Tuesday, December 19, 2006

Thailand Institutes Foreign Currency Controls; Stocks Drop 11% UPDATE: Controls Lifted

From Bloomberg

Investors based abroad will be able to invest just 70 percent of funds transferred to Thailand, and only recoup all of their funds if they keep the money in the country for more than a year, Central Bank Governor Tarisa Watanagase told reporters yesterday. Any withdrawals within a year will be penalized 10 percent of the original investment, according to the new rules.

PTT and Bangkok Bank both tumbled 17 percent. PT Perusahaan Negara, Indonesia's largest gas distributor, lost 3.8 percent. OTP Bank, a Hungarian lender that's been expanding in eastern Europe since 2002, fell 2.4 percent.

``There's panic among emerging-market investors,'' said Douglas Polunin, who helps manage about $150 million at Polunin Capital Partners in London. ``Investors don't want their money tied up.''

Thailand implemented these controls in an effort to curb currency appreciation:

Thailand's decision to impose controls on capital inflows should be little surprise. Its dilemma is one often faced by emerging markets: how to keep the exchange rate down to prevent a loss of external competitiveness when the rest of the world wants to invest in your country. None of the policy responses are fully satisfactory. Unfortunately, the most effective solution rests not in Bangkok, but Beijing.

The Thai economy has recently been stronger than expected. Growth will probably exceed 5 per cent this year and next, up from 4.5 per cent in 2005, in spite of September's potentially destabilising military coup. This economic outlook has attracted strong capital inflows, with the baht appreciating by 16 per cent against the dollar this year, to reach a nine-year high.

Fearful of losing competitiveness, the Bank of Thailand yesterday imposed capital controls. Thirty per cent of new inflows will have to remain in the country for at least a year, at no interest rate, or suffer a 33 per cent penalty on withdrawal. It is hoped that the restrictions will curb the capital inflow and prevent further baht appreciation.

Unfortunately, these controls had the opposite effect, not only in Thailand but in several other markets:

- Indian share prices closed sharply lower on fears of a tighter monetary policy and a decision by Thailand to restrict foreign currency flows, dealers said.

- Kuala Lumpur was down 1.96 percent, and Second Finance Minister Mohamed Yakcop said Malaysia is not going to impose capital controls.

- Jakarta slumped 2.85 per cent, Singapore was off 2.2 per cent, Mumbai shed 2.54 per cent, and Hong Kong closed down 1.19 per cent.

Here's what's happening in a nutshell. Thailand's currency is appreciating in value because Thailand's economy is growing. An increase in the Baht (Thailand's currency) makes their respective exports less competitive against other products. The Bank of Thailand's move was suppose to slow down the amount of capital coming into the baht, lowering it's rate of appreciation. In addition, the move is supposed to prevent quick currency speculation. Think of it as a way to stop something similar to day trading. However, the Bank of Thailand's policy spooked investors because it forced international money to remain in the country for a specific period of time. In other words, the Bank of Thailand's move prevented the free flow of capital. This makes Thailand a less attractive country to invest in. As a result, investors want to get out of Thailand as fast as possible. Other developing countries with similar risk profiles are caught in the withdrawal, essentially as collateral damage.

UPDATE: Thanks to Calculated Risk in the Comments for this.

The Thai government is lifting controls on foreign investment in stocks after the market plunged nearly 15 percent on Tuesday, rattling regional bourses amid worries about a repeat of the 1997 Asian financial crisis .

Finance Minister Pridiyathorn Devakula said that the controls -- announced just a day earlier -- would remain on foreign investments in bonds and commercial paper as part of central bank's measures to stem the surge of speculative investment in the Thai baht, which had risen to a nine-year high versus the dollar on Monday.

We'll have to see if the indexes rebound from their sell-off tomorrow.