Should the government seek foreign loans?

According to a recent cabinet decision, the Thai government will seek foreign loans to the tune of 2,000 million USD, including 1,000 million USD on loan from the World Bank, 500 million USD from the Asian Development Bank (ADB) and 500 million USD from JICA.

However, instead of seeking foreign loans, I think that the government should efficiently tap the foreign exchange reserves for economic and infrastructure development.

Firstly, Thailand has abundant foreign exchange reserves On February 20, 2009, Thailand had foreign exchange reserves worth 113,692.02 million USD, or 3,517,500 million THB, ranking 15th place in the world – higher than the USA or the UK.

Is the amount of foreign exchange reserves enough to keep Thailand’s financial status stable? I could say that Thailand has far more foreign exchange reserves than the country needs. According to international standards, the foreign exchange reserves that any country should have should be equal to the value of at least one quarter of their country’s import value. Thailand’s average import value twelve months ago was 14,172.76 million USD per month, making Thailand’s necessary level of foreign exchange reserves only 42,518.28 million USD.

As for the international finance aspect, according to the fiscal sustainability framework, no country should have a foreign short-term debt 3.5 times more than its foreign exchange reserves. Thailand has a foreign short-term debt worth 25,129.43 millions USD, implying that Thailand’s financial status is very strong, with liabilities held by foreign countries in Thailand’s stock market worth 22,441.71 million USD.

According to this information, if we were to set up a most extreme and unlikely scenario in which 1) All of Thailand’s capital money is drawn from the stock market, 2) All of Thailand’s short-term debtors re-call their money and 3) Thailand imports at the same rate as it ever has, but cannot export anything for three months, Thailand’s foreign exchange reserves would decrease by 90,089.42 million USD. After that, the country’s foreign exchange reserves are still worth 23,602.60 million USD – not deplete yet!

Secondly, excessive foreign exchange reserves may create an adverse effect on Thailand’s wealth In the current economic crisis, Asian economies are somewhat stronger than are the economies of the developed countries, therefore, against the currencies of the developed countries, Asian currencies will probably appreciate in the long run. Consequently, if the government does not utilize our foreign exchange reserves, its value will depreciate according to the general depreciation of reserve currencies. If foreign exchange reserves are utilized for infrastructural investment, such as irrigation or logistics, it will yield higher returns than is currently seen – holding its value in terms of USD and US government bonds – due to the very low interest rate now.

Now let’s discuss why tapping foreign exchange reserves is better than seeking foreign loans. A key factor we must discuss is the difference between the opportunity cost of holding foreign exchange reserves, represented by the rate of return on US government bonds, and the cost from the interest rate on foreign loans – whichever one has the lower cost is the preferable choice.

Let’s consider the interest rate for Thailand’s prospective sources of foreign loans. JICA charges a fixed interest rate of 1.4% over a period of 25 years. The World Bank and ADB use Libor as a reference rate, which is now at 2.12%, plus a little margin, so that both of them charge 2.12+%. The US government bond rate of return over a 30-year cycle is at 3.67%.

It seems that the interest rates on all foreign loans are lower than the rate of return on 30-year US government bonds. However, the Libor rate tends to increase, while the rate of return on US government bonds tends to decrease.

Therefore, I consider JICA loans as a good choice, since JICA’s interest rate is usually the lowest rate in the world, but, for the World Bank loans and ADB loans, the government should reconsider their decision carefully due to the possibility of changes in Libor and the rate of return on US government bonds.

Furthermore, even seeking loans from JICA, the World Bank and ADB may be not enough to meet budget necessity, because the government’s plan for infrastructural investment needs at least 2 trillion THB, or 57 billion USD. In the future, the government may need to tap some foreign exchange reserves as well as promote cooperation with both local and foreign companies in government investment projects.

Although it is reasonable to tap foreign exchange reserves, its utilization must be strictly controlled and regulated. The amount of foreign exchange reserves utilization must be optimal, that is, so that it does not affect fiscal stability; 1) Any remaining foreign exchange reserves must overvalue the demand for foreign currencies, including short-term foreign loans, liabilities held by foreign countries on Thailand’s stock market, and the import value for at least three months; 2) Utilization must be “smooth” to prevent fluctuation of the Thai Baht; 3) A clear framework must be set to make the utilization process transparent and corruption-free; 4) Types of investment projects must be limited to the field of government projects, in order to avoid loss – Singapore’s Temasek Holdings remind us that to tap foreign exchange reserves without limitation will lead to loss.

Dr Kriengsak Chareonwongsak
Senior Fellow, Harvard Kennedy School , Harvard University
kriengsak@kriengsak.com, kriengsak.com, drdancando.com