Thailand’s central bank was in trouble when the global financial crisis swept across Asia in 1997. The Banker asks Bank of Thailand deputy governor about the current state of play and the master plan for the financial sector.Like many Thais, Thirachai Phuvanat-Naranubala remembers clearly the dramatic events of July 2, 1997, when the Bank of Thailand (BoT) announced its decision to allow the national currency, the baht, to float. That fateful day was the tipping point of the 1997-98 financial crisis that swept across Asia and roiled emerging markets worldwide. It was also a day when the central bank was in the spotlight, not to mention in the firing line for tycoons who had borrowed offshore and failed to hedge the currency risk.
Mr Phuvanat-Naranubala, then director of financial company supervision, was promoted in 1998 to deputy governor. When he met The Banker, it was also July 2 but, rather than dwell on the past, the conversation focused on future challenges to Thailand’s economic resurgence. Selected highlights follow.
What’s your view of Thailand’s economic strengths and weaknesses?
The main strength has been [economic] growth driven by domestic demand and we have also been doing well in exports. So both of these factors have enabled us to grow quite well. In the first quarter of the year, GDP growth was 6.7% and a lot of people are now expecting growth for the whole year to reach 5%, so I think the strength is quite clear. By using domestic demand and keeping a steady course on exports, this has helped the economy.
But, of course, the other strength is the reforms that have been accomplished. Court procedures now are much more rapid. In the past, it was much more difficult to repossess the collateral. In the old days, a debtor with a good lawyer could drag the case through court for a good six years. The court is now authorised to cut out unnecessary witnesses, so the speed is better, and we have a real bankruptcy law that we didn’t have before the crisis.
Another part is the establishment of a credit bureau system that’s now in place. So I think, in terms of [financial] infrastructure, there has been quite a lot of progress.
The other aspect of reform is the recapitalisation of the banking sector and the introduction of better governance of the banks, forcing them to have clearer structures in terms of independent directors, their roles, the minimum number of independent directors and how truly independent they must be – all this is now clearly defined. Also banks now have to follow international practices in terms of reporting to the public and shareholders. So I think we have made a lot of improvements there.
The one weakness in terms of the overall recovery is that the recovery of business investment has not been as strong as we would like. This is partly due to excess capacity, which still exists. But we are seeing the rate of utilisation exceeding 60%. If you look back before the crisis, the rate of utilisation was only 70% or so. So I think there is hope that business investment will start to pick up. Until now, it hasn’t been very active.
A lot of banks have been recapitalised – there remains Thai Military Bank, which is still under the process. We still see an avenue for a solution that should be finalised fairly soon. So, overall, the banking system has been strengthened quite substantially.
What is your outlook on interest rates and inflation in Thailand?
We have just dropped our [benchmark] interest rate by 50 basis points, and you can see that the trend of inflation is quite benign.Inflation was hovering close to 0%, so we are trying to take precautions by acting early to prevent it going into the negative. We think it will be successful. As for whether there is room for more interest rate cuts, that will depend on a lot of factors.
Obviously, we will have to look at how it develops outside: what the reaction of the Federal Reserve and European Central Bank will be. At the same time, we have to keep an eye on asset prices. The stock market in Thailand is quite active. The volume of daily transactions has reached a level not seen in many years.
The Thai baht, in common with other Asian currencies, is getting stronger against the dollar. You must be conscious that if the baht gets too strong it could hurt your exporters.
That is certainly one of the factors we take into account because if the baht becomes stronger, in our economic model it would bring lower inflation. As our core inflation was close to zero, it would make sense to allow the baht to appreciate much further.
It is clear that this is a problem in many Asian countries and I have to admit I don’t see an end to it this year or next year. We keep an eye on the US dollar but also on other currencies. On a real basis, we’re still competitive. We have to keep an eye on our neighbours who are our competitors. So, even though Thailand has allowed the baht to appreciate, it was necessary to make sure the level of the appreciation was manageable and that the extent of the rise wouldn’t erode exporters’ ability. We are still keeping the baht relatively competitive.
Do you believe that China is exporting deflation to Thailand and east Asia?
I think that if we didn’t have China, we would have India or Vietnam or other countries coming up through a development process to worry about. So China is only one factor. But we admit that it is a very big one and is working on goods at many different levels. China is certainly a factor that must be taken into account in planning.
But a better approach is to make sure the private sector in Thailand can be competitive against China. This may mean developing a niche in export goods or it may mean working with China. If we look at the production process, the chain from raw materials to finished product, I think we are going to see more vertical specialisation. This is why we are seeing the volume of trade between China and the rest of Asia going up rapidly, because a lot of the goods that used to be made whole in other parts of Asia may migrate to China. The best we can do is to make sure we hold on to the parts of the process where we are still competitive.
Once the producer in Thailand decides to migrate, either to go up the value-added chain, improve its design or find its niches, I think price erosion will stop. But, obviously, whatever goods are produced in Thailand that compete with Chinese goods will mean producers are in a difficult position and will lose their pricing power, so they will have to upgrade their technology and their product. The one thing we can do in Thailand is to make sure the financial system can cater for that and help the real sector, which has to invest in new technologies and backtrack and take a different route, and has the capacity to do so. This is what we are trying to do, rather than complaining or worrying too much about China.
Can you tell us more about your master plan for the financial sector?
In the master plan, we are going to look at the role of foreign banks and see whether we can allow them to have more room, to create competition for the local banks. For the local institutions, we will be looking at the urban and rural level. We are going to have banks that need to consolidate to serve people in the city well. At the same time, there will be a category of banks that handle retail and rural customers. These banks will not be allowed to do sophisticated foreign exchange but will be mainly counter service and allow access to rural and lower-income consumers.
It should be finalised by the third quarter.
Do you foresee further consolidation in the banking sector?
I think it’s inevitable that if Thai banks start to expand abroad more, they will need to increase their size. One way to for them to expand is to combine. But our domestic market is also quite large so that even with 12 commercial banks, it is not overbanked. After we introduce a deposit insurance scheme and put everything in order, I think, in a few years time, we will allow new entrants, both foreign banks and new Thai banks. At that time, there must be an orderly exit for those banks that can’t cope. This will allow newcomers to come in and compete, and will make the banking system stronger.
How does the Bank of Thailand plan to replace the guarantee on bank deposits in place since 1997?
We have already drafted a law for deposit insurance and this is now with the ministry of finance. The law will allow a phased scale-out of the guarantee. It’s a political decision as to when this happens but I have a feeling it won’t take long. The deposit insurance will be a limited insurance. It will cover a large number of accounts but not a large amount of money.
How has governance of the banking sector improved since the crisis?
It has improved a lot. We have put our emphasis on supervision by risk base. We have also demanded that banks ask themselves: what are the risks? So I think that they are now reactive in the way they analyse and monitor the customers, and if they detect a problem, they go in early and stop the problem in its tracks. The banks have a much better system to manage their risk.
We have also tightened the regulations on lending to related parties. The previous approach was to go by legal interpretations [of related parties]. Now we go by business reality – if it’s a related party transaction, we will go after it.
The level of non-performing loans (NPLs) in the banking system is stuck at around 16% but isn’t going down further. Your comment?
Half of those NPLs are beyond salvation and that half represents cases pending in court. So they have to go through the motion of forcing the collateral. The other half can still be negotiated and we have set up procedures for negotiations with the customers. These tend to be small and medium-sized debtors and quite a few of them are beyond any solution.
Most banks have already made enough provisions against NPLs and increased their capital to cover that. Even though the NPL rate is still quite high, it shouldn’t be a drag on the banks’ ability to lend because they already made full provisions.
Foreign investment hit a record low in Thailand last year. Do you see any sign of it picking up?
The low figure last year was from foreign investors repatriating profits, which clouded the figure. But, on the whole, this is one issue that we have to tackle. We have to do it by linking up with the rest of the Association of Southeast Asian Nations (ASEAN) so that we are an attractive destination for foreign direct investment (FDI). We will have to allow more market integration, so we can produce something that can be sold throughout ASEAN to get economies of scale.
Thailand has always welcomed foreign investment and we’ve been active in trying to attract investment from small and medium-sized enterprises, such as auto parts producers in Japan. But the big mega projects may not come because there’s so much overcapacity – in steel, copper, cement and many other industries.
We need to make sure we attract the right kind of FDI, the kind that brings high technology, research and development and design ability that takes us to the next level. I think we will emerge with a clear plan. By making free-trade deals with various countries we are trying to position ourselves at the crossroads. We are also trying to improve the general abilities of our workers. That will take time but at least we have started.
