium- and long-term loans. Commercial Fiscal Outlook: Government has adopted an banks are already pricing their loans to their prime expansionary fiscal stance for 1999 and 2000, targeting customers at much below the base rate. However, the new higher spending on rural infrastructure. However, actual system still limits the banks' ability to lend to very high capital spending has fallen short of allocations by risk customers by putting a ceiling on the highest interest National Assembly in 1999 and is running at slower pace rate that Banks can charge their borrowers . in the first half of 2000--due to difficulties of implementing additional capital spending quickly. Exchange rate. In the first half of 2000, as import growth However, wage increases of 25 percent awarded last year, picked up there appeared to be a shortage of foreign has been disbursed -- already VND 2.5 trillion, half the currency. Despite this imbalance the exchange rate total, has been disbursed to workers in the first half of against the dollar only depreciated by 0.7 percent since 2000. A budget deficit of 2.4 percent of GDP (see table January. Two measures have helped ease the tension. 5) has already materialized. In 2001, the Government has First, a share of the receipts from crude oil exports was to meet significant costs of reform (VND 15 trillion in transferred from the budget to the State Bank of Vietnam current costs) as well as other priority expenditures. In (SBV). Second, restrictions on the use of letter of credits addition, public service salaries are expected to be raised September 18, 2000 4 East Asia Brief by an additional 16 percent (i.e. VND 3 trillion) This will well received, as it opened up access to foreign currency put additional pressure on the fiscal balance; if deficit is (see Corporate Update) to be kept at the current level, there will be need for additional revenue measures and improved revenue Enterprise and Banking Reform. On state-enterprises, collection. Government is following a policy of equitizations (see Corporate Update) of medium enterprises, divestitures Fiscal Costs of Reform. The State Bank of Vietnam, and outright sales of small and medium enterprises, together with the Ministry of Finance are attempting to liquidation of worst-performing ones and a restructuring estimate the fiscal costs of banking and SOE reform and process for many of the large ones. On banking reform, a develop a financing plan. It is early days yet, but combination of measures relating to restructuring of non- preliminary estimates suggest that these costs could be state and state-owned banks, improvements in regulatory quite high, nearly 12 percent of GDP. However, if most and supervisory framework as well as leveling the playing of the capital costs are financed by exchanging field for all banks are being undertaken (see Financial Government bonds for banks' bad debts ­ as is done in Update). many other developing countries ­ the burden on the budget will be mainly the interest cost of the bonds and Trade Reform. Vietnam has made further progress in the cash cost of severance payments for redundant SOE improving its trading regime. It removed 8 of the 19 workers. While that current cost is not trivial, it will be remaining QRs multilaterally, in January 2000, and funded by the donors once the reform programs are signed the long-awaited bilateral trade agreement with the approved. U.S. in July 2000. These two measures will open up the domestic market in terms of imports and foreign Public Expenditure Reforms. Since 1999, the Government investments in the service sectors, helping Vietnam to has initiated measures to increase the transparency of become more competitive in its domestic production. In budgetary information. In June 1999, Vietnam published addition, on ratification of the US trade agreement by the for the first time, budgetary information (the 1997 final U.S. Congress -- expected in the middle of next year ­ accounts and the 1999 budget plan) with a subsequent Vietnamese exporters will get "normal" access i.e. US publication in June 2000. As part of its goal of increased tariffs applicable to its exports will fall sharply. transparency, the Government, jointly with the donors and World Bank, has completed a public expenditure review AFTA: Vietnam is preparing to announce a detailed (PER) based on more detailed information, covering three annual road-map of tariff reductions and QRs removals quarters of total spending. Detailed analysis was for 2001-2006 to meet its commitment under the ASEAN undertaken for Agriculture, Health, Education and Free Trade Area (AFTA). Original members agreed that Transport. On that basis, various recommendations to tariff rates within AFTA should be reduced to no more improve public expenditure management were made, than 5 percent by the year 2003. Vietnam, as a latecomer including measures aimed at improving data recording to the agreement, committed itself to tariff rates of no and reporting, at better prioritization of public spending, more than 20 percent by 2003 and no more than 5 percent at coordinating recurrent and capital spending and at by January 1st 2006. Nearly 97 percent of the tariff lines enhancing the re-distributive role of such spending. will be covered by 2006, implying a significant increase Detailed timetable of actions as well as a two-year plan in competition for Vietnamese producers. for further analysis and work are being developed together by the donors and the Government. Structural Reforms The implementation of various reform measures picked up momentum in the last few months. Recent measures in respect of private sector, trade policy, and banking are worth noting. Progress towards finalizing a multi-year reform plan in these areas and in state-enterprises is also evident. Private Sector. Putting the more liberal Enterprise Law into effect in January and issuing regulations to remove more than a hundred business licensing requirements, generated a strong response from the domestic private sector as 5000 small and medium SMEs registered all across the country, with more than 1200 in manufacturing itself. The amended Foreign Investment Law was also September18, 2000 Vietnam 5 the rise since the opening. There is currently a lot of FINANCIAL SECTOR UPDATE discussions on the issue of Over the Counter Trading (OTC) of companies before being listed and private investors have expressed interest in participating in such CURRENT DEVELOPMENTS trading. While many of the Funds that were set up in early 1990s have winded up, there is now talk of creating new Vietnam funds. Many in the private sector see this stock Recent performance. The banking sector continues to market as an important signal of Government's intention grow in terms of its financial assets; in the non-bank area, to continue reform. the insurance sector has been growing rapidly too. With rapid overall credit expansion of 20 percent in 1999 and In early December, SBV finalized a decree that allows all 30 percent (projected) in 2000, banks ­ especially state- credit institutions in the country to make unsecured loans. owned commercial banks (SOCBs) have been lending at a Currently only state-run commercial banks can issue rapid rate as well. In the first six months of 2000, bank unsecured loans to only state-owned enterprises. credit expanded by VND 10 trillion. Nearly 75 percent of this credit growth was accounted for by three SOCBs-- The State Bank of Vietnam (SBV) has issued Decision agricultural bank (VBARD) accounted for 26 percent, No. 415, effective January 1, 2000, requiring all banks in ICBV for 24 percent, and BIDV for 23 percent. Vietnam to provide information on their borrowing Vietcombank (VCB) was more cautious, accounting for 9 customers to the central bank on a regular basis. The percent; all other non-state banks accounted for the rest. decision said the central bank needed to be given general In fact VBARD increased its total lending by VND 3.5 details about a customer within three days of a "credit trillion, with most of it going to non-state rural sector. relationship" being established with a bank. Banks also had to provide details on the financial health of their Recent policy developments. The Government continues borrowing clients each quarter, such as basic balance to reform the banking system, albeit at a gradual pace. sheet data from companies. Actions have been taken in respect several of the weakest joint-stock banks (JSBs) and plans for restructuring the Life Insurance Market Increases Fourfold. Vice-Minister SOCBs are being prepared. The interest rate system has Tam announced that the insurance premiums in 99 were recently been made more flexible, the deposit insurance four times what they were in 1998. The insurance sector company has been established and draft of the law for has had dramatic growth in 1999. Four major foreign Asset Management Company (AMC) has been prepared. insurance companies started operations in 1999 bringing However, the rapid growth in SOCB lending without the the total number of forms in Vietnam to 16. The first needed restructuring of their operations could potentially state owned life insurer was created in 19996. It is hoped worsen their current financial situation. Similarly, slow that the life insurance companies will play a large role in restructuring of JSBs after they are placed under special the development of capital markets. The government has supervision, risks increasing the losses in those banks. In drafted a new Insurance Business Law that should be addition, the Government has opened the long-awaited approved this year. stock exchange and made the interest rate more flexible POLICY IMPLEMENTATION AND ASSESSMENT The Government's banking reform program comprises of restructuring of non-state JSBs to strengthen them (and reduce their number from 52 to around 25) as well as Consolidation of Joint Stock Banks. Three banks have restructuring the SOCBs, and improving the regulatory closed and another two merged. One other JSB, and supervisory framework. While there has been originally classified by SBV as good, was suddenly considerable progress on the first and the third, placed under "special control" SBV has previously given developing and implementing a restructuring plan for all permission to Hanoi-based International Joint Stock four state-owned commercial banks (SOCBs) is proving Commercial Bank to take over the Mekong Joint Stock to be difficult. Currently, the overall restructuring Commercial Bank. Last year, the SBV approved the strategy for SOCBs is under discussion in Government. merger of two joint-stock banks, marking a step towards rationalizing and consolidating fixing the country's ailing Opening of Stock market. Vietnam launched its first stock joint stock banking sector. market in July of this year, signaling maybe continued reform. Treasury bonds and stocks are expected to be Late last year, two rural joint-stock banks of Tay Do and listed. Today stocks of only four companies are listed -- Chau Phu agreed to merge with the Phuong Nam Bank. Sacom (with an equity of VND150 billion), REE The two banks will operate as Phuong Nam branches in (VND120 billion), Hapaco (VND10.08 billion), the Mekong Delta region. The two banks though having a Transimex (VND22 billion). Market demand for their chartered capital of a mere VND1 billion ($71,300) each, shares have far exceed supply. Stock prices have been on have performed quite well and have a large number of customers in An Giang and Can Tho, the country's largest September 18, 2000 6 East Asia Brief agricultural provinces. Phuong Nam, with an equity of deposit they could raise, the SBV has stated that they will VND80 billion ($5.714 million), is now one of the largest ask the government to gradually remove restrictions on joint-stock banks in HCM City. In the middle of this year, foreign branches taking deposits in Vietnamese dong. The it took over the Dong Thap Rural Joint-Stock Bank and SBV has removed restrictions on dong deposit the Dai Nam Commercial Joint-Stock Bank. In addition to mobilization restrictions by foreign invested Joint-venture Phuong Nam, other city banks are also in negotiations to banks, but foreign bank branches are still restricted in take over rural joint-stocks banks to channel more capital their dong deposits/equity ratio at 25 percent. to agriculture and rural areas. Instruments for the Financial Sector The SBV should continue to allow the merger of JSBs in order to meet the goal of further consolidating the sector into 25 JSBs by the end of 2000. Vietnam now has around Trust Funds support: The PHRD Grant for preparation of 48 joint stock banks (down from 52), which are mainly SAC II has been completed. The grant financed visits by small semi-private institutions that sprang up following staff of the US Federal Reserve to review banking the adoption of economic reforms in the late 1980s. A supervision procedures of the SBV and draft number of joint stock banks have sought to merge or close recommended revisions. The SOE component of the in the past 12 months because of debt woes or lack of Grant has also provided assistance to the Government in capital. developing the necessary procedures for the restructuring of SOEs. SOCB Restructuring. SBV is in the process of approving a overall restructuring strategy for all 4 SOCBs. This A Financial Sector PHRD Grant ($1.3m) approved in strategy is expected to include among other things the October 1998, is financing work by two international following key principles: SOCB management will be held consulting firms who are assisting SBV on the accountable for ensuring the performance of its restructuring of the state owned commercial banks and the commercial lending; non-commercial or policy lending joint stock banking sector. The work is expected to be will be phased out and if any policy or non-commercial completed next month. lending is done, it will be supported by an explicit MOF guarantee; banks will adopt international accounting An ASEM Grant ($1.0m) is financing technical assistance system in respect of loan-classification and loan-loss to SBV from a law firm and a consulting firm on the provisioning and annual performance will be assessed establishment of asset resolution structures and legal through independent annual audits of banks; and re- framework to support creditor rights. The consultants capitalization of the banks will be phased over three-to- should complete their assignments in the next three to six four years, to in line with improvements in the banks months. operations (AMC will take over collateralized assets). The major objective of restructuring is to make SOCBs An ASEM Grant ($1.5 m) was approved for audits and operate on commercial principles and be accountable for other diagnostic work on joint stock banks. The proposal using budgetary support effectively. and the Request for Proposals are approved and are ready to be distributed to the consultants. The assessments Separate policy from commercial lending. The should be completed by the end of the summer. government on December 17 issued Decision 231/1999/QD-TTg and 232/1999/QD-TTg, effective from Technical Assistance Lending: A Payment System and January 1, 2000, to approve the establishment and Bank Modernization Project is currently assisting the regulations of the National Development Assistance Fund SBV and the six largest banks to improve the payment (NDAF). The establishment of the Investment Fund and settlement system in Vietnam through provision of an marks a significant step in separating the so-called policy inter-bank and 6 intra-bank networks ($49 m, approved lending from commercial lending. Under the Decision, 11/96). the NDAF will provide policy based lending through three channels: lend directly, provide explicit guarantees Donors: bilateral donors are supporting the reform of the for loans through SOCBs, and provide interest subsidies banking system (Germany), the auditing of one SOCB to loans extended through SOCBs. However, there are and the study of regulatory structures in other countries concerns that the direct funding for NDAF may be too (Netherlands), as well as training programs for central small to cover all the policy and development lending, bankers (Switzerland). especially lending to loss-making SOEs. Leveling the playing field for banks. Foreign bank branches are expected to get larger access to Dong deposits. As foreign bank branches operating in Vietnam continue to urge the SBV to lift the cap on the dong September18, 2000 Vietnam 7 Strong Response to Enterprise Law. In the first 8 months CORPORATE SECTOR UPDATE of this year, private sector registered more than 7000 small and medium enterprises. This growth rate of enterprises was exceptional, relative to earlier years. CURRENT DEVELOPMENTS However, the absence of information on firm-closures and on "greenfield" enterprises makes it difficult to ascertain the net-increase in enterprises or the rise in investment Recent output developments. Industrial sector output--a that this growth implies. Even if there are many large part of which is contributed by the corporate sector-- enterprises among the new registrations that have just after falling for three years in a row, has turned around. converted from an informal status to a formal one, this Both state and non-state sector output grew strongly. itself is significant in that entrepreneurs have increasing Though the state-enterprise output grew--as always-- confidence to come out and be recognized as Vietnamese more slowly than the two segments of the private sector, entrepreneurs. HCM city registered slightly less than half its growth rate was nearly three times that of last year (see of these enterprises i.e., 3,446 enterprises with an average Table 6). This was driven largely by a rapid expansion of registered capital of 1 billion dong. Sixty percent of these credit and rising domestic demand. Earlier stockpiles of were formed as limited liability companies. Without industrial goods fell sharply. For the first time, the knowing more about the characteristics of the firms it is domestic private sector output, outperformed the foreign difficult to assess whether such rapid growth of private private sector. This was facilitated by rising domestic and enterprises will be sustained. external demand, as their exports grew. Revision of the Foreign Investment Law. For foreign Table 6: Industrial Output Growth (%) investors, the revised Foreign Investment Law improved 1999 2000 the policy environment considerably, though the 8 M 8 M challenge of expeditious implementation of its provisions Total 10.3 15.5 remain. Some of the key improvements include the following: State sector 4.5 12.3 Non-state domestic sector 7.6 18.6 · Some foreign investment will be allowed on the basis Foreign-invested sector 19.9 17.4 of registration only, rather than licensing Source: GSO · Foreign-invested enterprises may be allowed to Domestic private firms exports of garment and footwear convert the form of their investment, and may merge grew by nearly 75 percent in 1999 and is growing rapidly and de-merge, in compliance with conditions and in the first half of 2000. Most of the growth of the foreign procedures to be set out by the Government in industrial sector came from oil, though non-oil exports Implementing Regulations. also contributed. · Every foreign investor will have the right to purchase Recent Policy Developments As part of its efforts to foreign currency from its commercial bank for the improve performance of the enterprise sector, purpose of making payments for current transactions Government has continued to liberalize the environment and for other purposes that may be permitted by law. for private enterprises and to reform state-owned- For infrastructure projects, Government will provide enterprises (SOEs). This year, the coming into effect of "support for foreign currency balance" and for very the Enterprise Law and the accompanying removal of important projects Government will "ensure" foreign more than a hundred business licenses, further currency balance liberalization of the Foreign Investment Law, the signing of the Nam Con Son gas deal, and allowing private · The Government is allowed to enter into guarantee investment in health and education has contributed to an agreements or to issue guarantees for any foreign improved policy environment for the private sector. invested project. This provides the Government Additional equitizations of SOEs, the establishment of the greater flexibility to push forward some of the Restructuring Assistance Fund, and the delegation of complicated infrastructure projects. authority to reform SOEs have also contributed to SOE reform. While there is some evidence of greater · Foreign-invested businesses will be allowed to grant confidence in the domestic private sector, within the mortgages over land use rights and assets attached to foreign investment community, "leavers" still outnumber the land to banks permitted to operate in Vietnam arrivals. The failure to conclude a BOT (build-operate- (including foreign bank branches). transfer) transaction after years of effort also continues to plague the morale of foreign investors. · Overseas Vietnamese investors will be entitled to the lowest rate of remittance tax (3 percent) and a 20 September 18, 2000 8 East Asia Brief percent reduction in the otherwise-applicable POLICY IMPLEMENTATION AND ASSESSMENT corporate income tax (except where the applicable tax rate would have been 10 percent). Though formal approval of the SOE reform program is · Three measures are aimed at providing tax relief to still awaited, Government has initiated implementation of foreign investors: (a) the remittance tax rate has been some parts of its plan, albeit slowly. Equitizations are reduced to 3 percent, 5 percent and 7 percent from 5 being carried out, competitive tenders/auctions are being percent, 7 percent and 10 percent respectively; (b) experimented, social safety-nets for workers are being put foreign parties to BCCs are allowed to carry forward in place and debt-restructuring modalities are being losses from one tax year to offset profits in any of the discussed. In addition, with World Bank support, following five years; (c) especially-encouraged technical assistance grants from donors are being used to investment projects and projects implemented in formulate and implement the SOE reform plan. areas of especially difficult socio-economic conditions will be exempted from import duties on Equitizations increasing. The number of SOEs becoming raw materials, materials and components imported joint-stock companies reached 451 this August. for production purposes, for a period of five years after the commencement of production Table 7: SOE Equitizations as of Aug 1, 2000 Number Total Registered SOE Reform program to be approved. Following nearly of SOEs Capital (Bn. 18 months of technical support, Government has now VND) developed a detailed SOE reform plan that is expected to be submitted to the leadership for approval. Its approval Total majority will trigger expeditious implementation of the program. privately owned The proposed reform is a strong one. It comprises of (a) diversifying ownership through equitization and >65% of shares divestiture; (b) reducing losses by liquidation of non- sold to non-state 294 763 viable state-enterprises (c) restructuring large state- investors enterprises that remain in Government hands, through 51-65% sold to various measures (including limits on access to credit, non-state investors 68 913 increased transparency through diagnostic audits, enterprise-specific "pilot" restructuring of three General Minority privately 89 605 Corporations (i.e. Seaprodex, Vinatex, and Vinacafe) and owned (d) ensuring an adequate social safety net for redundant workers. Furthermore, import liberalization under AFTA, Total 451 2.281 and later under the US trade agreement, is expected to increase competition for remaining state-owned enterprises and make them more competitive. Of the 451 equitized SOEs (i.e. those receiving business license under the Enterprise law), 294 sold 65 percent or In terms of coverage, the Government's proposed more of their shares to non-state investors and another 68 program envisages that 1857 SOEs would be equitized, SOEs sold more than 50 percent of their shares to non- divested and liquidated and another 423 would be state share holders, making a total of 362 former SOEs restructured and/or merged, over the next three years. that are now majority privately-owned. Thus a total of 2280 SOEs or a third of SOEs by number, will be reformed. Though this covers a small share of It was announced in January that 798 SOEs are to be employment and debt -- specifically 25 percent of SOE restructured/reformed through various methods. To employment and 16 percent of SOE bank debt ­ it is a expedite the process, Government delegated the power to good start and sends a good signal to the investors. deal with loss-making SOEs (capital of 1-5 bil. Dong) to However, the program also explicitly wants to keep the ministers, provincial committee's chairmen or SOE's profitable General Corporations in state-hands, with a management board's chairmen in Decision 55. The view to strengthening them and making them more Government is falling considerably behind that target. competitive. The challenge for the government is to ensure that the General Corporations that claim to be Auctions, a faster process of divesting SOEs, has not profitable are not given debt-relief. Profitable SOEs gotten off the ground yet. Decree 103 permits competitive cannot be delinquent borrowers, otherwise, budgetary tenders (the closest thing to auctions) as a means of funds appropriated for SOE and banking reform will have equitizing very small SOEs (i.e. capital of less than VND been wasted. 1 billion), though private buyers prefer mid-sized profitable SOEs that have significant land-holdings, according to a survey of their preferences in Haiphong. September18, 2000 Vietnam 9 Nevertheless, three such SOEs are in advanced stages to approved (iv) ASEM funds to assist Ministry of be auctioned by December 2000. Transportation in restructuring SOEs and (v) AusAID/IFC for a pilot auction/divestiture program for small SOEs Social Safety Net for SOE workers. This will be critical under the Haiphong People's Committeebeing component of the reform process. Recently the Ministry implemented by IFC. of Finance issued decision 177 to establish a Restructuring Assistance Fund to finance, among other Coordination with Other Donors. Work in this area is things, severance payments to redundant SOE workers. coordinated with other donors through the technical However, four sets of modifications would have to be assistance as well as through their lending program in made to the Fund's rules, if it is to be effective in several ways: (i) parallel missions are held regularly with alleviating transitional cost to redundant workers and the IMF (latest one was held during 22-31 August 2000) facilitating labor reallocation. First, the severance and tripartite meetings are held with the Government; (ii) package would have to be more generous than what is joint missions were also held last year with bilateral permitted currently under the Labor Code; various donors like Japan, prior to the Miyazawa loan to Vietnam suggestions for increases have already been made by the (iii) collaboration and cooperation continues with UNDP labor federation. Second, access to this fund has to be who is financing support for "Improving the Regulatory expanded beyond equitizations as is the case currently; Environment for Business". (iv) the ADB has already unless workers affected by divestitures, transfers and financed a Industrial Sector Governance Program Loan liquidations also have access, a more generous severance for $100 million; (v) DfID is finalizing an enterprise package for workers affected only by equitizations would reform technical grant, estimated at US$2 million, to be inequitable. Third, payment procedures have to be support pilot restructuring of three general corporations; made more transparent. Further regulations are thus (vi) AusAID has sponsored IFC activities in the area of expected to be issued to address these issues. SOE reform and may fund some of the diagnostic audits; (vii) JICA is funding a series of studies under the "Study Technical Assistance to support SOE Reform on Economic Development Policy in the Transition Toward a Market Oriented Economy in Vietnam" which includes a major section on SOE reform; (vii) Sweden has The technical assistance program for SOE reform is led under development a project ($1.4 million) to finance by the World Bank but supported by numerous donors. support for technical assistance for SOE reform to Ho Chi The technical assistance grants (see below) have been Minh City. developed to build capacity, to help formulate the full program, and then to support its implementation. Several grants have been mobilized through coordination among Donor-Government-NGO Working Group. A formal various donors amounting to nearly $10 million, not all of working group of donors and Government on SOE which at the same stage of implementation. This technical reform, was initiated in May this year and two meetings assistance to the government focussed initially in learning have been held so far. This group provides an avenue for from international experience and in doing empirical interactive discussion on the SOE reform program in the work on Vietnamese SOE sector, on which even basic presence of key Vietnamese government interlocuters. data was not available. A good deal of this assistance is This group--donors, NGOs and Government--is now the now helping to improve transparency of information on forum for discussions on the Government's five year SOE SOEs -- through an MIS (management information reform plan as also donor support for implementation of system) and through a debt and budget support the plan. Two meetings have been held. This group monitoring system for 200 large but troubled SOEs ­ as complements the more focused donor group on well as transparency of equitization and social safety-net equitizations, that has been ongoing for more than 18 fund. Support for diagnostic audits of 50-100 SOEs is months. also being supported by this technical assistance grants as also the pilot restructuring of three General Corporations. World Bank Administered Trust Funds/Grants: (i) Danish grant funds for advisory services, public awareness campaign, the establishment of a MIS for SOEs, and capacity building to the NERC is complete and a six-month extension has been approved; (ii) ASEM funds to support SOE reform in three pilot line ministries (industry, agriculture, and construction) and Hanoi municipality; procurement of consultants is finalized and they are expected to be in place in late March; (iii) Special PHRD grant to conduct operational reviews/diagnostic audits of large SOEs has been September 18, 2000 10 East Asia Brief agencies, research institutes and mass organizations. The SOCIAL SECTOR UPDATE other half were from donors and local and international NGOs. A diverse group of people attended the retreat. There were representatives from 15 Government KEY SOCIAL INDICATORS ministries and agencies, 5 mass organizations and research institutes, about 10 donors (including a large presence from Japanese agencies such as JBIC, JICA, and Latest Previous the Japanese Embassy), 4 international and 3 local NGOs. data period Participants worked largely in groups, with each of the 11 1997/98 1992/93 sectoral and cross-sectoral breakout groups building on Human Development the analysis presented in last year's joint poverty report Primary enrollment rate (net) Vietnam: Attacking Poverty. The groups considered what Female 88 86 was required to create opportunity, ensure equity and Male 90 85 reduce vulnerability in the five broad areas below: Lower Secondary enrollment Female 62 30 · Human and Social Development (Education, Health, Male 62 32 HEPR and Social Protection); Upper Secondary enrollment Female 27 6 · Agriculture and Rural Development (Agriculture, Male 30 9 Rural infrastructure); Post Secondary enrollment Female 9 2 · Economic Management (Macroeconomic Male 10 4 stability/fiscal policy/competitiveness, Enterprise Poverty & Income Distribution development); National Headcount Index 37 58 Urban Headcount Index 9 25 · Governance and Participation Rural Headcount Index 45 66 Gini Index 0.35 0.33 · Cross-sectoral Themes (Ethnic Minorities, Gender Government Expenditures 1998 (est.) 1997 (est.) issues, Vulnerable Groups). Health budget (% of total) 4.0% 4.5% Education budget (% of total) 10.9% 10.5% The working groups had very engaged and interesting Labor Market 1998 1997 discussions. Each working group had two facilitators from Urban Unemployment rate (%) 6.9% 6.0% the donor and NGO community (one Vietnamese and one Female 6.4 5.4 non-Vietnamese) and also a rapporteur from the Male 7.2 6.5 Government who reported back to the plenary. Each Participation rate (%) 1997/98 1992/93 working group produced a draft policy matrix for their Female 81 79 theme and although there still need considerable work to Male 82 83 fill in the gaps in many areas, including on monitorable Share of wage employment indicators, they are already very rich in substance and Female 40 43 contain a wealth of information to serve as a base for Male 60 57 developing a comprehensive poverty reduction strategy Share of urban wage for Vietnam. employment in total 8.9 8.1 Ministry for Planning and Investment works on first draft Days of strike during year na na of interim Poverty Reduction Strategy Paper (PRSP) MPI Real wages ( %change) 12.8% pa is currently drafting an interim PRSP and will be holding Male/Female Hourly Wage ratio 1.3 1.2 consultations inside and outside Government on the (agriculture) content of the draft over the coming months. The interim Source: Vietnam Living Standard Surveys: 1992/93 and 1997/98. PRSP drafting team are drawing on material from Three-day retreat to discuss a Comprehensive Poverty Government planning documents (particularly the draft Reduction Strategy for Vietnam. HEPR Strategy and the draft 10-year socio-economic strategy) as well as discussions at the Sapa Worskhop. In early July, the World Bank took the lead in organising a highly energizing and very productive 3 day retreat to Consultations on the draft Poverty Reduction Strategy work towards a Comprehensive Poverty Reduction (2001-2010) and five year HEPR programme 2001-2005. Strategy for Vietnam. The retreat was attended by 85 The Minister and vice Minister for Labour, Invalids and people, roughly half of them were from Government Social Affairs (MOLISA) chaired a two-day workshop in Hanoi to discuss the draft 10-year PRs strategy and five September18, 2000 Vietnam 11 year HEPR plan. Participants came from a range of ensure that this information is disseminated and used on a central Ministries and provincial agencies. This national more regular basis. The "VIETNAM: ATTACKING workshop, supported by the ADB, will be followed by POVERTY" report prepared for last year's Consultative two regional consultations in Ho Chi Minh City and Group meeting, recommended that future household Danang. surveys in Vietnam should aim to combine the strengths of the donor-funded VLSS surveys with those of the Poverty Projections to 2010: Using VLSS98 data, the Government-funded Multi Purpose Household Survey World Bank has estimated that the incidence of poverty (MPHS). It also recommended that there needed to be a could reduce to 6% by 2010. This reduction assumes that clearer division of responsibilities for data collection GDP grows at 7 percent per annum from 2000 to 2010, between GSO and other line agencies and rationalization that population growth is 1.5 percent per annum and that of the plethora of existing surveys. The mission's final expenditures rise at the same rate in urban and rural areas. report will be ready by early-October . Key Poverty will fall more slowly if it is less even however. If recommendations include: expenditures in urban areas rise twice as quickly as expenditures in rural areas, then the headcount will fall to a) future household surveys in Vietnam should be 10 percent by 2010. The projections suggest that food conducted on a sample of approximately 30,000 poverty could fall to 1.2 percent by 2010 as long as households. Such a sample size will be large enough growth is distributionally neutral. provide a good deal of information at the provincial level; Provincial Poverty Mapping Vietnam's current anti- b) future household surveys should adopt a "core and poverty programs rely heavily on the geographic targeting rotating" module format with a core module (covering of poor households. Yet the relatively small number of household size and composition, employment, households surveyed in its national household sample expenditures/incomes and receipt of public assistance) surveys do not allow poverty statistics below the regional administered every two years and additional rotating level to be estimated accurately. Meanwhile, questions modules on specific sectors administered at longer have been raised about the comparability and reliability of intervals. Two possible models were proposed: one with a the more disaggregated province, district and commune narrow range of rotating modules (covering agriculture, poverty statistics that are collected by MOLISA through education, health and household business) and the second the administrative reporting system. In order to bridge with a wider, but more expensive, range of rotating this gap, the World Bank has initiatedto combine the data modules (that would also include governance, collected by the 1998 Vietnam Living Standards Survey environment and infrastructure ). (VLSS) with that of the 1999 Population and Housing Census. This work uses variables that are common to both the Census and the VLSS to predict household and VIETNAM:POVERTYPROJECTIONS individual expenditures. These predicted expenditures can then used to make estimates of Poverty at various levels 40.0 of geographical disaggregation 35.0 At present, the full results from the 1999 Census are not 30.0 yet available. However, the 3 percent enumeration sample 25.0 of the Census (covering some 515,878 households) has been made available to the World Bank. This sub-sample 20.0 of the Census is large enough to allow statistics that are 15.0 provincially representative to be calculated. The results 10.0 available to date show that, as expected, the poorest provinces (with poverty headcounts over 60 percent of 5.0 individuals) in Vietnam are located in the Northern 0.0 Uplands and Central Highlands, while the most affluent 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 areas (with poverty headcounts below 25 percent) are Poverty(DNGrowth) FoodPoverty(DNGrowth) located in the South-east. However, there are also some Poverty(UnevenGrowth) FoodPoverty(UnevenGrowth) more surprising results, such as the central province of Quang Tri Province falling into the poorest category and Lam Dong, a province on the edge of the Central Vietnam Living Standards Survey 1998 available on CD- Highlands, falling into the richest one. ROM GSO is improving the dissemination of the VLSS98 results. Particularly useful, the GSO has made GSO Household Survey Strategy Mission In order to all the VLSS98 data available for purchase on a CD- monitor future progress in poverty reduction, Vietnam ROM. A revised version of the Statistical Abstract for needs to collect higher quality household survey data and the VLSS, which contains pre-processed statistical tables, has also released been released. Work continues on September 18, 2000 12 East Asia Brief improving the documentation available for the VLSS, Bank, MPDF and UNDP are providing funds for the together with tidying-up a few minor inconsistency in the study and UNDP and MPDF ­ with its expertise in basic VLSS data files. supporting the development of the SME sector ­ are coordinating the study. Responding to provincial requests, Research on commune-level fees and contributions the study has started by looking at 10 sectors for possible dicussed with Ministry of Finance The PPAs conducted in development by local authorities. This has now been 1999 clearly indicated that in some areas the system of narrowed down to four sectors which show sound levying commune-level fees and contributions was prospects for private sector development in this Province. causing confusion and hardship. Households reported MPDF will support labour-intensive companies to paying more than 20 different fees and contributions, formulate business plans. This will assist these companies calculated in a range of different ways. They also in approaching banks for finance. expressed frustration at the lack of information which accompanied the levying of these fees and contributions. Work on Social Safety Nets This issue was highlighted in Vietnam: Attacking Poverty as an important area for follow-up research. The Public Expenditure Review (PER) was exploring, among other On June 1-2, 2000 a Workshop on Labor Issues in SOE issues, aspects of fiscal decentralisation and the study on Reform was jointly organized by the CIEM and the fees and contributions complemented this work. The World Bank in Hanoi. Several Government agencies study makes the following recommendations: (including MOLISA, NERC and the Labour Union) put forward their proposals for SOE workers effected by the · There is a need to simplify the system, reducing the reforms. The workshop made progress in drawing the number of separate fees and contributions and different agencies closer together. There was general reducing the number of ways in which charges are agreement that voluntary separation should be encouraged calculated.; and acknowledgement that the current severance package · Commune finances should be made more transparent. as regulated by the Labor Code is not enough to Households should know exactly how their encourage voluntary separation. The participating assessments for fees and contributions are calculated. agencies proposed similar levels of compensation. They should also know, through the publication of However, more work needs to be done on the details of commune budgets and expenditure statements, how the package and funding availability for financing their fees and contributions have been spent. severance payments. Rigorous enforcement of Decree 29 (on the Promulagation of Grassroots Democracy) could help A new regulation - Decision No. 95/2000/BTC was issued significantly in this regard; on June 9, 2000 guiding the use of the Fund established · under the Decree 177 (the "Fund to Assist Rearranging Utility charges ­ especially electricity and irrigation and Equitizing SOEs"). The World Bank is continuing to water ­ should be more closely linked to work with severance government agencies to prepare consumption; additional regulations to allow for better use of donor · Ensure that the new, simplified system involves support in this area. calculating contributions in a way which is progressive; Formulation of a second Plan of Action for the · Establish simple, clear criteria for full and partial Advancement of Women exemption from fees and contributions and publish these openly; In the context of drafting its 10 year strategy and 5 year · Strengthen mechanisms which allow households to plan, the Government of Vietnam is also reviewing the raise questions about commune finance issues. impacts of its first Plan of Action for the Advancement of Collaborative study to examine the prospects for Private Women (1995-2000) and formulating its Second Plan of Sector Development in Tra Vinh A crucial finding from Action (2000-2005). It aims to do this in close partnership both the PPA in Tra Vinh and VLSS data was the with donors, through a joint GOV-donor Gender Strategy growing problem of landlessness in the Mekong Delta Working Group, in the hope that donors will support the region. Interviews with households in Tra Vinh suggest GOV's Second Plan of Action in a coherent manner rather that off-farm employment opportunities are extremely than allocate their resources in a fragmented manner. limited and this is causing severe hardship for those With this aim, GOV and donors are currently jointly households with no or marginal landholdings. Local drafting a Gender Situation Analysis which will be authorities responded to this finding by requesting help in launched at a national workshop at the end of October and developing the off farm sector and three organisations which will form the basis for the Second Plan of Action. (the World Bank, MPDF (Mekong Project Development The second Plan of Action is likely to have fewer Facility check), and UNDP) agreed to collaborate with objectives that the first plan, but will incorporate some provincial officials in studying the options. The World recently identified gender issues such as gender in September18, 2000 Vietnam 13 HIV/AIDS, family violence, gender stereotyping in participation, leadership and public decision making. education textbooks and women and political - Macroeconomic Update was prepared by Kazi Matin, Patrick Belser, Minh Van Nguyen and Viet Dinh Tuan (EACVF) - Financial Sector Update was prepared by Kazi Matin, Igor Artemiev & Duc Pham Minh (EACVF) - Corporate Sector Update was prepared by Kazi Matin, Carmen Genovese and Duc Pham Minh (EACVF) - Social Update was prepared by Nisha Agrawal, Carolyn Turk (EACVF) September 18, 2000 14 East Asia Brief VIETNAM ECONOMIC INDICATORS 1997 1998 1999 2000/p 1999 2000 Q3 Q4 Q1 Q2 Output, Employment and Prices GDP (% change previous year) 8.2 4.0 4.0 5.0 n/a n/a 5.6 6.6 Industrial production index (% change, previous year) 13.8 12.1 10.4 12.0 11.0 12.9 13.4 16.0 Unemployment Rate (%) (urban areas) 6.0 6.9 7.4 Real Wage Growth Consumer price index (% change, Dec-to-Dec) 3.6 9.2 0.1 2.0 1.4 0.1 -2.0 -2.4 Public Sector Government balance (% GDP) /1 -1.4 -1.1 -1.5 -2.8 Domestic public sector debt (% GDP) 3.8 3.4 Foreign Trade, BOP and External Debt Trade balance ($US million) -2,475 -2,156 -102 -933 144 -61 -216 -490 Exports of goods, ($US million) 9,145 9,338 11,520 13,478 3,068 3,308 3,054 3,386 (% change, previous year) 26.8 2.4 23.4 17.0 35.5 33.3 33.8 14.9 Key Export, (% change, previous year) - crude 4.7 -12.5 60.0 35.0 101.8 102.4 117.2 58.8 oil Imports of goods, ($US) 11,620 11,494 11,622 14,411 2,924 3,369 3,270 3,876 (% change, previous year) 4.4 -1.1 0.9 24.0 10.0 16.4 36.2 33.5 Current account balance ($US billion ) -1.8 -1.3 0.8 0.16 (percent GDP) -7.3 -5.1 3.3 0.7 Foreign Direct Investment (US$billion) 2.0 0.8 0.6 0.5 0.2 0.20 0.15 0.15 Total external debt ($US billion)/2 10.1 10.8 11.1 13.5 (% GDP) 40.7 41.7 40.7 45.6 Short-term debt ($US billion ) -0.53 -0.19 -0.18 -0.13 Debt service ratio (% exports of g&s) 11.5 15.5 13.7 14.9 Reserves, including gold ($US million) 2,085 2,028 3,424 3,544 (weeks of imports of goods and services) 10.3 10.1 11.0 10.0 Financial Markets Domestic credit (% change, period-end) 22.6 20.5 10.5 30.4 14.2 10.5 12.7 23.0 Short-term interest rate (3-M deposits, average) 8.1 9.6 7.0 7.0 7.2 7.0 7.0 7.0 Exchange rate (period-end) 13,92 14,008 14,040 14,115 12,292 13,896 14,008 14,300 0 Real effective exchange rate ( + = appn) (% change, previous year) 3.4 8.2 0.8 2.1 Stock market index (Dec 1996=100): non existing Memo: GDP in US$ billion 24.8 25.9 27.4 29.5 Note: 1. Overall deficit on cash basis (excl. on- lending) 2. Excludes non-convertible debt. September18, 2000