The Monetary Crisis of the Thai Baht

The Monetary Crisis of the Thai Baht

Macroeconomics II

SoSe 2004

Prof. Dr. Paul Bernd Spahn

Dipl. – Volkswirt Jan Werner

Saskia Scarbrough, Candace Toussaint,

Stefan Khanna, Sha He

2 Hier wird Wissen Wirklichkeit

Contents

1. Introduction

2. The Crisis : Overview

3. Background

4. Stabilization Strategy

5. Aftermath : On the road to recovery

6. Summary


Introduction

The Bahtulism epidemic• 20% loss of value by the Baht to US dollar in less than 1 week• Asian contagion spread rapidly across Asia

- Stock prices fell- Real estate prices plummeted- Non-repayment of loans in Yen, Marks and Dollar by banks

and corporations- Local currencies across Asia went into free fall, for example

Malaysian Ringgit Indonesian Rupiah Phillipine Peso


Thai dies : Bangkok SET index

Stock Exchange of Thailand SET Index

0

200

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1600

01.0

1.95

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3.95

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5.95

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1.95

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3.96

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5.96

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7.96

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9.96

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3.97

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5.97

01.0

7.97

01.0

9.97

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1.97

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9.98

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1.98


Background (1)

1.The economic boom• Point of origin: beginning of the 80´s, stock-market crash and

economic crisis• Japan‘s capital inflows prevent an IMF rescue• Thailand becomes an important exporter of manufactured goods• Over 2 decades economic growth averaging 6.7%

2. Endangered cyclical downturn• Huge demand for capital • Alternative countries for production (e.g. Vietnam, China) due to

inland wage increases


Background (2)

3. Regulation vs. Liberalization• Agreement with GATT and WTO Thailand opens markets

- Milestone decisions : Lifting of controls on all foreign exchange transactions on the current account

- Opening of the Bangkok International Banking Facility (BIBF)

• 3-year-plan (1990-1992) introduced to improve financial system

• Tight coupling of the Baht with the USD

• Opening of the bond and stock market for foreign investors

• Development strategy emphasizes role of private sector


Background (3)

4. Effects of Liberalization

• „Virtuous circle“ = high growth rates attract new capital inflows

thereby creating higher growth in economy and export

• Thai banks lend foreign borrowed money to domestic banks

• Oversupply in construction sector – 50% of loans are non-performing;

banks having trouble to service their foreign debt

• 1994: Depreciation of Chinese Yuan by one third – reduction in Thai

competitiveness

• 1995: US$ rises against most currencies – and so does the Baht

• Growth sinks from 26% in 1995 to 1% in 1996


The Crisis : Overview (1)

Macroeconomic landscape • Financial liberalization and deregulation since early 1990s• Strong capital inflows• Unhedged foreign currency borrowing• Excessive reliance on short-term external debt

Overvalued currency • The Baht‘s peg to strengthening US dollar arose suspicion of

being overvalued• Link between currencies looked unreasonable due to high current

account shortfalls, inflation & asset bubbles- Speculative runs triggered against the Baht by currency

traders hoping to profit from a devaluation



Political instabilities:• Over investment in unproductive sectors, especially in property

- Misallocation of funds in uneconomic factories (e.g. By cronyism, corruption)

• rotten pseudo-democracy (vote-buying)

Waning investor confidence• Attack on Baht by hedge fund operators such as George Soros

and Julian Robertson intensified (early 1997)• Increasing number of non-performing loans• Many investors exchanged Baht for dollars (fearing instability)• Massive sell-off of Baht by companies operating in the region



Government intervention• Interest rate increases. For offshore borrowers more than 1,300%

to deter speculators (May 1997)• Suspension of 16 finance companies• Billions of dollars invested (mostly on forward contracts) trying to

defend currency- Central bank finally depletes resources in the process

The bursting of the bubble• Devaluation and floating of the Baht on July 2nd 1997

- Foreign investors fled- Flurry of loan defaults by many businesses- Many banks on the brink of bankruptcy


Tumbling : Baht against the dollar

Thai Baht vs. US$20

25

30

35

40

45

50

55

60

2nd July 97"official" start of the crisis28th June

suspension of 16 financial institutions

May 97 Attack on Baht by

international speculators

5th August 97 Entry price into the IMF programm,suspension of 42 more financial companies, totalling 58

low in Baht vs. US$, approx. 6 month later


Sink or swim : Currencies against the dollar

Currencies vs. US$

20

25

30

35

40

45

50

2

2,5

3

3,5

4

4,5

5

Thai Baht

Phillippine Peso

Malaysian Ringgit (rhs)


Stabilization Strategy (1)

(under IMF consultation)• Short-term goals:

- restoring of market confidence & stability- stopping massive capital flight due to the Baht devaluation

• Long-term goals:- macroeconomic stability- implementation of key structural reforms- Recapitalization of the banking system



• 1st Letter of Intent : (14th August 1997)

• Fiscal side: Fiscal austerity (tax increases and expenditure cut to offset the costs of financial restructuring)

• Monetary side:- Stringent monetary policy to stabilize the exchange rate

(money growth declined)

BUT

Slowdown of the economy led to a large revenue shortfall



• 2nd Letter of Intent : (November 1997 - most difficult time, baht

reached 54 to a dollar)- Further cuts in government expenditures - Minor tax increases - More stringent monetary policy, with M2 growth to be kept at 1

per cent

• 3rd Letter of Intent : (24th February 1998)- to achieve a comfortable current surplus, whose attainment was

now mentioned as allowing fiscal relaxation.

• 4th Letter of Intent : (26th May 1998)• Change in IMF policy- Deficit spending as a stabilization strategy


Aftermath : On the road to recovery (1)

• Closure of 10 finance companies at the start of the crisis, aimed at

creating confidence towards the still existing finance companies- The opposite was the case, the closure was interpreted as proof for a

desolate finance sector

• Impossible Trinity: - capital mobility, fixed exchange rates, self-contained monetary policy

can‘t be realized simultaneously

• In the early stages:- Call for budget surplus and a restrictive money policy- Government intervention in the weakest banks



• Change in Policy since beginning 1998

• Fiscal policy shifts targeting budget deficits

• Focus: privatization in the intervened banks, sale of assets from

finance companies, restructuring corporate debt & strengthening the

institutional framework

• Foreclosure procedures introduced and foreign investment

restrictions are reduced

• High interest rates are reduced by mid-1998.

• Non-performing loans remain on a high level.

• Positive growth in late 1998 (GDP growth>4% in 1999)



• Foreign-exchange reserves remain $32-34 billion

• Strenghtening of both the Central Bank & the financial and corporate

sectors

• The established „Chiang Mai-Initiative“ among the ASEAN

members, China, Korea and Japan is an important example for the

new membership in that region. Swap-retail deals offered

• IMF criticized: Greater interest in safeguarding foreign creditors, than

avoiding collapse in Asia


Impact


Summary

• Until the crash of 1997, the Thai economy had performed

exceptionally well. The consequent crisis therefore raised many

questions as to the root of the problems. Was it purely speculation,

economic factors or a combination of both, that led to the dismay ?

• Besides all criticism towards the IMF policy one can conclude that the

reason for the crisis has not been financial liberalization, but the

inadequacy of regulation.

• In the end, transparency leads to increased confidence in the

financial system and reassures future foreign investments and

decreases the probability of a new crisis.

The Monetary Crisis of the Thai Baht

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