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Choices: Go broke or baht goes

July 2, 2001

At 5am on July 2, 1997, Vichai Punphocha, general manager of Dresdner Bank AG, was awoken by a surprise call. Somebody at the Bank of Thailand wanted to talk to him.

Vichai left Thailand for Germany when he was 17 years old and didn't return until he took up the Dresdner Bank assignment in Bangkok in 1993.

He was asked to go to the Bank of Thailand's Bangkhunphrom headquarters at 7am to attend an important meeting.

"What in the world is going on?", he wondered. Vichai was quite well known in domestic banking circles for being well rounded and outspoken.

Olarn Chaiyapravat, the economic guru who had predicted the golden era of the Thai economy a decade earlier, received a similar call from the central bank early that morning. He, too, was puzzled as to what exactly was going on.

Olarn had been arguing publicly against a devaluation of the baht because he felt it went against his pricing theory and it would not increase the competitiveness of Thai exports. Moreover, a devaluation would wreak havoc on the banking system and ruin the balance sheets of Thai companies.

He would never have believed that the central bank would do what it had finally been forced to do.

Olarn dressed quickly and rushed to the central bank. After getting out of his car, he walked towards the steps to the main entrance, where he bumped into Sirin Nimmana-haeminda, president of Krung Thai Bank. He asked Sirin whether he knew what the meeting was all about.

Sirin replied: "You bet: I think they're going to announce the devaluation of the baht."

Even then, Olarn could not bring himself to believe that the day of reckoning had finally come.

Floating down

On that fateful morning about 70 top local and foreign bankers, accompanied by their treasurers, gathered at the central bank.

Greeting them were governor Rerngchai Marakanond; Chaiyawat Wibulsasdi, deputy governor and manager of the Exchange Equalisation Fund; assistant governor Siri Garnjaroendee; assistant governor Tanya Sirivedhin; Bandid Nijathaworn, director of banking; and Kleothong Hetrakul, director of research.

The guests were handed a press release, written in Thai, outlining the decision to finally abandon the fixed exchange rate regime - in place since 1986 - in favour of a managed float.

Facing the uneasy local and foreign bankers, Rerngchai and his team immediately launched into an explanation of the rationale and technical points of central bank's new foreign exchange policy.

Since the conference was conducted in Thai, some of the foreign bankers, who had not brought along their Thai aides to interpret, were squirming in their seats. They were anxious to make sense of what was going on.

There were some important questions raised at the meeting. First, would banks still be allowed to enter into currency swaps or forward agreements with the central bank, and if so, at what rate?

Deputy governor Chaiyawat did most of the talking, saying these kinds of foreign exchange activities with the central bank would be temporarily suspended, but commercial banks could still enter into swap or forward agreements and quote rates among themselves.

Another banker asked about how the managed float system was going to work in practice. Chaiyawat answered that the central bank would still act as the lender of last resort but it would no longer quote a mid-rate as a benchmark for trading the baht against the dollar. Instead, market forces would determine the value of the baht.

He added that the central bank would simply step in every afternoon, between 4 and 4.30, in case any bank needed to cover its foreign exchange position. The value of a transaction would be in round figures - US$1 million, $2 million or $10 million, for example.

Later on in the day, the central bank went public with a full statement, telling the financial markets that it had decided to change its foreign exchange policy for good. The 13-year-old peg to a basket of currencies dominated by the greenback would be immediately superseded by a managed float system. This would allow the baht to move more flexibly in line with economic fundamentals.

The move amounted to a de facto baht devaluation, driving down its value by 15-20 per cent in one day.

The dam had finally burst.

In the absence of an official mid-rate, Standard Chartered Bank became the first player to test the waters. It quoted an onshore baht rate of Bt28 to the dollar. Banque Indosuez, the French bank, followed up by quoting the Thai baht at Bt29.50. In the offshore market, the baht was quoted at Bt28.50, sharply up from Bt24.70, effectively bringing the offshore and onshore rates into convergence.

Bangkok Bank quoted its buying rate for US banknotes at Bt24.98 and its selling rate at Bt30.16. Most local banks took a wait-and-see attitude.

Chaiyawat assured the world that within seven days, the market would find an equilibrium level for the baht. He had in mind that the baht should hover around its fundamental level of Bt28-Bt29. On that day, the interbank rate shot up almost 30 per cent, instead of 70-80 per cent as feared by bank regulators.

The central bank had moved to stem currency depreciation by raising its discount rate - the rate at which it lends short-term money to commercial banks - from 10 per cent to 12.50 per cent. But the Stock Exchange of Thailand displayed irrational exuberance by jumping 41.51 points to close at 568.79 on turnover of Bt10.42 billion.

Investors believed that the baht float would at least give authorities more room to manoeuvre in implementing monetary policy and end the uncertainty over the exchange rate mechanism. They were totally misguided.

Rerngchai was relieved in a way about finally letting the baht go, but he did not quite understand all of the ramifications. The worst was yet to come.

At the Fish House

A week earlier, either on June 25 or June 26, Rerngchai and Chaiyawat briefed finance minister Thanong Bidaya on the exchange rate crisis, in particular about the dwindling foreign exchange reserves and the huge swap obligations.

In early June, the net foreign exchange reserves of the Bank of Thailand fell to between $6 billion (Bt272 billion in today's baht) to $7 billion, before falling further to $4 billion to $5 billion between June 20 and 26, compared to $38 billion at the end of 1996. By June 30, foreign exchange reserves were virtually depleted, with only $2.8 billion left.

They were having their discussion at the central bank's Fish House, which overlooks Chao Phya River. Thanong recalled later: "A week after my appointment as finance minister, Khun Rerngchai came to me with the documents and said, 'Here you are, you need to make a decision [on the baht policy and the closing down of the 16 cash-strapped finance companies]'." When he learned about the swap positions and the foreign exchange reserves, Thanong agreed to go along with the plan to free the baht.

It was inevitable at this point that the central bank would surrender the currency peg system because $400 million to $500 million a day were being drained from its foreign exchange coffers. All the big banks were rushing to sell baht for dollars either to repay their foreign debts or to cover their short positions.

Chaiyawat proposed that the announcement of the floating exchange rate regime be made on July 4, right after the first half of the year, so that it would not mess up the accounting books of Thai companies.

It was no secret to outsiders that at this point the Bank of Thailand was broke. JP Morgan estimated that central bank reserves were in the red by $8 billion from the costly baht defence. News that Thailand had gone bankrupt was spreading like wildfire in the Singapore forex market.

Questions have been raised about the role of then prime minister Chavalit Youngchaiyudh in the failed baht defence. How much was he involved? Was he kept informed all the time about the foreign exchange reserves and the currency swap obligations? The answer is that Chavalit somehow must have known all that was going on.

One day in early June he asked Rerngchai what the current level of foreign exchange reserves was. When he was told that it had fallen to $4 billion, he was shocked. He was also told that this was the amount in early June and nobody knew how much would be left by late June. By this time, it was clear more than ever that the fixed exchange rate was doomed.

Going into a huddle

On June 29, top banking officials met again to prepare for the baht flotation. Afterwards, Rerngchai and Thanong went to meet the prime minister at Government House to update him. Also present at the meeting were Prime Minister's Office minister Bhokin Palakula, Chavalit's right-hand man, and Chatu Mongkol Sonakul, permanent finance secretary and budget bureau director. The discussion centred on the budget process.

After the meeting, only Thanong, Rerngchai, Bhokin and the prime minister stayed on to discuss foreign exchange policy. Just as Thanong was about to explain to Chavalit about the need to adjust the foreign exchange regime, Rerngchai protested because he was not comfortable with Bhokin's presence.

But the prime minister shrugged him off, indicating that it was all right for Bhokin to join in the conversation. So Thanong went ahead to inform the prime minister that the Bank of Thailand had decided to change the foreign exchange regime. He then passed it on to Rerngchai to report to Chavalit as necessary. Chavalit nodded his head.

It was only a day earlier that the prime minister had gone on television to assure the nation that there would be no devaluation of the baht.

After reporting to the prime minister, Rerngchai rushed back to the Bank of Thailand with the mandate. The declaration of the new managed float system would be made after June 30, when corporations would close their books.

Everything was kept top secret. Rerngchai did not even break the news to his wife. No reports would be typewritten in advance for fear of a leak. But word of the imminent baht flotation was beginning to trickle out.

Rumours abounded about the failures of five more commercial banks, adding to the pressure for him to hasten the adoption of a new foreign exchange system to curtail the growing panic.

On July 1, a bank holiday, Thanong, Rerngchai and Chaiyawat went to Government House to report to the prime minister again about the flotation of the baht. Chavalit had just presided over the Cabinet meeting held every Tuesday.

Again, Bhokin participated in the meeting. He asked several penetrating questions about the ramifications of the baht flotation. Rerngchai was impressed with his knowledge. Chavalit had no objection to floating the baht. He was given a file with documents advising ministries on how to prepare for the consequences of switching to a new currency regime.

Then Rerngchai and Chaiyawat handed Thanong a document authorising the altering of the foreign exchange regime. After reading it, Thanong said: "The situation is critical. So I'll go ahead and sign it, okay?"

After getting Thanong's signature, Rerngchai immediately went back to Bank of Thailand's headquarters to get ready for the desperate action.

Initial assessments were made about the impact of the flotation. Rerngchai and his staff discussed inflation - the upward price pressure on public utilities. Their assumption was that at most the baht would lose 10-15 per cent of its value after the flotation.

His team took a rough assessment of the value of the baht after the flotation with each member writing his estimate on a piece of paper and dropping it in a can. The opinions were mostly that the baht would fall to Bt32.

The matter was so confidential that he did not even dare send his daughter, who was studying in Canberra, Australia at the time, some money to buy Australian dollars for fear that later he would come under suspicion of using inside information to speculate against the baht himself.

Rerngchai agreed to move up the date to let loose the baht to July 2.

Thanong Khanthong



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