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Collapse of the Thai Baht

Fin444- International Financial Management Section: 2 Prepared For: Muneem Ahad(MhD)

Assignment One

Prepared By: Avee Barua Chowdhury- 071 531 030 Narmana Rashid - 071 528 030

Pianki Auditi Dutta - 071 418 030

Fall,2010

1. Investigate the causes of the Thai Baht collapse The main reason that caused the collapse of the Thai baht was the inflated commercial and residential real estate produced by the 1985-95, unrivaled economic growth and the fact that greedy investors believing that the growth was endless continued to borrow to financial institutions making the real estate market reach excess capacity levels. Thailand showed great performance during the early 1990s and it was one of the dominant economies in the world. It attained the highest Gross Domestic product which is 804 percent of the year. The major reason for such type of growth in the market is due to its export to the other countries of the world. The major reason for such type of growth in the market is due to its export to the other countries of the world. So the money earned from the export was further invested in the country in the area of construction and development. So in the year 1997 it was clearly seen that the boom is the property is getting excess in the country. By the early 1990s, Thailand was one of the strongest nations in Asia. A major factor fueling Thailands economy was its strong exports. The strong economy and low interest rates led to a building boom and significant investment. In January of 1997, Thailand ranked 8th in terms of world foreign exchange position. The building boom in Thailand led to an oversupply of residential and commercial buildings. Additionally, the building boom made the country reliant on foreign imports for materials. A great majority of the building in Thailand at this time was heavily financed with debt. By six months into 1997, visible signs of trouble were evident. Thailands inflation rate was growing, an adjustment on the Thai baht was necessary, and the government realized that the building boom had resulted in severe overcapacity. All of Thailands attempts to keep the baht afloat failed. In June of 1997 the exchange rate was $1 U.S. dollar to about 50 baht. Throughout this same year a land developer defaulted on a bank loan and the Thai stock market dropped by 2.7 percent. As other Thai developers and banks began to fail, Thailand plunged from a top spot in the world market
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to one struggling with a financial crisis. . However, Thailand investors just like South Korean investors invested heavily and in excess, unfortunately, when the economic environment observed a downturn, investors had to face the harsh reality of meeting interest payments on time and because of the devaluation of the national currencies relatively to the dollars, financial institutions now had to face the backlash of their strategy by repaying much more than they had borrowed. The case of Thailands relatively quick change of status is an example of faulty currency risk management. The collapse was due to several factors including overspending and heavy indebtedness. These two factors in particular had a huge impact on the countrys currency. The Thai crisis of 1997 was the large-scale sterilization of reserve outflows by the monetary authorities to ensure smooth growth of money supply during the crisis period. The rationale for this monetary creation was due to the Bank of Thailand (BOT) acting as a lender of last resort in the face of domestic banking fragilities and the threat of an outright collapse of the banking sector. Indeed, the provision of credit to the domestic banks and the concomitant focus on banking sector fragilities, provides a reason why activist (i.e. tight) monetary policy to defend the currency may not be a viable/preferred option. 2. Discuss what policy actions by the thai government or central bank might have prevented or mitigated the crisis and the subsequent global crisis. Various economists think that the Asian crisis was created not by market psychology or technology, but by policies that indistinguishable motivation within the lender and borrower relationship. The resulting large quantities of credit produced a highly leveraged economic climate, and pushed up asset prices to an unsustainable level. These asset prices eventually began to collapse, causing individuals and companies to default on debt obligations. The resulting panic among lenders led to a large withdrawal of credit from the crisis countries, causing a credit crunch and further bankruptcies. In addition, as foreign investors attempted to withdraw their money, the exchange market was flooded
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with the currencies of the crisis countries, putting depreciative pressure on their exchange rates. To prevent currency values collapsing, these countries' governments raised domestic interest rates to exceedingly high levels (to help diminish flight of capital by making lending more attractive to investors) and to intervene in the exchange market, buying up any excess domestic currency at the fixed exchange rate with foreign reserves. Neither of these policy responses could be sustained for long. Very high interest rates, which can be extremely damaging to an economy that is healthy, wreaked further havoc on economies in an already fragile state, while the central banks were hemorrhaging foreign reserves, of which they had finite amounts. When it became clear that the tide of capital fleeing these countries was not to be stopped, the authorities ceased defending their fixed exchange rates and allowed their currencies to float. The resulting depreciated value of those currencies meant that foreign currency-denominated liabilities grew substantially in domestic currency terms, causing more bankruptcies and further deepening the crisis. The Thai government and Thai companies have allowed themselves to be seduced by cheap hot money. Consequently, governments, companies and households should impose strict discipline on their fiscal affairs to avoid future crises. 3.Derive lessons from the Thailands experience that may be useful for other developing countries like bangladesh The Thailand financial crisis and the collapse of the Thai baht provide many lessons for those interested in foreign financial matters. Thailand was not the only country to experience a financial crisis in the latter half of the 1990s, yet the specific series of events in this country provide an interesting case study into the factors that can lead to crisis as well as what can be done to prevent one. For instance, in case of Bangladesh, the banks are giving out loans aggressively to the people resulting to reduced regulation in the banking sector because of adverse selection and moral hazard effects. Therefore, the government should restrict the banks from giving out loans without proper analysis of the borrower. Apart from that increased investment in housing sector and increased dependence on imports may also impose higher pressure on the countrys Balance of Payment situation
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as housing sector do not increase exports but higher imports worsens the current account. Thereby, the government may learn from Thailands experience that proper actions need to be taken so as to avoid any likely financial crisis like Thailand.

References http://www.freewebs.com/rrajan01/secondgen.pdf http://www.papermasters.com/collapse-of-the-thai-baht.html http://econmelt.blogspot.com/ http://www.blurtit.com/q950336.html