What they don’t teach you at West Point-style military academies, part one: how to defend yourself from unwanted currency flows without leaving your capital markets vulnerable.
Thailand’s newly minted military government stumbled badly over its tactics this week – imposing capital controls then, 24 hours and the elimination of some $22bn of market value later, performing an about-face.
The controls, which effectively imposed a reserve requirement tax on foreign portfolio inflows, demonstrated a poor grasp of that favourite tenet of military strategy: know your enemy. Foreign investors have ploughed a net $2.4bn into Thailand so far this year. As such, they look rather more friendly than the evil speculators of sovereign folklore.
In the absence of conclusive data, one theory is that the real culprits behind the recent spike in the baht were Thai corporates. Thailand Inc typically has a relaxed attitude to hedging, relying instead on the Bank of Thailand to keep the currency in check through intervention. However, dollar-negative news and rallies in Asian markets may have prompted companies to pile in to hedge their currency positions, pushing the baht higher.
When the authorities launched their witch-hunt, local banks would have been quick to point the finger at the usual suspects – foreigners – rather than the local great and good.)
The subsequent reversal was clumsy and could prove costly, since funding costs will likely rise to reflect heightened political risk. It further dents credibility in a government which, in its short life, has made several rash moves.
Bigger concerns raised by the Thai move, however, relate to the rest of the region. The Asian financial crisis of 1997-8 began to unravel in Thailand with the devaluation of the baht, and wreaked havoc across the region: currencies toppled, huge companies went bust and governments were obliged to nationalise debt-saddled banks.
Nearly a decade later, the issue is the mirror-image of the 1997 problem: capital inflows are driving currencies higher. The Thai baht, up 17 per cent against the dollar this year prior to the short-lived controls, was worst hit, but others are also suffering. Indeed,
JPMorgan notes that on a trade-weighted inflation- adjusted basis, the Thai baht is closer to its 10-year average than its peers, with the Indonesian rupiah up
30 per cent and the Philippines peso 17 per cent to the Thai baht’s 10 per cent.
The economies share more than appreciating currencies. They also share a heavy reliance on exports and mercantilist mindset that makes currency strength a competitive handicap – especially when measured against China. As a result, Asian central banks have a penchant for intervening in the foreign exchange markets to curb financial strength.
Will these central bankers now ape the men in khaki and introduce capital controls? The early signs suggest not – Thailand’s neighbours were quick to reiterate their liberal credentials on Tuesday – the day Thai stocks fell 15 per cent – and portfolio inflows are less pronounced in other South East Asian countries. More pertinently, countries such as Indonesia and the Philippines rely on these inflows for funding.
Instead, the likelihood is that Asian central bankers will adopt more orthodox monetary policy. Several have leeway to cut rates further – declining energy prices have helped lower inflation, in turn leading to a rise in real interest rates. Then again, having room for manoeuvre on interest rates is no guarantee it will be used: in Thailand, a notoriously inefficient user of energy, lower oil prices have effectively hiked real interest rates by 2.2 per cent since the first quarter.
Nearly a decade on, history has been rewritten. Some arch-villains of 1997 have been rehabilitated.
Free market purists who criticised some set pieces of that time – Malaysia’s imposition of capital controls, say, or Hong Kong’s intervention in the stock market – have been forced to concede the success of those measures. There has been little long-term fall-out: the Hong Kong government staged an elegant and profitable exit and Malaysia has proceeded (slowly) to liberalise.
Mahathir Mohamad, Malaysian leader during the crisis, has also made peace with the man he blamed for the 1997-8 crisis: George Soros, the US financier or – as he was then dubbed by Dr Mahathir – “moron”.
This week the former Malaysian leader took that back, exonerating Mr Soros. Of course he did not go so far as to accept any home-grown blame. Some things in Asia never change.