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4 Mar 2008

Financial Markets

Capital Controls Scrapped… Positive for Investment, but Putting Interest Rate Policy in Dilemma (Current Issue No.2046)

In a development widely expected in financial market since early in the year, particularly in light of the formation of the new government, late in the afternoon of February 29, 2008, the Bank of Thailand announced that the 30-percent reserve rules imposed on short-term capital inflows would be lifted, effective March 3, 2008.
Broadly speaking, the scrapping of these capital controls is tantamount to removing hindrances to foreign investment here, enabling greater inflows into the country. This will be positive for Thai capital markets, especially the debt market and other investments of the private sector, e.g., mutual funds and property funds.
However, this policy shift is occurring while the US policy rate is bearish and may thus place even greater upward pressure on the Baht due to capital inflows supported by the widening interest rate gap between Thailand and the US. The interest rate differential between the two countries is expected to become wider still if the US Federal Reserve (Fed) further cuts their key rate to a range of 1.75-2.00 percent by the middle of this year. This would put the Bank of Thailand in a difficult position in any attempt to implement adaptive interest rate policy. The policymakers may have to place greater weight on the higher inflationary risk in the wake of February's inflation climbing to 5.4 percent, over-year, particularly if global oil prices remain bullish. But the BOT's cuts seem to be inevitable.

KASIKORN RESEARCH CENTER (KResearch) takes the view that more expansionary monetary and fiscal policies as economic stimuli may put the Bank of Thailand in difficult straits when it comes to management of foreign exchange and the forging of monetary policies to maintain macroeconomic stability. Easing monetary and fiscal policies will eventually lead to concern about an inflationary trend that needs close watching.

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