Welcome to Pacific Exchanges, a podcast from the Federal Reserve Bank of San Francisco. I’m Nick Borst.
And I’m Linda True. We are analysts at the Country Analysis Unit and our job is to monitor financial and economic developments in Asia. Today’s episode is part of our series looking back on the Asian financial crisis as we approach the 20th anniversary of that event. We sat down with Supavud Saicheua, Head of Economic Research at Phatra Securities, to talk about Thailand’s role in the Asian financial crisis.
Every crisis, I would argue, every crisis is all about leverage. It’s all about debt at the end of the day.
Supavud has a wealth of experience at the intersection of both economics and policy-making in Thailand. Before his current role working in the markets, he served at the Thai Ministry of Foreign Affairs working on international economic issues. He also worked in Thailand’s Department of Economic Affairs on international trade negotiations.
In our conversation, Supavud does a great job laying out the economic and financial risks that developed in Thailand during the 1990s, and how they led up to the crisis. He also explains how investor perceptions suddenly shifted against Thailand, leading to capital flight and financial distress.
Yes, Supavud has a lot of insight into the thinking in Thailand at the time.
He does a great job explaining how the buildup in foreign debt was driven by borrowers that had too much faith in the stability of the exchange rate.
I think listeners will also be interested in his take on where Thailand stands today and what risks remain. With that, let’s listen to our conversation with Supavud.
Well, thank you for joining us today, Supavud. What were the main causes of the Asian financial crisis? Specifically, why did the crisis start in Thailand and then spread to the rest of Asia?
Well, thank you very much for that question. I think that it originated in Thailand because we in fact had the biggest imbalance, in the sense that we had a large current account deficit at the time amounting to something like 8.5% of GDP. That meant that Thailand was exporting less than importing goods and services to tune of one billion dollars a month, whereas our debt were short term. When the short term debt were more than international reserves, suddenly investors and speculators decided that the baht can’t be fixed at the rate that it was fixed at the time, 25 bahts per dollar.
Now, once that went under way, I think investors, creditors looked at other countries in the region which had similar problems, in other words, large current account deficit and large short term debt. Once countries like Indonesia and South Korea seemed to have similar problems, I think that that’s when it all went viral in the sense that other countries caught the bug from Thailand.
So you mentioned the buildup in foreign borrowing and the current account deficit, but then there was also the domestic aspect of domestic slowdown, weaknesses in the banking system. Can you give us a sense of how the domestic weakness and the international vulnerabilities interacted with each other and helped catalyze the crisis in Thailand?
I think those were very important subsequent secondary factors, but I have to go back all the way actually to the inconsistency of our monetary policy. I think that’s still the fundamental reason for the crisis and actually, you have to go back simply to go back and read Robert Mundell’s article, I think in 1962, talking about capital mobility and the fixed and flexible exchange rates. His argument is very simple. If you want to do these three things, you can’t do them at the same time. If you want to have capital mobility, if you want to have fixed exchange rates and you want to control your own domestic inflation, you can’t do all three, and Thailand was trying to do all three.
What we did was to liberalize our capital account, I think it was back in 1992, we wanted to have a lot of capital to rebuild our economy, to invest. We did get a lot of money coming in and when that happened, suddenly you have a lot more inflation in Thailand. The Bank of Thailand hiked interest rates. The lending rate in Thailand went up to something like 13% whereas international rates were something like 5-6%.
More and more capital tried to come in and the Bank of Thailand fixed exchange rates, and so everyone in Thailand borrowed money. It was unwise to do otherwise. If you are a Thai corporate and you have a choice of borrowing in dollars, 5-6%, or borrowing in Thailand, 13%, and the Bank of Thailand guaranteed the exchange rate being fixed, it was a no-brainer.
Then the point you made about the weaknesses in the financial system came in later after things got out of hand in terms of overleverage.
There were many causes and preconditions that led to the crisis in Thailand. What would you say was the exact defining moment that triggered the crisis?
I think the time came when a rating agency downgraded Thailand. I think it was a very clear signal that the creditors need to see, need to carefully scrutinize whether the baht could hold. Once you had that happen and you had speculators attacking the currency and the Bank of Thailand having to lose reserves to prop up the exchange rate, I think it became quite clear that the situation was going to be unsustainable.
And then, corroborating that was, of course, interest rates globally were also starting to rise. You had investors then questioning whether Thailand’s banking system could withstand the tightening that was going on, because as you know when the Bank of Thailand had to intervene to prop up the baht, they had to hike domestic interest rates and reduce liquidity in Thailand. That was when, at that time, people started to question the financial system, the bank’s reserves, whether they have enough to handle the rising interest rates and the rising nonperforming loans.
Now, as I mentioned to you before, the Thai corporates were borrowing a lot. They thought that it was easier to get higher return and equity that way. When those financial conditions tightened, that was when things came home to roost.
Was there a sense, both by regulators and corporations and banks doing this international borrowing at the time, was there a sense that this was risky or had the peg to the US Dollar been in place so long that people didn’t really internalize those currency risks?
To answer your question, no, people did not internalize the currency risks because the government and the Bank of Thailand assured us that the baht can be fixed at 25 baht to the dollar. As you would recall, at the worst time it went to 50 bahts per dollar.
So, all those Thai corporates that borrowed foreign money, and there were lots of companies that did that, suddenly found themselves that their debt doubled. The debt had risen significantly. I think at the peak, came up to something like 80 billion US dollars, and in that time, that was equivalent to something like 30% of Thailand’s GDP. Imagine that doubling after the baht went, that was when the biggest damage was done to the Thai economy.
You’ve covered how Thailand’s currency policy played a role in triggering the crisis. Did foreign investment funds exacerbated the problem?
It was all a question of, every crisis, I would argue, every crisis is all about leverage. It’s all about debt at the end of the day. Now, what exacerbated things was that we borrowed foreign money, and of course, when you borrow foreign money you can’t print foreign money to repay, which is what usually what central banks would do to help alleviate the situation in the short term. It was all about leverage, borrowing too much and borrowing too cheaply thinking that the foreign interest rates were low.
Foreigners, of course, were willing to lend to Thailand at the time. If you recall, Thailand’s GDP was growing, when it was growing relatively slowly, it was 7%. It was growing fast, it’s growing 10%. Everyone wanted to lend to Thailand and Thailand wanted to borrow. However, once they started to see things happening, they pulled money out quickly. To give you a quick understanding of the numbers at the time, back in 1996, we recorded that Thailand’s private foreign debt came up to about 70 billion US Dollars and foreign reserves were 30 billion. When foreigners saw that, they started to pull money out very, very quickly.
Once the crisis broke out, you had several multilateral organizations like the IMF and the World Bank and the ADB step forward with rescue packages for Thailand. There was also some bilateral aid from countries like Japan. How effective were these aid efforts at staunching the crisis and putting a lid on things and what about the subsequent structural reforms that came along with these aid packages?
I must say that the IMF, when they came in with the 17 billion US dollars package, came in with very, very tough medicine. At the time, I had the privilege to talk with the IMF team who come to visit us quite regularly during those few years. My contention has been that they were too tough in terms of their conditions in tightening domestic liquidity. They had the Bank of Thailand tighten monetary policy to such an extent that the interbank rate pushed up to 20%. Interest rates were 20% or higher. At the same time, they had the government tighten fiscal policy as well.
The tightening was to support the currency?
It was to support the currency. The argument was seeing that if you have 20% return on the baht, people will hold onto the baht. My problem with IMF at the time was that I thought that no corporate, no banks can survive on 20% interest rate, and as a result, the domestic demand collapsed in such a huge way that people were not confidently holding the baht because you can’t really be sure where your baht will be faced unless it’s cash. That would exacerbate. That would actually turn the money multiplier even lower.
Just to give you a case in point, when the IMF came in the first letter of intent, which is basically them telling us what we need to do to revive the economy, they forecast that GDP growth in 1997 was going to be 2.5%, and 1998 was going to be 3.5%, so very mild downturn from GDP growing 7-8% down to 2.5 in ’97 and 3.5 in ’98. As it turned out, GDP contracted 1.8% in 1997 and 10.4% in 1998. That was how far off they were in terms of assessing the intensity of their measures. To be fair, of course that measure caused the baht to weaken hugely, as I said, from 25 baht per dollar to 50 baht per dollar. You had a sharp turnaround in Thailand’s current account in three or four months. That’s unprecedented. You went from current account being minus 8.5% of GDP to plus 10% of GDP just within about 18 months or so. That’s a huge turn and the recovery was therefore driven hugely by export.
Fast forward to today, if you recall back in 1996, export was something like 25-30% of GDP. It is 65% of GDP now. Structurally, what has changed that, we are now much more export-dependent in terms of generating GDP. The banking sector, of course, had to recapitalize I think about three times, three rounds of bank recapitalization. A lot of dilution of existing shareholders, and the banking system now is actually very, very strong.
Was there an effort to put in place restrictions on foreign borrowing after this so that the same sort of problem wouldn’t occur again?
Interestingly enough, no. The Thai entrepreneurs and the Thai banker would argue were severely punished, having gone through the crisis that they’ve turned extremely, extremely conservative. I think I have not seen any corporates really wanting to borrow that much in broad terms. There are some companies that continue to borrow from abroad, but by in large, I would argue that that’s more an exception rather than a rule.
Today, foreign debt of the private sector is very, very small and the Thai banks as I said were very well capitalized and not willing at all to leverage. In fact, I would argue that the Thai banks are now too conservative and you are seeing that in domestic demand, quite weak, and inflation in Thailand year-to-date is about 1% compared to about 5-6% before the crisis.
How has the Thai economy changed since the Asian financial crisis and what reforms still need to be done?
Interestingly, the Bank of Thailand right now is encouraging capital outflow, encouraging deregulation, allowing Thais to invest abroad to diversify their investment. You also have in Thailand right now GDP growing much more slowly than back then. Back then, as I said, GDP growth of 7% was typical. It was actually slightly on the low side. Now, we struggle to get 3.5% and we’d be lucky to get 4% GDP growth.
Inflation in the past three years has been almost nonexistent, in part because of lower oil prices. But even looking at core inflation, that has dropped from about 2% three years ago to about 0.5% right now. The domestic economy has slowed down a lot, GDP has grown at a much slower pace and we consistently run current account surpluses. Current account surplus has been rather huge, 10% of GDP for the past couple of years. Thailand’s foreign reserves from 30 billion back in 1996 for the crisis is now hovering close to 200 billion US dollars.
You know, when you look at some of the other Southeast Asian economies in Indonesia, Malaysia or even more northern like Korea, it seems like they were able to return to their growth path more quickly than Thailand was after the crisis. Is there a reason you would pin on why Thailand’s recovery relative to these other countries sort of lagged behind?
I think the real reason has to be combination of things. As I mentioned to you before, the corporates are no longer willing to leverage and the banks are much, much more strict in their lending relative to back in 1996, in 1990s. But also structurally, I think Thailand has to admit that we are quickly entering into an aging society. This year will mark the year where our workforce begins to fall in absolute terms and this will continue for many decades to come, so we’re running out of workers in that sense. All else being the same. If you run out of workers, the return of capital will fall.
We also have much more competition compared to back in the 1990s. Ironically, that’s why the government and the Bank of Thailand at the time wanted to draw in lot of capital to build up Thailand’s production capacity because they saw the emergence of countries like Vietnam, maybe Indonesia and others, and they thought that we would take a leap ahead by leveraging and investing. Now, we’re stuck in a situation where the private sector in Thailand is less confident, I would argue, about Thailand’s economic prospects. You try so hard but you could not revive private investment.
Finally, with the political situation the way it is, you have an attempt to transition power from the military government to an elective government. That transition adds another dimension of uncertainty in terms of how policy will be made, whether politics will be stable and that’s also another headwind on private investment in Thailand, contributing to lower growth prospects.
You’ve worked in a variety of different roles, whether that’s academic, in the government, in the private sector. Have these different experiences changed how you view not only the Asian financial crisis looking backwards, but also when Thailand went through the global financial crisis. Has your perspective on financial crises changed over the years?
It has, I have to admit. It gives me an appreciation, having gone through the crisis, not wanting to go through it ever again. But having gone through the crisis, leverage is so important. Leverage is so dangerous. It becomes especially dangerous when interest rates starts to hike, starts to rise. I get that big lesson in my mind that I’ll never forget.
The other thing is as an economist, we tend to focus on flow variables. We focus on GDP, we focus on current account, exports, imports, even inflation. The crisis, when it hit you hard, it’s the problem about stocks actually. It’s the fact that if you have too high debt level and you have too high interest rates, you cause nonperforming loan, stock of nonperforming loan to rise and that has such a huge wealth effect, negative wealth effect, that it affect your flow variables. So, I now have a much greater appreciation of the importance of looking at stock variables such as nonperforming loans and how it impacts the economy.
Just to give you an example, when we saw back in July of 1997 that the baht began to depreciate and the Bank of Thailand was willing to allow the baht to depreciate, we all in Thailand, myself included, thought that GDP would grow because we would have a weaker currency, but we hadn’t appreciated the fact that when the currency weakened, it also caused the dollar debt turned into baht to be much higher and that actually overwhelmed all the positive effect of the baht depreciation on exports and it was the main reason for the crisis. At peak, nonperforming loans in Thailand was 42% of loans in the system. That meant that people were willing to not pay debt because if 40% can’t pay debt, the remaining 60 would probably say, “I don’t want to pay debt either,” and that’s how you have system regress and you had almost a near collapse at banking system, and that had affected the economy in such a profound way.
What are the biggest risks you see in Thailand and Asia today? And also, how prepared is Thailand and Asia for a future financial crisis?
I would argue that Thailand has learnt its lesson maybe too well and if anything, Thailand has risked financially of sliding into what happened to Japan after its crisis back in 1989-1990 where in combination with the aging of the population, you have deflation of demand that you risk overall deflation. Inflation has failed to pick up. The Bank of Thailand has a policy target for inflation of 2.5%. It hasn’t met that target for two years running coming to the third year. We’re risking going into deflation rather than excessive spending as was the case in the 1990s and we had large current account deficits.
For Asia today, I would still fall back on argument that debt is dangerous, and as such I thought that China’s situation bears close watching because loan growth in China, debt in China still continues to rise and when you have large debt, I have not seen large debt ending well in any case that I’ve seen so far.
Maybe just to wrap things up, looking back 20 years after the crisis now, what would you say are the enduring lessons that we should take away from the Asian financial crisis?
I think that borrowing in general is dangerous despite the fact you can always boost your return on equity, but then foreign borrowing is especially dangerous. The other lesson is of course, policy has to be right and our policy at the time was inconsistent. Again, going back to Robert Mundell who laid it down very well that you cannot have all those three things, you can’t control your money supply and hope to have capital mobility and fixed exchange rate. I would look at policy consistency as well.
I just want to mention to you that Thailand was also saved by the fact that fiscal side, the government was actually quite strong. If you look back in the 1990s, government was paying down debt and public debt was something like 20% of GDP, so the government had the ability to bail out the economy and having a strong fiscal position I think is also a very worthwhile thing to have.
Well great, thank you so much for joining us today.
We hope you enjoyed today’s conversation with Supavud. For more episodes like this, you can find us on iTunes, Google Play, and Stitcher. And if you like what you hear, please leave a review—feedback from listeners like you will help more people find us. And for even more content, look up our Pacific Exchange Blog, available at FRBSF.org. Thanks for joining us.