War cries over the Thai baht have been getting louder and louder.
On April 19, finance minister Kittiratt Na-Ranong fired the first major salvo when he admitted that not a day goes by without him thinking about sacking Bank of Thailand (BoT) governor Prasarn Trairatvorakul.
Less than a month later, Virabongsa Ramangkura, the chairman of the BoT, fired off another broadside when he urged prime minister Yingluck Shinawatra to intervene directly to resolve a currency dispute between the central bank and the finance ministry. Unless she did so, he claimed the economy could face a major crisis.
“I’m concerned if nothing is done to fix the problem, the country could sink to its demise or the economy could go into bankruptcy,” Virabongsa was quoted as saying in The Bangkok Post.
What is the cause of all this sabre-rattling? The rapid appreciation of Thailand’s currency against the US dollar. Since the start of the year, the baht has risen from THB30.39 against the US dollar to a 16-year high of THB28.55 on April 22, a rise of more than 6% in four months.
It’s the most rapid currency appreciation in the region. By comparison, the Malaysian ringgit rose 0.59% and the Indonesian rupiah appreciated 0.77% over the same period, while the Korean won fell 2% and the Japanese yen dropped close to 15%.
The hasty ascent has local exporters sweating.
“We are extremely worried that the baht has risen so fast,” says Isara Vongkusolkit, chairman of the Thai Chamber of Commerce and the Board of Trade. “What we need is a stable currency. It is now very difficult for Thai manufacturers to accept advanced orders when they can’t set their own product prices.”
Kittiratt for his part has called on the BoT governor and his colleagues in the Monetary Policy Committee to slash the policy interest rate from the current level of 2.75% to 1.75% to stem capital inflows and halt the baht’s appreciation. So far they have refused to play ball, arguing that cutting the rate would not deter inbound capital, but would risk fuelling bubbles in the real economy.
“We have seen a series of verbal interventions from the Bank of Thailand, but no concrete measures to slow down the baht,” says Kampon Adireksombat, head of economic strategy at Tisco Securities. “Our view is that the intention of the central bank has been to let the baht rise. However, once the currency broke through THB29 to the US dollar, the BoT felt it had gone too far.”
The rapid escalation of the baht’s value is not just a concern for the government and central bank. The upsurge in value means Thailand’s exports are less competitive internationally, while imports are cheaper. The last thing the government or BoT will want to see is the country’s economic growth curtailed by an overly strong currency.
The baht’s current strength does, however, offer an opportunity to encourage some needed industry development. The key challenge will be to resist political consternation long enough to undertake it.
Currency swings
Given the magnitude of recent currency swings, the private sector’s concerns about the strength of the baht are understandable.
Exports for the first quarter of 2013 rose by 4.3%, well below the government’s full-year target of 9%. Many economists believe that if the baht exchange rate remains above THB29 to the US dollar it will be unlikely to achieve that figure.
Amongst the worst-hit export industries, according to the Thai Chamber of Commerce, are likely to be agriculture, frozen foods and jewellery.
The government’s ‘populist’ rice-pledging scheme, whereby it pays above-market prices for rice in an effort to boost income for rural farmers, could also take a hammering. Rice exports are projected to plunge to 6.5 million tonnes this year from 6.9 million tonnes in 2012 because of uncompetitive prices.
Chen Namchaisiri, vice-chairman of the Federation of Thai Industries, believes that the longer-term impact of a strong baht could be far more damaging. He frets that it will erode Thailand’s competitive position relative to other countries in the region.
“If the Thai baht is strong for too long, it will destroy the manufacturing supply chain that we have built up over many years,” he says.
Yet it would be a grave mistake for the BoT to heed alarmist calls to lower the policy interest rate and ditch its inflation-targeting framework. Since inflation targeting was officially adopted in May 2000, Thailand’s inflation rate has averaged 2.7% a year, making it the lowest in emerging Asia outside of Malaysia.
Better still, the central bank’s ability to conduct monetary policy independent of the government has allowed it to restore credibility that was so badly tarnished in the financial crisis of 1997.
“Inflation targeting has proven itself to be a very solid strategy,” says Andrew Stotz, managing director of international business at Maybank Kim Eng Securities in Bangkok. “Just because we are in a period of discomfort, we should not abandon it.”
Ironic opportunity
The irony is that a strong currency provides decision-makers with an ideal opportunity to boost productivity and push Thailand further up the value chain.
It is not a moment too soon.
As of February 2013, Thailand’s unemployment rate stood at 0.62% of the labour force. What this low level means is that employees need to become more productive if they are to increase output and avoid severe wage inflation. To do that, they need better technology and increased automation.
“People are complaining about currency appreciation, but a strong baht gives companies an opportunity to import the machinery that can make Thailand more competitive,” says Stotz. “The slight hit they are taking on exports is nothing compared with the labour constraints they are facing.”
Indeed, according to a survey by Kasikorn Research, the acute shortage of skilled labour is now one of the biggest concerns for chief executives of companies listed on the Stock Exchange of Thailand (SET).
“We need to promote greater efficiency,” urges Isara. “When I compare our workforce with Malaysia or Japan, I can say we are much less productive than what we should be. We have to improve.”
The good news is that some companies, particularly those linked to the automotive sector, are already beefing up capital investment to speed up imports of machinery.
Yet the process of importing and installing new machinery is likely to take time. Moreover, its impact is far from certain.
“Importing new machinery is a medium-term solution,” says Chen at the Federation of Thai Industries. “The issue is what sort of export market we will have six months from now?”
There is a flip side to the equation too. A strong baht encourages Thai companies to invest abroad, which in turn helps to offset foreign currency inflows. In February, Thai Beverage and TCC Assets completed a takeover of Singapore-listed Fraser & Neave in a deal valued at US$11.2 billion.
Few analysts expect this takeover to be the last. And such acquisitions should help Thai companies make more profits, some of which will find their way back into the country.
Action plan
For his part, respected BoT governor Prasarn does not believe that recent baht appreciation has greatly affected the Thai economy.
“Based on the BoT’s and other government agencies’ assessments, the Thai economy remains resilient under various plausible scenarios of Thai baht appreciation,” he tells Asiamoney.
Nonetheless the BoT has made it clear that it is ready to act if necessary to reduce the valuation of the currency.
One of the toughest measures now under consideration is a requirement that foreign investors hedge their foreign-exchange exposure, meaning that they will not gain from any further appreciation of the baht. Other measures could include a ban on foreign purchases of central bank bonds as well as setting a minimum holding period of six months for foreign ownership of Thai government and state enterprise bonds.
“Given extraordinary monetary-policy conditions in the global economy, risks of excessive movements of the Thai baht may have heightened,” says Prasarn. “To the extent that they pose undue risks to macroeconomic stability and outlook, the Bank of Thailand is ready to implement an appropriate mix of policy tools to safeguard the overall economic conditions.”
Although somewhat belated, most bankers applaud the warnings aimed at deterring speculative foreign-capital inflows.
To date it’s not a huge problem in the country’s bond market. According to the Thai Bond Market Association, foreign holdings in Thailand’s bond market reached THB883.9 billion (US$29.3 billion) at the end of April, accounting for 9.9% of the total bond market. The figure is sharply higher than the THB710.5 billion that they owned at the end of 2012, reflecting the country’s favourable interest-rate differential.
However, the share of foreign holdings in the Thai bond market still remains relatively low compared with the 40% foreign holdings in Malaysia and 30% in Indonesia.
But the strength of the currency and Thailand’s relatively appealing bond yields could change that equation. Thailand’s 10-year bond yields 3.4%, an appealing rate when compared to the US 10-year Treasury benchmark’s yield of 1.7%.
Given excess global liquidity and strong economic fundamentals in Thailand, keeping a lid on capital inflows is likely to prove an uphill task.
Prasarn, however, takes a pragmatic view. “As long as the baht appreciation is accompanied by efficiency and productivity improvements, a strong baht in the long run would not necessarily imply loss of competitiveness of the economy,” he says.
Playing politics
The biggest danger to Thailand’s economic stability is that politicians will over-react to the latest policy disagreements by pushing for the removal of the BoT governor, by lowering the policy interest rate or by slapping on ill-thought-out capital controls.
The last time that the country experimented with draconian foreign-exchange controls in late 2006, it ended in disaster. Within 24 hours of announcing punitive measures on foreign holdings of bonds and equities, the authorities were forced to execute an embarrassing U-turn after the SET Index plunged by 15% in one day.
The fear this time around is that attempts to pressurise the BoT into taking sweeping action could undermine the central bank’s credibility and push up borrowing costs. Attempts by the government to do so could quickly prove counterproductive, particularly given that it has plans to raise THB2 trillion for infrastructure development over the next seven years. It will need to borrow a lot of that money, which means encouraging foreign investment. But foreign investors will be more leery of coming if the financial environment is unpredictable.
“The government is making a big mistake if it thinks that it can meddle with the BoT without causing unintended consequences,” warns one senior analyst. “The prime minister can expend a lot of political capital cutting interest rates, but what happens when capital inflows turn?”
Economists point out moreover that Thailand’s interest rates are already amongst the lowest in the region. Currently the BoT’s policy rate stands at 2.75%. That compares with 5.75% in Indonesia, 3% in Malaysia and 3.5% in the Philippines.
“The strengthening of the baht is being driven by forces way beyond Thailand’s control,” says Stotz at Kim Eng Securities. “This is about investors seeking yield that they are not getting in the West.”
Weak environment
With few signs that the global downturn will ease any time soon, the attraction of the Thai currency is unlikely to go away.
Siam Commercial Bank expects the baht to range from THB28.5 to THB29 against the US dollar for the remainder of 2013 on the back of gross domestic product growth of 5.1%. Rahul Bajoria, a regional economist at Barclays Capital, sees the baht trading at THB29 against the US dollar a year from now.
“While we believe that Thailand’s impressive growth performance does not offer a strong economic rationale for easing monetary policy, low inflation and a strong currency may allow the Thai central bank some room to cut rates,” he notes in a report dated May 20.
The reality is that a strong baht may well be here to stay.
If the government really wants to help exporters, it can do so by assisting small and medium-sized enterprises with exchange-rate risk, better educating the workforce and providing incentives for companies to move further up the value chain. That would raise productivity, output and ultimately the size of the country’s economy.
The sooner politicians take this lesson on board rather than gunning for the central bank, the better it will be for corporate Thailand.