Globalization and Thailand's Financial Crisis
Leightner, Jonathan E., Journal of Economic Issues
The standard, generic explanations for Asia's financial crisis inadequately explain Thailand's current crisis. Corruption, cronyism, risk taking, and weak bankruptcy/foreclosure laws made Thailand's crisis deeper and longer, but they did not cause the crisis. These problems existed while Thailand's real gross domestic product (GDP) grew by 8-13 percent between 1987 and 1995, which was one of the fastest growth rates in the world. Thailand's current crisis began when the combination of Thailand's recent success, high domestic interest rates, and fixed exchange rate led to destabilizing inflows of short-term capital after Thailand liberalized its capital account and set up an international banking center in Bangkok. These short-term capital inflows helped Thailand's banks but hurt its finance and securities companies. When Thailand's finance and securities companies started to fail, international expectations plummeted, short-term capital inflows dried up, and Thailand was forced to float its currency.
Even while enjoying one of the fastest growing GDPs in the world, Thailand worried because its labor costs were rising relative to its neighbors. Thailand knew that its mentor, Japan, experienced a similar problem in the 1960s and lost its international competitiveness in labor-intensive industries. Worried that a similar fate awaited, Thailand decided to befriend its potential future competitors. In the early 1990s, the Thai government initiated major drives to encourage joint ventures between Thailand and its neighbors. Thailand wanted to become the mentor, or patron, of the other Indo-Chinese countries.
Along with other things, a good patron promotes the growth of its clients. Thus, Thailand created the Bangkok International Banking Facility (BIBF) with the intent that this facility would specialize in financing growth in Indo-China. However, Thailand had to liberalize its financial and capital markets first. Thailand progressively eliminated its interest rate ceilings between June 1989 and 1992. In 1990, Thailand liberalized all current account foreign exchange transactions, followed by a relaxing of capital account restrictions [Wibulswasdi 1995, 2-3]. The BIBF officially opened in early 1993. By December 1995, all 15 domestic banks and 30 foreign banks had acquired BIBF licenses.
Due to relatively high interest rates in Thailand, BIBF's activities led to greater inflows of short-term foreign capital than the Bank of Thailand (BOT) desired [Sirithaveeporn 1997]. The inflow of foreign funds caused the spread between maximum lending rates and deposit rates at commercial banks to decline from 7.25 percent in June 1992 to 4.1 percent in June 1995. This declining spread hurt Thailand's 91 finance/securities companies, which did not have direct access to foreign funds. In contrast, Thai banks could acquire foreign funds at an interest rate 4-5 percent lower than domestic funds, which caused the effective spread between commercial banks' lending rates and their cost of funds to increase from 2.87 percent in late 1989 to 3.22 percent in late 1995 [Wibulswasdi 1995]. BIBF helped banks but hurt finance/securities companies.
Even before the BIBF, the playing field was not level between banks and finance/securities companies. Thailand's 15 domestic banks had a total of 3,000 branches, but Thailand's 91 finance/securities companies were forbidden to open branches. Thai banks could offer several different types of deposit services, but finance/securities companies were restricted to issuing promissory notes. Because of these differences, many Thais deposited their money in banks even though the interest rate paid by finance/securities companies was greater. Banks also offered a lower interest rate to borrowers; thus, potential borrowers would go first to banks for loans. Many borrowers who were turned down for bank loans due to relatively high risk would successfully obtain financing from Thailand's finance/securities companies. …