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Decisive action may stop recession

There are few other avenues open to the authorities to heal the financial system other than by drastic surgery, believe Vatchara Charoonsantikul and Thanong Khanthong.

Ayutthaya's failure to mobilise resources, to coordinate and manage strategies led to its fall to the Burmese in 1767. As Mark Twain puts it, ''History does not repeat itself but it rhymes."

The Chavalit government's failure to deal with the macroeconomic crisis rhymes perfectly with the turmoil inside Ayutthaya while the Burmese armies were engulfing the old capital.

There is a seemingly unbridgeable gap between the political apparatus and the Finance Ministry and the Bank of Thailand machinery, an inability to respond effectively and in timely fashion to the foreign exchange and financial crises which threaten to plunge the Thai economy into a recession.

It takes two to tango. Without effective coordination between the politicians and the bureaucrats, the chances of Thailand overcoming the macroeconomic dilemma are slim.

On Saturday, Prime Minister Chavalit Yongchaiyudh sent his emissary, Bokhin Polakula, to meet Chat Pattana leader Chatichai Choonhavan. Their talks appear to have centred on dissatisfaction with the economic team assembled by Finance Minister Amnuay Viravan.

If reports that Chat Pattana would like to get hold of the Finance portfolio are true, it only adds to the confusion and disarray at the very top of the country's macroeconomic management.

The political body hardly understands that Thailand is in deep peril, balanced on a tightrope. The slightest imbalance will send the whole country down into the disastrous Mexico valley.

When foreign speculators returned in mid-May for their second foray against the baht this year, banking authorities responded by shutting down the foreign exchange swap market.

The semi-exchange controls sent the cost of baht borrowings on the offshore market up more than 1,000 per cent, dealing the speculators a stinging blow. Some of them lost up to US$50 million (Bt1.3 billion) through this unsuccessful campaign to force a baht devaluation.

Trying to get a hold on the baht to settle their forward positions, some speculators circumvented the loopholes by selling back baht-denominated commercial paper to local mutual funds or financial institutions. This prompted the authorities to jump behind the speculators' back again by ordering the local institutions not to buy back commercial paper from foreigners.

This came after some local and foreign bank branches had already repurchased between Bt12 billion and Bt15 billion of baht-denominated commercial paper from the relieved speculators, who then lent out their fresh baht-supply to others on the offshore market for a handsome profit of 40 per cent in interest rate equivalents.

Undaunted, the foreign speculators, who had huge short baht positions to cover, tried to circumvent the regulation by going directly to importers and asking for forward invoices to get hold of the baht. Again, they were blocked by vengeful Thai regulators.

Last week the foreign speculators appeared to have found their baht mines in the stock market. They went in to mercilessly hammer the blue-chip stocks. Baht proceeds from the stock market battering were shifted offshore, where sharp profits from baht lending were easily made.

This time the cat-and-mouse game is over. The regulators cannot shut down the stock market. The foreign investors have emerged as a dominant force on the Thai exchange, accounting for almost 60 per cent of all buy and sell transactions last week.

With local institutional and retail investors running out of cash, the foreign investors have virtually taken the Thai market hostage.

Selling pressure from them will further depress the financial assets of most Thai companies, which tie most of their assets to stocks. A meltdown of their financial assets has complicated the task of the authorities to resolve the financial crisis.

With the stock market meltdown and a collapse in the credit system, liquidity has dried up. A shut-down of the foreign exchange swap market has also added to the foreign investors' nervousness over Thailand's policies.

An economy cannot function without liquidity. Even worse, most of the scarce money is being channelled unproductively to keep the troubled finance companies afloat.

Normal commercial lendings faced a big jolt, threatening to send the economy into a tailspin. There are grounds for a Union Bank of Switzerland economist's assessment that the chance of a recession in Thailand has increased from zero to 30 per cent.

If that does happen, local companies will go bankrupt and factories will close down. Unemployment will skyrocket and trigger social and political unrest.

In such a climate, no fresh investment will pour into the country. The agony from a recession heightens. That is pure disaster.

Of utmost concern is the almost virtual halt in capital inflow. As a capital deficit country, the Thai economy depends on foreigners by as much as 20 per cent of its total domestic money demand.

Until now, foreigners have been willing to finance Thailand's current account deficit to the tune of Bt300 billion to Bt400 billion a year.

With the financial crisis, that foreign money is not coming in, resulting in a shrinking of the economy to the level where it is being supported by domestic cash. Without foreign capital, there is no way the economy can grow six or seven per cent.

The cost of funds, or interest rates, have to be kept high to attract foreign capital and defend the baht. The high interest rate policy is sending Thai corporations to their knees. No companies in the world can afford to pay 15 to 16 per cent a year for a prolonged period.

And this adversely affects the price competitiveness of Thai manufactured goods in the global markets. When exporters cannot sell their products, that spells disaster for Thailand, which is unquestionably an export-led economy.

The speculative baht attack notwithstanding, the foreign exchange crisis is a by-product of a financial crisis. For years Thailand has mismanaged its macroeconomic policy by maintaining the currency peg system while moving to undertake radical financial deregulation.

While the interest rate has been floated, the foreign exchange rate is fixed. With the predictability of baht movements due to the fixed currency regime, foreign capital began to pour into the Thai market in the early 1990s.

If the currency peg system had been unpegged in 1993 or 1994, the ''hot money", or short-term capital, would not have flooded the Thai market and set the stage for the bubble economy.

This currency peg system now handcuffs the banking authorities' monetary policy. Without flexibility in managing the monetary policy, the central bank cannot set interest rates. Sooner or later the currency peg system must be abandoned.

Now Thailand is paying a dear price for the fixed exchange regime, which will have to be thrown away whenever the window of opportunity arises.

To complicate the problems, finance companies, which account for Bt1.4 trillion in total deposits, are in big trouble. A third of them could go bankrupt anytime if banking regulators deny them liquidity support.

The regulators are preparing a comprehensive mergers and acquisitions package to deal with the troubled finance companies once and for all. Yet the measures appear to have been delayed by a bureaucratic deadlock.

A lack of understanding from the political apparatus has further dealt a setback to attempts to resolve the financial crisis.

There are few avenues left for the authorities other than drastic surgery.

First, bankrupt finance companies must be allowed to go under by market forces.

Second, the mergers and acquisitions package must be pushed out boldly with incentives for merged finance companies to become banks as quickly as possible.

Third, the shut-down of the foreign exchange swap market must be lifted with new but fair rules limiting transactions.

Fourth, interest rates must be brought down to relieve economic woes.

Fifth, the currency peg system must be abandoned to allow the baht value to reflect the capital movements of Thailand's trading partners. This is not a one-time devaluation because a devaluation is a betrayal of international trust.

Sixth, measures to further deregulate the economy, accelerate privatisation, consolidate the fiscal policy, encourage investment over consumption, and bolster exports must be announced with a strong and credible action plan.

These measures must be implemented almost simultaneously and immediately if Thailand is to ever get out of this mess, which will also have far-reaching political implications. Time is running out.



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