Floating upstream, or over the cliff?

11 July 1997

Are you confused too? Where is the economy headed after the float? The projections now available are wildly different.

The messages coming out of the Bank of Thailand and the prime minister’s circle are generally positive. The float/depreciation has set us on the path to recovery. The baht will settle around 28 to the dollar. Inflation will notch up only a couple more percent. Japanese investment will soon be pouring into Thailand. Interest rates will fall before long. Exports will pick up through the rest of the year. Growth will be knocked back to 4+ percent this year, but the prospects for 1998 are bright. The stockmarket surge heralds the upswing of the cycle.

The messages coming from some local and overseas analysts are strikingly different. The baht depreciation will overshoot. The current-account deficit will get worse before it gets better (the J curve). Foreign capital will stay away because of uncertainty, or charge an extra interest premium to cover risk. Liquidity will get worse not better. Interest rates will soar. Inflation will move into double figures. The stockmarket will bellyflop within weeks or even days. Lots of companies will go bankrupt. The economy will shrink this year, and stagger through much of next. There could be a balance-of-payments crisis. We need the IMF. The float has not cured our problems. It has just taken us another step down the path to Mexico.

So which should we believe? The pessimists? The optimists? Neither? Or both?

Try "both".

The pessimists make a lot of sense. They have logic, data, models, and the history of Mexico on their side.

But the optimists have a point too. If we believe the future looks black, then we will make that belief come true.

What the optimists understand is that we are in the realm not of economics, but of psychology. And in a very special branch of psychology: the mentality of investment. All investments are bets on the future. Informed bets, for sure. But there is always an element of uncertainty. At fragile times like now, that element is very large. If everyone thinks the future will be bad, then nobody invests and the future certainly will be bad. But also vice versa.

The difference between the pessimists and optimists boils down to one thing: whether the investment flows out or flows in.

If the pessimist message gains general acceptance, then it becomes a self-fulfilling philosophy. Those who are broadcasting the message now will be able to pat themselves on the back for having such accurate foresight.

But the optimist strategy is tricky. Just saying that "everything is alright" does not ensure that everything will be alright. The central bank has been saying this for the past two years, and producing the figures projected to match. The bank must forgive us if we no longer believe them. The prime minister keeps saying "the worst is now over", and we keep going down.

This kind of boosterism is not the way to build confidence. Rather, it is the way to reduce it. Repeating that "everything is alright" sends exactly the wrong messages. It communicates to the investors, both local and foreign, that the team now in charge of the economy hasn’t the faintest idea what is going on. If the team thinks the float has fixed the problem, and that nothing else needs to be done, then Thailand is in real trouble.

Rather than repeating "the worst is now over", the premier should be saying: "the worst is yet to come. And this is what we are going to do about it."

Depreciating the currency is a very dangerous manoeuvre. The only chance of building confidence is by following up the float with the right sort of measures.

Float or no float, we still have to pay the bill for the splurge of the past few years. Too many foreigners turned up offering to lend us money. We took it and spent it. Too much went on wine and Mercedes. Too much went into not-very-productive investments. We got used to living beyond our means. We ran up a big debt. Now the foreigners are saying: we won’t go on supporting you in this indulgent lifestyle. In fact, we want the money back.

The depreciation buys us a little bit of time. But it doesn’t cancel the debt. In fact, it makes the debt bigger. And it makes the creditors a lot more jumpy, a lot more inclined to say: pay me back right now.

In the long run, we have to do two things to make them feel more secure. First, export more so we can pay off the debt. Second, save more so we are not as reliant on the foreign money inflows. If we take actions now which convince the foreign investors that we will save more and export more, then they may give us a hand. If not, they may pull the rug out.

After the last (1984) devaluation, the government did a lot to get exports moving. It rewrote the investment incentives to promote labour-intensive industries, cleared away some of the red tape, and beefed up trade diplomacy. We need to do much the same thing. Our export potential has changed, but the incentives have remained the same. We need a new set which are more appropriate to the electronic, automotive and other medium-tech industries which offer the best potential for growth. We need to take the axe again to the red tape and the corruption in the export process. And follow up on other measures, like the VAT refunds, aired at the Pattaya export summit.

Savings are more difficult. Household savings have slumped. In the past, rural households were much better at saving than city households. Over the past decade, we have converted villagers into cityfolk, and skewed the income distribution against the rural poor. As a result, rural savings are now a much smaller proportion of GDP. On top of that, city people have been saving less and less. As their incomes went up, and tariff reductions brought real prices down, they tended to spend as much as possible on all the new goodies available to them.

Reversing these trends is not going to be easy. Any measures to improve distribution, to get more money into the pockets of villagers, is going to help the savings level. It will be slow. But it still needs to be done.

For the city folk, falling incomes may reduce the urge to splurge. But there is no reason why this should happen automatically. It needs some incentivisation, and some leadership. Quickly. That probably needs a mix of some punitive taxes, and some publicity exercises. During bad times in the past, government banned neon signs. It probably didn’t save much. But it passed a message to people that this was a time for some austerity.

It’s going to be hard for Chavalit to spearhead a campaign of austerity. He just doesn’t fit the part. He lives in a palatial house. He likes to live well. But he needs to try.

More savings and more exports. We are not going to achieve these two things quickly. But the government has to convince the money markets that it understand these are the tasks, and is really acting on them. This will decide whether the investment flows in or flows out. And that will decide whether the float carries us upstream to calmer waters, or straight over the cliff.