July 1997 Currency Crisis Revisited

A few days ago Indian sock market got the beating following the global market crash. The greatness of the financial market is that it is always very difficult to anticipate its strange behaviour. Ten years ago I was lucky to predict the inevitable fall of Thailand’s baht by accidentally stumbling upon the London Economist’s cover story ‘Fall of Thailand’. As a keen student of international finance I had already internalized the fundamental factors leading to Mexican peso collapse in 1994-95. I could foresee the repeat of that currency episode in Thailand. I wrote a piece for The Hindu Business Line in mid-June 1997 and a week after Thailand was amidst its worst currency crisis.

Ten years after the crisis I would like to revisit now. An interesting paradox of Thailand’s crisis was that it was only a few months before the crisis both IMF and Asian Development Bank had given a good report card about its economic performance. Like other Asian miracle nations, Thailand too had a remarkable macro economic stability for a longish period. Inflation was moderate within manageable limits; government did not run into any budget deficit; indeed there was a fiscal austerity and the budget was in surplus. Until mid 1990s, Thailand’s export growth was robust. It was only threatened after Chinese currency’s devaluation in 1994. The debt service ratio was around just 10 percent. Huge capital inflows in pursuit of high interest rate at home and booming stock market conditions kept the exchange rate stable. All these made the banks and firms which had borrowed dollars not to hedge their exposure. Everyone was under an illusion that the fixed exchange rate would rule forever and not pose any problem at the time of repayment.

Then why did the currency was molested by the speculators? The prime villain of the piece was rise in current account deficit which stood at 8 percent of the GDP- a magic number which figured in the preceding Mexican currency crisis also. Another worrisome factor was huge rise in short term component of external debt which far exceeded the exchange reserves and more important for 12 long years exchange rate had been almost fixed with the dollar which really warranted a revision (devaluation) given a high real exchange rate appreciation that had taken place through inflation which itself was the consequence of cumulative capital flows resulting in expansion in money supply, notwithstanding some measure of sterilization under taken by the central bank of Thailand.

The currency was now ripe and ready for the speculators’ attack. Central bank by active intervention in both spot and forward markets tried in vain to protect the currency. Even the interest rate defence could not rescue it. On July 2, 1997 Thai’s baht had to fall. At that time no one would have imagined that this was only a beginning in a series of currency crises which were going to envelop not only the Asian region but also even distant lands such as Russia, Brazil, Argentina and even the US. If one single reason is to be given for the crisis, it can be rightly stated that a premature embrace of financial market liberalization and capital account convertibility without making any serious attempt to put banking and financial system in order.