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2 Nov 2007

Financial Markets

BOT Bonds: Monetary Instrument for Stabilizing the Thai Financial System (Business Brief No.2062)

Amid the falling US Dollar due to the US economic slowdown and structural problems there, KASIKORN RESEARCH CENTER (KResearch) holds the view that the Bank of Thailand may be compelled to constantly manage Baht stability. This will include absorption of Baht liquidity out of the system via the issuance of BOT bonds. In preparation for this, approval was sought at the end of October for the issuance of another THB500 billion in BOT bonds. This means BOT bonds issued would approach THB2.0 trillion, as there was THB1.2 trillion outstanding as of the end of September 2007. If the BOT issues these additional bonds as approved, financial markets are concerned about the central bank being saddled with an inordinately large debt in the future. However, if the foreign currency obtained by the BOT is well managed, bringing about higher returns than the cost of the bond issuance, BOT performance should not be a cause for worry. Moreover, if the central bank can effectively manage Baht stability, this would not only help contain the Baht's appreciation and cushion the adverse impacts of the stronger Baht on exporters, but would also lower the BOT's ‘sterilization' costs given that speculators might become more cautious about bringing in more capital to the country.

As for the effects on liquidity and financial costs, KResearch views that although the BOT bonds are issued, it will not change the net liquidity in the system at all because it would only absorb Baht liquidity increasing due to net capital inflows from foreign sources. Nonetheless, exchanging the Baht into foreign currencies would tend to increase financial costs on the Baht. When considering that liquidity in the system might decrease with a recovery in economic activity in 2008, the BOT bond issuances might result in a ‘crowding out' affect on other attempts at capital mobilization. Moreover, savings might be moved from commercial banks into these BOT bonds that banks buy-up and sell to customers or add to mutual fund investments. As a result, this could eventually force bond yields, as well as interest rates of some special, or fixed-term deposit products to increase. This is despite the fact that commercial banks may prefer to keep hold of their general deposit rates awaiting policy rate signals from the authorities.

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