Capital control effect on Thai bond market?
By Jon Fernquest[Introduction | Vocabulary | Article | Reading Questions | Answers]
 |
1. Why were capital controls left on the bond and money markets?
2. What is happening in these markets that warrants capital controls?
3. What will the long-term effect of capital controls be on the developing Thai bond market?
4. Are there historical cases in other countries that can help predict the effect of capital controls?
An interview in today's Bangkok Post with the president of Thailand's BEX bond exchange provides some answers to these questions.
Thailand's 2006 capital controls resemble Chile's proactive capital controls more than Malaysia's post-currency crisis controls. When Chile used capital controls from 1991 to 1998 foreigners had to deposit money with the central bank in a similar fashion to the current requirement. This was called an "encaje" (Spanish: strongbox for keeping money). For further information read "Introduction to capital controls." [link], page 25.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. Will the current capital controls likely have a positive or negative effect on Thailand's bond market?
2. What are the capital control regulations? (State concisely but exactly what happens)
3. What kind of penalty is imposed on short-term investments?
4. Has bond trading in Thailand increased recently? By how much?
(Provide a percentage, note: bond trading volume = turnover)
5. Does the recent change in bond trading indicate that speculators are "attacking the baht" ?
6. What is a yield curve?
7. What has effect of capital controls been on the yield curve of Thai bonds?
8. What effects have the capital controls had on the volume of trading on the Thai bond market?
9. Who typically holds short-term debt instruments? Foreign investors?
Local institutions and individual investors. Foreign investors are "relatively small players" in short-term debt.
10. What are some examples of short-term debt instruments?
11. What kind of debt instrument do bond market authorities hope to get capital controls waived for?
12. Will it be easier or more difficult to enforce capital controls in the bond market compared to other financial markets? Why?
Bangkok Post Article: December 21, 2006
Bond market on pace to 'collapse'
NUNTAWUN POLKUAMDEEWhile the equities market has received a reprieve from the central bank's capital controls, the bond market will suffer considerably if curbs remain in place on foreign investment, said Santi Kiranand, president of the Bond Electronic Exchange. ''The Bank of Thailand should revise its policy to lock up 30% of foreign inflows as a deposit, otherwise the bond market will collapse in the near future due to a lack of confidence in government policy,'' Dr Santi said.
Under the central bank rule, financial institutions must set aside a deposit of 30% with the central bank for transactions of more than $20,000 against the baht. Funds will be returned after one year without interest, with earlier redemptions subject to a 10% penalty.
The rule effectively imposes a 10% penalty on short-term investments, and helped spur Tuesday's massive sell-off on the Stock Exchange of Thailand.
Policymakers have since announced that equity and foreign direct investments would be exempt, but that inflows into the money and bond markets would remain subject to the rule to curb heavy inflows over the past several months that were aimed at speculating against an appreciating baht.
But Dr Santi questioned the objective of the rule, noting that average daily trade on the Thai Bond Market Association and BEX was only 17 to 18 billion baht for the first 11 months of the year, with daily trade averaging 30 billion in November.
Yield curves rose by about 30 basis points at the longer end of the curve on Tuesday, and continued to rise by around seven basis points at the long end. Government bond yields in shorter terms from three to 14 years dropped by four to nine basis points.
''The effect of the BoT policy is to make the bond market less active. Investors are taking a wait-and-see attitude and market sentiment is pushing up long-term yields,'' Dr Santi said.
The increase in daily turnover on the bond markets did not necessarily indicate that foreign investors were aiming to attack the baht, he said, as trade was mostly focused on long-term instruments.
Foreign investors were relatively small players in shorter-dated debt, such as commercial paper or bills of exchange. The segment was largely dominated by local institutions and individual investors.
''If the BoT insists on using this control, ultimately the bond market will lose as foreign investors flee altogether due to the reserve expense,'' Dr Santi said.
Both the BEX, a unit of the Stock Exchange of Thailand facilitating real-time bond trading for individuals, and the ThaiBMA, an over-the-counter market for institutional investors, plan to co-operate with the Association of Custodians to gather data about foreign fund flows into the central bank.
Bond market authorities hope to convince the central bank to waive the capital control for fixed-income investments.
Dr Santi acknowledged that it was difficult to track fund flows in the bond market as trade was primarily made through foreign and local banks acting as dealers for both local and foreign clients.
''It's not as clear cut as trading through the SET or the Thailand Futures Exchange, where one can check immediately through brokers on the source and destination of funds,'' he said.
Efforts to develop the Thai bond market, however, will depend on foreign investment. ''I think the central bank knows best about how foreign investors use their funds. But we need to understand the relationship of how investors manage portfolios and switch among the money, bond and stock markets,'' Dr Santi said.
Vocabulary (in discussion above)
Answer Key:
1. Will the current capital controls likely have a positive or negative effect on Thailand's bond market?
Probably a negative effect. The bond market may even "collapse in the near future due to a lack of confidence in government policy."
2. What are the capital control regulations? (State concisely but exactly what happens)
Capital inflows of more that $20,000 into the Thai bond and money markets from abroad must deposit 30% of the value with the central bank for one year without interest. If the money is withdrawn before one year, 10% of the deposit is subtracted as a penalty.
Thailand's 2006 capital controls resemble Chile's proactive capital controls more than Malaysia's post-currency crisis controls. Chile's controls did not apply to the stock market though. When Chile used capital controls from 1991 to 1998 foreigners had to deposit money with the central bank in a similar fashion. This was called an "encaje" (Spanish: strongbox for keeping money).
3. What kind of penalty is imposed on short-term investments?
Effectively, a 10% penalty or tax.
("Customers seeking repatriation of reserves before one year would receive only two thirds of the withheld amount. (Bangkok Post, 19-12-06).")
4. Has bond trading in Thailand recently increased? By how much?
(Provide a percentage, note: bond trading volume = turnover)
Bond trading increased significantly during November by 67% to 76%.
(Calculation: 30billion - 18b / 18b to 30b - 17b / 17b)
("...average daily trade on the Thai Bond Market Association and BEX was only 17 to 18 billion baht for the first 11 months of the year, with daily trade averaging 30 billion in November.")
5. Does the recent change in bond trading indicate that speculators are "attacking the baht" ?
Not necessarily, according to the article, since "trade was mostly focused on long-term instruments."
However, what is to prevent someone buying a long-term debt instrument and holding it for only a short period of time?
Also, as the BOT governor previously stated, the baht has recently rose "'beyond economic fundamentals', with capital inflows of $950 million in the first week of this month against an average of $300 million per week in November." (Bangkok Post, 19-12-06)
6. What is a yield curve?
A yield curve compares yields on bonds of different maturities.
7. What has effect of capital controls been on the yield curve of Thai bonds?
Long-term yields have increased while short-term yields have decreased.
8. What effects have the capital controls had on the volume of trading on the Thai bond market?
Trading has decreased. Investors are hesitant about committing funds to the market right now.
("The effect of the BoT policy is to make the bond market less active. Investors are taking a wait-and-see attitude and market sentiment is pushing up long-term yields...")
9. Who typically holds short-term debt instruments? Foreign investors?
Local institutions and individual investors. Foreign investors are "relatively small players" in short-term debt.
("Foreign investors were relatively small players in shorter-dated debt, such as commercial paper or bills of exchange. The segment was largely dominated by local institutions and individual investors.")
10. What are some examples of short-term debt instruments?
Commercial paper or bills of exchange
11. What kind of debt instrument do bond market authorities hope to get capital controls waived for?
Fixed-income investments.
("Bond market authorities hope to convince the central bank to waive the capital control for fixed-income investments.")
12. Will it be easier or more difficult to enforce capital controls in the bond market compared to other financial markets? Why?
It will be more difficult than enforcing it in the stock or futures market because it is "difficult to track fund flows in the bond market as trade was primarily made through foreign and local banks acting as dealers for both local and foreign clients."
Stock and futures trading in Thailand is centralised at SET and the Thailand Futures Exchange which makes checking easier.
