The Monetary Crisis of the Thai Baht

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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

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Contents

1. Introduction
2. The Crisis Overview
3. Background
4. Stabilization Strategy
5. Aftermath On the road to recovery
6. Summary

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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

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Thai dies Bangkok SET index
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Background (1)

• The economic boom
• Point of origin beginning of the 80s,
  stock-market crash and economic crisis
• Japans 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

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Background (2)

• 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

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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

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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 Bahts 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

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The Crisis Overview (2)

• 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

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The Crisis Overview (3)

• 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

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Tumbling Baht against the dollar
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Sink or swim Currencies against the dollar
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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

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Stabilization Strategy (2)

• 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

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Stabilization Strategy (3)

• 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

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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 cant be realized
  simultaneously
• In the early stages
• Call for budget surplus and a restrictive money
  policy
• Government intervention in the weakest banks

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Aftermath On the road to recovery (2)

• 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 growthgt4 in
  1999)

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Aftermath On the road to recovery (3)

• 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

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Impact
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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.