Tuesday, August 18, 2009

The Thai Economy

In the three decades leading up to the Southeast Asian financial crisis, which began in 1997, the economies of Southeast Asia, including Thailand, were growing at impressive rates. In Malaysia, Indonesia, and Thailand, average income more than quadrupled between 1965 and 1995, and in Korea, income rose seven-fold. Furthermore, incomes in these four countries climbed from 10 percent of the US average in 1965 to around 27 percent today.

One argument attributes the success of the East Asian countries from 1965 to 1995 to their outward oriented industrialization strategy. Specifically, “countries in South East Asia attracted export oriented foreign investment by integrating national production with international production, not merely through export orientation, but through specific institutions such as technology licensing, original equipment manufacturing, and export processing.” This strategy facilitated the development of complex production processes and greater integration with world markets, but it also necessitated financial reform to meet the demand for a greater range of sophisticated and well-regulated financial services.

In part, the root causes of the financial crisis can be traced back to Southeast Asian countries attempting to liberate financial markets to support more capital intensive production methods and attract foreign investment. For example, in an attempt to compete with Singapore and Hong Kong as a regional financial center, Thailand introduced the Bangkok International Banking Facility (BIBF) in 1992. The BIBF facilitated rapid growth in the number of financial institutions that could borrow and lend in foreign currencies, both on and offshore. This resulted in growing short-term foreign debt, rapidly expanding bank credit, and inadequate regulation and supervision of financial institutions, leaving the Thai economy vulnerable to a rapid reversal of capital flows.

After 1994 the ratio of short-term debt to foreign exchange reserves exceeded one, and by 1996 banking claims on the private sector reached 140 percent of GDP. Due to the significant influx of capital into the Thai economy in the early and mid 1990s, exchange rates began to appreciate in real terms as capital inflows put upward pressure on nontradeable prices. In late 1996 the fragile state of Thailand’s financial institutions was highlighted as investors began to speculate about the value of the baht. In spite of government attempts to inject confidence into the market, by late June, Thailand had sharply reduced its liquid foreign exchange reserves, and the baht was allowed to float on July 2, 1997.

As a result, foreign creditors withdrew their capital and the value of the Baht fell by more than 20 percent. The deteriorating state of financial institutions and creditor withdrawals in Thailand set off a chain reaction in other Southeast Asian countries as speculation with regards to the region as a whole heightened. From 1998-2001, however, the five countries impacted the worst by the crisis (Thailand, the Philippines, Indonesia, Malaysia, and South Korea) achieved an account surplus.

From 2002-2004 Thailand’s economy averaged more than 6 percent real GDP growth; however it has since slowed, averaging 4.9 percent from 2005-2007 and 3.6 percent in 2008. The slowdown was attributed to uncertainty stemming from political conflict; however, the 2008 global financial crisis has worsened the economic downturn.

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