Misarrage of Thai Currency
The paper analyzes the Asian financial crisis of 1997-98, in particular focusing on the mismanagement of Thailand’s exchange rate policy and the resulting misalignments of the national exchange rates, evaluating their impact on the economy. Specifically, the paper investigates the impact on Thailand’s trade with its two largest partners, the United States and Japan.
The study has identified the same misalignment between the REEP (real effective equilibrium exchange rate) and bilateral exchange rates against the dollar. The coverage of the yen allowed authors to dig deeper into misalignment patterns for the baht since they also bring the situation with the trade balance with Japan into the picture. They analyze possible causes of the imbalance in the external trade and the consistent deficit of six to eight percent in the years preceding the crisis.
The analysis of pre-crisis capital inflows demonstrates a sustained positive inflow of capital into Thailand. The inflows that created a large amount of debt were stimulated by positive premium offered by the Thai government and stable exchange rates. The adoption of the US dollar as a peg and subsequent decrease in the value of the dollar led to a significant appreciation of these currencies against the yen, followed by abrupt depreciation against the yen when the US exchange rate against the yen changed. The weak trade balance has often been noted as one of the main reasons for the imbalance of the financial system and subsequent collapse of the currency.
However, the authors note, there is no need to assume that a depreciation in the REER necessarily reflects misalignment since it can be caused by a number of factors such as change in equilibrium patterns in trade flows. The authors therefore apply the NATREX model to assess whether there really was a misalignment in currency exchange rates over time. They believe that misalignment is “diagnosed” when there is a discrepancy between the observed real equilibrium exchange rate and the natural real equilibrium exchange rate. The model finds the greatest misalignment in the exchange rate of the RERJP.
The misalignment of the baht had impact on bilateral trade relations, increasing the trade deficit with Japan and leading to a persistent surplus in trade with the US. In addition, the nation experienced a decline in the US share in Thailand’s trade and decrease in Japan’s share in the 1990s. The authors evaluate the relative importance of trading partners through trade densities. They indicate that Japan was remarkably “over-represented” as a trading partner in the US’s trading and this was merely the result of the general balance in the trade of both nations, the US and Japan. The VAR-test analysis leads to the conclusion that over one-fifth of trade deficit with Japan can be explained by baht misalignment. This means that Baht misalignment has serious impact on the trade between the two nations and helped fuel the trade deficit with Japan.
Therefore, the most conspicuous misalignment is observed in the bilateral exchange rate with the Japanese yen. This contrasts with more modest misalignments in the real effective exchange rate and the bilateral rate with the US dollar. This misalignment significantly contributed to the trade deficit in Thailand’s trade that widened in the period from 1990 to 1996. This deficit mostly comes from the trade with Japan. Since the best possible exchange rate is the one that ensures minimum volatility, it is clear that the regime of currency control was not optimal.
Rajan, R.S., Sen, R., & Siregar, R.Y. (2004). Misalignment of the Baht and its Trade Balance Consequences for Thailand in the 1980s and 1990s. Blackwell Publishing, pp. 985-1012.