Thai Junta Stumbles on the Baht

Thai stocks crashed Tuesday after the central bank imposed the harshest capital controls since the 1997 financial crisis in an effort to weaken the surging baht, prompting the government to quickly reverse course and exclude the stock market from the short-term fund restrictions.

The economic juggling resulting in the crash put the generals who took power in a military coup in September under increased scrutiny. In particular the crash immediately led to increased criticism of the junta’s economic team, which has spent its first few months slashing agriculture subsidies, making ambiguous statements about foreign ownership restrictions and talking endlessly about economic sufficiency — a vague philosophy attributed to King Bhumibol Adulyadej that many in the business community still don’t understand despite countless speeches on the topic.

“This is mismanagement to the first degree,” said a former member of ousted leader Thaksin Shinawatra's economic team, speaking on condition of anonymity. “They used the strongest medicine possible to keep the baht from rising, and they completely underestimated the market response. It’s sheer incompetence.”

In truth, however, the precipitous rise of the baht and other Asia currencies is as much a US dollar crisis as a Southeast Asian currency crisis, as Asian central bankers attempt to keep their currencies in line with a fast-sinking US currency and maintain their export competitiveness.

The Stock Exchange of Thailand suspended trading for 30 minutes Tuesday morning after the main index dropped more than 10 percent in morning trading due to a massive foreign sell-off. The benchmark SET index dropped 19.5 percent to its lowest level in three years before closing the day down 14.84 percent—the largest one-day decline since Saddam Hussein invaded Kuwait in 1990.

Investors were reacting to new Bank of Thailand (BoT) measures aimed at stemming speculative short-term capital inflows designed to force overseas investors to deposit 30 percent of non-trade-related baht purchases worth more than US$20,000 with the central bank interest-free for one year. If the money is withdrawn before 12 months, the BoT keeps a third of it, which effectively raises transaction costs 10 percent.

The measures prompted widespread criticism from brokers and were largely seen as an extreme action to appease exporters hurt by the sharp appreciation of the baht. The currency has gained about 16 percent on the dollar since January, nearly twice as much as its counterparts in Indonesia, Malaysia and the Philippines. After hitting a new nine-year high of 35.12 on Monday, the baht fell 2.2 percent on Tuesday to close at 35.85-90 per dollar.

“This is a very drastic measure by the BoT that nobody expected,” Kongkiat Opaswongkarn, CEO of Asia Plus Securities, Thailand’s third largest broker, told the Sentinel before the central bank exempted the equity market from the restrictions. “Even if the measures are reversed, it’s not going to restore investor confidence in the short term.”

About US$23 billion was wiped off the Thai bourse Tuesday and other regional markets suffered on a day where many recalled the financial crisis a decade ago sparked after Thai authorities unpegged the baht. Kuala Lumpur’s index lost 1.96 percent; Jakarta fell 2.85 percent, Singapore dropped 2.2 percent. Mumbai fell 2.54 percent and Hong Kong shed 1.19 percent.

SET President Patareeya Benjapolchai sent a letter to the Bank of Thailand shortly after the morning session, which saw stocks lose 11.76 percent, asking it to quickly reverse the measures that analysts called “draconian.”

“The market fundamentals haven’t changed,” she said at a hastily-called press briefing. “Stocks were hit mainly due to investors who are cautious about the BoT’s measures. I’d like retail investors to consider this very carefully and stop panic selling since this should be short-lived.”

Then she added: “The BoT should reconsider the measures.”

At first, Finance Minister Pridiyathorn Devakula refused to budge. Although the Bank of Thailand is supposed to be independent from the Finance Ministry, Pridiyathorn served as central bank governor until he became the chief economic policymaker after the generals deposed twice-elected premier Thaksin Shinawatra in the September 19 coup, and one his protégés, Tarisa Watanagase, took his place.

“The government will not reconsider the policy; let the market take its course and it will adjust itself,” he said after the market had already dropped 10 percent.

Pridiyathorn told reporters that the central bank measures announced Monday would only affect brokers and short-term currency speculators, and everything would return to normal in three days.

“The Bank of Thailand had no choice since we have found that there was speculation in short-term debt instruments,” he told reporters. “In the past three weeks there was huge capital inflow of more than 100 billion baht's clear they speculated on baht. We cannot turn a blind eye and allow foreigners to speculate on both the stock exchange and the currency because it damages everyone.”

But after a meeting with brokers and market officials at the end of the day, Pridiyathorn changed his tune.

In a television appearance, Pridiyathorn acknowledged that the capital measures had a “stronger than expected” impact on the stock market. “Investors panicked,” he said. “But we need to accept losses [in the stock market].”

Although stock market transactions will be liberalized, the restrictions remain on bond and money markets. It’s unclear if the U-turn on equities will impact index-compilers MSCI Barra and FTSE, which are both considering whether to drop Thailand from international equities indices. In that case, fund managers who follow the indices to make investments will completely pull out of Thailand, analysts said.

It would be “a severe blow” to the Thai market if MSCI Barra and FTSE reduce Thailand’s weighting to zero, said Brian Hoegee, a Bangkok-based managing director with Global Trader, a UK-based financial institution.

“If that happens, there will only be selling as many funds transfer assets to other markets in Asia,” he said. “This is a long-term and short-term blow to the foreign investment community.”

According to ABN Amro, Thailand has a 2.5 percent weighting in MSCI Asia excluding Japan, or a 2.8 percent of MSCI-Far East excluding Japan. Year-to-date foreign net inflow on the Thai bourse is about US$3 billion, compared to SET market capitalization of about $144 billion. If the period is extended to between January 2005 and November 2006, the net foreign buying is about $6.3 billion.

Many analysts had already started drawing up comparisons to capital controls imposed by Malaysia during the 1997 financial crisis. Ten years on, it’s still trying to fight off that reputation among foreign institutional investors.

Although Pridiyathorn said claimed the harsh measures were necessary to stop speculative inflows, many observers questioned whether the bank threw out the baby with the bathwater.

“The net loss for the Thai economy and the capital markets is much greater than the benefit of a weaker baht,” said Sompob Manarangsun, an economist at Chulalongkorn University. “The move also distorts the market, so it’s hard to know the real value of the baht. It’s bad policy that took into consideration short-term political measures.”

Exporters have complained for weeks that the central bank should intervene to stem the baht’s rise as their sales became uncompetitive. As expected, they cheered the Bank of Thailand’s intervention.

“The measures will help reflect the actual value of the baht and its stability,” said Chookiat Ophaswongse, president of the Rice Exporters Association of Thailand, according to the Bangkok Post. “Thai exports and Thai economy will be put in jeopardy if no action was taken.”

But many other businesses weren’t happy with the moves, as they further soured investors already upset over the government’s efforts to redefine foreign ownership rules and focus on “gross national happiness” instead of economic growth.

Kongkiat, one of Thailand’s top brokers, also worried that the appointed government may lead the country into dangerous waters.

“Pridiyathorn has never been the kind who likes to promote the stock market,” he said. “He’s always said that we make too much on capital gains that we don’t pay taxes for.

“Now Pridiyathorn’s in the hot seat,” Kongkiat added. “He faces no cost as he was appointed and will only be Finance Minister for a year. But he could end up hurting the economy for much longer."