BoT lifts remaining capital controls, effective from March 3

BoT lifts remaining capital controls, effective from March 3
The Bank of Thailand (BoT) finally decided to lift its remaining capital controls, effective from March 3. This is in order to restore foreign investor confidence. The BoT cited widespread expectations of the removal of capital controls, which had recently eroded the effectiveness of the 30% unremunerated reserve requirement (URR) in curbing baht appreciation. Below is a brief summary of the regulatory changes accompanying the removal of the URR:

(1) Encourage portfolio investment abroad by increasing the foreign investment limit for the Securities and Exchange Commission (SEC) to USD 30bn to allocate to securities companies, mutual fund companies, and individual investors (through investment with private funds or securities companies).

(2.1) Reduce the limit for domestic financial institutions to borrow THB from non-residents (for transactions with no underlying trade) to no more than THB 10mn.

(2.2) Increase the limit for domestic financial institutions to lend THB to non-residents for transactions with no underlying trade to THB 300mn (from THB 50mn previously).

(3) Revise the structure of Non-Resident Baht Account (NRBA) by segregating into Non-Resident Baht Account for Securities (NRBS) and Non-Resident Baht Account (NRBA) so as to help monitor fund flows of non-residents. Under the new structure, the transfer of baht between the same types of accounts is allowed, while the transfer between different types of accounts is prohibited.

How will this affect the Thai baht and two-tier market?
Following this event, we expect that the appreciation of Thai bath onshore (THO) will continue in the near term as the current account surplus is expected to persist over the coming months (although narrowing over time, given the higher demand for capital goods imports in order to facilitate mega projects from H2 08). In Jan 08, with export growth still strong, Thailand reported a current account surplus of USD 1.396bn. Fears of further THO appreciation will force Thai exporters to continue to be heavy net sellers of foreign exchange. In addition, it is likely that volatility in the THO will increase as capital flows in and out of Thailand will become larger in the absence of capital controls.

As for the differential between the Thai baht in the onshore and offshore markets, it is now likely to narrow given the potential for higher baht liquidity in the offshore market due to measures 2.1 and 2.2. Measure 2.1 suggests that offshore investors who have baht liquidity (but with no underlying trade) will now be able to lend up to THB 10mn to domestic financial institutions. This means that offshore investors who have baht liquidity will have to lend more in the offshore market instead. Given measure 2.2, domestic financial institutions are now allowed to lend THB to non-residents for transactions not supported by an underlying trade up to a revised limit of THB 300mn (from THB 50mn previously). Therefore, both measures should increase baht liquidity in the offshore market going forward, allowing USD-THB offshore to rise closer to USD-THB onshore. Yet, it is still unclear whether the two-tier market will be eliminated or converged. The BoT is expected to clarify this with more details on Non Resident Baht Accounts (NRBA) in a meeting called with all commercial banks on Monday 3rd March.

We maintain our call for aggressive rate cuts by the BoT
As highlighted in our OTG (Full lifting of URR is only a matter of time, 11 February 2008), we believe that the BoT has to manage the USD-THB interest rate spread to reduce the positive carry of the THB over the USD after lifting the capital controls. This is in order to mitigate the speed of THO appreciation. We expect the US Federal Reserve to cut rates aggressively over the coming months, taking the Fed Funds target rate to 1.0% by end Q3 08. If the BoT keeps its policy rate unchanged at 3.25%, the widening spread between the THB over the USD will inevitably add to appreciation pressures on the THO. In order to reduce the speed of THB appreciation, the BoT is therefore likely to consider cutting policy rates in the coming months. We maintain our view that the BoT is expected to cut rates by 25bps in each of the five MPC meetings from Apr-08 to Oct-08, taking the benchmark 1-day repo rate down from the current level of 3.25% to 2.00%.