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Rerngchai - sinner or scapegoat?

November 28, 2001

Rerngchai Marakanond, a former Bank of Thailand governor, is about to pay a dear price for his central role in the futile baht defence in 1997. Is he a scapegoat? Thanong Khanthong looks at the baht-defence debacle.

Why did Rerngchai Marakanond and his top officials decide to defend the baht in 1997 until the foreign-exchange reserves were almost depleted and they were left with no choice but to float the currency? If they had decided earlier to adjust the fixed-exchange rate system by weakening the baht, altering the basket of currencies, widening the trading band or floating the baht outright, they would have preserved the foreign-exchange reserves and saved Thailand from catastrophe.

The problem is that most people become experts only after all the facts have been laid out before them.

Looking back at the chain of tumultuous events, it is easy to pinpoint certain decisions Rerngchai and his top officials could or should have made. They could have floated the baht in December 1996, when the hedge funds first started to attack the currency; or in February or March 1997, after the currency skirmish that become known as the St Valentine's Day bloodbath; or even on May 12, 1997, right in the middle of the fiercest baht battle.

MR Chatu Mongol Sonakul, then permanent secretary for finance, was one of the sceptics of the fixed-exchange rate regime. He doubted that the baht could hold on amid the speculative pressure, the deteriorating economic conditions and most importantly, the capital outflows. During the crisis, he had several heated debates with Chaiyawat Wibulsawasdi, then deputy governor and the architect of the fixed-exchange rate system.

"Don't you ever think that you know all the problems alone," Chatu Mongol yelled at Chaiyawat at one point.

In an interview in April 1998, Chatu Mongol said that if the central bank had acted on the baht by widening the trading band or by devaluing it by 15 per cent in February 1997, the currency could have been salvaged at least at the Bt28/US dollar level. He believed that even though Thailand would still have been facing a crisis, the pain could have been substantially reduced.

For then the country would have at least been able to preserve US$24 billion in foreign-exchange reserves. The crisis would have been alleviated to a certain extent. And Thailand would not have had to surrender its financial sovereignty by seeking a $17.2-billion rescue package from the International Monetary Fund.

A group of US currency speculators also did their own post-mortem reckoning. According to Eugene Linden, ("How to Kill a Tiger," Time magazine, November 3, 1997, pages 24-25), US speculators believed that "a pre-emptive devaluation would have cost the (Bank of Thailand) about $10 billion of its $38 billion in reserves". But they said the reserves would have quickly been recouped because of the credibility the Thai authorities would have earned in the international marketplace.

Others view that any act on the baht would not have made a big difference, given the impending collapse of the economic bubble and the insolvency in the financial system.

The burden of his high office and the rapidly deteriorating circumstances caught Rerngchai off guard. His capacity to respond was awkward. He also had a limited understanding of the sophistication and complexity of modern financial markets. Most importantly, he and his team misread the big picture and didn't anticipate the consequences of a depletion of the foreign-exchange reserves and a forced devaluation.

As Rerngchai has confessed: "During the baht attack aggravated by the financial-system crisis, I had sleepless nights and, at times, almost suffered from a nervous breakdown."

On Black Wednesday, May 14, 1997, the hedge-fund operators and international money managers cornered Rerngchai and his team before dropping what amounted to an atomic bomb. They bet $10 billion against the baht that day alone. It was a winner-take-all gamble.

Since Rerngchai had delayed making the decision on abandoning the currency peg, he was led into that inevitable final confrontation. The global financial markets would force him to correct the macroeconomic imbalances, or the overvalued baht in this particular case, in the most painful and brutal way.

At that point, Rerngchai had still decided to continue with the defence, because it was too late to give in without wreaking havoc on the entire payment system. The central bank matched the assault dollar-for-dollar and ended up depleting what was left of the reserves on that single day.

That day was the culmination of a six-month period during which the central bank blew away more than $30 billion in foreign-exchange reserves. Rerngchai had tried to defend a fortress that could not be defended.

When shortly after, in August, the Kingdom sought a $17.2-billion rescue package from the IMF, the bank's net reserves had plunged to $800 million, a far cry from the $33.8 billion in December 1996.

This depletion of the reserves shocked creditors and investors, who completely lost confidence in Thailand, which had racked up what was then reported to be $90 billion in foreign-currency loans. (The central bank later found out that the actual size of the country's foreign-currency debt was $112 billion.)

Of this amount, $40 billion was short-term debts, which were largely unhedged for currency risks and would have to be repaid within 12 months.

Realising that Thailand would not have enough reserves to cover its short-term debts, foreign creditors and investors headed for the exits in panic. The massive capital outflow hit the economy like an earthquake.

The scene looked like people scrambling for the doors in a theatre after they heard somebody cry out the word "fire".

Shortly after the floating of the baht on July 2, 1997, Chaiyawat came out to assure the financial markets that the fundamental value of the currency should be around Bt28-Bt29 to the US dollar. If the worst came to the worst, he would accept that the baht should hover around Bt31-Bt32.

Yet after Thailand was forced by the IMF to publicly disclose its foreign-exchange swap contracts of $24.3 billion in August 1997, its credit standing immediately went down the tubes. And the baht slipped into a free fall.

In the eyes of the creditors, a Thailand without reserves was bankrupt. Nobody was paying any attention to the economic fundamentals. The foreign creditors and investors pulled out their investments abruptly from Thailand and subsequently from the region because they were afraid that other countries might also lie about their foreign-exchange reserves.

The result was severe economic dislocation, which changed the fundamentals in a spiral effect. This panic brought down the Asian miracle almost overnight.

It was a classic crisis of confidence that would lead to a collapse in domestic demand and a severe economic contraction the following year. The baht eventually hit rock bottom at Bt56 to the dollar on January 12, 1998. That year Thailand saw its GDP shrink 10 per cent.

This was quite unthinkable and very unnatural. But it did happen.

The men who defended the baht

In apportioning blame, it is necessary to start at the top.

General Chavalit Yongchaiyudh, then prime minister, and Amnuay Viravan, then finance minister, could not deny their responsibility for the baht fiasco. In an absence of leadership, the decision-making process had totally broken down.

Chavalit was an idle prime minister at Government House, not knowing the scale or the consequences of the baht battle. He was told by Rerngchai every time they met that the speculators would be dealt with decisively and that the Bank of Thailand would not have any problem bringing the crisis situation under control.

Chavalit frequently said that economics was not his trade, for he had spent most of his life in the military and in national security fields. Currency swaps were something exotic, beyond his grasp.

The central bank's foreign-exchange policy was a collective decision-making process. It involved Rerngchai; Chaiyawat, also manager of the Exchange Equalisation Fund; Siri Garnjaroendee, the assistant governor; Tanya Sirivedhin, another assistant governor; Bandid Nijathaworn, the director of the Banking Department; and Paiboon Kittisrikangwan, the division chief of the Banking Department.

There had been little unity among members of this elite group. The stature of the Bank of Thailand had already been eroding. Years of success had bred a culture of overconfidence and elitism. Personally, Rerngchai was not on good terms with Chaiyawat, who believed himself to be more qualified than the governor in matters of macroeconomics.

During the tenure of former governor Vijit Supinit, Rerngchai was kept inactive. He stayed at the note-issuing department for seven years, playing practically no role in any major policy decisions. When he took over the governorship in July 1996, the macroeconomic conditions of the country had already started to deteriorate.

Intellectually, Rerngchai was totally unprepared to cope with the financial and foreign-exchange crisis. Psychologically, he was not equipped for the demanding job either. He rose to the helm due to a bureaucratic system based on seniority instead of merit. Banharn Silapa-archa, the former prime minister, said he was obliged to appoint Rerngchai as governor because Rerngchai threatened to resign if he did not get the appointment.

Naturally, Rerngchai did not trust Chaiyawat, who was acknowledged as his superior intellectually. So he made Siri his top lieutenant. Much to the dissatisfaction of his colleagues, Siri was entrusted to simultaneously take charge of the Banking Department and the supervision of financial institutions. Chaiyawat was not happy at all.

After Chaiyawat returned to the Bank of Thailand following a brief stint as deputy and acting finance minister for the Banharn administration, Rerngchai asked him what kind of job he would like to do. Chaiyawat said he would prefer to keep his job at the Exchange Equalisation Fund and oversee the Economics Research Department. Rerngchai readily agreed.

As governor, Rerngchai would automatically act as commander in chief, personally responsible for foreign-exchange policy.

Between July 1996 and April 1997, Rerngchai was in full command. But in the ensuing period, he would be increasingly preoccupied with the crisis of the financial institutions. Since foreign exchange was not his field of expertise, the governor had an excuse to focus his energy on tackling the crumbling financial sector. Some time in March, he orally assigned Chaiyawat to look after baht policy.

As governor, Rerngchai naturally felt insecure to have a technically far superior No-2 man at his side.

Chaiyawat felt that he was not treated according to his capabilities. So, during the baht crisis, he managed to find time to write a book on stamp collecting. Later on, when he was questioned as to why he had become indifferent in the atmosphere of crisis, Chaiyawat defended his record by saying that he had not been given any important assignments. All the responsibilities were kept by the governor alone, he said.

However, Chaiyawat was at that time general manager of the Exchange Equalisation Fund, or guardian of the basket-of-currencies system.

The collective decision-making of the bank, as it turned out, evolved into individual judgements as to whether the fixed-exchange rate system should be altered. Siri and Tanya were more inclined to support a more flexible baht policy. Chaiyawat, Bandid and Paiboon thought that they could defend the baht. The governor went along with the Chaiyawat camp since Chaiyawat was supposed to know best.

The accepted line was that there would be no devaluation, nor any adjustment of foreign-exchange policy until the financial-sector crisis had been resolved. The Bank of Thailand's officials hardly came to grips with the reality that tackling the financial-sector crisis would take time.

In April 1997, the Baan Phitsanulok advisory team proposed to the prime minister that the baht be devalued by 15 per cent to jump-start exports.

Narongchai Akrasanee, then commerce minister who earned a PhD in economics from Johns Hopkins University, had also been urging the prime minister to adjust the foreign-exchange regime.

But Chavalit told him that he had got assurances from the Bank of Thailand that the reserves were still ample, covering six months of imports and so there was nothing to worry about.

Amnuay was also kept at arm's length from the Bank of Thailand's currency-war efforts, although he was in a position to have exercised greater leadership. He had the false impression that Rerngchai and his team knew exactly what they were doing.

Technically, Amnuay, too, did not understand the implications of the currency-swap or the baht-defence operation that was going on behind his back.

He used to ask Rerngchai why the foreign-exchange reserves level barely fell even after the Bank of Thailand had sold dollars to prop up the baht. Amnuay was told that that was because the Bank of Thailand was doing currency swaps, which also helped it manage liquidity.

"Is that it?" he asked. He did not probe further.

Since Rerngchai could not exercise his leadership to alter the foreign-exchange regime in the middle of the battle, he had to go long with the Banking Department's tactic of buying time.

The defence team thought that Thailand was facing a cyclical downturn, as evidenced by the slight improvements in exports and the current account in the first half of 1997. So, once problems in the financial system were resolved, confidence would return and capital would flow back to add to the Bank of Thailand's reserves.

But the team did not weigh the downside risks in the event that capital did not flow back. By engaging in currency swaps, the Bank of Thailand had spent its "future" dollars and might not have enough for settlements. It was a gamble that would backfire.

Amnuay had spent his early career at the Finance Ministry, so he understood the protocol. He had respect for the governor, in whom he also had full confidence.

It can be established that the hawkish members of the inner circle of the central bank's policy-makers who made decisions on the baht policy included Chaiyawat, Bandid and Paiboon. Their belief in the currency peg was like an article of faith. They sincerely believed in the integrity of the fixed-exchange rate system, Thailand's last stronghold that should not be yielded.

Unpegging the baht would amount to a leap into chaos and uncertainty.

Even after the mid-May baht attack and even before Amnuay's resignation on June 19, 1997, Chaiyawat's belief in the currency peg was still not shaken. His premise was that the country's economic fundamentals remained strong, that the slowdown was only cyclical, and that the baht was not overvalued.

With this wishful thinking, Chaiyawat signalled that the bank's defence of the baht should continue as the economy went through temporary adjustments on its way to an eventual recovery and as the banking officials tried to attend to the ailing financial system.

Chaiyawat, who was one of the architects of a successful 17-per-cent devaluation in 1984, cast his long and influential shadow over the Bank of Thailand's foreign-exchange policy. Any foreign-exchange adjustments would be impossible without his approval, given his "superior intellect", compared with his boss, Rerngchai.

By the line of command, he looked after the Economics Research Department and the Exchange Equalisation Fund. Rerngchai would not have the guts to alter the foreign-exchange policy without Chaiyawat's seal of approval. Chaiyawat was a true believer in the strength of Thailand's economic fundamentals. That was why he did not find it necessary to alter the foreign-exchange policy because eventually the fundamentals would prevail.

Even with the current-account deficit rising to 8 per cent of gross domestic product, Chaiyawat still believed that the deficit was a "good deficit" because the borrowed money was being used for capital investment in machinery equipment and raw materials for re-export. Olarn Chaipravat, then president of Siam Commercial Bank, held a similar view. The deficit did not derive from over-consumption.

But what nobody realised was that Thailand was already suffering from over-investment and an unproductive allocation of financial resources that would damage the financial system.

Economist Virabongsa Ramangkura did not believe that the current-account deficit was sustainable. He called for a devaluation in the early part of 1997 so that export growth could be revived. By doing so, a correction in the current account would also take place. In early June he also recommended to Chavalit that the baht be devalued to Bt32, a level that he believed the market would accept.

In the contentious debate over currency policy, time was to ultimately prove Virabongsa correct and Chaiyawat and Olarn wrong.

Rerngchai later bitterly recalled the circumstances surrounding his indecisiveness in dealing with the currency problems, complaining he did not get any signals from his top officials.

"How could I argue against them? They were the top brains of the country. I confess that I could never match their eloquence. They brought together all the statistics. If I did not believe them, to whom should I turn?" he said.

Since the Economics Research Department and the Banking Department had never signalled any change in the baht policy, Rerngchai was obliged to muddle through. He moved on to tackle the financial-institutions problem with different initiatives such as measures to govern mergers and acquisitions in April 1997, and the closing down of 16 finance companies in late June 1997.

On May 12, 1997, two days before the biggest attack, when he wrote and released his pivotal report on the foreign-exchange situation, Bandid essentially called for a continuation of the baht defence.

"The scale of the attack has become more serious and the latest incident has incurred higher losses to the reserves in the intervention to stabilise the foreign-exchange rate. Now the net foreign-exchange reserves have slightly fallen below the level needed to back the note issue. It is therefore necessary for the central bank to seriously consider the maximum limit at which the intervention to maintain the baht stability is tolerated, or at which the present foreign-exchange rate regime should be put under review," he wrote.

Even though Bandid recognised that the baht defence was a temporary measure to buy time for the government to pursue other policies and measures to tackle the economy's fundamental problems, he could not bring himself to recommend a change to the foreign-exchange regime apart from suggesting a possible review.

Paiboon was then a currency dealer, so he did not have the macro view. He appeared to believe that if the currency peg were altered, capital would not flow back into the country and that the Bank of Thailand would not be able to contain the damage and would suffer a similar fate to Mexico, which had suffered the collapse of the peso.

Tanya was quiet most of the time, although she, like Siri, had doubts that the peg would hold. She was weak and would play it safe. Both Tanya and Siri could not bring themselves to take a stand against Chaiyawat.

In one session after a heavy baht attack, Siri asked Tanya in a meeting about the real effective exchange rate of the baht or whether the baht was overvalued. Tanya did not reply, simply raising all of her 10 fingers in the air. The baht was overvalued by 10 per cent! Siri did not dare to look into the face of Chaiyawat.

The Nukul Commission blamed Siri for his lack of courage in fighting for what he believed was right. It believed that by May 12 when the Bandid report was passed on to Rerngchai on that same day, it was too late to reverse the situation.

Siri was also reprimanded for remaining idle or keeping his silence while the Bank of Thailand was incurring billion-dollar losses every day in its reserves due to a delay in adjusting the foreign-exchange regime.

"It is regretful that Siri lacked the courage or the self confidence to say what he believed to be right to protect the interest of the country," the Nukul Commission said. The commission also got the impression from Siri that Rerngchai, as boss, did not want to listen to a dissenting opinion.

Siri reacted bitterly to the judgement. He thought that the Nukul Commission treated him unfairly. In his statement of rebuttal, he said he had been sceptical of the currency peg since late 1996 when the baht had come under several rounds of attack. By March 1997 after he talked it over with David Robinson, who headed the IMF mission to Thailand, he began to seriously change his mind. Robinson went over to his office and urged him to persuade Rerngchai to alter the foreign-exchange regime. Robinson made it clear that Thailand would face a financial disaster if it did not change the peg. He also warned that the fallout from the Thai crisis could trigger a regional contagion effect.

Siri testified to the Nukul Commission that he had done his best to call for a change to the currency regime. He then blamed the culture within the Bank of Thailand, which did not encourage straight talking. "We would not hurt each other's feelings; a practice of writing a memoir to express a dissenting opinion never took place because we respected each other," he said.

Yet Siri said he had followed his duty by issuing the protests. He added that the Economics Research Department - which is the brains of the Bank of Thailand and controls all the economic and financial and foreign-exchange data - had never suggested any adjustment in the currency regime. So it was impossible for people in the operation such as the Banking Department to do anything but continue to defend the baht.

Siri argued that that even in the middle of the baht battle on Monday, May 12, 1997, it was still not too late to save Thailand. For on that day it was he who ordered Bandid to pen the report on the worsening foreign-exchange crisis, so that he could jam a brake on the mad defence.

As of that day, the net reserves stood at $17.74 billion, still higher than the IMF's rescue package of $17.2 billion and higher than they would be a year later in May, 1998 - $11.4 billion.

Siri said that before May 12, 1997 the Bank of Thailand had lost $8 billion-$9 billion from its reserves defending the baht, compared to the $13-$14 billion it would lose on the three days between Tuesday May 13 and Thursday May 15, 1997 alone.

But after Siri passed on the report to Rerngchai and Chaiyawat, the response was muted.

"I am confident that if my protest had been responded to immediately, the Bank of Thailand would still have kept this $17.74 billion and the damage to the Thai economy would certainly have been significantly less. At least, the Bank of Thailand could have saved the reserves from the intervention after May 12, 1997," he said.

See: How the baht was "attacked".








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