A case of desperate times crying out for extreme measures
May 28, 2001
Prime Minister Thaksin Shinawatra's call for higher interest rates is
unorthodox as it defies the conventional wisdom that high economic growth
and low interest rates pay the best political dividends.
Yet since the current economic situation is abnormal, an unorthodox approach
is probably what is required.
And after meeting Virabongsa Ramangkura, who has urged that deposit rates
be lifted at least 4 percentage points to stem the outflow of capital,
the prime minister has become more inclined towards this contrary view.
So last Monday he summoned Bank of Thailand governor MR Chatu Mongol
Sonakul, who was accompanied by his assistant Thirachai Bhuvanatnara-nubala,
for a workshop. The prime minister wanted to know whether the low-interest-rate
policy, implemented in August 1998, had been overdone or was still relevant
to the current economic conditions.
According to Government House sources, Thaksin's view was that fiscal
stimulus, the only tool left to salvage the weak economy, would be useless
if capital were pouring out of the country, no matter how much money the
government pumped into the economy. He has come to believe that the low
baht interest rate, even lower than US dollar rates, were the primary
cause of the outflow, now at a rate of US$1 billion a month. Not only
are foreign investors unwilling to hold the baht, but Thais are also selling
the baht if they can.
Moreover under the present conditions there would be an unwanted side
effect from any fiscal stimulus scheme. For every baht pumped into the
economy by the government, there would be upward pressure on imports.
At a time when exports are weak and the trade balance is already deteriorating,
fiscal stimulus would add pressure to the current account. Any current-account
deterioration ultimately leads to exchange-rate weakness and the end of
the economic recovery.
Keynesian-style fiscal stimulus may be effective in an economy with a
fixed-exchange-rate regime. In a floating-exchange-rate system it is less
effective, not to mention other complications caused by the capital outflows.
An economy that cannot hold on to money is doomed to fall into recession.
When Thaksin calls for interest rates - and he means deposit rates only
- to rise, he is aiming to tackle the capital outflows. In this sense
the prime minister, in spite of his instinct to go for high economic growth,
would like to go back one step to deal with the macroeconomic stability
first before pouring fiscal money into the economy to generate growth.
For without macroeconomic stability there is no way for the economy to
Certainly his line of argument reflects that of Virabongsa, the unorthodox
economist, whose view appears set to be tested and implemented, completely
reversing the monetary policy of the central bank.
Banks have been enjoying low interest rates for too long, with funding
costs of only 2 to 3 per cent against lending rates of 7 to 8 per cent
for prime customers, 14 per cent for housing loans at some banks and more
than 20 per cent for credit cards. The banks also are less inclined to
lend money to the cash-strapped economy, preferring instead to take the
low-risk option of buying foreign-currency securities.
Chatu Mongol and Thirachai were not ready to answer the question put
by the prime minister and his economic team, according to the Government
House sources. Chatu Mongol argued that low interest rates were necessary
to salvage the banking system and help the private sector to reduce its
high level of external indebtedness.
The central bank, he said, has exhausted its monetary tools, with neither
higher rates nor lower rates, and the remaining avenue to boost economic
growth is government spending. Lower rates have also led to a reduction
in the foreign debt, which has fallen from US$112 billion (Bt5.1 trillion)
in the pre-crisis to $76 billion. Chatu Mongol also made assurances that
the central bank would be able to manage with reserves at $32 billion
over the next five years.
But the prime minister said interest rates should also be looked at as
part of a multidimensional framework rather than from the narrow interests
of the financial sector. Chatu Mongol and Thirachai agreed to study the
economic models in the event of the implementation of the higher rates.
He requested that he and his team should have two weeks to work on the
issue. After leaving Government House, Chatu Mongol told reporters a different
story, implying that politicians were interfering with his monetary policy.
That's when the dam broke. A heated public debate ensued about interest-rate
policy and more importantly about whether the governor would last after
he had incurred the wrath of the prime minister. It remains to be seen
who is right or wrong in this contentious debate, but the final showdown
seems to be set for next Monday when Chatu Mongol presents his full report
to support his low-interest-rate policy. The report could be his signing
of his own death warrant.