Baht's strength is not what it seems

The Bank of Thailand is now facing a dilemma over how to manage the surging baht. It has been intervening frantically in the foreign exchange market to keep the baht from rising too fast and too soon. It is afraid that a strong baht will hurt exports. But the BOT is swimming against the tide of capital inflow and the current account surplus. Since the beginning of this year, the baht has risen 4.2 per cent to around Bt33.22 to the US dollar. If the trend continues, the baht could easily hit Bt32 to the dollar before the end of the year.

Actually, the baht is not getting stronger. It is the US dollar that is plunging on a downward adjustment. We only have to take a look at gold prices, which are reaching new record highs. Now, gold is trading at around $1,069 (Bt35,760) per ounce.

Investors are also leaving the financial markets and currencies and embracing hard assets instead. Confidence in the US economy and financial system is waning fast. For the US has not tackled the insolvency of its financial system. It has also continued to run a high deficit. Most important, the Federal Reserve will keep printing the dollar to meet debt obligations. Printing money will debase the value of the dollar. It will also threaten to create hyper-inflation in the future.

As of October 2, Thailand's international reserves (net forward position included) stood at $146.9 billion, an increase of 25 per cent ($28.9bn) from the beginning of 2009. The tide of capital inflow became noticeably significant from May, when international reserves surged by $19.3 billion or an average of $4.8 billion per month through to August. The trend did not slow in September. International reserves shot up $7 billion due largely to the BOT intervention via purchasing US dollarS.

By purchasing the dollar, the BOT pumps the baht into the system. Fearing that the baht might flood the financial system, it has to issue bonds to absorb the baht out. Between May and August, the BOT issued bonds totalling Bt24 billion ($700 million) or 3.6 per cent of US dollars purchased ($19.3bn). We would highlight that in September alone, the BOT issued bonds worth Bt135.8 billion ($4 billion) or 57.1 per cent of US dollars purchased ($7 billion). At the end of September, the outstanding BOT bonds stood at a high of Bt1.58 trillion versus Bt1.44 trillion in August.

There will be more capital inflow because investors around the world are shifting their funds to Asia, where growth prospects are brighter. This has created sleepless nights for BOT Governor Tarisa Watanagase. She said the authorities would closely monitor capital movements and denied that they would resort to measures to stem the inflow.

But since the BOT has been actively intervening to buy up the dollar, it is standing to lose money because the baht keeps on rising. When the total dollar reserves are booked in baht accounts, the BOT will post a big accounting loss. If the BOT loses money, it will create a loss of confidence. The BOT needs a revamp of its foreign exchange operation as the dollar value from its reserves keep on declining. If it does not manage the transition well, it will put the country's macro-economic stability at great risk.