No escape from economics reasons Dr Supavud Saicheua
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
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Today Dr Supavud Saicheua, managing director and head of research at Phatra Securities, adds yet another perspective in the ongoing currency crisis debate.
First of all, Dr. Supavud argues that there really isn't really a crisis at all, just opportunities and some difficult choices to be made.
Continued export-driven growth is not considered to be a serious option, or at least not as much as Thailand has been experiencing recently.
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Internationally, there is a lot happening that is relevant to Thailand's situation.
A paper by Dani Rodrick notes how contentious an issue exchange rate policy can be:
"One of the side effects of maintaining high real exchange rates is a surplus on the current account...This obviously has effects on other countries. Were all developing countries to follow this strategy, advanced countries would have to accept living with the corresponding deficits. This is a major issue of contention in U.S.-China economic relations at present. Moreover, when some developing countries follow this strategy while others do not (as in Asians versus the rest), the growth penalty incurred by the latter become larger as their traded sector shrinks even further under the weight of Asian competition."
The summary of the paper's argument:
"I provide evidence that undervaluation (a high real exchange rate) stimulates economic growth. This is true particularly for developing countries, suggesting that tradable goods suffer disproportionately from the distortions that keep poor countries from converging. I present two categories of explanations as to why this may be so, focusing on (a) institutional/contractual weaknesses, and (b) market failures. A formal model elucidates the linkages between the level of the real exchange rate and the rate of economic growth."
A blog posting yesterday by Dani Rodrick judges the currency appreciation that Turkey currently faces to be a mixed blessing:
"What has just happened in Turkey is a common occurrence in emerging markets. Once you open up to capital flows and adopt a floating exchange rate regime, financial markets determine the value of your currency. And the better you are at managing the economy, the more you get "rewarded" with an appreciating currency--except that you would have been far better off without the reward. It is a veritable Catch-22."
Rodrick argues that "maintaining a competitive currency under today's rules of the game requires a three pronged approach":
1. A large enough structural fiscal surplus to make room for looser monetary policy. A more competitive real exchange rate requires increased domestic saving relative to investment, and reduced national expenditures relative to income--and hence the need for a surplus.2. A modified monetary policy framework, which gives explicit role to the value of the currency. The central bank will have to have a view as to what the appropriate range is for the exchange rate, and take action to move it there. This does not imply or require targeting a specific level of the real exchange rate, which would be much harder (if not impossible).
3. The use of tax and prudential instruments to reduce capital inflows and manage foreign-borrowing-led consumption booms (such as deposit requirements a la Chile or increased liquidity requirements on financial intermediaries).
Item #3 seems to refer to the capital controls that Chile pioneered and Thailand adopted in December.
Please note that today's article actually appeared in the newspaper last week.
The article is so packed with useful economics vocabulary that it took a while to get it ready for this website, but today it is ready.
The useful economics vocabulary and phrases have been grouped at the front of the vocabulary section below.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. Should the current baht appreciation situation be called a "currency crisis," according to the author? Why or why not?
2. Is Thailand more or less vulnerable to currency appreciation than the US or other countries? Why or why not? (Express your opinion)
3. What percentage of national output are Thailand's exports?
4. What could be the full impact of baht appreciation, according to industry sources?
5. If Thailand had no exports, would there be any economic growth nowadays, according to the author?
6. What is the root cause of the baht appreciation problem, according to the author? What are the origins and history of the problem?
7. Does Thailand need its persistent current account surplus anymore, according to the author?
8. What one-off exceptional event caused a current account deficit in 2005?
9. Will dollars stop flowing into Thailand and the baht stop appreciating in the near future, according to the author?
10. Does Thailand's current and capital account surpluses create a surplus of dollars or baht in foreign exchange markets?
11. What happens if the central bank does not absorb the surplus of dollars flowing into Thailand?
12. Should a developing country have any capital outflows, according to the author? What about net capital outflows? What's the difference?
13. What is the consensus on the future movement of the US dollar, according to the author?
14. What are some reasons not to setup a Government Investment Corporation of Thailand (GICT) to accumulate foreign exhange reserves, according to the author?
15. What other Asian countries channel excess foreign reserves into a government investment corporation?
16. Why may letting the baht appreciate be the best long-term solution, according to the author?
17. What would the likely result of large cuts in interest rates? In the short-term and long-term?
To summarise:
18. What are the three options available to deal with baht appreciation?
What are the good points and bad points of each option?
Is choosing a mix of these options possible?
(Express your opinion)
Article July 19, 2007
ANALYSIS / MANAGING THE BAHTShift spotlight from exports
The crux of the 'baht problem' lies in Thailand's persistent current account surplus and the continued focus on export as the main engine driving the economy By SUPAVUD SAICHEUAI am surprised that the recent baht appreciation is now referred to as a crisis in the making. I recall numerous occasions in the past in which the United States' Treasury Secretary saw a strengthening US dollar as a reflection of US economic strength and wellbeing. A baht appreciation raises Thailand's purchasing power, enabling us to buy more of anything we want from the rest of the world. Yet, the Bank of Thailand (BoT) is being criticised for incompetently allowing the baht to appreciate. It has also been suggested that the BoT intervene more heavily and immediately cut rates by 1.0-1.5% in order to reverse the baht's appreciation, thus enabling exporters to survive.
I am sure that the Thai public is worried because the prime minister and top ministers are worried. Exporters, who account for 70% of Thailand's GDP, have made it clear that they want the baht weakened. Industry sources point out that thousands of Thai SMEs have already closed down. If the baht strengthens to Bt32/US$1, they said that half of Thailand's SMEs would have to close down and 2.5 million jobs would be immediately threatened.
Indeed, exports have been Thailand's sole engine of growth for the past 18 months. For example, in the first quarter of this year, if net exports were to be zero, then our GDP would have shown no growth at all.
I would argue that the crux of the "baht problem" is Thailand's persistent current account surplus that is now no longer needed. This surplus was essential during 1997-2004 when Thailand had to generate excess dollars to repay foreign debt, repay the IMF and build up international reserves lost during the 1997 economic crisis.
Once all the excessive debts had been repaid, Thailand began to attract a moderate level of capital inflow which began since 2004. We suddenly faced a situation in which we had surpluses in both the current and capital accounts - except for 2005, when misguided diesel subsidies helped incur a current account deficit of $8 billion (267 billion baht).
It is likely that Thailand will see a current account surplus of $10 billion (333.3 billion baht) and capital inflows worth $5-6 billion (200 billion baht).
The point is, we are generating a surplus of dollars, possibly with no end in sight as the dollar itself is also expected to depreciate vis-a-vis all currencies, not just the baht. This is because the US continues to run a current account deficit of about $2 billion (67 billion baht) a day.
Thailand's options
Faced with an unending stream of surpluses, either the BoT absorbs this excess or the baht appreciates in order for the market to clear.
Thailand has been doing a bit of both in recent years. Note that a typical developing country attracts a moderate level of capital inflow which means that it simultaneously runs an offsetting current account deficit which would enable its currency to stabilise.
Looked at another way, a developing country should not have net capital outflows (which means that it is investing in the rest of the world rather than investing in itself) which would have meant an offsetting current account surplus.
It would now appear that the BoT is tiring of accumulating more reserves than it needs, for obvious reasons. First, given the consensus that the dollar would depreciate further, such accumulation can only lead to more forex losses. Second, the need to sterilise the intervention has increased the BoT's baht-denominated debt in excess of one trillion baht versus Thailand's base money of only 800 billion baht. In addition, the $10.5 billion (350 billion baht) in forward dollar position is also a growing burden requiring continuing rollover and added losses to the BoT as the dollar depreciates further.
Option 1: Accumulate dollars
One option (apparently supported by many) is to force the BoT to continue this reserve accumulation indefinitely as a way of stabilising the baht. This would, however, require Thailand to make the legislative changes for excess reserves to be set aside under, say, a government investment corporation of Thailand (GICT) to spend/invest these excess dollars.
The legislative changes will be a challenge, especially accepting the possibility that some of GICT's investments could face losses.
This option is not ideal for two main reasons. First, persistent balance of payments surpluses arising from a policy of undervalued exchange rates would only force the GICT to get bigger, pushing it to eventually make risky investments. If it does not, and returns are low, then the opportunity cost to the Thai economy and people would be large. Second, excess reserves can be seen as a tax on imports. In other words, if the baht was allowed to appreciate, Thai consumers and investors would have enjoyed cheaper imports.
Option 2: Let baht appreciate and reallocate resources
The second choice is to let the baht appreciate and intervene only when the volatility is considered excessive. Here, the idea is to err on the side of caution and intervene modestly, given the already excess reserves and sterilisation burdens.
This option is hardest on exporters and faces the most serious political resistance. Yet, it is likely to be the best solution for the long run since, at the end of the day, there is a need to reallocate resources away from the export sector into the domestic economy.
Thailand's export was 35% of GDP in 1996. It is now twice that because of the need to generate excess dollars as mentioned above. Now that such is no longer needed, an equilibrium can only be restored by a contraction of exports and an expansion of imports, which can be achieved by a nominal baht appreciation. This means that the government and the BoT cannot afford to send out "false" signals that it is committed to keeping the baht weak. To do so would only incentivise exporters to stay put. Current criticisms of the BoT (and the Minister of Finance) for inaction are sending such signals to exporters who would be waiting for the baht to be "defended" at the level that allows exports to grow, continuing current account surpluses.
This does not mean, however, that the government and BoT should do nothing more. First of all, it is a lesson that too much dependence on exports and too little overall growth is risky. The government seemed contented with 4% growth but this leaves little room for economic shocks such as the baht appreciation. It would be much better to make it a policy target for growth to be around 6%, allowing a cushion to absorb unforeseen shocks.
Second, the BoT has been multi-tasking and this may have come at the expense of core policy objectives. It was keen to prevent property bubbles and set a ceiling on credit-card interest rates. These can be eased to create domestic spending opportunities.
In 2004, the BoT raised fears that mega-projects could have caused excessive current account deficits (which would ironically be much welcomed at the moment).
Third, the government needs to quickly come up with a set of policies and measures that would facilitate the reallocation of resources out of the export sector. This means looking to liberalise domestic sectors in order to create growth and investment opportunities. Of course, the notion that mega-projects are a priority must be more than just talk.
The appreciation of the baht must be seen for what it is: an increase in Thailand's purchasing power which presents us with the opportunity buy the many things we need from the world market.
Option 3: Create domestic inflation
I am afraid that this may be the most enticing option because it minimises the pains of adjustment and may even create euphoria, but there will be payback several years down the road. Calling for massive interest rate cuts would be classified as option 3.
Large interest rate cuts would necessarily mean significant easing of monetary policy since it is necessary to inject more liquidity to bring down interest rates. This monetary easing is likely to induce asset price inflation.
The stock market may be the first to react. Ironically, this could lead to more capital inflows in the short run, requiring even more monetary easing in the hope of dampening the rise of the baht. Subsequently, real estate prices would rise together with an air of exuberance, as positive wealth effect and inflationary expectations take hold. By then (say a year or two from now), headline and core inflation will be rising, bringing up production costs and wages.
Once this occurs, there will be no more worries about a strong baht. Rising domestic production costs will make exports difficult. Indeed, exporters will voluntarily turn inward to supply the domestic market because prices are rising faster here than world markets. Imports will likely surge for the same reason. Thus, Thailand would be able to cut back on its current account deficit through the creation of domestic inflation. For obvious reasons, those on fixed income (the majority in Thailand) will suffer the most from this option. They will see their cost of living go up and eventually a sharp rise in nominal interest rates in order to keep real interest rates positive. Income tax burdens will rise as inflated wages creep up towards higher tax rates. Entrepreneurs, bankers and stock brokers are likely to fare much better in times of inflation.
Conclusion
Thailand is at an important crossroads. Reducing the country's dependency on exports as the sole engine of growth is necessary and inevitable. Procrastination can only further damage the balance sheet of the BoT, making monetary policy management more difficult.
Taking the easy way out by inflating the domestic economy risks diluting Thailand's monetary policy credibility and is likely to hurt the majority through greater inflation risks. The baht's appreciation should be seen for what it is - an increase in Thailand's purchasing power which needs to be put to good use. The challenge for the government is to create growth opportunities in the domestic economy to facilitate the reallocation of manpower and resources away from the export sector.
Dr Supavud Saicheua is managing director and head of research for Phatra Securities. The views expressed are his own.
Vocabulary
export-driven growth - developing exports for sale on competitive international markets as an approach to economic development
notion - idea
contentious - causing disagreements and arguments
a mixed blessing - has bad points as well as the good ones (the blessing)
packed - full of
International Trade Vocabulary
balance of payments - money flowing into country less money flowing out of country (See The Economist)
current account - trade account, exports less imports
persists - continues to exist
persistent - continuing to exist, never changing or stopping
a surplus - positive (+), greater than zero (> 0)
a deficit - negative (-), less than zero (< 0)
incur - something unpleasant happens to you (for example, incur expenses, incur a penalty, incur the wrath of...)
* incur a current account deficit
* persistent balance of payments surpluses
* persistent current account surplus
reserves, international reserves - foreign currencies or foreign currency assets like treasury bills that a central bank holds, usually to meet future payments and needs for cash, recently China has began to keep reserves to keep its exchange rate low
reserve accumulation - collecting more and more reserves, a growing amount of reserves, one way to counteract currency appreciation
continue this reserve accumulation indefinitely - collecting more and more reserves forever
intervene, intervene in foreign exchange markets -
* intervene more heavily
* intervene modestly
sterilise the intervention - when the central bank intervenes and buys foreign currency reserves this increases the domestic money supply, when the central banks sterilises (cancels out) this effect by selling an equivalent amount of bonds (See The Economist on sterilised intervention)
waiting for the baht to be "defended" - defending the baht means the central bank intervenes and buys or sells baht and dollars to keep the baht at a target level
an undervalued exchange rate - keeping an exchange rate below the value it would be under normal supply and demand
policy of undervalued exchange rates - keepign the exchange rate so exports are cheap and competitive on international markets, like China is currently doing
nominal - actual amount, including inflation
real - adjusted for inflation, reduced to eliminate the increase due to inflation
volatility - the amount by which a price swings up and down, a measure of risk (See The Economist)
stabilise - reduce or eliminate volatility
stabilising the baht - making the baht's value (exchange rate) move less
dampening - making less strong
* dampening the rise of the baht
a forward position in an asset - (See The Economist and Wikipedia)
forward dollar position -
maturity - the end of an investment, when payments or income stream ends
rollover - reinvestment of funds at maturity
continuing rollover (of forward dollar position) - reinvesting everytime the security reaches maturity)
Government Investment Corporation of Thailand (GICT) - a Thai government run corporation like Temasek or China's China Investment Company for investing in (currently only a dream that some people have) (See Wikipedia on Sovereign Wealth Fund, Temasek Holdings, Government of Singapore Investment Corporation)
Inflation Vocabulary
inflation targeting - when the goal of moentary policy is to control inflation (See The Economist on inflation target)
cost of living - the cost of maintaining a standard of living over time, measured by a consumer price index (CPI), inflation increases the cost of living (See Wikipedia on cost of living and Consumer Price Index, and The Economist on Consumer Prices)
purchasing power - how much you can buy with your money (with inflation your money is worth less, so it buys less, inflation reduces purchasing power)
induce - cause
* induce asset price inflation
a bubble, an asset price bubble - asset prices rise to unreasonably high levels given true asset values, because investors are over-enthusiastic about a market (See glossary)
keen to - very much want to do
* keen to prevent property bubbles
fixed income - when a person's income does not vary much from period to period, also more commonly used for retired people receiving a fixed pension
bracket creep - when inflation pushes wages and salaries into higher tax brackets (See Wikipedia)
creep up - move slowly
inflated wages creep up towards higher tax rates - bracket creep
Monetary Policy Vocabulary
inject more liquidity - put more money and credit into an economy
inject - put into
liquidity - how easy an asset can be turned into cash, cash that can be used to buy other things (See glossary and The Economist)
monetary easing - monetary policy that increases money and credit in economy
nominal interest rates - the normal everyday interest rates that include inflation
real interest rates - interest rates with inflation taken out, comparable over time to other interest rates
a ceiling - an upper limit (See glossary)
set a ceiling - set an upper limit
* set a ceiling on credit-card interest rates
diluting - making less strong (for example, diluting a chemical with water makes it less strong)
diluting Thailand's monetary policy credibility - making Thai monetary policy less believable (for example, by making people believe that Thai monetary policy can't stick to long-term goals like controlling inflation
credibility - believability
diluting credibility - making less believable
purchasing power - how much you can actually buy with the money that you have (inflation reduces it, currency appreciation reduces import purchasing power)
General Economics Vocabulary
opportunity cost - what you give up to get something, which is its the true cost (See The Economist and Wikipedia)
in equilibrium - system in balance, balanced system, at rest, not moving (for example, supply is balanced by demand, or supply = demand) (See The Economist)
disequilibrium, out of equilibrium - system out of balance, not at a rest point, moving towards a rest point (for example, there is excess demand or excess supply, when supply and demand are not in balance, when supply does not equal demand) (See The Economist)
restore equilibrium - move to a balanced state, once again
an equilibrium can only be restored by... - the only policy that will bring the economy into balance is...
facilitate the reallocation of resources - make it easier to move resources to other uses
facilitate the reallocation of manpower and resources away from the export sector - help the Thai economy shift from exports to other goods and services
facilitate - help (See glossary)
allocation - distributing parts of the whole to different people (See glossary)
reallocation - undoing an allocation, and allocating once again, in a new way
manpower - workers, labourers (See The Economist on labour and Wikipedia on labour economics)
Phatra Securities - one of the leading securities companies in Thailand, engaging in three different types of securities business: securities brokerage, investment banking, and investment, included in the SET 100 (See website and company overview):
offsetting - reducing the effect of (See glossary)
shift spotlight from x to y - shift attention from x to y
the crux of - the most important part (that explains everything else)
a subsidy - money paid to keep some project alive and working
misguided diesel subsidies - oil subsidies that were a mistake
the main engine driving the economy - the main activity generating income in the economy, keeping it working
consensus - what most people agree on
* given the consensus that
multi-tasking - doing two or more things at the same time, doing in parallel not serially
core - the most important set or group
core policy objectives - most important goals of policy
keen - want very much
ironically - strangely the opposite of what you expected
enticing - attractive, makes you want to have it
an option - a possible choice
the most enticing option - the most attractive choice
euphoria - feeling intense happiness and excitement
payback several years down the road -
an air of... - having the appearance of..., looking like...
exuberance - being excited, cheerful, and energetic
with an air of exuberance - looking cheerful, excited, and energetic
at an important crossroads - the decisions made now will are important in determining the future of Thailand's economy
procrastination - waiting to the last possible moment to do something
Answer Key:
1. Should the current baht appreciation situation be called a "currency crisis," according to the author? Why or why not?
No, it should not be called a crisis because a strong currency is:
a. A sign of economic strength and wellbeing.
b. Raises Thailand's purchasing power, enabling us to buy more of anything we want from the rest of the world.
2. Is Thailand more or less vulnerable to currency appreciation than the US or other countries? Why or why not? (Express your opinion)
Because Thailand is a small open economy (trade is large fraction of GDP), Thailand is probably more vulnerable than much larger and richer countries like the US.
Thailand is probably has the same level as other Asian economies of the same size or smaller such as the Phillipines, Malaysia, or Vietnam.
3. What percentage of national output are Thailand's exports?
70%
4. What could be the full impact of baht appreciation, according to industry sources?
a. Thousands or even half of Thailand's SMEs could close down.
b. Massive unemployment with 2.5 million jobs lost.
5. If Thailand had no exports, would there be any economic growth nowadays, according to the author?
No, for the Thai economy in its current situation, no exports means no growth.
6. What is the root cause of the baht appreciation problem, according to the author? What are the origins and history of the problem?
The root cause of baht appreciation is Thailand's persistent current account surplus, according to the author.
a. This current account surplus was needed from 1997 to 2004 to generate excess dollars to repay foreign debt and the IMF as well as build up foreign exchange reserves.
b. Once Thailand had repaid the foreign debt in 2004, capital inflows started, and Thailand faced surpluses in both its current account (trade account) and capital account.
7. Does Thailand need its persistent current account surplus anymore, according to the author?
The persistent current account surplus is no longer needed, since all foreign debts from the 1997 crisis have been paid off.
8. What one-off exceptional event caused a current account deficit in 2005?
Diesel subsidies in response to oil price increases.
9. Will dollars stop flowing into Thailand and the baht stop appreciating in the near future, according to the author?
Not likely, since Thailand is "generating a surplus of dollars, possibly with no end in sight, as the dollar itself is also expected to depreciate vis-a-vis all currencies, not just the baht. This is because the US continues to run a current account deficit of about $2 billion (67 billion baht) a day."
10. Does Thailand's current and capital account surpluses create a surplus of dollars or baht in foreign exchange markets?
A surplus of dollars.
a. Dollars buying baht to pay for the exports reflected in the current account (trade) surplus.
b. Dollars buying baht to invest in Thai stocks as reflected in the capital account surplus.
("Once all the excessive debts had been repaid, Thailand began to attract a moderate level of capital inflow which began since 2004. We suddenly faced a situation in which we had surpluses in both the current and capital accounts...The point is, we are generating a surplus of dollars, possibly with no end in sight...")
11. What happens if the central bank does not absorb the surplus of dollars flowing into Thailand?
Baht appreciation.
12. Should a developing country have any capital outflows, according to the author? What about net capital outflows? What's the difference?
Of course, a developing country can have capital outflows. It just shouldn't have more capital outflows than inflows (= net capital outflows) because it is developing and should be using all its national resources for economic growth. ("Net" means "Outflows - Inflows")
13. What is the consensus on the future movement of the US dollar, according to the author?
The consensus is that the dollar is going to depreciate further, according to the author.
("First, given the consensus that the dollar would depreciate further, such accumulation can only lead to more forex losses.")
14. What are some reasons not to setup a Government Investment Corporation of Thailand (GICT) to accumulate foreign exhange reserves, according to the author?
a GICT would eventually make bad investments as Thailand accumulated reserves and GICT got bigger and bigger with an undervalued exchange rate.
b. Excess reserves are effectively a tax on imports, making them more expensive than have to be.
c. Also, there could be a foreign backlash if all Asian economies start using massive accumulated reserves to buy up important western companies.This has already become an issue in the United States.
15. What other Asian countries channel excess foreign reserves into a government investment corporation?
China is most well-known, but Singapore also does this with Temasek which bought Shin Corp.
16. Why may letting the baht appreciate be the best long-term solution, according to the author?
a. There is no longer a need to generate excess dollars to pay back IMF loans, so export sector no longer so important.
b. "Reducing the country's dependency on exports as the sole engine of growth is necessary and inevitable."
c. There is a need to shift resources out of the export sector.
d. "The challenge for the government is to create growth opportunities in the domestic economy to facilitate the reallocation of manpower and resources away from the export sector."
e. Too much dependence on exports for growth is risky
f. Baht appreciation is an increase in Thailand's purchasing power and an opportunity to buy the many things it needs from the world market.
g. This includes expensive infrastructure (mega-projects) that will enable future growth, for example, investment in transportation and roads.
17. What would the likely result of large cuts in interest rates? In the short-term and long-term?
Liquidity would be injected into the economy.
Money and credit in the economy would lead to asset price inflation and perhaps asset price bubbles in the real estate and the stock markets.
Initially in the short-term, there would be a positive wealth effect but also rising inflationary expectations eventually.
Within two years there would be inflation pushing up wages and production costs, then exports will definitely become less competitive and production would shift towards the domestic market with its rising prices.
The cost of living as well as interest rates (nominal) would rise making life for most people more difficult, especially those on fixed incomes. Income tax burdens would also increase.
To summarise:
18. What are the three options available to deal with baht appreciation?
What are the good points and bad points of each option?
Is choosing a mix of these options possible?
(Express your opinion)
Option 1: Accumulate dollars (Accumulate reserves with government investment corporation)
Option 2: Let baht appreciate and reallocate resources (free appreciation eliminates unneeded export sector)
Option 3: Create domestic inflation (reduce interest rates, sterilise reserves)
