Short term capital controls: Reaction of Thai economists
By Jon Fernquest[Introduction|Vocabulary|Article|Reading Questions|Answers]
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Yesterday, surprise imposition of short-term capital controls by the Thai central bank, followed by an equally quick reversal the same day, surprised many.
The reversal leaves controls on bonds and money market investments. Hopefully, with quick freeing of the stock market from controls foreign investors will quickly forget it even happened.
Many point out that after Malaysia imposed short-term capital controls to "stabilise" their currency, a long period passed before they were able to "restore confidence and attract investment back," but capital controls were imposed after the currency crisis in Malaysia and rather defiantly by Mahathir. Pridiyathorn is a pragmatist who does things transparently and, usually, by the book.
The harsh realities of international financial markets may have an impact. Many large institutional investors are said to have "explicit rules against investing in markets with capital controls." (Bangkok Post, 20-12-06, link) Open-ended mutual funds can also not afford to have money locked in for one year. (Bangkok Post, 20-12-06 link)
In this case, capital controls were imposed proactively: 1. to protect small exporters (who account for a large fraction of the Thai economy) from eroding competitiveness in international markets and future bankruptcy, and also perhaps 2. in anticipation of a currency crisis (small open economies like Thailand face the impact of the ongoing rebalancing of the US-China trade imbalance).
The Thai bond market is still in its infancy. How will these controls affect its development? That short-term borrowing costs will increase, notably for the Thai government, may be the most important short-term effect. (Bangkok Post Business, B2, link).
Possible reasons motivating the controls were presented in yesterday's Wall Street Journal Online. The current consensus of economists on exchange rate adjustments was cited:
"...There's a well-developed economics literature that explains why exchange rates that move by a large amount tend to do so abruptly. In a nutshell, the idea is that as soon as people start feeling that a substantial currency drop is imminent, everyone tries to dump it at the same time, ensuring that the fall becomes precipitous... (Paul Krugman provides a nice summary of the classic economic literature on the subject.)"
Some Thai experts have made calls for more Thai economics education. The assumption that all speculation is due to "gambling" by short-term speculators needs to be viewed more critically. Some speculation is actually necessary for the proper functioning of markets and the hedging techniques that exporters can use to protect themselves from short-term exchange rate fluctuations.
That some experts claim that the baht is still undervalued by about 10% when "considered on a purchasing power parity basis" certainly warrants a closer look. (20-12-06, B1, link)
To read the actual announcement at the Bank of Thailand (18-12-06) as well as the previous set of controls (04-12-06). The Economist also has coverage.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. What kind of capital controls are Thai academics calling for?
2. What kind of foreign investments do Thai academics want to encourage?
3. What kind of foreign investments do Thai academics want to discourage?
4. Is the reserve requirement of 30% too high? Should they be used for a short or a long time?
5. What result are many Thais expecting from the central bank's short term capital controls? Is this reasonable?
6. If the Bank of Thailand fails to weaken the baht with short term capital controls, what might happen to the way that people (investors, exporters, the general public...) think about it?
Bangkok Post Article: December 20, 2006
Experts: Speculation no, FDI yes
PARISTA YUTHAMANOPLeading academics have called for more comprehensive controls on speculative capital inflows while maintaining openness to foreign direct investment (FDI). Chalongphob Sussangkarn, president of the Thailand Development Research Institute, said the central bank should consider easing its new 30% reserve rule.
''The reserve requirement may be too high. If the central bank fails in its aim to weaken the baht, it will result in a loss of credibility,'' he said.
The central bank on Monday imposed a new rule requiring foreign investors to deposit a 30% interest-free reserve for transactions against the baht. Transactions backed by trade or investment are exempt.
The rule however prompted the sharpest one-day loss in the history of the Stock Exchange of Thailand.
Mr Chalongbhop said investors sold off shares to take profits on fears of a weaker baht, and that funds should eventually return to the stock market if backed by strong fundamentals.
''Previous measures to curb short-term speculation in the bond market have done little to stem the appreciation of the baht. So the central bank sought to control the funds directly,'' he said.
''The market is highly sensitive and difficult to control. The central bank may have underestimated the market. If they could turn back the clock, they probably would not issue such drastic measures.''
Teerana Bhongmakapat, an economist at Chulalongkorn University, said the central bank measure was an ''overdose''.
''Such measures are justified as a tool to stem short-term capital flows, but the reserve rule of 30% is too severe,'' he said, adding 3% to 5% would be better and that measures should be short term.
Mr Teerana said authorities should focus more on educating the public about currency risks rather than focusing on market intervention.
''We must understand the importance of the capital markets. We should also consider how much the public should bear currency risk. The state can't shoulder all the burden,'' he said.
''I don't think such measures are an appropriate way to control short-term flows. Better to adjust economic conditions through means of reducing public spending and reduce inflationary pressure to ease pressure on interest rates.''
Varakorn Samkoses, president of Dhurakijpundit University, said the central bank vastly underestimated the impact the measures would have on the market.
''The baht weakened by 50 satang yesterday in exchange for the loss of [800 billion baht] in value on the stock exchange. I think that's too much of a price to pay,'' he said.
Vocabulary (in discussion above)
Answer Key:
1. What kind of capital controls are Thai academics calling for?
Thai academics are calling for "more comprehensive controls on speculative capital inflows."
2. What kind of investment do Thai academics want to encourage?
Foreign direct investment (FDI). (long-term, job-generating, human capital building, export market building)
3. What kind of investments do Thai academics want to discourage?
Speculative capital inflows. (short-term, hot money, in and out, hedge funds, little concern over development of the economy)
Large amounts of "hot money" that flows into the country for a short period and then quickly flows out. Like an impersonal tsunami leaving a wake of destruction in its path.
4. Is the reserve requirement of 30% too high? Should they be used for a short or a long time?
30% is probablty too high. A small pcercentage like 3% or 5% for a short period of time might be better.
("'Such measures are justified as a tool to stem short-term capital flows, but the reserve rule of 30% is too severe,' he said, adding 3% to 5% would be better and that measures should be short term.")
5. What result are many Thais expecting from the central bank's short term capital controls? Is this reasonable?
Many Thais expect short-term capital controls to weaken the baht, but even experts are not sure that they actually will.
Baht appreciation could be either short or long-term.
If the baht is experiencing a long-term trend of appreciation, short-term capital controls will not weaken the baht.
If the baht is appreciating merely because short-term speculators are "gambling" on the baht, then short-term capital controls could weaken the baht.
However, no one is sure how much of the baht appreciation is long or short term. In fact, some claim that the baht is still undervalued by about 10% when "considered on a purchasing power parity basis." (20-12-06, B1, link)
6. If the Bank of Thailand fails to weaken the baht with short term capital controls, what might happen to the way that people think about it?
It might lose credibility, i.e. people might start thinking that it doesn't know what it is doing.
("If the central bank fails in its aim to weaken the baht, it will result in a loss of credibility.")
