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IMF not worthy of rates praise


February 27, 1999 -- For all the credit it claims, the IMF cannot really say that it was the first advocate of interest-rate cuts in Thailand, Vatchara Charoonsantikul and Thanong Khanthong report in the third part of a series

Thai interest rates, which were kept high for a prolonged period to defend the baht between late 1996 and August 1998, arguably precipitated severe recessionary conditions and irreparably destroyed Thailand's manufacturing base.

From the outset, restoring currency stability was the prime objective of the International Monetary Fund support programme for Thailand. Interest rates were raised sky-high to make it more attractive to hold the baht and to make it more costly to speculate against it. IMF officials were preoccupied with stabilising the plummeting baht and would not allow the Thai banking authorities to release their grip on monetary policy until August 1998. This prolonged period of high interest rates pushed the Thai economy deeper into recession.

The overnight repurchase rate (the rate at which banks trade bonds with each other to adjust their liquidity) averaged 19.65 per cent in July 1997, the month that the baht was floated, while the baht was hovering around Bt30.27 to the US dollar. Short-term rates were then kept consistently high until they peaked in December 1997 at an average 22.87 per cent. In that month, the baht was traded at a low of Bt45.29 to the US dollar. By January 1998, the baht hit a historic low of Bt56 to the US dollar, while short-term rates averaged 21.86 per cent.

Interest rates were then on a declining trend, averaging 20.57 per cent in February, 18.83 per cent in April, 18.08 per cent in June and 13.84 per cent in July. During the same period, the baht also strengthened to Bt46.30 in February, Bt39.48 in April, Bt42.36 in June and Bt41.19 in July. The critical period came in August when short-term rates were immediately brought down to 13.84 per cent, since when they have continued their sharp decline to 2.6-3 per cent.

From the beginning of the Chuan administration, which came to power in mid-November 1997, Tarrin Nimmanahaeminda, the finance minister, raised the nation's hopes that the crisis would be tackled more effectively. He asked the IMF to review the high-interest-rate policy in the second letter of intent, but the IMF did not agree. Dr Virabongsa Ramangkura, the outgoing Chavalit government's deputy prime minister, and Dr Kosit Pampiemraj, its finance minister, also agreed to the policy of keeping interest rates high despite pressure from the private sector to make credit cheaper.

Soon Tarrin began to share the IMF's conviction that interest rates had to be kept high to defend the baht because the country was bleeding badly from capital outflow. For if the baht was allowed to weaken significantly it would create a vicious circle of currency depreciations, which would not only add inflationary pressure but also destroy the balance sheets of banks and corporations. Besides, Thailand also needed to import. A weaker currency means higher prices for oil and pharmaceutical products, for instance.

There was another school of economic thought that if interest rates were kept too high they would eventually destroy the real sector. Once factories or industries were closed down because of the collapse of their balance sheets it would be difficult to revive them. A former Bank of Thailand official suggested then that the authorities should let the baht float lower by pumping liquidity into the system as a trade-off for safeguarding the manufacturing sector. However, doing so should not be an alternative to badly needed structural reforms in both the financial and corporate sectors aimed at re-establishing the competitiveness of the Thai economy.

But the IMF stood firm on its currency-stability and high-interest-rate policy. Every time the Thai monetary authorities tried to argue the case for lower rates with Anoop Singh, the deputy director of the IMF's Asia-Pacific Department, Singh would shake his head. Interest rates would be kept high in the third letter of intent (February-May 1998). Singh would say to the Thai authorities something like: ''You are saying the same thing again. Interest rates cannot be brought down because it goes against the theory. Isn't it because of political pressure that you are calling for a relaxation of monetary policy?''

It was not until April 1998 that the banking authorities began to make their intervention felt on bringing rates down. This was not aimed at stimulating the economy or relieving the cash-strapped corporate sector but at meeting the target for reserve money, or the monetary base for printing money, agreed in the IMF programme. As it turned out, reserve money fell below the target all along. The target was Bt455 billion in Sep 1997 and the actual figure Bt422 billion, Bt489 billion in Dec 1997 and the actual figure Bt455 billion, Bt480 billion in March 1998 and the actual figure Bt451 billion, and Bt468 billion in June 1998 and the actual figure Bt445 billion.

At a Cabinet session Abhisit Vejjajiva, the PM's office minister, called for the banking authorities to take a look at why the banking authorities had failed to pump in money to meet the target, resulting in tighter monetary conditions.

The credit for bringing rates down should go to M R Chatu Mongol Sonakul, the Bank of Thailand governor, who last August began to put a brake on the Financial Institutions Development Fund's borrowings to prop up the financial system. Suddenly there was ample liquidity in the system. At that time the IMF still argued for high rates to defend the baht. With a shift in fiscal policy to a more expansionary programme and a sudden reversal in the current account from a deficit in 1997 to a surplus in 1998, there was more room to cut rates.

For all the credit it claims, the IMF cannot really say that it was the first advocate of interest-rate cuts in Thailand. It became so only with the benefit of hindsight.



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