Thailand: Riding the Financial Crisis Roller Coaster

By: Connor Rice

I. Introduction

Ever since its formation in 1939, Thailand has gone through a lot of political instability.

The country was formerly called Siam, until a bloodless revolution in 1932 led to a constitutional

monarchy. The country allied with Japan during World War 2, yet switched its alliances to the

United States since their troops fought alongside America during the Korean War. In 1997,

Thailand was the cause of a major financial crisis that affected not only the economic welfare of

Thailand itself, but also the rest of Southeast Asia. During the 1990’s Thailand had been

prospering economically, which caused foreign investors to overestimate the amount of

investment they could stably put into Thailand’s economy as well as the amount of economic

stability the country had. Due to a lack of proper government practices when it came to fiscal

and monetary policy, the value of the baht ended up collapsing. The inability of politicians to

give loans to investors caused widespread bankruptcy in addition.

Thailand has dealt with a large amount of political turmoil as well in the past decade,

with the removing of Thaksin Chinnawat, the prime minister of Thailand since 2001, during a

military coup in 2006. In 2008, 2009, and 2010, there were massive protests by competing

political factions. Thaksin’s younger sister, Yinglak, gained power through winning an election

in 2011, but her power was almost overthrown due to a massive flood that hit Thailand in 2011

that almost completely inundated Bangkok. The World Bank estimated that the economic

damage caused by the flood was 1,425 billion baht. (CIA World Fact book) Throughout 2012,

the Puea Thai-led government has attempted to create government reform as well as political

reconciliation, but it faced a large amount of opposition from Thailand’s Democratic party.

Many have been killed in the violence associated with ethno-nationalist insurgency in Thailand.

The country has been speculated to potentially have another crisis, which could be caused similar

factors of the 1997 one. In order to stop that, Thailand needs to pay attention to a plethora of key

economic policies, since ignorance of them led to the sad story of poor policy decisions leading

to economic collapse.

II. The Buildup To Poor Decisions Due to Export-Oriented Growth And Surging FDI

As stated, one of the main drivers of this financial crisis was the sudden extreme

devaluation of Thailand’s currency, the baht. In the early 1990’s, the baht had a pegged

exchange rate against the U.S. dollar of about 25 baht per dollar. (Worldbank) However, there

was a difference in the two countries in terms of interest rates. The real interest rate in Thailand

was 9.2% in Thailand, where in the United States the real interest rate was 6.4%. (Worldbank)

Thus, many banks that were based in Thailand started borrowing from the US in terms of dollars,

converting the dollars into Baht, and then lending the baht for the higher interest rate. There is

an obvious arbitrage opportunity, as the spread among the interest rates is 2.8 percentage points.

People started noticing Thailand originally because economic performance in Thailand

was stellar from the 1980s into the early 1990s. From 1986 to 1988 real GDP growth per year

rose from 5.5 percent to 13.3 percent. (WorldBank) The main driver of such great GDP growth

was Thailand’s shift from import substitution to export oriented industrialization. Originally

Thailand and other nations in the area were called “Newly Industrialized Economies,” because

they had recently broken from military rule and were working their way to becoming developed

nations. Initially, during a period from the 1960’s to the mid 1970’s, Thailand and other

economies took a policy of import substitution, where an emphasis was put on consuming

domestic goods and services over imports to increase aggregate demand and stimulate growth of

national income. (Siriprachai 2) However, during the 1980s Thailand switched to Export oriented

industrialization in order to achieve more rapid economic growth. This resulted in the previously

stated GDP increase and an ensuing investment boom.

Thailand GDP Growth 1980-1990 (Source: Worldbank)

Thailand’s economy attracted a large degree of foreign direct investment at this time. The

government was loosening its policies on international trade left and right. There were decreased

tariffs, liberalized trade policies, and investment promotions. (Jiranyakul) This influx of

economic prosperity led to an increase in confidence in the investment sector, as new projects on

infrastructure increased dramatically in the 1980s until the 1990s. Thailand’s increase in

infrastructure was attributed to large foreign direct investments from foreign nations such as

Japan, the United States, the United Kingdom, and Singapore. Thailand was seen as the perfect

place to put FDI for countries with strong currencies such as Japan, where in Thailand labor was

cheap and natural resources were plentiful.

Exports to the three countries that were Thailand’s major trading partners (United States,

Japan, Singapore) accounted for 47.22% of exports in 1990 and 48.65% of exports in 1995

(Jiranyakul) Imports from the three partners accounted for about 49 percent of all imports in

1995. Most of the FDI was going towards non-tradable projects however, which put upward

pressures on the price level. During the late 1980’s, the percentage of Thailand’s GDP that was

exports consistently increased through the mid 1990’s. In 1983 exports made up 20% of

Thailand’s GDP, where in 1988 it made up 33% of Thailand’s GDP. (Worldbank)

Thailand also imported heavily from other countries. By 1989, Imports accounted for

35% of Thailand’s GDP. (WorldBank). These imports consisted mainly raw materials,

(including petroleum) capital goods, and chemical goods. As imports were greatly increasing

compared to exports, Thailand was becoming increasingly import dependent and was suffering

from current account deficits.

With increasing net exports, as seen by Thailand, income also increased. This increase in

demand would apply to both traded and non-traded goods and services. Tariff reductions

liberalized the importing of goods, which helped to mitigate some of the aggregate demand

increase that was attempting to push up domestic prices. If prices became to high, exports would

start to suffer, which would take a huge toll on Thailand’s export-oriented economy. This trend

continued throughout the 90’s, which caused the current account balance to decrease steadily.

The appreciation was real, as the central bank had the baht pegged to the dollar at an of

25$/Baht, but the real exchange rate ties in the price level in the country compared to price levels

of other countries, so exports would still suffer.

With the increasing price level, it was key to keep inflation down or GDP growth would

take a massive blow. The central bank, for the most part, did a fairly good job of managing

inflation. The inflation rate throughout 1990-1996 was consistent at about 5.1% on average.

Thailand also had an impressive savings rate situated at around 33.5% of its GDP. (Worldbank)

However, this was due to a lot of spending of foreign reserves, which came back to haunt

Thailand later on.

III. Here Comes the (Investment) BOOM

During the early 80’s the borrowing that accounted for the increase of net capital inflows

was equally distributed between the public and private sectors. (Jansen) Capital inflows for the

country also exceeded its current account, implying that Thailand was increasing its federal

reserves. A likely move, as an increase in the amount of debt incurred would require the central

bank to have backup ammunition against having to default on their debts that are owed to foreign

monies. The central bank was building up foreign reserves when times were good, because the

central bank printing money and buying foreign currency would not have terrible effects since

the economy was in an expansion. The government feared exchange rate devaluation, so while

the economy was doing well in the early 1990s, the central bank of Thailand could easily print its

own currency and sell it for currencies abroad and keep those for a later sale if people started to

think the baht was going down.

Later, in the period of 1987 to 1992, most of the borrowing was towards the non-

financial sector. Thus, most of the money went into industries that were booming at the time,

such as foreign companies that had been setup by foreign prospering nations such as Japan.

Thailand started relying heavily on cheap Japanese imports for machinery during this period.

However, during the period from 1992-1997, the focus of capital inflows was focused on

the financial sector of the economy. This change was partially due to changes in the government

policies at the time. Originally, Thailand was maintaining an interest rate ceiling at around 5%.

Then, once policies of the government changed, the interest rate was able to move freely and

then started to increase to around 8 or 9 percent. This attracted a new business sector of financial

institutions that started accounting for a great amount of foreign debt. Monetary policy of

Thailand also made this easy because the Bangkok international Banking facility (BIBF) was

established. The idea behind this policy was that most of the transactions would be “out-out,”

meaning countries would borrow abroad and then lend abroad. Unfortunately for Thailand, the

transactions were “out in” and as mentioned before, people were borrowing abroad and then

lending in Thailand, where interest rates were high. This meant there would be a significant

amount of risk for Thailand if interest rates abroad started to rally.

If, for instance, the interest rates in the United States start to increase, investors will see

that there is a better opportunity to earn money back in the United States than there is in

Thailand. Thus, investors will withdraw a large amount of deposits from the banks in Thailand

and start investing them in American assets or other assets abroad. The withdrawal of funds

from banks in Thailand are running out of reserves because most of their funds had been lent out,

which leads of to an inability of banks to provide liquidity. Thus, unless the central bank or some

other institution could bail out the banks, bankruptcy ensues.

Most of the major firms were highly leveraged as well, causing an even greater risk of

having large amounts of debt. The leverage ratio of Thai corporations increased from 1.6% in

1988 to 2.4% in 1996. (Worldbank) According to Karel Jensen, high amounts of leverage will

equate to large swings in exchange rates and or interest rates (Jensen 131) When Thailand policy

makers started to realize this situation, it started reverting to capital controls. There were large

attempts in 1995 to keep foreign exchange flow interaction down. The minimum amount on

foreign borrowing for the BIBF was raised to 2 million US dollars. A withholding tax was

introduced on interest payments on foreign loans in addition. Finally, banks and finance

companies had to make interest-free deposits at the central bank equivalent to 7 percent of short-

term non-resident deposits and of short-term foreign borrowing. (Jansen 131-132)

The Thai government did do a good job when it came to saving. Looking at the data,

fiscal spending policy was pretty stable during the early 80s up until the late 1990s. Around

1985, the government shifted to a more effective control of the budget, imposing strict

expenditure ceilings and lowering the ceiling on public sector borrowing. (Jansen 129) The

government expenditure fell from 19 percent in 1985 to 14 percent in 1989-1990. (Jansen 129)

One cause of the decrease was the massive growth in GDP that occurred, but government cuts

played a role as well. Government expenditure was stagnant from 1985 to 1999. Having a

budget surplus in the context of Thailand was beneficial because it would help keep price level

down as well as pay back loans. With the increasing domestic demand, price levels were bound

to go up, so it was good that the government didn’t worsen the price level in Thailand by

increasing the price level through spending on goods and services.

However, investment booms basically cancelled out the budget-surplus benefit, so this

was still a crucial time for the central bank of Thailand to take action. The central bank focused

on keeping the inflation rate stable, in hopes that this would balance the exchange rate

difference, which relates to purchasing power parity. Purchasing power parity suggests that one

could take any currency, trade it for another currency on the exchange rate market and then buy

the same basket of goods in the country of the foreign currency as a basket of those goods in the

original country. The inflation rate throughout 1990-1996 was consistent at about 5.1% on

average. However, the exchange rate was pegged and interest rates were high, which led to some

of the arbitrage opportunities that triggered the investment boom. At first, monetary policy was

mainly controlled through the direct change of money aggregates. However, there was a shift in

monetary control to interest rates once the financial sector started having a more prominent role

in Thailand’s economy, contributing to the arbitrage opportunities.

Even though a common function of Central banks is to be a lender of last resort, financial

institutions had become less and less dependent on Thailand’s central bank for credit. Central

bank credit stood at 54 percent of the monetary base and 5.1 percent of the broad monetary

aggregate at the end of 1998. (Jansen130) By 1996, these respective ratios had fallen to 20% and

1.8%. Most of the financial institutions leverage came from abroad as well. The net foreign

liabilities of commercial banks and finance companies, as a percentage of M3, increased from

less than 5 per cent in 1986–90 to 19 per cent in 1994 and 25 per cent in 1995/6. (Jansen 130).

Fiscal surplus also implied that the government was running out of bills that could be

sold. With a large current account deficit, debt was already held a fair amount by foreign

investors. To solve this problem, the central bank started printing some of its own bonds in

certain years between the late 80s and the early to mid-90’s, in attempt to reduce some of the

high liquidity that resulted from the swarm of net capital inflows. However, most of this attempt

of monetary policy contraction didn’t do much, as the central bank issued 33 million baht in

bonds, which was only a small fraction of the foreign borrowing by financial institutions. (Jansen

131)

IV. A Bad Combo Of Financial Malice and Poor Monetary Policy

Another setback that caused Thailand to exacerbate their dilemma was how poorly their

financial institutions were run. Most of the banks and financial institutions gave loans that did

not take into consideration the ability of borrowers to pay back loans, rather the criteria was

based on relationships held with the banks. A paper written by members of the Institute of

Economic Research at Hitotsubashi University said, “Some of the connected families are

connected to the owners of banks by marriage. For example, members of the Sophonpanich

family, which has been the largest shareholder of the largest bank in Thailand, the Bangkok

Bank, married to the Leesawattrakun and Srifuangfung families. The Lamsam family, which has

been the largest shareholder of the Thai Farmer Bank, the third largest bank as of the end of

1996, is also tied to the Wang Lee, the Yip In Tsoi, and the Chutrakul by marriage for more than

one generation.” (Chutatong Charumilind Raja Kali Yupana Wiwattanakantang 12-13) In

addition, scholars have found empirical evidence that companies with high degrees of

shareholdings are the ones who banks dealt with the most directly, “We define firms as

connected to these connected families if any of these families own at least a 10% stake in the

firms. Our results show that 22.22%, 26.30%, and 32.96% of firms in our sample are affiliated to

the top 20, 30, and 60 connected families. About 11.48% of the samples are those in which the

controlling shareholders are the major shareholders of banks and finance companies.”(13) It was

also extremely difficult for non-connected banks to get loans because they were charged interest

rates that were very high and unrealistic, “The banks stick to cartel practices, segmenting the

market between prime customers, who have to be given rates that are comparable to those on

international markets, and other customers who are charged much higher rates.” (Jansen 135)

Scholars have dubbed this practice of lending to close relatives as “cronyism” because the

process of lending is not based on merit. Often times, these bad loans had huge negative

consequences, sometimes leading the banks to foreclosure. For instance, the Bangkok bank of

commerce allegedly granted a very large amount of loans to firms that were affiliated to Rajan

Pillai, Rages Sakdina, Adnan Khashoggi and Suchat Thanchareon, who were close friends of the

bank’s president and major shareholder, Krirk-kiat Jalichandra. (Crony Lending 10)

The Central bank did not do a good job of preventing financial institutions from making

bad loans either. The Bank of Thailand punished neither financial institutions responsible nor

major executives for lending to risky projects that led to ill-performing loans. The BOT also

failed to recognize that problems with loans given after 1991 were serious and needed to be dealt

with urgently. (Crony Lending) To the central bank’s defense, there were plans for foreign

banks to come into Thailand in order to increase competition, but the plans were slow to

materialize and did not come in time to mitigate some of the downsides of the crony lending

done by Thai banks.

Some of the bad lending by banks and financial institutions went to assets that were

greatly overvalued as well. For instance, many loans went into backing up real estate. However,

Thailand had become less competitive in terms of exports starting around the mid 1990s.

Countries like China had increased their exports they sold which became too much competition

for Thailand to stand up against. In addition, semiconductor demand had gone down in the

world overall, which hurt Thailand because semiconductors were one of Thailand’s major

exports. Thus, around 1995, Thailand’s economic growth was becoming slow. The large amount

of buildings and residential housing that were built became less desired, so vacancy in Thailand

started increasing. Thus, many business owners were unable to pay back loans they received

from financial institutions. The dollar did not help matters either, as an increasing amount of

individuals saw the dollar as the currency to be held rather than the baht, which put even more

pressure on the central bank of Thailand to keep the baht from devaluing.

The Central Bank was trying as hard as it could to keep the exchange rate pegged. As

stated before, there was a massive building up of foreign reserves, which was held in order to

protect the baht from falling in value. It then sold these reserves in order to keep the baht stable

once financial liberalization kicked in. It was only a matter of time until the rest of the world

evaluated how unstable Thailand’s financial system and economic policies were. The financial

system failure would have deadly consequences as well, as financial institutions made up a

significant portion of Thailand’s stock market. If stock markets plummeted, thousands of people

would have lost the dollars they had invested, resulting in an economy-wide slump.

Thailand Total Reserves as a Percentage of Total Debt (Source: Worldbank)

V. STOP!.... Crisis Time

In late 1996, the baht finally began to come to its knees. The bad loans that were made by

Thai banks started coming to light, which caused people to believe that the banking system in

Thailand was going to fail. Because of all the uncertainty, people in Thailand started to believe

the baht would eventually fail. The central bank of Thailand attempted to keep the value of the

baht from decreasing by selling its foreign reserves, which would increase the supply of foreign

reserves held by the public, thus decreasing some of the need for people to trade in baht for

foreign currencies. From 1994-1996 reserves as a percentage of total foreign debt for Thailand

dropped from 46% to 34%. (Worldbank). Thus, people tried to speed up the process of baht

failure by borrowing in baht, then exchanging that for foreign currencies. Then, once the baht

lost its value, people could convert the foreign currencies they had back into baht and pay back

their loans, which have now become cheaper to pay off because of the decreasing value of the

baht. Another type of arbitrage opportunity had presented itself.

When Thai banks and financial institutions started to fail, the Thai government could not

keep its bailout promises, which many of the banks and financial institutions had been counting

on for compensation on the bad loans they made. However, because they had used so much

money to purchase foreign reserves, they could not give the banks additional funds in fear it

would trigger capital outflows. In addition, the central bank also said that it would attempt to

save “Finance One,” Thailand’s largest financial institution, by organizing a merger with another

financial institution, similar to JP Morgan purchasing Bear Stearns during the financial crisis of

2008. The central bank also failed to live up to this proposition. The bank was already

struggling defending the baht to such a great degree that when these financial institutions failed,

the central bank could do almost nothing to help them.

Finally, when practically all of its reserves had been used to defend the Baht, the central

bank switched from a fixed exchange rate to a floating exchange rate in July of 1997. As soon as

the announcement was released, the value of the baht dropped from 25 baht per dollar to 28 baht

per dollar. By December of that year, the value of the Baht had plummeted to 48 baht per dollar,

which means the baht became worth half of what it used to be worth. When the baht lost so

much of its value, all the people who had been borrowing in foreign currencies and lending in

baht would have a much more difficult time paying back the loans that they took out in the

foreign currencies. The arbitrage opportunities were eradicated with the baht floating and

devaluing massively. Banks that had borrowed heavily in foreign currencies now would have an

even tougher time paying back the loans they had already taken out, because now they would

have to have double the money they had before just to pay back the principals on their loans.

Some of the more connected banks were able to avoid the serious bullet of defaulting on

loans because they had an easier time getting long term loans instead of short-term ones. These

banks, instead of having to pay back principles on their loans, would only have to pay the

interest rate disadvantage. For instance, if the interest rate gap was still in effect, and a bank had

borrowed 1 million in a long term loan and then loaned it in the baht, they were making out well

at first because the interest rates in Thailand were higher than other countries. Now, with the

baht devaluing, the interest these banks would earn in Thailand would give them half the money

they were getting before, so the interest payments became a lot more expensive. The money they

needed to take out of their own pockets was feasible, however, where the short term loans had

much greater consequences because the principles of the loans were ridiculously high, which

most banks were unable to pay.

With such a great devaluation of the baht, it would mean that imports would start

becoming much more expensive. Since Thailand was already suffering from a huge current

account deficit, a devalued baht would be extremely bad news for the economy as a whole.

People’s average costs of goods would skyrocket and some people may have had trouble getting

their daily needs.

The uncertainty that was created throughout this failing of banks and financial institutions

and devaluing of the baht should also be mentioned. The stock market inevitably crashed thanks

to so many failing businesses. From mid 1995 to mid 1998, the stock market went from a market

value of 1400 index points to almost zero. (SET trading economics) With the stock market

crashing, businesses failing left and right and a huge devaluation kicking in, Thailand was at its

lowest low.

VI. IMF, IMF, IMF to the Rescue!

Thailand asked many institutions to aid them on their defaulted loans and lost funds due

to the financial crisis. Some declined, but Thailand ended up receiving funds from the

International Monetary Fund of 35 billion dollars for reform and adjustment to the Thai financial

system. (IMF) 85 billion dollars was also given through multilateral and bilateral resources, but

those funds were not successfully used. (IMF) The IMF also helped restructure the poor actions

taken by various firms in the financial and non-financial sectors in order to prevent ill projects

from being taken on like during the buildup to the catastrophe of 1997. All weak financial

institutions were closed in order to stop further losses, central bank supervision of financial

institutions was closed, and regulation required for financial intermediaries was tightened. (IMF)

At first, some of the policies initiated by the international monetary fund weren’t as

successful as they had hoped. First, the Thai population still questioned the effectiveness of

policy implementation due to premature rollbacks of monetary tightening and political

uncertainties. Also, information was revealed in regard to the standings of official exchange

reserves of the bank of Thailand further increased uncertainty. Thus, exchange rate

depreciations and capital outflows did not decrease as much as was hoped at first. (IMF)

Since the exchange rate increased to such a high extent and efforts were slow to

materialize, Thailand went into a much deeper recession than expected. During 1997 when the

crisis started, annual GDP growth decreased to -1%, and in 1998 it decreased further to -11%.

(Worldbank) Monetary policy was tight, which included the pushing up of interest rates, which

would increase the demand for the local currency. With a higher interest rate, people would

make more profit by investing in Thai baht, which would cause some capital inflow after the

massive amount of capital outflow resulting from the crisis. The crushing amount of short-term

debt had to be paid as well, which stood at about 36.5 billion US dollars and Thailand only had

2.9 billion of net official reserves (Sussangkarn).

Thailand’s situation seemed to be ameliorating to some extent once 1999 came around.

By the end of March 1999, foreign reserves had increased to about 14 billion, which is a ratio of

slightly less than .5 when compared to Thailand’s short-term debt. (Sussangkarn). The

government was hesitant to use foreign funds even though interest rates were back to pre-crisis

levels between 2000 and 2002. The global economy was also suffering from a slump during this

period, which caused Thailand’s exports to suffer and GDP to not grow as rapidly as hoped.

Bank policies were getting back on the right track, which initiated a boost in economic

growth. One bank, called Krung Thai, was government owned, which was successful in the post

crisis period because of an inundation of funding from the Thai government’s proceeds, thanks

to the IMF. Government owned asset management companies were able to eat up most of the

loans given out by commercial banks that could not be paid back, dubbed non-performing loans

(NPL’s). (FRBSF) With this boost of the company’s balance sheet, the company had an

advantage on other private owned banks and commercial banks. The government stressed banks

like Krung Thai to lend to individuals with credit problems that could not borrow from other

banks, which led to Krung Thai controlling 20% of Thailand’s commercial banking sector.

(FRBSF) The increasing amount of domestic credit worked successfully for the betterment of

Thailand’s business cycle, as Thai growth grew by 5.4% in 2002 and by 6.7% in 2003, and

consumption grew by 4.9% and 6.2% respectively. (FRBSF). The current account turned to a

surplus that allowed Thailand to pay off its debt to the IMF early. The Baht had slowly begun to

rise up again in the early mid 2000’s, which caused Thailand to make more off of its exports and

afford its imports. Since Thai growth was centered around domestic credit this time around,

there was no risk of the rapid depreciation of the baht through extreme amounts of net capital

outflow.

There were perceived risks that increasing credit rapidly even domestically could cause

Thailand to fall into the same set of ill circumstances that came about in 1997. Part of this was

due to the credit boom of the mid 2000’s. Policy makers and researchers feared that a high

amount of increased credit would cause a growth bubble similar to those that have occurred in

areas like real estate. The IMF had done studies showing people see the perceived growth thanks

to domestic credit expansion, but once some of the loans prove to be unsuccessful, the highly

leveraged banks that are common in emerging economies fail, causing an economy wide slump

just like the one that had previously occurred in Thailand. IMF reporting stated that private credit

booms in emerging markets are associated with a 70% probability of consumption and

investment booms, followed by banking crises with a 75% probability, and currency crises with

an 80% probability. (FSBSF) However, total growth income levels did not return to their pre-

crisis amounts until six years after the crisis. (Allen Hicken)

What was done during the crisis had a deep impact on Thailand’s political system and for

the general well-being of the Thai people. Thailand’s politics were completely revolutionized.

Pre-crisis, Thailand’s business elite were behind the scenes on the set of Thailand’s politics.

This played into Thailand’s connected lending problems that resulted in the plethora of NPL’s,

which led to the failure of banks and financial institutions. Thailand’s political scene also

consisted of a wide range of parties that did not have sufficient policies and were short-lived.

This brought Thai politicians to take on roles where government positions were predatory rather

than beneficial to the Thai economy. The policies of many political parties were mainly based

on gaining support for a narrow group of politicians to gain a candidate specific network of

support. Thus, most politicians did not take on policies aimed at providing public goods.

(Hicken).

VII. Conclusion

Overall, Thailand suffered from an attack from the economic triangle of fixed exchange

rates, free flowing capital, and independent monetary policy. The main lesson observed through

academics is that if a country has two of these policies instated, it is impossible to stably keep the

third. Thailand’s train of thought as to stabilizing its exchange rate was that if purchasing power

parity holds, then keeping the inflation rate low would cause the exchange rate to be relatively

stable. However, due to monopolistic tendencies of some firms, barriers to trade, and differing of

the real quality of goods across different countries all combat purchasing power parity’s validity.

In the long term it works empirically, but not in the short term, so there was no way keeping

inflation under control could maintain the fixed exchange rate. Essentially, Thailand tried to

allow free capital flows while keeping the exchange rate pegged, yet it also allowed interest rates

to become extremely high causing an inundation of foreign demand for the baht in terms of

lending. Thailand should have let the baht float early in order to balance some of the decrease in

demand for baht. This would have caused financial institutions to be able to pay their debt more

efficiently. Alternatively, it could have done a better job with managing interest rates. Since the

purchasing power parity doesn’t hold in the short run, the high interest rates to combat inflation

did not work; it just caused people to pursue hot money, which led to the huge increase in capital

inflows. Fearing the flows would reverse, the central bank kept their interest rates high, since

they feared investors would leave if they did not. Finally, if they really wanted to keep their

exchange rates pegged and their interest rates high, there was no way they should have allowed

that much foreign capital to come into their country because it would lead to financial crisis like

the one that occurred. Poor monetary and fiscal policy led to an obvious arbitrage gift, which

caused Thailand to be economically exploited by the whole world.

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