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High price to pay for keeping the baht low

Publication Date : 12-10-2012


The International Monetary Fund (IMF) said this week that China, Malaysia and Thailand's currencies are undervalued relative to the economies' medium-term fundamentals. It also added in its World Economic Outlook that these countries should focus on fiscal policy to support growth.

The IMF's assessment inadvertently plays into the hands of Mitt Romney, the Republican Party's US presidential candidate. Romney has vowed that he will declare China a currency manipulator on day one of his office if he wins the election. China has been pegging its yuan to the dollar tightly as part of its currency management system. This has kept the yuan competitive relative to other currencies, thereby helping fuel Chinese exports and piling Beijing's huge current account surplus even higher.

The baht has also managed to remain competitive, boosting Thai exports. The Bank of Thailand (BOT) looks upon exports as the main engine of economic growth. Its foreign exchange policy so far has been biased towards creating a competitive currency to prop up the export sector. Many other export-led economies, including Singapore and South Korea, have also pursued this policy to keep their currencies competitive, as they prefer to build up their current account surplus and accumulate foreign exchange reserves.

But, as Milton Friedman said, there is no such thing as a free lunch in economics. By pursuing a policy with a bias towards a weak currency, the BOT has intervened in the foreign exchange market to sell the baht and buy up the US dollar.

The Thai central bank has then issued bonds to mop up the baht liquidity from the financial system. The dollar assets in its portfolio yield 1.50 per cent at the most. But it is paying 3.5 per cent on its BOT bonds. This foreign exchange intervention has been going on rather actively since 2005. The central bank has slowed the foreign exchange intervention somewhat over the past year.

But the damage has been done. The value of the dollar has kept falling, while the baht has appreciated. When marked to market, it creates losses to the central bank's account. According to its chairman Virabongsa Ramangkura, the BOT had suffered accumulated losses of 470 billion baht (US$15.3 billion) as of March. "Now the accumulated losses should have surpassed 500 billion because the losses occur every single month," he added.

The BOT recently held a symposium in which a distinct theme of monetary independence emerged. It also undertook to tackle the nagging question: "Does it matter if the central bank incurs losses?" BOT researchers were quick to point out that since the central bank, unlike private companies, is not profit oriented and has a special mandate to safeguard macroeconomic stability, it can incur losses because the benefits of a stable macro-economy outweigh its own losses.

This assumption is self-serving at best. A loss is a loss. It appeared that the central bank's researchers already had the answer in their minds before they set out to gather data to support their argument that the BOT losses were not critical to its operation.

Surprisingly, most top Thai policymakers, including MR Pridiyathorn Devakula, Dr Narongchai Arkasanee and Thirachai Bhuvanat-naranubala, did not seem to mind seeing the central bank's losses soaring. They treated the losses, which could reverse in the event of dollar appreciation, as a matter of bookkeeping. Dr Prasarn Trairatvorakul, the central bank governor, also subscribes to this premise, hence the expanding losses in the central bank's book.

What the BOT has failed to ask is: what if the losses shoot up to 1 trillion baht? Or what if the baht appreciates to 27-28 baht to the dollar and hangs there for a sustained period? By that time it would be too late to salvage its reputation. The central bank would then be forced to write off the losses by raising fresh capital. Where will the money come from? If it were to print money to pay for the realised losses, it would be punishing all Thais who hold the baht since the currency's value would be debased. If it were to use money from the budget for recapitalisation, it would lose the independence it has so cherished, with the bitter memory of the 1997 financial crisis not yet faded. The politicians and the public will utter the same line: "Oh, the central bank screws up again."

Apparently, the BOT is making a bet in its foreign exchange intervention on behalf of the export sector. Most central banks incur losses in their bond operation rather than in their foreign-exchange operation. Since its foreign-exchange operation team operates with a mindset that losses do not matter, they might lack prudence or fail to be careful enough in their intervention. This is quite normal. If you spend other people's money, you tend not to be careful with your spending. But if the money comes directly from your own pocket, you'll tend to think twice before going beyond your limits.

Yes, keeping the currency weak has a cost. It debases the value of the currency or undermines the purchasing power of citizens. The central bank's job is to maintain price stability or guard the value of the currency. The weak-currency policy pursued so far by the central bank serves the export sector at the cost to the overall economy and also its own accounting book. It is time to revise this policy direction.

*US$30.6 baht


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