The Hindu Business Line : The Thailand retraction, a misstep

It is difficult not to feel sorry for Thailand. In the first instance, it faced an emerging crisis and attempted an unpopular course to grapple with it. Indeed, the Thai authorities could have anticipated the fierce resistance to their steps from foreign investors and institutions. But they lacked the strength to steer the course and muddied the situation by retracting in less than 24 hours. The financial press is busy heaping insults on the injury already suffered by Thailand.

What was the problem? On December 18, Thailand's central bank imposed capital controls to stem the rapid appreciation of the baht. Invariably, the entire Western press characterised it as `draconian'. It was not so.

Managing capital inflows

The Bank of Thailand's (BoT) press release of December 18 stated that "despite recent measures aiming at discouraging short-term capital flows and limiting Thai baht speculation, short-term speculative inflows of various forms continue to persist, as evidenced by the volatility of the Thai baht and its rapid pace of appreciation." To curb speculative inflows, the BoT decided to impose an unremunerated reserve requirement on short-term inflows. Financial institutions are required to withhold 30 per cent of currencies, except those related to trade in goods and services. The blocked funds may be taken out after one year. Earlier, repatriation could be only up to two-thirds of the amount. The idea was to manage short-term capital inflows through controls and taxes a la Tobin.

Even in 2005, when the IMF Executive Board studied the Article IV Report, it expressed satisfaction over the BoT's management of the exchange rate and advised it to shift its attention to interest rate, which was quite high.

During the spring meetings of the IMF in September 2006 in Singapore, Mr Rodrigo de Rato, IMF Managing Director, said: "... Thailand's economy is fundamentally strong and financial market reactions have been limited. Regional markets have also been little affected thus far." He went on to add that Asian economies are resilient to shocks "having strengthened their macroeconomic frameworks, increased exchange rate flexibility, and reduced external vulnerabilities in recent years." His optimism did not include portfolio flows and the problems faced by Asian central banks in managing them. Nor the behaviour of the US dollar.

Baht gyrations

The BoT, like other Asian central banks, was pursuing a policy of intervention in foreign exchange markets only to reduce daily volatility and speculative activity and not to counter the effects of real trade and investment flows. However, by mid-November 2006, the baht's gyrations turned worrisome.

On November 10, it fell to 7.5-year-low of bath 36.5 vis-à-vis the US dollar. This was perhaps due to the weakening of the US dollar after reports of the efforts of the People's Bank of China (PBC) to diversify its forex reserves, which were about the trillion-dollar mark.

By November 14, the baht continued to strengthen and slipped almost to an eight-year low of 36.39. This was not only due to the policy of PBC to move away from dollar, but also to fund flows into regional and local stocks and bonds. Soon, it was observed that while the baht had appreciated by about 12 per cent against the US dollar, other regional currencies had gone up 3-6 per cent only.

By December, the baht had appreciated by 15 per cent and the BoT began its struggle to cope with it. In its view, the appreciation of the baht was unjustified by economic fundamentals as it was unrelated to trade and service flows.

The shock therapy

Earlier, the BoT had relied on such administrative measures as allowing exporters to hold dollars abroad, relaxing restrictions on Thai investments abroad, restricting sale of instruments to non-residents, and so on.

These had not proved effective as events unfolded. By December 18, the baht appreciated by almost 20 per cent. It was perhaps the lowest point in ten years. It was then that the BoT decided to go in for a "shock therapy".

As Prof Brad Setser, a research associate at the University College, Oxford, wrote in his blog (December 19, 2006), "Thailand's preference for capital controls over more orthodox monetary tools such as lower interest rates suggests an element of panic. This is understandable since it reflects the policy dilemma faced not just by Thailand, but by all countries trying to compete with China."

What should have shocked the Thai authorities was not the fallout in the Thai stock market but across the globe. Some economists wrote about the grim prospects for further liberalisation in Asia and how it could trigger capital controls elsewhere.

The impact on Thailand's benchmark, Stock Exchange of Thailand (SET) Index, was shattering. It plunged as much as 19.5 per cent. A dealer is reported to have said, "Please call an ambulance, there is bloodbath."

More than its domestic impact, the Thai authorities would have been shaken by its impact on other countries. Indexes in Malaysia and Singapore dropped by 2 per cent, that in India by 2.5 per cent and Indonesia posted a drop of 3 per cent.

Even Hong Kong and the Philippines were not spared. It was reminiscent of the contagion of 1997, which spread from Thailand to neighbouring countries.

Mr Pridiyathorn Devakula, Thai Finance Minister, was quite brave on Day One. He said, "This was not a mistake. Measures always have side-effects. Once we knew the side-effects, we quickly fixed it." However, the global press was not charitable.

Many wrote about the emergence of a new crisis in Asia with Thailand as the epicentre. It is likely that the Thai authorities were unprepared for the regional spread and did not want to be accused of triggering another crisis in the region. Mr Pridiyathorn Devakula back-tracked within a day and was blamed for it too

Lessons for India

The Thai experience has lessons for countries like India. It may be recalled that recently when the Reserve Bank of India raised the CRR by 0.5 per cent and removed Rs 13,500 crore from the banking system, this was seen by foreign investors as an unnecessary tightening.

The BSE Sensex plunged 5.8 per cent and it took two weeks for the index to recover. Bloomberg called it "the perils of shock therapy". Fortunately, the RBI did not retract. Ultimately, the firmness in policy corrected the BSE.

Truly, it is desirable to pursue sound and prudent policies based on mutuality of interests; it should not be the case that policies, which subserve larger national interests, should be sacrificed at the altar of foreign investors.

Undue dependence on portfolio flows and exaggerated attachment to stock market indices seem to abridge our liberty to pursue independent policies.

(The author, a former Finance Ministry official, has experience in international, financial and trade issues.)

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