February 10, 2008

Next week will be Judgement Day for the capital controls. Dr Surapong Suebwonglee, the finance minister, will hold a meeting with top policy makers of the Bank of Thailand, the National Economic and Social Development Board, the Budget Bureau and other agencies on how to deal with the capital controls.

Already we know that he has the answer in his mind.

Samak Sundaravej, the prime minister, told the foreign press on Friday that Surapong had remarked to him he planned to scrap the capital controls. But since this was a delicate issue, the government would have to handle it in a cautious way otherwise it would be seen as trying to trampling on the Bank of Thailand's turf, Samak said.

Tarisa Wtanagase, the central bank governor, and her team are determined to fight back. They will be armed with documents to defend their capital control measures. They have signalled that once the Finance Ministry has seen the data on capital movements, they would change their mind about lifting the capital controls off at this juncture.

MR Pridiyathorn Devakula, the former central bank governor, has also come out in defense of the capital controls. But other supporters of capital controls are diminishing.

Indeed, the capital controls, imposed since December 2006, have been significantly watered down. Now only foreign investors seeking to bring their dollar in to invest in the Thai bond market would be affected by the 30 per cent capital reserve requirements (They can only invest 70 cents of every one dollar brought in. The remaining 30 cents must be parked with the central bank in an interest free account. This rule will affect only short-term foreign capital of less than one year.)

Will Surapong buy the central bank's data?

Now it appears that capital is turning to the US to purchase the bonds in anticipation of further cuts of the US interest rates. Lower rates will result in higher bond prices. The euro has also weakened quite sharply against the US dollar as a result of the change of tide.

If the Bank of Thailand were forced to cut interest rates to stimulate the economy in the face of the US crazy rate cuts, they are afraid that the foreign investors might be tempted to make a return and buy the Thai bonds. In that case, if the central bank were to lift off the capital controls, the capital that flows into the Thai bond might push up the value of the baht.

Will that happen? I don't know.

For the foreign investors to speculate against the baht, there are only two channels -- via the stock market and the bond market. It is difficult to speculate the Thai currency via foreign direct investment account and other channels.

However, foreign investors did not make their presence felt dramatically in the bond market during Pridiyathorn's reign. Pridiyathorn left the central bank in november to serve as deputy prime minister and finance minister in the Surayud government.

In the last three months of 2006, there was huge capital flowing into the country. But most of the inflow represented the current account surplus from Thailand's buoyant international trade.

It took time before we could discern what kind of capital flowing into the country -- current account surplus, or equity investment or bond investment, or foreign direct investment. Some people now are suspicious that the central bank jumped the gun then, interpreting capital inflow from the current account surplus as hot money speculating against the Thai baht!

But the central bank then, under the governorship of Tarisa, believed that the Thai baht had become a proxy for for currency speculation. It viewed that the money flowing into Thailand was largely aimed at speculating on the uptrend of the baht. Fearing that further intervention would result in their losses, they decided to introduce a blanket package of capital controls. The following day they were obliged to undo the capital controls on equity investment.

Ever since the central bank has been introducing a series exemptions on its capital controls package. Now only foreign investment in the Thai bonds is restricted under the capital control rules.

Tarisa and her team intervened in the foreign exchange market rather half-heartedly throughout the most part of 2007, resulting in forex losses. If you intervene the baht at one level, say Bt34 to US dollar, then allow it to rise to Bt33, you end up with losses in the total foreign reserves portfolio when marked to market.

Starting in the final quarter of 2007, the baht management has since improved after the central bank  is more willing to intervene steadily to stem the baht rise. As a result, foreign exchange reserves have shot up dramatically.

The meeting next week between the Finance Ministry and central bank and other agencies should be a venue for comparing notes. The Finance Ministry also has its own figures, so does the central bank.

I am afraid the central bank might not be able to withstand the Finance Ministry's emphatic message this time. As I have said, Dr Liap already has his own answer. But how can Tarisa fight back or back off while keep the dignity of her office?