The onshore baht surge: Underlying causes?
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
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Today's article by Bangkok Post business reporter Parista Yuthamanop is a tour de force of foreign exchange and financial markets terminology.
Today's vocabulary, in the vocabulary section below, is grouped by concepts such as: derivatives, liquidity, regulations, and financial markets.
This will enable you to study the many ways that these words are used in the article before reading.
As you'll see, todays article explains why there was another round of strong baht appreciation yesterday.
The baht appreciation was caused by a change in regulations regarding foreign exchange transactions by foreigners.
The goal seems to be to slowly bring the onshore baht exchange rate in line with the offshore rate.
Experts seem to be expecting further baht appreciation.
For further reading, study past Bangkok Post articles on Thailand's monetary and exchange rate policy and also financial markets.
Also read today's Bangkok Post article on how experts over at the Export-Import Bank of Thailand are planning for the eventual end of the current boom in Thai exports.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. What new level did the baht reach yesterday?
2. How significant is this new level?
3. What event was the precipitating factor behind this sudden change?
4. What will foreigners or Non-Residents (NR) now be allowed to do that they weren't previously?
5. What special conditions apply to this new arrangement?
6. How does the BOT expect this change to improve conditions in onshore and offshore baht markets?
7. What caused the split of the market for baht into two separate onshore and offshore markets? When did the split happen?
8. Why is hedging baht currency exposure more expensive offshore than it is onshore?
9. What exactly do the December capital controls require? How has the scope and strength of these controls been gradually modified and weakened?
10. Will these measures stem the appreciation of the baht and make exporters happy?
11. How much of the current baht appreciation is due to inflows into the Thai stock exchange which are essentially betting on further appreciation of the baht? (Express your opinion)
Bangkok Post Article July 10, 2007
Eased rules cause baht to surge
Capital inflow after swap rules changedPARISTA YUTHAMANOP
The baht continued to gain ground against the US dollar yesterday, reaching a new 10-year high at 33.77/8 to the greenback. The gain came as the Bank of Thailand announced that it would allow foreign investors to renew swap contracts with local banks for certain transactions over a one-month window. The move aims to reduce the gap between local and offshore rates. The baht was quoted at 31.65 to the dollar in offshore trade.
Most Asian currencies closed higher yesterday against the dollar on expectations of stronger economic growth and continued capital inflows into the region. Regional equity markets also closed higher, with Sydney, Mumbai, Hong Kong, Jakarta and Seoul all closing at all-time highs.
Suchart Sakkankosone, the senior director for the central bank's exchange control and credits department, said that foreign investors could now hedge their currency exposure for certain transactions with local banks.
The rule change would help reduce the gap between the onshore and offshore markets, he said.
The baht has effectively been split between the onshore and offshore markets since last December, when the Bank of Thailand imposed stringent capital controls to curb "hot" capital inflows that had led to a 15% appreciation of the baht in 2006.
Mr Suchart said the regulatory change would help foreign banks and non-resident investors who had undertaken currency swaps with hedging in the offshore market. These markets came under pressure due to low liquidity following the 30% reserve rule on inflows imposed on Dec 18.
The central bank would now allow foreign investors to hedge their exposure in the domestic market for transactions matched with an underlying investment as long as that investment originated before Dec 19, 2006.
Investors unable to complete the transaction within the timeframe could apply for an exemption from the central bank.
Mr Suchart said that onshore swaps for qualifying transactions would be exempted from the 30% reserve rule, and could be taken from July 16 through Aug 17.
He said the thin liquidity in the offshore market meant that investors closing open positions faced higher financing costs due to the baht's scarcity. This in turn resulted in further pressure on offshore rates for the baht to appreciate, which had a psychological impact on domestic rates.
"Before the 30% reserve rule was imposed, there was no rule that hedging had to be made with Thai institutions. As a result, some foreign investors undertook hedging transactions with foreign institutions," he said.
Mr Suchart stressed that foreign investors could sell dollars onshore to close contracts only to match their actual investment transactions priced at existing market rates.
The offshore contract could only be closed with an onshore contract at the maturity date of the original deal, he added.
The Dec 18 rule required foreign investors to set aside a 30% reserve for inflows into certain asset classes.
But the rule has been made largely moot, with exemptions offered for foreign direct investment and equity investments. The central bank has also waived the rule for inflows fully hedged against currency risk.
Usara Wilaipich, a senior economist with Standard Chartered Bank, said the measure would help to narrow differentials between onshore and offshore baht exchange rates.
"In the end, the measure will help to improve sentiment. The closer gap between the two markets should prove supportive for the central bank's lifting of the 30% reserve requirement in the future," she said.
But a local treasurer, who asked not to be named, said the measure could result in more Thai currency circulating in the offshore market.
"The measure would help to bring the offshore baht rate and swap premiums closer to the onshore market. But it may fail to address the long-term problem," he said.
The measure would increase the central bank's workload as it limited the screening process to a one-month period.
"The central bank should allow investors to obtain baht liquidity gradually, instead of setting 'golden minutes'. There could be limitations as to how well the central bank could screen cases," the trader said.
Thiti Tantikulanan, the head of capital markets at Kasikornbank, said that recent trends indicated that the baht would continue to appreciate.
The currency could possibly reach 33.70 to the dollar by the end of the week.
"The baht is likely to continue to strengthen due to strong fundamentals. For instance, Kasikorn Research Center projects the current account surplus this year to be as high as $12.5 billion," he said.
Mr Thiti said the central bank's rule change yesterday would have no real impact on the currency, noting that the baht continued to strengthen in intraday trade.
Vocabulary (in discussion above)
Derivatives - Vocabulary
derivatives - traded financial assets that derive their value from other assets (base assets), for example an option to buy a stock share in the future, a contract to deliver a commodity in the future, or a contract to swap your money for money in another currency for a time, derivative are used to hedge against market risks
risk - uncertainty about the future, price volatility or volatility in total returns on an asset which could include annual dividends too (See The Economist on risk)
risk exposure - volatility in asset and returns on the assets you hold
* he is exposed to a lot of risk
* he has a lot of risk exposure
hedge - protecting yourself against risk by exposing yourself to a new risk that offsets the existing one (See The Economist on hedging)
hedge their currency exposure - reduce risk of exchange rate volatility with an asset that moves in the opposite direction, if the price of one asset goes up when the other goes down they cancel each other out
a swap - when two people exchange the cashflow of a liability or an asset for a limited period of time, derivatives such as swaps are one method of hedging (See The Economist on derivatives)
swap contracts - an agreement to swap currencies for a period of time
renew - continue, do again
* renew swap contracts
* renew swap contracts with local banks
a currency swap - foreign exchange swap, exchanging one currency for another for a limited period of time (See Wikipedia and Economist on derivatives)
onshore swaps - a swap in Thailand
bring the offshore baht rate and swap premiums closer to the onshore
market -
Regulations: Vocabulary
stringent - strict, tough regulations
ease rules - make rules less strict and tough
impose regulations - create regulations
capital controls - government restrictions on capital moving into and out of the country (See The Economist)
non-residents (NRs) - foreigners, people who are not Thai
non-resident investors - foreign investors
the 30% reserve rule on inflows -
moot - not real (for example, a moot court competition is a competition that simulates a real law court)
the rule has been made largely moot - the rule is not really a law, nto effectively a law, because another law has superceded and replaced it
waive - give permission not to do (See glossary)
waived the rule for y - give y permission not to follow the rule
* increase the central bank's workload
screening - check for problems
Liquidity - Vocabulary
liquidity - having cash or assets quickly convertable into cash (See glossary)
low liquidity - have little cash (to do business with and survive)
market liquidity - money changing hands in buy and sell transactions
thin liquidity - very little buying and selling
* thin liquidity in the offshore market
* obtain baht liquidity gradually
Markets and Price Movements - Vocabulary
onshore markets - markets inside Thailand
offshore markets - markets outside of Thailand
the greenback - the US dollar
gain ground against - appreciated when compared to
closed higher yesterday against the dollar - appreciated when compared to the dollar
all-time highs - the highest ever, a record high
markets came under pressure - some event caused buying and selling which caused the price to go up (buying) or down (selling)
* resulted in further pressure on offshore rates for the baht to appreciate
* help to improve sentiment - make people feel more optimistic about market developments
close a contract - to bring a contract to the an end
close a swap contract - to pay back the currency that you initially swapped for another currency
sell dollars onshore to close contracts - sell dollars to pay off swap contracts within Thailand
a window - a limited period of time
over a one-month window - during a limited period of one month
complete the transaction within the timeframe -
Kasikorn Research Center - a for pay research center at Kasikorn Bank (See website)
current account surplus - roughly exporting more than importing (See The Economist)
intra - within
intraday trade - buying and selling in the market during the day
tour de force - a skilled performance
Export-Import Bank of Thailand - a government owned bank which started operations 1994 which provides support to Thai investors overseas as well as local investors in business relating to export or business which earns or saves foreign exchange (See website)
in line with - agree with, be equal to (See glossary)
the precipitating factor - the trigger, the cause that started, the immediate cause (See glossary on trigger)
Answer Key:
1. What new level did the baht reach yesterday?
In onshore trading the baht reached 33.77 to the dollar and 31.65 in offshore trading.
2. How significant is this new level?
This new level was the highest level in the 10 years since the 1997 crisis, so it is very significant.
3. What event was the precipitating factor behind this sudden change?
The BOT made a change in its foreign exchange regulations.
4. What will foreigners or Non-Residents (NR) now be allowed to do that they weren't previously?
Foreign or Non-Resident (NR) investors could now hedge their currency exposure for certain transactions with local [onshore] banks" instead of relying on expensive hedging at offshore banks as they have since the capital controls were imposed in December.
5. What special conditions apply to this new arrangement?
Foreigners will only be allowed to move their currency exposure hedging from offshore to onshore for investments originating before Dec 19, 2006 when capital controls were imposed.
"The central bank would now allow foreign investors to hedge their exposure in the domestic market for transactions matched with an underlying investment as long as that investment originated before Dec 19, 2006."
6. How does the BOT expect this change to improve conditions in onshore and offshore baht markets?
The change will "reduce the gap between the onshore and offshore markets."
7. What caused the split of the market for baht into two separate onshore and offshore markets? When did the split happen?
The baht market split into separate offshore and onshore markets when capital controls were imposed last December.
("The baht has effectively been split between the onshore and offshore markets since last December, when the Bank of Thailand imposed stringent capital controls to curb "hot" capital inflows that had led to a 15% appreciation of the baht in 2006.")
8. Why is hedging baht currency exposure more expensive offshore than it is onshore?
There are not a lot of transactions in the offshore market (thin liquidity) therefore transactions cost more.
("He said the thin liquidity in the offshore market meant that investors closing open positions faced higher financing costs due to the baht's scarcity. This in turn resulted in further pressure on offshore rates for the baht to appreciate, which had a psychological impact on domestic rates.")
9. What exactly do the December capital controls require? How has the scope and strength of these controls been gradually modified and weakened?
a. Investors had to "set aside a 30% reserve for inflows into certain asset classes."
b. There are exemptions for FDI and equity investment, and inflows fully hedged against currency risk.
("The Dec 18 rule required foreign investors to set aside a 30% reserve for inflows into certain asset classes."
("But the rule has been made largely moot, with exemptions offered for foreign direct investment and equity investments. The central bank has also waived the rule for inflows fully hedged against currency risk.")
10. Will these measures stem the appreciation of the baht and make exporters happy?
Not likely. Most experts agree the baht will continue to appreciate.
11. How much of the current baht appreciation is due to inflows into the Thai stock exchange which are essentially betting on further appreciation of the baht? (Express your opinion)
