Unpegging the baht from the US dollar three years ago would have avoided the bubble economy, report Thanong Khanthong and Vatchara Charoonsantikul in the final of a five-part series on Thailand's mismanagement of the macro-economy.

Thai monetary authorities missed a golden opportunity to unpeg the baht from the US dollar in 1995 when the International Monetary Fund (IMF) put forward a proposal that Thailand either adopt a more flexible baht policy or overhaul the basket of currencies.

The IMF economists argued that abandoning the fixed exchange rate regime would allow Thailand, which had been facing growing inflationary pressure from the massive influx of capital inflow, to improve its monetary control and interest rate policies.

Yet the conservative Bank of Thailand opted for the status quo. Vijit Supinit, the then central bank governor, and Dr Chaiyawas Wibulswasdi, the assistant governor and manager of the Exchange Equalisation Fund, found that since the fixed exchange regime had been an anchor of macro-economic stability over the past decade, there was no reason to touch it. In fact, the fixed exchange regime should have been abandoned in 1994 when there were signs that Thailand had been coming under severe policy strains from the capital inflow.

Net capital inflows amounted to US$9.68 billion (Bt242 billion) in 1990, $11.29 billion in 1991, $9.47 billion in 1992, $10.49 billion in 1993, $12.16 billion in 1994 and $21.60 billion in 1995.

Total international reserves also jumped from $25.43 billion in 1993 to about $39 billion in 1996. The Thai financial system was swamped by foreign capital, setting the stage for the creation of a bubble economy and sloppy loans which would turn sour later.

Due to the fixed exchange regime, the foreign capital was unchecked when it flooded the Thai financial system. There were almost no exchange risks at all. To counter the inflationary pressure from foreign capital, Vijit resorted to tightening the monetary policy. Over the past three years, interest rates have been on an uptrend, dealing a severe blow to Thai businesses and the stock market.

Vijit and Chaiyawas were afraid that unpegging the baht from the US dollar would lead to an appreciation of the Thai currency, which would hurt exports. However, by defending the value of the Thai baht, they have lost the battle on the liquidity front.

It is now evident that, as some economists have pointed out, managing liquidity to set interest rate policy is far more important to the central bank than keeping the value of the baht stable in the fixed exchange regime. The currency peg system has significantly undermined the central bank's monetary control, leading to the formation of a bubble economy. The Thai economy crashed last year, triggered by a drastic drop in exports.

Unpegging the baht or adopting a more flexible currency policy can only be done when the economy is healthy. Now with concern over Thailand's macro-economic instability, particularly the high current account deficit, any move to touch the exchange rate policy will backfire. Economists say if the band of baht/US dollar trading is widened, the baht will hit the floor. ''The more you widen it, the steeper the baht will plunge because of the lack of confidence," said one notable economist.

The same argument applies with floating the baht during this time of gloomy economic outlook, for the baht could depreciate by at least 10 per cent the first day it is floated.

Finance Minister Amnuay Viravan would very much like to adopt a more flexible baht policy. Devaluation is out of the question. Yet he has regularly and consistently been asked about the prospects of a devaluation to prop up exports. ''Even if you hold my head under water three times or four times, I would still argue against devaluation. The cost to Thai business is too dear," said another well-informed economist.

Thailand's total external debts are about $89 billion. With international reserves of $39 billion, the country's net debts are only $50 billion.

A devaluation of say, 10 per cent, would immediately add $8.9 billion to the debts. Complete panic would set in, setting the stage for another Mexican-style financial disaster.