Under Pressure

FX Strategic Overview
Standard Chartered Bank reiterates the call that GCC countries should and will revalue their currencies against the USD over the next few months. While a trade-weighted basket would be ideal, this seems unlikely for political reasons. However, inflationary pressures continue to mount and the Federal Reserve continues to cut rates, putting ever-increasing pressure on the GCC to revalue.

SCB FX Leveraged Model Portfolio
We continue to make solid, if cautious progress. Year to date, the SCB FX Leveraged Model Portfolio has a cumulative simple return of +6.72%. We continue to hold one trade recommendation - short USD-SAR via 6M forward outright and are looking for other opportunities in Asia, Africa and G10.

SCB FX Real Money Portfolio
The SCB FX Real Money Portfolio has had a good start to the year. Having hit its take profit rule as more than 50% of Q1 FX forecasts were traded through, we currently stand +2.34% (non annualised). We are not reoptimising and re-entering just yet as we think there could be better re-entry levels in coming days.

Options Strategy
The inversion in several implied vol curves appears to offer good opportunities, notably in USD-KRW, USD-TWD, USD-INR, USD-JPY and EUR-USD. This month, we examine 3M digitals in USD-JPY and 6M call spreads in USDINR.
Corporate Hedger pp. 8 Treasurers will need to be opportunistic, but conservative in managing AXJ translation risk. We expect a USD rebound against the majors in Q2 and Q3.

Correlations
Risk appetite is fading, weighing on high-beta EM currencies. However, current account surplus currencies will outperform in this environment. The correlation between GBP-USD and EUR-USD continues to decline as GBP underperforms.

FX Forecasts and Forecast Review
We revised our USD forecasts lower against the majors to take account of persistent downside momentum and perceived official tolerance, while still anticipating a temporary USD rebound in Q2/Q3.

FX Focus
We expect TWD to retrace as political gains give way to economic concerns ZAR: Further losses are likely as the economic outlook continues to worsen


The Need for Change to GCC Pegs Remains
We reiterate our call for a revaluation of GCC currencies in the coming months. While a revaluation followed by a switch to a trade weighted targeting regime would be ideal, we believe the second best solution of keeping the peg following a revaluation is more realistic. The economies of the GCC are suffering the consequences of their current policy set-up due to a decoupling between the domestic economies and that of the anchor currency (the U.S.). The longer the problem is not dealt with the harder the adjustment will be.

If introduced a trade weighted basket would not need to be too complicated. Two currencies, the EUR and USD, would suffice. However, we do not detect that there is enough appetite in the Gulf to depeg from the USD, at least not at the moment when the USD is facing so much pressure. GCC currencies like to stand by a friend, in this case the USD, when the friend is need. Our view is that a significant step revaluation is the second best and most likely solution and we maintain our call for a significant revaluation of GCC currencies in coming months. The debate in the region on currency reform is resurfacing.

It Should be Easier to Manage a Boom
It is positive at least to see GCC countries booming even at a time when the outlook elsewhere is not so rosy. But the boom needs to be managed. Real interest rates are now negative. One does not really need to look that far back to understand the problems cheap credit can create. It was not so long ago when the US economy was awash in liquidity.

In this note we look at some of the most popular arguments which are being made against any change in the current FX regimes, and we dismiss them. In an environment where government spending is high, oil prices are above USD 100pb and monetary conditions are ultra loose, inflation will continue to rise. We view rising inflation as the biggest risk to achieving sustainable growth. Monetary policy needs to tighten. A revaluation is the way to achieve these tighter conditions.

Housing is not only a Domestic Factor when you are Importing Building Materials
A popular argument in the region is that the main driver of inflation is the housing market which is completely unrelated to the currency policy. This is not entirely true. First, construction materials are mainly being imported. It has been estimated by Moody's that in the second half of 2007 the price of cement increased by 40% and that of steel by 25%. The rising cost in housing is not just a domestic factor. The weak currency is making the imports of materials even more expensive.

Second, labour costs are also increasing. GCC countries are relying heavily on imported labour. Foreign workers have seen the purchasing power of their earnings diminish over the past year, not only because of the higher inflation but also because of the weakness of GCC currencies vs. currencies like the Indian Rupee (INR). The result is higher wage demands, which is translating into even higher construction costs and more pressure on the housing market.
Finally, the availability of what effectively is free credit, when one looks at real interest rates, is more than likely to increase the pressure on the housing market from the demand side. Credit growth in the region is rapid, for example in the U.A.E, consumer debt increased by almost 40% y/y in 2007.

How Much is Your Money Worth?
There is also an argument that a revaluation will hurt the region because of oil income and USD based investments. Oil proceeds might feel higher because of the weaker currencies, but in terms of value they are not. Income from oil and from returns on USD investment is worth less internationally because of the weakening USD and less domestically because of rising inflation. The idea that a weak currency would boost incomes when it comes to the purchasing power of this income is merely a case of money illusion. This is not so different to feeling richer by printing more money. An OPEC study explains that 73% of oil revenue was lost between 1970-2004 because of the weakening USD and rising inflation. It is not only important to see what the income level is but it is also important to see the purchasing power of this income.

Creating a Stable Environment for International Investors
Saudi Arabia wants to become a top 10 Foreign Direct Investment (FDI) destination in the world by 2010. Advocates of the status quo argue that a revaluation would jeopardise investment inflows. Inflation and rising costs are a much bigger risk for FDI than any revaluation. For a country to become an attractive investment destination macroeconomic stability is paramount. Take for example Turkey. For a number of years Turkey was one of the least popular investment destinations in the world. Those were times of macroeconomic instability and high inflation. However, in the past three years, when the Turkish authorities finally managed to get inflation under control, foreign investment in Turkey soared. FDI in Turkey was increasing at a time when the Turkish Lira (TRY) was showing impressive gains. The stronger currency was not an impediment to FDI. On the contrary, it was indicative of the success of the country. Over the past three years, which were years of significant TRY strength, Turkey attracted more FDI than in the previous 20 years combined.

The two top FDI destinations in the world in 2007 were China and India. The currencies of both countries appreciated in that year. The main reason why the authorities in China and India tolerated stronger currencies was to fight rising inflation. The Chinese yuan (CNY) appreciated by 6.4% and the INR by more than 12% in 2007. The currency adjustment has clearly not made China and India less attractive destinations.

Macroeconomic stability, regulatory environment and the prospects of GCC economies will be key when it comes to attracting FDI, not an undervalued currency.
Kuwait was Right to Scrap the Peg

Kuwait decided to scrap its peg to the USD and introduce a currency basket in May 2007. Critics claim that if Kuwait's decision to scrap the USD peg last year was correct, inflation should have stopped rising. The latest inflation figures from October 2007 show inflation at 7.26%. The rise in inflation and this growth in the money supply have been used as criticisms over Kuwait's decision to scrap the US dollar (USD) peg and the introduction of a currency basket in May 2007.

Before one criticises the decision, one needs to bear in mind two important arguments. First, inflation has indeed risen, but it is still significantly lower than inflation in the U.A.E and Qatar. It is also important to take into consideration that inflation could have been much higher than 7.26% had the authorities kept the USD peg.

Second, the Kuwaiti dinar (KWD) has appreciated against the USD by 6.22% from the introduction of the basket to 4th March. This is not enough. It is also worth considering that the KWD currency basket we monitor is below the highs it reached earlier this year. In other words the authorities have allowed the KWD to appreciate vs. the USD, but not by enough to compensate for the sharp drop in the value of the USD vs. other currencies. At least the Kuwaiti authorities have the flexibility to accelerate this pace of appreciation. Given the inflationary pressures and the growth in monetary aggregate, it is likely to see more KWD appreciation against the USD in the near future.

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%.

Further implications from the new measures

Further implications from the new measures
Thailand
The end of the 30% unremunerated reserve requirement (URR) on bond investment, as well as a number of measures aimed at improving offshore Thai baht (THB) liquidity announced on 29-Feb have caused the onshore and offshore Thai baht (THO and THB respectively) to converge. This is likely to remain the case in the foreseeable future. While the government is also expected to bring out new policies to curb Thai baht appreciation, other near-term factors convince us that the outlook for THO is positive and as a result
Standard Chartered Global Research has revised its USD-THO forecast to reflect this positive outlook.

These positive factors include the USD-THO interest rate differential to remain in favour of the THO in coming months, capital inflow in view of lower interest rates, and the current account continues to stay positive in the near term, and be more dominant over the capital and financial
account net inflow.

Revised USD-THO forecast (previous forecasts in brackets)
Q1-2008 Q2-2008 Q3-2008 Q4-2008
(32.75) (33.25) (33.50) (34.00)
Source: SCB Global Research

How it all started…
To begin our discussion on what will change after the BoT lifted the remaining capital controls, it is important to recall the remaining capital controls imposed since 18-Dec-06, which can be summarised as below.

(1) All non-resident purchases of Thai baht onshore (THO) are subjected to a 30% URR, with the exception for payment of good and services, repatriation of investments abroad by residents, long-term foreign direct investment into Thai companies, equity investments on the Stock Exchange of Thailand, stock index futures on the Thailand Future Exchange, transactions by development organisations, and government external borrowing.

(2) Exemptions were also extended to fully-hedged foreign borrowing for long-term investment, hedged inter-company loan, hedged packing credit (less than 180 days), hedged investment in government bonds, debentures, bills of exchange & promissory notes, and hedged investment in mutual funds.

(3) Foreign investors were required to set up separate Special Non-resident Baht Accounts for their investments in securities (called SNS), bonds (called SND), and trade (called SNT). Under such

special accounts, foreign investors are also required to sell the Thai baht they received after liquidating their investments, and exchanging for foreign currencies in the on-shore market only.

A closer look at the new set of rules
The BoT finally decided to lift the remaining capital controls, effective from 3-Mar. In parallel, the BoT introduced additional measures, which are summarised in our On the Ground released on 29-Feb, in order to promote more outflows.
In addition to that we want to use this opportunity to provide some clarification on the measures, especially on Non-Resident Baht Account, after the 30% unremunerated reserve requirement (URR) was lifted.

(1) Non-resident Baht Account is now divided into 2 types:
(1.1) Non-resident Baht Account for Securities (NRBS) for investment in securities and other financial instruments such as equity instruments, debt instruments, unit trusts, financial derivatives transactions traded on TFEX, AFET including sale proceeds, returns, and related payments from such investments
(1.2) Non-resident Baht Account (NRBA) for general purposes such as trade, services, direct investments, investment in immovable properties, loans, and other transactions
(2) Transfer between Non-resident Baht Account
The transfer of baht within the same type of accounts is allowed, while the transfer between the different types of account is prohibited. Meanwhile, day-end balance is still capped at THB 300mn for both NRBS and NRBA.
This implies that:
(2.1) Baht fund in NRBS cannot be transferred to NRBA, and vice versa
(2.2) Baht fund in a NRBA can be transferred to any other NRBA
(2.3) Baht fund in a NRBS can be transferred to any other NRBS

(3) Non-resident foreign exchange transactions without underlying
Non-residents are now allowed to execute foreign exchange transactions without underlying. However, it is still subjected to the following rules from the BoT.
(3.1) Total outstanding balance undertaken by each financial institution of all transactions which result in providing baht liquidity to non-residents without underlying must not exceed THB 300mn per group of non-residents (previously capped at THB 50mn).
(3.2) Total outstanding balance undertaken by each financial institution’s borrowing baht from nonresidents without underlying must not exceed THB 10mn per group of non-residents

(4) Request for unwinding of hedging transactions
Non-resident can seek the BoT’s approval to unwind their hedging contracts with their counterparties, as they were required to hedge in order to be exempted from the 30% URR. Upon receiving the application, the BoT will consider the request for approval within 15 working days.

Two-tiered market has now converged
What was in the past under capital controls? Under previous rules by the BoT, “financial institutions shall withhold 30% of foreign currencies purchased or exchanged against baht from their customers as reserves except in certain cases such as – goods, services, direct investment, investment in stocks, investment in immovable properties, and loans, investment in debt instruments and unit trusts which have been fully

hedged. This suggests that non-resident was restricted to trade baht onshore with no underlying, or they will be otherwise subjected to the 30% URR rules.

Inflows into Thailand interest rate markets could continue
The lifting of the URR, along with possible rate cuts by the central bank, is a positive development for Thai interest rate markets. Of course the positive knee jerk reaction to local interest rates following the lifting of the URR has already taken place. However, given the prospect of that more overseas investors could now include Thai financial assets in their benchmarks, and the fact that we expect BoT to cut its 1-day repo rate by a collective 125bps from 3.25% currently to 2% by end-2008 as highlighted in our OTG (BoT lifts capital controls, 29 February 2008), the portfolio inflow should be Thai baht positive near term. Thailand has already experienced a large net bond portfolio inflow in Q4-2007 in anticipation of the lifting of the capital controls after a significant outflow Q1-Q3-07 (see Chart 2). The lifting of the capital controls may continue to attract inflows to the Thai interest rate markets, and hence supportive for the THO near term.

Current account to dominate capital account for now
The trade balance narrowed significantly in Jan-08 to USD 170mn from USD 1,069mn in Dec-07. This reflected much higher imports of capital goods and oil-related products. However, Thailand reported a still solid current account surplus of USD 1,396mn in Jan-08 from USD 1,661 mn in the previous month due to a very large net services and transfer account of USD 1,226mn. However, the current account surplus is likely to narrow later in the year as the trade balance deteriorates due to a combination of factors. These include 1) sluggish exports due to weak demand from Thailand’s top export markets, the US and derived demand from Asia, and 2) stronger imports given large demand for capital good imports to facilitate mega-infrastructure projects from H2-08. As the current account surplus narrows, the capital account will become more important. That is at the time where exporters are likely to become less aggressive sellers of USD-THO. Meanwhile, there will be higher demand for buying USD-THO from importers. Together with potential greater portfolio investment abroad by domestic investors as well as state owned enterprises swapping their foreign currency lending into local currencies, as proposed by the MoF, we should see the risks of more corrections in USDTHO later in H2-08.

BoT lifts remaining capital controls

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%.

BOT year 2007 news

Markets & Investing

A bull run against all odds

Politics was uncertain. Growth was modest. Consumer consumption declined. And the US sub-prime crisis lingered. With these negative factors hurting investment sentiment, the Thai stock market managed to rise 23% in 2007.

Elections held the key to the rally in 2007. The SET began its ascent when the poll date was fixed, before closing the year up 24%, at 843.28 points as of Christmas Day 2007.

Despite the strong gains, investors could not help but feel they'd been riding a roller coaster because the ascent had not been exactly smooth as silk. One negative factor after another, both at home and abroad, kept hitting the market, threatening to knock the fledgling climb off course.

Analysts agreed that the main factor contributing to the market rise was foreign capital inflow, which was even smaller than the year before. Moreover, Thai stocks were considered relatively cheap when compared to their regional peers, given the price-to-earning ratio of 11-12 times.

During the first half of the year, the Stock Exchange of Thailand (SET), the laggard in Asia, moved at a snail's pace, the lingering impact of the imposition of the 30% capital reserve rule by the Bank of Thailand in late December 2006.

Moreover, the unsettled nominee case related to the Shin Corp-Temasek share sale and the revised Foreign Business Act were shaking confidence of foreigners investing in Thailand.

Private investment, meanwhile, was at a stand-still, as several investors have delayed new projects and expansion plans in face of political instability. The Surayud Chualanont-led government itself was busy dealing with legal reforms and did a little to spur economic activities.

Then, out of the blue, the SET index ticked up in the second half, soaring 24% to close at 843.28 points as of Dec 25, 2007. The lowest level was 616.75 points on Jan 9 and the highest was 915.03 points on Oct 29.

The clouds seemed to have lifted when the election date was fixed on Dec 23, and the case of PTT delisting was finalised with the court ruling in favour of the energy giant. PTT survived an effort by consumer groups to delist it but its gas-pipeline assets would be transferred back to the state.

The SET's market capitalisation rose to 6.52 trillion baht as of Dec 25 from 5.08 trillion baht at the end of 2006. Twelve companies were added to the stock markets in 2007, spreading equally between the main board and the Market for Alternative Investment (MAI). Among 476 listed companies on the SET, the average dividend yield was 3.46%.

The MAI outperformed the main board and its index gained 35.75% to close at 266.97 points as of Dec 21, 2007, after hitting the year's high of 306.64 points on Oct 22 and the low of 175.61 points on Jan 9.

Market capitalisation of the MAI stood at 36.89 billion baht on Dec 21, 2007, up from 21.81 billion baht at the end of 2006. There were a total of 48 listed companies on the small board.
Total Access Communication or DTAC made the first dual listing ever on the SET after it had been listed on Singapore stock exchange for years.

In 2007, the new highlighted product was ThaiDex SET50, the country's first equity exchange-traded fund launched on Sept 6, using SET50 as the benchmark index. The SET hopes to build up the asset sizes of TDEX, as w9ell as ETFs in other exchanges in the years to come.
One Asset Management manages TDEX, along with its consortium of six companies led by KGI Securities. Three months after the launch, TDEX has proved to be quite popular with its unit price rising to 6.10 to 6.30 baht from its initial public offering price of 5.58 baht.

But in 2007, the local bond market, hit hard by the 30% capital reserve rule, was lacklustre. The proportion of non-resident investors dropped to only 1% compared to 15% before the imposition of the new rule, leaving only commercial banks and local institutional investors as key players.
The US sub-prime fallout also increased costs for local companies looking to issue debt instruments offshore, as bond yields could be pushed up due to perceived higher risks.

Trade in the Bond Electronic Exchange (BEX) remained small in 2007. Retail investors were less than keen to invest in bonds despite the BEX's efforts to urge market dealers to promote more transactions through electronic trading. In a bid to boost activity, the market asked the central bank and the Thai Bond Market Association to transfer government and state-enterprise bonds to list on it but trading volume has remained low.

On the contrary, the country's fledgling derivatives market, the Thailand Futures Exchange (TFEX), achieved its trading target of 5,000 contracts per day, 20 months after opening. It is viewed as the area of high growth and potential for the capital markets.

The TFEX started out with SET50 index futures, which come in four series. The second product was SET50 index options, which was introduced on Oct 29.

The new products to be launched next year are stock options and bond yields, with a full range of products to be offered over the next five years. To increase activity further, additional brokers will also be recruited next year and more educational and training programmes held to familiarise investors with the products.

Meanwhile, its forerunner, the Agricultural Futures Exchange of Thailand (AFET), demonstrated only marginal growth, with trading volume of 500 contracts a day, or half its target.

Even though the bourse had six products, only the ribbed smoked rubber sheets No.3 was popular, while the other five products - white rice 5%, standard Thai rubber 20, tapioca starch premium grade, latex, and tapioca chip - attracted only lukewarm interest. The number of brokers providing trading services on the market also dropped to nine by the end of 2007 from 16 early in the year.

One obstacle is said to be the government's price-intervention schemes for most agribusiness products such as rice, distorting their prices and market mechanisms.

Not surprisingly, the three-year-old AFET still has to rely on the Ministry of Commerce's budget of around 150 to 200 million baht per year to stay afloat.

Napaporn Kurupasutachai, the AFET's acting president, said one of products with high growth potential was tapioca chip. The market is also considering adding a new product, Thai jasmine rice, next year. It will also expand trading hours for 45 minutes, from 3pm to 3.45 pm, and reduce the tick of the ribbed smoked rubber sheet No. 3 to five satang from 10 satang next year to boost trading liquidity.

CHALLENGES AHEAD
Analysts and SET executives agreed that the stock market would be more volatile next year as the unsolved sub-prime crisis, which would slow the US economy further, would continue to put pressure on market sentiment this year.

However, foreign fund managers will still have their eyes on Asia, where robust growth is led by China and India, as investments in the region will continue to generate higher returns than those in US-dollar assets and the Thai bourse will benefit from the foreign inflow.

At home, the sentiment will improve drastically after an elected government is formed, possibly in early 2008. Consumers are expected to resume their spending and industrialists their investments by then.

The newly elected government plans to pour investments into a number of infrastructural projects, particularly Bangkok's new mass transit routes, to boost economic activities next year. Some analysts are optimistic that the SET index could reach 1,000 points in 2008.

Patareeya Benjapolchai, the SET president, also aimed high in 2008. It is set to attract 34 new listed companies to both the SET and the MAI, which will raise about 300 billion baht in funds.

Among the major IPOs in 2008 are Esso, Star Refinery, Thai Tap Water Supply and Thai Beverage, the brewer of Chang Beer, which will seek dual listing in Thailand after listing on the SGX.

Daily trading volume is expected to rise to 22 billion baht next year from 18 billion baht in 2007. Some 100,000 trading accounts will be added to the customer base, up from 480,000 currently.
In the face of globalisation, the SET is forced to restructure itself to cope with rising competition from other bourses. The market is preparing to demutualise to boost its efficiency and flexibility to attract both local and foreign investors.

The SET has strengthened its ties with six Asean bourses by co-operating among themselves and linking up their trading systems. The process is projected to be completed in 2015.
Thailand Securities Depository (TSD), a SET subsidiary, is gearing toward T+2 transactions by 2008.

Competition in the brokerage business is getting tougher with commission rates set to be floated by 2010. In the meantime, brokers are diversifying their revenue bases by adding fee-based incomes.

The top three brokers are Kim Eng Securities, with a 7.98% market share, and Phatra Securities and Asia Plus Securities, with 5.74% each.

The bond market will also face greater volatility in 2008 and fixed-income funds could sell off long-term bonds in light of rising interest rates. The gap between short-and long-term bond yields is to widen next year.

banking & finance

Evolution: The next episode

The Thai banking landscape continued to evolve in 2007, driven by new regulations to upgrade domestic standards and foreign investments in local institutions.

The year saw a number of major partnerships between local and foreign banks: Bank of Ayudhya with GE Capital, BankThai with TPG Newbridge, Thanachart Bank with ScotiaBank, and TMB Bank with the ING Group.

The deals offered local partners access to capital, technology and know-how as the Bank of Thailand continued to tighten the country's regulatory infrastructure. New rules and regulations, such as the consolidated supervision programme, the adoption of International Accounting Standard 39 and the Basel II capital accord, and the introduction of limited deposit insurance, were major milestones for the sector in 2007.

Bank of Ayudhya's tie-up with long-time retail partner GE Capital was first announced in August 2006. By the end of September 2007, GE had taken a 32.8% stake in BAY on a fully diluted basis, with the Ratanarak family's holdings reduced to just 25.1%.

GE Money Retail Bank was closed and assets were transferred to the Thai bank, which also announced the acquisition of GE Capital Lease, a local auto hire-purchase provider.
BAY's vision is an ambitious one, with a target to be "Thailand's most admired universal bank" and achieve a return on equity (ROE) of more than 20% by 2010. The bank is Thailand's fifth largest in terms of asset and deposit size, with a 9% market share in loans and deposits.

More surprising to market watchers was the first-quarter deal between Thanachart Bank (TBANK) and Scotiabank. The Canadian-based bank took a 24.98% stake in Thanachart Bank by acquiring 157 million shares from Thanachart Capital and another 276 million in new shares issued by Thanachart Bank.

The share sale was priced at 16.37 baht per share, or 1.26 times the book value per share. The 7.1-billion-baht deal helped boost TBANK's capital adequacy ratio to 12.9% at the end of September from 11.1% at the end of 2006. ScotiaBank now holds 24.98% of TBANK, with TCAP holding the remainder.

ScotiaBank also has an option to boost its shareholding to 49% by purchasing additional bank shares from TCAP at a price of 1.6 times book value up until the end of 2008.

TMB's deal was closed only after months of speculation and delay. The country's sixth-largest bank in assets had planned to raise 35 billion baht in capital as early as late 2006 in anticipation of higher loan-loss provisioning needs to comply with the IAS 39 standard.

ING Bank emerged as a surprise investor after talks between the Finance Ministry and Singapore's DBS Bank, TMB's two largest shareholders, collapsed over disagreements in pricing, as well as management control.

Under the recapitalisation plan approved by shareholders in November, ING will take a 25.2% direct shareholding in TMB and another 4.92% stake through non-voting depository receipts, paying 1.6 baht per share for 13.11 billion shares. ING will also have the right to boost its shareholding to as much as 35% over the next five years.

Existing shareholders, including the Finance Ministry, will be offered a rights issue at 1.4 baht per share, with 0.4941 new shares offered for every one share held. The ministry's shareholdings will be diluted to 26.11% from 31.18%.

The 37.62-billion-baht recapitalisation will help boost TMB's capital adequacy ratio to 17.93% at the end of 2007 from 10.16%. TMB also announced that it would set aside 25 billion baht in new provisions in its fourth-quarter financial statements and also tighten its loan classification standards.

BankThai's recapitalisation plan was similarly convoluted and troubled, particularly after it emerged that the bank was the sole Thai institution to have invested in US sub-prime mortgage assets.

In the first half of the year, BankThai floated a 32.88% stake at 4.17 baht per share, or 1.3 times book value, to private equity firm TPG NewBridge and co-investors Blum Capital and Marathon Asset Management.

The 3.05-billion-baht capital increase gave TPG Newbridge, Blum and Marathon a shareholding equivalent to that of the Financial Institutions Development Fund, and helped raise the bank's capital adequacy ratio to around 9%, or just slightly higher than the regulatory minimum of 8.5%. Executives said a second round of recapitalisation would then be made to raise capital to 14% of risk assets.

But the recapitalisation plan was stalled after the bank posted second-quarter losses of 1.56 billion baht, largely due to loan-loss provisions set against non-performing loans to President Agri Trading and to cover losses in its offshore investments in collateralised debt obligations.
Terms for its capital increase were changed three times over the year. In May, the bank had proposed floating 2.24 billion new shares at 3.46 baht each, which was later changed in October to 4.44 billion shares at 1.73 baht each and a par value of 3.75 baht. The plan was changed a third time in December to a subscription price of 1.36 baht per share, which bank executives said was necessary to adjust for the bank's lower market share price and higher provisioning burden to cover its CDOs.

In 2008, two other banks - Siam City Bank and ACL Bank - are expected to see significant shareholding changes.

Siam City Bank, now 47.5% controlled by the FIDF, is looking for a strategic partner to help bolster its IT and risk-management platforms. For ACL Bank, the bank's major shareholder Bangkok Bank is looking to divest its 19.3% stake to China's ICBC. But the deal has been delayed pending approval of the new Financial Institutions Act, which will raise foreign shareholding limits to 49% from 25% now.

From a performance standpoint, most Thai banks reported weaker earnings for the first nine months of 2007, owing to higher loan-loss provisioning charges.
According to the Stock Exchange of Thailand, net profits for the first nine months totalled just 10 billion baht for listed bank stocks, compared with 21.9 billion in profits for the same period last year.

But for 2008, profitability is expected to rebound, thanks to lower provisioning requirements and a projected pickup in loan growth to 7.5% to 10%.

Insurance

Consolidation on the horizon

Mergers and acquisitions in the Thai insurance industry are on the horizon due to more rigid capital requirements under new insurance laws.

In face of more intense competition, insurers are stepping up their efforts to ensure that the services they provide to clients are fast and reliable.

Chai Sophonpanich, chairman and president of SET-listed Bangkok Insurance, one of the country's leading general insurers, said the Thai insurance industry was expected to starting seeing M&A movement in 2008, but activity would really pick up in 2009 after local insurers have gone through a wait-and-see period.

"Whether M&As among Thai firms happen depends largely on how seriously the new independent insurance governing body takes the enforcement of the new capital requirements under the new acts," said Mr Chai.

The Office of the Insurance Commission (OIC), under its old name the Department of Insurance, has proposed introducing a risk-based capital assessment as a way of improving the industry's financial strength.

Companies registered after 1997 are required to have paid-up capital of 500 million baht for life business and 300 million baht for non-life firms.

Risk-based capital measures the minimum amount of capital that an insurance company needs to support its overall business, considering the size and degree of risk involved.

The risk-based capital measures are due to start tentatively running early next year, but the OIC itself has never clearly stated when the new capital requirement measures would officially come into force.

According to Mr Chai, the capital requirements for the insurance industry should be lifted to 500 million baht for non-life and 800 million baht for life business to reflect the changing business environment.

However, if the regulator really followed Mr Chai's proposal, dozens of existing insurers, particularly poorly capitalised players, would definitely fall prey to consolidation or liquidation.

According to a recent report by the US ratings agency Standard & Poor's, capitalisation levels notably for the non-life sector have actually declined over the past five years.

The ratio of shareholders' funds to net premium income stood at 89% at the end of 2006, compared with 110% in 2001. Excluding revaluation reserves for assets, which are booked as part of shareholders' funds, the ratio was only 74% in 2006. Solvency ratios are expected to fall over the medium term as the market grows and funding sources remain limited.

Without fully disclosed information, Standard & Poor's estimated that some insurers have marginally sufficient capital, using a risk-based capital analysis. This is due to the sector's higher investment risks and lower risk-management sophistication.

The risk-based capital regime is likely to shake up the industry, the US rating firm warned, with weaker players being eliminated or consolidated due to market fragmentation and limited funding channels.

To boost the sector's capital strength, the insurance regulator intends to raise the investment ceiling for foreign companies holding stakes in Thai insurers to 49% from 25% over the medium term.

However, S&P says Thailand's non-life insurance sector has a stable underwriting performance as the country has limited exposure to catastrophic risk. The tsunami that hit southern Thailand in December 2004 had only a slight impact on the industry because many properties were uninsured. The overall non-life market reported a combined ratio (on an earned premiums basis) of about 97% between 2002 and 2006.

The loss ratio has stood at 56%-59% in the past five years, which highlights the market's stability. This is partly attributable to the industry's tariff system, in which most insurance premium rates follow set rates or a minimum set by the regulator and insurance associations.

Voluntary motor class is the sector's main underperformer in terms of underwriting results. It has had a combined ratio of between 106% and 109% in the past five years, highlighting the stiff competition. Its disappointing performance, however, was offset by other major business lines such as fire, marine and personal accident, which reported underwriting profits over the same period.

Investment profits, which generated yields of about 3.4% in 2006 and an average of 4.0% over the past five years, contributed to the sector's profitability. Return on revenue was satisfactory at a three-year average of 7% in 2006.

According to a recent report of Thai Reinsurance, Thailand's general insurance is expected to grow 5.91% in 2007 to an estimated 100.70 billion baht from 95.09 billion baht in 2006.
The growth is expected to fall in a range of 5.9% to 8.5% in 2008 to between 106.60 billion and 109.26 billion baht, propelled by improved confidence in the country's economic and political prospects following the Dec 23 general election.

According to Thai Reinsurance, industry growth in 2008 will be largely driven by the miscellaneous segment, which is expected to grow by between 10.1% and 11.3% to 32.72 billion to 33.11 billion baht from an estimated 29.75 billion in 2007, a 9% rise from 2006. However, the industry's key contributor remains motor insurance, which accounts for about 60% of total premiums.

Next year, the motor insurance business is projected to grow by between 4.7% and 8.1% to between 62.8 billion and 64.84 billion baht, from an estimated 59.99 billion baht in 2007, a rise of 5.7% from 2006, as consumer confidence improves and carmakers step up marketing campaigns.

The growth rate for the fire business was also expected to improve slightly because of the government's stimulus measures to boost the sluggish property sector, as well as declining interest rates. The fire insurance business should grow in a range of 0.4% to 3% to between 7.18 billion and 7.42 billion baht in 2008 from an estimated 7.16 billion this year, down 0.2% from 2006.

The marine cargo segment is projected to improve as well, given that the baht is unlikely to gain further against the dollar and international trade is expanding. The value of marine cargo coverage is expected to increase 0.9% to 1.8% to between 3.83 billion and 3.87 billion baht, up from an estimated 3.80 billion this year but down 1.8% from 2006.

For the life business side, S&P's says competition may squeeze out smaller players with unsustainable niche market positions as financial strength varies widely within the sector.
In addition, the regulatory environment is focused on policyholder protection and financial strength.

Foreign participation in the life insurance industry is strong, with joint ventures and branch operations controlling most of the market.

According to S&P's, the outlook for Thailand's life insurance sector is stable, reflecting the industry's strong growth potential. It is backed by adequate overall earnings and capital, as well as improvements in expertise and sophistication through foreign investment.

Although the Thai regulator has proposed reforms to enhance the market's governance and financial strength, the sector is still constrained by a shallow investment market, regulatory investment restrictions and lengthy product approval procedures. The intense competition in this highly concentrated market has left some companies with persisting negative spreads and a high expense base.

After recording slowing growth for five consecutive years (2002-2006) - decelerating from 24.8% in 2001 to only 4.6% in 2006 - the life insurance industry has accelerated in 2007 thanks to a sharp decline in fixed deposit rates among financial institutions. Earlier in 2007, the rate stood at around 2% against the peak of more than 5% in 2006.

It could be said that bancassurance - in which banks serve as sales agents - has contributed greatly to the rapid growth of the life insurance industry. The accountability and trustworthiness of banks with bancassurance aids in expanding the industry's customer base. Typically, consumers show greater trust in banks as insurance sales agents than in other agents. The market share of premiums via bancassurance risen since commercial banks received permission to operate insurance businesses in 2002. Marketing strategies were launched in earnest since 2004. Of the total premiums earned by the industry, direct premiums via bancassurance increased from 5.7% in 2004 to 10.8% in 2006. Looking ahead, the market share of bancassurance is expected to rise to a range of 13.0-15.0% in 2007-2008, according to Kasikorn Research Center.

Meanwhile, the market share of premiums via sales agents is expected to drop from 89.8% in 2004 to 82.8% in 2006. In 2007-08, that share may fall to 77-80%, the research house predicted.

On the downside, the life insurance industry was affected by numerous negative factors during the latter half of 2007. These included record high oil prices, which are likely to deal a severe blow to GDP growth, as well as inflation and waning consumer confidence in the year to come. Worse, a bullish trend in fixed deposit rates that has resumed since the end of the third quarter of 2007 will also deal a blow to the industry.

The hikes in fixed deposit rates are a response to the Bank of Thailand's savings bonds issued at the end of August. Furthermore, the forthcoming issue of Financial Institutions Development Fund (FIDF) savings bonds in late November is seen as another catalyst for earlier-than-expected increases in deposit rates at commercial banks. This was seen from the launch of fixed-deposit products with interest rates of 2.0-3.5% per year in the final quarter of 2007.
Under these circumstances, other forms of savings, especially life insurance - a long-term savings product - are likely to be hindered. Currently, interest rates on insurance policies range between 3.0-4.0%.

However, KResearch projects that the second-half 2007 performance of life insurance companies is still unlikely to fully reveal the negative trends. But the situation may result in weaker growth in direct written premiums over the entire year to around 10.0-14.0% growth at the end of 2006, accounting for around 192-199 billion baht, compared to the first half the year when growth hit 15.6%.

As for KResearch's projection for 2008, the growth of direct insurance premiums will decelerate to around 5-6% compared to 2007, and have a value of around 202-210 billion baht.
Thailand's life insurance industry has the chance to keep growing during this period of economic recovery, but the growth may seem less striking.

The exception to this would be if something special were to happen, such as the government granting permission to increase tax deductions on insurance premiums over the present ceiling of 50,000 baht per person per year.

KResearch holds the view that the growth rate in direct insurance premiums earned from bancassurance would likely continue leading growth in the life insurance business.

Ready for a revival

propertyThe overall market, sluggish for two years, is likely to recover in 2008 thanks to planned megaprojects by KANANA KATHARANGSIPORN

Ready for a revival
The two-year slowdown in the property market is expected to end in the second half of 2008 as the political situation will likely become clearer after a new government is formed in early 2008.

The new government should restore confidence in all sectors. Besides boosting the country's economy, the construction of new mass-transit routes should be accelerated as they would lift the overall economy.

New mass-transit lines and extensions will also open up new development opportunities. Homebuyers, especially younger ones, have expressed overwhelming interest in buying places near mass transit lines as it can reduce travelling expenses.
Of the two extension lines under construction, Onnuj to Soi Baring is expected to be completed by the first quarter of 2009, and Taksin to Bang Wa is scheduled to open in 2010. Most projects launched along these routes closed sales a few days after the launch.

At the same time, new routes announced by the interim government in mid-2007 attracted both developers and homebuyers, even though bidding was delayed until after the new government is formed.

These routes include the Blue Line, running between Bang Yai and Bang Sue, and the Purple Line, from Bang Sue to Tha Phra and Hualamphong to Bang Khae. The Purple Line is the most popular, with condominium developers launching many new projects along the route.

While external economic conditions pose a major worry for developers, the higher costs of development due to the rise in oil prices are the most challenging domestic factor facing the industry in 2008.

Construction costs started rising along with oil prices in early 2007. In the third quarter, the housing and land price index rose even higher. Land prices jumped 4.7% in the third quarter compared to the same period in 2006, while single houses increased 2.6% and townhouses rose 3.1%.

The country's economic outlook in 2008 looks grim as local and foreign investors lost confidence in the interim government, hurting foreign direct investment for the whole year of 2007.

The shocking policies included the Bank of Thailand's capital controls and proposed amendments to the Foreign Business Act (FBA) issued in late 2006 by the Surayud Chulanont government.

The FBA issue in particular prompted foreigners to stop buying real estate. Demand in the office and retail sectors fell sharply as existing international companies and retailers appeared reluctant to expand their businesses, according to property consultant Jones Lang LaSalle Thailand (JLL).

Many firms are waiting to see to what extent the new act will affect foreign business operations in Thailand. At the same time, not many new multinational companies are setting up shop in Thailand.

Corporations also decided to defer expansion plans as the near-term economic outlook is less than exciting. All of these factors resulted in a low take-up rate during the first half of 2007, JLL reported.

The weak confidence was also reflected by a drop-off in the number of land allocation permits and property transactions. In the first nine months of 2007, the number of land allocation permits in Greater Bangkok totalled 226 projects with 34,490 units, down 14% from the same period in 2006.

According to the Real Estate Information Centre (REIC), land and property transactions nationwide during the first eight months dropped slightly from the same period in 2006. The number of transactions hit 558,349, down 2% from 2006, while the total value was 6.87 billion baht, a 4% decline.

Meanwhile, the total number of housing construction permits nationwide during the first half of 2007 declined by 20% from the same period of 2006 in terms of construction area. In Greater Bangkok, the decrease was 32%.

The number of low-rise housing construction permits in Greater Bangkok fell by 2% in terms of unit numbers and 16% in terms of construction area. The number of high-rise buildings increased by 3% but the total construction area declined by 47%. These figures signalled a development trend in smaller-sized residential units.
In addition, the number of low- and medium-income residential units nationwide approved by the Board of Investment (BoI) in the first nine months of 2007 fell 75% to 10,534 units from 42,635 units in the same period in 2006. The large drop was caused by a decrease in Baan Ua-arthorn low-cost housing units.

The value of new housing loans for developers nationwide during the first nine months of 2007 dropped by 1% to 22.3 billion baht as many developers raised funds from property bonds, as seen by the 50% jump from 2006.

Housing loans for individuals in the first nine months of 2007 slightly rose by 4% year-on-year to 195.74 billion baht. Major factors included the downward trend in interest rates during the year and high competition among commercial banks. As a result, outstanding housing loans for individuals totalled 1.43 trillion baht, up from 1.35 trillion baht at the end of 2006.

During the first seven months of the year, the number of newly completed and registered housing units in the Greater Bangkok area totalled 38,417 units, down 7% from the same period in 2006.

Of the total number, 7,981 were high-rise units, up by 7% from the same period in 2006. Low-rise units fell 10% to 30,436. Of those, 22,154 units were single houses, 778 were duplex houses and 7,504 were townhouses and shophouses. Among the total number of single houses, 8,599 units were built by developers, down 13% from the first seven months in 2006.

REIC predicted the total number of newly completed and registered condominium units in Greater Bangkok would hit at least 18,000 units in 2007 and more than 20,000 units in 2008 due to the high number of completed units arising from the jump in high-rise housing construction permits during 2004-2006.

According to a survey by Agency for Real Estate Affairs (AREA), 24,227 condominium units were launched in the first eight months of the year, representing 60% of all residential units launched in 2007.

Most of newly launched condo units were in the middle-priced segment with prices less than three million baht. Some developers started building condominiums priced below one million baht a unit, reflecting the lower purchasing power of many consumers.

Sale of high-rise units this year remained strong, while those of low-rise units were not so good. The take-up rate for new condominium units resulted from the higher cost of transport, some speculation and investments for capital gains and rental returns.
I

n 2007, AREA estimated that 67,630 units worth a combined 145.53 billion baht, or an average unit price of 2.152 million baht, came onto the market. Meanwhile, the number of newly registered houses would total 47,000 units by the end of 2007

Bangkok Post Economic Review - Year-end 2007

The votes have been counted and the haggling over who will form Thailand's next government has begun. Optimists believe the fact that elections took place at all gives cause for hope. Pessimists say the country has gone back to square one.

The generals who overthrew Thaksin Shinawatra in September 2006 had hoped for a better legacy. Though armed with the best of intentions, they and their hand-picked legislators never came to grips with modern political realities.

Despite the policy drift and the interim government's failure to achieve some of its more ambitious plans, the country's economy sputtered ahead in 2007. Things could have been worse, given external factors such as high oil prices and the US credit mess.

The fact that many investors maintained their confidence in Thailand speaks well of the country's great potential. But even the most bullish business leaders will want more clarity and reassurance than they've received over the past year or so.

To describe 2007 as a lost year might seem a bit unfair, but a glance around the region suggests that a lack of resolute policymaking can cost a country dearly in a fast-changing world. Thailand clearly has catching up to do.