1997 Thai Currency CrisisECON 462

Professor CastilloSpring 2011

Team 4Abdiqani HassanLouisa Pangilinan

Yang Qichen

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Causes of the Crisis

Baht was pegged to the U.S. dollar U.S. dollar appreciated, Thailand became

less competitive Net exports declined Thailand depreciated its currency to

promote exports International financial market lost

confidence in Thailand Investors sold their Thai baht

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Formation of the Trade Deficit

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Causes of the Crisis - continued

Thai baht depreciated from 25 to 55 per $1 US dollar in the summer of 1997

Excessive Spending - both consumer and government

Banks lent money to everyone for private real estate and other spending

Liberalization of the financial sector encouraged domestic companies to borrow extensively from foreign countries

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Liberalization of the Financial Sector

Again, liberalization allowed capital to flow freely in and out of the country Supervision was eliminated Domestic banks were now open to outside the world

Since the foreign interest rate was lower Thai businesses and investors bought foreign currency and invested in domestic

Foreign debt increased from 20 bil to 95.4 bil USD in Nov 1997; the short-term debt accounted for over 40% which was 2.5 times of the foreign reserve, and accounted for over 40% of GDP

The US dollar depreciated, so there followed the Baht the speculation; the rest is history

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Effects of Decreased National Saving

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Thai Baht Exchange Rate (1995-1999)

20

25

30

35

40

45

50

55

Jan-

95

May

-95

Sep-9

5

Jan-

96

May

-96

Sep-9

6

Jan-

97

May

-97

Sep-9

7

Jan-

98

May

-98

Sep-9

8

Jan-

99

May

-99

Sep-9

9

Th

ai B

aht

to $

1 U

S

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More factors that contributed to the Crisis

Real Estate Collapse up to 15% More than 150 Financial Institutions where

shut down like the Financial One Company Major lay offs Poverty rate increased Stock market dropped 75% Fall of the world’s demand of

semiconductors which was one of the Thai major exports

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Effects to the Aggregate Economy

Exports declined Cost of raw material and wages increased Lost major customers such as the U.S. and

Europe China emerged as an intimidating

competitor in international trade

During the Crisis

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Scope of the Crisis

Thailand experienced severe banking-financial sector crises that began before its currency crisis

Pre-crisis nonperforming loan rates were 19%, or roughly 30% of GDP; in 1998, the delinquency rate increased by 30%.

The cost of recapitalizing and restructuring the banking system reached 35% of GDP.

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Scope of the Crisis (continued)

The CPI rose about 11% between June 1997 and 1998

Thailand’s government domestic debt jumped to almost 10% of GDP; external public sector rose to almost 25%

1997 Q4 RGDP dropped 4.4% vs the previous year; the first half of 1998 dropped another 15%

Unemployment rate averaged 1% during 1994-1997; it increased to 3.4% in 1998.

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Response of policy makers

Thailand followed tight monetary policies; it did not allow its monetary base to expand

Monetary authorities extended enormous credit lines to its banking systems; central bank credit to deposit money banks rose 761%

Thai government waited 26 days to ask the IMF for help

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Response of policy makers (continued)

IMF intervened - reversed the devaluation process Temporarily increased interest rates to halt

currency depreciation, and reduce expenditures in all sectors of economic system

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Effects of a Decrease in Investment Demand

Post-Crisis

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The IMF’s Intervention

IMF gave a lending package of US$ 16.7 billion and asked the Thai government to reduce financial expenditure, increase value-added tax, and prohibit seeking help to those problematic financial institutions and real estates

Official foreign reserves increased to about US $14 billion by the end of March 1999------current account turned into substantial surplus----Thailand began to strengthen by Feb 1998

BUT DID THAT REALLY HELP???BUT DID THAT REALLY HELP???

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Bad Impact

Thailand faced a huge cost that was severe economic contraction---Real GDP growth declined from the second quarter of 1997, and declined another 8.4% in 1998.

IMF had forecasted the following: a positive real GDP growth of 3.5%, a current account deficit of US$ 5.3 billion, and a capital account surplus of US$ 1.8 billion in 1998. BUT EVERYTHING HAPPENED IN THE OPPOSITE

IMF badly misjudged the severity of the IMF badly misjudged the severity of the economic downturneconomic downturn

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What the Thai Government did Baht used to link to USD. Now government let

it free flow. Baht depreciated: 1USD-25 Baht 1USD-56Baht

Used tight financial and fiscal policy Shut down problematic financial institutions,

and merged the good conditional banks to enhance the power

Increased the supervision to the financial institutions, established special entities, and improved the process of auction of laws

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Recovery of the Economy Turned production from being domestic

oriented to more export oriented Currently, Thailand’s banking system is one of

the strongest in the region based on capital adequacy ratio

Thai banks rely on domestic funding through its deposit base. Lending against deposits is about 88%; therefore, liquidity is no longer a problem

Now considering more on reducing risk in order to stimulate lending

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What the Thai crisis has taught us

Correctly understand financial liberalization

Depend on the country itself at the prime time

Enhance supervision’s fairness and transparency

Preventing is always better than solving problems

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Thank You