BEHIND THE SCENES
Black Tuesday: Did the BOT overreact?
From his interview with Tarisa Watanagase, the Bank of Thailand governor, and Achana Waikhuamdee, the central bank's chief economist, Thanong Khanthong examines the Bank of Thailand's capitalcontrol measures introduced last week to rein in baht speculation.
The key questions are that the central bank are facing two real problems - massive capital inflow and intense baht speculation. But are the capital control measures an answer to these two underlying problems? Do the central bankers overreact? What did they discuss before coming up with the measures that caused Black Tuesday.
SINCE October this year, foreign capital had been flowing into Thailand like crazy, amounting to almost US$1 billion a week in December alone.
With the capital inflow, baht speculation was intense, moving frantically at 3040 satang a day. Soon after assuming office as the first female governor of the Bank of Thailand in November, Tarisa Watanagase had to confront the problem of hot money, which drove up the baht and threatened to undermine Thailand's overall export competitiveness.
In fact, as pointed out by Achana Waikhuamdee, the central bank's chief economist, the banking authorities had been studying how to deal with the hot money - money that moves into and out of the country within one year - over the past two years. They had warned the exporters to watch out the baht appreciation; they had also warned the currency speculators that they would introduce tough medicine to curb speculation.
This year alone, the baht was the best performer in the region, rising by 15 per cent from Bt41 to Bt35. As Thailand is maintaining a floating exchange rate regime, the baht has become very volatile, unlike the fixed yuan or the Hong Kong dollar. Singapore has also allowed its currency to move in a very narrow band. With these three major currencies being fixed, it was more convenient for the currency traders and speculators to go after currencies such as baht or Korean won.
On December 4, the central bank issued tough measures to deter baht speculation. But the currency traders and speculators shrugged them off. The baht bounced up to Bt35.10Bt35.15/US dollar as if to challenge the authorities with a "catch me if you can" phrase. Tarisa and her team went so far as to warn that the central bank would eventually tax the hot money if the speculation did not recede.
Thailand has been facing two real problems - heavy capital inflow and intense baht speculation.
Today's excess liquidity problem is larger than the 1990s. The Bank of Thailand's increase in foreign exchange reserves, as a percentage of the gross domestic product, is larger today than the era of the economic bubbles.
According to a report of DBS Research Group, published on December 22, 2006, between 1992 and 1995, foreign exchange reserves' increase as a percentage of GDP ranged from 2.5 per cent to 4.0 per cent. Today's increase has doubled the ratio in the 1990s, amounting to 4.6 per cent in 2002, 4.8 per cent in 2004 and 6.2 per cent in 2006.
When MR Pridiyathorn Devakula began his tenure as governor of the Bank of Thailand in 2001, Thailand's reserves stood at around US$30 billion. When he left office to become deputy prime minister and finance minister in November this year, reserves more than doubled to US$64 billion.
The Thai central bank is now facing a serious problem of liquidity management or how cope with capital inflow as money is leaving the US, the world's financial centre, to Asia, where economic growth prospects are the best. To be frank, the central bank is not sure how to cope with the excess liquidity beyond the size of the Thai economic system to absorb.
So far it has intervened in the financial markets to keep the baht less volatile. By doing so, it has issued bonds amounting to about Bt700Bt800 billion to mop up the excess liquidity from its buying of the US dollar to prop up the baht. The carrying cost of these bonds is about Bt50 billion a year.
The heavy capital inflow was accompanied by intense baht speculation. The central bank's officials in the monetary policy department and in the monetary policy committee played a key role this time in coming up with a strategy to deal with the baht speculation. The baht was moving up like a one way bet. The exporters were yelling like mad.
There were talks in the financial markets that the baht could eventually go up to Bt29 to Bt32 to the US dollar. Ten years after the 1997 meltdown, the crisishit currencies of Asia are climbing back to their value. The Korean won is now trading at 900, compared with 800 during the precrisis. The Singapore dollar is also close to its precrisis level.
The baht started off at Bt25 in the precrisis 1997 before crashing to Bt56 in January 1998. Ever since it has been fluctuating sharply. Now it is trading at the Bt35 level. So naturally, the speculators are seeing ample room for the baht to climb further back to its precrisis level.
The week before last week, when the capital controls measures were announced, the central bank's officials looked at several options to deal with the oneway movements of the baht. According to Achana, some of the options included a requirement for people bringing money into Thailand to swap half of the amount into baht or to convert their currencies immediately. But the central bank could only have an oversight over financial institutions, not individuals.
Then the officials discussed about the taxing the shortterm inflow outright. But doing so would need cooperation from the Finance Ministry, making the matter very difficult to implement or to withdraw afterward.
Finally, they decided to go for the Tobin tax model, which requires investors to set aside as reserves a certain percentage of their money before they are allowed to invest. This would slow down the pace of the inflow. The Thai officials discuss the reserve requirements at the ratio of 10, 30, 50 per cent before agreeing with the 30 per cent rate. If the investors agree to invest in Thailand for more than one year, they will get their reserves back. If not, 10 per cent of the total amount would be taxed.
It took Chile, which introduced the Tobin tax in the old days, about four years to plug the loopholes. The Thai authorities did not want to go around to plug the loopholes, so they decided to go for wholesale capital controls in the equity market, money markets and other investments, although the original aim was to curb the speculation in the debt market.
Tarisa agreed to go along with the capital control measures as they could be implemented at once within the jurisdiction of the central bank. The week before last week, the officials discussed the impact of the reserve requirement measures on the different markets such as equities, bonds and other investments. They differed on the impact of the capital control measure on the equity market. Still, in the worse case scenario, the stock market would fall 70 points before the panic subsided as investors came back to their sense.
Most important, the banking authorities were afraid that the baht would hit Bt34, a psychological level that would further make it difficult to hold back the baht. China and Vietnam, which fixed their currencies, are having an advantage over Thailand.
But after the capital control measures were announced last Monday, the stock market crashed on Black Tuesday, plummeting to almost 20 per cent at one point. The foreign investors condemned Thailand for hitting under the belt. There were huge sell orders in the brokers' account for the following day, forcing Pridiyathorn to back track on equity investment restrictions otherwise the stock market would have collapsed further.
For now the baht may weaken to a more comfortable zone of Bt35Bt36 due to the capital control measures. But it does not mean that the problem of inflow and baht speculation will go away. Investors will be trying to find the loopholes to circumvent the rules. Capital inflow will continue to come in spite of his temporary setback. Companies, which do not have access to the equity market, will have a tough time raising their money in the bond market.
The central bank's resolve is about to face a real, bigger test in the coming months.
By Thanong Khanthong