The Fund knew Thailand’s predicament was bad—but not how truly awful it was.
Thailand’s revered late-nineteenth-century monarch Chulalongkorn—known to Americans as the Crown Prince in The King and I—built his children a small, elegant riverside pavilion, which later became part of the Bank of Thailand’s complex of buildings. There, in the last week of June 1997, Rerngchai received an important visitor—Thanong Bidaya, who had Just been appointed finance minister on June 21.
A few days earlier, Thanong had been in Hong Kong on vacation with his wife, enjoying a respite from his responsibilities as chief executive of a major commercial bank. But an urgent call came from Prime Minister Chavalit Yongchaiyudh, making an offer he couldn’t refuse—the Finance Ministry portfolio, which had Just become vacant. A novice to government, Thanong spent his first couple of days in office attending a cabinet meeting and a parliamentary session and delving into the details of the government’s pending budget proposal. But now he wanted to find out how solid the country’s financial position was, and he asked Rerngchai essentially the same question Fischer had posed a few weeks earlier: What was the exact status of the central bank’s reserves?
Unlike Fischer, Thanong was in a position to demand an answer. It surpassed his worst suspicions: Of the more than $30 billion that the Bank of Thailand publicly claimed to hold in reserves of dollars, yen, and other hard currencies, only a couple of billion dollars was readily available for defending the value of the baht. The rest had been committed for future delivery in a series of complicated transactions during a pitched battle to fend off the hedge funds a few weeks earlier. Thanong managed to remain cool, but said he would have to go to the prime minister for a major decision on what to do about the country’s fixed exchange-rate policy.
The information Thanong learned that day was dynamite. The Bank of Thailand had embarked on one of the most audacious currency defenses in history, a desperate maneuver in which the central bank nearly emptied its financial war chest and hoped that nobody else would figure it out.
One of the central bank’s chief battlefield tacticians was Paiboon Kittisrikangwan, the young technocrat whose Job of managing the baht’s fixed exchange rate had once been so humdrum. He and his colleagues had started off in early 1997 reasonably well armed, with $38 billion in reserves of dollars and other hard currencies. That amount was many times more than any individual hedge fund or other speculator would be willing to gamble against the baht. So the Bank of Thailand appeared to be in a position to buy plenty of baht at the official rate of 25 baht per dollar from anyone betting on its fall—and by showing its determination to maintain a stable exchange rate, it hoped to discourage its tormentors. But throughout spring 1997, speculation against the baht intensified, reaching a crescendo in the second week of May, with the attackers including Soros’s Quantum Fund, other hedge funds, and a host of traders at U.S. financial institutions such as J. P. Morgan & Co. and Goldman, Sachs and Co.
A central bank can defend a currency in several ways. Usually the most effective is to raise interest rates. A higher interest rate on, say, Thai government bonds or Thai bank deposits would increase their appeal to investors—who must buy baht in order to invest in them. But in spring 1997, the Bank of Thailand had already lifted borrowing costs and was reluctant to go much further; the economy was slowing, and many finance companies were scrambling to avert bankruptcy.
Another currency-defense method is to intervene in the foreign exchange markets, to pump up demand for the currency. In the Bank of Thailand’s case, this would mean using its reserves of dollars to buy baht. The Bank of Thailand did a substantial amount of such buying, because under the fixed-rate system for the baht, it was obliged to exchange one dollar for every 25 baht that someone wanted to sell.
But the central bank’s officials didn’t want to rely on this sort of intervention exclusively. For one thing, buying baht reduced the amount of the Thai currency circulating in the nation’s economy, which had the same effect as Jacking up interest rates. For another, selling dollars from reserves risked inciting the speculators to redouble their efforts. Once the likes of Soros, Morgan, and Goldman saw that the Bank of Thailand’s reserves were shrinking, they would gain confidence that the day of reckoning for the baht was nearing.
So Paiboon and his colleagues used other techniques to mitigate and disguise the effects of their baht-buying and dollar-selling. Much of it involved the “swap” market, where participants can buy or sell one currency for another with a promise to trade the currencies back after a certain number of weeks or months. It is not necessary to understand the intricacies of this market to comprehend the essence of what Paiboon did. He obtained dollars in the swap markets, thereby replenishing the central bank’s reserves, and in the same transactions he unloaded baht, thereby replenishing the amount of baht circulating in the Thai economy. Problems solved! But there was a catch—because in each of these swap transactions, the central bank was entering into commitments to reverse the transaction a few months later.
The beauty was that the Bank of Thailand didn’t have to disclose the commitments, so its published figures indicated that it still had ample dollars in the till. The downside was that the more this practice continued, the fewer dollars the central bank actually had that were readily available to defend the baht, because so much of its dollar stockpile was already committed to these future transactions. (The same was true of another of the central bank’s stratagems for propping up the baht, which involved using the “forward” market, where it contracted to sell dollars a certain number of weeks or months in the future.) The long-shot hope was that the speculators would eventually give up, and the central bank could quietly and gradually put its finances in order.
The Bank of Thailand deployed enormous sums using these tactics, especially during the second week in May—throwing $4 billion into the market one day, $6 billion on another. Yet the hedge funds relentlessly pursued the short-selling attack. “The market is not afraid,” Paiboon’s department concluded on May 13.
May 14, 1997, was “an unforgettable day” for the top management of the Bank of Thailand, according to the Nukul Commission Report, which quoted former head Rerngchai as recalling: “Everyone panicked, and some even cried.” On that day, the central bank threw $10 billion into the fray, using various markets, without beating back the speculators.
Only a handful of officials knew the dreadful secret—that once the official reserve figure was adjusted to reflect the dollars committed in the swap market, the Bank of Thailand was nearly out of hard currency. Rumors were swirling that the reserves were well below the official figure, but even senior government policymakers were denied access to the data by bank officials. “We said, ‘You have to tell us!’” recalled one cabinet minister who was a member of a panel with oversight responsibility for some of the funds used in the baht defense. “They [Bank of Thailand officials] said, ‘Legally, we don’t.’”
The Bank of Thailand’s obsession with secrecy was understandable. A leak of the information about the reserves would be akin to showing a weak hand to an opponent in a poker game. And the Bank of Thailand’s hand was getting very weak indeed.
The central bank had one weapon left in its arsenal. On May 15, it deployed that weapon. Reversing its policy of liberalizing the Thai financial market, the Bank of Thailand ordered all twenty-nine local and foreign banks in Thailand to stop lending baht to anyone outside the country. The baht would cease flowing outside of Thailand unless there were a genuine, trade-related reason such as payment for imports.
The move inflicted acute pain on the hedge funds, to the tune of $400 million to $500 million in losses. Now it was virtually impossible for anyone to short the baht, since going short required borrowing the Thai currency. Traders in New York, London, and other financial capitals who had already sold baht short scrambled madly for the baht they needed to repay loans they had already borrowed. The interest rate they had to pay on their borrowed baht zoomed t
o triple-digit annualized levels, then to 1,000 percent, 1,500 percent, and even beyond. At a press conference, Chaiyawat declared sternly that speculators “have to pay the price.” Stanley Druckenmiller, Soros’s chief lieutenant, would later admit: “They kicked our butt.”
The selling pressure on the baht eased in the following weeks, prompting some market commentators to conclude that the Bank of Thailand had triumphed. Prime Minister Chavalit called the central bank and promised to treat the staff to a victory party. But the celebrations proved premature. Thailand may have thwarted the foreign speculators, but an even bigger source of potential baht-selling lurked within its own borders.
On June 19, 1997, Finance Minister Amnuay, a vocal champion of the fixed exchange rate, resigned in a dispute over tax policy, triggering new worries about a baht devaluation. Suddenly, the floodgates opened anew. Hedge funds were no longer the main problem. Now it was Thai banks and corporations that were selling baht en masse, in a mad rush to acquire the billions of dollars they needed to pay short-term debts that were falling due soon. Their foreign creditors, who had once lent money so willingly, were demanding immediate repayment as their loans matured, and they were refusing to extend the loans further. Few of the Thai borrowers had bothered to hedge themselves against the possibility of a collapse in the baht (though they could have done so by paying for contracts in the currency markets to obtain dollars at a fixed exchange rate in the future). Their frantic baht-selling and dollar-buying weren’t covered by the Bank of Thailand’s antispeculator rules, and the central bank held nowhere nearly enough reserves to stem the run.
At a meeting presided over by Chaiyawat on Saturday, June 21, the bank’s top policymakers glumly concluded that the fixed-rate system could not survive, and they prepared to let the baht’s value float according to market forces. The following week was when Thanong, Amnuay’s replacement as finance minister, discovered the true size of the reserves. A plan was hatched to announce the float at the earliest practicable opportunity.
At 4:30 A.M. on July 2, 1997, Bank of Thailand officials began phoning senior executives at commercial banks in Bangkok, telling them to come to a meeting at the central bank in two hours. A flash message announcing the float was transmitted to government news services at 7 A.M., and at 8:30 A.M., the Bank of Thailand broadcast a public-address announcement to its Junior employees. At a press conference later that day, Rerngchai said; “I haven’t slept for two months. I think that tonight I’ll be able to sleep at last.”
Still, the true size of the bank’s reserves would remain a carefully guarded secret, at least for the time being, even from the IMF. Thai officials feared that if the markets realized how much of their reserves were tied up in swap contracts, selling pressure against the baht would know no bounds.
IMF officials were indignant over the Bank of Thailand’s refusal to share the information, which they believed they had a right to know in light of their mandate to help maintain international financial stability. They tried to divine the amount by quietly querying market sources in Southeast Asia, but ended up with a wide range of estimates.
In an episode that still evokes chuckles and eye-rolling among some at the IMF, Chaiyawat finally revealed to Fischer in late July 1997 how much of the central bank’s reserves were committed in the swap market—but only on the condition that Fischer not tell anyone else at the Fund.
The riverside pavilion built for King Chulalongkorn’s children is informally known as the “Fish House” because of the aquatic inhabitants of the Chao Phraya river that throng to the area nearby. Visitors may entertain themselves by standing on a veranda Jutting over the river and tossing pieces of bread, furnished by Bank of Thailand employees, attracting fish that reach several feet in length. This building served as the main site of the negotiations between top Thai economic policymakers and the IMF in the summer 1997 crisis, and fish-feeding proved to be a frequent pastime for Fund negotiators. When disagreements erupted requiring the Thais to consult among themselves, Fund economists were ushered to the veranda and given loaves of bread. It soon became clear that the two sides would have many disputes, prompting Hubert Neiss, who led the IMF mission, to observe to his colleagues, “We’re going to need a lot of loaves.”
Neiss’s mission got off to a Jarring start when it arrived on July 29. The officials who were presumed to be their main interlocutors in the negotiations (Chatu Mongol Sonakul, the chief bureaucrat at the Finance Ministry, and Bank of Thailand Governor Rerngchai) resigned only hours after the mission arrived. Thus the team generally sat around idle for three or four days.
The chilly reception from the Thais bespoke their ambivalence about accepting IMF support. In the days following the floating of the baht on July 2, Prime Minister Chavalit first sent emissaries to Japan and China to secretly request bilateral loans of hard currency, but they were refused. (In Japan’s case, one reason was that the Thais would not disclose information about the swaps.) “The prime minister was stunned and depressed,” recalled a cabinet minister who was with him when the news came. “He kept saying, ‘Then we have no choice [but to invite the IMF] ... are you sure the conditions will be okay?’” The Thais’ misgivings were not assuaged by what they heard at the first meeting with Neiss.
Standard economic theory holds that when a country’s economy appears to be headed into a slump, the proper policy is to pump up government spending and reduce taxes, thereby putting more money in people’s pockets to cushion the effect of Joblessness, and to cut interest rates, thereby stimulating borrowing and spending by consumers and businesses. But in the opening session with the Thais, Neiss made it clear that the IMF would require Bangkok to embrace a different policy: austerity. “The program,” Neiss intoned, “is based on the restoration of confidence, which is based on tight monetary and tight fiscal policy.” His words stunned the Thai negotiators, who felt that on budget and tax matters in particular, they were certainly not guilty of profligacy.
The IMF demanded, as a condition for its loan, that the Thai government take several measures aimed at producing a substantial budget surplus, including increasing the value-added tax (similar to a national sales tax) from 7 percent to 10 percent. Altogether, the IMF’s conditions required Bangkok to raise taxes and cut spending by an amount equal to 3 percent of GDP. To put that in perspective for Americans, it’s as if the United States raised taxes or cut government benefits by $300 billion in one year, or over $1,000 for every man, woman, and child in the country.
Negotiations were heated. Finance Minister Thanong, who came to the Fish House in the evenings after long budget sessions in Parliament, stormed at one point that “the time will come when no IMF staffer will be able to come to Asia.” To his consternation, the IMF was insisting on an increase in bus fares, because of the costly government subsidy that kept fares low. The two sides finally agreed that only fares on air-conditioned buses would rise; fares on buses without air conditioning would remain subsidized, since the nonair-conditioned buses tended to serve the poorest riders. But the Fund held its ground on the basic issue and won agreement on a major tightening of fiscal policy, including the rise in the value-added tax.
Given the lessons taught at the IMF Institute, it’s easy to understand the rationale behind the Fund’s approach: Thailand was running a very large current account deficit, so it was living beyond its means; and since it had maxed out on its credit cards, the time had come to bring imports down into balance with exports. That, in turn, required dampening overall demand, and the most effective way to do that was to force the government to tighten its belt, even if the government’s belt was already pretty tight.
But the IMF failed to grasp that Thailand needed no help whatsoever in reducing demand, because its economy was heading off a cliff. In 1998, Thai GDP would shrink by a whopping 10 percent, the result being that the country was “living within its means” far more quickly—and brutally—than the IMF had anticipated or anyone had wanted. Imports would shrivel so fast that the count
ry ran a current account surplus of 12.7 percent of GDP in 1998. In other words, the last thing the Thai economy needed was higher taxes and budgetary stringency, since all that would accomplish was the intensification of an unexpectedly deep recession.
Officially, the IMF program for Thailand was based on a forecast of 3.5 percent growth in the nation’s economy in 1998, though that figure was essentially a “political” forecast aimed at boosting public confidence. “In our hearts, we thought growth would be about zero,” said one member of the Bangkok mission. But either way, the Fund was grossly miscalculating the depth of Thailand’s woes. “We certainly didn’t expect growth to be as negative as it turned out to be,” the mission member said.
To its credit, the IMF changed its stance a few months later as the severity of the recession became more apparent, urging Thailand to adopt stimulative fiscal policies rather than contractionary ones. Staffers recalled, with some awe and relief, that Fischer told them the Thais should be encouraged to run a budget deficit—“something I never thought I’d hear us say,” as one IMF economist put it. But not until March 1998 did Bangkok adopt the new expansive approach, and even then it was a while before government agencies reversed their budget-cutting modes. Meanwhile, unemployment rose to 6 percent in 1998, triple the level of two years earlier, and wages in urban areas shrank an average of 8 percent.
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