ECONOMYNEXT – Thailand’s currency crisis in 1997 was triggered by monetary policy inconsistent with its exchange rate policy, a former governor of the country’s central bank, Veerathai Santiprabhob, told an economic forum in Sri Lanka .
The Bank of Thailand launched the baht in July 1997, after depleting its reserves by keeping rates low, released its International Monetary Fund program in August.
The collapse of the currency, with a domestic banking sector laden with foreign borrowing, led to a sharp increase in bad debts, which were already piling up, triggering a banking crisis.
“And this monetary crisis and this banking crisis originated in the first place from mismanagement of central bank policy,” Veerathai told an economic forum organized by the Colombo-based Advocata Institute in a rare confession for a central banker.
“What we call the impossible trinity, as anyone who studies macroeconomics well knows, we can have a regime with free mobility of capital, independent monetary policies and a fixed exchange rate. It is the impossible trinity. But we had this system.
“The Ministry of Finance did not want to change the exchange rate regime. No politician likes to devalue.
The Bank of Thailand was one of the most entrenched central banks for most of the Bretton Woods era and after, where politicians supported monetary stability and strong exchange rates, following the experience of World War II in particular.
Thai leaders had resisted the creation of a central bank in the early 1930s on the advice of British experts, including James Baxter who advised the Minister of Finance.
Thailand operated a fixed exchange rate where the monetary agency was under the Treasury, buying and selling the baht at 10.80/11.20 against the pound sterling like a currency board.
The politicians and their advisers of the day were not corrupted by the Harvard-Cambridge economy that destroyed developing countries after World War II.
However, under pressure from the Japanese during World War II, Thailand established a central bank pegged to the yen. He was forced to buy government securities and issue money against the self-inflating yen. Inflation soared and by the end of World War II the country was without reserves.
After the war, the Bank of Thailand began to replenish its reserves through a remarkable tactic of buying dollars at a redemption requirement of 40 baht against sterling and selling at 60 to mop up the cash.
It shifted the anchor to the US dollar following the pound crises, devalued with the US dollar during the Bretton Woods collapse, then revalued to 20.
Its 20 baht peg to the US dollar had broken only twice in 1981 during the first monetary policy tightening by US Fed chief Volker and in 1985 during the second round of tightening. For more than 20 years, Thailand has managed to maintain its peg at 25.
Central banks typically blame deficits, after accommodating them with printed money to keep rates low.
With a strong currency, it is easy to manage the budget, since taxes have a high and stable real value year after year and there is no demand for subsidies since monetary stability serves as an automatic social safety net.
Since budgets are usually blamed for currency meltdowns, Advocata asked about the budget.
“The fiscal position was very strong,” Veerathai said. “The budget deficit before the 1997 crisis was 1 to 2% of GDP. Our public debt was in single digits.
Most of the East Asian countries that were hit by the 1997 crisis and the speculative attacks – usually through the swap market – had good budgets.
Soft-peggers typically blame members of the public for importing goods that are typically net savers — especially in Asia where banks are risk averse — and lack the ability to create a currency crisis.
In 1993, Thailand decided to be an international financial center emulating Hong Kong and Singapore and established the Bangkok International Banking Facility (BIBF).
“So the government and the central bank tried to encourage local banks to use the International Banking Facility, by issuing regulations for what we call inbound transactions,” Veerathai said.
However, unlike Singapore and Hong Kong, the Bank of Thailand was not a currency board and now had a policy rate like a floating exchange rate bank.
In a currency board, capital inflows automatically lead to a spike in liquidity and an immediate drop in rates that discourage new inflows. However, with a policy rate, an interest rate differential develops, encouraging new inflows.
Most of the money flowed in and banks lent to domestic companies, leading to a dollarization of liability.
As the central bank tries to sterilize stopping the “overheating” of liquidity in today’s economic terminology, the interest rate differential is widening further, encouraging domestic businesses to borrow for lower dollar loans. dear and strangers to lend.
“There was a big mismatch, borrowing short and lending long, so bank balance sheets were weak,” Veerathai said. “We also had asset price bubbles with huge capital inflows.”
Large inflows added to the usual foreign direct investment in Thailand widened the current account deficit sharply in the following years.
A bank had problems in 1996. Several finance companies were closed. Foreign speculators who saw the current account deficit widen borrowed baht through offshore market exchanges and began to touch parity.
Bank of Thailand then made the next fatal mistake. It became the counterpart of swaps generating new baht, keeping interest rates low.
The Bank of Thailand lost almost all of its $30 billion in reserves in 1997 and, according to IMF data at the end of 1997, was left with about $19 billion in swaps.
To reduce pressure on the currency, the Bank of Thailand banned foreigners from borrowing domestic currency, thus shutting down the swap market and eventually unwinding its swap stock with massive losses which were factored into the IMF program .
Short-term interest rates soared to 23% and, combined with the currency collapse, bad debts rose above 47% as companies were accustomed to low rates during the period when the peg was working better.
Currency board Hong Kong held, however, with speculators taking heavy losses on their swaps as short-term rates rose, imposing huge costs every time they tried to roll over a contract.
Thailand’s IMF program relied heavily on exchange rate stability, but the impossible trinity no longer worked.
“..[I]If there is increased pressure on the exchange rate, we will raise interest rates and tighten the monetary program if necessary,” the Bank of Thailand told the IMF.
Thailand’s monetary program also had no political conflicts, its foreign reserves target had a cap on net domestic assets with the reserve currency as an indicative target.
When bank credit collapsed, investment fell and loans were repaid, the balance of payments moved into a large surplus in 1998 as more loans were repaid, confidence returned, exceeding forecasts for the IMF program, allowing rates to fall.
However, the IMF no longer makes such programs.
Same impossible trinity in a new bottle
At the time, the IMF benefited from Stanley Fischer, its first managing director, who knew the difference between a clean float and a peg. He hoped at the time that there would be a shift to single-anchor regimes.
“Hong Kong’s economy has successfully withstood massive external shocks and the linked exchange rate remains strong,” Fischer said in a speech in June 1997.
“As a result of the crisis, we are likely to see more countries adopt flexible exchange rate systems, or, if they succeed, do so permanently, for example, as in Hong Kong, through a currency board”,
“Countries that adopt floating rate regimes will need to think about the basis of their monetary policy; increasingly, around the world, the benefits of an inflation targeting regime are being recognized.
“However, this simple dichotomy is unlikely to be the final word, and some countries may seek intermediate regimes, such as a broad target band for the exchange rate, around a central rate which itself may evolve gradually. “, he also said.
Two decades later, the intermediate regimes have won with violently contradictory monetary and exchange rate policies in the form of flexible inflation targeting that are neither clean floats nor hard anchors with inflation targets. as high as 6% leaving more than enough room for policy errors as experience over the past few years has shown.
Meanwhile, the causes in the real economy are still attributed to monetary crises: trade deficits, current account deficits, factor productivity, poor governance, fiscal deficits, rather than discretionary or flexible central bank action. . (Colombo/October 9, 2022)