Bangkok's Independent Newspaper Page 1 of 4

Print Cancel

Opinion

The Baht currency: What is at stake?

Published on September 27, 2010

After the baht appreciated 8 per cent so far this year, concern about the economic
consequences of such a rise is becoming more evident especially when a further rise in the
baht is being anticipated. The belief that the baht will continue to rise is not far-fetched
when viewed within the broader context in which the central banks of the G3 key reserve
currencies - US dollar, euro and yen - are committed to near zero interest rates and
quantitative easing.

The G3's unprecedented monetary easing

The global monetary easing we are witnessing today is unprecedented. This is because the major
economies are unable or unwilling to use fiscal policy to counter the economic slowdown that is
now evident. For example, the US is mired in the politics of the November mid-term election,
which will likely allow the Bush tax cuts to expire, implying a tightening of fiscal policy next
year. Few other fiscal stimulus programmes are likely to come about even though US GDP will
grow only about 1.5-1.6 per cent during the second half of this year.

In Europe the fear of falling victim to a "Greek tragedy" had most countries committing to fiscal
tightening starting in 2011. This is even as eurozone GDP growth is expected to be an anaemic 1
per cent during the second half of this year, with most of the periphery countries mired in
recession. During the same period, Japan's GDP growth is expected to be less than 1 per cent.

The inability to use fiscal policy means that the job of engineering the economic recoveries of the
G3 must rest solely on the shoulders of monetary policy. Near zero interest rates were put in place
nearly two years ago in December 2008. But this is clearly not sufficient in the context of the
devastating losses suffered by the banking system, over-leveraged consumers and near 10-per-cent
unemployment.

Enter quantitative easing (QE), in which the G3 central banks not only depress short-term interest
rates but also print money to buy bonds so that longer-term interest rates are kept exceptionally
low as well.

On September 21, the US Federal Reserve said in effect that the US economy is slowing down and
that inflation is too low. Economists see this as a signal that the Fed is moving ever closer to QE2,
when it would intensify its purchases of US treasuries in order to bring long-term interest rates
down even further to offset the possibility of a double-dip recession.

Meanwhile, the European Central Bank continues its policy to give unlimited credit to commercial
banks. Closer to us, the Bank of Japan is believed to be conducting unsterilised intervention to
weaken the yen, which means trillions more yen are being put into circulation.

http://www.nationmultimedia.com/home/apps/print.php?newsid=30138771 27/12/2553
Bangkok's Independent Newspaper Page 2 of 4

The challenge facing Thailand

In a nutshell, the problem for Thailand is that major global reserve currency countries want (need)
near zero interest rates for the next year or two. Thailand, however, needs to see its short-term
interest rates rise back to more normal levels, say, about 3 per cent, because the economy is
returning to normal growth rates of 3-5 per cent. How can the Bank of Thailand raise interest rates
to 3 per cent in a world of near zero-per-cent interest rates?

That is, keeping interest rates in Thailand above the world interest rate could attract endless flows
of capital into this country if capital is allowed to move freely. Since most economists believe that
the G3 will keep interest rates much lower for much longer, I would argue that the challenge for
Thailand this time is far more daunting than in the final months of 2006 when the central bank on
December 19 started requiring foreign investors to set aside 30 per cent of their investment as
reserves for one year in order to deter money from coming into Thailand.

Back then, global interest rates were normal and capital inflows were quickly beaten back - in part
because of the aforementioned measure and in part because the central bank subsequently cut Thai
interest rates. Globally, US and European economies expanded rapidly on cheap credit and
Thailand was largely ignored.

This time, the G3 will be printing as much money as necessary to prevent their economic
slowdowns from turning into double-dip recessions. There is an unprecedented but inadvertent
coordination of G3 monetary policies to produce excess global liquidity. The fact that the G3 may
be exporting inflation to the fast-growing emerging markets does not yet seem to be
acknowledged by the G3 central banks.

The three choices

Under the circumstances, conceptually there appear to be three choices available to Thailand. The
first alternative is to keep our currency more or less fixed to the US dollar, the main global reserve
unit. This would appear to best suit our exporters - strictly speaking, exporters and those who
compete with imports - and maximise short-term economic growth because domestic purchasing
power rises.

This option could therefore be preferred by a government that will soon face an election. This
would, however, imply central bank intervention to buy US dollars and sell baht. As the amount
involved will likely be substantial, the Thai economy risks overheating and asset bubbles in the
longer run. The experience of China, which needs to constantly concern itself with real estate
bubbles and rising wages and prices, is likely, in part, to have been the result of keeping its
currency largely fixed to the US dollar.

The second choice is to allow the baht to appreciate freely vis-à-vis the global reserve currencies.
The baht's appreciation could, however, be very rapid because Thailand is running a current-
account surplus, attracting foreign direct investment and offering attractive interest rate
differentials. For example, the Thai government bond is yielding 2.4 per cent while its US
counterpart yields 0.4 per cent.

The danger is that the baht would appreciate sharply, causing considerable harm to exporters.
GDP could also slow down rapidly. But in so doing, it is also likely that inflation will fall sharply,
allowing real interest rates to rise without the need for the central bank to raise nominal interest
rates. In the worse case, the rapidly appreciating baht could threaten the economy with
considerable deflationary pressure.

http://www.nationmultimedia.com/home/apps/print.php?newsid=30138771 27/12/2553
Bangkok's Independent Newspaper Page 3 of 4

The third alternative is to continue raising Thai interest rates to curb future inflation and introduce
measures to curb inflows of foreign capital. In other words, if Thailand wants to run its monetary
policy independent of those prevailing in the reserve currency countries, it needs to detach itself
from a world in which capital is mobile. In short, if Thailand wants its interest rates to rise above
that of the world, inflows of capital must not be allowed to undermine this endeavour.

Normally, emerging markets have no reason to reject - even partially - foreign capital inflows. But
these are not normal times. With capital mobility, the G3 monetary policies could be interpreted as
exporting inflation under largely pegged exchange rates while producing deflationary forces if
currencies are allowed to appreciate sharply.

In practice, these three alternatives are not mutually exclusive. Policies can be put in place to
allow a combination of certain outcomes to take place.

Related issues

Based on past experience, the central bank is allowing the baht to appreciate gradually in order for
exporters to have sufficient time to make the necessary adjustments. My concern is that should the
US Federal Reserve launch QE2 at the end of this year as anticipated by many, the intervention
cost of such a strategy could rise very quickly. In such an event, the increased burden will likely
be shared by the central bank and exporters.

What is this burden? Intervention to slow down the baht's appreciation means that the central bank
needs to buy dollars and sell baht. But dollars, and other key reserve currencies, yield very low
interest rates and are expected to depreciate in value.

Meanwhile, the baht sold into the system would depress domestic interest rates. But since the
central bank wants to keep interest rates high, it must then sterilise the intervention by selling
central bank bonds to withdraw the excess baht from the system.

What is happening is clear. The central bank is accumulating a depreciating asset - dollars - while
piling on appreciating baht debt. It should therefore come as no surprise that the central bank
faced chronic losses from asset write-downs during the past 10 years. Last year, the interest
income the central bank received from foreign currency holdings fell short of the baht interest it
paid out by over Bt10 billion.

Taking the argument one step further, one sees another anomaly. The central bank's intervention to
keep the baht steady is in effect subsidising foreign investors' acquisition of high yielding Thai
assets. In temporarily cheapening the baht, the central bank is providing an incentive for foreign
investors to buy Thai assets - whether bonds or stocks - more cheaply. Meanwhile, Thailand now
holds over US$150 billion (Bt4.7 trillion) in foreign reserves that are providing low yields and not
contributing much to the country's economic development.

There is yet another irony. When the US and Europe faced their financial crises in 2008-09, it was
widely expected that the fall in asset prices would cause substantial write-downs of equity. The
sources of new equity were expected to be Asia, the Middle East and even emerging markets,
including various sovereign wealth funds. However, this did not generally happen because interest
rates were quickly cut to almost zero, which helped to prop up asset prices that minimised
recapitalisation needs.

It is therefore ironic that instead of these countries buying up key US and European assets, the
current G3 monetary policies are creating the opportunity for investment funds from the G3 to
acquire key assets in cash-rich and de-leveraged emerging markets!

http://www.nationmultimedia.com/home/apps/print.php?newsid=30138771 27/12/2553
Bangkok's Independent Newspaper Page 4 of 4

Could things turn out differently? If the political situation in Thailand deteriorates, the increased
risk premium could discourage capital inflows. Alternatively, the ability to keep US interest rates
low also depends very much on the willingness of US trade partners to accumulate dollars and US
treasuries. Nearly half of newly issued US treasuries are bought up by foreigners, especially
foreign central banks. Since the US government runs a budget deficit well in excess of $1 trillion
annually, the appetite for US bonds would need to remain substantial in the years to come.

Thus, a willingness to be good creditors to America plays a key role in maintaining the plentiful
global liquidity situation prevailing today. This means that a protectionist backlash that turns
implicit international cooperation into confrontation could lead to unanticipated reversals that
would produce volatility in interest rates, exchange rates and asset prices.

Supavud Saicheua is managing director of Phatra Securities. The views in this article are his own
and not related to Phatra Securities.

Privacy Policy © 2009 Nation Multimedia Group

September 28, 2010 10:30 pm (Thai local time)

www.nationmultimedia.com

http://www.nationmultimedia.com/home/apps/print.php?newsid=30138771 27/12/2553