The Engine of Thailand’s Growth Once Again Receiving Fuel

Mr. Thayer will be writing on topics of general interest to our subscribers.

Mr. Thayer has spent the last 20 years as a professional financial analyst. Presently based in Denver, Colorado, USA, his background includes investment analysis of a wide variety of securities of companies in the U.S., Japan, Korea, and Thailand. In addition to his new duties at Thaistocks.com, he is a Senior Contributing Analyst engaged in

institutional equity research for Westergaard.com, Inc. in New York City. He also serves as a special due diligence and valuation consultant for small-cap mergers and acquisitions.

Mr. Thayer professes to have lost money in the Thai market in 1997, but his enthusiasm for the many opportunities in smaller stocks at the SET is greater than ever.

Here is his first contribution:

The Engine of Thailand’s Growth Once Again Receiving Fuel

The fuel for the engine of Asian growth in the late eighties and early nineties was capital invested by foreigners. When Thailand and other Asian Pacific countries were forced to devalue their currencies in 1997, the associated flight of foreign capital severely amplified the economic distress. Will foreign capital return to Thailand, now that the currency has stabilized? The answer appears to be a resounding "Yes!"

There is a popular perception that devaluation deters future foreign capital because foreign investors believe they would be hurt by possible further declines in the dollar value of their assets. Morgan Stanley economists Denise Yam and Andy Xie, explained in a recent article that while capital flight takes place if the market expects devaluation, capital does return after devaluation takes place. The economics is simple: devaluation expands the current account and increases foreign demand for cheaper domestic assets. The resulting improvement in the balance of foreign capital brings back flight capital. Recent data on Thailand, as well as other recovering Asian economies, confirms this logic.

Is an exchange rate a price or a promise? A fixed exchange rate involves an element of promise, similar to that of the gold standard, whereas devaluation is a promise broken. The question is whether investors later punish the authorities for devaluing the currency by refusing to make investments. Since investors are forward looking, such behavior is illogical. In reality, what appears to deter foreign investors are inconsistent monetary and fiscal policies. As long as post-devaluation policies are consistent and credible, foreign capital is likely to return quickly. Recent data confirms that foreign investors have growing confidence in the Thai government.

Morgan Stanley argues that the immediate impact of devaluation is a current account turnaround -- imports become more expensive while exports become less so. The improved current account reduces the probability of a country going bankrupt and makes the return of capital a more rational outcome; capital flight before devaluation and the return of that capital after devaluation are both rational outcomes. Not only is expectation important, as long as foreign investors believe in a government's pledge to keep the exchange rate stable, foreign capital will flow in and make this pledge self-fulfilling. The question is whether the prevailing exchange rate is credible at the current levels of the current account balance and economic activity.

Moreover, capital flight driven by the expectation of devaluation can take many forms, in addition to simple deposit switching. Short-term capital outflows (flight capital) could show up in the balance of payments in the form of (1) a decline in (or negative) net equity portfolio investments, and (2) a rise in trade credits granted to foreign importers as exporters keep their foreign exchange earnings in foreign currencies. The current account undergoes an immediate turnaround after devaluation. Foreign direct investment (FDI) would likely be attracted in response to the expectations of a rebound in the economy increased corporate profitability and lower asset prices. Flight capital would then follow.

Capital flight from the Kingdom was devastating in 1997. But as the current account swung to a surplus of US$14.3 billion in 1998 versus a deficit of US$3.1 billion in 1997, direct investment and short-term capital surged. Foreign funds from the current account, FDI and returning flight capital amounted to 16% of GDP in 1998.

The strong inflows of funds to Thailand has enabled it to build up foreign reserves and repay foreign debt -- US$14.6 billion was repaid during 4Q97-1Q99. The total debt has been reduced to US$83.9 billion (24.5% short term) from a high of US$96.7 billion (40.2% short term) in the third quarter of 1997. The country's stock of reserves also began to recover in the second half of 1998.

Yam and Xie assert that the Asian crisis was caused by over-investment financed by unhedged short-term foreign debt. The leverage is currently being unwound, partly through debt-equity swaps, which have boosted direct and equity investment. The current trends are creating a much more stable environment for the Asia/Pacific countries, thus reducing their vulnerability to short-term capital flows.

Devaluation has indeed worked for the countries in the region. It has allowed them to price their capacity into the global market and resume growth this year. Countries like Thailand should remain attractive to foreign investors for the foreseeable future. Once again, the engine of growth should drive the economy to prosperity.

Robert Thayer, CFA.  For Thaistocks.com

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