International Finance in Emerging Markets: Issues, Welfare Economics Analyses and Policy Implications

228 Pages·2008·2.15 MB·English

by  Dr. Songporn Hansanti

CONTRIBUTIONS TO ECONOMICS
Songporn Hansanti
Sardar M.N. Islam
Peter Sheehan
International
Finance in
Emerging Markets
Issues, Welfare Economics Analyses
and Policy Implications
Physica-Verlag
A Springer Company
International Finance in Emerging Markets
Songporn Hansanti Sardar M.N. Islam
● ●
Peter Sheehan
International Finance
in Emerging Markets
Issues, Welfare Economics Analyses
and Policy Implications
Physica-Verlag
A Springer Company
Authors
Dr. Songporn Hansanti Professor Sardar M. N. Islam
Head of International Business Professor and Director
Department Decision Sciences and Modelling Program
Kasetsart University CSES, Victoria University
Faculty of Management Sciences Melbourne
Postmail Box 107 Australia
40/852 Prachaniveth 3 [email protected]
Thasai, Muang, Nonthaburi
Thailand 11000
[email protected]
Professor Peter Sheehan
Professor and Director
Centre for Strategic Economic Studies
Victoria University
Melbourne
Australia
[email protected]
ISBN 978-3-7908-2043-0 e-ISBN 978-3-7908-2044-7
DOI: 10.1007/978-3-7908-2044-7
Contributions to Economics ISSN 1431-1933
Library of Congress Control Number: 2008923470
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Preface
This book reviews the contemporary issues in international monetary and
financial economics (such as financial liberalisation, crisis, exchange rate
determination, capital control, domestic capital market reform, etc.) in an
emerging financial market such as Thailand from a welfare economic per-
spective, highlighting the social welfare implications of these issues. This
book also suggests a normative social approach (as formalised in the new3
welfare economics paradigm) (see Islam 2001a,b ; for a discussion of this
concept) for analysing and addressing these issues and formulating approp-
riate policies.
Undertaking the above tasks, the asymmetric information paradigm
and other elements of the new3 welfare economics paradigm are adapted in
analysing the international financial issues of Thailand, their causes and
economic and social welfare consequences.
The last two decades have been a critical period for Thailand’s devel-
opment. From the mid-1980s to the beginning of the 1990s, the Thai
economy performed remarkably well and was a showcase for the world
economy. Having achieved a double-digit growth rate for a brief period,
Thailand in the late 1980s was regarded as the fastest growing economy in
the world by the World Bank and the IMF. With prospects of further rapid
economic growth, the Thai government accepted Article VIII of the IMF,
which required Thailand to liberalise and deregulate its financial system.
Accordingly, Thailand removed most regulations on its financial system
from 1989 to early 1994. Consequently, the country enjoyed further eco-
nomic growth and large volumes of capital began to flow into Thailand’s
financial market. Unfortunately, the story of Thailand’s success was short-
lived and soon ended, after the financial liberalisation was completed.
Finally, economic growth came to a sudden stop and the crisis erupted in
July 1997.
This book investigates the recent issues in International Finance in
Thailand, focusing on the major issues such as the contribution of financial
liberalisation to the crisis in Thailand, the sequence of financial liberalisa-
tion, capital controls, and exchange-rate policy, using the asymmetric in-
formation paradigm (market, policy and institutional failures). In addition,
this study also examines time-series data and other information to explore
vi Preface
the consequences of financial liberalisation for the crisis in Thailand. The
book divides the analysis into three parts. Part I reviews the literature on
contemporary international financial issues and investigates the financial
liberalisation framework that Thailand pursued in opening up its financial
system. Part II explores the impact of financial liberalisation on the Thai
economy, focusing on the issues of sequencing of financial liberalisation,
capital controls and exchange rate policy. Part III reviews financial liber-
alisation theory and the Thai crisis. In this final part, we present our con-
clusions about the contribution of financial liberalisation to the financial
crisis in Thailand.
The Thai financial crisis was a watershed in Thailand’s economic deve-
lopment. The crisis generated considerable analysis, literature and confer-
ences on its cause. However, comparably little work has been undertaken
on exploring the development and social welfare implications of the crisis
for Thailand’s immediate and mid-term future. The most immediate impli-
cation of the crisis was the initial drop in income throughout the Kingdom.
New numerical estimates that reflect the movements in social welfare re-
sulting from the crisis are developed and presented in this book. It is
shown that while the financial crisis had a dramatic negative impact on
average income levels, the processes of financial liberalisation and global-
isation that preceded the crisis were also having negative impacts on the
social welfare levels of Thailand. Conventional measures of social welfare,
such as Gross Domestic Product or economic growth provide misleading
information on social welfare movements. By adjusting this measure for
the net benefits of financial liberalisation, a more intuitively correct meas-
ure of social welfare is possible. This study will develop a time series,
1975–1999, which estimates this new adjusted GDP measure of social wel-
fare. It shows that stark differences exist between unadjusted GDP meas-
ures of social welfare and financial liberalisation adjusted GDP over this
time period. Following this, it is possible to undertake new analyses of the
development and social welfare implications. This book explores the op-
portunities for changes in public policy that can prevent further crises.
Various public policy initiatives can now be more fully considered than
was possible in the past. This book therefore represents a significant con-
tribution to both development and welfare economic literature.
The study shows that four policy errors in international financial man-
agement, especially in the financial liberalisation process, which were
caused by the asymmetric information problem, existed in the Thai econ-
omy during the study period and contributed significantly to the financial
crisis in Thailand. The four errors were inappropriate sequencing of finan-
cial liberalisation, too rapid and too extensive liberalisation of capital con-
trols, misalignment of the exchange rate through a basket of currencies
Preface vii
dominated by the SU dollar and lack of adequate supervisory systems in
the face of large scale capital inflows, giving rise to moral hazard prob-
lems. These errors contributed to problems of a high level of current
account deficit, speculative behaviour, overinvesment, loss of competi-
tiveness, increased short-term external debt and excessive investment in
and lending to the domestic markets. These problems resulted in economic
instability and disruption, and made the country vulnerable to financial cri-
sis when the expectations of foreign investors were not met.
In addition, a quantitative empirical analysis (by applying cost benefit
analysis) of financial liberalisation and the associated processes shows that
the cost of financial liberalisation has been higher than its benefits in
Thailand in recent years.
This book, therefore, provides an in-depth analysis of some emerging
and enduring issues in international finance from a welfare economics
perspective, especially the issues of financial liberalisation, exchange rate
determination, capital control and financial crisis, which provides an im-
proved understanding of social welfare implications of international fi-
nance in an emerging financial market.
There is probably no book currently available which addresses the fi-
nancial issues discussed in this book from a welfare economics perspec-
tive. The theoretical issues are balanced by the application of welfare
economics to an emerging market. This book fills that gap. It can be used
as a reference book by researchers, academics, practitioners, policy mak-
ers, and postgraduate students in the areas of finance, financial economics,
monetary economics, and development economics. It can be used a refer-
ence or an additional text for a finance subject at the Masters or Doctoral
level.
Our special thanks go to Dr. Ruchi Gupta, Dr. Susan Zeidan, Dr.
Abdullahi Ahmed and Mrs. Margarita Kummick for their comments and
help with editing and proofreading this book.
Thailand Songporn Hansanti
Australia Sardar M.N. Islam
Australia Peter Sheehan
February 2008
Table of Contents
Chapter 1: Introduction...................................................................1
1.1 Introduction………………………………………………...................1
1.2 Recent Issues in International Finance.................................................4
1.2.1 Overview of International Financial Crises................................4
1.2.2 Views on the East Asian Crises..................................................8
1.3 Statement of the Problem and Objectives of the Study......................10
1.3.1 Objectives of the Study..............................................................10
1.3.2 Finance and Welfare Economics............................................... 11
1.4 Book Outline......................................................................................13
PART A: Literature Review – The Emerging Issues
Chapter 2: Recent Issues in International Finance:
A Literature Review.............................................................21
2.1 Introduction........................................................................................ 21
2.2 Financial Liberalisation: Sequence and Order................................... 21
2.2.1 Overview..................................................................................22
2.2.2 Sequence and Order of Financial Liberalisation:
A Literature Review................................................................23
2.3 Capital Controls.................................................................................26
2.3.1 Controls on Capital Outflows..................................................27
2.3.1.1 Preventive Controls on Capital Outflows...................27
2.3.1.2 Curative Controls on Capital Outflows.......................28
2.3.2 Controls on Capital Inflows.....................................................29
2.4 Exchange Rate Policy........................................................................30
2.4.1 Factors Influencing a Choice of Exchange Rate Policy...........31
2.4.2 Overview of Fixed and Flexible Exchange Rate.....................32
2.5 Asymmetric Information....................................................................35
2.5.1 Asymmetric Information: An Overview..................................36
2.5.2 Theory of Adverse Selection...................................................37
x Table of Contents
2.5.3 Theory of Moral Hazard..........................................................39
2.5.4 Financial Crises and Asymmetric Information........................41
2.6 Summary............................................................................................44

Chapter 3: Overview of Thailand’s Approach to Financial
Liberalisation........................................................................47
3.1 Introduction........................................................................................47
3.2 Thailand’s Economic Development...................................................48
3.2.1 The Six National Development Plans......................................48
3.3 History of Thailand’s Economic Growth...........................................51
3.4 Forces Influencing Financial Liberalisation in Thailand...................53
3.4.1 Internal Forces.........................................................................53
3.4.1.1 Export-Led Growth Policy..........................................53
3.4.1.2 Acceptance of the IMF Article VIII............................54
3.4.1.3 A Sound Fiscal Condition...........................................55
3.4.2 External Forces........................................................................56
3.4.2.1 Opening of Neighbouring Economies........................56
3.4.2.2 The Trend Towards Globalisation of the
Financial System........................................................57
3.5 Financial Liberalisation Framework..................................................58
3.5.1 Trade Reforms and Interest Rate Deregulation.......................58
3.5.2 Relaxation of Exchange Rate and Capital Controls.................60
3.5.3 The Establishment of International Financial Facilities..........61
3.5.3.1 The Establishment of the Bangkok International
Banking Facilities (BIBF)..........................................61
3.5.3.2 The Export-Import Bank.............................................62
3.6 Summary............................................................................................64

PART B: The Thai Experience

Chapter 4: Analysis of Sequencing of Financial Liberalisation
in Thailand...........................................................................69
4.1 Introduction........................................................................................69
4.2 Reforms of Foreign Trade Pattern.....................................................70
4.3 Reduction of Deficits and Maintaining Foreign Reserve...................73
4.4 Foreign Exchange and Capital Control Reforms...............................77
4.5 Domestic Financial Reforms.............................................................82
4.6 Summary............................................................................................86
Table of Contents xi
Chapter 5: Capital Controls: Consequences of Financial
Liberalisation........................................................................89
5.1 Introduction........................................................................................89
5.2 Pattern of Net Private Capital Flows.................................................90
5.3 Characteristics of Thailand’s Capital Flows......................................95
5.3.1 Capital Flows to Banking Sector.............................................95
5.3.1.1 Capital Flows of Commercial Banks..........................95
5.3.1.2 Capital Flows of the BIBF..........................................99
5.3.2 Capital Flows to Non-bank Sector.........................................102
5.3.2.1 Capital Flows as Foreign Direct Investment (FDI)...103
5.3.2.2 The Loan Component of Capital Flows....................107
5.3.2.3 Capital Flows as Portfolio Investment......................109
5.3.2.4 Capital Flows of the Non-resident Account..............113
5.4 Summary………………………………………………………......115
Chapter 6: Exchange Rate Policy and Its Consequences...................117
6.1 Introduction......................................................................................117
6.2 Exchange Rates and Their Determination ...................................... 117
6.3 Overview of Thailand’s Exchange Policy.......................................119
6.4 Development of Thailand’s Basket of Currencies...........................121
6.5 Consequences of the Basket of Currencies......................................122
6.5.1 Impacts of a Pegged Exchange Rate to Trade Growth..........122
6.5.2 Surge in Funds to Thailand’s Financial Market.....................131
6.5.2.1 Commercial Banks’ Source of Funds.......................132
6.5.2.2 The BIBF’s Sources of Funds...................................138
6.6 Summary..........................................................................................143
PART C: Welfare Economies, Economic Theory and Policy
Chapter 7: Review of Financial Liberalisation Theory
and the Thai Crisis............................................................147
7.1 Introduction......................................................................................147
7.2 Inappropriate Sequence of Liberalisation........................................150
7.3 Loosening Controls over the Capital Account……………….........155
7.4 Problems of Stable Exchange Rates…………………………….....157
7.5 Asymmetric Information: Problems of Moral Hazard…………..….161