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Devaluation anniversary

Baht back strong but challenges remain

In the 15 years since the embattled baht was floated on July 2, 1997, Thailand's economy and currency have skidded through considerable turbulence, but for sustainable strength, proper policies are required to sail the economy and baht through worse weather towards firmer ground, economists say.





The Thai baht came under heavy attack in 1997 due to a toxic recipe. The unit was pegged at Bt25 against the US dollar and backed up mainly by foreign reserves that were considered too thin against foreign claims built up through lax regulation of local financial institutions over the years. As Thailand was a net importer due to a relatively small export sector, it suffered current-account deficits. The financial system's non-performing loans reached nearly half of outstanding loans. The combination led to capital flight, the failed defence of the baht and eventually the de facto devaluation that sparked the Tom Yam Kung crisis.

"The euro area crisis is a clear example. A disaster is in sight if one end (monetary policies) is fixed and the other (the currency) is not," Sutapa Amornvivat, chief economist of Siam Commercial Bank, said last week.

Within six months after devaluation, the baht lost as much as 140 per cent of its value, sinking from Bt25 to Bt57.6, before finding equilibrium in 2001 when the economy was brought back to its normal path by export income and the International Monetary Fund's rescue package was repaid. During the harrowing years, the number of commercial banks shrank from 15 to 13 today - also with the integration of many finance houses.

Since 2001, the baht has been biased towards appreciation, thanks to years of current-account surpluses, low investment from the public and private sectors, and consistent portfolio investment, said Usara Wilaipich, senior economist of Standard Chartered Bank (Thai). From 45 per cent of gross domestic product before the crisis, investment by the public and private sectors is now less than 20 per cent, which kept capital goods imports at a low level.

This trend is expected to continue. Thailand has enjoyed current account surpluses for most of the past 10 years, which resulted in the continued build-up of international reserves. From $27 billion in 1997, foreign reserves peaked at $189.9 billion on April 29, 2011 before retreating slightly to $173.1 billion as of June 22 this year.

"Economic fundamentals in Asia have changed significantly, with higher current account surpluses, better economies in Asia, better capital markets, bond market development, deeper capital markets and higher reserves. Asian foreign reserve positions are much higher," said Danny Suwannapruti, senior rates strategist at Standard Chartered Bank in Singapore.

The baht could weaken again, as witnessed in the past months under the influence of global fund flows, but the Thai economy is in a much better position now to withstand the depreciation, he said.

The first obvious lesson learnt from the devaluation is that fixed exchange rates, with very few exceptions, do not work, said Thiti Tantikulanan, head of Kasikornbank's capital markets business.

"Secondly, history (Mexico in 1994, China in 1995, Brazil and Argentina in 2000) has shown that a currency with weak fundamentals may put off facing the music in the short run but eventually market demand and supply will restore its true value," he said.

Sadly, not all countries had learned from Asia. In 2008, Iceland's currency, the krona, dropped by 150 per cent, also on a high current account deficit and high non-performing loans in the banking system.

After the tumultuous years, the baht and the economy have picked up resilience. Parson Singha, chief strategist for global markets at HSBC Thailand, said the authorities have done the right thing in letting the market mechanism determine the exchange rate, with occasional intervention only to ward off shocks.

While the currency should be allowed to move in line with market forces, from a macroeconomic management point of view, from a business point of view, the currency should be stable and appropriately valued.

"Ultimately the key challenge for policymakers should be that the currency is not too volatile on a day-to-day basis, and that the currency does not strengthen too much against comparable currencies in the region," he said.

Yet, coming with the managed float system are greater challenges as local economic fundamentals could be overridden by global forces, particularly with the surplus liquidity in the global financial system and ease of capital movement. The prolonged euro crisis indicates more injections into the banking industry. Periodically, this will give rise to "risk-off" mode, when investors sell emerging assets and bring money home. When good news return, they would return to risky assets. In the past months, the baht has traded in a wide band against the greenback.

Standard Chartered's Usara said the two-way movement of the exchange rate is in sight, but the strong economic fundamentals will further guarantee the upside. This is bad for exporters, but rather than fighting against the tide, policymakers should honour the market and seek balancing through more investment in mega projects and the promotion of overseas investment. New investment over the next five years would invite growth in imports to the point that Thailand runs current account deficits, but if such investment benefits the economy and boosts growth, Thailand will welcome capital inflows and the baht can rise again.

"Baht sensitivity will be greater. Still, despite the upside possibility, it is nearly impossible to see a revisit of a sharp spike like in the past, when it shot up from 46 per dollar to 30. The landscape has totally changed," she said.

"The Bank of Thailand has learnt a lesson - the intervention has been kept to a minimum, only to neutralise volatility and keep the currency close to neighbouring currencies for the sake of competitiveness. Rather than focusing on forex rates, policymakers should emphasise economic fundamentals. Balancing is the key."


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