The Day of Reckoning

At 5am on July 2, 1997, Vichai Punphocha, the general manager of Dresdner Bank in Bangkok, rose to a surprise phone call. Somebody from the Bank of Thailand was on the line.

Vichai had left Thailand for Germany at 17 and never returned to his homeland until he took up the Bangkok assignment in 1993. The official asked him to arrive at the Bank of Thailand's Bang Khun Phrom headquarters at 7am to attend an important meeting.

Dr Olarn Chaipravat, president of Siam Commercial Bank, also received a similar call early that morning. "What exactly is going on?" he asked himself. He got dressed quickly and rushed to the central bank.

Olarn incidentally bumped into Sirin Nimmanahaeminda, president of Krung Thai Bank, at the doorsteps leading to the entrance. He asked Sirin why the central bank was crazy enough to call a meeting at this early hour.

Sirin said: "I bet they are to announce a devaluation of the baht." Even then, Olarn could not bring himself to believe that the day of reckoning had arrived. He had been arguing all along against any attempt to devalue the baht, which he believed would not benefit Thailand in any way.

On that day about 70 top local and foreign bankers, accompanied by their chief treasurers, gathered at the Bank of Thailand, where they were greeted by Rerngchai Marakanond, the central bank's governor, Chaiyawat Wibulsawasdi, the deputy governor, Siri Garncharoendee, the assistant governor, Tanya Sirivedhin, the assistant governor, Bandid Nijathaworn, the director of the Banking Department, and Kleothong Hae-trakul, the director of the Research Department.

Officials quickly distributed a press release, written in Thai, to the bankers, outlining the central bank's decision to scrap the fixed-exchange rate regime in favour of a managed-float system.

Finally, Thai authorities had made their decision to release the baht, which had been fixed to the US dollar at around Bt25 for more than a decade.

Yet few among the top bankers could have foreseen the ramifications of that simple announcement, which would shake the world, spread the tom yam kung disease and plunge Thailand into financial insolvency.

Thanong Bidaya, the finance minister, would later claim credit for his contribution to the devaluation policy. "I announced a policy to float the baht. It was a daring decision. I think it was a management decision. I had to do it quickly because if I had delayed it, my reputation as a decisive finance minister would have been tarnished," Thanong told foreign correspondents in Bangkok on September 2, 1997.

Rerngchai and his team immediately went into the business of explaining to local and foreign bankers about the central bank's new foreign-exchange policy and clarified some technical points. The meeting was conducted in Thai. Some foreign bankers, who did not bring along their Thai aides to help them with the interpretation, were squirming in their seats, trying to make sense of what was actually going on.

There were some important questions asked at the meeting. First, whether the central bank would still allow the banks to enter into a currency swap or forward agreements with it, and if so at what rate? Chaiyawat did most of the explaining. He said these activities with the central bank would be suspended temporarily but each bank would be allowed to enter into a swap or forward agreement and quote rates between themselves.

Second, how was the managed-float system going to work in practice? Chaiyawat said the central bank would continue to act as a lender of last resort. It would no longer quote the mid-rate as a benchmark against which the baht was traded to the dollar. But market forces would instead determine the value of the baht. The central bank would simply step in every afternoon, from 4pm to 4.30pm, to provide liquidity in case any banks needed to cover their foreign-exchange positions. The value of the transactions would be in round figures - US$1 million, $2 million or $10 million, for example.

Later the Bank of Thailand told the financial markets it had decided to change its exchange-rate mechanism to a managed float from the 13-year-old policy of pegging the baht to a basket of currencies dominated by the US dollar.

The dam broke

The announcement effectively devalued the baht by about 15-20 per cent in one day. The dam was finally broken.

In the absence of an official mid-rate, Standard Chartered Bank was the first bank to test the waters. It quoted the onshore baht rate at Bt28 to the dollar. Banque Indosuez, the French bank, followed by quoting the baht at Bt29.50.

In the offshore market, the baht was sharply quoted up at Bt28.50 from Bt24.70, effectively converging the offshore and onshore rates. Bangkok Bank quoted its buying rate for US dollar bank notes at Bt24.98 and the selling rate at Bt30.16. Most other local banks preferred to wait and see.

Chaiyawat reassured that within seven days, the markets would find an equilibrium to the baht. He had in mind that the baht should hover around its fundamental level of Bt28 to Bt29. On that day, the interbank rate shot up to less than 30 per cent, instead of 70 to 80 per cent as feared by the banking regulators. They had moved to stem the currency depreciation by raising the discount rate - the rate at which it lends short-term money to the commercial banks - from 10 per cent to 12.50 per cent.

But the Stock Exchange of Thailand index showed an irrational exuberance by jumping 41.51 points to 568.79 on turnover of Bt10.42 billion. Investors believed the baht float would at least give the authorities more room to manoeuvre its monetary policy and end the uncertainty over the foreign-exchange rate mechanism.

Morgan Stanley Asia said in its report on that day: "The new equilibrium exchange value of the baht depends on where along the spectrum from first-best to worst we end up. We see the Bt32/dollar range as consistent with the need to reverse the appreciation of the real effective exchange rate that has occurred since 1995 and allow for the 'crowding in' of labour and capital from the construction, property and banking and finance sectors to the manufacturing sector, which will characterise the economy's post-devaluation recovery path."

But the war with the hedge funds was not over yet. Rerngchai still hoped that he could keep speculator George Soros at bay from his attempt to obtain baht to cover his huge currency-swap positions. The Bank of Thailand still kept its two-tier currency system in place. "Since we shut down the onshore baht market to foreign speculators, Soros won't be able to obtain baht easily, although the baht has fallen to a tempting level of Bt28 on the onshore market after the flotation," one of the top Bank of Thailand officials said.

In short, Soros, identified by the central bank as its number one enemy, would not be able to cash in, and the Bank of Thailand still hoped that Soros would default his positions and get some of his fingers burnt.

But Soros would have the last laugh. His hedge funds, including most other global funds speculating against the baht, would make a fortune on the baht's devaluation. They finally broke the back of the Bank of Thailand.

For its decision to unpeg the currency, Thailand was sharply criticised for its crony capitalism. Business Week (July 14, 1997) wrote in its editorial: "Thailand's bubble economy had burst, and its battle against the global economy has ended in defeat.

"Thailand, Korea and other Asian countries have hit a wall in their economic development. Rising labour costs are forcing them to manufacture and export more sophisticated products. But the crony capitalism that delivered high economic growth based on toys, textiles and other simple goods is having a difficult time making the transition.

"The Thai government, beset by political divisions and poor management, waited too long to act. Now, it must raise interest rates and put a brake on the entire economy. But it should go much further. Just as in China, the rule of law and the play of the marketplace must replace contacts and corruption."

After the devaluation, Ekamol Khiriwat, the former Bank of Thailand deputy governor and secretary-general of the Securities and Exchange Commission, called Dr Amnuay Viravan, the former finance minister, and congratulated him, saying the measures must have been worked out neatly with good support measures put in place.

Amnuay resigned under tremendous pressure from the Chavalit government less than two weeks before the baht devaluation. He was succeeded by Thanong. Amnuay told Ekamol bluntly that there were no measures at all to support the transition from the fixed exchange rate to a managed float. The devaluation was done out of complete desperation.

Ekamol was bewildered. Did the Bank of Thailand know what it was doing?

The Democrats, who led the opposition bloc, immediately sensed that something fishy was in the air. They charged that General Chavalit Yongchaiyudh, the prime minister, might have benefited from the abrupt abandoning of the foreign-exchange regime. A company with close links to the military had been moving about $5 million a day to Singapore for a few days before the baht was floated.

"The government has apparently left the public in the dark as it churned out each remedy for the economy without taking into account the spill-over effect," Tarrin Nimmanaeminda, a Democrat member and former finance minister, slammed the Chavalit government.

Abhisit Vejjajiva, another star of the Democrats, said the government's abrupt decision to float the baht meant that its attempts over the past six months to defend the currency did not reflect the baht's real value. He said the government had wasted a lot of reserves defending the baht. He called for Chavalit to step down.

"I think the prime minister should decide if it's time to restore the economy and if it's time to have a more reliable leader working for the interests of the people," Abhisit said.

He also accused Chavalit of backtracking on his pledge not to devalue the baht.

Did Chavalit know that the central bank would have no choice but to float the baht?

One central bank official said: "I believe the prime minister had been kept informed about the entire situation. So it was not a surprise that a day after Thanong's takeover of the finance portfolio, Rerngchai went into a meeting one day with a broad smile and told his aides over a decision to change the foreign-exchange policy. If the signal did not come from the prime minister, it could hardly be interpreted otherwise because the governor did not have the guts to make the decision from the outset."

Thanong Khanthong

The Nation