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The Monetary Crisis of the Thai Baht Macroeconomics II SoSe 2004 Prof. Dr. Paul Bernd Spahn Dipl. – Volkswirt Jan Werner Saskia Scarbrough, Candace Toussaint,

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Presentation on theme: "The Monetary Crisis of the Thai Baht Macroeconomics II SoSe 2004 Prof. Dr. Paul Bernd Spahn Dipl. – Volkswirt Jan Werner Saskia Scarbrough, Candace Toussaint,"— Presentation transcript:

1 The Monetary Crisis of the Thai Baht Macroeconomics II SoSe 2004 Prof. Dr. Paul Bernd Spahn Dipl. – Volkswirt Jan Werner Saskia Scarbrough, Candace Toussaint, Stefan Khanna, Sha He

2 Hier wird Wissen Wirklichkeit 2 Contents 1. Introduction 2. The Crisis : Overview 3. Background 4. Stabilization Strategy 5. Aftermath : On the road to recovery 6. Summary

3 Hier wird Wissen Wirklichkeit 3 Introduction The Bahtulism epidemic 20% loss of value by the Baht to US dollar in less than 1 week Asian contagion spread rapidly across Asia -Stock prices fell -Real estate prices plummeted -Non-repayment of loans in Yen, Marks and Dollar by banks and corporations -Local currencies across Asia went into free fall, for example  Malaysian Ringgit  Indonesian Rupiah  Phillipine Peso

4 Hier wird Wissen Wirklichkeit 4 Thai dies : Bangkok SET index

5 Hier wird Wissen Wirklichkeit 5 Background (1) 1.The economic boom Point of origin: beginning of the 80´s, stock-market crash and economic crisis Japan‘s capital inflows prevent an IMF rescue Thailand becomes an important exporter of manufactured goods Over 2 decades economic growth averaging 6.7% 2. Endangered cyclical downturn Huge demand for capital Alternative countries for production (e.g. Vietnam, China) due to inland wage increases

6 Hier wird Wissen Wirklichkeit 6 Background (2) 3. Regulation vs. Liberalization Agreement with GATT and WTO  Thailand opens markets -Milestone decisions : Lifting of controls on all foreign exchange transactions on the current account -Opening of the Bangkok International Banking Facility (BIBF) 3-year-plan (1990-1992) introduced to improve financial system Tight coupling of the Baht with the USD Opening of the bond and stock market for foreign investors Development strategy emphasizes role of private sector

7 Hier wird Wissen Wirklichkeit 7 Background (3) 4. Effects of Liberalization „ Virtuous circle“ = high growth rates attract new capital inflows thereby creating higher growth in economy and export Thai banks lend foreign borrowed money to domestic banks Oversupply in construction sector – 50% of loans are non-performing; banks having trouble to service their foreign debt 1994: Depreciation of Chinese Yuan by one third – reduction in Thai competitiveness 1995: US$ rises against most currencies – and so does the Baht Growth sinks from 26% in 1995 to 1% in 1996

8 Hier wird Wissen Wirklichkeit 8 The Crisis : Overview (1) Macroeconomic landscape Financial liberalization and deregulation since early 1990s Strong capital inflows Unhedged foreign currency borrowing Excessive reliance on short-term external debt Overvalued currency The Baht‘s peg to strengthening US dollar arose suspicion of being overvalued Link between currencies looked unreasonable due to high current account shortfalls, inflation & asset bubbles -Speculative runs triggered against the Baht by currency traders hoping to profit from a devaluation

9 Hier wird Wissen Wirklichkeit 9 The Crisis : Overview (2) Political instabilities: Over investment in unproductive sectors, especially in property -Misallocation of funds in uneconomic factories (e.g. By cronyism, corruption) rotten pseudo-democracy (vote-buying) Waning investor confidence Attack on Baht by hedge fund operators such as George Soros and Julian Robertson intensified (early 1997) Increasing number of non-performing loans Many investors exchanged Baht for dollars (fearing instability) Massive sell-off of Baht by companies operating in the region

10 Hier wird Wissen Wirklichkeit 10 The Crisis : Overview (3) Government intervention Interest rate increases. For offshore borrowers more than 1,300% to deter speculators (May 1997) Suspension of 16 finance companies Billions of dollars invested (mostly on forward contracts) trying to defend currency -Central bank finally depletes resources in the process The bursting of the bubble Devaluation and floating of the Baht on July 2nd 1997 -Foreign investors fled -Flurry of loan defaults by many businesses -Many banks on the brink of bankruptcy

11 Hier wird Wissen Wirklichkeit 11 Tumbling : Baht against the dollar

12 Hier wird Wissen Wirklichkeit 12 Sink or swim : Currencies against the dollar

13 Hier wird Wissen Wirklichkeit 13 Stabilization Strategy (1) (under IMF consultation) Short-term goals: -restoring of market confidence & stability -stopping massive capital flight due to the Baht devaluation Long-term goals: -macroeconomic stability -implementation of key structural reforms -Recapitalization of the banking system

14 Hier wird Wissen Wirklichkeit 14 Stabilization Strategy (2) 1st Letter of Intent : (14th August 1997) Fiscal side: Fiscal austerity (tax increases and expenditure cut to offset the costs of financial restructuring) Monetary side: -Stringent monetary policy to stabilize the exchange rate (money growth declined) BUT  Slowdown of the economy led to a large revenue shortfall

15 Hier wird Wissen Wirklichkeit 15 Stabilization Strategy (3) 2nd Letter of Intent : (November 1997 - most difficult time, baht reached 54 to a dollar) -Further cuts in government expenditures -Minor tax increases -More stringent monetary policy, with M2 growth to be kept at 1 per cent 3rd Letter of Intent : (24th February 1998) -to achieve a comfortable current surplus, whose attainment was now mentioned as allowing fiscal relaxation. 4th Letter of Intent : (26th May 1998) Change in IMF policy -Deficit spending as a stabilization strategy

16 Hier wird Wissen Wirklichkeit 16 Aftermath : On the road to recovery (1) Closure of 10 finance companies at the start of the crisis, aimed at creating confidence towards the still existing finance companies -The opposite was the case, the closure was interpreted as proof for a desolate finance sector Impossible Trinity: -capital mobility, fixed exchange rates, self-contained monetary policy can‘t be realized simultaneously In the early stages: -Call for budget surplus and a restrictive money policy -Government intervention in the weakest banks

17 Hier wird Wissen Wirklichkeit 17 Aftermath : On the road to recovery (2) Change in Policy since beginning 1998 Fiscal policy shifts targeting budget deficits Focus: privatization in the intervened banks, sale of assets from finance companies, restructuring corporate debt & strengthening the institutional framework Foreclosure procedures introduced and foreign investment restrictions are reduced High interest rates are reduced by mid-1998. Non-performing loans remain on a high level. Positive growth in late 1998 (GDP growth>4% in 1999)

18 Hier wird Wissen Wirklichkeit 18 Aftermath : On the road to recovery (3) Foreign-exchange reserves remain $32-34 billion Strenghtening of both the Central Bank & the financial and corporate sectors The established „Chiang Mai-Initiative“ among the ASEAN members, China, Korea and Japan is an important example for the new membership in that region. Swap-retail deals offered IMF criticized: Greater interest in safeguarding foreign creditors, than avoiding collapse in Asia

19 Hier wird Wissen Wirklichkeit 19 Impact

20 Hier wird Wissen Wirklichkeit 20 Summary Until the crash of 1997, the Thai economy had performed exceptionally well. The consequent crisis therefore raised many questions as to the root of the problems. Was it purely speculation, economic factors or a combination of both, that led to the dismay ? Besides all criticism towards the IMF policy one can conclude that the reason for the crisis has not been financial liberalization, but the inadequacy of regulation. In the end, transparency leads to increased confidence in the financial system and reassures future foreign investments and decreases the probability of a new crisis.

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