Phuket Finance: Currency crisis warning signs

PHUKET: THE strength of the Thai Baht is a major topic of conversation these days, especially since so many Phuket residents are living on a fixed income, denominated and paid in a foreign currency from abroad. We have all been feeling the same pain as the combination of the strong baht and domestic inflation has led to our hard-earned money buying less and less. Oddly enough, I am one of the few who believe better days may not be that far away and there is plenty of historical evidence to support this view.

I actually had the idea for this article as I was studying for the six-hour CFA (Chartered Financial Analyst) level-two exam which I will be sitting shortly, and one of the topics that really hit home was on the warning signs of a currency crisis. Much to my relief, Thailand’s current situation has the baht appearing to be the poster child for a currency crisis in the making.

But unfortunately, similar to any bubble or impending crisis, it is impossible to predict the catalyst or timing of when the proverbial fan will be hit. What is clear is that the current course of the baht is irrational and unsustainable, and that something will eventually have to give.

According to the CFA Institute, some of the warning signs of a currency crisis are deteriorating trade terms, a dramatic decline in official foreign exchange reserves, a foreign exchange rate higher than the mean reverting level, high inflation, equity markets experiencing a boom-bust cycle, and expanding nominal private credit.

While we are unsure of the actual state of the government’s foreign exchange reserves, there have been reports in the local press that all is not right. I won’t make any judgments, but instead leave it to the reader to consider what to believe on this. And I’ll do the same with regard to the published official inflation figures, but it does seem to met that prices are rising at an ever-increasing rate and that the published figures do not reflect this.

The Thai market has been one of the biggest boomers for three years in a row now and every boom is followed by a bust.

The banks here, while not nearly as bad as those in the US leading up to the real estate crash there, have been forking out easy money to buyers of their first homes and first automobiles at a pretty rapid clip. Thus nominal private credit is surely expanding, and you should keep in mind there are no fixed rate mortgages handed out by Thai banks. Thus if borrowers struggle even a little to make payments now, any rise in interest rates could likely see defaults shoot through the roof.

Most major movements in any market overshoot the long term mean and typically end in the same kind of rapid movement we have seen from the baht recently. Usually there will be a final spike with something like a 50% retracement afterwards, but of course this doesn’t always happen. Looking back at history, it appears we are above the long term mean reverting level by quite a bit. Thus the baht pretty much fits nicely into the box of a currency crisis in the making.

Unfortunately, predicting the precise end of bubbles is a fool’s game. So for those of you on fixed foreign incomes, I can’t say it won’t get worse before it gets better. If you look back at where the baht was before the 1997 crisis, we still have room for it to strengthen even more without going into ‘craziness territory’. I do think this will not last forever or even that much longer, and if you sit tight we will eventually see the baht return to more reasonable levels, even if not all the way back to where they ended after the last crisis.

David Mayes MBA resides in Phuket and provides wealth management services to expats around the globe, focusing on UK pension transfers. He can be reached at david.m@faramond.com or 085-335 8573. Faramond UK is regulated by the FSA and advises on pensions and taxation.

This article appears in the current issue (May 18-24) of the Phuket Gazette newspaper, now on sale at newsstands throughout the island. Digital subscribers may download the full issue, this week and every week, by clicking here.

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— David Mayes