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Published on March 6, 2008

Now that the Finance Ministry and the Bank of Thailand (BOT) have joined forces to build demand for the dollar, the central bank believes the baht will eventually become stable purely as a result of market mechanisms.

While the economy is gradually picking up, the baht will weaken when the import of goods accelerates. The revocation of capital controls will allow further bond-market development without interruption and as the economic-restructuring process makes progress in the medium term, supporting factors such as low interest, the stronger baht and tax measures will come into play.

The BOT said it needed to manage inflation expectations amid inflationary pressure from oil-price rises. A rate cut could lead to a belief that the central bank cannot control inflation, which would indicate lowered competitiveness.

BOT Assistant Governor Suchada Kirakul said in an exclusive interview with The Nation that the baht will move in a two-way direction rather than one-way appreciation due to domestic factors, along with the expected influence of the US sub-prime crisis.

Demand for dollars will improve after commercial banks were allowed to lend more baht to non-residents and the Finance Ministry will gradually refinance foreign debt into baht. The ministry will also slow down the borrowing of new foreign loans or immediately swap external debts for local ones to reduce pressure on the baht.

The assistant governor recommended that Thai companies refinance their debts during this appropriate time when the baht is Bt10 stronger against the dollar compared to 2005.

The central bank, however, will step into the market if the currency remains strongly volatile which might lead to an adverse impact on the real sector. The BOT now has more tools to manage liquidity affected by the baht intervention.

"The baht will increasingly fluctuate," Suchada said. "We will not see one-way bets but two-way flows. If both exporters and importers hedge their exposures, the baht will not fall under pressure."

Before the BOT removed the capital controls, the baht had accelerated significantly because exporters quickly sold off their dollars while importers reduced their buying of dollars. Foreign investors also injected money into the Thai bond market despite being subject to the 30 per cent reserve requirement.

Last November, exporters hedged their incomes at 30 per cent of total export value but the hedging transactions reached 52 per cent in February. Importers reduced their hedging from 32 per cent in November to 20 per cent in February.

According to Suchada, Thailand is unlikely to experience an influx of capital inflows like it did in 2006 although domestic interest rates will be higher than US interest rates, thanks to changing environmental factors.

The US sub-prime crisis brings about credit-crunch conditions. Global funds are increasingly cautious about taking investment risks, particularly those in emerging markets. Risk aversion has become an important factor to be addressed as it can happen any time.

Suchada said that many foreign investors suffered an immense impact from the sub-prime fiasco, for example, and had to write down their losses. Investors will have to think harder about whether it's worth putting money in risky countries like emerging markets.

Moreover, the BOT's introduction of capital controls indicated to investors that the central bank could announce any drastic measure any time, so they will be more cautious about putting too much money into Thailand.

In 2006, a huge amount of capital had flooded into Asian countries, including Thailand, although the Thai policy interest rate was lower than the Fed fund rate of 5 per cent. At that time, the market bet on a one-way direction for the baht.

So far this year, the baht has generally been stronger by 6.58 per cent against the dollar, 9.57 per cent stronger against the Japanese yen, 8.72 per cent against the Swiss Franc and 7.05 per cent against the Australian dollar.

Suchada said the world's most powerful currency, the US dollar, would possibly turn around in the fourth quarter of this year or the first quarter of next year as a result of the Federal Reserve's bold moves to cut the Federal fund rate, Washington's fiscal policy, and capital inflows to buy cheap assets in the US.

"It depends on whether the market believes that the sub-prime crisis has come to an end or not," she said. "If the market forecasts that the measures introduced will quickly strengthen the economy, the dollar could turn around."

As the market expects the BOT to chop its policy interest rate while the government wants to boost the economy with growth of 6 per cent, Suchada said the BOT's decision on interest rates would take into account not only short-term but also medium and long-term conditions.

She said if lowering the interest rate caused higher inflation, manufacturers would suffer higher costs. A slow decision on the key rate to ensure low inflation would be able to restore confidence.

"Monetary policy has a lagging impact on the economy over four

to six quarters after implementation. It is not too late if the Monetary Policy Committee cuts the rate at its next meeting, but financial costs in the market have already decreased due to the decreasing bond yield curve," said Suchada.

Anoma Srisukkasem

The Nation