Read the article below, then answer the following questions. The article

comes from the period leading up to the 1997-1998 Asian financial crisis,

which started in Thailand but then spread worldwide.

The Economist May 17th 1997

The scorching hot morning of Monday May

12th might have been the start of a betterthan-usual week for Thailand's embattled

financial authorities. The steady climb of

America's dollar against the Japanese yen

had gone into reverse. That should have

eased pressure on the Thai currency, the

baht, which is linked to a dollar-dominated

basket of currencies. Its strength has for

months made it subject to sporadic attack,

as the Thai economy has weakened. But

by Thursday, the central bank had spent

nearly $10 billion defending the baht's peg.

It had raised interest rates for offshore borrowers to more than 1,300% to deter speculators. Devaluation, which the government

had resisted almost as a matter of national

pride, was looking inevitable. And, as the

stock market index fell to its lowest level

for eight years, Thailand's dismal economic

spiral took yet another turn downward.

The government's own actions contributed mightily to the baht's travails. A

senior economic advisor had been quoted

as suggesting a devaluation might be necessary. This deviation from official policy was swiftly denied. But it fueled rumors of an imminent ditching of the finance

minister, Amnuay Viravan, and a shift in

policy. The impression of confusion was

heightened by an emergency meeting on

May 11th which saw the prime minister,

Chavalit Yongchaiyudh, announce that he

was going to take personal charge of the

economy. Meanwhile, the economic news

keeps getting worse. The government had

predicted that Thailand's GDP would grow

by 6% this year. That now seems very optimistic. Exports, whose growth had led

a decade-long boom, have failed to expand

since the start of 1996. The inefficiency of

Thailand's labor-intensive industries, combined with the overvalued baht, has been

bad for business. The drive to become an

exporter of more advanced goods received

a blow this month when Texas Instruments

pulled out of a highly publicized electronics joint venture because of Thailand's economic difficulties.

Due to the slowing economy, the government is heading for its first budget

deficit in more than ten years. The size

of the projected shortfall ($770 million) is

not enormous. But the very fact of a deficit

adds to the sense of drift. Hapless efforts to

rescue the floundering financial and property sectors only reinforce that feeling. As

much as 400 billion baht of property loans

have gone bad, leaving banks and finance

companies in serious trouble. Rescue plans

are moving slowly.

Devaluation will make their life even

harder. Many banks have borrowed in dollars to make high-interest baht loans or finance baht costs. Of Thailand's foreign

debt of about $90 billion, some $70 billion is owed by the private sector, much

of it by financial institutions. While the

value of the bank's assets keeps shrinking

as the property market collapses, the value

of their foreign liabilities continues to rise.

a. (2 Points) The article states that the exchange rate of the Thai baht

has been closely tied to the U.S. dollar. Why should a depreciation

of the dollar against the yen help Thailand's economy?

b. (3 Points) Why might the interest rate on baht deposits have risen

as high as 1,300 percent?

c. (3 Points) In a diagram, show how a statement by "senior economic

advisor" that a devaluation might be necessary would affect the foreign exchange market and the Thai central bank's foreign exchange

reserves.

d. (2 Points) Explain how banks that have borrowed dollars and made

baht-denominated loans would be affected by a devaluation of the

baht.