There were also not enough "Monkey's Cheek" projects to hold the water during flood time. (His Majesty used the analogy of a monkey using one of its cheeks to hold its favourite food while it continues to munch on other food.) In the end, His Majesty called on officials to divert the water into his own land in Ayutthaya to help stave off the damaging effects of the flood on the capital. This was a textbook example of water management. The Bank of Thailand's officials are at a loss over how to manage the massive inflow of foreign capital that is flooding the Thai financial system. Massive liquidity from abroad has been flowing into the country since the beginning of the year, more so over the past four months. The inflow, coupled with baht speculation, has driven the value of the baht from Bt41 to the US dollar, to Bt35 to Bt36. Thai exports have been badly hurt by the baht's surge.

In the first 10 months of this year, the central bank bore a huge cost of Bt75 billion from its intervention in the foreign exchange market to keep the value of the baht from a sharp rise. As it bought up US dollar for its foreign exchange reserves, it lost about Bt5 on every dollar purchase. This is not to mention the central bank's additional cost of issuing baht bonds to mop up liquidity from the financial system when it bought US dollars and sold the baht into the financial system.

The intervention might have already cost the central bank more than Bt100 billion for the entire year. But don't worry about the Bank of Thailand's huge intervention cost or its profits and losses. Its task is to ensure financial stability so that at the end of the day the average Thai will not be hurt by economic troubles.

But the big question is whether banking authorities have done their job appropriately when it comes to liquidity management. Have they failed to design a mechanism by which they can deal with an excess of capital inflow, as was the case with the irrigation officials' water management techniques? How can the bond market and other markets be developed to absorb the liquidity like the Monkey's Cheek project in water management? Thailand is overall facing a shortfall in water for agricultural and consumption purposes, yet it cannot manage the sudden downpour that leads to flood damage. Thailand will also need foreign capital to finance its current account deficit in the medium term, but in the short term it can't handle the massive inflow. This is the dilemma facing the country.

There is no easy solution to short-term capital movements, which threaten to wreak havoc on the Thai economy. So far, banking authorities have decided to prescribe tough medicine by imposing reserve requirements of 30 per cent for the capital brought into the country. They can declare victory for the moment because the baht has slipped back to the Bt36 level, instead of moving up to Bt34 and further damaging Thai exports. But this tough measure has badly hurt sentiment in the equity market and is destroying the debt market, which is equally important in providing overall stability in the financial system.

You may recall that during the 1997 financial crisis, the Thai bond market was too illiquid to absorb the shock from the baht attack. When currency speculators attacked the baht by selling Thai currency for the US dollar, the baht was sucked out of the financial system, causing liquidity to dry up and interest rates to jump all of a sudden. The central bank was forced to intervene by selling the US dollar for baht to inject liquidity back into the financial system; otherwise the payment system would have collapsed. If the bond market had been developed with greater depth, the liquidity crisis could have been alleviated to a certain degree.

While the central bank's reserve requirement might effectively deter capital inflow in the short term, it will destroy the bond market, which raises a need that is equivalent to the one behind the Monkey's Cheek Project. Dr Chalongphob Susangkarn, the president of the Thailand Development Research Institute, has called upon banking authorities to revise its 30 per cent reserve requirement. The TDRI model recommends imposing a 2 per cent reserve requirement across the board instead without discriminating against any markets or against long-term or short-term capital. The TDRI is afraid that the central bank's tough measure might kill the bond market in the long run.

Dr Teerana Bhongmakapat of Chulalongkorn University earlier recommended that the reserve requirement should stand at 3- to- 5-per cent for three- to six- month capital, depending on the appropriate fine-tuning.

We are seeing more recommendations on the table to avert the liquidity crisis, but a debate on monetary loosening to let the baht slide has not been discussed prominently. Again, you might also recall that when MR Pridiyathorn Devakula took office as governor of the central bank in mid-2001, he raised interest rates by one full percentage point to defend the baht. Then he was afraid of capital outflow and the sliding baht. Strangely enough, this time around, Pridiyathorn has not seen the point of cutting the interest rate at a similar level to soften the baht.

Yes, the banking authorities are still cautious about inflation, but this choice should have been made in the first sequencing before the reserve requirement was pushed out as the very last resort. In this money game, you don't throw out your trump card too soon.

Thanong Khanthong

The Nation