Speed bump

Pridiyathorn Devakula playfully suggests that as the grandson of a Thai prince, he was fated to become Thailand's central bank governor. Born 57 years ago in a palace owned by his forebears on the riverside grounds of the Bank of Thailand, Pridiyathorn in fact follows in a long tradition of Thai central bank chiefs of royal descent.

These to-the-bank-born governors have, by and large, served the country well, often acting as bulwarks against the financial excesses of military regimes. Pridiyathorn serves the democratically elected government of Prime Minister Thaksin Shinawatra, who appointed him. But he has also found himself in the role of official spoilsport since becoming central bank governor in June 2001.

The former commercial banker and boss of the Export-Import Bank of Thailand with the American MBA has recently toughened lax bank rules by substituting risk-based for transaction-based lending standards (see box). More controversially, Pridiyathorn has intervened early and repeatedly in the markets to cool down credit card, property and bank boomlets. And he has implemented credit controls for real estate developers and banks to avoid the sort of Thai bubble that triggered the 1997­'98 Asian financial crisis.

These bold and mostly justified moves have earned Pridiyathorn plaudits from international investors. Yet the central bank's initiatives have often worked at cross-purposes with the Thaksin government's agenda of rapid economic growth: The prime minister famously predicted in 2003 that the Thai economy would expand at a blazing 10 percent this year.

Thaksin has made his current displeasure with the prudent Pridiyathorn clear, through critical comments to the press and a government initiative that aims to curtail the central bank's power. Now many Bangkok watchers believe that the political winds have shifted decisively and that the prime minister -- who has reorganized his cabinet eight times since 2001 -- will most likely oust Pridiyathorn as part of a broad government reshuffle in the wake of his resounding electoral victory on February 6. Thaksin's populist Thais Love Thais party secured more than 380 of the 500 seats in the lower house of the National Assembly, and the popular premier in early March formed the country's first democratically elected one-party government.

Pridiyathorn may well be on the premier's "out" list. "Speculation is that the government will replace the governor with someone who is more market-friendly," notes Derek Bloomfield, a banking analyst at J.P. Morgan Chase & Co. in Bangkok.

(Market watchers speculate that if Thaksin does sack Pridiyathorn, he will replace him with Chaiyawat Wibulswasdi, a senior adviser to the Finance Ministry who served as central bank governor in the wake of the 1997 collapse. The Massachusetts Institute of Technology­educated economist brokered Thailand's $14.2 billion International Monetary Fund bailout package in August 1997. He resigned in May 1998 amid criticism of his handling of the baht crisis. Considering his closeness to Finance Minister Somkid Jatusripitak, many analysts believe that if Chaiyawat were reappointed to the central bank, he would take a more growth-friendly approach to monetary policy and bank supervision than Pridiyathorn has.)

The prospect that the Thaksin government will dismiss Pridiyathorn disturbs Bloomfield and many other observers. As he points out: "In the longer term you need checks and balances in the system to keep growth from getting out of control. Pridiyathorn has put many necessary circuit breakers in place, and his removal would send a strong [negative] message to the market."

An academic at prestigious Chulalongkorn University in Bangkok, Thitinan Pongsudhirak, who wrote his recent Ph.D. dissertation at the London School of Economics on the Bank of Thailand, concurs with Bloomfield's assessment of Pridiyathorn: "He has put his foot down to stand on principle. He is trying to assert the Bank of Thailand's independence, and this has not gone down well with Thaksin. It seems at times he is almost daring the government to fire him."

It is certainly easy to get that impression. Pridiyathorn has raised interest rates by 100 basis points since August to cool the economy -- in the midst of a hotly contested election campaign in which Thaksin, a telecommunications billionaire, ran for his second term largely on the boast that his pro-growth policies had turned around the economy. Nor did Pridiyathorn ingratiate himself with the prime minister when he observed at a seminar held by the Thammasat University Economics Association in December that, from an economic perspective, it didn't matter who won the election. Either party, the central bank chief explained, would inherit a stable, well-managed macroeconomy, and voters should opt for the party with the better medium- and long-term economic vision (which party that was he carefully declined to specify).

The politically weakened yet still feisty chief opposition Democrat Party (which now holds just 96 seats in the lower house) warned during the campaign, and continues to insist, that Thaksin's high-octane economic policies could lead to a 1997-style implosion. "Sustainability is the major concern" for the government, says Korn Chatikavanij, the Democrat Party deputy leader who is charged with overseeing economic affairs. "They haven't seen the follow-up investments from their consumption policies that they had hoped for. Low interest rates have boosted growth, but you can't do that forever. It's looking more and more challenging for them."

IRONICALLY, WHEN PRIDIYATHORN WAS TAPPED to run the central bank in mid-2001, he was at first viewed as too accommodating. In 1999, two years after the Asian financial crisis hit, 47 percent of all outstanding credits in Thailand's financial system had been deemed by the central bank to be nonperforming. In full crisis mode, it had taken custody of more than half of those bad loans, worth nearly 1.4 trillion baht ($36.6 billion). But in mid-2001 almost B900 billion worth remained in cold storage at the bank's rescue facility, the Financial Institutions Development Fund. Meanwhile, debt restructuring had bogged down. Asset foreclosure was proceeding at a snail's pace. Most of the country's banks were teetering on the brink of insolvency. And Thailand's economy was in the doldrums.

Pridiyathorn dramatically broke with his well-regarded predecessor, Chatumongkol Sonakul. He eased harsh austerity measures and rolled back strict regulations that had been aimed at restoring investor confidence in banks but that -- four years later -- were constraining recovery, in his judgment.

"After the crisis everyone was in bad shape," he says from his posh office overlooking Bangkok's muddy Chao Phraya River. "If I had maintained all those strict regulations, which were up to a New World standard -- which were even tougher than before the crisis -- all our sick patients would have died."

After initially hiking the rate on the bank's benchmark 14-day repurchase rate by a full percentage point, to 2.5 percent, in June 2001, in the name of "stability," Pridiyathorn turned around and started to loosen monetary policy to spur growth. By mid-2003 the repurchase rate stood at 1.25 percent -- a record low.

Bucking the global trend toward tighter money in last year's first half, Pridiyathorn didn't tinker with the repurchase rate until August, incrementally edging it up to 2 percent by the end of last year. On March 2 the bank's monetary policy committee raised rates a further 25 basis points, citing a need for stability following a slowdown in growth because of the December tsunami, a drought and higher oil prices.

No less critical to Thailand's recovery effort than Pridiyathorn's easy-money strategy was his tempered philosophy of bank supervision. The governor had the central bank adopt an accommodating, "support-oriented" approach to overseeing banks rather than a strictly "regulation-oriented" one.

"Formerly, regulators were very good at saying, 'This is a malpractice, that is a malpractice,'" explains Pridiyathorn. "I said, 'That's okay, but what I want is not just banks with good practice but banks that are performing their duty in the economy. We must share this obligation with the banks' management.' With this attitude the cooperation between commercial banks and the central bank now is very, very good."

Pridiyathorn's contacts among Thailand's banking elite from his two decades as a banker and seven years as head of the Ex-Im bank have been a boon to his delicate mission. "We are able to use a Thai way of communicating. We are friends; we use personalities to get things done," he has said.

Immediately upon taking over the central bank, Pridiyathorn held heart-to-heart chats with Thai bankers to gain an intimate insight into their institutions' financial straits. Then, courting still more controversy, he relaxed a rule that barred banks from lending to business clients with a record of nonpayment. Instead, banks were allowed to judge a borrower's creditworthiness on a loan-by-loan basis. The governor reasoned that this was the best way to get Thai banks to resume lending to crisis-ravaged and debt-ridden but basically sound businesses.

~!SIDEBAR 493972, 2, width /!~

This so-called reclassification strategy came in for sharp criticism from many foreign analysts, who argued that giving deadbeat debtors access to new loans raised moral-hazard risks and threatened to undermine nascent efforts to introduce a credit culture based on prudence in Thailand. "Overall, Pridiyathorn has done quite a good job," says J.P. Morgan Chase analyst Bloomfield. "But we haven't always been thrilled with everything he has done."

Thailand's nonperforming loans have dropped from nearly 50 percent of all credits at the height of the crisis to 10 percent. Still, some analysts wonder how many of the restructuring deals, brokered in a climate of record-low interest rates, will come undone now that the bank has begun to raise rates.

As Pridiyathorn discovered, though not to his total surprise, lowering interest rates was only part of what was needed to get banks to return to the urgent business of making new loans. Months after the central bank reduced its benchmark rate in 2002, capital-starved Thai banks were still competing vigorously for deposits -- paying as much as 3 percent on time accounts.

"I asked them: 'What are you guys doing?'" recalls Pridiyathorn. "'With rates that high and margins so low, you are killing yourselves.' After a straight talk they all started to reduce interest rates together."

As banks' spreads began to improve, so did their earnings. Average profits as a proportion of assets rose from negative numbers to 0.7 percent in 2003 and 1.5 percent last year -- on a par with Thai banks' profit margins in the early-1990s boom.

Pridiyathorn, though, wasn't the only one vigorously priming the pump. Thaksin had been elected prime minister in January 2001 on his promise that a more business-minded government could get Thailand's economic wheels turning again. He has implemented an array of expansionist policies, including a populist drive to use grants and loans to incubate a new class of small and medium-size entrepreneurs able to compete in global markets. Bangkok has employed state funds and tax incentives to revive the real estate market, as well as to prop up government-favored companies on the Stock Exchange of Thailand.

Thaksin recently unveiled bold new fiscal-stimulus schemes aimed at shifting the recovery into a higher gear. The government has earmarked as much as B2 trillion for infrastructure projects over the next four to five years, including an ambitious, B400 billion expansion of Bangkok's mass transit system.

The December 26 tsunami, which cost the lives of some 3,000 Thais and 2,500 foreign visitors and devastated a number of Thailand's beach resorts, apparently won't have much impact on the larger economy. The Bank of Thailand estimates that government and private reconstruction spending will offset much of an expected temporary drop-off in tourism.

Pridiyathorn asserts that Thailand has now "fully recovered" from the Asian financial crisis, pointing to a wide range of indicators to underscore his optimism. GDP grew 6.5 percent in 2003, and official estimates suggest the economy grew at a similarly brisk pace last year. Standard & Poor's Corp. upgraded Thailand's sovereign debt rating to BBB+ last August. Along Bangkok's traffic-choked streets indications of a new boom are ubiquitous. Building cranes dot the skyline. Domestic consumption is buoyant, and factories are humming along at near-boomtime levels of 75 percent. "We are back to the good old days," says Pridiyathorn.

YET FOR ALL THE PROGRESS, THERE ARE GROWING concerns about the sustainability of Thailand's revival. They hinge mostly on the massive amount of lending by state-owned banks.

Most conspicuously, Krung Thai Bank, the country's second-biggest by assets, accounted for 70 percent of all new wholesale and retail lending in Thailand in 2002 and 2003. Ministry of Finance officials handed Krung Thai's officers annual lending targets. Private sector bankers carped that Krung Thai's lending spree forced them to cut their rates.

As early as the beginning of last year, Bangkok bank analysts were posing pointed questions about Krung Thai's balance sheet -- and about the conspicuous lack of intervention by the central bank. "Clearly, the aggressive growth at state-policy banks [e.g., the Government Housing Bank] and state-owned commercial banks was becoming a big concern for the banking system," says Vincent Milton, the managing director of Fitch Ratings in Bangkok. "The time was ripe to toughen up regulatory oversight."

Pridiyathorn and his deputies, meanwhile, had begun applying the brakes to areas of the economy that they believed were at risk of overheating. To prevent a bubble from forming in consumer finance, the central bank boss imposed an 18 percent annual interest rate cap on credit cards. And reversing his 2002 decision to scrap minimum salary requirements for credit card holders -- a policy that jibed nicely with the government's desire to stimulate consumption-led economic growth -- Pridiyathorn reinstated the rule in November 2003.

In addition, in mid-2004 the central banker announced a 70 percent cap on the amount that developers and commercial real estate buyers could borrow against the value of a project. That promptly put many ambitious real estate ventures on hold, although Bangkok's high-end condominium segment is still on the upswing. Pridiyathorn also required banks to submit details of projects valued at more than B100 million.

Then he dropped a bombshell. Last August, Pridiyathorn forced Krung Thai Bank to reclassify 12 loans worth $1.1 billion, or 5 percent of its portfolio, as nonperforming. "We have the duty to make sure banks are not overly optimistic and do not make bad loans," explains Pridiyathorn. "It's just an early precaution, and it pays. If you wait another year, it may be too late. We have taken the right precaution and over the past year have calmed down overheating in real estate." Nevertheless, investors dumped Thai bank shares, and concerns about contagion spread.

Pridiyathorn launched a central bank investigation that uncovered irregularities behind some of Krung Thai's loans -- a dark reminder of the politically motivated lending and rampant corruption that contributed to the 1997 collapse. On February 14 the central bank brought fraud, embezzlement and malfeasance charges against 21 Krung Thai directors.

Further political fireworks may be on the horizon. Former Krung Thai executive director Suchai Jaovisdha is among those facing criminal charges. His older brother, Suchart, was Finance minister and chief government custodian of Krung Thai Bank at the time that Suchai was allegedly overseeing suspect loans in 2003. Suchart was conspicuously missing from Thaksin's newly named cabinet. Krung Thai's in-house investigation of its bad loans blamed middle-ranking loan officers. Bank executives declined to be interviewed for this article.

The Bank of Thailand's reclassification of the Krung Thai loans was notable not just for the size of the assets involved; it also marked the first time that central bank auditors had applied a qualitative yardstick to loan appraisals, gauging the borrowers' ability to repay, not just their payment records. These tougher, less mechanical criteria were a signal to bankers and investors that Pridiyathorn intended to tighten standards.

Some Thai banks welcome the move. "We are actually quite supportive of what he is trying to do," says David Hendrix, executive vice president of Kasikorn Bank, one of Thailand's top privately held commercial banks. "Now that we've recovered, he's trying to lift Thai banks up to international standards -- that's our goal, too."

Still, some banking analysts complain that Pridiyathorn's adoption of qualitative criteria was too abrupt and should have been telegraphed better to foreign investors. "First we're told banks have enough capital, then all of a sudden, they don't," says Andrew Maule, head of banking research at ABN Amro Asia Securities in Bangkok. "Apart from transparency issues, the inconsistency causes unnecessary volatility in the system. We'd like to see more cut-and-dried criteria." In defense of his policy shift, Pridiyathorn contends that qualitative criteria are in keeping with best international practices and, what's more, are critical to Thai banks' meeting the impending Basel II capital rules.

Maule and most other economic and financial analysts give Pridiyathorn high marks for his tough stand on Krung Thai, interpreting it as an indication that the Bank of Thailand means to assert its independence and check the government's economic policy excesses. But such independent-mindedness has not endeared Pridiyathorn to the Thaksin government the way it has to foreign investors.

When the central bank chief refused to endorse the reappointment of Viroj Nualkhair as Krung Thai's president, it put Pridiyathorn on a collision course with Finance Minister Somkid, who had appointed Viroj. The two officials sparred in the press, and Pridiyathorn won out: Viroj was not renamed, and his replacement as Krung Thai chief was an outsider, Apisak Tantivorawong. Since his appointment last November, Apisak has dramatically scaled back Krung Thai's lending, putting it solidly on a par with the average Thai bank's 10 percent or so annual loan growth.

Pridiyathorn's unbending stance on Krung Thai has put him in a tight spot politically, however, as Thaksin had been relying heavily on the bank to finance his growth policies. In October the prime minister told reporters that central bank reform was lagging and that the institution had become too centralized around its governor. And last month Thaksin's chief policy adviser, Pansak Vinyaratn, publicly faulted the central bank's management of foreign exchange reserves, arguing that at $47 billion they were too high.

Pridiyathorn takes strong issue with these official complaints. For a start, he says, diverting reserves to pump priming, as the government has proposed, violates the central bank's bylaws. As for reforms, he cites his ongoing drive to downsize the bank's 4,000-strong bureaucracy by one quarter by 2007. He also claims that he has institutionalized checks on his own authority, in line with making the bank much less hierarchical. "I used to count seven procedures to get something done in the past," Pridiyathorn says. "Now it only takes three. Being flatter, the chain of command is shorter, so the work process is faster. That's universally accepted."

The central bank chief sees his mission of reforming the bank in the most fundamental sense: He would like to restore the Bank of Thailand to its past glory. The bank's failed defense of the baht depleted the national coffers and triggered the Asian financial crisis. Revelations of high-level political corruption at the quasi-independent bank badly tarnished the once-august institution's reputation for competence and integrity.

The Thaksin government, though, does not appear to be mollified by Pridiyathorn's efforts to restore the bank's luster. The Ministry of Finance in January floated a radical proposal to strip the central bank of all responsibility for banking regulation and turn that pivotal task over to a new superregulator operating under the Ministry's purview.

Pridiyathorn has strenuously opposed the proposal. Analysts and investors have also balked at the Ministry's trial balloon out of fear that a powerful superregulator could fall captive to political interests. "The Bank of Thailand has reestablished itself as a credible regulator," contends Fitch's Milton. He suggests that Bangkok should institutionalize the central bank's independence from the Ministry of Finance. As it is, the Finance minister has the power to remove, as well as appoint, the central bank chief -- though not without the risk of upsetting investors. Predictably, the notion of independence for the central bank, though much in vogue in the wake of the 1997 crisis, has found little favor with the Thaksin regime.

If it is not accorded independence, the Bank of Thailand may have to rely in good part on Pridiyathorn's moral authority and the sheer force of his personality to assert its will. The central banker's unwavering self-confidence may have something to do with his royal lineage; his grandfather, Prince Devawongse Vapoprakarn, established Thailand's Foreign Ministry in 1892 and for more than a decade served concurrently as the country's chief diplomat and general comptroller of the Treasury.

Pridiyathorn's self-assurance no doubt also flows in some measure from his Wharton School education, his two decades as a successful commercial banker -- he rose to senior executive vice president of Thai Farmer's Bank -- and his presidency of the Ex-Im bank from 1993 to 2000. He has a healthy sense of perspective, the kind that central bankers need and too many elected politicians lack.

"There's a very good saying: Anyone who is not too concerned about saving his or her own chair can always do the right thing," says Pridiyathorn. "Any government would go for growth, so you need some organization to make sure that growth is achieved with stability. How can we go along with them, make sure growth is achieved while telling them that they need stability -- without offending or comforting them? That is the art. That is my job."