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25 May 2005

Financial Markets

Thailand's Net Capital Movements: Confidence toward Thai Economy More Weight than Interest Differential

Kasikorn Research Center (KRC) has analyzed the interest rate differential between Thailand and the US, net capital movements and the Baht trend. Major points are summarized below:
  • The correlation between the Thai-US interest rate differential and Thailand's net capital movements, before and after the 1997 economic crisis, has differed over time. Pre-crisis, the Thai-US interest rate differential was quite influential to the direction of net capital movements (which however might be the result of liberalization of Thailand's international capital movements and the overheating of the economy that led to a liquidity crunch in the domestic financial system, prompting higher demand for loans, and speculation in the Baht under the fixed foreign exchange rate regime, then.) However, the correlation between the two variables after the crisis and the Baht's floatation changed from the pre-crisis period. Thus, KRC takes the view that other factors, particularly, Thailand's economic growth and investor confidence, as well as foreign debt repayments (on top of the international interest rate differential) have had heavier influence on Thailand's net capital movements than the interest rate differential.
  • The private sector's net capital outflow over the first two months of this year was recorded at around USD1.99 billion. Looking closely, however, it was found that the majority of the total outflow ? or around USD3.5 billion ? came from commercial banks (including BIBFs). Meanwhile, foreign direct investment (FDI) exhibited a net capital inflow of around USD121 million, while portfolio investment exhibited a net capital inflow of USD5 million, during the same period. KRC is of the view that such movement is not of great concern. Although it seems that the negative Thai-US interest rate gap may have caused capital outflow from the banking system, the real cause of the outflow may come from a glut of excess liquidity among commercial banks that have failed to extend loans as much as hoped in the midst of numerous economic risks. Thus, those commercial banks may opt to manage their liquidity through investment in foreign assets that provide them with higher returns.

However, if the Thai economy grows more over the remainder of this year on the back of public and private investment, demand for bank loans may increase, thus leading to a reduction in excess liquidity in the banking system. (The situation seemed to be clearer in April.) Finally, commercial banks may end up bringing back funds invested overseas to run their core businesses here at home. Meanwhile, investor confidence, that is expected to improve if the Thai economy grows as forecast, may inevitably have a positive effect on the growth trend of FDI and portfolio investment, even though the differential spread between Thai and US interest rates is still minus.
  • Concerning the Baht value, KRC views that Baht's depreciation in the past was not very worrying. From March 11, when Baht started to depreciate, until May 24, the Baht got weaker by 4.3 percent against USD, but after comparison with Euro, the Baht has appreciated by 1.9 percent. Meanwhile, Baht has been moving in tandem with other regional currencies, particularly the Yen. This can be seen from the time when the Baht started to get weaker since the middle of March, when the Correlation Value of the Baht and Yen was still higher than 70 percent, which indicated that their movements were rather closely aligned with each other. Moreover, if one compares the net forward status of the BOT, pre- and post-depreciation of the Baht, it would be seen that the BOT has been intervening on behalf of the Baht to curtail volatility outside the framework of regional currency values. This initiative should help to instill greater investor confidence.
  • In conclusion, KRC is of the opinion that, from the US Federal Reserve's policy which has tended to implement its strictly-controlled interest rate increases at a faster pace than the interest rate policy of the Thai authorities, resulting in the differential spread between Thai and US interest rates plunging to a more negative value in the future, it is still not very worrying toward the status of net capital movements of Thailand. The trend of Thai economic growth and investor confidence should likely be more influential to capital inflows and outflows. If the Thai economy can surmount surrounding negative factors and can come up with higher growth, as expected over the remainder of this year, it will create more investor confidence toward the overall investment picture in Thailand and improve components of the net balance of capital movements, whether FDI, portfolio investment or the net capital movement of the commercial banking sector, changing them to a higher net capital inflow. Such an adjustment should be positive to the Baht's direction amid a situation where the US Dollar is still pressured by their current account and budget deficits, as well as the trend where China's exchange rate system may become more flexible. -

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