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BOT hid US$10 bn in swap contracts


THE Bank of Thailand has concealed about US$10 billion in forward swap contracts, which it has been building up to offset the capital outflow probably since February, to give the impression that its foreign exchange reserves were hefty enough to defend the baht, foreign exchange experts say.

Forced by the International Monetary Fund to disclose its foreign exchange positions, central bank governor Chaiyawat Wibulswasdi said last week the BOT would be obliged to settle $23.4 billion in foreign exchange swap contracts due over the next 12 months. Of this huge amount, $14.8 billion accounts for off-shore transactions and $8.6 billion for on-shore transactions.

In a foreign exchange swap contract a party agrees to settle with a counter-party a currency contract baht for dollar or dollar for baht in the most prevailing transactions in Thailand at a certain amount and a certain cost with delivery due at a specified period in the future.

Appearing concurrently on iTV and Channel 9 with Deputy Prime Minister Virabongsa Ramangkura last Thursday, Finance Minister Thanong Bidaya told Suthichai Yoon, the moderator, that only $4.9 billion of the $23.4 billion in forward contracts was used to defend the baht in mid-May. Another $8.6 billion is on-shore swap contracts Thai companies have settled with the BOT as a hedge against foreign exchange risks.

Both Thanong and Chaiyawat have declined to account for the remaining $9.9 billion in swap contracts, but foreign exchange experts say this amount was used by the BOT in an attempt to build up its reserves for the dual purpose of offsetting the capital outflow and making the reserves look bigger than they should actually have been.

Attempts to re-build the depleting reserves to counter the capital outflow and to avoid devaluing the baht would have started some time in February when Thailand's balance of payments began to experience a deficit minus Bt26.6 billion in February, minus Bt700 million in March, minus Bt15.5 billion in April, minus Bt112.3 billion in May and minus Bt24.6 billion in June.

The current account deficit has also been putting pressure on the foreign exchange reserves at every step. The current account deficit the gap between domestic savings and investment demand, which must be financed by foreign savings reached minus Bt22.5 billion in January, minus Bt14.7 billion in February, minus 15.9 billion in March, minus Bt36 billion in April, minus Bt22.8 billion in May. The June current account deficit figure is not available yet due to the delay in compiling import and export statistics.

Surprisingly, during this particular period the BOT still managed to keep its foreign exchange reserves at a high, albeit steadily declining, level. The foreign exchange reserves stood at $39.2 billion in January, $38.1 billion in February, $38.1 billion in March, $37.3 billion in April, $33.3 billion in May, and $32.4 billion in June.

Chaiyawat, appearing on another television programme recently, indicated that the July foreign exchange reserve was $30 billion.

However, on July 2 the BOT, then under Rerngchai Marakanond's leadership, decided to float the baht, amounting to a de facto devaluation of the currency. Questions have already been raised as to why the BOT bothered to devalue the baht when it still had plenty of foreign exchange reserves in store.

The answer is clear: the BOT's reserves are not that high because the figure provided by the BOT has not taken into account the $9.9 billion in swap contract obligations over the next 12 months. Deducting this amount and the $4.9 billion in the cost of defending the baht from its books the BOT should have had only $15 billion left in reserves.

Moreover, a current account deficit to the tune of $1 billion a month, combined with a risk of short-term debt outflows amounting to between $30 billion and $40 billion some time in October if they are not rolled over, means that the BOT could risk running its reserves into negative territory if no fresh capital from the IMF or foreign governments is forthcoming.

Thailand's foreign exchange reserves are all borrowed, derived from capital inflows or foreign savings that exceed the current account deficit. When foreign or local investors bring in US dollars to finance investments in Thailand they sell the dollar for the baht in both the spot market and swap market with the Thai central bank, which holds most of the baht supply.

In its attempt to fool the financial markets with its maverick accounting tactics under the pretext that it would defend the baht at all cost until exports pick up, the BOT appears to have run into a trap of its own making. Foreign exchange experts say the central bank was forced to defend the baht in December last year when there was a change of government and Thailand's export sector hit the wall.

Amid the deteriorating macro-economic conditions, complicated by the financial sector crisis, capital had begun to flow out of the country due to a growing lack of confidence that the country would have sufficient foreign exchange to service its huge foreign debts worth $90 billion. This capital outflow, added to periodic baht attacks as foreign speculators built up their short baht positions, put tremendous pressure on the baht and the tight money market.

The capital outflow, as witnessed by the balance of payments crises, would automatically drain the baht into the BOT's coffers and the BOT would exhaust its channels for releasing the baht into the system again without risking inflaming inflationary pressure. The BOT was forced to build up its reserves to improve domestic liquidity and maintain the integrity of the fixed exchange regime.

At first, the reserve build-up was small as the BOT went out to bid up the dollar against the baht. Over a period of five months or so, the reserve accumulation grew in size and maturity until it reached almost a staggering $10 billion. Things were obviously getting out of control, yet Rerngchai, who was not keen on foreign exchange, did not appear to understand the implications.

Rerngchai thought that this offshore activity, which was totally imprudent of the central bank, merely represented an attempt to improve domestic liquidity and prop up the baht.

Chaiyawat, who directly managed Thailand's foreign exchange reserves, hinted at this objective. ''The offshore activity that we engaged in with foreign banks was a consequence of our need to keep the baht at a certain level, fixed by the Exchange Equalisation Fund. Particularly during the pressure of the baht attack, which resulted in the tightening of the baht market, the swap contracts helped improve the tight money conditions."

The fixed exchange regime proved to be costly for it allowed fluctuations of only two satang up or down in the daily baht/US dollar trading. To keep the baht within the trading band, huge reserves on the back of confidence something the BOT did not have at that time was needed.

By law, for every Bt6 in reserves or hard currencies the BOT is allowed to print Bt10 into the system. But in practice the BOT has to be conservative, printing Bt10 for every Bt10 in reserve back-up. Hence, the reserve build-up by the swap obligations allowed the BOT to print more money into the system to improve domestic liquidity and at the same time defend the integrity of the currency peg system.

Appalled by the balance of payments crises, foreign experts say the BOT rushed to re-build its reserves, first by selling the baht for the dollar in the spot market before entering forward contracts (sell dollar for baht) to neutralise its swap obligations. By doing so, they say, the foreign currency speculators should easily have detected the BOT's activity, which inadvertently created an outflow of baht in the offshore market.

This offshore baht supply was used as ammunition by George Soros and other big-time speculators in their assault on the baht in mid-May. They would have easily detected that the central bank's foreign exchange reserves were not as high as advertised.

A currency expert who previously worked for an American bank said the baht attack on May 14 was perfectly timed with the BOT's obligations to roll over its swap contracts, built up exactly three months ago on the previous baht attack on St Valentine's Day, Feb 14.

The BOT must have realised the futility of its attempt to defend the baht after the May battle given its obligations to settle $23.4 billion from its reserves over the next 12 months, the outflow of $1 billion a month through the current account deficit and an outflow of short-term debt to the tune of $30 billion to $40 billion in October.

A central bank official said that the last three weeks of June until July 2 seemed like eternity for the central bank, which had decided to surrender its fixed exchange regime amid the massive outflow of capital. The BOT wanted to wait until the second half of the year to float the baht to avoid affecting the financial statements of Thai corporations, which would have happened if the devaluation took place in June.

The massive outflow in June took place amid rumours of an imminent baht devaluation and calls for outright devaluations by Virabongsa and Ammar Siamwalla, a leading economist. This outflow is significantly reflected in the $8.6 billion in on-shore swap obligations undertaken between Thai companies and the BOT.

With the baht having lost around 30 per cent of its value and the reserves being depleted, it was inevitable that the government would seek the IMF's assistance, which came in the form of $20 billion in stand-by credit and bridging loans to shore up the BOT's international reserves.

The IMF-sponsored financial and economic reform programme tames the Thai tiger and turns it into pussy cat. One of the provisions of the programme calls for the BOT to maintain at least $23 billion in reserves, equivalent to four months of imports. This suggests that the BOT's reserves must have been significantly run down.

With hindsight, the BOT did not pay heed to calls by the IMF in June 1996 to rein in stability as Thailand faced current account deficit pressure. The IMF wanted Thailand to reduce the current account deficit, cut the budget, strengthen the banking system, and adopt a more flexible foreign exchange regime. Instead, the Banharn government, under the weak BOT, continued to grow the economy at 8.6 per cent last year at the expense of an unsustainable current account deficit, which would eventually lead to a loss of confidence.

Michel Camdessus, managing director of the IMF, severely criticised Thailand for its failure to act more swiftly to prevent a full-blown financial crisis. He said Thailand's problems ''could have been corrected at much less cost to the economy and the economy of neighbouring countries if they had been addressed in a more timely manner."





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