Will Banking Reform Get the Boot, Too?

The fall of Thailand's central banker bodes ill

Chatu Mongol Sonakul was never a man who took orders well. In a country where bluntness is a cultural affront, his outbursts against fiscal malfeasance and corruption have long rankled his superiors in Thailand's civil service--and once got him sacked as Permanent Finance Secretary. Only his standing as a relative of the Thai royal household kept him out of the wilderness. But Harvard University-trained Chatu Mongol was just the sort of principled iconoclast Thailand needed to fix the credibility of its central bank in 1998, after the country's financial crash. Named Bank of Thailand (BOT) governor by reformist Prime Minister Chuan Leekpai, Chatu Mongol oversaw sweeping reforms and restored the BOT's independence in monetary policy.

But Chatu Mongol's maverick ways have again cost him his job. And the consequences for Thailand are troubling. On May 29, new Prime Minister Thaksin Shinawatra ousted the central bank chief after a bitter row over savings deposit rates. Chatu Mongol wanted to keep rates, which the government influences via its control over half of the banking system, at their current level of around 2% to encourage consumer spending and shore up the economy, which is slowing badly less than three years after a harrowing 8% contraction. Thaksin wants rates raised. His reasoning: Higher rates would help the baht, which has slipped 15% since last spring, to around 45 to the dollar, by enticing savers to keep their money in Thailand. Thaksin also argues higher rates will juice the economy by swelling the bank accounts of consumers, who save 35% of their income, making them more willing to spend.

Spurring the economy by raising interest rates? Now that flies in the face of economic theory. Higher deposit rates generally prompt consumers to save more money, rather than spend it. They also force banks to charge more for loans--making it more expensive to finance everything from car purchases to new factories. Thaksin's response: He aims to press banks to keep their lending rates in check, although that could hurt their balance sheets. If that's the plan, cautions Thai Farmers Bank President Banthoon Lamsam, "the banking system would slip into negative territory."

A former telecom tycoon, Thaksin swept into power on a populist platform that promised big spending for health care and rural development, plus a government bailout of banks. The problem is how to pay for it all. Public debt has risen from 48% of gross national product to 58% in a year. So analysts suspect Thaksin will push the BOT to print money to fund his programs, a policy Chatu Mongol stubbornly resisted.

That's not all. Thaksin has removed any semblance of central bank independence. The BOT lost credibility in the mid-1990s when regulators winked at reckless lending and squandered the nation's foreign reserves in a futile effort to prop up an overvalued currency. Under Chatu Mongol, the BOT beefed up oversight, improved transparency, and forced banks to adhere to higher capital adequacy standards. Now, "the danger is that the central bank can be effectively used to finance the government deficit," says Deutsche Bank Chief Asia Economist Michael Spencer.

"TEAM PLAYER." It's too early to tell if these fears are warranted. New BOT Governor Pridiyathorn Devakula, 53, vows the bank will call its own shots. He has headed the Export-Import Bank of Thailand and a new debt-management agency. Government spokesman Yongyut Tiyapairat insists "the central bank will remain independent and absolutely free from political power." But an official press release says there must be "close coordination" between the BOT and government on monetary policy. "Pridiyathorn is more of a team player," says a government finance adviser.

The biggest fear is that Thaksin will order tight capital controls, as Malaysia did in 1998, to protect the baht. With Chatu Mongol gone, says ABN Amro Asia Ltd. Country Chief Executive David Kadarauch, "the specter of capital controls and a pegged exchange rate have become a distinct possibility." That would send investors fleeing--and foreign investment applications are already down 20% this year. Merrill Lynch Phatra Securities predicts Thai economic growth will slip to 2.5%. And capital flight could cause the baht, now at its lowest ebb in three years, to drop further.

Although Thaksin got elected as a big-spending populist, many observers assumed his business acumen meant he appreciated open markets. Now they're wondering whether Thailand is about to roll back reform.

By Frederik Balfour in Bangkok

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