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p. 16 of 17 BACK | NEXT Executive Summary Map I. Recent Economic Developments II. Short and Medium-Term Economic Prospects and Policy Issues III. Selected Policy Issues A. Fiscal Sustainability B. Corporate Debt Restructuring

Country Economic Review: Thailand : III. Selected Policy Issues

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A. Fiscal Sustainability

54. Thailand’s public debt increased from about 15 percent of GDP in 1996 to about 58 percent of GDP by end of 2000. Financing this debt absorbed 10.7 percent of government revenues in FY2000 compared with 4.5 percent in FY1996 (para. 15). For FY2002, the budget deficit is projected to be 3.7 percent of GDP. This will add to the public debt. Based on official estimates, the Government is likely to run a budget deficit over FY2001-FY2006. Two major contributing factors include the ongoing fiscal stimulus package to stimulate economic recovery and increased debt interest payments. Mounting pressures to support domestic demand could threaten fiscal sustainability over the medium term. In this context, the Government’s stated objective is to move toward a balanced budget position by FY2007.

55. To gauge whether a country’s fiscal position is sustainable, the ratio of pubic debt to GDP is key.²⁸ A steeply increasing public debt to GDP ratio is generally regarded as a cause for concern, since it would typically be accompanied by a deterioration of key macroeconomic indicators, and could trigger concerns about sovereign creditworthiness. Technically, a stable or declining debt to GDP ratio requires that the primary fiscal surplus should be on average at least as large as the product of the stock of public debt and the difference between the real interest rate for deficit financing and the real GDP growth.²⁹ If, on average, the primary fiscal surplus is less than the product of the difference between the real interest rate for deficit financing and real GDP growth and the ratio of public debt to GDP, fiscal policy is said to be unsustainable, and the ratio of public debt to GDP will grow over time.

56. The assumptions on which the MOF's debt projections depend include real GDP growth rate averaging 5.0 percent during FY2002-FY2007; an increase in the value of VAT from 7 to 10 percent from FY2003 and onward; real debt interest averaging 3.5 percent; and inflation averaging 2.4 percent.³⁰ Based on the above assumptions, public debt as percent of GDP is set to fall and the primary fiscal balance to GDP is set to increase between FY2002-FY2007 (Table 15). The projected primary fiscal surplus outweighs real debt servicing obligations, and suggests that Thailand's fiscal policy is sustainable. However, this conclusion is sensitive to the precise assumptions made about the growth rate of the overall economy, the evolution of interest rates, underlying primary revenue and expenditure streams, and the broader institutional context within which fiscal and debt management policies are articulated.

1. Growth Rate

57. Following modest recovery in 2000, GDP grew by 1.9 percent year-on-year in the first half of 2001. Growth is expected to slow in the second half of 2001 (para. 39). However, as fiscal and monetary policies remain broadly supportive of growth, economic growth is expected to accelerate by the second half of 2002, provided the global economy and electronics demand rebound. But downside risks remain. Thailand is unlikely to escape the downdraft of an overall slowing of world growth. The general expectation of a pick-up in growth toward the second half of 2002 is uncertain.

58. Growth outcomes are crucial to debt dynamics. In a recent IMF study, the trajectory of the debt to GDP ratio in Thailand is compared under alternative assumptions about economic growth.³¹ Assuming real growth of 5 percent, VAT at 10 percent, and average interest rate of 6 percent, the ratio of public debt to GDP declines to less than 40 percent of GDP by FY2007.³² But under a slower growth scenario (assuming real growth at around 2 percent, VAT at 10 percent, and average interest rate at 6 percent), the debt to GDP ratio expands to more than 50 percent of GDP and is on an unsustainable path. Over the medium term, Thailand would have difficulty sustaining domestic demand through fiscal means and maintaining a stable debt ratio, if growth outcomes turn out to be less favorable than currently anticipated.

2. Interest Rate of Deficit Financing

59. By law, the Government can finance budget deficits only from domestic sources. The Government relies on domestic debt financing to bridge the gap between its revenues and expenditures. MOF issues Treasury bills for short-term liquidity purposes and Treasury bonds for medium- and longer-term deficit financing. During FY2000-FY2001, the average interest rate for deficit financing was 5 percent with bond maturity ranging from 1 to 15 years. In the context of ample domestic liquidity and with limited avenues for alternative investments, institutional interest in government debt issuance has been strong. Going forward, this level of support cannot be guaranteed. Portfolio considerations may limit the market's ability to absorb government bonds, especially if there is a shift away from emerging market debt to "safe haven" assets. Of course, if the recovery gathers pace, the public sector would increasingly have to compete for funds with the private sector, which would then exert upward pressure on interest rates. If the real interest cost of Government debt were to outstrip growth, a rising primary balance would then be needed to stabilize the debt to GDP ratio.

3. Revenue

60. In Thailand, the revenue-to-GDP ratio was about 16.5 percent in FY2000, lower than the precrisis level of 19.4 percent in FY1996. To improve revenue mobilization, a number of measures are expected to be introduced. The Government plans to increase VAT to 10 percent from 7 percent by October 2002. This could mobilize additional annual revenue of about B70 billion. In addition, the Government plans to privatize about 15 state enterprises during FY2001- FY2003. This could mobilize about B700 billion of capital revenue. While this will not directly affect the primary fiscal balance, it will reduce the stock of debt. However this reduction will prove transitory if the underlying conditions for a stable path of the debt to GDP ratio are not met. However, were privatization of state owned enterprise (SOE) to lead to faster growth, ease interest rates, or improves the primary balance, it would also engender more stable debt dynamics. Among other steps that Thailand could take to encourage stable debt dynamics would be to improve the mobilization of direct tax revenue, which currently accounts for only just over 5 percent of GDP.

4. Expenditure

61. As a result of the Government’s fiscal consolidation, real expenditure is likely to be reduced during FY2002-FY2007. First, debt service costs are likely to fall as a result of legal reforms on public debt management. The current Budget Procedure Act places limitations on the refinancing of domestic debt that raises costs. For example, domestic debt cannot presently be prepaid before maturity. The Government has also established a committee to study proposed amendments to the current act. Second, a welcome prospective development is that SOE debt is likely to fall. The draft Public Debt Management Bill will provide a more efficient system of guarantees on SOE debt by charging guarantee fees. SOEs seeking a government guarantee will in future be subject to a risk assessment and fees will be charged based on their risk profile. SOEs that are capable of borrowing on their own credit will be encouraged to do so without government guarantees.³³ By changing the incentives facing SOE management, and by encouraging greater operational efficiency, these measures should help ease the burden of public debt. Third, to improve public expenditure management, the Government has undertaken public administration reform since 1999, and introduced internal accountability mechanisms and transparency audits to expenditure spending agencies. This may help reduce deficits and debt.

5. Institutional Strengthening

62. A number of measures to strengthen fiscal institutions have been introduced. First, fiscal deficits must be kept in line with the Budget Law. The proposed increase in the budget deficit of B200 billion in FY2002 is at the upper limit level for deficit financing imposed by legal restrictions. According to Article 9, Budgetary Appropriation Act B.E. 2502, borrowing to finance the budget deficit must not exceed 20 percent of expenditures plus 80 percent of principal repayment expenditure in the budget. Therefore, based on the annual budget expenditure of B1,023 billion in FY2002, the upper limit level for deficit finance is estimated to be about B205 billion in FY2002. Second, following budget system reform that began in 1999, the budget will soon be prepared in a comprehensive medium-term framework that emphasizes fiscal sustainability.

63. In conclusion, the ratio of public debt to GDP has risen quickly over the past five years. Unless this trend can be arrested, concerns will mount over debt sustainability and sovereign creditworthiness. Reassuringly, a number of measures are in process that are conducive to move stable debt dynamics and a reversion of the public debt to GDP ratio to its precrisis level. However, the outlook for public debt is clouded by, among other things, uncertain prospects for economic growth. If growth falters over a protracted period, the Government would face a difficult challenge in balancing the need for fiscal stability with pressures to support the domestic economy.

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