Going For Broke

ON May 12th, 1997, right in the middle of the fierce currency battle, Dr Bandid Nijathaworn, the director of the Bank of Thailand’s Banking Department, completed his final touch on a highly confidential report that would represent an overall foreign exchange defence strategy of the central bank.

Dr Siri Garnjaroendee, the assistant governor, was the one who ordered him to prepare the report. (Dr Bandid Nijathaworn, "Intervention in the Foreign  Exchange Market for Baht Stabilisation," Memorandum No. 355/1997, the Banking Department, the Bank of Thailand.)

The report summarised the key events that took place since late 1996 and the outcome of the central bank's intervention. Its thrust was that the situation was increasingly critical, yet manageable.

Bandid Nijathaworn

Between January and February 1997, the Bank of Thailand spent US$7.8 billion from its foreign exchange reserves to defend the baht. Reserves stood at US$38.1 billion, but this amount did not include the swap contract obligations, which climbed to US$12.2 billion.

By April, the reserves dropped further to US$37.3 billion, with the swap obligation rising to US$13.69 billion. In May the crisis was most critical, with the speculators trying to destroy the fixed exchange rate system. The foreign exchange intervention was costly, sending the reserves, as of May 9th, down to US$36.6 billion.

When the swap contracts of US$18.86 billion were taken into account, the Bank of Thailand’s net reserves stood at a dangerously level of US$17.74 billion -- barely enough to back money in circulation at that time.

In the final paragraph of his landmark report, Bandid asked his immediate boss, Siri, for an authorisation to continue to intervene in the foreign exchange market to defend the baht. The intervention, Bandid believed, should continue while measures were being worked out to restore confidence to the Thai economy.

Bandid admitted that the pressure on the baht would continue insofar as the economic fundamentals remained poor, exports did not pick up and the stability of the financial institutions failed to improve. He added that the loss of confidence in the BOT's foreign exchange policy continued due to widespread devaluation rumours.

The Chavalit government’s failure to commit to fiscal consolidation also made the matters worse. Bandid cautioned that the central bank's policy-making body should consider the farthest limit at which the foreign exchange intervention would be tolerated.

At the same time, the Bank of Thailand needed to review of the fixed exchange rate system. Before the reserves ran down to zero, he suggested that the central bank enter into swap agreements with other neighbouring central banks to rebuild fresh reserves or to mobilise new funding directly from the financial markets.

The Bandid Report

The following is the Bandid Report, frantically put together during the most critical time of the central bank.

"THE Bank of Thailand has given the assignment to the Banking Department to monitor the financial and foreign exchange markets by allowing it to intervene in both markets as deemed necessary. This is to ensure stability of the baht, so that it moves within the band of the basket of currencies regime.

The Banking Department also looks after the domestic money market to make sure that liquidity is adequate and the interest rate level is appropriate in line with the monetary policy.

But since 1996 there has been increasing pressure on the baht. This can be explained by the slowing economy and the falling exports, the real estate and stock market slump, as well as the financial sector instability. These factors have undermined confidence of the foreign investors in the foreign exchange rate policy.

They also triggered the speculators to launch an attack on the baht on several occasions in order to create pressure on the authorities to devalue the currency and/or adjust the foreign exchange regime.

Under these circumstances, it is necessary for the central bank to intervene in the foreign exchange market to defend the baht and to restore confidence to the foreign exchange rate regime. In every intervention, the central bank has been able to bring the situation under control as evidenced in the reports of the Banking Department's foreign exchange activities and in constant discussions being held.

However, the economic fundamentals and the confidence in the financial institutions have not unravelled, coupled with a prospect of the government facing a deficit in its fiscal position. The Banking Department viewed that if the fundamental problems are tackled timely, with tangible results, a restoration of the investors' confidence will be difficult.

Pressure and the attack on the baht from the foreign speculators will continue and become more serious. The Banking Department would like to review and summarise the circumstances under which the speculators have applied pressure on the baht, with the central bank's counterattack and the results of its operation and the policy recommendations that should be undertaken down the road.

The Situation in Late 1996

The weakness of the economy and the financial system has affected the foreign investors' confidence since the second half of 1996, particularly after Moody's Investors Service, on September 3rd, downgraded the ratings of the country's short-term debts.

This led to a continuing outflow of capital, and the Exchange Equalisation Fund (EEF) was obliged to sell a net US$1.8 billion between July and December 1996 to the commercial banks, compared to a net buy of US$2.04 billion in the first half of the year.

The capital outflow became more serious in December 1996 when the economic fundamentals, especially the exports and the financial sector problems, had deteriorated.

Interviews given by the politicians on adjustments of the foreign exchange regime further undermined the confidence of the foreign investors, who rushed to take their money out of the country before closing the accounting books by the year’s end.

A strong dollar rally against other major currencies added even more pressure on the baht. The foreign exchange rate between the US dollar and the baht was very volatile, frequently rising beyond the level fixed by the Exchange Equalisation Fund.

In December, the Exchange Equalisation Fund sold out US$2.91 billion in order to reduce the pressure on the baht and to keep its value from veering off the mid-rates as quoted by the basket of currencies system. To prevent panic among the investors and a pull-out of their investment, the central bank found it necessary to sell the dollar in the spot market by US$1.97 billion.

Intervention in the spot market not only helped stabilise the foreign exchange rate in the market and keep its movements at an appropriate level, it also reduces demand for buying the foreign currencies of the commercial banks from the Exchange Equalisation fund.

In conclusion, the pressure on the foreign exchange rate in December 1996 was largely a consequence of the foreign investors pulling their investment out of the country, coupled with a demand to buy the dollar by the domestic corporations who began to lose confidence in the foreign exchange rate system. The pressure was not a result of the attack from the currency speculators.

The dollar selling to support the stability of the baht by the Exchange Equalisation Fund and the intervention of the Banking Department in the tune of US$4.88 billion in December resulted in a drain of liquidity in the money market. To prevent interest rates from rising beyond the normal level which could have created turmoil in the markets and inflict damages on the weak financial institutions, the Banking Department sought to sterilise parts of its dollar selling by engaging in the buy-sell swap.

As of the end of 1996, the central bank registered outstanding foreign exchange swap contracts by US$4.75 billion, which would reach maturity in 1997. The foreign exchange reserves as of the end of December 1996 fell by US$900 million over the previous month to US$38.7 billion.

The Baht Attack in January-February 1997

The foreign investors began to plough their money back into the country, a seasonal pattern at the beginning of the year. But the inflow was also buoyed by an announcement that the government would chop Bt50 billion off the budget spending.

In the first three weeks of January foreign capital substantially flowed into the country, leading the Exchange Equalisation Fund to buy US$2.43 billion from the commercial banks.

In the final week of January, rumours on the baht devaluation began to flood the markets. On Thursday January 30, the day when the Bank of Thailand reported the monthly economic data, the speculators, beginning in the morning, began to buy up the dollar and sell the baht in order to fuel the panic.

To stem the situation from going out of control, the central bank intervened relentlessly in the foreign exchange market by selling the dollar and buying the baht until noon. It also denied the devaluation rumours, which helped stabilise the currency.

The commercial banks bought only US$20 million from the Exchange Equalisation Fund. In the afternoon after the central bank announced the key economic indicators, which showed the government's running a revenue deficit in the first three months of the fiscal year by Bt54 billion, the foreign speculators began to attack the baht in another round.

The Banking Department stepped in to intervene in the foreign exchange market until the market returned to normal by the end of the day.

Moreover, the Banking Department had been closely monitoring the movements of the baht until the London market closed and until noon in the New York market. It intervened as necessary in order to keep the value of the baht within the fixed exchange rate band and to restore investors' confidence. On that day the central bank sold a total of US$1.49 billion, but the speculators continued to mount on the baht attack.

The following day, on January 31, the central bank had to intervene further by spending US$2.21 billion, which was barely enough to prevent the commercial banks from buying the dollar from the Exchange Equalisation Fund for a total of US$1.11 billion. By the end of the day, the situation cooled down.

In the first three weeks of February, the baht continue to come under pressure due to a lack of confidence in the economic conditions and concern over the stability of the financial institutions and the aggravating real estate problems.

Rumours of the baht devaluation were even louder. The dollar also strengthened substantially from Y122.15 and DM1.6385 by the end of January to hit a four-year record high of Y124.82 and DM1.7050 by the middle of February.

On February 14th, Moody's also announced that it had placed Thailand's long-term currency debts under review for a possible downgrade. The speculators launched their dollar buying and baht selling again, forcing the central bank to intervene with US$1.07 billion.

The situation in the final week of February was better after the central bank issued a firm statement with detailed reasons that devaluation was not a way out to resolve the economic problems.

There was a positive piece of news about the fiscal discipline of the government. The Cabinet approved a spending cut by Bt100 billion, including introducing concrete measures to tackle the non-performing loans of the financial institutions, which had exposure to the real estate business.

A government-run agency (the Property Loan Managment Corporation) was set up to acquire the problem real estate loans from the financial institutions. Its financing would come from a scheme to issue zero-coupon bond in the region of Bt100 billion.

Confidence of the investors in the government's policy to tackle the economy and the financial institutions began to improve.

The dollar also weakened against the major currencies in the late February, resulting in a return of foreign capital throughout the final week of the month. The Exchange Equalisation Fund bought a total of US$1.52 billion from the commercial banks.

The Stock Exchange of Thailand Index also rose 5.7 per cent between February 19-26.

In sum, the Exchange Equalisation Fund spent a total of US$7.8 billion to fend off the speculative attacks on the baht during late January and February 1997. The foreign exchange reserves as of the end of Feburary fell to US$38.1 billion. The outstanding foreign exchange forward contracts rose to US$12.2 billion.

The Situation Between March and April 1997

In general, the foreign exchange market between March and April 1997 was relatively calm. There was periodic pressure on the foreign exchange rates, which coincided with the negative news.

For instance, on March 3, the Stock Exchnage of Thailand suspended the trading of stocks in the banking and finance sectors in anticipation of a press statement on the Finance Ministry's decision to tackle the financial institutions. There were rumours on March 6 that the governor would resign.

On March 18 Standard & Poor's downgraded the credit rating of the big Thai banks. On March 19th, One Holding defaulted on its bond. On April 9 Moody's downgraded the long-term currency ratings of the Thai government. Investors were deeply concerned about the health of the financial institutions and the weak economy. They were not sure either whether the BOT would adopt a new foreign exchange regime.

These factors deterred foreign capital from flowing back. Despite the absence of currency attack in these two months, the Exchange Equalisation Fund sold a total of US$1.65 billion to the commercial banks. There was no much need for the central bank to intervene in the foreign exchange market. The central bank ended up spending only US$740 million in overall intervention.

By the end of April, the official reserves fell to US$37.3 billion. The foreign exchange swap contracts rose to US$13.69 billion.

A New Round of Baht Attack on May 9, 1997

In the final two days of April until May 8, pressure in the swap (sell-buy) market was conspicuous. This pushed the swap premium from 34 satang/US dollar for a six-month contract and from 69 satang for a one-year contract on April 28 to 40 satang and almost 80 satang respectively on May 8.

The pressure took place despite the central bank's attempt to slowdown the pace of the swap premium by engaging in the buy-sell swap in the foreign exchange market every day between May 2 and 8 for a total of US$3.2 billion.

Intervention in the foreign exchange swap market was aimed at preventing the swap premium from skyrocketing, which would have impact on the domestic interest rates. It helped restore confidence to the investors so that they would continue to bring money in to investment in the baht.

If the premium and interest rates were allowed to rise indefinitely, investors, who intended to bring capital into the country, would wait until they were certain that the interest rates hit the peak level. Earlier investors in the baht would have to suffer losses. And if premium continued to rise substantially, they might be forced to cut losses and withdraw their investment from the Thai market by rushing to buy the dollar and sell the baht. This would further add pressure on the baht.

On the other hand, if the premium and interest rates had stability, with a downward trend, they would encourage the investors to bring their capital back to the market. This would be beneficial to the baht.

Apart from the abnormal pressure in the foreign exchange swap market, there were signs that the speculators began to attack the baht in another round. Rumours were swirling around about the widening of the trading band of the Exchange Equalisation Fund and a reshuffle of the finance portfolio, which objected the baht devaluation policy.

The rumours were also aimed at undermining the credibility of the Finance Ministry and the Bank of Thailand to the extent that the prime minister was rumoured to have planned to take the power of deciding the foreign exchange regime in his own hand. The rumours spread into the markets and caused panic among the investors.

The speculators began to attack the baht by buying the US dollar/selling Thai baht in the spot market and simultaneously engaged in the sell-buy swap. The speculators would benefit from these activities if they could push the dollar/baht exchange rate up (resulting in a weak baht) immediately in the spot market; and/or push the swap premium up. The speculators would make huge profits if they could force the Bank of Thailand to devalue the Thai currency.

On the other hand, if the speculators failed to push the dollar/baht exchange rate in the spot market or the swap market, they would incur losses because they borrowed baht at high cost to hold US dollar. So the defence strategy of the central bank was to try to withstand the buying dollar force/sell baht in the spot market by selling dollar and buying the baht at an amount large enough to prevent the baht from weakening.

The central bank's intervention in the swap was aimed for the same purpose. Because if the spot exchange rate and the swap premium rose too high, they would trigger panic among the investors as well as the local private sector.

If these people lost confidence in the foreign exchange, they would step in to buy the dollar and sell the baht to limit the foreign exchange losses. This would further add pressure on the baht. For this reason, the central bank's intervention must be decisive, hitting the iron while it was still hot and intervening at a scale large enough to prevent the exchange rate from rising beyond the normal level that could have eroded the investors' confidence.

This time the speculators chose to attack the baht in the evening of May 8 after the Bangkok market closed down. They bought the dollar and sold the baht substantially in London, pushing the spot rate up by 10-12 satang above the mid-rate as quoted by the Exchange Equalisation Fund.

The attack continued in the New York market and created panic among the treasury dealers and the general investors. The pressure on the foreign exchange began again when the Asia market opened in the morning of May 9th.

The attack sent the exchange rate to veer four to five satang above the mid-rate at 7:00 AM. Half an hour later, the exchange rate climbed further by nine and 10 satang. The central bank intervened in the offshore markets, both in Singapore and Hong Kong, in order to contain the turmoil in the currency market and push the exchange rate in the spot market and the swam premium back to the normal range.

The intervention extended from the Asia, London to the New York markets. However, to save the foreign exchange reserves, the intervention in the London and the New York markets was limited to reduce the volatility of the exchange rate, instead of aiming to bring the exchange rate back to the normal range.

Therefore, the exchange rate in the New York Market, on May 9, closed at five to six satang above the mid-rate. The currency attack this time was very severe, forcing the central bank to spend US$6.08 billion from its reserves to intervene in the spot market. (The intervention took place mostly before noon Bangkok time). It could fairly restore stability to the foreign exchange rate.

The commercial banks bought only US$105 million from the Exchange Equalisation Fund, while the swap premium and the domestic rates did not rise significantly due to the intervention of the central bank through the buy-sell swap in one single day for US$3.94 billion.

Altogether, the central bank's foreign exchange trading from the end of April to May 9 totalled a deficit US$700 million. This sent the foreign exchange reserves down to US$36.6 billion. When the net foreign exchange swap contracts were taken into account, the net foreign exchange reserves fell to US$17.74 billion.

The Policy Direction The Banking Department expects that the foreign speculators will continue to attack the baht insofar as:

1) the economic fundamentals do not improve or the exports do not pick up;
2) the instability of the financial sector does not improve;
3) the investors feel less confident with the foreign exchange regime due to the consistently public debate about the exchange rate policy;
4) the government cannot maintain fiscal discipline.

The intervention in the foreign exchange market to restore stability to the baht and to defend the integrity of the currency peg system represents only a temporary measure, buying time for the government to pursue the policies and measures to tackle the economic fundamentals. If the economic fundamentals are not quickly or seriously resolved, the foreign speculators could exploit the economic and financial weakness of the country to fuel the rumours and undermine confidence among the general investors.

The baht attack will return as has happened in the past. The Banking Department suggests that the way to maintain the stability for the baht under the present foreign exchange regime, while the economic fundamentals are being resolved, is that the central bank should continue to intervene in the foreign exchange market to restore confidence as has been implemented.

However, the scale of the attack has become more serious and the latest incident has incurred higher losses to the foreign exchange reserves in the intervention to stabilise the foreign exchange rate. Now the net foreign exchange reserves of the central bank has slightly fallen below the level needed to back the note issue.

It is therefore necessary for the central bank to seriously consider the maximum limit at which the intervention to maintain the baht stability is tolerated or at which the present foreign exchange regime should be put under review.

The Banking Department views that before the net reserves of the central bank (the reserves deducted by the foreign exchange swap contracts) shrink to zero, the central bank should seriously determine the appropriateness of the present basket of currencies system and the policy to stabilise the baht.

In addition, the central bank should move quickly to mobilise fresh foreign exchange reserves from abroad to further stabilise the baht, such as entering into the swap agreements with the neighbouring central banks or borrowing directly from the financial markets. This is a preparation of the resources in time of crisis.

This is for your acknowledgement and your approval on the Banking Department's policy to continue to intervene in the foreign exchange market to stabilise the baht."

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