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Free float only the first factor

Floating the baht is a necessity but not sufficient to rectify Thailand's economic fundamentals, say Vatchara Charoonsantikul and Thanong Khanthong.


Most Thais seem to have been caught in a state of irrational exuberance, believing that the Thai economy or business in general will suddenly improve as a result of the Bank of Thailand's floating of the baht.

This is a misguided sentiment. ''People should not be as simplistic as to believe that things are going to improve overnight because we have adopted a new currency regime," said Dr Prasarn Trairatvorakul, the deputy secretary-general of the Securities and Exchange Commission.

''Floating the baht represents only one necessary condition for the banking regulators to have more flexibility in managing monetary policy. The new foreign exchange regime alone is by no means sufficient for the restructuring of the country's industrial sector."

The Thai standard of living will be tested by the extent to which the country can improve its production processes, apply new technology, educate its workforce, sell more goods in world markets, invest in new infrastructure and attract additional foreign direction investment. These are fundamentals for any economy.

The Thai public have largely thrown their support behind the central bank's decision to abandon the currency peg system, which has been an anchor of Thailand's macroeconomic stability over the past decade. They have the right to believe things will get better.

Over the past six months, amid the sharp deterioration of macroeconomic conditions, the value of the baht had become the subject of grave misgivings. Yet the central bank had virtually no choice under the currency peg system. It had to keep interest rates high and exhaust its international reserves to defend the baht from speculative attacks.

Foreign capital, crucial to keep lubricating the Thai economy, had been draining from the country. So it was merely a question of timing as to when the BOT would throw out the fixed exchange rate mechanism and embrace a more flexible foreign exchange regime that would give it more independence to set interest rates or to manage the money supply.

Tackling the foreign exchange policy would provide foreign investors with an element of certainty that they could bring their money back. That would pave the way for liquidity to improve and interest rates to fall, which would give Thai businesses a shot in the arm.

However the timing to unpeg the baht was highly questionable. There had been pressure from business interests for some time for the BOT to devalue. All the big corporations have emerged unscathed from the baht flotation because their ties to politics give them advantages unavailable to others.

The money motive aside, the BOT could also sense the pressure from another round of baht attacks after the mid-May assault. The baht was attacked again in London and New York on July 1, while Hong Kong was celebrating the handover.

The BOT, which had already come under criticism for its costly defence of the baht, calculated that the situation with its reserves would not improve if it clung to a fixed exchange rate when the financial markets had already discounted the baht to Bt30.

So the BOT decided to take a leap of faith by floating the baht instead of devaluing it, which would have set another questionable benchmark for the currency. This move also amounted to a de facto devaluation of the baht, which lost 15 to 20 per cent of its value on day one.

The Thai public do not fully understand the implications of Thailand's embracing a new foreign exchange regime. Much worse, they have been misguided into believing that business conditions in general will improve dramatically in the post-currency peg era.

With the stock market staging a big rally over the past two days, increasing by almost 90 points, most people have interpreted this as a sign of confidence. Not yet.

Foreign investors, who have largely driven the Thai equity market, earlier snapped up blue-chip stocks, which are very cheap, because they needed the Thai currency to cover their short baht positions. Following the baht floatation, they were able to get Thai stocks at 15 to 20 per cent cheaper when the local currency depreciation was taken into account.

Fundamentally, the Thai economy has not changed. It is still facing the current account deficit problem. The service account is also deteriorating. The finance sector crisis is still far from resolved. Thai exporters and industrialists are still struggling from their loss of competitiveness.

They can no longer bank on their past success, built on low labour wages, outdated production processes, abundant natural resources and easy money.

So instead of misleading the public into believing the managed baht float will help the Thai economy to take off in full stride, Prime Minister Chavalit Yongchaiyudh should embrace reality. He should provide a guiding conscience and an indication as to where the nation will be heading.

Double-digit growth rates will now be history. The country's failure to improve education standards is causing a shortage of skilled labour.

This slows structural adjustment of the economy and limits potential growth. If this structural bottleneck is not cleared, potential growth of 6 to 7 per cent will never be achieved.

So far there has been a complete lack of leadership as to how the country will be managed under the new foreign exchange regime. Greater uncertainty and greater challenges are lying ahead. The Thai economy is now completely globalised and requires a leader of global proportions.

From now on baht movements will reflect confidence in the Thai leadership, putting pressure on the government to raise its standards to meet international expectations. So far the SET index has been the only barometer measuring investors' confidence in the Thai government.

Dr Pisit Lee-ahtam, the chief investment banker of Bangkok Bank Plc, is on target when he expresses his concern that there will be more foreign exchange volatility lying ahead. ''The foreign exchange volatility will put pressure on Thai companies to stay alert and keep up with the growing uncertainty in their businesses," he said.

The baht was quoted yesterday at an onshore rate of Bt27.50 to Bt28.70 per dollar, compared to an offshore rate of Bt29.20 to Bt29.90 per dollar. The BOT has a range it would like the baht to fare against the US dollar, yet nobody knows where the baht will find its equilibrium. It will depend on capital movements and the country's macroeconomic conditions.

The Bank of Thailand has raised its discount rate to 12.50 per cent to tame inflation and try to attract foreign capital.

So interest rates are not going to fall easily, further dampening prospects of an economic recovery. The GDP will be contracted to 4.8 per cent this year, according to the central bank.

Inflation will soon be on the rise, starting from higher costs of oil and energy before spreading to consumer goods. Companies or factories that have lost out will close down. Labourers will be laid off, aggravating social problems.

Thai corporations, with external debts of more than US$60 billion, will have to pay at least $8 billion more in foreign exchange losses.

This amount, though largely unrealised for now, should more than wipe out corporate profits.



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