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.