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Published on July 26, 2007

If you look at the economic and financial policies at the moment, you will see several dilemmas and contradictions.

The Bank of Thailand (BOT) does not want the baht to become too strong. But it has been too slow and too clumsy to react to prevent the currency strengthening.

On December 18 last year, the BOT introduced draconian capital controls by separating the onshore and offshore baht markets. The move was aimed at curbing speculation against the baht by preventing foreign traders or investors from having access to the onshore baht.

The capital controls have squeezed out the baht liquidity in Singapore, prompting traders and investors to scramble for the baht. Their tendency is to sell US dollars and buy baht, thereby putting upward pressure on the baht. As a result, we are now seeing a widening gap of about Bt4 between the onshore and offshore baht rates. In Singapore, the baht is traded at more than Bt29/US dollar, compared with around Bt33.60/US dollar in Bangkok.

If the capital controls were removed, traders and investors would have more room to reverse their positions by selling the baht and buying the dollar, thereby helping to stabilise the baht through the market-force mechanism.

The wide gap between the onshore and offshore baht rates reflects a serious symptom in Thai economic and financial policies.

BOT Governor Tarisa Watanagase has insisted that with the capital controls, the onshore and offshore baht markets have been completely cut off. They no longer have any relationship with each other in practical terms, though psychologically speaking the Bt4 gap between the onshore and offshore rates might have some impact on investors.

Tarisa has tried to soothe concerns by arguing that the central bank, since July 15, has eased rules by allowing foreign investors to hedge their foreign exchange risks with local banks. In the long term, the gap between the two markets should converge, she said.

She admitted that exporters might feel nervous if the offshore rates become too high, prompting them to sell the dollar for the baht, which further pushes up the baht.

The government's attempts to stem the baht's rise by introducing all kinds of measures appears to go nowhere in bringing the situation under control.

"The fact that the onshore/offshore gap widened instead of narrowing despite news of the imminent measures suggests that the government is only addressing the symptom and not the cause of the problem - which is the liquidity squeeze in the offshore market from the capital controls," said DBS Research Group in its report issued on Tuesday.

"Offshore players are also sending another message to Thai policy-makers not to fight the baht appreciation, whose appreciation is supported by the fundamentals. Apart from robust trade surpluses, the currency is also supported by capital inflows into Thai equities in anticipation of the recovery in the economy."

For how long can we go against the market?

Second, the baht has become stronger because capital is moving into the country in a one-way street. There is no way for the money to flow out. The money flowing into the country to drive up the value of the baht comes from the trade surplus and foreign investment in the Thai stock market.

This situation has been going on for quite some time, but it was not until Tuesday that the Cabinet had a chance to introduce measures to liberalise the foreign exchange regulations. This would allow greater flexibility to exporters, Thai residents and companies to hold or manage foreign exchange the way they see fit.

What a stark contrast between the 30-per-cent withholding tax measures and the foreign exchange liberalisation package! Yet the Cabinet's measures are a bit too little, too late.

As a result of the government's attempt to bring down the baht, the currency has softened a bit to the Bt33.60/US dollar range. The level is significantly weaker than the 10-year record high of Bt33.0-Bt33.3 a weak ago.

"Nonetheless, the measures do have a significant effect in that the BOT is using available instruments to tamper with the level of the baht if it deems the level to be misaligned vis-a-vis the regional currencies as well as to the current state of the economy, but importantly without the draconian measures like those we experienced late last year," said UOB Economics-Treasury Research (July 24, 2007). UOB does not think that the Thai central bank will remove the capital controls any time soon.

There are two main reasons to remove the capital controls:

First, the onshore baht will have to depreciate by at least 10 per cent to Bt38/US dollar. Second, the trade surplus must narrow more significantly.

"We also think that BOT needs the assurance that speculative activities on the baht will not return once the measure is removed [which is the most difficult condition to fulfil]," said UOB.

 "At present, we think the measure will only be removed after the transition to a new government."

The exporters are lamenting the strong baht, which hurts their competitiveness. But whenever they sense the baht might become stronger, they rush out, like in early July, and dump their dollars to limit erosion of their profits.

The exporters would like the central bank to bear the burden of loss on the foreign exchange intervention alone, while they are quick to cover their positions.

Thai businesses have not started to import in significant volumes to upgrade their manufacturing. A recovery in imports will help cushion the baht's rise. This is probably the best way to rectify the currency problems.

Finally, Tarisa has hinted that the BOT is satisfied with the current level of the foreign reserves of more than US$73 billion. This implies that the central bank might not want to accumulate more reserves for fear of losing money from the buying up of the US dollar to keep the baht more stable.

Thanong Khanthong

The Nation