What will happen to capital controls
and central bank independence
with Thailand's new government?
By Jon Fernquest |
An op-ed piece in today's Bangkok Post takes a look at the problem of what to do with the baht if the baht starts appreciating again.
The newly elected People Power party (PPP) has "pledged to remove the 30% reserve rule on inflows as part of a programme aimed at reviving foreign investment and sentiment."
To refresh your memory about what "capital controls" are, what they've become, and how they originated, today's article provides some background:
The reserve rule, first announced on Dec 18, 2006, initially required foreign investors to set aside 30% of their inflows as an unremunerated reserve with the central bank, and was structured as a penalty against short-term "hot" inflows.But the policy has attracted considerable criticism from investors, who are typically wary of any obstacles impeding their ability to bring in - and take out - capital.
Dec 19, 2006, the date when the 30% reserve requirement took effect, will be remembered as a historic day for the Thai economy. The baht was under a significant upward pressure in 2006, as the current account reversed from a deficit of $7.9 billion the previous year to a surplus of $2.2 billion.
Foreign investors flocked to baht-denominated assets in speculation of further currency appreciation and higher yields, pushing the baht up 17% for the year up to mid-December 2006, or more than double the gains posted by other regional currencies against the dollar.
Capital inflows totalled $10 billion in the first 10 months of 2006, compared with $8 billion for all of 2005. Only $800 million went into the Thai bond market, and inflows into the Stock Exchange of Thailand were on par with the previous year. But inflows into bills of exchange, a form of debt instrument, doubled while inflows into property funds quadrupled from the previous year.
The central bank, cognisant that exports were crucial for economic growth as domestic demand and investment remained weak, began signalling in the fourth quarter of 2006 that "measures" would be taken to clamp down on speculative inflows. But inflows continued to grow, leading the central bank to impose its blanket reserve rule on the capital market.
As originally announced, foreign exchange transactions against the baht of more than $20,000 would be subject to the 30% unremunerated reserve requirement. The reserve would be refunded in full after a one-year period, otherwise a 10% penalty would be imposed.
On Dec 19, 2006 the SET dropped 14.8%, the largest one-day loss in the history of the stock market. The market capitalisation of the SET shed 820 billion baht as investors dumped their positions in panic.
While the government reversed its stance and exempted equity inflows from the measure later that day, the market decline inevitably resulted in weaker investor sentiment and a negative wealth effect for consumers...
Today, the reality is that much of the original capital control measure has been diluted. For most asset classes, with the exception of the bond market and property funds, the reserve rule has either been waived or eased with investors given the option to exempt their flows if they fully hedge their currency exposure. Rules remain in place requiring investors to manage flows through special non-resident accounts, but this is less of an outright barrier than an added administrative requirement.
Eliminating capital controls would have a salutary effect on Thailand's fledgling bond market:
"Eliminating the rule for the bond market...would help market development and potentially attract needed foreign funds to meet rising demand for capital from both the public and private sectors this year.At present trading by foreign investors in the bond market stands at just 1% of daily turnover, compared with 15% before the Dec 18 control was enacted."
Central bank independence has been a big issue debated in Thailand for a long time (Read previous articles: article1, article2, all articles on 2007 currency crisis).
Central bank governors such as Ben Bernanke in US have authority that is independent from elected governments because in the past politicians have attempted to pump the economy up temporarily before elections, sacrificing long term health and stability for a temporary good showing at the polls. The most famous case was the pressure that US President Richard Nixon exerted on then Fed chairman Arthur Burns to create a favourable economy for the 1972 elections (See Nixon's politcal business cycle and historical political business cycles in the US at EH.NET).
Thailand's export industries are the sector of the Thai economy most likely to be exerting political pressure to keep the baht weak so that their export prices can remain competitive on international markets.
China has used a strategy of foreign reserve accumulation to keep their currency weak and exports strong and then to use these accumulated reserves to invest strategically in the world economy via sovereign wealth funds, a strategy that has quickly become controversial as they become the only alternative available to bail failing financial insitutions out from their subprime troubles.
Several decades ago South Korea's president Park Chung Hee spearheaded a successful export-driven growth strategy formulating an industrial policy and micromanaging many aspects of the Korean economy including the exchange rate and the allocation of credit and import quotas strategically to different promising export industries. (See Dani Rodrick's blog on industrial policy at Harvard).
(Source: Bangkok Post, 24-01-08, temp-link)
Vocabulary:
pledged - made a serious promise to do something
30% reserve rule - the law that requires some kinds of investment money flowing into Thailand, to deposit money to ensure that the money will stay in Thailand for at least one year
refresh my memory - mention some details about something so that I can remember what you are talking about
reviving - bring to life again
sentiment - general feelings about something, wither positive (optimistic) or negative (pessimistic)
unremunerated - not paid for (interest not paid on money you deposit, for instance)
wary of - cautious because there might be danger or problems
obstacles - things make it difficult to do something
impeding - preventing activity or making activity more difficult
under a significant upward pressure - factors are causing it to increase a lot, but it hasn't increased yet
flocked to - came in large numbers to
baht-denominated assets - assets that you must pay for in baht
on par with - equal to
bills of exchange - a promise to pay at a specific time issued to suppliers by purchasers in exchange for goods. Bills may be held to maturity or sold at a discount on the money market if cash is required sooner (Source: Prentice Hall glossary)
a debt instrument - a written promise to repay a debt
quadrupled - increased to four times larger than it was initially
cognisant that... - knowing that...
clamp down - take strong official activity to control illegal activities
speculative - buying something in hope of later selling for a profit
impose - force people to do something
blanket - covers everything, applies to everything
market capitalisation - the total value of all a company's stock shares, or in the case of a stock market like SET, the total value of all the shares traded on the stock market
dumped their positions - sold the investments they had, turned them into cash
in panic - strong fear and anxiety, that makes people act without thinking carefully
reversed its stance - changed its opinion
exempted - given permission not to follow a rule (See glossary)
inevitably - certain to happen, cannot be prevented, cannot be avoided
negative wealth effect - reduced the value of their savings or wealth
diluted - making weaker and less effective
waived - when an authority says someone does not have to follow a rule
given the option to - was allowed to make the choice to
hedge their currency exposure - protect themselves from losing money because the currency changes value (the baht appreciates, for instance)
outright - complete and total
an outright barrier - something that completely prevents entry into a place
have a salutary effect on - an experience that is good for you in the end, even though it may not seem so to begin with
fledgling - new and without experience (like a baby bird not yet out of the nest)
central bank independence - when the central bank is left without political interference to pursue long-term monetary policy objectives such as inflationary targets
exert pressure on X - use pressure to get something they want from X
foreign reserves - foreign currencies that a government possesses
accumulation - collecting together a large number of things over a period of time
sovereign wealth funds (SWFs) - large funds of money that a government accumulates and invests (See Wikipedia)
spearheaded - lead in an aggressive fashion
export-driven development - the strategy of developing an economy by generating national wealth from exports to other countries
industrial policy - government policy to influence which industries expand and which shrink using subsidies, tax breaks, and other incentives and rewards
micromanage - when a manager involves themselves with low level details of operations rather than delegating them to other lower level managers
allocation - giving part of something to someone
credit - loans of money made to companies and people
quotas - limitations on the quantity that someone gets
