Financial liberalization and the capital account : Thailand, 1988-97

The authors examine Thailand's macro-economy and micro-economy for the period 1988-97 to assess the extent to which the country's mix of macroeconomic and financial sector policies contributed to its economic crisis in 1997. They conclude that the crisis was fundamentally one of private sector debt, rooted in private behavior that affected the magnitude and composition of investment and how it was financed. Unlike the Latin American debt crisis, the Thai crisis was not caused by excessive sovereign borrowing. Financial sector weakness--including inadequate regulation and supervision, implicit deposit insurance, concentrated ownership structures, and poor accounting and disclosure--combined with liberalization of the financial sector and capital accounts, increased vulnerability by creating incentives for risk-taking by financial institutions. Many macroeconomic fundamentals were strong, but the combination of tight monetary policy and an inflexible exchange rate created strong incentives for residents to expose themselves to excessive foreign exchange and liquidity risks. Weak corporate governance, including close corporate links to the banking sector, encouraged risky investments and over-diversification in the corporate sector.