Although Thailand's external debt has risen since 2009, the situation is very different from that in 1997. Most importantly, external vulnerability indicators suggest that the current level of external debt is acceptable. Better risk management in the banking system and the corporate sector also contributes to the soundness of the country's external position.
Thailand has seen a significant increase in external debt from 75.3 billion US$ at end2009 to 94.1 billion US$ as of October 2010. The level approaches the historical peak of 112.3 billion US$ back in June 1997, and at the same time, short term debt outstanding of 46.5 billion US$ represents an increasing share of total external debt. This development has drawn attention and raised concerns regarding Thailand's external vulnerability. Are we still doing okay in terms of external financing? Or is there a possibility of another round of excessive external borrowings as in 1997? These questions warrant further investigation.
During the years leading up to the 1997 financial crisis, Thailand borrowed from abroad to bridge the gap of widening current account deficits, with quite a substantial portion of the external borrowings being shortterm financing (ST: LT debt ratio was 41%:59% at endJune 1997). Most external debts were denominated in US dollar and concentrated in the banking and corporate sectors.
At the time, debt financing was a popular tool for corporate shareholders to finance their business expansions without having to dilute their shareholdings. As a result, debttoequity (D/E) ratio of Thai corporations averaged at 200% during 19881996.*(1) This was made possible by financial liberalization in the early 1990s, especially with the presence of Bangkok International Banking Facilities (BIBFs)*(2) which helped mobilize overseas funds more easily. Availability of 'cheap' loans together with nonstringent bank lending policies eventually spurred speculative activities such as vacant land price speculation. Meanwhile, Thailand's external debt soared from 52.1 billion US$ at end1993 to the peak of 112.3 billion US$ in June 1997.
In the wake of the 1997 financial crisis, Thailand's external debt declined significantly as the current account turned around to surplus. With shortterm liabilities drastically pulled back by creditors, the ST: LT debt ratio also dropped noticeably to 21%:79% by 2003. After that, the external debt outstanding stabilized, before picking up once again in late 2009 as highly accommodative monetary policy coupled with slow economic recovery in advanced economies and better growth prospects in emerging (EM) economies induce more capital flows to the region, in particular to the debt securities markets.
To determine whether or not external debt is worrisome, one needs to look at its composition and in relative to other macro variables. Here, we take a look at the external debt composition and find out that it looks very different from a decade ago.
First, the nature of the government sector's external liabilities is noticeably different. Prior to 1997, government external debts were predominantly in form of longterm project loans. Since 2009H2, however, government external liabilities have risen from a rapid accumulation of nonresidents' holdings of Bahtdenominated government as well as central bank bonds. This phenomenon coincides with the recent massive capital inflows and greater foreign demand for EM securities observed across the regional markets.
As a result, at present 61% of the central bank's external liabilities are in the form of nonresidents' holdings of central bank bonds. In contrast with that, most of BOT's external borrowings in 1997 were loans from the IMF and other institutions to support the country's balance of payments position.*(3) Such loans peaked at 12.8 billion US$ in 1999 and were fully repaid by June 2003.
Another component that has contributed to the recent surge in BOT's external borrowings is the increase in the Special Drawing Rights (SDRs) allocations from the IMF. Normally, SDRs allocations serve as a low cost way of raising IMF member countries' international reserves. They represent the IMF's commitment to unconditional financial resource provisions should a country be in need. For Thailand whose international reserves stood at 171.1 billion US$ at endOctober 2010 (equivalent to 12.0 months of imports), however, the SDRs allocations of 1.5 billion US$ at end October 2010 are merely symbolic as the country's very strong external position suggests that Thailand is not currently in need of balance of payments support from the IMF.
All in all, unlike in 1997, a higher level of government and central bank external borrowings at the moment does not suggest structural weaknesses of the economy. On the contrary, it is a by product of stronger demand for EM assets as a result of promising economic outlook of the region.
Second, banking sector's external debts are no longer 'cheap' loans to finance domestic - often speculative - activities as with the case of BIBF loans, but are now shortterm borrowings by resident banks, especially foreign bank branches, in order to 'square off' their FX exposures in response to the marked increase in Thai exporters' FX hedging transactions.*(4) Before 2008, resident banks would normally 'square off' their positions by withdrawing their foreign assets (i.e., currency and offshore deposits). But since 2008, with their outstanding foreign assets having declined significantly, resident banks have shifted towards shortterm borrowings from affiliate nonresident banks instead.
Third, while the corporate sector also sees a rapid increase in external borrowings, most of it is due to trade credit liabilities that come with the pickup in international trade activities. Although the outstanding liabilities stood at 18.4 billion US$ in October 2010, as opposed to 4.1 billion US$ at end1997,*(5) BOT's recent survey indicates that there have been substantial increases on both the asset and liability sides of the transactions, with trade credit claims consistently outgrowing trade credit liabilities. In addition, such rise confirms the adequacy of financial and credit access of Thai importers and exporters to finance their cross border trades.
Next we take a look at some basic external vulnerability indicators to see whether or not the current level of external debt should be a cause for concern. What we find out is that all indicators stay well above international standards and do not suggest alarm, as follows:
Reserves/Shortterm debt ratio , which measures the adequacy of a country's shortterm liquidity against possible sudden outflows, was at 3.9 times in 2010Q3, staying well above the minimum threshold criteria of 1.0 time and the alarming level of 0.7 time at end1997.
Debt/GDP ratio , which assesses a country's ability to service its foreign debt by comparing external debt with income, as captured by GDP, stood at 32.2% in 2010Q3. While edging up slightly from the previous quarter, the ratio was nonetheless well within the internationally accepted benchmark of 80.0% and significantly below the ratio of 64.8% at end1997.
Debt/XGS ratio , which measures a country's ability to service foreign debt from its foreign currency earnings from exports, was at 44.1% in 2010Q3. That figure was much below the international criteria's threshold of 220.0% and 149.0% at end1997.
Debt Service Ratio , which looks at a country's ability to service external debt compared to its foreign currency earnings, stood at 4.0% in 2010Q3, the lowest level since 1980 and well within the international criteria's threshold level of 20.0%. At end 1997, the ratio suggested a bit more fragility at 15.7%. The positive decline of this ratio has been a result of lower debt principle repayments while export earnings increase over the years.
The rising level of external debt has been a result of factors that do not indicate weaknesses or vulnerabilities of the country, namely, rising foreign investors' demand for EM securities, attempt by banks to manage their portfolio risks in response to higher hedging demand of exporters, reclassification of SDR allocations, and buoyant international trade activities. At the same time, all key vulnerability indicators suggest that Thailand's external status remains strong. Therefore, unlike in 1997, the country is not near the state of overfinancing with excessive external borrowings.
Nevertheless, to remain vigilant, cooperation is required from all related parties to maintain external liabilities at manageable levels.The corporate sector should observe prudent debt management guidelines, with emphasis on corporate governance, debt creation discipline, and limits to balance sheet risk exposure and debt mismatches. The banking sector must implement prudent lending and borrowings policies.Finally, the public sector must closely and regularly monitor external debt developments while implementing prudential measures in order to ensure that we are not going to approach an excessive level of external debt down the road.
Loser, Claudio M., 2004, "External Debt Sustainability: Guidelines for Low and Middle Income Countries".
Mariano, Roberto S. and Villanueva, Delano, 2005, "Sustainable External Debt Levels: Estimates for Selected Asian Countries".
Pinto, Songtum, 2004, "Thailand's External Debt Management".
Standard & Poor's, 2010, "Global Credit Portal, Ratings Direct: Thailand".
Wang, Yen Kyun, 2004, "Causes and Prevention of External Debt Crises".
*(1) Yen Kyun Wang, ChungAng University, 2004
*(2) In 1993, the Bank of Thailand (BOT) established BIBFs as an alternative financing facility with lower cost of international borrowing to encourage foreign capital inflows to finance domestic investment as well as investment across the Indochina region.
*(3) BOT’s loans were part of the 17.2 billion US$ financial assistance under the economic rehabilitation program sponsored by the IMF, JEXIM and regional central banks (through bilateral swap agreements). The funds were borrowed to cushion depleting international reserves triggered by massive capital flight.
*(4) The cost of offshore borrowings is lower than that of onshore borrowings through buy/sell swap agreements; hence, resident banks choose to borrow from abroad. (For more details, see figure 5).
*(5) Unlike trade credit liabilities in 1997, which were estimated based only on existing flows data, trade credit outstanding since 2004 have been obtained from BOT’s annual survey conducted with local importers and exporters. The information captured includes the maturity of trade credits (mostly provided on a short?term basis) and position data on both export credits (claims) and import credits (liabilities).
Mr. Chatwaruth Musigchai
Team Executive
Ms. Aujjira
Thanaanekcharoen
Senior Economist
Ms. Nantaporn
Pongpattananon
Economist
Balance of Payment Analysis Team
Domestic Economy Department
Monetary Policy Group
Source: Bank of Thailand