BOT foreign exchange losses in 2006 from baht appreciation
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
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Last week the Bank of Thailand (BOT) reported a loss of 174 billion baht for 2006. Most of the loss came from changes in the value of foreign currency assets (foreign reserves) that the bank accumulated during 2006 while defending the baht against further appreciation. Further appreciation in the baht would have made Thai exports less competitive on international markets.
These large losses will remind many of the 2005 guilty verdict against former central bank governor Rerngchai Marakanond. Mr. Rerngchai was ordered, effectively, to pay back the 186 billion baht of foreign reserve losses the central bank accumulated under his tenure. The foreign exchange losses announced last week are roughly the same:
1997: "...Mr Rerngchai approved the use of the country's foreign reserves to defend the baht from intense attacks by speculators between Nov 1, 1996, and June 30, 1997, before admitting defeat on July 2, 1997. The central bank, under Mr Rerngchai's direction, entered into more than 2,000 swap transactions to intervene in currency markets. The swap decisions later resulted in losses of about 186 billion baht due to the depreciation of the baht after it was floated."2006: "The Bank of Thailand posted an unaudited net loss of 174 billion baht for 2006
There are important differences in the two foreign reserve losses.
The 1997 losses came from depreciation after an unsuccessful attempt to defend a fixed exchange rate. They were not normal operating practice. The 1997 losses also have to be reduced by the inflation over the last ten years for an accurate comparison.
The 2006 losses arise from appreciation of the baht and appear to be a normal cost of operations for Asian central banks aimed at reducing volatility in an exchange rate. Another major difference is the policy of transparency and adherence to international best practice of the current Finance Minister M.R. Pridiyathorn Devakula who was in charge of the BOT for most of 2006. For example, Pridiyathorn has been very successful at stabilizing the
"That effective exchange rate stability is a goal of policy in Thailand is made more plausible by the way that the baht traded before and after the change of central bank governors at end-May 2001. Before, a general policy of not intervening, and rather using variations in restrictions on cross-border capital flows to influence the exchange rate, left the baht among the more volatile currencies in East Asia other than the yen. Its bilateral dollar volatility was not far below that of sterling. From June 2001 to end-2005, the baht’s volatility, especially in effective terms, fell to levels below those observed for sterling and not far above those of the Singapore dollar, which is explicitly managed against an effective basket. Whether the goal is to stabilise the level of the effective exchange rate around some target path set to be consistent with the inflation target, as in Singapore, or only the volatility of the effective exchange rate is hard to say. (McCauley, 2006, 176, see below)
Pridiyathorn's tenure as BOT head was 31 May 2001 - 6 October 2006. For further reading, read the Bank of England's Primer on Exchange Reserves. And the following informative paper on monetary policy in Thailand and Malaysia:
McCauley, Robert Neil (2006) "Understanding monetary policy in Malaysia and Thailand: objectives, instruments and independence," in Monetary policy in Asia: approaches and implementation, BIS Papers No. 31, December 2006, from a conference held at the Hong Kong Monetary Authority in November 2005. [http://www.bis.org/publ/bppdf/bispap31.htm]
Reading Questions
Here are some questions to guide your reading (See answers at end):1. How much did the Thai central bank lose from foreign exchange reserves that fell in value after the baht depreciation last year?
2. How much of the loss came from foreign exchange reserves?
3. Is this an official and final figure? (Use inference)
4. How much did the central bank's foreign exchange reserves increase last year ?
(Give percentage)
6. On the accounting books of the central bank, how are foreign reserves
held? (Give percentage breakdown)
7. What does the "operating loss" represent?
8. What caused the loss from holding foreign currency assets to
be greater than the return from holding these assets?
9. Why did the central bank's foreign reserves increase last year?
10. Did other Asian countries intervene in foreign exchange markets last year?
11. What would have happened if the central bank did not intervene, according to Dr. Atchana?
12. What steps were taken by the central bank to lessen appreciation?
13. Why evidence is there that the central bank losses were part of normal operation and not a reflection of incompetence?
14. What implication in the article is there that Korean foreign exchange losses could have been even worse?
Article: 24-02-2007
BANK OF THAILAND / CURRENCY MARKET INTERVENTIONCentral bank posts net loss of B174bn from stronger baht
PARISTA YUTHAMANOPThe Bank of Thailand posted an unaudited net loss of 174 billion baht for 2006, primarily due to valuation effects on the country's foreign reserves from last year's appreciation of the baht. Atchana Waiquamdee, a deputy central bank governor, said of the total loss, 173 billion resulted from the valuation of the bank's foreign currency asset portfolio based on exchange rates at the end of the year. The central bank made an operating loss of one billion baht for 2006.
Foreign reserves rose by $15 billion last year, from $52 billion in January to $67 billion in December.
Of the assets, $29 billion was held in the central bank's investment portfolio, $36.6 billion reserved to back banknotes in circulation and the rest held with the Exchange Equalisation Fund.
The central bank's operating loss stemmed from interest costs of 4% to 5% on the bank's outstanding bonds issued to absorb liquidity in the market. Foreign currency assets meanwhile generated an average return of 7% for last year, but this was offset by the baht's appreciation.
The baht last year strengthened from 40.8 baht to the dollar in January to 36 at the end of the year, resulting in the value of the bank's foreign currency assets declining in baht terms.
Dr Atchana said the build-up in foreign reserves in 2006 stemmed from the central bank's intervention in the market to help slow the appreciation of the baht.
"We intervened in the market heavily last year. But central banks throughout the region did the same. If we hadn't, the baht would have strengthened more than 17% last year," she said. While the central bank had diversified its portfolio away from the dollar to other currencies, the baht still appreciated across the board.
"The loss did not reflect any incompetence by the bank in reserve management," she said.
Dr Atchana said many central banks in the region were expected to post losses for 2006, given heavy intervention to slow the appreciation of their currencies against the dollar. South Korea's central bank, for example, posted a 2006 balance sheet loss, even though the bank had not revalued its reserves based on market prices at the end of the period under a process known as mark-to-market.
Dr Atchana stressed that the losses would not affect the central bank's operations as they were unrealised. A planned amendment to the Currency Act would also allow the bank to separate unrealised losses from operating losses, so that it would not affect contribution to the Finance Ministry.
In 2005, the central bank posted a 1.7 billion baht net loss, with a 7.43 billion baht loss resulting from valuation effects.
Vocabulary (in discussion above)
foreign reserves - "These are assets of the central banks which are held in different reserve currencies such as the dollar, euro and yen, and which are used to back its liabilities, e.g. the local currency issued, and the various bank reserves deposited with the central bank, by the government or financial institutions." (See Wikipedia on Foreign Exchange Reserves)
an audit - "an independent assessment of the fairness by which a company's financial statements are presented by its management. It is performed by competent, independent and objective person or persons, known as auditors or accountants, who then issue a report on the results of the audit." (From Wikipedia on Audit)
unaudited - has not been audited yet, official financial reports issued regularly are usually audited
valuation effects - changes in the value of assets that cause gains or losses
banknotes in circulation - cash (paper baht) held by the public (in circulation = outstanding, see below)
Exchange Equalization Fund - a foreign-exchange management unit of the central bank
x stemmed from y - x was caused by y
outstanding - held by investors, money borrowed that has not been paid back yet (For example, you will have to pay your outstanding bills with the store before you can purchase more)
outstanding bonds - bonds held by investors
a liquid asset - cash, or an asset that can be quickly sold and converted into cash (real estate is usually not very liquid)
liquidity, market liquidity - "an assets ability to quickly be liquidated or converted through an action of buying or selling without causing a significant movement in the price and with minimum loss of value" (See Wikipedia on Market Liquidity)
absorb liquidity in the market - decrease the money supply, in open market operations exchanging assets like bonds for cash which reduces or absorbs the amount of cash in the economy (See Wikipedia on Open Market Operations or the Bank of England's handbook on Foreign Exchange Reserves Management, especially pages 24-29 on liquidity management)
x offset by y - the effect of y was reduced by x (for example, losses from chicken sales were offset by hamburger sales)
a build-up in - increase in the amount of (for example, there was a build-up in weapons before the war)
intervention in the market - actions by the government to change prices in a market (normally the demand of buyers and the supply of sellers determines prices)
reflect - show, prove, demonstrate (for example, his inexpensive clothes of the millionaire do not reflect his wealth)
incompetence - unable to do their job or task properly
Currency Act - Read the act at the Bank of Thailand.
Answer Key:
1. How much did the Thai central bank lose from foreign exchange reserves that fell in value after the baht depreciation last year?
174 billion baht.
2. How much of the loss came from foreign exchange reserves?
99% of the loss came from foreign exchange reserves.
(173 billion / 174 billion)
The remainder, 1%, was an "operating loss."
3. Is this an official and final figure? (Use inference)
Probably not. It is "unaudited" and official reports are usually audited.
4. How much did the central bank's foreign exchange reserves increase last year ?
(Give percentage)
Foreign exchange reserves rose by 29%.
[(67 - 52 billion) / 52 billion]
6. On the accounting books of the central bank, how are foreign reserves
held? (Give percentage breakdown)
Central bank investment portfolio - 43%
Backing banknotes in circulation - 55%
Exchange Equalisation Fund - 2%
7. What does the "operating loss" represent?
The operating loss represents the normal cost of doing open market operations.
(bonds issued to absorb liquidity in the market) which is the way central banks control interest rates and the money supply (See Wikipedia on open market operations)
http://en.wikipedia.org/wiki/Open_market_operations
("The central bank's operating loss stemmed from interest costs of 4% to 5% on the bank's outstanding bonds issued to absorb liquidity in the market.")
8. What caused the loss from holding foreign currency assets to
be greater than the return from holding these assets?
The great appreciation of the baht wiped out the average return on foreign currency assets of 7%.
("Foreign currency assets meanwhile generated an average return of 7% for last year, but this was offset by the baht's appreciation.")
9. Why did the central bank's foreign reserves increase last year?
"The build-up in foreign reserves in 2006 stemmed from the central bank's intervention in the market to help slow the appreciation of the baht," according to deputy central bank governor Dr Atchana.
10. Did other Asian countries intervene in foreign exchange markets last year?
Yes. ("We intervened in the market heavily last year. But central banks throughout the region did the same.")
11. What would have happened if the central bank did not intervene, according to Dr. Atchana?
The baht would have appreciated even further, by 17%, instead of what it did appreciate by, which is not given.
12. What steps were taken by the central bank to lessen appreciation?
The central bank diversified its portfolio, moving some of its portfolio from dollar assets to assets in other currencies.
("While the central bank had diversified its portfolio away from the dollar to other currencies, the baht still appreciated across the board.")
13. Why evidence is there that the central bank losses were part of normal operation and not a reflection of incompetence?
Many central banks in Asia intervened heavily in the foreign exchange markets to slow appreciation of their currency and suffered losses as a result.
("The loss did not reflect any incompetence by the bank in reserve management," she said...Dr Atchana said many central banks in the region were expected to post losses for 2006, given heavy intervention to slow the appreciation of their currencies against the dollar.)
14. What implication in the article is there that Korean foreign exchange losses could have been even worse?
If Korea had use the market price to value its foreign assets, it would have lost even more. That is what the "even though" in the following following passage implies:
"South Korea's central bank, for example, posted a 2006 balance sheet loss, even though the bank had not revalued its reserves based on market prices at the end of the period under a process known as mark-to-market."
