The Bank of Thailand's policy interest-rate cut may not be able to rein in the appreciating baht as expected. A BOT study has found that the interest-rate spread does not have a significant impact on the currency.

The report states that during the downward trend when the policy rate went from 2.5 per cent in July 2001 to 1.25 per cent in July 2003, the baht strengthened from Bt45.62 against the dollar to Bt41.78.

Entitled "Impact of Interest Rates on Foreign Exchange", the report maintains that whether an interest-rate change affects the baht depends on two conditions: the interest-rate spread must have an impact on capital movement, and the capital movement must act as a key factor for a change in foreign-exchange value.

However, the study found that interest-rate spread was only one of many factors affecting capital movement. Confidence, risk and expectations about foreign exchange also have a huge impact on capital movement.

Capital movement is also one of many factors influencing the baht, regional currencies also playing a key role.

The interest-rate spread has a partial impact on capital movement. For example, the spread

was reduced from 0.2 per cent in 2003 to minus 0.56 per cent in 2005, but the narrow spread did not cause higher capital outflows.

In contrast, there were net capital inflows of US$2.6 billion (Bt91 billion) in 2005, compared with a net outflow of $0.2 billion in 2003.

"The figure indicated that interest-rate spread is not the only factor that foreign investors consider for capital movement," said the report.

According to the report, confidence and risk also play key roles in capital movement. This is reflected in the risk aversion to emerging markets in the middle of last year and the beginning of this year when foreign investors transferred their assets out of emerging markets into developed ones. The situation happened although the interest-rate spread of the two markets did not change significantly.

Moreover, expectations about foreign-exchange values also stimulate capital movement. Aside from the interest-rate change, foreign-exchange movement causes a return on investment.

"If the investors expect any currency to appreciate by fundamental economic factors or speculation, investment in assets of that currency, despite a low interest rate, will be attractive," said the report.

According to the report, aside from capital movement, regional currencies have influenced the baht. The baht has been stronger because of the current-account surplus and the strength of re-gional currencies against the dollar.

In the first 11 months of last year, capital flowing into Thailand amounted to $5.5 billion.

After the 30-per-cent withholding reserve was introduced, $0.2 billion in capital flowed out in December and January, but the baht was up 0.6 per cent, and Nominal Effective Exchange Rate rose 1.8 per cent from the end of last November to the end of January.

Despite the capital outflows, the baht was strengthened by the current-account surplus of $2.8 billion during those two months.

Anoma Srisukkasem

The Nation