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Learning from Thailand's mistakes


AS the leaders of the Asia-Pacific Economic Cooperation are about to approve a framework for a new global financial architecture, Dr Olarn Chaipravat, the president of Siam Commercial Bank, said the emerging market economies can draw two lessons from Thailand's mistakes in its financial and foreign exchange market regulations.

The first mistake, he said, lay in the Bank of Thailand's lax regulations, which allowed the inexperienced local commercial banks to directly conduct foreign exchange transactions with offshore banks. The Bank of Thailand also had no experience in dealing with direct US dollar/baht transactions with offshore banks, except with the International Monetary Fund and the World Bank, he added.

''Over the past two or three years we became involved in foreign exchange trading using the baht to trade directly with the offshore parties. Singapore has never allowed this to happen. They don't allow Singaporean banks to trade Singaporean dollar with offshore banks,'' Olarn said.

Through liberalisation of the capital account since the early 1990s, Thai commercial banks were allowed to trade baht/US dollar with the offshore banks, hence creating a huge offshore baht market in Singapore. An unofficial study of the Monetary Authority of Singapore found that offshore baht trading in Singapore reached more than US$10 billion a day at its peak, dwarfing by several times by the onshore trading of between $2 and $3 billion a day.

The huge offshore baht market became a stockpile for currency speculators and hedge-fund operators to attack the baht. They did so by shorting the Thai currency, expecting to drive its value down before borrowing cheaper for settlements and pocketing the profits. Attacking the Singapore dollar is almost impossible because there is no supply outside Singapore for speculators to use as a stockpile.

It was not until January 1998 that the Finance Ministry and the Bank of Thailand issued a regulation barring local banks from conducting offshore trading of the baht, without underlying trade, at more than Bt50 million per transaction. This capital control is an effective measure to put an end to offshore currency speculation.

Lesson number two involves the lax finance and banking regulations in supervising the offshore baht denominated debt market, Olarn said. During the early 1990s, at the height of the financial bubble, Thai companies avoided high interest rates at home to fight inflation by floating commercial paper in the offshore market as a means to raise cheap money.

Commercial papers, like bills of exchange (B/E) and negotiated certificates of deposit (NCD), were floated by Thai companies and financial institutions in overseas markets, which enthusiastically welcomed these baht denominated papers because they offered high interest rates and presumably were free from exchange risks owing to the currency peg system.

Olarn's study, conducted last year, found that outstanding B/E and NCDs reached almost $10 billion in 1997. However, by the middle of the year, the amount dropped to $5 billion owing to redemptions by foreign banks and the speculators who liquidated their baht holdings to settle their forward positions in the baht attack.

After the Bank of Thailand played hardball against hedge funds and currency speculators by shutting down the foreign exchange swap markets on May 15 1997, some funds lost money because they did not hold baht assets before attacking the baht. However, the supply of baht through the B/Es and NCDs that were floated helped other foreign funds muddle through before emerging with huge profits after the Thai central bank caved in by floating the baht.

In the baht's defence, the Bank of Thailand also built up huge offshore swap contracts, which reached more than $14.2 billion when Thailand was forced to disclose the amount in August last year, in return for the IMF's rescue package. These huge offshore swap contracts led to a panicky outflow of capital from Thailand because investors were shocked that Thailand might not have enough reserves to defend the currency.

Olarn said now Thailand no longer has to worry about short-term capital because it is appropriately regulated. ''We should focus more on how to attract quality capital to stay in the country,'' he said.

More than $10 billion in short-term capital has fled Thailand since the baht was floated in July last year. Yet most of this money has been replaced by official money in the $17.2 billion rescue package put together by the IMF.




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