Holding the monetary policy course
in the face of continued baht appreciation
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
 |
As baht appreciation continues those affected are raising their voices.
Central bank governor Dr. Tarisa Watanagase and Finance Minister Dr. Chalongphob are sticking to their guns, maintaining a relatively independent and stable monetary policy, while at the same time providing a well-reasoned set of answers to the questions raised by those pushing for more intervention.
The official long-term policy objective remains inflation targeting and not exchange rate targeting. [Inflation Target, Exchange Rate Policy, Papers from 2000 Conference]
Dr. Chalongphob's comments drew attention to larger scale world market forces at work. Noting that investors shifting out of dollar-denominated assets were generating capital inflows into the region.
Dr. Tarisa noted that despite some capital inflow into the stock exchange being short-term and speculative, the stock exchange has also drawn long-term investment attracted by the "strong economic fundamentals" of the Thai economy.
For further reading, check out diagrams at the BOT that describe monetary policy and its effect on the economy.
Also check out the frequently updated speeches and presentations of central bank governors and deputy governors. Noteworthy is the following recent quote in which Dr Tarisa addresses a greater worldwide appetite for risk and lower risk premia:
On the other hand, numerous transitory factors may also have been responsible for this change in risk appetite and risk premia. A reversal in any of these factors could result in risk aversion away from emerging markets and destabilizing capital flows, and a rise in risk premia. Let me name a few factors. Firstly, the situation of global imbalances and slide of the USD has led to preference for investment in emerging markets, particularly given ongoing – but by no means sustainable - expectations of appreciating currencies in emerging market economies. Secondly, low interest rates worldwide and the high level of global liquidity have led to search for yield in riskier investments. This may be a temporary phenomenon if we believe that the extended period of accommodative monetary policy worldwide is unsustainable, and eventually monetary would need to tighten to compensate for this era of profligacy. Thirdly, similar investment strategies employed by hedge funds and other funds could lead to momentum trading and herd movements, both in terms of inflows and outflows. Any shocks that trigger a change in these strategies could result in large movements of capital." Dr. Tarisa Watanagase, Governor : "Panel Discussion on Financial Globalisation, Capital Flows, and Challenges for Central Banks" at 77th BIS AGM, Basel, Switzerland (24 June 2007) [Speech]
Check out a recent discussion paper with a surprising conclusion:
Runchana Pongsaparn (June, 2007) "Inflation Targeting in a Small Open Economy: a Challenge to Monetary Theory," Bank of Thailand discussion paper, [Paper Link, Discussion Papers]Abstract: This paper aims to address the role of exchange rate under inflation targeting as a practical challenge to modern monetary policy facing a central bank in a small open economy – with a particular focus on Thailand. Monetary theory and empirical evidence have provided conflicting policy recommendations regarding the role of exchange rate under inflation targeting. In theory, the objective of monetary policy could be achieved by a single policy instrument – interest rate. Exchange rate is endogenous to the change in policy rate through UIP condition and plays only subsidiary role as a channel through which the policy rate can transmit. The paper proves that, in practice, the linkage between interest rate and exchange rate is weak as evident in the failure of UIP, while exchange rate movement is found to have an important implication on output but not so much on inflation. Therefore, exchange rate may be used as another policy instrument to complement interest rate. The optimal blend between the use of interest rate and exchange rate is an important practical challenge to a small open economy under inflation targeting.
Study past Bangkok Post articles on Thai monetary policy and financial markets.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. Is Thailand alone in experiencing currency appreciation?
2. Would central bank intervention to stem baht appreciation likely have the intended effect, according to the central bank governor?
3. What are the two motives for foreigners investing in Thai securities?
4. Why do you think retail investors should "exercise caution" like the article suggests? (Express your opinion)
5. What has the impact of baht appreciation been on expectations about the future of the export sector in Thailand?
6. Does the fact that Thai exports have jumped an impressive 18% in dollar value mean they jumped this much in baht value?
7. Is Thailand's central banking policy to target the exchange rate or the inflation rate in its monetary policy?
8. What does the central bank adjust to achieve their target inflation rate?
9. What two statements did the central bank governor make about the effects of policy yesterday?
10. What group of people in the Thai economy has the recent baht appreciation helped?
11. Is Thailand's export sector a special strategic sector that should have economic policy (or industrial policy) especially made for it? (Express your opinion)
12. What large country is currently experiencing changes in its asset markets that is having a large impact on world currency markets? What big changes are taking place?
Bangkok Post Article July 11, 2007
CURRENCY / CONTINUING APPRECIATION AND ITS IMPACTInflows to SET keep lifting baht
Central bank sees relief in second half PARISTA YUTHAMANOPThe baht yesterday continued to gain ground against the US dollar despite intervention by the Bank of Thailand.
The currency strengthened to as much as 33.45 to the dollar yesterday, up from 33.77/80 on Monday. The baht has gained 7% against the dollar so far this year.
Central bank governor Tarisa Watanagase said the appreciation of the baht stemmed from capital inflows by investors in the stock market, and urged exporters to not panic and dump dollar holdings.
Capital inflows were affecting the entire region, she said, and added that any move by the central bank to weaken the baht against the market trend could spur even greater inflows and speculative activity.
Dr Tarisa said the central bank was ready to intervene in the currency markets to help smooth volatility.
In any case, regulators expected the baht to weaken in the second half of the year as exports slow and the current account surplus shrinks.
"There are expectations that the baht will weaken later in the year, in contrast to earlier projections that the baht would continue to strengthen," Dr Tarisa said, pointing to signs of a recovery in imports in April and May.
She added that investors should exercise caution given the rapid bull run in the stock market. The SET has been one of the hottest markets in the region this year, with the main market up 23% over the past three months.
From January to July 6, a total of $22 billion in capital has poured into Asia, helping push many regional markets to all-time highs.
The Stock Exchange of Thailand alone has seen foreign investors hold a net buy position of 120 billion baht for the year to July 9.
"If you ask whether capital inflows into the stock market represent speculation on the baht and stock prices, the answer is a bit of both," Dr Tarisa said.
"Yes, there are some who are investing due to the country's strong economic fundamentals and hold a long-term view. Other flows represent hot money for speculation. Retail investors should exercise caution."
The strengthening baht has raised fears over the sustainability of export growth and the impact of shrinking profit margins on local firms, particularly small and medium-sized companies and manufacturers that depend on local content.
Exports have been the main engine for economic growth this year, rising some 18% in US dollar terms for the year to date.
Dr Tarisa said the central bank would target the interest rate policy at inflation rather than exchange rates, adding that the relationship between interest rates and currency rates was uncertain.
"There is no certainty that an interest rate cut would result in fewer inflows," Dr Tarisa said. The central bank's Monetary Policy Committee will meet next week to decide whether to change its one-day repurchase rate, now set at 3.5%.
A regulatory change on Monday allowing foreign investors to borrow baht locally to settle offshore hedging positions had not affected exchange rates, Dr Tarisa added.
Finance Minister Chalongphob Sussangkarn said the appreciating baht had affected the price competitiveness of local exporters, but had also helped reduce the debt burden of companies with foreign loan obligations.
"You need to consider the overall picture, not just the impact on exporters. We don't want to see exchange rates move quickly, but we need to allow rates move in line with market forces," he said.
Dr Chalongphob said that Thailand and other Asian countries were attracting capital inflows as investors shifted out of dollar-denominated assets.
Rising investments by government agencies would help ease pressure on the baht over the next several months.
Vocabulary (in discussion above)
sticking to their guns - not changing, even under pressure to change
inflation targeting - when central bank policy tries to achieve an inflation target, if forecast inflation is above target then interest rates are raised, if below target then interest rates are cut, the current chairman of the American central bank Ben Bernanke is a well-known advocate of inflation targeting (See The Economist and Wikipedia)
x gains ground against y - x increases relative to y
intervention - central intervention in the foreign exchange market, buying or selling baht
currency strengthened to - currency appreciated or increased in value
stemmed from capital inflows - was caused by capital inflows
spur even greater inflows - cause even more increases in capital coming into the country
x in contrast to y - x compared to y (which is different)
projections - forecasts, opinion about future situation or value
exercise caution - be careful
bull market - stock prices increase and people are making money
rapid bull run in the stock market - bull market
hot money - short-term speculative money (like water boiling, the money is moving around nervously looking for opportunities)
retail investors - small non-institutional investors (for example, everyday people who invest their savings in the stock market)
sustainability - is possible to continue on into the future
sustainability of export growth - strong exports can continue
main engine for economic growth - the main factor causing economic growth
target the interest rate policy at inflation - interest rate is adjusted (as policy instrument) to control inflation rate (policy target)
central bank's Monetary Policy Committee - the committee at the central bank that makes monetary policy decisions and interest rate changes (Read description at the Bank of Thailand)
open market operations - the buying and selling by the central bank in financial markets that controls the level of liquidity in the economy and maintains a given target interest rate.
repurchase rate - the interest rate target that BOT open market operations aim to achieve:
BOT: "The BOT-operated repurchase market is the primary channel for the Bank’s open market operations. In order to maintain the policy rate, the Bank regularly injects and absorbs liquidity through the market while simultaneously acting as a matched-principal broker. The Bank has operated the repurchase market for over 25 years since its establishment in 1979."
BOT: "refers to interest rate quoted in the repurchase market, where BOT serves as the bond registry, agent of payment, and direct counterparty to each market participant. The underlying assets qualified for uses in this repuchase markets are goverment bonds, BOT bonds, and state enterprise bonds with government guarantee over principals and interests. BOT repurchase market existes for 1, 7, and 14 days, as well as 1, 2, 3 and 6 months maturities. Note that the 14-day repurchase rate is used by BOT as the intermediate target under the pursued Inflation Targeting monetary policy framework" (Source: Bank of Thailand)
one-day repurchase rate - the shortest maturity in the BOT repurchase market
settle - settle a financial transaction, pay the amounts owed
offshore - outside the country
hedging positions - amounts of assets being held to reduce the risk of other investments (hedging)
positions - amount of a financial asset currently being held
* settle offshore hedging positions
in line with - agreeing, matching
in line with market forces - agreeing or going along with market forces (not trying to work against or counteract the market)
Answer Key:
1. Is Thailand alone in experiencing currency appreciation?
No, capital inflows and currency appreciation are affecting the whole region especially India's large economy.
2. Would central bank intervention to stem baht appreciation likely have the intended effect, according to the central bank governor?
No, central bank intervention to stem appreciation might actually stimulate more speculation, greater capital inflows, and even more baht appreciation.
3. What are the two motives for foreigners investing in Thai securities?
Foreigners might be motivate to inves in Thailand:
a. For the long-term attracted by Thailand's strong economic fundamentals.
b. For the short-term, attracted by speculation and short-term profit (hot money).
4. Why do you think retail investors should "exercise caution" like the article suggests? (Express your opinion)
Maybe because short-term speculative investment can cause volatility in asset prices and make it easier to lose large amounts of money quickly.
5. What has the impact of baht appreciation been on expectations about the future of the export sector in Thailand?
Baht appreciation has "raised fears" about the "sustainability of export growth."
6. Does the fact that Thai exports have jumped an impressive 18% in dollar value mean they jumped this much in baht value?
Probably not, depending on how they calculate it, because the baht has appreciated, so dollars per baht have decreased, so the increase in exports
won't be as much if valued in baht.
7. Is Thailand's central banking policy to target the exchange rate or the inflation rate in its monetary policy?
To target the inflation rate.
8. What does the central bank adjust to achieve their target inflation rate?
The interest rate.
9. What two statements did the central bank governor make about the effects of policy yesterday?
a. There is no certainty that another interest rate cut would result in fewer capital inflows in the future.
b. Yesterday's change in regulations "allowing foreign investors to borrow baht locally to settle offshore hedging positions" has "not affected exchange rates."
10. What group of people in the Thai economy has the recent baht appreciation helped?
People who borrowed dollars and who are paying these loans back. Baht appreciation has reduced the debt burden of companies with dollar-denominated loans because they now pay back the loan with baht that is worth more.
11. Is Thailand's export sector a special strategic sector that should have economic policy (or industrial policy) especially made for it? (Express your opinion)
In export-driven growth such as South Korea experienced (1970-1990) or China is currently experiencing, appreciation could reduce exports and growth by making exports less competitive on international markets.
12. What large country is currently experiencing changes in its asset markets that is having a large impact on world currency markets? What big changes are taking place?
The United States. Investors are shifting out of dollar-denominated assets.
("'You need to consider the overall picture, not just the impact on exporters. We don't want to see exchange rates move quickly, but we need to allow rates move in line with market forces,' he said. Dr Chalongphob said that Thailand and other Asian countries were attracting capital inflows as investors shifted out of dollar-denominated assets.")
