How to staunch the bleeding of capital?

October 13, 2000

SHOULD the Bank of Thailand raise interest rates to defend the baht and jam the brakes on capital outflow, which is threatening not only the baht's stability but also international reserves? This is the most contentious economic issue being broadly debated at this juncture as Thailand grapples with deteriorating macroeconomic confidence.

Both Dr Virabongsa Ramangkura, the macroeconomist, and MR Pridiyathorn Devakula, the president of the Export and Import Bank of Thailand, have urged the banking authorities to reverse their low interest rate policy and raise the rates. Higher interest rates, they argue, would make it more attractive for corporations or investors to hold the baht. Moreover, it would also deter corporations from issuing low-interest domestic bonds to refinance their external debt.

Both experts were apparently concerned over the continuing outflow of capital, which has started since the beginning of this year. Overall, in the first six months of this year, the balance of payments faced a net deficit of US$2.54 billion. Virabongsa, in particular, pointed out that Thai interest rates cannot hold since they are lower than US rates, leading to a flight to the US dollar. With higher oil prices, it is only a matter of time until the Thai economy will face problems again if the government does not manage macroeconomic stability artfully enough.

He believes that the situation now looks like a replay of the second half of 1997 when capital fled Thailand in panic. So he is calling for the authorities to balance stability and growth. But Bank of Thailand Governor Chatu Mongol Sonakul is determined to rigorously pursue low interest rates until there are firmer signs of recovery. He believes that it is still too early to raise the rates, for that would send the wrong signal to financial markets. With capacity utilisation of only 54 per cent, higher interest rates would dampen this recovery process.

Chatu Mongol and Virabongsa also perceive the capital outflow differently. The central bank governor does not see any unusual signs of capital outflow. Indeed, it is his deliberate policy to let the corporations repay their external debts. Thailand's foreign debts remain too high at more than US$80 billion, compared with the pre-crisis sum of US$105 billion. If the debts can be brought down to some US$60 billion, they would be more manageable; otherwise Thailand would be in trouble again in the event of another financial crisis.

With this line of thinking, Chatu Mongol first pursued a rather strong baht policy throughout most of 1999 to allow the corporations to reduce their external debt load. But his real aim has been to keep a more independent monetary policy. After Thailand adopted the floating exchange rate regime in July 1997, the baht has been moving pretty much in line with market forces. The authorities attempted to ensure that the markets worked their way. If there were to be only one choice between the exchange rate and the interest rate, the authorities would go for an independent monetary policy.

Moreover, Chatu Mongol also needs to save the Thai banking system. With non-performing loans hovering at around 30 per cent of total loans, low interest rates are necessary to keep the banking system moving. Higher rates would deal a blow to the carrying costs of the banks' NPLs. Corporate debt restructuring also needs low interest rates to encourage both debtors and creditors to come to a final agreement. It is going to take time to restore the health of the banks, so Chatu Mongol would like to keep interest rates low as long as possible and as long as inflation does not threaten to strike the economic recovery.

Overall, Thailand has lost the momentum to recover more strongly because of the slow pace of corporate debt restructuring. Thai corporation owners need to reduce their debt load by letting go of part of their assets and equity in exchange for fresh capital and better management. This side of corporate debt restructuring has been little discussed, yet it lies at the heart of the mother of all problems. The main reason that the foreign investors are fleeing Thailand is because they don't see the pace of corporate debt restructuring moving fast enough. This is evidenced in their sell-off of Thai stocks since the beginning of this year at a net of more than Bt33 billion.

So what is wrong with the baht, which has hit a 28-month low at about Bt43.50 to the US dollar? In an era of floating exchange rate regimes, it is increasingly difficult to manage the exchange rate. Even the European central bankers cannot defend the euro, which has been falling sharply against the US dollar. The baht is not becoming too weak, but the problem is the US dollar has become too strong. However, since 1999 Thailand's market has been categorised as being the same as Indonesia's and the Philippines'. So whenever there are jitters in those countries, there are spillover effects in the Thai market. Now it's time to muddle through.

BY THANONG KHANTHONG