Keeping interest rates high to defend the baht may increase the risk of putting the country into in a vicious economic circle, Thanong Khanthong reports.

Finance Minister Tarrin Nimmanahaeminda signalled that short-term interest rates would be raised to defend the baht, but analysts warned that a high interest rate policy would increase credit risk and in the end put further downward pressure on the currency.

As the baht collapsed further to finish around Bt45.80 to the US dollar after hitting Bt46 at one point on the back of regional financial turmoil, the top Thai policy-makers rushed to announce that short-term interest rates would have to go up to attract investors into holding baht-denominated assets.

The government has struck a deal with the International Monetary Fund (IMF) that monetary conditions will have to be tightened if the local currency fails to stabilise.

The baht has slumped by about 73 per cent of its value against the US dollar since it was floated on July 2.

Thai corporations and finance companies appear to have been drawn into a vicious circle of higher credit risk, leading to higher interest rates and a weaker economy.

''This diminishes the ability to pay, thereby increasing credit risk further, necessitating successive rounds of interest rate increases in a self-defeating effort to stem capital outflow,'' said a strategist at a top Thai finance house.

''In a normal economy, the real interest rate should stay at 5 per cent to 7 per cent. There is no way that Thai businesses are viable in an environment that sees real interest rates hover around 12 per cent. If you had this same real interest rate in the US, the economy would go under in six months. In Hong Kong, it would take only three months,'' he added.

The strategist charged that the high interest rate policy was short-sighted, for when investors took a hard look at the credit risks against the high return on their baht-denominated assets, they would come to the conclusion that the risk adjusted return was not worth the money.

Other financial analysts warned that the next wave to hit the Thai economy as a result of the tight liquidity would be systemic risk created by Thai companies, particularly those which had saddled themselves with dollar loans or had over-leveraged their borrowings.

''Imagine if the Thai petrochemical industry were to go under, it would create Bt100 billion in non-performing loans in the banking system. And this is just one case,'' said one finance executive.

''If Thailand keeps interest rate high for at least another year, there will be no companies left,'' said Vichai Punpocha, general manager of Dresdner Bank AG. ''With the high cost of funds, even good companies with strong performance will go under.''

The incompetence of Bank of Thailand and finance officials in negotiations with the IMF has been blamed for increasing the risk of recession. Critics have charged that Thai policy makers clearly underestimated the size of the country's finance and foreign exchange crisis when they negotiated for the US$17.2-billion bailout loan from the IMF.

The package is clearly not enough to cushion Thailand's balance of payments crisis and give the central bank adequate reserves to back up the shaky baht.

Both Prime Minister Chuan Leekpai and Finance Minister Tarrin have tried to argue that the baht slump is due largely to external factors beyond the ability of the government to control, yet it can also be argued that the inadequacy of the IMF bailout package has also contributed to the weakness of the currency.

A renegotiation of the IMF package is needed, otherwise the government must set out on a roadshow to borrow more money to boost the depleting reserves of the central bank. Doing so will help improve liquidity in the system and pave the way for lower interest rates.

Analysts have warned that any grand designs to clean up and recapitalise the Thai banking system might fail if foreign investors are not sure when the economy will bottom out. An economy that has reached its bottom is usually signalled by lower interest rates, which is not likely to come to pass in the near term.

''If interest rates don't come down and the baht doesn't stabilise, foreign investors won't be able to calculate the costs of recapitalisation in the banking system. There will be growing risks from loan deterioration if the economy continues to weaken,'' the strategist said.

He called on Thai companies to unload their assets in a grand sale, which would attract the ''vulture funds'' from overseas. Fresh money from abroad would improve local liquidity conditions, but Thai owners are still hanging on tight to their properties.