Wednesday, December 20, 2006

Adventures in Capital Controls

Thailand has been in the news over the past couple of days because of the fun and games they've been playing with the imposition of capital controls. (Of course, to investors in the Thai financial markets who may have lost lots of money in recent days, it may not seem like fun and games...)

In brief, the story is this: Thailand's currency has been slowly appreciating in recent years... but the pace of that appreciation has increased noticeably in recent months, as illustrated in the picture below (note that downward movement indicates a weaker dollar, and stronger baht).

Like practically everyone else in Asia, Thailand is not too keen on their currency getting stronger, because they don't want their exports to suffer. So, they've been doing some intervention in the foreign currency markets to keep the baht from appreciating too much, as the next picture illustrates.

Obviously, those interventions have not been sufficient to prevent a growing rate of baht appreciation of late. But it's also worth noting that Thailand has not been buying nearly as many dollars as many other Asian countries, such as Malaysia ($80bn in foreign currency reserves), Singapore ($135bn), India ($170bn), Korea ($235bn), Taiwan ($265bn) and China ($1,000bn).

So instead of ramping up their purchases of dollars in the foreign exchange markets, the Thai central bank hit upon the idea of imposing capital controls, effectively taxing capital inflows into Thailand. The idea is that if money from around the world stops flowing into Thailand (which has presumably been happening because international investors think that they can earn capital gains by holding baht assets as the baht appreciates), then that will relieve the pressure on the baht to appreciate.

The problem is that the stock market in Bangkok didn't like that idea very much. It dropped 15% yesterday. Under intense pressure from Thai financiers, the Bank of Thailand then partially reversed course yesterday, allowing the stock market to recover partially on Wednesday. Bloomberg reports:
Dec. 20 (Bloomberg) -- Thai stocks rallied from the biggest slump in 16 years after the military-led government scrapped restrictions for international investors that roiled shares in emerging markets.

The SET Index jumped 11 percent to 691.55 at the close, its biggest gain since Feb. 2, 1998. It was the largest fluctuation among equity markets included in global benchmarks. Yesterday's 15 percent drop erased $23 billion in market value, prompting the government to rescind penalties on equity investors who don't keep their funds in the country for a year.

The policy reversal, a day after the new rules were announced, damages the credibility of Thailand's three-month-old government, led by former army chief Surayud Chulanont. International investors had increased stock purchases since a Sept. 19 coup ended seven months of political turmoil that disrupted government spending and dented consumer confidence.

"It makes investors doubt these people can manage the country," said Jorry Noeddekaer, who helps manage $1.4 billion of Asian stocks at New Star Asset Management Ltd. "It would take a lot of good moves to rebuild credibility."
The capital controls in place now are probably next to useless as a way of reducing capital inflows into Thailand. Any investor who wants to bet on an appreciating baht can still do so via the stock market. And a clever financial firm should have little difficulty making investments in the Thai bond market (which are nominally still subject to the capital controls) look like they are investments in stocks (which are not).

Ironically, the Thai central bank's screwy policy enactment and reversal will probably still have the desired effect. As the Bloomberg story quoted above notes, the erratic and investor-unfriendly tendencies that the Bank of Thailand demonstrated will certainly have the effect of dampening investor enthusiasm for Thai assets.

So despite their clumsiness, the Thai central bank has probably achieved their desired goal after all - just not how they originally intended to. It's a very expensive way to do it, but central bank foul-ups are always a good way to make people stop buying your currency.

Just ask Mexico.

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