The ailing symptoms in 1996

A turning point at the Bank of Thailand in mid 1996 revolved around the Bangkok Bank of Commerce. The credibility of the central bank was badly wounded.
 
On July 1, 1996, Vijit Supinit, the governor, was forced to resign from his office. His six-year reign came to an end abruptly, though not surprisingly.

Vijit Supinit

He was embroiled in the Bangkok Bank of Commerce scandal. The Bank of Thailand closed one of its eyes while the rogue bank got itself into trouble with high finance. Most of its loans went into stock market speculation. As the stock market headed downward, BBC lost its capital in a hurry.

But the central bank assisted BBC in its recapitalization. Vijit did not think that BBC had a big problem then. The problem had more to do with Thai politics. If there were confidence in the political stability, the financial markets would reward BBC with a recovery.

This was Vijit’s emphatic view over the BBC affair.

The Banharn government was having a tough time managing the economy on a downturn. The Thai bubble economy was losing its steam. Asset quality of the banks was deteriorating fast. Indeed, the Thai crisis started in 1996 with an infection until it burst off in 1997.

In the end, BBC could still not survive. The Democrats exposed the BBC scandal in Parliament, telling the whole world who the politicians were enjoying a big party at BBC.

The central bank ended up losing Bt120 billion in a bailout for BBC, whose non-performing loans were almost 100 per cent.

The episode dealt a serious blow to the Bank of Thailand's credibility. If the BBC was in this kind big mess, what would happen to other banks or finance companies?

Banharn Silapa-archa, the prime minister, would like to remove Vijit. Bodi Chunananda, the finance minister, had to do the dirty job. He told Vijit to lodge criminal charges against Krirk-kiat Jalichandra, the president of BBC, and his accomplice, Rakesh Saxena, the Indian-born financier, for causing huge damage to the bank.

Banharn Silapa-archa

Bodi threatened to fire Vijit if he failed to bring the case to court. Vijit scrambled to put the case together. He filed the charges against Krirk-kiat and Saxena with the police. The charges did not carry much weight because they were put together in a hurry.

Saxena already left Thailand quietly, while Krirk-kiat was stuck in Thailand. Saxena had the last laugh.

Still, Vijit could not keep his job. He did not stay in the office long enough to witness the baht attack in November and December of 1996.

Vijit handled the baht attack during the Mexico financial crisis in 1994-1995 and was able to bring the situation under control. That episode gave rise to confidence within the Thai central bank that it would be able to handle the foreign exchange crisis under control with its fixed exchange rate system.

Please tighten the budget

Since the Bank of Thailand strongly determined to maintain the fixed exchange rate system and had exhausted the limits of its monetary tool, it could only hope that the government would pursue fiscal discipline. Tightening the fiscal policy would help curb the economic overheating and narrow the current account deficit.

The high level of the current account deficit of 8 per cent of the gross domestic product and the economic overheating posed the biggest problem of Thailand’s macro stability. 

But there was no evidence that the Bank of Thailand sounded an alarm bell with the Banharn government over a need for fiscal tightening. Fiscal policy was in the domain of the Finance Ministry. Despite Thailand government's fiscal prudence over the past decade, the balanced budgets in 1994 and 1996 was not enough to combat the overheating. A fiscal surplus was necessary to cool down the overheating.

The Budget Bureau, which is under the oversight of the Prime Minister's Office, the Fiscal Policy Office, which is under the Finance Ministry, the National Economic and Social Development Board, the government's think tank, and the Bank of Thailand traditionally work out the annual fiscal budget together. The finance minister normally chairs this meeting to strike out the budget deal.

The Nukul Commission, set up by the Chuan government later to investigate what went wrong with the 1997 financial and banking crisis, found that on January 18, 1995,  Tarrin Nimmanahaeminda, the finance minister of the Chuan government, chaired a meeting to outline the fiscal budget for 1996. The meeting agreed to balance the budget. There was no evidence that Vijit tried to fight for a fiscal surplus to reduce the demand pressure in the economy.

After Dr Surakiart Sathirathai succeeded Tarrin as finance minister in the Banharn government, there was no evidence either that the Bank of Thailand opposed the fiscal balance.

Since 1995, the Bank of Thailand had been tightening its monetary policy by intervening actively in the repurchase market, where banks adjust their short-term liquidity by trading bonds with each other. The Bank of Thailand was one of the major players. Vijit admitted to the Nukul commission that it was the politically motivated policy that complicated the country’s macroeconomic management.

"There had been a conflicting policy in the macroeconomic management. Several finance ministers, whether they are Dr Surakiart Sathirathai or Khun Bodi Chunnananda, all laid out these major policies: bringing down the interest rates, keep economic growth at 8-10 per cent, accelerating the fiscal spending to meet the project demand. The fiscal policy was flawed. It gave rise to a loss of confidence in the macro policy of the government and brought about conflicting signals,” Vijit testified to the Nukul Commission.

Surakiart also told the Nukul Commission that the governments in the past had been going against any attempt to formulate a fiscal surplus. On the contrary, they would like the central bank to lower the interest rates to keep businesses going and everybody happy.

What Surakiart did not say was that fiscal budget was the golden eggs for the politicians make the money. "The budget is like an ice-cream. The politicians would lick it until there is only the stick left before handing it over to the people. That's really the Thai way of managing the budget," Tarrin joked privately to his friends.

Vijit would not admit that the fixed currency regime was the main reason that created demand pressure in the first place. The baht should have been unpegged first.

In his view, the Thai crisis started when Bodi announced that the government would continue to go for high economic growth of 8-9 per cent. That was when the financial markets began to lose confidence in Thailand because this would mean that the Thai government did not care about the inflationary pressure, the economic overheating or the high current account deficit at all.

Of Hamburgers and Foreign Exchange Policy
 
The Banharn government collapsed before the end of 1996 when the Thai exports reported zero growth for the first time in modern history. Gen Chavalit Yongchaiyud, who led the New Aspiration Party, took over as prime minister with support from other coalition partners. He appointed Dr Amnuay Viravan, a technocrat and a banker, as head of his economic Dream Team.
 
Amnuay would head the Nightmare Team instead, confronting the currency problems throughout his tenure of slightly more than half a year.

On Christmas Day at 16:00 hours at the Bank of Thailand's Old Palace Building, Amnuay Viravan and Dr Narongchai Akrasanee, the commerce minister, held a meeting with the top Bank of Thailand officials to discuss a possible change of the currency regime. They had hamburgers for the meals. This meeting took place before Amnuay went on to chair a meeting of the Exchange Equalisation Fund.
 
Also attending were Rerngchai Marakanond, the Bank of Thailand governor, Chaiyawat Wibulsawasdi, the deputy governor, Jaroong Nookwun, the assistant governor, Siri Garnchaorendee, the assistant governor, and Tanya Sirivedhin, the assistant governor. Chaiyawat simply stopped by to say hello before making an excuse to leave for elsewhere.

Chaiyawat Wibulsawasdi

Chaiyawat was conscious about his superior status over Rerngchai, who did not match his technical and intellectual prowess. He did not quite consider himself as part of the team. After leaving briefly to join the Banharn government as finance minister, Chaiyawat did not enjoy a good working relationship with Rerngchai.

The Banharn government appointed Rerngchai as governor because of the one reason that he was the senior-most official. Also, the politicians considered Rerngchai an easy man to deal with.

Leaflets were swirling inside the central, attacking Chaiyawat for bowing to the political demand by agreeing to serve Banharn. He could have suspected that Rerngchai was behind the leaflets. If merit were to be taken into account, he - not Rerngchai -- would have been picked to become governor.

Banharn defended his move to appoint Rerngchai as governor. He said Rerngchai told him that if he were not appointed for the top job, he would resign.

Jaroong Nookwun

Jaroong recorded a detailed account of the meeting on that Christmas Day of 1996 with his writing. He was a very nice person.

On that day, the meeting discussed the experience of Malaysia and South Korea, which adopted a managed float system, according to Jaroong’s notes. In that month alone, Jaroong wrote that the Bank of Thailand lost US$3.9 billion in international reserves from the capital outflows, apart from having to inject Bt10 billion into the money market to improve liquidity and to prevent interest rates from rising too high.

The Banking Department also intervened in the foreign exchange market in the tune of US$1.9 billion to try to bring the baht within the narrow trading band. Jaroong noted further that with the combined losses of US$5.8 billion in reserves, the Bank of Thailand entered into the foreign exchange swap contracts to sterilise the contractionary effect of the capital outflow.

Through the swap contracts, the central bank bought the US dollar and sell the baht with an obligation to sell the dollar and buy the bath back at a certain time in the future. This foreign exchange management helped the central bank pump the baht back into the system to prevent a collapse of the payment system as a result of a sudden disappearance of the baht from the system though the currency attack.
 
The Bank of Thailand also tried to keep interest rates at a high level to deter the speculators from borrowing the baht to buy the US dollar. The meeting noted that there was a tendency of the local commercial banks to keep the US dollar in their portfolios. There were several underlying reasons for a run on the baht.

The dollar was on an up trend. The baht, tied to the dollar, would weaken as a result. Investors were adjusting their asset allocations. Foreign investors were heading for the exit, selling Thai shares and exchanging the baht into the dollar to bring money out of the country. The investors were also having waning confidence in the authorities' ability to tackle the economic overheating and the current account deficit.

There were also rumours about the Bank of Thailand's move to adjust its basket of currencies. The meeting also discussed the baht situation in the offshore market, the baht was traded way off the official trading band. The discussion also touched on a possibility of floating the baht. If that were the case, it might put a brake on capital outflow and the foreign exchange reserves would not be drained. But the consequences would be clear that the baht would be depreciated and the customers of the Bangkok International Banking Facility would suffer.

If the trading band of the baht were to be widened, it would also lead to a depreciation of the baht. But exports would be boosted. But the Thai debtors would suffer.

Jaroong scribbled in his notebook: "Need to do it (adjusting the foreign exchange regime) now otherwise it would be more painful."
 
Despite this gruesome assessment, the meeting could not reach any definite decision on the timing to adjust the foreign exchange regime to make the Thai currency more flexible. The team thought that fixing the exchange regime or devaluing the baht while capital was flowing out of the Thai market might further fuel the panic and aggravate the macroeconomic distress.

More importantly, changing the currency regime would bring about instability or turmoil that would be difficult to contain. The meeting agreed that if capital began to flow back, they would fix the exchange rate system.
 
In most of the meetings, Chaiyawat, the chief strategist of the Thai macroeconomic planning and guardian of the foreign exchange policy, would argue consistently about need to defend the integrity of the currency peg system and assure that the baht was not overvalued.

Rerngchai would never be able to argue with Chaiyawat on the foreign exchange policy, about which he knew very little.

In one of the meetings Siri asked what would happen if the central bank continued to defend the baht. To which Chaiyawat replied that the baht was not overvalued and that if the exchange regime were to be adjusted it would create adverse consequences.

To further reinforce his position, Chaiyawat brought over his team from the Economic Research Department to brief Rerngchai about what he believed to be the appropriate course of the foreign exchange policy -- that is, stand pat.

In early 1997, the central bank’s top officials viewed that unpegging the baht or adopting a more flexible currency policy could only be done when the economy was healthier or when capital was flowing back into the country. Now with concern over Thailand's macroeconomic instability, particularly the high current account deficit, any move to touch the exchange rate could backfire.

The central bank’s assessment was that if the baht of the baht/US dollar trading was widened, the baht would weaken to hit the ceiling. The baht then was trading within a very narrow band of one or two satang a day.

"The more you widen it, the steeper, the baht would plunge because of the lack of confidence," one central bank official said.

Floating the baht would also result in a devaluation by at least 10 per cent on day one. Thailand's external debts were about US$89 billion. With international reserves of US$39 billion, the country's net external debts stood at US$50 billion.

In December the balance of payments deficit hit Bt19.2 billion, sparked by a US$5 billion baht attack by the foreign speculators. In that single month, according to Bandid Nijathaworn, the director of the Banking Department, the Bank of Thailand sold out US$4.88 billion to defend the Thai currency.

It was that month that a general agreement was reached between Rerngchai and his top aides that once capital began to flow back into the country, the central bank would do some fixing to its currency peg system.

Exports in 2006 hit 0.1 per cent growth. The current account deficit reached 8.9 per cent of the gross domestic product.

In January the sea was relatively calm. The hedge fund operators waited for 19 days to evaluate the policy of the Chavalit government. If Thailand was not going to do something about its foreign exchange regime, the hedge funds would re-launch the attack on the baht. The Thai macro positions were in bad shape.

Siri sent a couple of notes warning Rerngchai about the currency attacks. Something would need to be done about the foreign exchange policy. The central bank officials held numerous meetings. There was a quiet agreement that the baht rate needed to be adjusted when capital began to flow back into the country.

The window of opportunity opened up in January when there was an inflow of capital for more than 20 days. Siri reminded Rerngchai about the promise he had given him that he would take action on the currency.

But Rerngchai brushed it aside, not knowing that the Thai house was already on fire.

The IMF Envoy Flies Over

Michel Camdesuss, the IMF's managing director, sent his special envoy, Bijan Aghevli, to Thailand during this time to lobby the Thai authorities. He would like Thailand to fix its foreign exchange regime as soon as possible. Before that his and the IMF’s position on the Thai foreign exchange policy was not clear and far from a consensus.

Camdessus quickly changed his mind by suggesting an outright baht devaluation. On January 31, 1997, he told Amnuay that Thailand should proceed to pursue fiscal and monetary tightening as well as adopting a comprehensive programme to tackle the ailing financial system. Then Thailand should move next to adjust the foreign exchange regime.

Camdessus did not forget to emphasise that the Thai authorities should consider making the foreign exchange regime more flexible, which would certainly amount to a devaluation, as soon as possible.

The IMF's quick change of heart stemmed from its re-reading of the deteriorating situation in Thailand, which would not be in a position to fend off the speculative attack against its currency for long.

It was probably due to Camdessus's unclear stance at this juncture that led Amnuay later to claim that even the IMF was not decisive enough.

"Even the IMF itself was not really sure about what to do with the then fixed currency regime, "Amnuay said. (Amnuay accepts role in currency blunder, The Nation, May 5, 1998, Page A3).

Chaiyawat, who was then manager of the Exchange Equalisation Fund and deputy governor, expressed his surprise at that time about the IMF's quick change of heart. Earlier, the tone of the IMF was rather mild over the Thai fixed exchange rate system. However, Chaiyawat’s feeling then also reflected his steadfast position that the foreign exchange regime should not be touched.

But to the surprise of many people who knew him well, Chaiyawat frequently emphasised that defending baht did not fall under his line of management since it was delegated to Siri. That’s why he would not know about the scale of the baht attack or when the attack would take place.

In early March 1997 the finance companies got into big trouble with their property loans. Amnuay and Rerngchai ordered 10 of them to raise capital by more than US$300 million. This led to a run on other finance companies. Over all the Thai financial system was saddled with Bt800 billion in bad debts incurred by the property sector. Half of this accounted for the finance companies and the other half for the banks.

However, the banking sector was about five times as large as the finance sector, so the problem in the finance sector was particularly acute. Later that week in March 1997, Camdessus, reproached the Thai financial regulators for lax supervision.

But he tried to calm the investors’ nervousness by assuring that "I don't see any reason for this crisis to develop further."

Camdessus said Thailand is not the only country in the region to lack a developed regulatory framework for its financial markets. "In many countries in Asia and elsewhere, prudential regulation and supervision have not kept pace with the new complexities of banking businesses," he said.

He pointed out that such regulation is all the more necessary where there is big foreign money involved.

"The presence of large capital inflows reduces the room for policy manoeuvre and limits the scope for policy mistakes," he added. (Leo Gough, "Asia Meltdon: The End of the Miracle?", Capstone Publishing Ltd, Oxford, UK, Page 33.)
 
In that month of March 1997, the IMF sent another a team, headed by David Robinson, to review Thailand's macroeconomic conditions as part of an annual ritual. It concluded that the policy priority for Thailand to pursue is to introduce a more flexible foreign exchange regime, which would not only increase the central bank's independence to manage its monetary policy but would also reduce the incentives for the short-term foreign capital to flow into the country.

David Robinson

After reading the IMF's report, Rerngchai did not pay any heed to the warning because he and his team believed that the slowdown in the Thai economy, including the export slump, was cyclical rather than structural.

Chulsu Kim, deputy director general of the World Trade Organisation, who visited Thailand in March 1997, also said the slowdown of the Thai economy in 1996 was cyclical rather than structural. "While more time appears to be needed for a full analysis, most economists seem to view this phenomenon as cyclical rather than structural," he said. "Of course, as East Asian economies mature, their growth rates will inevitably tend to slow somewhat." (Thanong Khanthong, "Sluggishness seen as cyclical, not structural," The Nation, March 26, 1997, Page B14.)

Rerngchai and his top aides believed that the current account deficit could be tackled by tightening the fiscal and monetary policy. Rerngchai hoped that once the key economic indicators improved, the pressure on the baht would subside.

This belief was shared by Chaiyawat, who was Thailand's contact man with the IMF.

Between January and February 1997, according to Bandid Nijathaworn, the then director of the Banking Department's report, the Bank of Thailand already ploughed out US$7.8 billion to defend the baht, sending the foreign exchange reserves down to US$38.1 billion. The currency swap contracts, built up to sterilise the central bank's spot market intervention, hit a staggering US$12.2 billion.

Robinson, the IMF's mission chief, came over to see Siri at his office. He asked Siri to persuade Rerngchai and Chaiyawat to devalue the currency, otherwise Thailand would pay a very dear price for the consequences.

Siri could only take a long breath.

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