Baht appreciation: crisis or opportunity?

Shift 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 SAICHEUA

I 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.