8.2 Two central policy issues, exchange rate and handling of problems at private financial institutions, deserve strong attention, since not only did they involve various parties and generate widespread repercussions, but they actually spurred up critical tension in financial markets and weakened investor confidence to a large degree.
8.3 In 1990 Thailand started recognizing Article VIII of the IMF, which led to three rounds of foreign exchange control liberalization (in May 1990, April 1991, and February 1994). Another pivotal episode was the establishment of the Bangkok International Banking Facilities (BIBF) in March 1993 to serve as groundwork for international banking services and mobilizing capital across border to support regional economic growth. The Bank of Thailand (BOT) quoted more competition and development of financial system as underlying rationale. An immediate question is whether the BOT was aware that once local exchange rate was not market-determined, opening up the country’s capital account would totally nullify effectiveness of monetary policies, and since capital inflows (outflows) induced by higher (lower) domestic interest rates would cancel the intended tightening (loosening) of domestic liquidity. Conceptually, the only discretionary instruments that remained effective were exchange rate and fiscal policy.
8.4 Three perplexing points about BOT’s actions are as follows. First, according to internal reports, before starting BIBF, BOT was well-aware that liberal capital transactions would limit the capability of monetary policy if exchange rates continued to be tightly pegged to the basket. Second, that basket-pegged exchange rate policy, which was initiated in 1984, was kept in use even after the capital account was liberalized and BIBF went into effect. Third, fiscal policy was largely neglected as a means to tone down looming inflation and current account deficits. Instead, the BOT resorted to higher interest rates so as to contain credit expansion and expenditures. Eventually, influx of capital inflows, induced by interest rate differentials and minimal exchange risks, instigated overheating of the economy.
8.5 Given that the authorities knew beforehand that liberalized capital account could negate monetary policy, their hesitation to float exchange rates must have been an outcome of conservatism and/or business plus political influences, particularly those heavily hinging upon external debts. One excuse for restricting exchange rate movement was to avoid bankruptcies of debtors and to uphold credibility of the nation. However, a vicious circle or greater difficulties occurred as rigid exchange rates further encouraged foreign borrowings or higher exchange rates further encouraged foreign borrowings or higher external indebtedness which magnified the risk of bankruptcies, lower credibility, and other financial disruptions if floating exchange rate regime was chosen. Therefore, several parties voted for postponing a flexible exchange rate system again. In short, these exchange rate predicaments of Thailand demonstrate two prominent lessons for developing countries. First, policy consistency should be continually adhered to. For example, should foreign exchange funds be allowed to move in and out of the country liberally, their prices or exchange rates ought to be determined by market force of given an equal degree of freedom. Second, once any policy change is deemed conceptually proper, it should be immediately implemented; delaying it for whatever reasons tends to complicate the matter.
