Time to bring the baht to heel for sake of economy

A foreign exchange board displays figures at Don Mueang airport. Concerns are growing over the effects of the strong baht. (Bangkok Post photo)

Complaints about the strong baht are growing louder by the month. Many are puzzled at why Thailand's currency keeps appreciating despite a weakening economy and falling exports. At the beginning of the year, the US dollar/baht rate was at 32.33. As of Wednesday, the baht had strengthened to 30.18 per dollar.

A whopping 7.1 % appreciation. One would expect to see this in a booming economy with strong export growth. On the contrary, Thai GDP growth has plummeted from 3.7% in the fourth quarter last year to 2.4% in the third quarter this year, while Thai exports of goods and services fell 6.1% in the first nine months of this year. Why do Thai economic facts not correspond with economic theory?

The classic answer from the Bank of Thailand is that exchange rates are market determined, and the baht is fluctuating in line with the currencies of our trading partners. The first part is true, but the latter part is not. During the first nine months of this year, the baht appreciated 9.1%, 6.9% and 6.2% against the China's yuan, the US dollar and Japan's yen respectively. These three countries are our biggest trading partners, accounting for 34% of total exports. But it doesn't look like the baht is moving in tandem with them.

This prompts a million-dollar question. Should we let the market or the economy determine the exchange rate? In other words, should we manage the exchange rate by theory or by facts?

In the view of economists, including the International Monetary Fund (IMF) and Bank of Thailand, the exchange rate is sacred and should be determined by market forces. Interventions should be made only to smooth out short-term disturbances, such as unusual inflows or outflows of capital. Messing with exchange rates can only bring chaos (at least according to the textbooks). Moreover, management of exchange rates should only be done by adjusting domestic interest rates. So, in 1997 when we were approaching 50 baht/dollar, domestic interest rates were pushed up above the 20% level. Then a couple of weeks ago, when we were about to break the 30 baht/dollar mark, the BOT rate was lowered to 1.25%. But did the measures work? Nope.

If the baht is being determined by market forces, as the theory says, we must address two disturbing facts.

Fact number 1. The baht exchange rate is not doing what it's supposed to do, ie balancing external accounts like international trade and current accounts. The exchange rate is a type of "price". Its job is to clear the market. When a product is not selling well, the price is pushed down to stimulate demand. If a product is selling too fast, the price mechanism works in the opposite direction. (The simple law of supply and demand.) Exchange rates are meant to do the same.

Unfortunately, theory does not translate into facts in Thailand, because the baht is not responding to trade movements. Appreciation of the baht did not curb trade growth in 2017 and 2018, while the massive export decline in 2019 is not pushing the baht down. It seems like exports and the currency each have minds of their own. Of course, in good years nobody cares. The baht can do as it pleases as long as exporters are doing well. But in bad years, all eyes are on the currency, like now.

Traditional economists will quickly argue that one cannot focus only on export figures. One has to look at the overall trade balance and current account balance. A very good and valid point. But should the exchange rate be there to support the economy and Thai exporters, or should it be left to markets to determine, as theory dictates?

An example might help here. Imagine a country where exports are falling because of slow world demand but imports are falling even faster because factories are shutting down and jobless consumers have no money. In a case like this, the trade balance will improve and the currency, as determined by the market, will appreciate. But the stronger currency will further choke the export sector. And if this country's export sector accounts for 60% of GDP, imagine the effects on the economy.

Fact number 2. At the micro level, economic facts and economic theory are planets apart. In theory, when one country has a trade surplus with another, its currency will strengthen against the trading partner's currency, and, in the long run, the stronger currency will act to shift the trade surplus back into balance. The currency will move in the opposite direction when an economy has a trade deficit with a partner.

If we apply that theory to the real world, the baht should be falling against China's yuan as Thailand recorded a trade deficit of $15.3 billion with China from January to September of this year. But the fact is that the baht has appreciated 9.13% against the yuan. The same goes for Thai-Japan trade. Our currency has strengthened 6.23% against the yen despite our trade deficit of $6.7 billion with Japan over the same period.

These two facts strongly indicate the movement of the baht bears little or no relationship with the real economy. Worst of all, it is hurting the real economy. Factories are shutting down, workers are being laid off, and the Thai economy is sinking further into the abyss. It is time (actually long overdue) to find the "right" value of the Thai currency and manage the exchange rate, based on economic facts, to that level.

The baht should be managed at both the macro- and micro-level. Micro-level management, in my view, is more important. A level of 30-something-baht per US dollar could be acceptable since we have a large trade surplus with the US, but the baht-yuan and baht-yen valuations are certainly not okay.

Thai authorities have to choose between doing what is best for the economy or adhering to economic theory on exchange rate management. My choice is clear.