Anatomy Of A Currency Attack

To illustrate the baht attack, an incident in the final week of January 1997 served as a good example. On that day the attack almost sent the baht to break the psychological Bt26/US dollar level after the currency speculators drove it up to Bt25.969.

Again, the rumours were coming out of the Singapore market, which was the region's financial centre. Baht offshore in Singapore was about 14 times larger than the onshore market, reaching a daily volume of US$10 billion.

The speculators played on the devaluation rumours and the jitters over the macro-economic woes to justify their heavy baht selling, driving its value down in hopes of reaping profits by buying it back later at lower rates.

On January 30, the volume of the offshore baht market activity in Singapore was staggering, reaching US$10 billion. This size was twice as large as the onshore baht market.

Overall, Singapore's foreign exchange market in about 14 times larger than Thailand's. There were about 10 major players in Singapore, including Bank of America, Citibank, Chase Manhattan Bank, Standard Chartered Bank, Banque Indosuez, Deutsche Bank, Hong Kong and Shanghai Bank, JP Morgan, Bankers Trust, NatWest Bank and the Union Bank of Switzerland.

The volume of offshore baht trading had been growing significantly over the past four to five years following Thailand's move to liberalise trade, investment and the financial sector. Liberalisation of the country's capital account in the early 1990s led the baht to flow freely out of and back into the country beyond the ability of the banking authorities to keep a watchful eye.

The hectic pace of offshore baht trading on January 30 illustrated how vulnerable the Bank of Thailand was in the face of a currency attack. With the stock market heading for a free fall, the collective wisdom of the foreign currency speculators had it that something was fundamentally wrong with the Thai economy. The currency peg, they thought, would not hold.

Then there were rumours about the deteriorating asset quality of Finance One Public Company Ltd, Thailand's largest financial house. The Bank of Thailand was about to release its monthly statistics for December, which would give a more complete picture of the Thai economy in 1996.

As it turned out, there was confusion over the interpretation of the key economic data, particularly the current account deficit and the foreign exchange reserves.

At 2.39 PM, the speculators in Singapore began to launch their attack. In the morning, the Exchange Equalisation Fund fixed the baht/US dollar rate at Bt25.87. This meant that the EEF would buy the dollar at Bt25.85 and sell it at Bt25.89 - a narrow plus or minus band of two satang. One satang is one one-hundredth of the baht.

As a normal practice in currency dealing, the deal date for a transaction is two working days. In this particular case, the deal date for the Thursday, January 30 transactions was February 3, which fell on Monday (Saturday was a holiday). The swap point, derived from calculating the short-term baht interest rate of about 15 per cent and the US dollar interest rate of about 5.5 per cent was four satang.

The swap point is essentially an interest rate differential between two trading currencies.

Therefore, the ceiling for the baht/US dollar settlement should have been Bt25.93; that is the Bank of Thailand's sell rate of Bt25.89 plus four satang in swap point. But the baht devaluation rumours and the panic selling of the Thai currency that ensued drove the baht down to Bt26.00 to the US dollar -- seven satang higher than the ceiling rate.

The objective of the speculators was to force the baht down (short on the baht and long on the US dollar) and then buy it back later for profits. This type of situation was commonly seen in the European Monetary System, where currencies were floated against a basket of currencies until specific limits were reached.

Attacks occurred when major external foreign exchange players thought that a currency was overvalued and can no longer be supported. They then launched raids on the market, selling the currency heavily to force the corresponding central bank into devaluation.

After readjustment against the basket, they closed their positions at much lower prices, generating substantial profits.

The next day on January 31 saw the foreign exchange recover from the Thursday's turmoil. Yet this similar attack would continue to occur in so far as Thailand failed to rectify its macroeconomic imbalances and could not restore confidence to its currency.

Baht trading in Singapore would not affect Thailand if it was limited to the players there. But the problem arose when they overbuilt their exposure and need more baht from the Thai market to close their net positions.

The cross-border selling put pressure on the Thai currency and tighten the domestic liquidity market as well as hammering the stock market.

On that day baht selling was attributed to a sharp plunge in the Thai stock market, which lost 60.50 points or 7.1 per cent, before closing at 788.04.

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After the Bank of Thailand had done nothing to fix its foreign exchange system, the hedge funds and speculators started to circle around the baht in February 1997 again. They waited for three months until their forward contracts were up for a roll-over.

It would be a battle of nerve.

In the bloody battle in February 1997, the central bank hit back by firing US$1.07 billion from its reserves to bring the situation under control.

Goldman Sachs, the US investment bank, got into hot water with the Thai banking authorities. Its research articles suggested that a baht devaluation was imminent. This further fuelled the speculation against the baht.

Dr Bandid Nijathaworn, the director of the Banking Department, cited Goldman Sachs as one of the major culprits behind the devaluation rumours, which had escalated since the beginning of the year.

Bandid Nijathaworn

On February 4, 1997, Goldman Sachs' Asian Weekly Analyst indicated that although its analysis showed the baht was fundamentally close to fair value, "recent development have increased the probability of devaluation. We now we believe the probability is 25 per cent instead of 5 per cent."

At that point, the baht already came under a hail of attack, which spent the spot rate of the baht down to Bt25.980 to Bt25.985 against the mid-rate of Bt25.920.

On Monday February 3rd, the mid-rate stood at Bt25.86 to the US dollar. The baht lost some ground that week before the Singapore and Hong Kong financial markets closed for the Chinese New Year holiday between February 5th and 6th.

Adding further pressure on the baht was a sharp rise of the US dollar against the major currencies, particularly the Japanese yen. The greenback hit Y124, a four-year record high.

The Thai Farmers Bank's research unit issued a critical report against the Bank of Thailand for failing to foresee the baht attack.

"What the central bank did not anticipate was the selling of the baht in those two markets right before their holidays, which seriously affecting the Thai market over the latter half of the week," it said. "Moreover, there was heavy baht selling in New York, which added pressure on the currency."

Rerngchai Marakanond, the governor of the Bank of Thailand, and his aides moved quickly to stem the turmoil by ordering the cash-rich Government Savings Bank to withdraw its lending from the inter-bank market. They would like to squeeze the liquidity out to curb the baht speculation.

Rerngchai Marakanond

In the temporary absence of the Government Savings Bank from the inter-bank market, a large pool of liquidity has been drained from the system, resulting in a sharp rise of the inter-bank rate to a spectacular 30 per cent on February 7th.

The Government Savings Bank largely lent out its money to the foreign banks, which needed the baht most to speculate the local currency by selling it short.

Rerngchai's aim was to force the foreign banks to release the dollar from their mouths, which would pour back liquidity into the baht market. But the foreign banks and speculators turned around to take on the finance companies by asking for their money back to shore up their liquidity.

The squeeze sent the inter-finance market rate to hit 40 per cent at the end of the week. It looked almost like a cat-and-mouse game.

Then it was believed that if the exporters, who had gigantic dollar holdings of about US$40 billion a year (Bt1 trillion), sold the dollar out for the baht, they could have improved the outlook of the currency.

At that point, the importers, the exporters or the corporate borrowers of foreign currencies were not doing anything because there were nervously watching the currency war from the sidelines.

Overall, the Bank of Thailand's Banking Department and the Exchange Equalisation Fund spent US$7.8 billion to defend the baht, sending its foreign exchange reserves down to US$38.1 billion. The foreign exchange swap contracts shot up to US$12.2 billion.

The baht attack in February 1997 and the continuing volatility in the foreign exchange market led Siri Garncharoendee, the assistant governor, to change his mind about the currency peg. He believed that the Bank of Thailand would not be able to sustain the baht under further attacks.

Siri asked Bandid to assess the possibility of the Bank of Thailand's success in defending the baht in the future. Bandid's reply was that it was impossible to make the assessment.Warnings from Fischer and Surasak

In that month, Stanley Fischer, the first deputy of the International Monetary Fund, signalled to Dr Amnuay Viravan, the finance minister, for the first time that it was time the Thai authorities devalue the baht. Fischer would not spell out an outright baht devaluation. But his message was clear because the continuing pressure on the baht would jeopardise the Bank of Thailand's foreign exchange reserves.

Stanley Fischer

Fischer wrote to Amnuay: "To continue to support the exchange rate at its present level will require not only maintaining high real interest rates for the foreseeable future (with serious effects on the banking system) but also entails the risk of a rapid rundown in reserves."

ON March 24, 1997 Amnuay went to give a keynote address to the 1997 Fortune Gobal Forum in Bangkok. He urged the foreign investors to continue to have confidence in the currency peg, which would not be revised.

"We remain convinced that our actions to defend the baht and maintain its stability are premised on sound economic principles, and not on national pride. We have never doubted that this is the correct approach, and I can assure you that this policy will coninue well into the future," he said.

"The present exchange system has been the anchor of growth and stability for the past 13 years and has helped to encourage steady foreign direct investment inflows. The system is sound, credible and sustainable."

Amnuay Viravan

Were these Amnuay’s own words or was he only parroting the script of the Bank of Thailand?

After Chaiyawat's return from the interim Committee Meeting of the IMF in April, he told Rerngchai that he met Fischer and the IMF's staff that the Bank of Thailand could handle thehedge fund operators and speculators.

Any time Chaiyawat would turn to Siri and asked for liquidity, Siri would say that liquidity was scarce, it was necessary that they should use it withprudence.

By April, Surasak Nananukul, a former bank official at Bangkok Bank, and his team presented a proposal to Gen Chavalit Yongchaiyudh, the prime minister, calling for a baht devaluation by 15 per cent in order to boost exports.

Surasak, who has already passed away, was kept outside the central bank’s circle. He ran a small office of economic advisors to the prime minister at Baan Pitsanulok, the official residence of the prime minister.

But Chavalit sat on Surasak’s proposal. He had assurance from the Bank of Thailand that everything would be brought under control.

Chavalit said the Bank of Thailand told him that the country's foreign exchange reserves were still ample, amounting to six months of imports, although the IMF normally required a country to keep reserves at a level that could support imports by three months.

Inside the Bank of Thailand, there was also a hectic debate on the foreign exchange regime. There were several reasons that the baht exchange rate system should not be altered. Chaiyawat was the most influential thinker in this field.

First, the current account deficit could be resolved by maintaining a tight fiscal and monetary policy. The export downturn could be explained as cyclical as opposed to structural. Other reasons led to the export slowdown include frauds in the redemption of the value-added tax, the spread of the shrimp disease, and the shut-down of the Thai-Burmese border which affected the fishery industry. In the industrial sector, Thailand's competitiveness remained strong against the neighbouring countries because the baht was still weak against the regional currencies.

Moreover, the baht was not overvalued significantly to warrant a devaluation. It was overvalued by 7-8 per cent. When compared with the currencies of Singapore, Malaysia, Hong Kong and Taiwan and Chiana, the Thai currency remained competitive.

The baht defence 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 at a time of growing macroeconomic distress.

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