The Hindu Business Line : Panic in Bangkok...<br> ... With baht on the boil

As quickly as Thailand imposed restrictions on foreign investments, it withdrew them, at least partially, going by the impact on the stock market. A. SESHAN analyses the Thai crisis and suggests that India, which is headed towards full convertibility, may have lessons to draw.

The knee-jerk reaction of the stock market in India to the meltdown in Thailand is a striking illustration of the increasing globalisation of the Indian economy and the impact of this process on the country's fortunes. In contrast, the 1987 worldwide crash had been non-event in India.

December 18 Measures

On December 18, Dr Tarisa Watanagase, who recently took over as Governor of Bank of Thailand (BoT), announced that despite restrictive measures limiting speculation in the Thai baht, short-term flows of various forms continued to persist, as evidenced by the volatility of the currency and its rapid appreciation. The BoT, therefore, decided to implement an unremunerated reserve requirement on short-term capital inflows. Financial institutions were required to withhold 30 per cent of foreign currencies bought or exchanged against the baht, except those relating to trades in goods and services, or repatriation of investments abroad by residents, to be deposited with the central bank effective December 19.

Foreign investments in mutual funds, foreign currency borrowings, property funds and foreign-currency-denominated loans were also included in a subsequent clarification of the regulatory measure. Reserves would be returned with no interest for investments held in the country for one year with shorter-term investments penalised at 10 per cent. The Thai market crashed and the BoT modified its restrictions exempting equity and foreign direct investments. Intra-company loans between foreign companies and domestic subsidiaries are also expected to be covered in the rule, forcing local firms to borrow in baht to finance their operations.

Authorities relaxed the regulation after the Stock Exchange of Thailand (SET) Index fell 14.84 per cent per cent on December 19 in the market's largest one-day loss, with the main index losing 108.41 points to 622.14 points. The Index has since rebounded slightly, closing at 680.31 points on December 22. The baht was trading at 36.36/44 to a dollar on December 22. It had been around 35 on December 18.

Pressure on the baht

To understand the severe measures taken by the BoT, a look at the background. The baht had been under pressure for quite some time. There had been huge capital flows to the bond market for quick profits from investments and currency appreciation. In November, short-term capital of $500-600 million entered the government bond market. Outstanding commercial papers and corporate bonds rose sharply to baht 200 million and baht 600 million respectively, from baht 30 million and baht 500 million respectively, at the beginning of the year. The bond market became a conduit for speculators to pump in foreign money as the central bank had limited non-resident deposits to baht 300 million. Trade in fixed-income securities ballooned as foreign investors took positions in baht-denominated assets in anticipation of a further weakness of the dollar. According to the Thai Bond Market Association, outright transactions by foreign investors in November alone totalled baht 102 billion or 17 per cent of total transactions — double the volume recorded the previous month.

This year, till end-November, the currency had appreciated against the dollar by 13-14 per cent breaking the 35.9 baht barrier leading to appeals from exporters for help from government. Despite the central bank's measures to curb baht speculation, the currency remained up by 13.3 per cent, which was much higher than the appreciation of Indonesia's rupiah (7 per cent), Vietnam's dong (9 per cent), Malaysia's ringgit (5.4 per cent) the Philippine peso (6.9 per cent) and China's renminbi (3.1 per cent) against the US dollar. Further, the advantage in import cost reduction was not available for small and medium firms using local raw materials heavily.

December 4 Measures

Stringent measures were announced even as early as December 4, which did not attract much attention internationally, perhaps because they did not cover the stock markets. On that day, the BoT said that the rapid appreciation of the baht, resulting from the depreciating trend of the US dollar and the economic stability of Thailand and the Asian region, had caused capital to flow from US dollar-denominated markets into the Asian markets, including those of Thailand. In addition, the BoT found significant short-term flows into the debt securities market that also contributed to increased volatility of the currency.

To prevent speculation in the currency, financial institutions (FIs) in Thailand were advised on December 4, of restrictions on short-term transactions with non-residents. Sale and purchase of all types of debt securities through sell-and-buy-back transactions with non-residents for all maturities were banned. FIs could enter into transactions with non-residents for settlements relating to investments in securities only when they were longer than three months. They could borrow baht from non-residents without underlying trade or investment for a maturity longer than six months.

The Exchange Control and Credits Department had announced, even on December 4, that it was considering a withholding tax on short-term inflows, which surprisingly did not get much publicity, either locally or abroad. It was the actual introduction of this measure on December 18 that caused the turmoil in the Asian markets.

State of Thai Economy

The Thai economy has done well in the recent period. The GDP growth is expected be around 5 per cent. Although headline inflation rose to 3.5 per cent in November from 2.5 per cent in October, the overall economic stability improved, as reflected in the continued deceleration of core inflation from 1.8 per cent in October to 1.7 per cent in November. According to the experts in the private sector, Thailand's exports are likely to grow by less than 10 per cent next year if the baht remains below 38 per dollar. A strong baht is expected to reduce the competitive edge of Thai exports in such fields as textiles and garments and gems and jewellery, the latter employing more than one million skilled craftsmen, 70 per cent of whom live in the rural areas. These are the sectors where Thailand faces competition from India. The baht's strength is estimated to have caused forex losses of 10 billion baht and one billion baht for the textiles and garments, and gems and jewellery industries, respectively.

For the 11 months of 2006, Thailand's total exports amounted to $118.99 billion, up 17.2 per cent compared with the corresponding period in 2005. Imports reached $116.80 billion, up 7.5 per cent. The surge in exports increased Thailand's trade surplus to $2.18 billion compared with a deficit of $7.08 billion in the earlier period.

Reflections on the Reserve Rule

The BoT Governor considered the reserve rule as more flexible than an outright tax, and had deliberated on a number of reserve ratios ranging from 10-50 per cent. The 30 per cent rate is equal to an opportunity cost of 1.5 per cent, given that inflows could yield returns of 5 per cent on interest rates and 15 per cent from the appreciation of the baht. The central bank has foreign reserves of about $65 billion, compared with $49.8 billion at end-2004. Foreign reserves climbed as the central bank had purchased dollars to curb baht appreciation from capital inflows. BoT bonds were then issued to absorb the excess liquidity in the market through a process of sterilisation. (Unlike the Reserve Bank of India, the BoT issues its own bonds for open market operations.)

But the baht's gain this year has already caused the central bank to post paper losses of baht 300-400 billion, as the value of the bank's reserves has dropped in local currency terms. Interest costs for central bank bonds stood at baht 50 billion per year. The BoT feels that the cost imposed on investors is not that high and that the heavy selling came from what it calls "a market panic".

There are many parallels between India and Thailand and we can certainly learn a lesson or two from the latter even as we progress towards the full convertibility of the rupee.

(The author is a former Officer-in-Charge of the Department of Economic Analysis and Policy of the Reserve Bank of India. The views expressed are personal.)