The Thai Baht Strengthens and the Economy’s Set to Weaken,

Walking down the street every day in central Bangkok I see numerous currency exchange rates flashed at me from large metallic boards yet something has been of striking concern rather recently. What has been catching my attention is the increasing strength of the Thai baht against major foreign currencies. Let’s look at the US dollar as an example. Currently the US dollar is worth a mere 29.8 baht which is a staggering 2.5% increase in the Thai baht’s strength (comparatively to the USD) since the beginning of this year when the exchange rate was 30.6 baht to the dollar. This is partially caused by Japan’s and the US’s recent monetary policies with objectives to weaken their currencies. The US has numerous incentives to do this.  The US's debt to China is one of many examples.  But, what does the strengthening of the Thai Baht really mean?

Well, for Thai exporters this means a lot! A stronger currency has a severely negative effect on exports. Lets look at this in a little more depth then. A Thai exporter will look to sell their product, lets say rice, for a value of 15,000 baht per ton. This exporter will ask for 15,000 baht per ton the whole year ceteris paribus (all things remaining equal, e.g no inflation). However, this 15,000 baht per year although was only 490.2 US dollars at the beginning of 2013, is now, after a mere 6 weeks into 2013, worth 503.4 US dollars. This means that fellow rice exporting countries such as India, Vietnam and Pakistan will become (comparatively to Thailand) more competitive assuming that their currencies maintain a stable (or at least a more stable) exchange rate with the US dollar. This has proved to be the case.  The Vietnamese Dong has recently had a rather stable exchange rate and the Pakistani Rupee has actually depreciated (became weaker) against the US dollar improving their competitiveness in the rice market.

So in a simplified manner you can see the problem with the appreciating Thai Baht for Thai exporters, their prices are becoming less competitive because of the strengthening (appreciation) of the Thai baht. Luckily (for Thailand) Vietnam is predicted to suffer from a drought problem causing a scarcity of supply (smaller quantity of rice produced), this therefore reduces the international supply of rice shifting the demand for Thai exporters in the rice industry to the right (an increase) as importers (purchases) of Vietnamese rice now look for other exporters to satisfy their demand.

Unfortunately, for Thailand, competition is hardly scarce either so although the drought issues and other limiting factors to the supply of rice in other countries will still occur, Thailand is unlikely to absorb a much larger proportion of demand. In fact, in relation to the strengthening currency, Thailand’s rice exports are far more likely to shrink than remain stable because the currency’s strength will have a far greater effect. Although other political schemes of a price guarantee method have significantly affected the Thai rice exports, the example stands for all products.

Private industries now look to the government to lower interest rates, reducing the amount of capital inflows. This reduces the demand for the currency as less people are converting their money  into Thai Baht in order to save their money in high interest earning accounts. The lower interest rates discourages foreigners from saving in Thailand and encourages money to be driven out of Thailand’s capital account and injected into other countries with higher interest rates. You’d want to get the highest rate of interest possible wouldn't you? Well on a more macro scale, this explains the outflows of the capital account which flow into other economies (other countries with higher interest rates). As shown on the graph the reduction in demand for the Thai currency and the increase in supply (as less money is being saved by domestic savers, so more is on the market) will lead to the depreciation of the Thai baht. It’s important to note that this is the THB to USD exchange rate, this means it’s the market for Thai Baht or rather, how much the Thai Baht is worth in USD. The graph represents the value of Thai Baht in US dollars, while before I have been talking about it the other way around, the value of the US dollar in Thai Baht. I have been mentioning USD to THB exchange rates because these are much more commonly used and known about however when focusing on only the effects on the value of the THB then we should always use the THB to USD exchange rate. That is, the market for the Thai Baht rather than that for the US dollar. The depreciation of the THB, as mentioned before, will make Thai exports more competitive again as 1USD will be worth more baht than it was before. In other terms, the cost of 15,000 baht for foreign importers of rice will be far less in their currency than before. So, appreciation is a serious problem that the Thai economy currently faces, what should they do?

It should be noted that the depreciation of the Thai Baht should, theoretically speaking, lead to an increase in inflation caused by the increased demand for exports. The increased demand for exports will increase aggregate demand for the economy as whole, this will cause demand pull inflation where the increased demand in relation to fixed long run aggregate supply will increase the price level. This is shown by the graph to the right as price rises from P1 to P2 due to a shift of demand for AD1 to AD2. To a smaller extent, the increase in import prices for Thailand will cause cost push inflation. This is when the cost of imports, which may be raw materials used for manufacturing for example, rise in price. This increase in costs for producers (who use these raw materials) results in a shift in supply to the left (a smaller amount of supply) as there is less incentive for suppliers to keep on producing their products due to greater costs in manufacturing and thus, lower profits.  

In the long term , when the price elasticity of demand is more elastic (that is, when price changes, demand changes by a greater percentage), then the depreciation of the Thai Baht will lead to an increase in total revenue (due to a greater demand) and benefit the Thai economy greatly. Appreciation having the opposite effect which is what’s happening right now. Because exports contribute to around 2/3^rds of the Thai economy, this is a serious economic and political issue that will test the face of Thai political leadership.