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Economy needed brakes years ago


With hindsight, the monetary authorities should have slammed the brakes on the spectacular money supply growth three years ago to avoid a bubble economy, Thanong Khanthong and Vatchara Charoonsantikul report in the first of a series.

Thailand is paying dearly for the current economic mess created by severe flaws in the management of the macro-economy over the past three years.

The top policy-makers at the Bank of Thailand and the Finance Ministry did nothing to avert the inflow of foreign capital which flooded the financial system and brought with it fearsome inflationary pressure.

In retrospect they should have unpegged the baht from the US dollar to create more uncertainties for speculators bringing in masses of cheap cash from overseas.

With the currency peg system, easy credit grew spectacularly, setting the stage for a bubble economy that would burst in 1996. It was easy for the hot money to get into the country because the currency peg ensured there were no exchange risks.

The fixed exchange rate regime, formulated in 1984 when Thailand was forced to devalue the baht, was one of the cornerstones of Thailand's macro-economic stability. It served its function well over the following decade, when the US dollar happened to weaken against the major currencies. The baht, pegged to the dollar, also weakened against the other currencies, hence helping Thai exports to take off in a grandiose way.

In spite of his stature as the country's top macro-economist, Vijit Supinit, the then-Bank of Thailand governor, did not seem to pay enough attention to the cause of stability.

A believer in the supply side of economics, Vijit had confidence in the strength of the economy, believing that the widening current account deficit, accentuated by the capital inflow, would subsequently be absorbed, if not totally offset, by export earnings.

Tarrin Nimmanahaeminda, who had left his brilliant banking career to become finance minister, then did not grasp the macroeconomic implications of the capital inflow. He went along with Vijit's suggestion that monetary tightening would suffice to deal with the hot money.

Vijit dared not touch the currency peg system, believing that it was serving the objective of ensuring confidence in the Thai economy. He elected to rely solely on a tightening of monetary policy to combat the inflationary pressure brought about by the capital inflow.

It proved to be a war he could not win. The tight monetary policy, which forced interest rates high, punished Thai businesses. The greatest irony of all was that the money market, which was supposed to be tight, was not at all tight during that period because it was swamped by massive capital inflow.

Money supply expanded by more than 20 per cent annually from 1994 to 1996, probably the highest in the world. In fact, money supply growth should be kept at 11-12 per cent or about two or three percentage points above the growth of the gross domestic product of 8.6 per cent to 8.7 per cent.

Money supply growth of that scale was a recipe for disaster. It amounted to opening a floodgate for inflation that would severely undermine economic stability.

Bank lending expanded massively as a result, jumping by 28.5 per cent year-on-year in 1994 and by 24.2 per cent year-on-year in 1995. Thai banks were over-leveraged, as evidenced by a loan-to-deposit ratio of 124.2 per cent in 1994, 130.5 per cent in 1995 and 131.6 per cent in 1996 (any figures above 100 per cent are financed by foreign money).

The offshore banks, under the auspices of the Bangkok International Banking Facility (BIBF), made things worse. Scrambling to get a full branch licence, the BIBF banks booked massive offshore loans to add to the inflationary pressure and the asset bubble.

Starting from scratch in 1993, the BIBF banks built up their assets aggressively until they posted Bt1.27 trillion in outstanding foreign currency loans by October 1996.

Just take a look at Thailand's international reserves, which truly reflect the money supply growth. Total reserves jumped from US$25.43 billion in 1993 to US$30.28 billion in 1994, US$36.13 billion in 1995 and almost US$40 billion in 1996.

Over a period of three years, some Bt500 billion in high-powered money, from the increase in the country's reserves, was added to the inflated financial system. No financial system in any country in the world could accommodate that kind of bubble. Japan had already gone bust in 1990-1991 in this fashion.

And where did most the money go? When there is easy credit around, it is natural for the money to go speculative for quick return. In Thailand's case, the easy money went into the finance sector, stocks, land and the property market, hence creating a financial bubble.

When the economy began to turn sour last year, when exports dipped to zero growth, when the central bank began to introduce regulations to slow down the velocity of the money flow because the current account deficit looked unsustainable, when foreign investors began to attack the baht for fears of devaluation, only then was it clear that things were really starting to get out of hand.



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