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Published on March 5, 2008

Financial flows in economics can be compared to the water flow in hydrology. At times an unanticipated and very large flow in either direction can cause severe damage to the country as the currency value can swing wildly in a short period of time.

If the volume of fund or water flows is managed properly within tolerable limits, not too much or too little, the financial flows and the resulting exchange rate will benefit the country.

On the contrary, if the authorities have no adequate understanding about the types, magnitudes and reasons of private fund flows and get panicky when at a rising currency value or water level in the city, they can react irrationally by abruptly and artificially erecting a massive barrier against capital inflows instead of attempting to recycle the overflows out of the country via normal policy instruments such as relaxing outdated exchange control regulations to encourage compensating capital outflows.

A country that has the newly acquired status of current account surplus will do well to intervene in the FX market to keep the domestic currency value within the target zone and maintain exporters' competitiveness in the world market.

Those who were in Thailand in December 2006 would certainly be shocked by the adverse consequences of the much derided 30 per cent reserve requirements against all capital inflows imposed by the Thai authorities, some remnants of which still remain today after more than one year of the policy fiasco.

I am happy to report that the reserve requirement has been abolished, effective since Monday.

Subsequent relaxation of exchange controls and more refined and better coordinated foreign exchange interventions by the authorities, together with required local currency financing, have proved that it is possible, prudent and appropriate to manage the cross-border fund flows and supplement this management by official interventions to hit the resulting market-oriented exchange rate zone at the level that will maintain exporters' competitiveness.

Now the real question, as asked recently by the new prime minister Samak Sundaravej, is whether or not the Thai government and its officials know how to determine the appropriate level of the country's target exchange rate, as many of our neighbours such as China, Malaysia and Singapore seem to know.

And if Thailand collectively knows an answer to this question, the other question is whether or not the authorities from the central bank and the Ministry of Finance know how to manage and intervene to hit that target exchange rate zone for the benefit of exporters, farmers, wage earners and the rest of the economy?

It is the mandate of any democratically elected government to manage these five intermediate policy targets - exchange rate, short-term interest rate, annual public sector expenditure budget, minimum-wage rate and long-term bond rate - as the means to steer and direct the economy towards a simultaneous fulfilment of at least five other ultimate objectives besides exporters' competitiveness, including the following:

1. Output Growth and Labour Employment, often known as Real GDP or Value Creation Growth Objective.

Growth objective must be considered in terms of both quantity (e.g. at least + 6 per cent per annum) and quality to assure as near full employment of domestic labour and capital resources as possible. Through better education and workers' skills, higher quality growth will result in better quality products and better quality of life.

2. Price Objective (e.g. inflation rate not higher than 4 per cent per annum).

Such an objective is to prevent goods and services prices from rising too rapidly and erratically in such a way that various groups' real income and real purchasing power are systematically eroded and destroyed.

3. Income Distribution Objective (e.g. farmers' and workers' real income should not change dramatically and adversely relative to those of the middle- and upper-class professionals).

This is probably the most difficult objective for the government to deliberate and arbitrate in a democratic society, yet politics dictates that any government must make the required decisions.

4. Financial Stability Objective (e.g. the banking system including the central bank must be sound, well capitalised and have ability to properly manage financial risks and discharge their policy and fiduciary duties).

The 1997 Asian Financial Crisis has destroyed the creditability of the commercial and central banks of Asia.

The financial fiasco that happened in Thailand again in December 2006 (hence the introduction of the 30 per cent reserve requirement) has not helped the country.

The sound economic and financial policy reputation achieved in the 1960s, 70s and 80s is yet to be restored in the eyes of sophisticated international investors and analysts.

This is probably the most complex and intricate policy issue faced by the new, government.

5. Fiscal Sustainability Objective (e.g. the Ministry of Finance cannot forever service debt payments of the central bank arising from the 1997 Financial Crisis from the annual budget appropriations).

The central bank must be re-capitalised as soon as possible with a new business and management plan to restore its financial creditability, coherent policy responsibility and accountability, rational policy implementation, transparency and the ability to consult and communicate effectively with the public, government departments and agencies and the international community.

This is probably the last option left for the Ministry of Finance and the government of Thailand in their attempts to restore the central bank's creditability and save long-term public funds.

Olarn Chaipravat is an adviser to the Fiscal Policy Research Unit.

Olarn Chaipravat

The Nation