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In the second half of last month, the dollar fell and the baht rallied past Bt34. Offshore portfolio investment accounted for the surge in gross international reserves. The current account also continued to show a surplus, expanding from $1.9 billion in August.

The central bank is now facing a dilemma in its foreign exchange management. On the one hand, it has attempted, futilely so far, to arrest the rise of the baht in order to accommodate exports. Through its foreign exchange intervention, it has bought the US dollar and sold the baht in the spot market in order to weaken the Thai currency.

Fearing that all the baht sold in the spot market could swamp the system, the central bank has almost simultaneously mopped up the baht liquidity through a sterilisation process. It uses a currency-swap scheme - selling the dollar into the forward market with a promise to buy the baht back. Yet still, the dollars purchased in the spot market have been more than the dollars sold in the forward market.

According to CitiGroup, the Bank of Thailand sustains its sterilisation operations by maintaining its net forward book, comprising mostly of dollar swaps, currently at US$14.2 billion, an intra-week gain of $52 million.

The Bank of Thailand "sterilised about $1.6 billion worth of baht over the past six weeks while allowing the baht to appreciate to Bt33.59/US dollar from roughly Bt34 during the week ending August 28".

"However, this amount sterilised was no match for what was 'accommodated' by way of higher gross international reserves accumulation by way of the central bank's dollar purchases in the spot market."

The problem with this foreign exchange practice is that the Bank of Thailand will be booking heavy losses. Since it has accumulated the dollar in the hope of driving down the baht - but the dollar is still dropping in value - its international reserves will log heavy losses in baht terms.

There are rumours the central bank might have already faced paper losses in excess of Bt500 billion.

The problem is that the central bank has not diversified its holdings away from the dollar fast enough when it is clear that the dollar can only go south in the foreseeable future.