BOT independence for innovation:
Currency swaps for currency stability
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
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Last week Thailand's new Finance Minister Dr. Chalongphob Sussangkarn declared that he would follow a strict policy of central bank independence.
How much independence does the Thai central bank governor currently have by law?
Technically not much, since the finance minister has "the authority to hire - and fire - the central bank governor with cabinet approval" (Bangkok Post, Business, 13-11-06) which means effectively that the finance minister can replace the governor whenever he wants, which we now know won't happen.
In November of last year the government was working on an amendment to the Bank of Thailand Act that would make the BOT more independent (See previous article on central bank independence)
The new Finance Minister also stressed that exchange rate volatility has to be controlled and that since the best way of controlling volatility is not yet known, the BOT would have to learn as it goes.
Both hedging and the 30% reserve rule are options for foreign investors. If hedging turns out to be less of a burden on investors, than currency swaps, the financial instrument used for hedging, might become an important part of Thailand's financial markets.
If foreign investors choose the hedging option, investment funds must remain in Thailand for at least three months and investors "must enter into a plain vanilla hedge with a custodian bank for a term of at least 3 months." (Source)
Today's article will look closely at the language used to describe these financial instruments and policy. It will also step through a real example of a currency swap to clarify the language used to describe them.
For further reading, check out the article "Central bank Independence: What does it mean?" and "Exchange Regulations in Thailand: A Guide for the General Public."
Reading Questions
Here are some questions to guide your reading (See answers at end):1. What kinds of political pressures has the Thai central bank faced recently?
2. How great was the immediate market response to loosening foreign exchange controls last week?
3. Why problem does capital controls address that every middle-income country like Thailand faces?
4. Why might the results of Thailand's experience with capital controls be useful to other countries?
Article: Bangkok Post 16-03-2007
Minister: BOT 'blazing a new trail' with reserve rule
'No pressure' for central bank to actWICHIT CHANTANUSORNSIRI
PARISTA YUTHAMANOP
The Bank of Thailand enjoys full independence in setting the country's monetary policy, Finance Minister Chalongphob Sussangkarn declared yesterday.
"I don't feel comfortable about these reports that the central bank is under pressure to lift the capital controls. These reports only encourage currency speculators," he said.
"Today I would like to reiterate that there is no pressure on the central bank to review what it has done."
Dr Chalongphob yesterday met with central bank governor Tarisa Watanagase at the Finance Ministry to discuss economic policy.
The central bank has come under growing pressure to cut interest rates and lift the Dec 18 reserve rule on capital inflows to help ease pressure on the baht and boost economic growth.
The baht yesterday reached a new nine-year high at 34.98 to the dollar as exporters continued to sell greenbacks in anticipation of further baht appreciation.
Bond yields, meanwhile, moved only slightly with 40 billion baht in transactions yesterday, the first day under which an exemption on the 30% reserve requirement took effect for foreign investors in Thai bonds and unit trusts. Transactions must be fully hedged through currency swaps to qualify for the exemption.
Some analysts have speculated that the appointment of Dr Chalongphob, a respected economist and former president of the Thailand Development Research Institute, indicated that the 30% reserve rule would soon be scrapped. But Dr Chalongphob, who sharply criticised the central bank in January for imposing capital controls, struck a more conciliatory tone yesterday.
"Every country around the world needs to manage the volatility of their currency, particularly middle-income countries. But what is the best way to accomplish that remains a question," he said.
"We are learning as we go, as there is little experience from other countries to help us," he added. "Indeed, we are blazing a new trail, and many other countries are watching closely to see what the results will be of our experience from what has happened over the past four months. In the end, they might have to take similar actions to control their own currencies."
The central bank has justified the Dec 18 measure as necessary after billions of dollars in capital inflows poured into the market late last year, making the baht one of the best performing currencies in the world against the dollar. But a strong baht would potentially undermine the country's export sector, the key engine of economic growth.
Still, the haphazard approach taken by the central bank, including its embarrassing move to exempt foreign equity investments one day after the 30% rule was implemented, has come under severe criticism from the capital market.
Dr Chalongphob said both fiscal and monetary policy needed to move together to ensure economic stability. He played down suggestions that yesterday's meeting suggested any imminent change in policy.
"There will not be any changes to monetary policy that shake the markets. As finance minister, I fully support the idea that monetary policy is the role of the central bank," he said.
"It's not the role of the Finance Ministry or any other agency to direct the central bank to take any action. But of course, we can and should exchange views together."
Dr Tarisa, meanwhile, stressed that the 30% rule remained unchanged. Investors now had the option to avoid placing a reserve by fully hedging currency exposure on inflows.
She said the recent pressure on the baht had stemmed not from foreign speculators, but dollar sales by local exporters over misunderstandings about the regulatory changes.
"We are only giving investors an option to the reserve rule, not lifting it," Dr Tarisa said.
The central bank would not impose any further changes to the Dec 18 rule, as nearly all asset classes have been exempted so long as inflows were fully hedged, she added.
Under the latest exemption, foreign investors can invest in bonds and unit trusts through a special account with custodian banks called Special Non-resident Baht Accounts for Debt Securities and Unit Trusts (SND). Investors must purchase currency swaps with at least three-month maturities to cover their overall exposure.
Investors failing to fully hedge their exposure will be subject to the Dec 18 rule, which requires a 30% reserve to be set aside interest-free with the central bank for all inflows. Investments shorter than one year are subject to a 10% penalty.
In any case, foreign bond investors remained mostly wary yesterday despite the rule change.
Ariya Tiranapra, a senior vice-president at the Thai Bond Market Association, said foreign investors had been selling bonds since the beginning of the year to take profits. "Most of the sellers had invested before the capital controls were imposed. They have been taking profits from declining yields as confidence hasn't returned," she said.
Since Jan 1, the bond market has recorded 30 billion baht in foreign net sales, compared with a 30-billion-baht net buy position for all of 2006. The three-year yield was quoted at 3.99% yesterday, with the 10-year at 4.19% and 4.49% for 19-year bonds. Short-term yields of one to seven days rose to nearly 5%.
Songpol Chevapunyarote, head of capital markets at Kasikornbank, agreed that the market was barely affected yesterday.
"We haven't seen investment coming in bonds or unit trusts due to the [eased] measure. The exemption still results in operational burdens for investors," he said.
Export sector sales were still driving the baht, as dollar demand from importers remained weak.
"The baht is being driven by demand and supply factors, not panic selling. The trend hasn't changed since the beginning of the year," he said.
Vocabulary (in discussion above)
* central bank independence - when the central bank is free to make monetary policy decisions without the interference of politicians who might force monetary policy changes that damage the economy in the lon-run (See Wikipedia on central bank independence)
* Bank of Thailand Act - the laws that regulate the operation of Thailand's central bank
* volatility
exchange rate volatility
controlling volatility
* hedge - reduce risk, protect against bad event
hedge against x - reduce risk of x happening
fully hedged transactions - reducing price risk to zero
a hedged transaction - reduce price risk, reduce the risk of price changes for a future sale or purchase, (make the
price that will be received in the future more certain, for example a rice farmer might seek to fix a price today
for rice that will be harvested in the future)
the 30% reserve rule, reserve requirement - the requirement that 30% of any foreign investment be set aside interest-free with the central bank
vanilla - the plain simplest version, with no special features
* a custodian bank - a bank which holds and safeguards financial assets for a person or company (See Wikipedia on custodian)
financial instruments - the general term for all the different kinds of assets that can be issued by a company to raise money for their business, including stocks, bonds, and derivatives used to manage risk (See Wikipedia for a table)
* enjoys full independence - can make decisions without being outside political influence (who has authority to appoint or dismiss often can influence decisions)
* pressure - trying to force someone to do something
x put pressure on y to z
under pressure to
there is no pressure on
ease pressure on
come under growing pressure
* lift - stop
lift the capital controls
lift the reserve rule
* reiterate - repeat again (what was said earlier)
* greenbacks - U.S. dollars
* do x in anticipation of y - do x because you expect event y to happen
* an exemption on x - permission to not follow regulation x
qualify for the exemption - not required to follow regulation (because they meet the requirements)
x qualifies for y - x has all the requirements to receive y
the qualifications for y - the requirements needed to receive y
x qualifies as y - x has all the features necessary to be y
* x takes effect from y - x officially starts on date y
* currency swaps - (See Wikipedia on currency swaps)
* Thailand Development Research Institute (TDRI) - "established in 1984 to conduct policy research and disseminate results to the public and private sectors. TDRI is Thailand's first policy research institute; it was conceived, created and registered as a non-profit, non-governmental foundation and is recognized as such by the Royal Thai Government. The Institute provides technical and policy analysis that supports the formulation of policies with long-term implications for sustaining social and economic development in Thailand." (From website also see Wikipedia)
* scrapped - get rid of, stop, cancel
* conciliatory - show you are willing to end a disagreement
* struck a more conciliatory tone - speak in a way so as to end disagreement
* manage the volatility of a currency - take steps to reduce sudden and frequent change in the value of a currency (these stable and predictable prices help business people do business)
* middle-income countries - "low income, $875 or less; lower middle income, $876 - $3,465; upper middle income, $3,466 - $10,725; and high income, $10,726 or more" using per capita Gross National Income (GNI) (See World Bank country classification)
* learning as we go - since it has never been done, we must learn as we are doing it
* blazing a new trail - doing something completely new (that hasn't been done before)
* haphazard approach - not systematic, done without planning
* implement - do what is planned, execute plans, carry out plans
* shake the markets - a sudden change that effects supply, demand, and asset prices in financial markets (stable predictable prices that don't change a lot are necessary to make good business decisions)
* imminent - about to happen
* exchange views together - discuss their different opinions about issues
* fully hedging currency exposure on inflows -
.
* x stems from y - y caused x, y because of x
* giving an option to x - x is not the only option or choice (other choices are possible)
* impose a change - force a change (change is required, not optional)
* would not impose any further changes - no more changes
* a unit trust - "A financial product where money from a number of investors is pooled together and invested collectively in investments such as shares and bonds. Each investor owns a unit, (or a number of them) the value of which depends on the value of those items owned by the fund. A unit trust allows modest investment to be diversified away from a holding in a single or small number of companies." (Source; See Wikipedia on Unit Trust)
* Special Non-resident Baht Accounts - non-Thai bank accounts in Thailand holding money for specific purposes such as trade or investment
* Special Non-resident Baht Accounts for Debt Securities and Unit Trusts (SND) - special non-Thai bank accounts holding money for investment in Thailand (See BOT press release 1 March 2007 )
* three-month maturities - the final payment date of a loan or other financial instrument, after which point no further interest or principal need be paid (See Wikipedia in maturity in finance)
* exposure - not protected from danger or harm (for example exposure to risk or exposure to extremely cold weather)
* cover their overall exposure - reduce exposure, reduce risk, hedge risk
* fully hedge their exposure - reduce risk to zero
* wary - cautious because of possible dangers
remained mostly wary
* selling to take profits - a phrase commonly used among investors when a lot of people sell
* Kasikornbank - Kasikorn Research part of Kasikorn Bank in Thailand is one of the most important sources of information on Thailand's economy and financial markets (See Kasikorn Research)
* a burden - a responsibility that causes difficulties, difficult work
* operational burdens for investors - makes the work of investors more difficult
Answer Key:
1. What kinds of political pressures has the Thai central bank faced recently?
Pressure to cut interest rates and lift foreign exchange controls.
2. How great was the immediate market response to loosening foreign exchange controls last week?
Not very great: "bond yields..moved only slightly."
3. Why problem does capital controls address that every middle-income country like Thailand faces?
Every country needs to manage the volatility of their currency. Capital controls are one way of doing this.
4. Why might the results of Thailand's experience with capital controls be useful to other countries?
Since "there is little experience from other countries" in the use of capital controls to control volatility, Thailand is "blazing a new trail" and "many other countries are watching closely to see what the results will be."
Chile and Malaysia have used capital controls in the past, but the situation in which they were used is not the same as Thailand's current situation.
