The stock market crashed the following day - "Black Tuesday" - because of panic selling, as no foreign funds would stay in a country with draconian capital controls.

MR Pridiyathorn Devakula, the deputy prime minister and finance minister, backed off quickly by removing the capital controls on equity investment and leaving only capital controls in the money market in place. Although the stock market recovered on Wednesday, the damage to Thailand's credibility is far reaching.

If Pridiyathorn had failed to back off in time, the stock market would not have had anything left to sell. The authorities mismanaged the foreign exchange, causing an unintended stock market crash.

In the run-up to the announcement of the capital control measures on Monday, central bank authorities had been at a loss over the sharp rise of the baht. The Thai currency had appreciated by 16 per cent since the beginning of this year alone - rising from Bt41 to Bt35 against the US dollar. If the situation was not corrected, Thai exporters could have gone bust because the baht could have climbed further to Bt31-32. Countries like China and Vietnam have been maintaining cheaper currencies to undermine Thailand's competitiveness.

Foreign funds had been pouring into Thailand, particularly since November. This month alone, some US$1 billion has swamped the Thai money market on a weekly basis. Tarisa Watanagase, the central bank governor, and her officials had been warning that they would introduce tough measures to deal with baht speculation. Given a choice between Thai exports and the stock market, they decided to protect the former, the bread and butter of the Thai economy.

Twice they hinted that they might tax short-term capital. And finally, they imposed the capital controls - in a clumsy way.

The culprits speculating on the baht this time were leveraged funds mainly from Japan and the US. From Singapore, they were making money betting on a "one-way-street" rising baht. The situation is reminiscent of the period leading up to the 1997 financial crisis. But it is all in reverse mode. Then, Thailand was running a current account deficit of 7-8 per cent of gross domestic product. It was saddled with huge foreign debts of more than US$100 billion, more than half of which accounted for short-term loans. With sagging exports, the foreign hedge funds and investment banks bet that the banking authorities would have no choice but to devalue the baht to prop up exports.

Instead, the central bank elected to defend the integrity of the fixed exchange-rate regime, which marked the Thai currency rigidly at Bt25 to the dollar. It was afraid that if it let go of the baht, it would bankrupt Thai companies and Thai banks. As a result, the central bank lost almost all of its foreign exchange reserves in a hurry. After the ill-considered intervention, it finally caved in to the pressure by floating the baht outright and sought a support programme from the International Monetary Fund. But this time, the situation has been easier to handle. During the run-up to the 1997 crisis, the Thai central bank had to sell the dollar to support the baht. Since it did not print the dollar, it eventually ran out of greenbacks to virtually bankrupt the country. Now, the central bank has the advantage of foreign exchange intervention by buying the dollar and selling the baht. Since it prints the baht, it has an unlimited source of funding to ward off foreign speculators. Like a casino dealer, which issues the chips, the central bank can never lose in a money game of this style.

Strangely enough, instead of intervening to buy up dollars to accumulate even more foreign exchange reserves and keep the baht competitive at the same time, the central bank feels wary of doing so. When Pridiyathorn was serving as governor, the central bank was excited that it could build up its foreign exchange reserves from US$30 billion to US$35 billion, and before long it was able to make early repayments to the IMF. After, the bank's reserves jumped sharply due to the current account surplus and the continuing inflow of foreign funds. Now, reserves have reached US$64.5 billion, which is double the pre-1997 crisis level.

It is true the baht had become the proxy of regional currencies, and the global leveraged funds had found it convenient to speculate on its upward trend. The speculators bought up Thai financial assets such as short-term and long-term bonds and got involved in other currency trading. But the central bank was always able to fend off the speculation in several ways.

First, the bank might not have managed the baht well in previous years. The baht was relatively weak against other currencies. So it was natural for it to be the subject of speculation this year. This raised questions about the central bank's foreign exchange management.

Second, it could buy up the dollar to weaken the Thai currency. By doing so, it could sell the baht and increase money supply. Then it could mop up the excess supply by issuing bonds. It might be reluctant to amass foreign exchange reserves for fear of having to issue bonds at a loss from high interest rates. But it can also earn a return from the US dollar.

It would do no harm if Thailand's reserves were to climb to US$100 billion. China is not afraid to build up its reserves at all. Beijing now has some US$1 trillion in reserves and is diversifying its investments throughout the world, buying up strategic assets important to China's long-term growth and prosperity. Singapore is also willing to intervene heavily in the foreign exchange market to keep its currency stable, spending at times as much as US$60 billion in currency swap obligations.

Third, a dose of administrative control would not be too bad to ward off the baht speculators. If the central bank had quietly bought up the dollar until the baht reached Bt36, then it could immediately issue some sort of tough administrative measures, briefly, to defend the baht at that level. Currency contracts, intended to roll on upon maturity, could be subject to tax. The foreign speculators would lose their money, forcing them to unwind their positions. Then the game would be over.

These are the kind of selective administrative measures in the foreign exchange market that would not hurt the capital market or other good foreign investment in Thailand, and that would be an acceptable practice. The central bank has to fight the currency speculators at their own game. That's what the Bank of Japan has been good at doing, keeping the interest rate low at 1 per cent while maintaining a weak yen at the same time to prop up Japanese exports.

Fourth, signalling a cut in interest rates would also help ease the baht speculation. Lower interest rates would normally help weaken currencies.

Finally, the central bank could also move quickly on financial liberalisation by allowing greater flexibility for Thai funds to invest in the overseas market. Capital outflow in the form of investment by Thai companies and Thai investment funds would help reduce the upward pressure on the baht. Singapore funds are now investing on a global basis. In overseas investment, Thai funds are just learning how to walk.

Or the central bank could set aside a portion from its reserves to set up a Thai version of the Government Investment Corporation of Singapore. Then this Thai-style GIC could bid for other assets overseas (just avoid Singapore Telecom please!).

If these policies had been pursued one way or another, the Finance Ministry and the Bank of Thailand might not have committed such a foolish act on Monday with their indiscriminate capital controls. "Black Tuesday" hurt good money and created a huge dent in Thailand's credibility.

Thanong Khanthong

The Nation