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    Case - 1

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    Alan Sam
    The causes of Thailand's financial crisis in 1997 were a series of events that led to large current account deficits, high foreign borrowing, and overvaluation of the Thai baht currency pegged to the U.S. dollar. This resulted in Thailand's foreign exchange reserves dropping to alarming levels and investors starting to pull funds out. The best solution was for Thailand to let the baht float within a broader band, allowing a controlled devaluation to reduce the current account deficit while preventing a level of devaluation that would make imports too costly. An immediate free float risked a bank run due to short term borrowing becoming more expensive.

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    Case - 1

    Uploaded by

    Alan Sam
    42 views2 pages
    The causes of Thailand's financial crisis in 1997 were a series of events that led to large current account deficits, high foreign borrowing, and overvaluation of the Thai baht currency pegged to the U.S. dollar. This resulted in Thailand's foreign exchange reserves dropping to alarming levels and investors starting to pull funds out. The best solution was for Thailand to let the baht float within a broader band, allowing a controlled devaluation to reduce the current account deficit while preventing a level of devaluation that would make imports too costly. An immediate free float risked a bank run due to short term borrowing becoming more expensive.

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    Bhat Crisis Case Analysis

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    The causes of Thailand's financial crisis in 1997 were a series of events that led to large current account deficits, high foreign borrowing, and overvaluation of the Thai baht currency pegged to the U.S. dollar. This resulted in Thailand's foreign exchange reserves dropping to alarming levels and investors starting to pull funds out. The best solution was for Thailand to let the baht float within a broader band, allowing a controlled devaluation to reduce the current account deficit while preventing a level of devaluation that would make imports too costly. An immediate free float risked a bank run due to short term borrowing becoming more expensive.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    42 views2 pages

    Case - 1

    Uploaded by

    Alan Sam
    The causes of Thailand's financial crisis in 1997 were a series of events that led to large current account deficits, high foreign borrowing, and overvaluation of the Thai baht currency pegged to the U.S. dollar. This resulted in Thailand's foreign exchange reserves dropping to alarming levels and investors starting to pull funds out. The best solution was for Thailand to let the baht float within a broader band, allowing a controlled devaluation to reduce the current account deficit while preventing a level of devaluation that would make imports too costly. An immediate free float risked a bank run due to short term borrowing becoming more expensive.

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    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
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    Case Analysis of Thailand in May and June of 1997

    The Causes

    What happened in Thailand was a consequence of series of events, actions by the


    Thailand Government. The process started in the 1990s when foreign investors,
    particularly from the U.S started to venture into lucrative Asian Markets such as Thailand.
    The local currency, Baht pegged to the US dollar was highly overvalued then. This led to
    high current account deficits (CAD) as high as -7.7% of GDP in 1991(Exhibit 7). If the
    currency had been allowed to float freely, the current account deficit imbalances will have
    been balanced by the floating currency rates. However, this was not the case, as Bank of
    Thailand (BOT) had to continually buy foreign reserves to keep the Baht pegged at a fixed
    rate to the US Dollar.

    The high CAD was primarily was financed with short term borrowings .The BOT gave a
    free hand to financial intermediaries in Thailand to borrow foreign currency at lower rates
    and lend to native customers at high rates. As the Bhat was pegged to USD, there was
    not much risk. However, the foreign inflows into Thailand were primarily used in non-
    productive investments such as real estate .Real estate cannot be traded and hence
    would not contribute to reduce the CAD. This also led to situation where prices of assets
    such as land rose largely. In order to absorb the excess amount of Baht in the market,
    BOT had to buy Baht by selling their foreign reserves. The foreign exchange reserves
    gradually reduced to alarming levels in 1997 to be able to fix the Baht. Moreover, by 1997,
    investors started pulling out their funds out of Thailand further depleting foreign reserves.
    In the end, BOT had no option but to devalue the currency.

    The Solution

    1. Defend it

    The BOT cannot afford to hold a fixed exchange regime due to the following reasons:

    Forex reserves have dwindled dangerously. Most of the available reserves


    would only be sufficient to meet forward contracts.
    Holding on to a fixed regime will further allow speculative attacks on the
    Baht

    2. Let it float within a broader band

    This seems the reasonable decision as it temporarily allows the currency to devalue
    according to market forces, but prevents it from devaluing to an extent that is detrimental
    to the countrys economy. The partial float will allow the Baht to reduce the disequilibrium
    in CAD. At the same time, it wouldnt allow the Baht to devalue to a level that makes it
    imports extremely costly.

    Baht will initially depreciate due to the high CAD. A large current account deficit should
    put downward pressure on Baht. If Thailand imports more than exports then this involves
    selling Bahts to buy foreign currency to be able to buy the imports. A depreciating Baht
    will make Thailand exports cheaper, imports more expensive and thus help to reduce
    CAD and reduce the disequilibrium.

    3. Devalue it at a lower pegged level

    This is not a feasible solution as it enhances the chances of further speculative attacks.
    Moreover, the short term borrowings of financial intermediaries will become costly and
    may lead to a bank run.

    4. Float it freely

    This is again not a feasible solution as the short term borrowings of financial
    intermediaries will become costly and may lead to a bank run.

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