Thailand's Currency Crisis

http://www.meetinthailand.com/images/thailand-map-small.jpg Map of Thailand

Thailand was the first country in Southeast Asia to experience a currency crisis, but this distinction did not last for long. Thailand's financial troubles immediately affected the countries around it, most noticeably Indonesia and Korea, then Russia. Thus, "Thailand's Crisis" and "the Asian crisis" are used almost interchangeably. We will focus specifically upon Thailand, but most of these countries were affected in much the same way.

Thailand's exchange rate up until the 1990's was fixed, meaning there was a fixed ratio of that currency (the baht) to another, in this case it was a ratio of baht to US dollars. This type of regime can have problems when international money flows are highly mobile. If investors suspect that the government cannot (or will not) maintain the ratio, the investments will be taken away, which in turn will force the devaluation the investors were afraid of. In Thailand's economy, this was a warning sign, since many financial institutions had accumulated a large amount of external liquid liabilities.

Two Theories about the Origins of the Asian Crisis

There are many opinions about the exact origins of the currency crisis that grew in Thailand and then Eastern Asia. There are facts, but then there are also several cause-and-effect chains of events, and some put more stress on different events. All opinions, however, fall into two general categories.

The Fundamentalist View

Those holding to the fundamentalist view claim that flawed financial systems caused the crisis as well as its spread. Thus, the beginnings of the crisis were actually several years prior to July 1997, building over time until the actual currency issues became known. Most East-Asian countries pegged their currencies to the dollar. Until 1995, this worked well as it kept inflation relatively low, kept the currency stable, and encouraged exports. However, when the dollar began appreciating compared to the yen and other major Asian currencies the East Asian countries involved in the crisis began losing their competitiveness on the global market. World trade crashed drastically after the Asian countries had experienced two years of rapid growth, further affecting the markets. Starting in April of 1995 the US dollar appreciated continuously and noticeably. This dragged dollar-linked Asian currencies up, making their exports uncompetitive, leading to large currency account deficits.

The Panic View

Those who hold to the panic view don't discount the vulnerabilities: increasing current account deficits, falling foreign exchange reserves, fragile financial systems, highly leveraged corporations, and overvaluation of the real exchange rate. But these vulnerabilities were not enough to explain how fast the crisis appeared, nor the depth to which it affected the economies involved. This view holds that the economic fundamentals were essentially flawless (as had been commented on prior to the warning signs of the financial crisis). Several points suggest that the crisis was panic-induced. First, there were no clear warning signs, such as an increase in interest rates on the region's debt or downgradings on the region's debt by debt rating agencies. Second, prior to the crisis, international banks made substantial loans to private firms and banks that did not have any sort of government guarantees or insurance. These facts contradict the idea that moral hazard was so pervasive so that investors knowingly made bad deals, assuming they would be bailed out. It is consistent, however, with the notion that international investors panicked in unison and withdrew money from all investments--good or bad.

The Chain of Events

Thailand's economy was rapidly growing until early 1997, in part because the Thai people - specifically large corporations - had found they could borrow money at low interest rates overseas, in dollars, more cheaply than they could at home, in baht. This rapid growth was bound to stop somewhere.

The Thai government changed their strategy regarding economic controls. Rather than direct controls, the government began using more indirect market-conforming controls, such as interest rates. But it is true that in general, financial liberalization reduced the power of the central bank to influence monetary policy. This monetary policy became even more difficult as the financial market became more liquid as a result of the capital inflows from international investors.

By late 1996, foreign investors began to move their money out of Thailand because they worried about Thais' ability to repay. From 1990 through 1996, ten percent of the Thai GDP was from foreign capital. This inflow had tripled from '94 to '96, the public inflow going from $25.8 billion in 1994 to $83.5 billion in 1996. This was a huge boom for the Thai economy.

If capital inflows slow or reverse, economic booms can collapse. This is precisely what happened in Thailand. Net foreign financing went from $106.6 billion in 1996 to $28.8 billion in 1997. By 1998, instead of receiving 10% of their GDP, the capital outflow became 8.5% of GDP.

In February of 1997, both foreign investors and Thai companies hurried to convert their baht to dollars, which were far more reliable. The Thai central bank responded by buying baht with its dollar-denominated reserves and raising interest rates. On July 2, 1997, the central bank stopped holding the baht's fixed value against the dollar. In that single day, the currency lost 16 percent of its value.

http://www.reisebilder.ch/bilder/th10v.jpg Thailand's currency: the baht

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