Asian banks take steps to prevent 'tequila effect'

Asian banks take steps to prevent 'tequila effect'

HONG KONG (AFP): Asia central banks are likely to try to stabilize regional currencies to prevent a "tequila effect" from spreading following the Bank of Thailand's move to float the baht, analysts said.

The "tequila effect" refers to the impact that resounded in the region from the Mexican peso crisis of early 1995.

After resisting the temptation for months, the Bank of Thailand (BoT) finally bit the bullet Wednesday and caved into speculative pressure by introducing a "managed float" to replace the baht's peg to a basket of currencies.

The currency immediately sank by almost 20 percent, with downward pressure on the peso and the ringgit forcing the central banks of the Philippines and Malaysia to intervene to defend their currencies from attack.

In the longer term, however, other countries could be forced to take similar measures to remain competitive with Thailand.

"The depreciation is not the most significant aspect of this move. The aim was not to boost exports but to give the BoT freedom in monetary policy," said Neil Saker, research director at Socgen-Crosby Securities in Singapore.

Saker described the baht's float as a "very bad move" and said that the next likely target for speculative attack was the Philippine peso.

"I think the Philippines is clearly the most vulnerable," he said, adding that the country's strong-currency policy was undermined by political confusion and poor economic fundamentals including a sizable current account deficit. "When speculators find that kind of situation, they're on the move."

In a defensive move, the Central Bank of the Philippines raised overnight rates to 20 percent on Wednesday while Bank Negara Malaysia intervened in the foreign exchange market to support the ringgit, dealers said.

But Saker said the Malaysian unit, which is already floating, "probably will survive the current crisis."

Tony Nafti, regional economist at Credit Lyonnais Securities Asia in Singapore, said the Bank of Thailand finally realized it could no longer resist the pressures of the market.

"Even the Bank of Japan, with its considerable foreign exchange reserves, cannot stand up to the market," he said. "Once the dust has settled, we are looking at 15 to 20 percent depreciation."

But while making Thailand's exports cheaper, a competitive depreciation is by no means a miracle cure for a country faced with a sharp slowdown in economic growth following the collapse of the local property market and subsequent problems in the financial sector.

In the short term, Thailand should be able to avoid a Mexican- style crisis which saw a massive outflow of capital in late 1994 and early 1995.

On Wednesday, the Bank of Thailand raised its discount rate from 10.5 percent to 12.5 percent although the central bank is expected to use its new freedoms to relax monetary policy once the situation stabilizes.

But that is not likely to prevent the emerging recession which follows a decade of spectacular growth.

Saker reckons Thailand's gross national product (GNP) will grow by only one percent this year while Credit Lyonnais -- recently reprimanded by the Bank of Thailand for forecasting a one percent contraction in economic activity -- is revising its projections in light of the new exchange-rate regime.

Notwithstanding a pickup in exports, "it's going to be way lower from the downward revision of 4.8 percent," Nafti said.

Similar problems face other Asian economies in the longer term following Thailand's move. "They should be looking at the competition aspect," he said.